Financial Crisis 101 - 10/20/08

November 12, 2008 2:35:28 PM PST
So how afraid are you? Really? Well, readers of The New York Times were introduced this morning to a way to determine the level of fear in the stock market.I'm not talking about how afraid you are individually. You just have to check your blood pressure for that. What I'm talking about is an index that measures the level of fear of all investors collectively. Appropriately, it's called the Fear Index.

Technically, it's called the VIX. I won't bore you with the explanation how they arrive at the index other than to say it measures how volatile investors think the Standard and Poor's index will be over the next 30 days. The idea is that the larger the anticipated ups and downs in the S&P, the more anxiety there is in the stock market.

It sounds like this is both a cause and an effect measurement. In other words, the higher the Fear Index is, the more fear it then creates; very much a self-fulfilling prophesy. So what's our Fear Index now? Well, last Friday, it measured 70.33. That's the highest it's ever been since the VIX was introduced in 1993. So what does this do for us? Well, now we have an actually number that tells us we're scared to death.

Thanks, I needed that.

In the news, Fed Chief Ben Bernanke testified before the House Budget Committee today and said two things that will make headlines. He reported that the credit markets are beginning to loosen a tad, (he didn't actually use the word "tad") and he also said he favors another stimulus package for the purpose of boosting the economy. "With the economy likely to be week for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by Congress at this juncture seems appropriate."

He wouldn't say how big the stimulus package should be, nor would he specify how the stimulus should be spent, other than to say this: Congress "should consider including measures to help improve access to credit by consumers, homebuyers, businesses and other borrowers. Such actions might be particularly effective at promoting economic growth and job creation."

Bernanke's comments on the idea of a stimulus package may have been largely responsible for the rally in the stock market today. The Dow was up 400+ points. I don't mean to be cynical, and nowhere have I read that anyone is questioning Bernanke's sincerity in advocating a stimulus package. But the package is the brainchild of some Democrats in Congress and the White House and Congressional Republicans seem to be cool to the idea.

Bernanke was appointed by President Bush, and the polls say Democrat Barak Obama is the favorite to win the upcoming election. Is Big Ben taking this opportunity to play a little politics and poker so he can hang around should there be a Democratic administration? Some pundits say yes. I don't think so.

Speaking of the economy being seen through a political lens, I'd like to be able to present other peoples' points of view about the financial crisis, and in many cases, those points of view won't necessarily be politically neutral. This is tricky, because I need you to understand that I don't bring to this blog any political point of view of my own. None. And over a period of time, you should be confident that I will include diverse opinions from respectable sources, but I can't necessarily accomplish that in a single blog.

What I can do is keep score and make sure that I am fair. And you have to trust that my only agenda here is to give you another source of information during these times of financial crisis.

O.K., now that we're clear on that, I read an interesting piece on something called the History News Network, which comes out of George Mason University. The piece was written by a professor at the University of North Carolina, Wilmington, Robert Brent Toplin. He lays the blame for the current financial mess squarely at the feet of Ronald Reagan.

More interesting to me is how the piece illustrates the centrality of regulation/deregulation to the discussion about the banking crisis. But remember, this article represents one side of the argument. Many economists believe that the converse is true. This is the professor's view.

Ronald Reagan rarely catches any blame these days for the present economic mess that is destabilizing markets in the United States and around the world. In fact, Americans often praise the former president for taking the country in bold new directions during his years in the White House. Politicians contribute to this love-fest by naming schools and roads after the iconic president.

These admirers rarely acknowledge how central Reagan's ideas are to the market difficulties troubling us today. As the country's greatest modern champion of deregulation, perhaps Ronald Reagan contributed more to today's unstable business climate than any other American. His long-standing campaign against the role of government in American life, a crusade he often stretched to extremes, produced conditions that ultimately proved bad for business. Ronald Reagan promised to take government off the backs of enterprising Americans. He told voters that government was not the solution to the nation's problems; it was the problem. "The nine most terrifying words in the English language," said Reagan, are, " 'I'm from the government and I'm here to help.' " His speeches contained numerous warnings about the chilling effects of bureaucratic regulation. Government leaders think, he said, "If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it."

Ronald Reagan was not the only major champion of deregulation. Economist Milton Friedman served as the idea's principal philosopher, and Newt Gingrich was a leading advocate in Congress. But Reagan was the most influential figure to make the term "government" sound like a naughty word.

The main problem with Reagan's outlook was a failure to recognize that government regulation can serve business interests quite effectively. Many of the regulatory programs started by Franklin D. Roosevelt's New Deal in the 1930s aimed to promote fairness in economic competition. That legislation required greater transparency so that investors could more intelligently judge the value of securities in the stock market. The reforms mandated a separation of commercial and investment bank activities, since speculative investments by commercial banks had been one of the principal causes of the financial crash. Roosevelt's New Deal also created a bank insurance program, the FDIC, which brought stability to a finance industry that had been on the verge of collapse.

These and other improvements of the 1930s worked splendidly. For the next half century American markets operated with impressive stability. There were periods of boom and recession, but the country's financial system did not suffer from the kinds of shocks that have upset the American economy in recent years.

The turn away from rules that promote fair business practices fostered dangerous risk-taking. An early sign of the troubles occurred on Reagan's watch. When the requirements for managing savings and loan institutions became lax in the 1980s, leaders of those organizations invested money recklessly. Many institutions failed or came close to failure, and the cleanup cost more than $150 billion. Yet blame for that crisis did not stick to the Teflon President.

Recent troubles in the American economy can be attributed to a weakening of business regulation in the public interest, which is, in large part, a consequence of Reagan's anti-government preaching. In the absence of oversight, lending became a wildcat enterprise. Mortgage brokers easily deceived home buyers by promoting sub-prime loans, and then they passed on bundled documents to unwary investors. Executives at Fannie Mae packaged both conventional and sub-prime loans, and they too, operated almost free of serious oversight. Fannie's leaders spent lavishly to hire sixty Washington lobbyists who showered congressmen with campaign funds. Executives at Fannie were generous to the politicians because they wanted to ward off regulation.

Meanwhile, on Wall Street, brokerage firms became deeply committed to risky mortgage investments and did not make their customers fully aware of the risks. The nation's leading credit rating agencies, in turn, were not under much pressure to question claims about mortgage-based instruments that were marketed as Blue Chip quality. Government watchdogs were not active during those times to serve the interests of the public and the investors.

The most influential person to call for a more powerful watchdog recently is Secretary of the Treasury, Henry Paulson. After responding to the credit crisis by working with the Federal Reserve to shore up and bail out floundering business organizations, Paulson has become the leading challenger to Reagan's outlook on government. During an August 10 interview on Meet the Press Paulson stressed over and over again that "the stability of our capital markets" requires "a strong regulator." Our regulatory system is badly "outdated," Paulson complained. Market discipline should be tightened by assigning a "regulator with the necessary power," said the Treasury Secretary.

Henry Paulson never mentioned Ronald Reagan's name during the interview, but the implications of his remarks were clear. Reagan's views of the relationship between government and business helped to put the nation and the world into a good deal of trouble. It is time to recognize that the former president's understanding of economics was not as sophisticated as his enthusiastic supporters often claimed.

Reagan deserves credit for serving as a vigorous defender of free markets, but he carried the idea to extremes. Ironically, the great champion of business enterprise advocated policies that have seriously hurt business here and abroad.

The current financial crisis will have obvious impact on many industries, many of which wouldn't occur to us right away. Both the Wall Street Journal and the Philadelphia Inquirer have done pieces about how the crisis is already hurting colleges and universities.

Today's Inquirer focused on Penn State President Graham Spanier. He's in Cleveland today to lead an emergency session at the Association of American Universities' annual meeting to talk about how higher education can best respond to the economic downturn. We'll talk about the economic crisis on campus in a subsequent blog, but another industry that caught my eye today is the movie business. Is it retrenchment time in Hollywood? Could be. Two major movies scheduled for release over the holidays are going back on the shelf for awhile.

Paramount is delaying "The Soloist" just a month before it was supposed to come out. The Soloist is meant to be an Oscar showcase for Robert Downey Junior who will now have to wait 'til next year. Also being put off is "Defiance", a movie with James Bond star, Daniel Craig. Paramount is reportedly responding to the financial crisis by reducing its number of releases from twenty-five to twenty a year. Presumably, that will mean layoffs and other cost cutting measures.

And they said the movie business was supposed to be recession proof.

Jim Gardner


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