Economic Crystal Balls

by John M. Curtis
(310) 204-8700

Copyright February 21, 2009
All Rights Reserved.                    

       Growing concerns about the economy prompted former President Bill Clinton to urge President Barack Obama to show more optimism.  Before his $787 billion stimulus plan was passed by the senate Feb. 10 and approved by a House-Senate Conference Committed Feb. 12, Barack was all business, warning of an economic calamity should his plan not pass.  Clinton, of course, wants Barack to act cautiously with the bully pulpit, lest he make a bad situation worse.  There’s so much psychology in managing the economy, or so believed the late prolific Claremont Graduate School dean Peter F. Drucker.  Drucker talked frequently about “rational expectations” driving financial markets.  His ideas were taken to the extremes by Sen. John McCain’s (R-Ariz.) senior economic advisor, former Sen. Phil Gramm (R-Texas) when he called today’s economic mess a “mental recession.”

            Gramm’s comments helped torpedo McCain’s campaign, already taking on water because of the sputtering economy and his VP pick of Alaska Gov. Sarah Palin.  It’s beyond ironic that Gramm, himself, was partly responsible for the current economic mess, having sponsored the 1999 Gramm-Leach Bliley Act, essentially ending the 1933 Glass-Steagall Act, preventing banks from owning investment houses, insurance companies and other financial institutions.  Glass-Steagall was designed to prevent a repeat of bank failures during the Great Depression, where banks invested heavily in the stock market.  Gramm’s support for the 2000 Commodity Futures Modernization Act produced the so-called “Enron loophole,” enabling the now defunct energy giant to trade derivatives or “single-stock future” securities to escape regulation, allowing energy companies to trade willy-nilly.

            Former Federal Reserve Chairman Alan Greenspan now supports a partial nationalization of some U.S. banks.  Government intervention was once unthinkable to the “high priest” of free markets.  Growing worries about nationalization have driven the price of Bank of America and Citibank stock into oblivion.  Despite protests to the contrary by BofA CEO Ken Lewis, BofA, once considered among the nation’s most solvent banks, could fall anytime.  Buying Countrywide Funding, the nations’ leading mortgage lender, and Merrill Lynch sent BofA’s balance sheet into copious red ink.  It’s inconceivable that Lewis, who’s made millions in bonuses and executive compensation while BofA imploded, is still at the helm.  “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.” Greenspan told the Financial Times.

            Greenspnan presided at the Fed during the end of Glass-Steagall and start of runaway mortgage-backed derivitive trading, now blamed for the failure of Lehman Bros., Fannie Mae, Freddie Mac, AIG Insurance and other institutions trading in high risk investments.  Nationalization was supported recently by conservative Sen. Lindsey Graham (R-S.C.), a key McCain supporter.  “We should be focusing on what works,” said Graham.  “We cannot keep pouring good money after bad,” referring to more cash bailouts for insolvent banks.  “If nationalization is what works, then we should do it,” signaling a new kind of GOP pragmatism.  Greenspan and Graham echo the views of New York University Stern Business School professor Nouriel Roubini and billionaire hedge fund manager George Soros, both believe that something must be done to get rid of toxic debt paralyzing credit markets.

            GOP hysteria about socialism prompted 100% of House Republicans to reject Barack’s $787 billion Economic Recovery and Reinvestment Act.  Only three GOP senators supported the plan.  Were it not for Sen. Arlen Specter (R-Penn.), the bill would have crashed-and-burned.  “We are in the third and fourth innings,” said Roubini, known for his bearish forecasts.  Roubini’s estimate is contingent on Treasury Secretary Tim Geithner acting boldly to restore credit markets.  If the White House equivocates or back-peddles, it could cause more damage to U.S. credit markets.  Geithner has established so-called for “stress tests” to ascertain which banks lack the liquidity to function independently.  Soros and Roubini see nationalization as comparable to receivership, when the Federal Deposit Insurance Corporation takes over insolvent financial institutions.  Once banks are properly restructured and purged of debt, they can be resold back to private investors.

            All indications point toward more choppy water in U.S. and global financial markets.  Greenspan called the meltdown a once-in-a-century event, harking back to so-called “financial panics” in U.S. history.  Greenspan also doesn’t like to be blamed for the permissive regulatory atmosphere leading to the current crisis.  Her surprised his critics calling for nationalization of insolvent banks.  “I understand that once in a hundred years, this is what you do,” said Greenspan, mentioning nothing about reinstating Glass-Steagall prevent another crisis.  Greenspan did nothing to rein-in unregulated hedge funds, whose short-selling harms long-term investing.  While Barack’s stimulus plan offsets rising unemployment, the Congress must get back to work and fix fatal flaws in the regulatory scheme.  Hedge funds and reckless trading can’t be allowed to sabotage the U.S. economy.

John M. Curtis writes politically neutral commentary analysing spin in national and global news.  He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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