Nobel Prize-winning economist and Columbia Business School professor, Joseph Stiglitz argues in this interview that we are headed for another collapse. His arguments are sound and should be listened to.
Nobel Prize-winning economist and Columbia Business School professor, Joseph Stiglitz argues in this interview that we are headed for another collapse. His arguments are sound and should be listened to.
In an article printed in The New York Times last November, Andrew Ross Sorkin addressed the issue of corporate governance by exploring the proposed takeover of the British confectioner’s company Cadbury by the American company Kraft. The article explains that because British Boards of Directors act, essentially, in an advisory capacity, the decision to sell the company is based on the shareholder’s desires.
Since the article was written the takeover of Cadbury by Kraft has been complicated by various developments, but the issues discussed by Sorkin still hold. Sorkin used the proposed takeover as an opportunity to discuss the differences between the power of corporate governance in England and in America. In the British system, shareholders have much more control over the future of their investments, while in the American system, much of the control of the company is ceded to a Board of Directors and so takeovers, like that of Cadbury by Kraft, generally require the Board’s blessing to move ahead.
Recently, I came across an article on Yahoo Finance detailing the similarities between our current economic market and the market of the 1929. The author of the article, Simon Maierhofer, did a great job of summing up the ways our current economic crisis is paralleling the historical Great Depression and how our economic forecasters ought to rely more on history to help manage their expectations of buying opportunities and economic recovery. I felt that Maierhofer’s observations were worth some commentary here at Wallet Blog and I wanted also an opportunity to point our readers over to his article for their own edification.
One of the key points that Maierhofer made that I found particularly interesting was his point that during both time periods, the economic devastation was preceded by extreme optimism, that no one (or very few experts anyway) seemed to see the imminent collapse on the horizon. It was also interesting to me that both economic disasters seemed to be preempted by the collapse of a real estate bubble. I, for one, had never numbered a housing boom as one of the causes of the Great Depression. Maierhofer also points out that one of the most striking similarities between the market then and now is that trouble seems to be across the entire economy and not simply located in a few kinds of sectors.
If Treasury Secretary Timothy Geithner doesn’t know how to get appropriately compensated for the loans / bailouts that he keeps approving on behalf of the United States Government then he shouldn’t be giving out these loans at all. His mismanagement of these negotiations is wasting our money.
For instance last year, when Geithner, then operating through the New York Fed, decided to bailout AIG, the ailing insurance giant was already in negotiations with banks that would have retired their Credit Default Swaps with AIG paying 40 cents on the dollar. Once Geithner took over the negotiations, he instructed AIG to pay 100 cents on the dollar. The flubbed negotiations cost American taxpayers at least $19 billion (i.e. 60% of the $32.5 billion that AIG paid to retire the swaps).
A while back we wrote a piece describing the basic problems with Bullish opinions currently circulating about the end of the recession. In that article, we showed the various continued symptoms of our nation’s economic problems and the signs that we are still in a very real recession, even if abstract economic terminology currently suggests otherwise. Recently, I came across the following graph in an article by Henry Blodget, and I think that it shows further evidence that the stock market is already overvalued and the bulls are wrong about their predictions.
All along it has been our contention at Wallet Blog, that the board of director’s system for American public companies is in need of significant repair. Specifically, its problem is that shareholders lack the ability to control who serves on the board of directors of their own companies at any point in time.
Lately, we have seen more and more stories in the financial news telling us that the various boards of directors of American public companies have acted in ways that are either suspicious, irresponsible, or just plain illegal. With each such story, we see the SEC attempting to curb the corporate excesses one problem at a time. In a recent story, the SEC has begun investigating the role of consulting firms in setting salaries for CEOs. Specifically, the question is whether recommendations about CEO pay packages are compromised when the same consulting firm hired by the board also provides other services to the company? In other words, are these consulting companies providing generous recommendations to the board about the CEOs pay packages in order to keep the CEO happy and minimize the chances that the CEO replaces them with another consulting firm for all the other services that they provide?
Recently, a judge denied Bank of America’s attempt to settle with the SEC for $33 million dollars under accusations that the Bank presented false information to its shareholders about Merrill Lynch employee compensation packages. The judge reasoned that the $33 million would end up being paid by shareholders, effectively forcing them to pay a bill twice which they should have never had to pay at all. While we agree with the decision we clearly can not continue operating in a manner where shareholders are helpless in running their own companies.
Does it not seem odd that the owners of the company are not responsible for hiring corrupt or incompetent management or for allowing that corruption to continue? Unfortunately, the reality with the current Board of Directors system is that shareholders cannot be responsible because they have very little power to decide who will sit on that board or to quickly remove board members when their attitudes or behaviors work against the shareholder interests. If shareholders could have ousted Ken Lewis at any point in time, then they should have been responsible for any wrongdoings under his leadership.
The bulls are pointing to the end of a recession and a robust recovery ahead for the American economy. Their optimism is based on a definition of the recession, in economic terms. For economists, a recession ends when the economy ends its negative growth. These terms, however, are theoretical. In practice, a robust recovery must parallel a robust recovery at the American household level, which is unlikely to happen for a number of reasons:
Many economists are calling for more stimulus money by the federal government, but it is clear that what the country really needs is smarter spending. We desperately need to make investments with government funds that will deliver strong returns on the nation’s money, and thus, we believe that the federal government ought to invest in new technologies that will turn America’s trade deficits into strong surpluses. It is precisely for that reason that this is the right time for a ‘Manhattan Project’ on energy independence.
Given the recent economic upheavals, as well as the unprecedented manner by which the government is handling these dilemmas, a lot of people are worried about what inflation will do to our savings and investments. One option that investors have to safeguard against inflation is to put money into Treasure Inflation-Protected Securities or TIPS.
Basically, the principal investment for TIPS is adjusted by the Consumer Price Index (measures inflation) + A Fixed Yield that is unique for each TIPS (recently it has been around 2%). This means that your investment primarily rises or falls along with inflation. To use a simplified example, if you put in $100 in a TIPS that has a 2% ‘Fixed Yield’ and the nation goes through 5% of inflation in a year, then the value of the TIPS will raise from $100 to $105 over that year (as a result of the 5% inflation)+ 2% of $105 to a total value of $107.1.
Our country’s economy has been operating from bubble to bubble. From 1996 until 2000, we were in a tech bubble. Our faith in the financial potential of the dot com industry was boundless, though it ultimately proved ill placed. From 2000 until 2006, we were in a housing bubble which, when it burst, laid the foundations for the current recession. During these periods, the country placed its economic hopes on new, seemingly plentiful, frontiers that promised new means by which to make money. Older values were made to seem, by comparison, out of touch and out of date. As a result, we, as a nation, allowed ourselves to slip further and further away from the fundamentals necessary for a healthy economy.
Now, we stand on a precipice. We could create another of these economic bubbles to put our financial hopes into - an option as illusory as ever - or we could find some way to return to the fundamentals that have, historically, made our nation’s economy strong. Over the last decade, we allowed our exports to slip and made our economy deeply reliant on imports from the rest of the world. We have let the trade deficit grow too wide without finding new products or new technologies to export, and as a result have found ourselves without a significant industry to insure future success in the global economy.
My point, in the past, has been that if America had allowed AIG to go into prepackaged bankruptcy, as we are doing with Chrysler and GM, we would have been in a better position to deal with the money AIG owes through Credit Default Swaps (CDS) because we could have negotiated payback for those positioned to collect on AIG’s obligations. AIG owed money, we bailed them out to save the economy, and the result is that AIG paid off a lot of its obligations, and we, as taxpayers, now own billions of dollars of nearly worthless AIG stock.
For the ones that are still not convinced, let us look at Goldman Sachs and its position concerning AIG. AIG paid out $13 billion bailout money to cover its CDS obligations to Goldman Sachs. Actually, taxpayers paid Goldman Sachs, AIG just acted as a conduit. The $13 billion was incredibly good for Goldman Sachs whose stock has since risen, but not nearly as good for AIG whose stock is perpetually on the verge of tanking. However, the major problem here is that taxpayers paid AIG to pay off Goldman Sachs. The result is that taxpayers own AIG stock (on the verge of collapse), and own no stock in Goldman Sachs (which is on the road to recovery). Moreover, because CDSs are still unregulated, Goldman Sachs stands to make about $30 billion if AIG does, eventually, go bankrupt because of the CDSs they’ve taken out on that eventuality. It is possible that other companies have similar CDSs bought against AIG, but since, remarkably, there still is no system of market regulation set up for CDSs, we can’t know for sure.
This recession has been characterized by the presence of companies that are so vast and influential that their failure actually endangers the American economy. The names of these companies, GM, Chrysler, AIG, Citibank, Bank of America, and so on, are all too familiar to us from their prominent place in news stories about economic disaster. In order to prevent systemic economic collapse, America has resorted to bailouts and political bankruptcy, essentially changing the “rules of the game” in order not to have these failing companies take our economy down with them. What is clear is that the benefits reaped by the economy in allowing the existence of these financial giants is nothing as compared to the damage caused by their collapse. Companies that are too big to fail should simply not be allowed to exist.
We should remember that capitalism is based on free market principles in which companies compete with each other. If one fails, other and presumably better companies take its place. Thus, the market evolves so as to better meet consumer demands. Companies fail in a free market economy because they are unable to compete with stronger business models. Moreover, they should be allowed to fail in these circumstances so that better business models can take their market share.
We, at Wallet Blog, are as anxious for good news about the economy as is everyone else. We’d love to concentrate on giving money management advice for the vast fortunes the nation reaps in boom years, rather than discussing the pros and cons of economic rescue plans and the need to overhaul the financial industry. However, there’s a fine line between finding a ray of hope in this recession and simply misreading statistics.
A recent Associated Press headline read: Jobless benefit rolls drop sharply to nearly 6.7M. Good news right? Less people are receiving unemployment benefits. That can only mean one thing: all the people who’ve lost their jobs have found new employment. How could a drop in unemployment payouts be anything but evidence that the nation is finally on the upswing? After all, the AP article recounts the various highlights of this statistical evidence and calls them encouraging signs…
According to CNNMoney, all of the news surrounding the stock market in the past few months, “has been good news, or at least neutral news,” but nothing bad. The rationale for all of these happy feelings is that the market has the ability to prognosticate for the worst of times, and did so in March when we saw the Dow dip to around 6,500. Additionally, it’s believed that 6,500 represented a worst-case scenario that never actually happened, and that therefore we’ve seen the lowest of the low.
While this perspective fueled the three-month surge, it lacks fundamentals that can be found on page one of Investing for Dummies. Before we fall for the hype, let’s face the facts. We are in uncharted economic conditions, and face headwinds that we’ve never seen before and that cannot yet be fully understood.
The thing about corporate democracy, as it has been allowed to flourish, is that it isn’t very much like a “real democracy”. Basically, in a “real democracy” that you and I would recognize, people either vote for or against something. If there are more votes for yes then yes wins the day, otherwise, no. What we don’t think about as much is the number of people who don’t really vote yes or no, but who don’t vote at all. In a “real democracy”, these people don’t really count.
On the other hand, in a corporate democracy when it comes to counting the votes from shareholders in publicly traded companies, those votes that aren’t cast, still count. Officially, the votes not voted are given over to the brokers. The brokers in charge of these votes are likely to defer their position to the suggestions made by the board of directors. Thus, whatever the directors put up to a vote, they can be assured of having it go their way because they are supported by a silent majority.