Monday, October 29, 2007

It ain't over yet.

Markets are the dominant fact of our lives. They are pervasive and volatile, and yet we continue to be surprised as each peak and valley is upon us.

Last week, we moved to the next phase of the sub-prime mortgage “crisis” as major financial institutions began to succumb to reality, to unwind financial positions and to write-down the value of financial assets. Citibank, Merrill Lynch––the most visible brands in the financial markets––lost billions, and billions more that expected.

How? Just a lot of the same-old, same-old. We have been there so many times over the past quarter century––the Savings and Loan Crisis of the late 1980s, the Japanese market collapse of the early 1990s, the Asian fiscal crisis of the late 1990s, the Dot-com collapse at the beginning of the decade––and each time there are three distinct phases. First, there is the “Gee, it doesn’t get any better than this,” phase.

This is the home-value-as-ATM phase, the NASDAQ hitting 6,000, or the Nikkei nearing 39,000, which was epitomized to me in the late 1990s when a Merrill Lynch broker called our home to propose a product where we would take out a home-equity loan to invest in the stock market. How long had he been a broker? Just a year. This time, the exuberance was manifest in the mortgage markets, where buyers could finance 100% or more of a home purchase, and then pay less than the interest-only cost of the loan for several years.

The problem that these mortgage products claimed to solve is that housing was too expensive, and therefore new products were needed to make things affordable. But the logic was backwards. The housing was too expensive because the financing was too cheap. Take away the financing, sit tight for a while, and the markets will correct. Prices will not stay up if demand dries up. Might take time for people to let go, but reality will set in.

That is the first law of markets. They move. The interesting part of the current crisis is how eager people have been to pronounce how long the correction in the real estate markets will take. This is the “Is it over yet?” phase, and here is a simple rule: If people are still asking if it is over yet, it ain’t over yet. This is the question that keeps people holding on and resisting selling, hoping that the bottom has been reached.

It is only when people give up that the third phase arrives, the vaunted “capitulation" phase. This is when fear sets in, when hope is lost, and when, ironically, it has already become a better time to buy than sell.

In our present financial crisis, the meltdown has not come yet. Some real estate markets will not be hit so hard because they never rose so high, while others, like Manhattan, will not be hit so hard because of exogenous factors. In the case of Manhattan, the plummeting value of the dollar has already driven home prices down over 25%––in Euros––bringing foreign buyers into that market.

The shining star in this financial moment has been the Federal Reserve Bank. Over the past three years, the Federal Reserve has steadily increased the Federal Funds Rate––the rate at which it lends money to member banks and the primary tool that it uses for regulating the pace of economic activity. The Fed was raising rates not as it normally does to subdue economic growth and tame inflation, but for the simple reason that after the collapse of the Dot-com bubble and 9/11 the Fed reduced the Fed Funds Rate to 1.00% from 6.50%, and within the Fed there was great concern that if rates were not raised, they could not be lowered again in the event of a new crisis.

Yes, the logic seems odd––to raise rates for the purpose of being able to lower them––but the fear was real. If there were to be a new crisis––such as the one that is now upon us––and the Fed Funds Rate were still at 1%, the Federal Reserve would have few effective tools for addressing that new crisis and supporting the financial system.

And through it all, Japan loomed as a lesson of how bad things could get if the central bank was left with no tools in the toolbox. Japan, as some might recall, was looming as the new world economic colossus in the late 1980s with their stock market and real estate prices in the stratosphere when the bubble burst and values plummeted by as much as 75%. Faced with price deflation, Japan’s central bankers proved unable to thwart the decade-long recession that ensued––even as they pushed interest rates down to 1/10th of 1%––with devastating social and economic consequences.

Fortunately, in the months ahead, this will not be our challenge. The Federal Reserve retains control over the monetary levers that it needs and unlike the Japanese, American consumers continue to spend money through thick and thin. The difficult choices will be on the regulatory and policy side. Specifically, with a presidential election looming, Washington will be faced with the decisions of how much pain can be tolerated before the bailouts begin.

There will be hard choices ahead, but even the resources of the federal government cannot forestall the pain that comes during a major market decline and new regulation always seems to be designed to address the last crisis rather than the next one. The question that will endure––from one market bubble to the next––is whether, when faced with things that appear to be too good to be true––a no-cost mortgage for example––people might pause for a moment before they sign up and consider that maybe they are.

Saturday, October 27, 2007

Winds of war

For those who might have missed the vanguard of the French New Left back in the day, the Situationists were anarchists who sought to create situations that would engender a response that would provide a critique of the system that they sought to destroy. So one day, they put up posters in the metro with pictures of a man sitting behind his desk, in the crosshairs of a gun, with a caption reading, “Wouldn’t you like to kill your boss today?”

Except, of course, that no one got it. No rash of boss-killings ensued, no national debate on the absurdity of work in the capitalist system. Just more ennui.

Osama Bin Laden, on the other hand, was more effective. Sitting in a cave in North Waziristan, his goal was to drive a wedge between the 1.4 billion Muslims and the West, as a first step toward rebuilding the pan-Islamic caliphate. His method was pure Situationist. He would attack America and sit back and wait for the response. It was not his attack that would create the outcome he sought, but the reaction of his adversary, the reaction of the all-powerful, morally corrupt Americans. They would come after him, and in so doing would go to war on Islamic soil. They would slaughter Muslim women and children in their wake, and those images would be broadcast across the world.

He tried for years before we took the bait. He attacked our embassies in Africa. He attacked the Kobar towers. He attacked the USS Cole, but we did not respond. Finally, with the ranks of Al Qaeda reduced to a few dozen stalwarts, they chose to attack the U.S. homeland in a final effort to prod the Americans to come after him.

Bull’s eye.

Six years later, even as the American military trumpets the defeat of Al Qaeda in Iraq and Dick Cheney declares that Bin Laden has been reduced to irrelevance, Al Qaeda has grown from a few dozen men in a cave to a world-wide movement, and the challenge of bridging Islam and the West has become one of the defining societal challenges of this era.

And now a second front has been joined, and we are being baited once again. Iran is working hard to goad the Bush administration to double down on its strategy of preemption and would be quite pleased with an attack, particularly the discrete assault on nuclear facilities that is contemplated in the western media. A limited strike would be the best of all possible worlds. All the benefit, so little destruction.

The Bush administration has become a wonderful foil for the Iranians. After all, little more than a decade after the revolution that brought the clerics to power, the Guardian Council was faced with a popular movement demanding openness, democracy and secularization. Efforts to repress dissent only increased that momentum of the reformists, as the modern Iran that the Ayatollahs sought to forestall grew in the public imagination.

It was the Axis of Evil rhetoric that gave the Guardian Council the latitude to crack down on reform and elevate Mahmoud Ahmadinejad to the Presidency. Since then, the Iranian’s have played a dangerous game, but pursued their strategy diligently, and Ahmadinejad has played the nuclear and Israel cards skillfully.

The Iranians have two goals in this game. First, and foremost, the regime wants to stay in power. This requires an external threat to the regime that can justify the repression of domestic opposition and undermining of democratic institutions, and engender nationalist support for the regime. For this goal, the Americans could not have served interests of the clerical regime any better. Oil revenues are high, Americans are arrayed along their borders beating the drums of war, and even secular Iranians and Iranian ex-patriots support the regime’s assertion of Iran’s national right to pursue its nuclear program.

Second, the regime desires to assert Shi’a leadership in the Islamic world in its struggles with the West and to counter the ascendancy of Al Qaeda. This is an issue that blends ethnic and sectarian rivalry, with substantial historical resonance. After all, the Shi’a lived under the Sunni boot for more than a millennium until the fall of the Caliphate in the 1920s, only to find a new boot appear in its stead, this one made of British and American leather. This goal requires building the Iranian brand in the minds of the far-flung Islamic nation, the Umma, and has been the purpose behind Iranian support of Hamas and Hezbollah, its assault on the Danish cartoons, its Holocaust rhetoric, and Ahmadinejad’s visit to Columbia University, where he took the West’s verbal assaults and gave the lie to the West’s claims of openness and tolerance.

What could be better now for the Iranian regime than to be attacked by the Americans? What better way to in one moment harden domestic resentments against a common external enemy and build sympathy and support across the Islamic world? What better way to establish Iranian bona fides as the Islamic David standing against the American Goliath?

Where in all of this is the American art of strategy in the world? Why are subtlety and nuance the purview of others? Why do we not consider what happens on day two and day three and day four after we utter our words or launch our spears?

Last month, the Iranians showed the other side of their strategy, when, at the request of Lee Hamilton, Iranian supreme leader Ali Khamenei ordered the release of Halah Esfandiari. Esfandiari, an Iranian-born scholar, had been imprisoned for nine months as a “threat to the Iranian state.” Her comments after her release were notable. When she protested to her chief interrogator that she was not a spy, but just “wrote articles and organized symposia,” the Iranian official replied, “Yes, and that is how it started in Ukraine and Georgia.”

The Iranians care first and foremost about the survival of their regime, and the greatest threat the regime is not guns and bullets, but words and ideas.

Now we are at another moment of decision––when we should be thinking clearly about what strategies will best achieve the goals that we seek––before we launch a new war and once again find ourselves doing the bidding of our adversaries. But even as our adversaries in the world have proven adroit at nuanced strategy and asymmetric warfare, our stance in the world has become more linear and less subtle, more bellicose and less thoughtful.

Unfortunately, bellicosity apparently plays in Peoria, so the winds of war may loom as irresistible. Among the leading Republican candidates, war with Iran has become the new national security shibboleth, and with an eye to the general election Hillary Clinton is marching in lock-step. But behind all of the heated words, is there much thought going on? About day two, about day three or about day four?

How is it that five years into the Iraq war, we might once again succumb to the drumbeat of national security populism? Is it possible that our political class has lost the capacity to think about the implications of their words, to be a little more wise and a little less warrior, and to discern whether they are being manipulated by others more thoughtful and strategic than they?

As we dig our hole deeper and deeper, we should remind ourselves that we are neophytes in this neighborhood. When he was in New York, Ahmadinejad made reference to the invasion of Greece by Darius II, over 2,000 years ago. The Sunni and the Shi’a are playing a complex game of tribe and faith that dates back a millennium. The Turks ruled the region for centuries and are loathe to be dictated to. And the Russians, the French and Brits have been contesting the region since before the battle of Yorktown.

We just might not be as smart as we think we are. And everyone else might know a thing or two. And that would be OK.

Monday, October 22, 2007

Memories of Billy Rohr

It did not take long for the grumbling to start: “Are the Red Sox ready to become the Yankees?”

A knife to the heart of those whose lives have been defined by the seasonal yearnings and disappointments inherent to the chosen path; a sharp rebuke to those whose own human frailty led them over time to root as much for the defeat of their Nemesis, as for that chimerical moment when their own heroes might emerge triumphant.

A close friend––still warm from the heat of Dustin Pedroia’s night––remarked of what the future might hold for a team whose young roster of Beckett and DiceK, Ellsbury and Papelbon, DelCarmen, Lester and Buccholtz––along with the evening’s diminutive star––have their best years before them, but was quick to add that should they sign A-Rod, she would “have a hard time continuing as a Red Sox fan.”

For such is the life. Once the yearning defines the soul, the conditionality is inevitable. We are fans, after all, not whores. We cannot be bought. After a lifetime of waiting, what is another decade? Better that than debasing the very meaning of the journey.

The Red Sox have won nothing yet this year––thought last night was a glorious night––and just one World Series to redeem the hopes of those who forty years ago saw a season begin with Billy Rohr blanking the Yankees, and who believed that with he and Yaz and Rico and Boomer, Santiago and Lonborg, the future was bright. A young roster can come to naught, as the Conigliaro brothers can attest, as the heroics of Bernie Carbo and Hendu and Pudge can so easily be taken away by Calvin Shiraldi and Johnny Mac.

It is way too soon to rest on one night’s laurels, for this may be Colorado’s year, but we learn to love the moment and to feel the warmth from the moment that Coco Crisp––a name for the ages––crashed into the wall with the ball cradled in his grasp––for Siddhartha Gautama and every Red Sox fan knows that such moments are fleeting. Each must be inhaled and savored for what it is, for the journey itself.

The moment is barely past when we are awoken from our reverie.

Unable to tolerate the moment of joy for Red Sox fans, whose torment they have so enjoyed over the decades, New York writers dig deep for a journalistic Haiku, and strike with full force.

“Are the Red Sox ready to become the Yankees? Are they ready?”

Saturday, October 06, 2007

The problem of Europe

Two weeks ago, Nicholas Sarkozy launched his most direct assault on the European Central Bank. In the view of the new French President, the ECB’s tight money policies threaten to undermine his efforts to open up the French economic system and stimulate economic growth and liberalization. The ECB policies, Sarkozy suggested, were biased toward Germany’s enduring fear of inflation and against his policies of stimulating growth and international competitiveness.

The rift between Sarkozy and the ECB has been exacerbated by the trading relationship between the Euro, the Dollar and the Chinese Yuan. As the value of the Dollar has collapsed under the weight of massive U.S. current account deficits, the Euro has risen to new heights, while the Chinese currency, which does not trade freely, has only risen modestly. The result has been that European goods have become less competitive in the U.S. market. The ECB can ameliorate this problem, as Sarkozy has suggested, by reducing interest rates––at least in concert with U.S. central bankers––which would stem the pace of the Euro’s rise. But this, the Gnomes of the ECB insist, is not their job. Their job is to fight inflation. They are independent. Go away.

Sensing their inability to move the ECB to act, some European finance ministers have responded to the Euro’s rise by beseeching Ben Bernanke to raise U.S. interest rates to support the Dollar. This, however, is not going to happen. The Federal Reserve just lowered interest rates in response to the sub-prime lending crisis, and any upward move would undermine U.S. markets. The Fed’s mandate is to fight inflation and to support economic growth, and whatever is going on with the Euro is simply not their job.

More to the point, the price of Mephisto shoes might be the symptom, but it is not the problem. The problem is more fundamental. It is the problem of Europe.

The European Union is a nice idea. Like the Iraq War, it is an idea that gained momentum among many constituencies that came to support the same policy, though for different reasons. For some, who saw the emergence of Asia and the United States as two great economic forces, the European Union would create a third trading block to protect the European economies. For others, the EU represented an opportunity to assert Europe as a political counterweight to the United States imperial power in the post-Cold War era. For yet others, the EU was necessary to bind France and Germany together so tightly that a third world war between the historic rivals would become an impossibility.

The reality of creating a European Union has been a tough go. The “domestic” economic strategy of the European Union has mirrored the industrial policy of the United States over the decades. While the United States implemented policies to stimulate economic growth in its poorer states––in the south and in the west––so has Europe invested in the economies of its southern and poorer members. Neo-classical trade theories have been realized, as countries with comparative advantages in labor costs or other attributes have benefited, while growth in the Franco-German heartland has stagnated. Imagine Ireland, Portugal and Spain as the sunbelt of Europe.

However, while the rustbelt gave way in economic and political clout to the sunbelt in the U.S., the rise of new economic powers in Europe threatened the cultural identity of the members, as well as the economies of the older powers. European Unionists have implemented the attributes of nationhood before the participants agreed to become a single nation. They have centralized regulation, asserted legal hegemony and created a single currency, even as the EU constitution has failed to win ratification. The Euro-centrists have said yes, even as the people continue to say no.

In the United States, political union came first, then came the struggle to determine the extent to which the center could impose its will on the member states and undermine local law and custom. As one observer noted, the issue finally came to a head in 1863, when the two sides convened at a small town in Pennsylvania to settle matters. After three days of debate, the supporters of a strong center won the day and the matter was settled.

Sarkozy is raising the central question of how a nation that cannot control their monetary policy can seek to control their future. His policies, his presidency and the ability of France to chart a new economic path––one in which fiscal policy will play a reduced role relative to market forces––depend on a parallel monetary policy that makes capital available to a growing entrepreneurial sector.

Alan Greenspan unwittingly underscored Sarkozy’s point of the important linkage between fiscal and monetary policy during his recent book tour, when he indicated the extent to which he directed monetary policy to support the fiscal policies of the federal administrations. Far from adopting the strict constructionist stance of the current ECB, Greenspan recognized the anti-inflationary impacts of technology and deregulation, and allowed an expansive monetary policy that led to sustained economic growth, even as the Dollar and federal current account deficits might have warranted the tighter monetary stance.

Europe, for anyone who has visited recently, is not what it used to be. The quaint villages are not quite as quaint. The local bakeries are disappearing. Local cultures are ceding to the forces of economic integration. Ironically, it is France’s Hungarian-born President that is raising the central question, not just about whether France can control its economic destiny, but whether, just two years after the French voters rejected the proposed European Constitution, France has already lost its ability, and right, to be La France.