It is the economy; now let's ditch the stupid

I had a very interesting task assigned me a couple of months ago, by our friend Mack. He was preparing a paper for a Senate hearing on the futures trading market and whether speculation was driving up prices. He asked me to read the paper and make sure it was in English, essentially. That a reasonably smart person uninvolved with the markets could actually read the thing.

(I should disclaim before I go further that the analysis below is from my brain, not Mack's. He may or may not agree with what I have taken from this experience.)

I think the single most surprising part of this exercise for me was learning how much of the market is unregulated- the parts of the market that have brought the most staggering returns for a few people at the tops of their pyramids. The few people whom Alan Greenspan lauded for the "creative" products they packaged and sold, the very products which now are the most threatening to the stability of our economy. As explained on today's NYT opinion page:

Today, regulatory authority is divided among the Federal Reserve, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Office of Federal Housing Enterprise Oversight, the Securities and Exchange Commission, the Commodity Futures Trading Commission, state banking regulators and state insurance regulators. That’s too many players.
What’s more, this balkanized system supervises only half of the relevant financial universe. It neglects investment banks, hedge funds and institutions like mortgage companies that issue asset-backed securities. The assets of these unregulated entities total about $10 trillion — which is the same amount we see on the regulated side.
The unregulated institutions pose particular risks because they are highly leveraged and financed primarily through short-term money markets rather than customer deposits. And unlike big banks, many of them do not disclose their finances to the public.

This is something I didn't understand until I delved into Mack's paper, and I'll wager that most Americans don't, either.
The second most impressive thing that I took from reading this paper was not a surprise, but an illumination. The markets don't hold my interest the way, say, politics does, so I hadn't ever thought about it, but securities markets and commodities markets do not operate on the same principles.

Duh, says you. Well, sure. But the reason I hadn't thought much about it is that I'm not a commodities investor. My family is the typical passive investor model: 401ks that are diversified according to our choices, and if we buy anything else it's with a sort of Motley Fool philosophy: the market always, eventually goes up, so buy what you know and don't be afraid to hold, etc.
What I failed to realize is that the market doesn't just mean traditional securities anymore, it also includes securitized risks and futures, packaged and moved over from the commodities market.
And make no mistake: the passive investor doesn't belong in commodities. The futures market is not a hold and wait game, it is not a place for long term investment. It is not a place for Motley Fool readers. Mack likens it to a Nascar track, and the new investors (large funds that end up in, say, my 401k) are like little Ford Focuses with untrained drivers, jumping into the race without regard for the danger they're causing.

Many pundits have noted that in this election season the GOP is, in effect, asking Americans to just give their failed policies another chance. Forget accountability, they mean well, and if you can just ignore the past few years and our current realities and remember that they're the party of pragmatic no-waste government and personal responsibility, you'll see the very need to continue down their broken and debris-strewn path. Nowhere do they make this case louder than on the broad and complex topic of the economy.

They continue to broadcast that rewarding entrepreneurship (and what is Andrew Mozillo, if not an entrepreneur of the highest order) and trusting the "free" market will mean that we all can get rich- just watch the money flow and the trades grow. They toss around the threat of socialism. What they want you to fear is a country where government takes care of, and controls, the decisions of every citizen- which isn't socialism, they're actually invoking communism, but whatever.

What they want you to forget is that in this country, right now, industry's major losses are socialized for the greater good, and almost no responsibility assigned to the major players whose wealth is almost unimaginable to most of us, and whose decisions lead directly to the loss and collapse you and I pay for.

And they fail to point out that almost none of us know the rules of the game, and that once our playing dollars are gone to the guys who invented the rules and benefit most from them, we will also have to bail out their failures. In this game of Monopoly, our losing turns replenish the bank, which buys up the properties that the winners ditch after they take the Free Parking money. If we pass Go again, we try to buy up the bank's properties again. But the Free Parking guys always return, buy us out according to rules we still don't understand, and erect a bunch of hotels.

Again: many eminently more qualified than me have explained this very clearly, over and over again. It's time for all of us to start talking about the costs to the country and society, and to what sensible reform might look like. Which is why this NYT editorial today caught my eye.

I know Americans for the most part don't enjoy wonkiness. I know that sloganeering is employed throughout campaigns because it largely works. But the fact is, we are going to have to ignore the slogans of both parties and understand what a pickle we've found ourselves in, and demand some real reform in the regulation of the markets. Again, from the Times:

The next president must first create a single framework for the major financial borrowers, administered by the Federal Reserve alone. This wider regulatory umbrella should be more conservative. In particular, the minimum levels of capital and liquidity that financial institutions are required to maintain should be higher than they have been in recent years. And the institutions should put in place better and more detailed systems for reporting — internally as well as to regulators and the public — on all the risks they are taking.
These steps, as they make institutions more stable, will also reduce their financial leverage and thus their ability to generate earnings. Their managements won’t like it, but the institutions — and, indeed, the entire financial system and the Fed itself — will be less exposed when severe turbulence hits the financial markets again.
For its part, the S.E.C. should require that publicly owned financial institutions provide more data in their quarterly reports. Any risks that the institutions retain, whether on or off their balance sheets, should be disclosed. And they should better explain the methods they use to determine the values of their own assets.
To fulfill its wider supervisory role, the Fed should also be given the authority to collect data from firms that are not publicly owned, including hedge funds and commodities trading firms.
Finally, much stronger restrictions should be imposed on the kinds of predatory mortgage-lending practices that preceded this crisis. The Fed recently proposed new rules for banks that would, for example, require better verification of borrowers’ income and reduce onerous prepayment penalties. These rules should be applied to all mortgage lenders. For those institutions not managed by the Fed, the rules should be enforced by other federal agencies or state banking regulators.

A key political factor is in the 2nd paragraph above. Tightening up regulation will mean that management at the top of these institutions will have a tougher time generating earnings. They will fight hard, should any reform package be placed on the table. We will be told that the proposed regulation "inhibits entrepreneurship" and is therefore Anti-American.

But we're going to need to ask ourselves, when we talk about entrepreneurship and the American Dream, are we talking about imagination and creativity and earned rewards, or carpet bagging?

It seems to me that any system that enriches the very, very few and then corrects their failures with public money is an example of the latter. And I hope this country is grown-up enough to ditch the slogans and face that.

End note: Mack was, ultimately, depressed by the results of the Senate hearing. The results, he said, were just shallow talking points and didn't address complex market realities at all. So if the hearing was any indication of our readiness to ditch the fluff and pursue reform, it didn't bode well.

Unsurprisingly, the hearing was chaired by neo-Republican hero, Joe Lieberman.