Thursday, October 28, 2010

"Is it Time for the Draft?"

Sydney M. Williams

Thought of the Day
“Is it Time for the Draft?”
October 28, 2010

On June 21, 1945, with the war in Europe over but with fighting continuing in Japan, my father wrote my mother from Plezzo di Tarvisio, Italy of a celebration being held for a man who was returning home because he had accumulated “over 85 points”. At the time my father had 69 points, more than half of which (36) represented his four children. But the 16 points he needed meant another eight months overseas, or sixteen months in the U.S., barring another campaign. Nevertheless, enough points eventually meant rotation home. In contrast, in Iraq and Afghanistan today, many soldiers in our voluntary army are experiencing multiple tours.

The history of conscription reaches back to the Civil War. However, only about 2% of Union soldiers who served were draftees. The vast majority of the 2,100,000 who served in the Union army were volunteers. In World War I, President Wilson decided on conscription. Nearly 3,000,000 men were drafted over a two year period. In 1940, a year and a quarter before the United States’ entrance into World War II, the Selective Training and Service Act was enacted. President Roosevelt’s signing of that Bill began the first peacetime draft in the United States. In time, as the War proceeded, the Act was amended to require all men between the ages of 18 to 65 to register, with those between the ages of 18 and 45 being immediately liable for induction. (At the time my father was drafted, in the spring of 1944, he was 33 and had three children with a fourth due in four months.) For fifteen months, following the end of the War, the nation returned to an all-volunteer force. The Selective Service System was established by Congress on July 1, 1948 and with it a peace time draft.

In 1968, at the height of the Vietnam War, Nixon ran for President on the promise to end the draft. It was his belief that ending the draft would effectively undermine the anti-Vietnam War peace marches. In fact, its end was a consequence of the anti-war movement. In early 1973, two years before the fall of Saigon, it was announced that no further draft orders would be issued. The last drawing had been for men born in 1953. However, in 1980 Congress re-instated the requirement that eighteen year-olds register with the Selective Service System.

Until Iraq there had been no major military conflicts since Vietnam. There had been small skirmishes. President Reagan had Granada; President Clinton had Kosovo. George H.W. Bush had the first Gulf War; but in the scheme of things those were small theaters, with armed conflicts quickly concluded, at least as it pertained to U.S. forces.

The wars in Iraq and Afghanistan have again raised the question: should a draft be reinstituted? Arguments supporting an all-volunteer army generally center on costs and efficiencies. Walter Oi, writing for Regulation magazine in July 2003, a publication of the Cato Institute, stated: “This shift [from draft to volunteer] appears to have had a dramatically positive effect on U.S military preparedness.” He cites, as examples, the Gulf War, and the first few weeks of Iraq and Afghanistan. Defending the all-volunteer army, Deputy Chief of Staff, G-1 United States Army, in an interview in July 2008, was quoted as saying that the “all-volunteer force is the envy of every single free society around the world.” He added: “Millennial-generation young men and women do have a sense of duty.”

But an all-volunteer army incurs costs. It is, in truth, a mercenary army. While one might argue there is a difference between an all-voluntary army and a mercenary one, I would suggest the difference is more embedded in perception than in reality. We have outsourced the risk and dangers of combat to a small group of people to whom most of us have little connection. Defense Secretary Gates, in his speech at Duke a month ago, said that fewer than 1% of Americans served in uniform over a decade of war. War is usually a result of failed diplomatic initiatives; as Carl von Clausewitz famously wrote, “War is a continuation of policy by other means.” Mr. Gates went on to warn of a “self-perpetuating cycle of civilian-military alienation.” He fears that the armed services concentrate themselves in “enclaves like the south and mountain west, while large urban, wealthy and coastal populations increasingly grow distant from military life.” “There is a risk over time,” Secretary Gates added, “of developing a cadre of military leaders that politically, culturally and geographically have less and less in common with the people they have sworn to defend.”

In recent years, those of us who are being defended read of soldiers assuming multiple combat tours in Iraq and Afghanistan – sometimes as many as four or five. While multiple tours were not unusual in other wars among the officer corps, especially graduates of the military academies, they were not common for enlisted men. Even during World War II when men were drafted “for the duration of the war plus six months”, a point system allowed those who had served in combat to eventually rotate home.

The decision to wage war would likely be approached more cautiously if those who serve fight were truly citizen soldiers – a good, not a bad thing. We do not live happily in a democratic society because it is efficient. We do so because of the freedoms it affords. Those freedoms are worth defending; hiring professionals who risk their lives to save ours demeans the democracy being defended. A professional voluntary army may be easier and quicker to deploy, but it misses something when it excludes multiple segments of society.

I do not deny that a voluntary army has served us well over the past three and a half decades. But if Mr. Gates is right and the alienation grows, the decision to commit troops might come to resemble a video game to those in charge at home – an intense, but sanitized view of war. Soldiers would be little more than red pins on a map. In a letter to my mother, my father wrote of the accuracy of Bill Mauldin’s caricatures: “In combat, soldiers that I saw looked just as dirty and unshaven most of the time and often a lot worse. If you go two or three weeks without shaving and sleep in holes and sweat and hit the ground or mud or dust or whatever happens to be under your feet when a shell comes over (sometimes it was manure), you don’t end up looking like the beautifully groomed soldier you see mowing down the enemy in advertisements.” That experience should not be limited just to those professionals we pay to fight for our wars.

Georges Clemenceau, Prime Minister of France at the end of World War I, allegedly said: “War is too important to be left to the generals.” No more should our democracy rely on a mercenary army. We are all beneficiaries; we should all serve, if not in the military then in some form of national service.

Wednesday, October 27, 2010

"The Anti-Election"

Sydney M. Williams

Thought of the Day
“The Anti-Election”
October 27, 2010

In six days voters will go to the polls for what could be a “sea change” election. The President has argued that if only he had the time to explain what he was doing voters would endorse his programs. Nancy Pelosi, the embattled Speaker of the House, made a similar plea, coated in arrogance: “We haven’t really gotten the credit for what we have done.” The fact of the matter is that the President has given more speeches explaining his programs than any President in history. The election next Tuesday will be a referendum on the President’s policies. If the Democrats lose the House, as is expected, it will be a refutation, not of him but of his policies. But, should the Republicans take control of the House, they must realize that their victory is not an endorsement of their proposals. This election is not for someone or some ideas; it is a vote against specific acts passed by Congress and signed by the President. It is an anti-campaign, which has made it nastier than usual.

“Blue Dog” Democrats, in some cases, are running against the President, in a rash bid to save their seats, but at the risk of fracturing their Party. Frank Caprio, the Democratic candidate for governor of Rhode Island and not endorsed by the President, in telling him to take his endorsement and “shove it” is but an extreme example of Democratic fratricide. A vituperative spirit is present in all elections, but the level of meanness and anger during this cycle appears elevated. But should that be such a surprise? A number of exogenous events is playing itself out. A credit collapse in the summer of 2007 nearly sent the financial markets into oblivion a year later. Billions of dollars were anted up by the government in a necessary (in my opinion) effort to save the financial system. However, in saving the system they allowed hundreds of bankers on Wall Street to generate unconscionable profits. That should never have happened, but unfortunately time, which might have allowed wisdom to temper action, was not a luxury for those who were then making decisions. The economy caromed into recession, but thankfully with the financial system intact. Today the unemployed combined with the underemployed account for about 25 million Americans – almost one in five working Americans.

Stimulus money went primarily to save or increase jobs at the state and local level – jobs that are mostly unionized and which on average pay better than those in the private sector. The money did not go to visible projects, such as the Interstate Highway System or the TVA. As a result the infrastructure of roads and bridges continues to deteriorate, providing the sense of a third world country. Madison Avenue in New York, for example, one of the most expensive shopping areas in the world, is barely drivable, roughly equivalent to a goat path in Haiti.

This confluence of negative economic events has been made more frightening because of the rise of Islamic fascism, creating a new type of war, but one even more menacing and deadly in its difference from conventional war, because it is civilians who are usually targeted.

What makes this particular moment unique, though, from past stressful times is that the U.S. (and, in fact, most of the West) has had to deal with a plethora of debt, debilitating entitlements, aging populations and contracting economies. The developing world, in stark contrast, is alive with youth, vigor, enthusiasm and a can-do attitude. It is demoralizing for many that the largest economy in the world – the beacon for the poor and unwanted – has become dependent on a country whose economy is less that one third its size. For much of the last two and a half decades, as consumers, we benefitted from an emergent China. Manufactured goods were cheap, and the demand for raw materials had little effect on commodity prices. Today, the very size of their economies and the rapidity of their growth cause them to compete with us for labor and for products as diverse as corn, cotton and copper, raising prices despite feeble economic growth. While deflation hovers and economic prospects appear bleak, confusingly inflation is rising.

But we have been in tough situations before. The country was never as divided as it was during the Civil War when two percent of the population were killed over a four year period. Depressions and recessions have plagued the Country over the years. The Vietnam War divided America seemingly beyond repair, between the young and the old, the rich and the poor and the educated and uneducated. However, the Country survived and prospered. It should do so again.

Watersheds of this magnitude do not happen in a moment, nor do they recover quickly; they progress over years. We live during a time of instant and omnipresent news, immediate analysis from people of every opinion. The ubiquity of the internet is felt by everyone. No matter one’s fears, one can find justification; whatever one’s opinions – no matter how extreme – one can find support. At lunch yesterday a good friend told me a story that a wise elder had passed on to him many years ago. My friend, as a young man, was a workaholic who spent six days a week at his desk. This mentor suggested taking Friday’s off and doing something he had never done before, like working in his garden. He told him to try it for twelve weeks. That was several years ago. My friend told me it changed his life, giving him time for reflection and improving his effectiveness. We cannot all take a day off, but finding time to ruminate allows us to better adapt to the future.

In the meantime the election looms. While many opponents of the President’s policies may not be able to intelligibly articulate their disapproval, they instinctively resist what they sense is a too-intrusive government. This has resulted in angry partisanship, which is reflected in our politicians. Part of the problem is that there is no common enemy – no common grievance that draws us together. The diversity of our people is our great strength, but trying times magnify our differences. The Republicans may win the House and make important strides in the Senate, but humility should be their constant companion, for their victory – if that is the outcome – is not a vote for them, but a vote against the other guy.

Tuesday, October 26, 2010

"Watch What They Do, Not What They Say"

Sydney M. Williams

Thought of the Day
“Watch What They Do, Not What They Said”
October 26, 2010

The Group of 20 finance ministers returned to their respective homes on Sunday from their meeting in Gyeonju, South Korea with, as the New York Times put it, a “veiled” decision to “refrain from competitive devaluation of currencies” – a pledge, not a written agreement A proposal by US Treasury Secretary, Timothy Geithner, to impose a specific 4% of GDP limit on trade surpluses (Germany’s is currently 6.1% and China’s is 4.7%), was rejected in favor of using “indicative guidelines”. To monitor and act as referee of global trade activity, the IMF was given increased funds and the composition of the board was altered to give more influence to emerging countries. According to the Wall Street Journal, the accord is one “that relies on goodwill and peer pressure to persuade countries to comply with internationally agreed norms, rather than enforceable sanctions.”

What makes the events in South Korea so timely is that the world is going through a wrenching change. The engines of growth over the past sixty years – the United States and Western Europe – are sputtering. It is the emerging nations – China, India, Brazil, Southeast Asia and even parts of Eastern Europe – that are leading the globe back to health. Gideon Rachman, in the “Life & Arts” section of this past weekend’s Financial Times, has a fascinating article, “End of the World as we knew it”. He writes that, following the financial crisis of 2008, a win-win attitude that embraced globalization “is now being replaced by a zero-sum logic, in which one country’s gain looks like another’s loss.” Some of that sense was evident in the news reports coming out of the meetings in South Korea. As the Wall Street Journal wrote in an editorial on Monday: “The real problem with the global economy is that most of the developed world, in particular the U.S., isn’t contributing as much as it should to the current world expansion.” America’s fixation with China serves as an example.

The concept of Mr. Rachman’s zero-sum logic was visible in the reported discussions emanating from Gyeonju. Concerns, especially those expressed by Mr. Geithner, going into the meeting include the accusation that China has not let the Yuan float freely. In turn, China and other surplus nations fear that another round of quantitative easing in the U.S. will lead to competitive devaluations of other currencies and, possibly, inflation. The University of Chicago’s John Cochrane, in this morning’s Wall Street Journal, asks: “Since when is every trade surplus or deficit an ‘external imbalance’ in need of correction?” Devaluing currencies to steal exports may serve a short term goal, but ignores the role of technology, productivity and wage flexibility in competing for trade. Devaluing currencies risk currency wars, protectionism and the ignition of global inflation. It is walking the walk, not talking the talk that investors should consider.

Twenty-five years ago five finance ministers (United States, West Germany, Japan, the U.K. and France) met at the Plaza Hotel where they agreed to devalue the dollar, in what became known as the Plaza Accord. The reasons had to do with America’s current account deficit, then at 3.5%, (especially that with Japan) and, according to Wikipedia, “to help the U.S. economy emerge from a serious recession that began in the early 1980s.” Of course, we now know that that recession had been over for three years – in November 1982. However, among the unintended consequences of that Accord was that an export-dependent Japan went into recession, leading to expansionary monetary policies, which four years later resulted in a real estate and stock market bubble. The Chinese – the intended victim this time around – one can be assured, are well aware of that agreement and its consequences.

The finance ministers did agree to revamp the IMF’s (which has 187 country members) 24-member board, making it more representative of today’s world, shifting six percent of voting power from the richest countries to developing ones. Europe will give up two of its nine seats and Brazil and India will no longer have to share a seat. Additionally, the G-20 agreed to double the quotas that determine how much each country contributes to, and may borrow from, the institution. As enforcer of the “indicative” Gyeonju agreement, the IMF may prove able, but there are many who question its effectiveness. The New York Times article quotes Eswar S. Prasad, a former IMF economist: “The IMF can say its piece, but it is ineffectual when it comes to influencing large economies.” They also quote Dominique Strauss-Kahn, the fund’s managing director: “We cannot oblige a country to do something, but what we can do is to notice that a country has a commitment and fulfills, or not, a commitment.”

Mr. Rachman may be correct in assigning the date on which the world changed to the fall of 2008, but I would suggest the spring of 2000 was a precursor. The equity bubble popped in March 2000 and, with the loss of $6 trillion in equity valuation, logically should have lead to a severe recession. The speculative bubble kept growing, fed by cheap money, only now in commodities, homes and bonds, thus postponing the day of reckoning. During those years, as consumer debt increased, the U.S. dollar lost 36% of its value (measured by the US Dollar Index). Despite the weak dollar, the current account deficit grew from 2% of GDP to 3.2% today, belying the argument that a cheap dollar is the way to increase exports. It was spending more than we earned that got us into our troubles today – a situation abetted by government. It is that fact, which is being addressed by consumers (and has been by businesses), that needs to be recognized and addressed by Washington.

Next month the G-20 leaders will meet in Seoul. This will be the fifth meeting since the aftermath of the credit crisis in the fall of 2008. Time will tell the success of the meeting. While it is no doubt positive that all parties continue to talk, I do worry that the sputtering engines of growth in the West may encourage our political leaders to tap into the latency of protectionism, a condition which lurks just beneath the surface. It is the “doing”, not the “saying” that needs to be watched.

Monday, October 25, 2010

"Liberal Hubris"

Sydney M. Williams

Thought of the Day
“Liberal Hubris”
October 25, 2010

A regrettable characteristic of many, but certainly not all, coastal liberal elitists is their tendency to be patronizing – belittling even. Their mantra: “The unwashed masses cannot survive without our ‘divine’ guidance.” This condescending attitude was visibly apparent as Vivian Schiller, the president of NPR, who arrogantly and insultingly explained the firing of Juan Williams. Ms. Schiller suggested that Mr. Williams should consult with his “publicist” and “psychiatrist”. As Friday’s New York Times put it, “…he (Mr. Williams) had violated the organization’s belief in impartiality, a core tenet of modern American journalism.” Given that other NPR news analysts, like Nina Totenberg and Cokie Roberts, routinely offer liberal opinions indicate that double standards are alive and well within the, in part, publically funded NPR.

Anyone who has listened to NPR knows that the one thing that cannot be said about them is that they are “impartial”. They are a distinct left-leaning news organization, which is their right. I have no problem with their decision to fire Mr. Williams, or any employee. That is also their right. Even the decision to have a lower level functionary do the dirty deed by telephone – an action which connotes cowardice – was their right. It does not really bother me that NPR is partially funded by the Federal government, for the subsidy is small and shows like “Car Talk” are worth the small percentage of their budget that we as taxpayers ante up. What I object to is their putting the firing into the context that this was a high-minded decision, uninfluenced by outside pressure, such as that exerted by CAIR (the Council on American-Islamic Relations) or by the hundreds of e-mails sent by their liberal base demanding such action. The decision, as reported by Saturday’s New York Times, “was not the product of political or financial pressures.” It was, as Ms. Schiller said in the same article, because “he had several times in the past violated our news code of ethics with things he had said on other people’s [read Fox News] air.”

This attempt to intimidate reporters, journalists or commentators by making them conform to a prejudicial set of standards, while masquerading as fair and unbiased, is a disheartening commentary on the political correctness of today’s mainstream journalism. (It will be interesting to see if NPR has the guts to stand up to similar pressure urging the firing of Mara Liasson, the other NPR employee who is a regular Fox contributor.)

It is also worth noting that Mr. Williams’ comments, as fuel for his firing, were taken out of context. Following the statement on the “O’Reilly Factor” for which he allegedly was fired – that seeing airline passengers in Muslim garb made him nervous, a condition that few of us could honestly deny – he went on to state that all Muslims should not be branded as extremists: “We don’t want, in America, people to have their rights violated, to be attacked because they hear rhetoric from Bill O’Reilly and they act crazy.” Those are hardly the words of a liberal turncoat. In fact, the whole decision is reminiscent of the “act-before-you-think” school that caused the firing of Ms. Shirley Sherrod by the Department of Agriculture after right wing blogger, Andrew Breitbart, played a widely-viewed, edited video of her allegedly making negative comments about a poor white farmer. The Department of Agriculture soon recognized their error; this rush to judgment is driven more by perception than by reality.

Besides working for NPR, Juan Williams is the author of four or five books (Eyes on the Prize is generally considered one of the best books written on the civil rights movement), a periodic op-ed columnist in many national newspapers and a regular panel member on Fox’s Special Report with Brett Baier. In other words, more than a journalist, Mr. Williams is valued for his opinions. A journalist should be unbiased, but most are not as we all well know. On the other hand, opinion writers, by definition, are never “impartial”; they are paid to express their opinions, so we know that the real reason for the firing of Juan Williams had to do with the board’s decision that they simply did not like his associations.

I have read much of what Juan Williams has written and have watched and listened to the man. While I do not always agree with him, he spars competently against such conservatives as Fred Barnes, Bill Kristol and Charles Krauthammer – all articulate men. He is often the lone voice of liberalism. One would think that liberals would admire and respect his performance.

This is not the first time that NPR has allegedly sided with the Islamic community against those who have actively (and accurately) warned of extremists within the Muslim community. Steve Emerson of the Investigative Project in Washington, the world’s largest center studying militant Islamic activities, was effectively black listed by NPR as an “Islamophobe” in 1998. Even his prescient warning on May 31, 2001 that “Al Qaeda is…planning new attacks on the U.S… [and has] learned, for example, how to destroy large buildings…” has not resulted in a return visit.

Ironically, it is Fox News that comes out well in this incident. NPR, with their liberal hubris, has shown themselves to be narrow minded and uninterested in contrarian views, while Fox News has added a noted liberal to help balance their generally conservative views.

Friday, October 22, 2010

"Lessons From the Weimar Republic"

Sydney M. Williams

Thought of the Day
“Lessons From the Weimar Republic”
October 22, 2010

The story of Germany’s dazzlingly descent into destructive hyperinflation in the early 1920s was vividly retold by Art Cashin of UBS a little over a week ago in one of his daily “Cashin’s Comments”. Mr. Cashin wrote: “At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar…[Nine years later], by late November 1923, you would need 4.2 trillion marks to get one dollar.” In the previous twelve months, the rate of inflation had soared by a factor of 2000.

Art Cashin uses the example of a loaf of bread, which, in dollar terms, cost $0.13 a loaf in 1914. Four years later, after the war, that same loaf cost $0.19. In the middle of 1922, it cost $3.50 and by the end of the year it cost $700.00. Eleven months later, in mid November 1923, that same loaf cost $100 billion.

The German people largely blamed the cause of the hyperinflation on two factors: the debilitating reparations that the Allies demanded of Germany, and on bankers and speculators. There is little dispute that the total level of reparations was punitive, to say the least. The 132 billion gold marks demanded would be roughly equivalent to $6 trillion in today’s dollars, an amount roughly two times Germany’s current annual GDP. The terms of the Armistice called for annual payments of 2 billion gold marks, plus 26% of the value of their exports.

John Steinbeck once wrote that people have a need, especially in times of stress, to find a cause for their problems. The German people were no different. Anti-Semitism rose, as people looked for someone to blame (other than themselves); Jewish bankers became an easy and visible target, setting the stage for Hitler and National Socialism.

But the real cause of the inflation was simpler; it was the excessive printing of money. Germany was inundated with debt. Many of the buyers were foreign, most of whom recalled Germany’s glorious past and could not conceivably foresee her despicable future. Inflating one’s way out of debt is tempting. In the early months many businesses accepted inflation and quickly learned to adapt – borrowing marks, speculating in foreign exchange, and converting money into hard assets, goods and fixed plant.

But the problem with inflation is that it is insidious. Savers are penalized. It is seductive; it often starts modestly and then can accelerate geometrically, entrapping the people.

In the United States, we had a taste of inflation in the late 1970s. Fortunately, President Carter nominated Paul Volcker to be Chairman of the Federal Reserve, and then President Reagan gave him the reins he needed to stop inflation, inducing a recession, but saving the country from something far worse.

The story of Germany’s exodus from the clutches of hyperinflation is fascinating in its simplicity. On November 12th, 1923 Hjalmar Schacht became currency commissioner. On the 16th, the Rentenmark was introduced on the basis of one Rentenmark for one trillion Reichsbank marks. Rentenmarks were introduced slowly and backed by hard assets. Since the Rentenmark, at this point, was not legal tender, the new Rentenbank refused credit to government and speculators who could not borrow Rentenmarks, for there were few around. However, the discounting of trade bills was allowed and the amount of Rentenmarks gradually expanded, but in a controlled manner.

On November 20th Reichsbank president Rudolf Havenstein died and Hjalmar Schacht was named president. By November 30th there were 500 million Rentenmarks in circulation. By January 1, 1924 the number had increased to a billion and to 1.8 billion by July. The old Reichsbank marks continued to depreciate. Nevertheless, the currency had stabilized and by August 1924, everyone was able to convert their old Reichsbank marks on the basis of a trillion for one.

However, the ground had been laid for the emergence of National Socialism. It would take another ten years before Hitler took control of the government, buried the Weimar Republic and assumed dictatorial powers granted him by the Third Reich. In 1938, Hitler and his minions began a military campaign that ultimately cost 70 million people their lives – thirty million of them civilians.

We should never forget those ravages of inflation ninety years ago, its social as well as its financial consequences and how easily it can slip under the tent virtually undetected. When debt becomes overwhelming (and many of its owners non nationals), the easy path is to keep rates low, continue to print money and let the currency slide. Among the things we learn from reading history is that things are often not what they seem. Perception and reality become blurred. Actions (and inaction) have consequences. History helps us to understand how people respond to events, to try to anticipate behavior.

Thomas M. Hoenig, President of the Federal Reserve of Kansas City gave a speech ten days ago in Denver in which he questioned the need for another round of quantitative easing. He worries that it could lead to a commitment to keep funds rates too low and the Fed’s balance sheet too large. “The natural tendency”, he said, “will be to maintain an accommodative policy for too long.” He worried that inflation expectations might become unanchored. As regards to the current policy of zero rates, he said: “Zero rates distort market functioning…zero rates lead to a search for yield and, ultimately, the mispricing of risk; zero rates subsidize borrowers at the expense of savers.” Words to ponder.

The financial crisis we experienced two years ago continues to reverberate. We entered new territory and, while the system appears to have stabilized, commonsense suggests prudency. Those in emerging countries – those not subject to the legacy constraints of developed nations – are competing for goods and services; they are also competing for jobs. Their elevation to consumers means opportunity for some, but pain for others. Those, like numerous politicians, union members and others, who believe that the world will remain as it was will be disappointed. Shrinking debt at home and expanding competition from abroad will be painful for those who are incapable of adapting. The lessons from the Weimar Republic are worth remembering.

Thursday, October 21, 2010

"Retirement - Is There One in Your Future? - Part II"

Sydney M. Williams
Thought of the Day
“Retirement – Is There One in Your Future? – Part II”

October 21, 2010

January 1, 2011 will mark 65 years from when the first baby boomer was born. On that date, 78 million of those babies born between 1946 and 1964 will begin retiring. There is simply not enough capital to ensure everyone a secure retirement.

For sake of simplicity, let us assume that on average each retiree required $50,000 of annual income. Approximately $20,000 will come from Social Security – assuming it is still there. The other $30,000 of income will have to come from IRAs, 401(k)s, pension plans, etc. Assuming a return on the capital of 4%, that means each of the 78 million people need (or will need) about $750,000 in retirement savings. Of course, they may choose to dip into principal, betting that the grim reaper appears before the bailiff. Seventy-eight million people times $750,000 equals $58.5 trillion. According to Federal Reserve data, U.S. household wealth stands currently at $53.5 trillion. That number, of course, includes the value of one’s home, and the assets of those already retired and those who are younger. This is a crisis that is barreling our way like an eighteen-wheeler down a crowded street.

Optimism has long characterized the typical American. He (or she) tends to look forward, not backward. “Live for today for tomorrow will take care of itself”, would appear to be our motto. While such an attitude is appealing in many ways, it has led to irresponsible carelessness, when it comes to preparing for retirement. And the chickens are coming home to roost. The generation that proceeded mine was one for whom defined benefit plans were commonplace at major corporations – one worked long and hard and the company’s pension plan, supplemented by Social Security provided an adequate income for old age. (My grandparents’ generation, except for the few with private resources, had to rely on family, or became wards of the state.) With the exception of union workers (now, largely government workers) and a few others, my generation and the baby boomers that follow have no such safety net, though we do have Social Security. In 1974, under the Employment Retirement Income Security Act (ERISA), Congress created IRA accounts for those not covered by a corporate pension. Four years later, Congress established 401(k) plans. Today, IRA and 401(k) plans hold a total of about $6 trillion – about $34,000 for each baby boomer, assuming all the money belonged to them which it does not. Unfortunately the funds in retirement accounts are not nearly sufficient for the demand retiring boomers will require.

These facts - that boomers are close to retiring and that the funds available are clearly insufficient, along with enormous federal deficits – have prompted some proposals from Washington that are disconcerting, if not outright frightening. Two years ago, House Education and Labor Chairman George Miller (D – California) and Jim McDermott (D – Washington), then chairman of the House Ways and Means Subcommittee on Income Security and Family Support, considered the tax break for 401(k) contributions, substituting a new system of guaranteed retirement accounts to which all workers would be obliged to contribute. Joint hearings were held last month by the Department of Treasury to consider “lifetime income options for retirement plans”. Since Social Security is already bankrupt, the concept of layering on even more entitlements seems foolhardy at best and has convinced some opponents that such a decision would result in the eventual confiscation of all assets in private IRA and 401(k) plans - a process undertaken in Argentina two years ago.

What is especially galling is that Congress has their own very liberal retirement plan; so, like the deceptively named Patient Protection & Affordable Care Act, they are proposing legislation from which they would be exempt.

There is no simple answer. But a way forward must be found. Common sense suggests that any solution will have to include an increase in the retirement age and some form of a means test for Social Security. Of course a means test implies giving up of payments that one has already contributed; so should be tax deductible. A solution should also recognize that incentives are needed to encourage investment and discourage consumption. The system will have to provide the opportunity for those who can afford it to be able to invest far more in retirement accounts on a tax advantaged basis than they now do, especially if a means test for Social Security is implemented. The current system does not work. If a working person contributes the maximum allowable today for twenty-five years and if one assumes a 5% annualized return - two times the current rate on the Ten-Year – he (or she) would accumulate less than $1,000,000 - an amount that will prove barely sufficient for retirement.

As undemocratic as this may sound, we must recognize that there never will be equality in outcomes – some people will always be richer than others. There is an enormous variation in looks, brains and physical prowess - characteristics beyond our control. People are not the same and each person must play to their individual strengths. Society will always be stratified. However, there should be no impediments to ascending the ladder of success, just as there should be no barriers from falling. That is the way America has always been and it is the way she always should be. A society that is fluid, one that rewards brains, industriousness and thrift will be far more successful than one that rewards dependency and profligacy. In the meantime, “Houston, we have a problem.”

Tuesday, October 19, 2010

"We Are Not Japan, But..."

Sydney M. Williams

Thought of the Day
“We Are Not Japan, But…”
October 19, 2010

An article on the front page of Sunday’s New York Times, “Japan Goes From Dynamic to Disheartened–Retrenchment Offers the West a Grim Vision of the Future” was sobering – “chilling”, as described by my partner, Andy Monness.

By the summer of 1945, Japan was devastated. Of a population of about 73 million in 1940, approximately 2.7 million had been killed. As a percent of their population, Japan’s losses were more than ten times those in the United States. The only atomic bombs ever used in hostile action devastated Hiroshima and Nagasaki, in August 1945. However, like the mythical Phoenix Japan rose from the ashes of war to become the world’s second largest economy. (It has recently been surpassed by China, and is now stagnating.) In the early years, as Japan took to the task of rebuilding, she was not alone. In the immediate aftermath of the War, the American government, under the auspices of the Supreme Commander of the Allied Powers, played a crucial role, for example paying the Japanese government large sums for “special procurements” during the Korean War. Nevertheless, most of the credit for their economic “miracle” must go to the Japanese people. For the thirty-five years between 1955 and 1990, their economy compounded at 12%; per capita income increased ten fold – a growth rate that exceeds that of China today.

Since 1990, Japan’s economy has essentially stood still. GDP has stagnated, per capita income has declined and “the nation,” as Martin Fackler writes in the Times piece, “has been trapped in a corrosive downward spiral of prices…” Mr. Fackler goes on: “Now, as the United States and other Western nations struggle to recover from a debt and property bubble of their own, a growing number of economists are pointing to Japan as a dark vision of the future.” While there is little question, in my mind, that there is no easy quick exit from our troubles – we have dieted on a menu of debt-induced growth and are now undergoing treatment, accompanied by DTs.

But before, emptying the bank account, selling the homestead, purchasing a shotgun and heading for the hills, it is important to re-look at the size of twin Japanese bubbles in 1989. The Nikkei Index peaked on December 29, 1989 at 38,915.87. Stocks commonly sold at 150-250X earnings. The Index compounded annually for 44 years at 17% – a feat, I believe, unmatched in human history. Even with the Nikkei at 9498.49 – less than one quarter of its high 21 years ago – the sixty-five year compounded annual return has been 8.8%, about 250 basis points better than long term returns from U.S. stocks.

Real estate prices were even more dramatic, both in their rise and in their fall. According to Wikipedia, peak prices in Tokyo’s Ginza district (roughly equivalent to New York’s Madison Avenue) fetched $93,000 per square foot in 1989. In contrast, in the summer of 2007 when prices in New York were close to their highest levels, 660 Madison Avenue (home to Barneys New York) sold for $1,453 per square foot. By 2004 prices for office space in Tokyo’s financial district had lost 99% of their value and Tokyo’s residential homes were selling for one tenth of their peak prices, but were still listed as among the most expensive in the world.

An economy undergoing detoxification from consumer over-borrowing, as ours is now doing, cannot be enticed to grow through increasing leverage. That, in my opinion, is the mistake the Fed and all those in Washington and elsewhere who are urging more quantitative easing are making. Lower mortgage rates will not attract home buyers, nor will cheap borrowing costs encourage hiring or greenfield investment by businesses. What is needed is confidence in the future. That should be the sole focus of Washington. Lower rates are a boon to speculators, which is why many on Wall Street favor them. They have produced enormous profits for bond funds like PIMCO. But low rates are a bane to savers and especially hurt the elderly – food and fuel prices are being driven higher by speculators with access to cheap credit, while bond and saving account yields are low. Low interest rates abet the rise in commodities, a move which at some point will be reflected in higher consumer prices. And, of course, low interest rates mask the negative impact of expanding federal deficits.

It is, of course, this recent experience of ours that causes one to compare our situation to that of the Japanese. But the differences are more significant than the similarities. In contrast to Japan, our stock bubble – pale in comparison to that of Japan – was limited to tech, media and internet stocks. It occurred ten years ago, five to seven years before our real estate bubble. Japan’s two bubbles occurred simultaneously.

But even more important, the U.S. is a nation of immigrants, of peoples from all over the world. That diversity is our strength. Japan’s population is homogenous. The population of the United States, according to the CIA World Factbook, is growing at a rate just under 0.98%, while Japan’s is declining at 0.19%. The total fertility rate (the expected number of children born per woman in her child-bearing years) for the years 2005-2010, according to the United Nations, is 2.05 in the U.S. and 1.27 in Japan. (Anything over 2.00 indicates positive growth.) As well, we are blessed with an abundance of raw materials and a climate conducive to a variety of crops.

Despite my assertion that we are not Japan, I am mindful of the risks we face. It is demand that is missing from our economy. Quantitative easing is an attempt to goose demand by supplying cheap dollars – a perversion of supply side economics. Taken too far, it risks cheapening the dollar. In The Economic Consequences of the Peace, John Maynard Keynes wrote: “Lenin is said to have declared that the best way to destroy the Capitalistic System is to debauch the currency…The process engages the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million can diagnose.”

But we are not Japan. The differences are too big, but that does not mean we do not face risks. Japan’s fate should be a constant reminder to policy officials in Washington. More than anything – more than flooding the system with currency, more than paternalistic promises from Washington – we need a restoration of confidence that provides the individual and business the incentives and the conviction to invest, be it in a home or in a factory. Low interest rates and a depreciating dollar will not do the job.

Monday, October 18, 2010

"A Rising Middle Class in Developing Nations"

Sydney M. Williams

Thought of the Day
“A Rising Middle Class in Developing Nations”
October 18, 2010

The story for our times has been the rising middle class in developing nations, especially those in Asia, but also in Brazil, Russia and parts of Eastern Europe. “China’s ascendancy”, writes Geoff Dyer in the weekend edition of the Financial Times “in recent years has been so dramatic that governments around the world, as well as Beijing itself, are still struggling to adjust.” The increasing importance of this rising middle class is reflected in their economies, which are credited with helping drive the West toward recovery. It is the principal explanation for higher food costs around the world, for one of the initial benefits of rising income is eating better. It is responsible, at least in part, to the currency conflagrations ominously consuming many in Washington. It is manifested in declining birthrates, and a concomitant aging population in parts of the world where such trends would have been inconceivable three decades ago.

Food shortages persist throughout the globe due to a combination of poor land, adverse weather conditions, outdated seed technology and corrupt governments. While much has been done – think Norman Borlaug, the recently deceased “father of the green revolution” – more needs to be done – consider the people in Somalia. Unfortunately, as long as politics and corruption are interchangeable, malnutrition will persist. However, an expanding middle class in much of the developing world where corruption is less prevalent and incomes are rising, the demand for more and better food products is driving up prices for corn, wheat and soybeans. In this globally interconnected world those of us in the developed world better hope that those in developing nations continue to improve their lot, for our well-being is tied to theirs.

A pull-out section in Fridays Financial Times, “Special Report on World Food” addressed the problem of the undernourished, but failed to consider the rising demand for more and better foods. (Interestingly, the common denominator of the most undernourished nations – Haiti, the Democratic Republic of Congo, Comoros, Burundi and Eritrea – is that, according to Transparency International, they constitute some of the most corrupt governments in the world.) But appetites in developing nations are becoming more sophisticated. To produce a pound of beef it takes more corn than to produce a pound of chicken or pork. And all meat products, in terms of protein, are more expensive to produce than the direct byproducts of the grains.

A weak currency, no matter the rouge and the lipstick being applied by many in Congress, the White House and at the Fed, is a vote of no confidence for the issuing country. Those like New York’s Senator Schumer, a China basher of the first caliber, must be careful less what they wish for transpires. Since March 2009, the Dollar on a trade weighted basis is down 14.3% and has been particularly weak against currencies of developing countries such as Brazil and Malaysia, and against such commodity driven economies like Canada and Australia. Even the much maligned Chinese Yuan has risen 2.8% in the last seven weeks. Also, since March 2009, the Bridge/Commodity Index has gained 58%, sowing the seeds for future inflation.

While no expert on currency markets, I found the interview with Robert Mundell in Saturday’s Wall Street Journal fascinating. The interview was conducted by Judy Shelton, the author of Money Meltdown: Restoring Order to the Global Monetary System. In response to a query as to his opinion of the $4 trillion now trading daily in the global currency markets, Professor Mundell argues that “currencies should be fixed, as they were under Breton Woods or the gold standard. All this unnecessary noise, unnecessary uncertainty; it just confuses the ability to evaluate market prices.” I am not qualified to offer an informed opinion, but as Mr. Mundell points out: “Fixed exchange rates operate between California and New York.” And they now operate between Germany and Portugal, in large part because of Robert Mundell, the father of the Euro. Fixed exchange rates would seem to serve as a de facto single currency.

It appears increasingly apparent that the Federal Reserve, with the Obama Administration’s complicity, is trying to devalue the Dollar – purportedly to provide a trade advantage, but at the risk of rising future inflation. (It should be noted that the Bush Administration pursued a similar policy when Mr. Greenspan was at the helm of the Fed.) Professor Mundell’s recommendation? Ms. Shelton writes: “He (Mundell) thinks the European Central Bank, along with the Federal Reserve, should intervene in currency markets to limit movement in the world’s single most important exchange rate, pointing out that the dollar and euro together represent 40% of the world’s economy.” Finally Judy Shelton asks Professor Mundell: “You mentioned gold? The price of gold is an index of inflation expectations, Mr. Mundell says without hesitation.”

What we do know is that this rising middle class in the developing world will serve to increase world trade, which should serve to help all economies. Not surprisingly, many American and European companies are far ahead of their respective governments in recognizing these macro changes taking place and the opportunities these present. It is true that all countries are not equally “fair” when it comes to trade, so conversations among nations must be continuous. China, it can be argued, is a mercantilist state, but I would also argue that they are increasingly being carried along by the inexorable current reflecting the more modern views of David Ricardo and Adam Smith. The real risk is protectionism, the erection of barriers, nationalism and the spread of xenophobia.

Malthusians and adherents of the Club of Rome once worried that the world was becoming over populated; today there are those that worry the opposite might become true – a planet graying indefinitely. Among developed nations (and even among some developing ones), the United States is unique, in that with a combination of births and immigration our population continues to expand. Exports, as I have argued in the past, should become more important to our growth.

In the November issue of Foreign Policy, Phillip Longman, author of The Empty Cradle, argues that a consequence of this rising affluence is already seen in a slowing in the world’s birth rates and an aging of the population. He points out that, according to the U.N. Population Division, “the world’s population will increase by roughly one-third over the next 40 years, from 6.9 to 9.1 billion.” But, he cautions: “Indeed, the global population of children under 5 is expected to fall by 49 million as of mid-century, while the number of people over 60 will grow by 1.2 billion.” In Sunday’s New York Times , Natasha Singer writes: “For the first time in human history, people aged 65 and over are about to outnumber children under 5. “Aging”, as Mr. Longman writes, “is a rich-country problem.” But it is also a problem in developing nations like China. It is another consequence of the rising tide that is lifting millions, if not billions, of people out of the depths of poverty and into the ranks of the middle class.

An increasing affluence in the developing world will provide more competition; it will serve to highlight educational differences. There will be losers and winners. The former will be those who cling to the past; the latter will include those who see the rise of the middle classes in the developing world, not as a threat, but as an opportunity. In this regard and in the U.S., business leads government.

Thursday, October 14, 2010

'We Live in Interesting Times"

Sydney M. Williams

Thought of the Day
“We Live in Interesting Times”
October 14, 2010

As we head toward the end of the year, there are three external events to which attention should be paid. The first will be the election on November 2nd, which is widely expected to increase Republican’s representation in Congress, possibly giving them control of the House. To me, that seems a stretch, but the super majority that Democrats have enjoyed for the last two years will be gone. The second event will be the Federal Reserve Open Market Committee meeting on November 2nd & 3rd. Their statement will be released on the 3rd of November, the day after the election. The third event will be a vote in Congress on extending the Bush tax cuts, at some point before the year end.

As regards those external events, the market seems to be expecting that Republicans will take control of the House; that the Federal Reserve will express a willingness to further expand quantitative easing, and that the Bush tax cuts will be extended for all except the wealthiest.

Perhaps that is still the most likely outcome. However, it is possible that the market may not be discounting the domino effect of a Republican victory. Should the Republicans do better than expected in the election – not my expectation, but a possibility – it could be that fiscal conservatives within the Fed may influence the others to back off on further easing – or, at least to postpone a decision until the December meeting. And, if Republicans take control of the House, Democrats may extend the Bush cuts for all parties, based on the concept that any tax increase during tough economic times is never a good idea, enacting them as the “Obama” tax cuts.

The odds, in terms of the Republicans taking control of the House, may be less than 50%, but they are probably not as low as 30%. The question then: how will markets react?

In my opinion, which should always be taken with a hefty dosage of salt, bonds would fall (interest rates would rise) and stocks would fall, at least immediately. The expectation of persistent low rates seems to be built into the stock market, and many managers believe that continued easing is key to avoid dipping back into recession.

However, for several reasons, a Federal Reserve that remains “accommodative”, but avoids “QE2”, I believe would be better for stocks and the economy, though it could signal an end to the Treasury rally. Despite the better than 12.5% rally since the end of August, domestic equity mutual funds continue to get redemptions. Uncertainty as to the economy and the fate of tax rates continue to weigh on investors.

Chairman Bernanke will be speaking tomorrow morning at 8:15AM at the Federal Reserve Bank of Boston Conference. The title of his speech: “Revisiting Monetary Policy in a Low Inflationary Environment” – certainly not propitious for tightening and likely not for continuing the current path of accommodation. Everybody expects a new round of quantitative easing, but rates, including mortgages, are already at historic low levels. It is not interest rates that are hurting the housing market. It is the lack of confidence in the economy and the seemingly inability of our politicians to fix things that are forestalling recovery in housing. The foreclosure mess (as I wrote on Monday) is just a further example of the way in which politicians insert themselves into a problem that the private sector was already correcting.

Additionally, low interest rates are nurturing what could be future problems. Energy and food costs are up and returns on savings are down – taxing the poor and limiting investment returns for the elderly, not a happy scenario for a Party that claims to look after those groups.

Nevertheless, it is possible that a Republican victory could set off a chain of events that might smart in the short term, but could be positive as we go through 2011. Even the Federal Reserve may not be immune.

Wednesday, October 13, 2010

"The Tunnel - It is More Than Just the Tunnel"

Sydney M. Williams

Thought of the Day
“The Tunnel – It is More Than Just the Tunnel”
October 13, 2010

Forty-eight years ago President John F. Kennedy signed Executive Order 10988, an event which – perhaps consciously, perhaps not – changed the priorities of government. With that order, public employees were permitted to unionize. In 1937, President Roosevelt had said: “All government employees should recognize that collective bargaining, as usually understood, cannot be transplanted into public service.” George Meany, who served as the first president of the AFL-CIO, had argued in 1959 that it is “impossible to bargain collectively with government.” But union membership, as a percent of the working population, was already in decline and the leadership of the AFL-CIO sought new members. In 1960 union membership was 15.5 million, or 28.6% of the private workforce, a decline from 32% in the mid 1950s. Today, according to the Bureau of Labor Statistics, total union membership is almost identical, at 15.3 million, but represents only 12.3% of the workforce – 7.4 million private sector workers (7.2%) and 7.9 million public employees (37.4%). Public employees have been the saviour to unions, and have filled the coffers of Democratic campaign chests.

A consequence of the rise of public unions was a corresponding increase in benefits, particularly healthcare and retirement costs. It is hard to get accurate data for the states and local governments, but federal spending provides a guide. Congressional Budget Office records indicate that federal outlays for mandatory spending have risen from 33.8% of the budget in 1965 to 59.9% in 2005. The Complete Idiots Guide to Economics by Tom Gorman (you have to love the title!), in 2003, cited that entitlements comprised about 65% of the federal budget. Republican Senator Judd Gregg of New Hampshire, when Chairman of the Senate Budget Committee in 2005, stated: “Mandatory entitlement spending now represents a whopping 55% of all federal spending.” Whichever number is correct, the trend is obvious. The result is less money to spend on infrastructure projects so badly needed around the country. And that, then, leads to Governor Chris Christie’s decision to abort the proposed tunnel between New Jersey and New York. According to a study the Governor undertook, the original estimate of $8.7 billion looked more likely to be $11 billion and possibly $14 billion. For a state with a $29.4 billion budget and a $10.5 billion deficit, a few extra billion dollars means something, at least to the people – the taxpayers – if not to the politicians.

Unsurprisingly, Christie’s decision was attacked by the usual suspects. Bob Herbert, in a recent New York Times op-ed provided litanies of what we once were able to do and what we no longer can do. However, nowhere did he question the distorted priorities of states – in New Jersey, for example, the benefits to state and municipal employees exceed by 40% benefits paid to comparably employed workers in private industry; and the cost of those benefits are rising annually at 16%. Paul Krugman, also in the New York Times, argued that interest rates are low, implying that the state, already in arrears, should increase their borrowings; like Herbert, he bemoaned what he sees as a country without vision – without the capacity to foresee what value these big projects might provide.

But, again, and also like his fellow columnist, no mention is made of the fact that entitlements consume an increasingly large percentage of our resources, a consequence of a decision made forty-eight years ago – and, today, prevent us from spending on needed projects. The problem of entitlements did not suddenly appear. They have crept up silently and insidiously on an unsuspecting electorate and on politicians who seemingly chose to ignore the rumbling signs of an impending storm. These mandatory obligations loom ominously. They limit options. And Mr. Christie and a few others have realized there is no easy answer. The sad fact is there are things we cannot afford. There are times, as Governor Christie’s decision made clear, when the only answer is “no”. Perhaps the governor will be unable to bear the pressure and will change his mind. If he does, it will only serve to delay an inevitable day of reckoning; it won’t eliminate it.

David Brooks, in yesterday’s op-ed in the New York Times, wrote that we have “an immobile government that is desperately committed in all the wrong ways.” “The situation”, Mr. Brooks adds, has created “the Democratic Party’s epic failure.” All of us, including Mr. Christie, I am sure, would like to see the tunnel built, roads improved and bridges repaired, but a decision was made decades ago that no longer permits that type of spending. Decades ago, future obligations were small, and the future seemed far away. No one knew how big these obligations would become. But they are here and they are real.

There are those who want to continue as though nothing has changed; there are others who view themselves as stewards of the people’s money – not because they are nasty or insensitive, but because choices must be made.

Tuesday, October 12, 2010

"Technology That Could Change Our Lives"

Sydney M. Williams

Thought of the Day
“Technology That Could Change Our Lives”
October 12, 2010

No American born after December 19, 1972 has witnessed a man walk on the moon. That was a startling revelation to me when I realized how distanced that time was. A dozen years earlier, in 1960, the idea of anyone walking on the moon seemed incredible – science fiction. Then, on May 25th President Kennedy spoke before a joint session of Congress. The concern at the time was the Soviets, that they were beating us in the race to space. The new President decided to throw down the gauntlet. Toward the end of the speech he said: “I believe that this nation should commit itself to achieving the goal, before this decade is out, of landing a man on the moon and returning him safely to earth.” It was a heady time when anything and everything seemed possible.

As a country we seem to have moved away from that “can do” attitude that allowed a man or woman born in the 19th century to have watched televised images of Neil Armstrong taking man’s first steps on the moon, a spectacle denied to virtually everyone under forty. Technology has continued to make great strides, albeit in terms of communication, access to data, social networking and game technology.

We have all dreamt of technological advances that will alter our world and our lives irrevocably. Beginning in the late 1930s and proceeding into the early 1950s, Robert Heinlein wrote a series of short stories that were collected and published in 1967 in a volume entitled, The Past Through Tomorrow. In those stories he wrote of personal helicopters, nuclear energy, smart roads, rocket ships and other futuristic concepts, many of which never appeared. In 1962, Hanna-Barbera, producers of The Flintstones, created The Jetsons, a space age counterpart to their earlier sitcom. Technology has always been fascinating, feeding the imagination of the young and creative.

Having a home one hundred miles up Interstate 95, I am acutely conscious of the growing urban-suburban problem of traffic congestion and reckless motorists. I have often speculated as to whether at some future point the Interstate might be automated, so that a car would only have to drive to the entrance ramp, the system would then take control, depositing the car at a pre-determined exit. So, it was with excited anticipation that I read the Sunday’s New York Times article headlined, “Look Officer, No Hands: Google Cars Drive Themselves”. The story and the vehicles seemed to emerge from the pages of Mr. Heinlein, suggesting the possibility of a life-altering technology, more impactful, in a practical sense, than the mission to the moon forty years ago.

The article describes how Google has altered seven cars, each of which has driven a thousand miles with no human intervention, on highways and city streets, including the steep and curvy Lombard Street in San Francisco. Collectively the cars have driven 140,000 miles with only occasional human control. The one accident, thus far, occurred when one of the cars was stopped at a red light; he was back ended. As John Markoff, the reporter on the story writes: “Robot drivers react faster than humans, have 360-degree perception and do not get distracted, sleepy or intoxicated, the engineers argue.” Lives could be saved and the capacity of the roads would double.

Of course, there are legal issues, and the technology appears ahead of the law. Mr. Markoff adds: “Under current law, a human must be in control of a car at all times, but what does that mean if the human is not really paying attention as the crosses through, say, a school zone, figuring that the robot is driving more safely than he would.?”

As the Times points out, even the most optimistic predictions would put commercial production of automated vehicles a decade into the future. Autonomous vehicles, however, are nothing new. At least once a week we read of a Drone attack on some Taliban hideaway in a cave along the Afghanistan-Pakistan border. Engineers have been working with automobiles for over forty years. The technology in some of today’s high end cars have the ability to anticipate problems, for example alerting the driver if he appears to be drifting. The technology is here, but the costs must come down to convert the concept to a commercially viable product.

I am not much of a technologist. I have trouble with my integrated TV/PC system at home. In fact, it has always been the past that has fascinated and intrigued me. Nevertheless, I was excited to read of the “Googlemobile”; for it seems a product that is timely. Roads are congested and the possibilities of adding new lanes along the northeast corridor are virtually nil. Ill-mannered drivers travel recklessly, with little regard to others. One does not drive on I-95, one attacks. Mass transportation should be a viable alternative, but what we have is often dirty, uncomfortable and inconvenient. Besides which, most Americans value the independence a car provides. Google’s tests indicate that the cars can even be programmed for different driving personalities – from cautious to aggressive.

Google, according to reports this morning, is investing, alongside a transmission and energy companies, in a wind farm off the East Coast of the U.S. Perhaps that will become their focus. Energy independence is a worthy goal. And perhaps robotic drivers will remain a dream, tilting at windmills, no more than a will-o’-the-wisp; but to me the prospect is exciting: a practical technology that would help solve innumerable problems – highway deaths, transportation woes, energy conservation. I read the article and thought (and hoped) I saw the future.

Monday, October 11, 2010

"The Foreclosure Flap"

Sydney M. Williams

Thought of the Day
“The Foreclosure Flap”
October 11, 2010

A root cause of the global financial crisis was a failure on the part of banks to maintain stringent underwriting standards, allowing them to grant mortgages to potential homeowners with insufficient capital and income. Government, as has been well documented, not only encouraged but mandated such profligate behavior. Questionable practices by mortgage brokers and consumer greed played important roles. Nevertheless, banks violated an inherent obligation to their owners – the shareholders.

It now appears there has been sloppiness on the part of some banks when it came to the process of foreclosing on homes where the mortgagor fell behind in his payments and violated the terms of his contract. Last Wednesday, four major banks decided to suspend foreclosures in twenty-three states where the process must be approved by a judge. The decision was prompted by the disclosure that the wrong person at the bank may have been signing off on the intended foreclosure notice.

That decision has drawn attention to the foreclosure process and Congress is now determined to convert what is a sensible decision on the part of the banks – to temporarily suspend foreclosures pending internal investigations as to the cause and to make corrections – into a political football. Not allowing a crisis to go to waste, on Thursday Democratic Representative Edolphus Towns of New York demanded a national foreclosure moratorium. On Friday, Senator Harry Reid of Nevada inserted his oar, endorsing the recommendation. Keep in mind, according to an article in today’s Wall Street Journal, the process has never been expedient. Today the process takes 478 days, versus 302 days in 2005. It should also be remembered that currently about one third of all home sales are foreclosure sales.

Ironically, and almost comically, the Senate, in the waning days of the 111th Congress, passed in September, and sent to the President the Interstate Recognition of Notarization Act of 2010, a bill designed to smooth the foreclosure process for lenders. While the bill’s sponsor was a Republican, it sailed through both houses of the Democratically-controlled bodies of Congress. Last Thursday, the President pocket vetoed the bill – a decision to not sign a bill when Congress is not in session.

Donning populist colors, a few Democrats jumped to the defense of [allegedly] disenfranchised homeowners, portraying them as defenseless persons, ejected from their houses into the dark and chill of the night by unfeeling bankers. However, as the Journal reports in today article, most foreclosures occur after “borrowers have already turned over the keys to the home and walked away from their loans.” No one has suggested that banks were foreclosing on those current on their payments.

Nevertheless, millions of homeowners have negative equity – 21.5% of all mortgaged homes at the end of the second quarter, according to Credit.Com. The temptation to walk is strong, yet most owners continue to respect the contract they signed.

There is no question that a large number of people are caught in a terrible bind. They willingly bought a house, in many cases beyond their means, enticed by rising prices and easy mortgage terms, requiring little documentation. They took out a mortgage equal to the value of the house. Instead of rising, home prices began to decline; the economy went into recession; the financial crisis struck; they lost their job; whatever savings they had were gone. With no assets, these people had no choice but to vacate their home, or to continue to live there but not paying their mortgage. Banks repossessed the house and the foreclosure process began. The foreclosure process has always been time consuming. Five years ago the process averaged 302 days; today it is 478 days.

Should the government intercede in these proceedings? Several state attorneys general, as well as members of Congress, as mentioned above, have urged a nationwide moratorium. On the other hand, White House advisor David Axelrod on CBS’s “Face the Nation” questioned the need for such action. A moratorium would have consequences. First, it would have the effect of diminishing the ability of poorer people to obtain credit and will raise their interest costs. Young, aspiring homeowners would essentially be barricaded (or severely curtailed) from the housing market. Secondly, prices for houses must be allowed to find a natural level; the market must be allowed to “clear”. Artificially supporting a price, by restricting supply, forestalls the inevitable day of reckoning. The experiences in California and Florida are instructional. Both saw prices drop 50% between 2007 and 2008. California, which does not require the approval of a judge for a repossessed house to be sold, foreclosures have begun to decline and prices have been rising nominally. However, in Florida, a state in which the process must go through the courts, foreclosures continue to rise and prices continue to fall.

Politicians helped get us into the current mess. Those who have adopted the mantle of Populism, while vouchsafing empathy, are making things worse. Sensitivity and personal feelings are worthy characteristics, but a democratic society can only function and thrive under rules of law. Blame for financial crisis and the housing debacle has many fathers – bankers, builders, brokers, politicians and consumers. Aggravating the problem by permitting those who have violated the terms of their contracts to stay in their homes will not help. The consequences are too important.

Thus far Congress has been eager to lay all the blame for the crisis on bankers, brokers and builders; they have absolved themselves and consumers from any complicity. You will sooner see Elvis return to the stage than hear Senator Chris Dodd or Representative Barney Frank (or any other politician, for that matter) admit culpability for their role in the process. Foreclosures are an unpleasant aspect of capitalism. As politically tempting as it may be to place a temporary ban on them, it is a bad idea. In fact, speeding up the process of foreclosures will do more to hasten an ultimate and inevitable recovery.

Friday, October 8, 2010

"Corporate and Individual Investors Choose Liquidity Over Long Term Investment"

Sydney M. Williams

Thought of the Day
“Corporate and Individual Investors Choose Liquidity Over Long Term Investment”
October 8, 2010

This morning the New York Times quotes the yield on the FINRA-Bloomberg High-Yield Index at 8.00%. A little less than twenty-two months ago that index yielded just in excess of 25%, suggesting returns on the index of 300%. – a remarkable comeback, especially considering that the economy still struggles, employment remains high and the government’s debt has increased at a rate that virtually mimics the return to high yield securities. From the depths of their March 2009 lows, stocks have rallied 74%, not bad, though not equal to that of high yield bonds.

At the same time cash remains high, both in money market funds, on corporate balance sheets and in other liquid assets. On the other hand, as former Fed Chairman Greenspan mentioned in an interview yesterday, corporate fixed investments are at record lows. It all suggests that cash is available, but investors are interested in liquidity as opposed to the type of long term investments – R&D, infrastructure, etc. – needed to make the kinds of improvements our economy needs to grow and flourish in a globally competitive world. Despite the trillions of dollars government has thrown at the system, they have failed to instill the confidence necessary to rebuild the economy.

The Federal Reserve’s next meeting will be November 2 and 3 – after the election – at which time they will likely decide as to whether to implement further quantitative easing. If recent experience is any guide, it would seem that any further easing is more likely to further debauch the Dollar, rather than help the economy.

Thursday, October 7, 2010

"To Ease or Not, That is the Question"

Sydney M. Williams

Thought of the Day
“To Ease or Not, That is the Question”
October 7, 2010

Investor Business Daily had two squibs yesterday on page 2, under the title, “Economy”. The first quoted Chicago Fed chief, Charles Evans, who argued that the Fed should be far more aggressive in spurring the economy and bringing down unemployment. The second was an observation by Nobel Prize-winning economist Joseph Stiglitz – a man who supported last year’s stimulus plan – who claimed that the Fed’s efforts to flood the economy with cash are doing little more than sowing “chaos” in global currency markets. Together, the comments reflect the disparate opinions, as to how to revive the economy, ricocheting around Washington, academia and trading desks.

Unemployment at 9.6% remains elevated and economic growth at 1.7% (the revised number for the second quarter) will do little to alleviate that situation. The Fed cannot lower the Funds rate below zero; so they are left with quantitative easing, or rather a second round of easing, known as QE II.

The Fed has already expanded its balance sheet from $800 billion before the crisis to $2 trillion today, in an effort to keep long term rates low. Partly in consequence, the rate on the Ten-Year has declined from 3.84% at year end to 2.37% today – a 38% decline in yield in just over nine months. Thirty-year fixed rate conventional mortgages are 4.25% today versus 5.11% a year ago. On the other hand, according to Index Credit Cards, rates on consumer credit cards have risen from 15.38% a year ago to a range of 16.74% to 16.85%, suggesting that aggressive easing by the Fed has not meant lower rates for low income consumers. An additional factor suggesting that the Fed may be “pushing on a string” is to look at a Bloomberg chart depicting the velocity of money. For the last eight years the quarterly turn in money has been between 1.85 and 1.92 times. In the last six months of 2008 when credit conditions froze, velocity declined sharply to under 1.7 times. It rose modestly beginning in the spring of 2009, but, since May, has now declined to the low levels of early 2009.

It could be that the Fed is convinced that by flattening the yield curve the “carry” trade may disappear. Should that happen, the thinking might be, banks would then be willing to assume some risk and lend money to corporate or individual borrowers, in place of buying Treasuries. That remains to be seen.

The Fed and the Administration are stuck between a rock and a hard place. They have effectively taken short interest rates to zero and, through purchases, have helped keep long rates down, but nothing much has happened. On the other hand, they are afraid of the consequences of doing nothing. Banks are reducing lending and shoring up damaged balance sheets. Businesses, citing uncertainty, are not expanding, or at least not hiring. Consumers are spending only on essentials – the effective result being a regressive tax. Unemployment remains elevated. Countries are competing as to who can cheapen their currency the quickest.

As an expert on the 1930s, Fed Chairman Ben Bernanke appears to particularly fear deflation, so is willing to run the risk of inflation. Inflation, though, can also be insidious, as we in this country learned in the late 1970s and the early 1980s and, as the Germans have never forgotten from the days of the Weimar Republic’s hyperinflation in 1921-1923. A good friend tells me that the only good thing to come out of those hyperinflationary days in Germany was the number of young, attractive fräuleins who entered the world’s oldest profession!

An article in the October 5th issue of the Boston Globe suggests a “little hair of the dog” is being offered as a remedy. Fifty thousand dollar interest-free, two to three year loans are being offered by HUD to borrowers in Massachusetts who “have suffered a significant drop in income and [are] at least three months behind on mortgage payments.” Crises are almost always orphans, but the truth is this one has many fathers: Wall Street, Politicians, mortgage brokers and mortgage banks, real estate agents, homebuilders and millions of people who took advantage of easy credit and dream-like expectations that the good times would continue to roll. But when this ball dropped it did not bounce and the sad fact is we are all experiencing hangovers for past excesses, which will likely persist for some time.

It may well be that the Federal Reserve will be able to dance through the rain drops, implementing another round of easing and then unwinding the positions before they begin to bite, though the odds against are long. Speaking in Toronto yesterday, former Fed Chairman Paul Volcker said: “The challenge now is we have intervened, it becomes more and more difficult, the monetary policy…the fiscal policy. We sure have to maintain some confidence in the Dollar or none of this would work.” Charles Schwab put it well in last weekend’s Wall Street Journal: “Our economy is ready to heal. It just lacks broad-based confidence among consumers and business people. It would be a giant boost to confidence if the Fed stood aside and returned to its traditional role as defender of monetary stability.” Mr. Schwab is right. Faith in the Dollar and a restoration of confidence are more critical than flooding the nation with money.

Wednesday, October 6, 2010

"Banks - Is There Another Chapter to the Story"

Sydney M. Williams

Thought of the Day
“Banks – Is There Another Chapter to the Story?”
October 6, 2010

In a report on Monday, J.P. Morgan notes that 295 banks with $600 billion in assets have failed since 2007, and that the number continues to rise. What seems remarkable to me is that more banks with even greater assets have not failed. Perhaps they will, though the rate of failure has moderated this year.

Reflecting the demise of manufacturing and the rise of the service economy, the Financial Sector’s weighting in the S&P 500 has expanded from 0.8% in 1970 to 21.3% in 2005 – from the smallest segment to the largest. (Today, Financials have shrunk to 16.3%, second to Information Technology.) Despite the beatings bank stocks endured in 2007-2009 due to a near-death experience in 2008, the twenty year stock performance for most of the larger banks – notable exceptions being Citigroup and BankAmerica – has substantially trounced that of the market. The shares of JP Morgan, US Bancorp and Wells Fargo, for example, have outperformed the market by a factor of four over the last twenty years.

The nexus of Banks’ extraordinary growth during the 1990s and the first half of the 2000s included an expansion in risk taking via an aggressive use of off-balance sheet vehicles, the creative use of derivative instruments, the elimination of many components of Glass-Steagall, the growth of proprietary trading desks and favorable treatment by the Federal Reserve which accommodated their money needs by keeping interest rates extraordinarily low in the early 2000s. But, as much as anything, it was the housing industry – the run up in prices, the use of new and innovative mortgages, and persistent low interest rates – that encouraged risk taking by individuals and led banks to the edge of the precipice.

The value of the housing stock in 2007, according to data from the Federal Reserve, was estimated to be $21.15 trillion, against which were just under $10 trillion in mortgages. The Case-Shiller Home Price Index for their 20 City Composite showed a peak to trough decline of just under 30%. While home prices peaked in late 2005-early 2006, the data suggests a decline of about $6 trillion, or 60% of the equity value of homes!

Smaller businesses would have been allowed to have failed, but the banking industry was deemed integral to global capital markets. And it was decided large banks were to big too fail. The system could not fail, and it did not, though the landscape is littered with victims.

The Treasury acquired billions in troubled loans, made equity investments in banks, and guaranteed other loans and deposits. The Federal Reserve, by December 2008, had lowered the Fed Funds rate to 25 basis points from 425 basis points a year earlier. In keeping Fed Funds close to zero, and with a steep yield curve, the Federal Reserve permitted banks to reduce risk, while allowing them to earn (essentially) risk free returns. In acting as quickly and as expeditiously as they did, the Bush/Obama Administrations saved the financial system in late 2008-early 2009; however, they also sowed the seeds of the Indian summer we are now experiencing.

The Fed is certainly aware that they have provided ideal conditions for banks. Easy and cheap credit and a steep (though now moderating) yield curve allows banks to earn (relatively) risk free returns, permitting them to rebuild their balance sheets. The Federal Reserve and HUD have been discouraging banks from foreclosing on mortgages, as the damage it does not only to the mortgagor, but to the neighborhood and the economy. The question occurs: is this a deliberate policy – allowing banks to rebuild their balance sheets, so that write-offs of troubled loans can be postponed to a more opportune time?

There have been two other times during the past eighty years when the banking industry was under severe stress. The first was in the 1930s when margin calls (stocks could be bought on 10% margin in the late 1920s) forced speculators to raise cash, which created runs on banks. By 1933, 4000 banks with $140 billion in assets had been closed. Adjusted for inflation, that $140 billion would be equivalent to $2.3 trillion today! (And, of course there was no deposit insurance at the time. The FDIC was created in 1933, in conjunction with Glass-Steagall.) The second time was the S&L crisis in the late 1980s and early 1990s. Over a ten year period, 2800 banks with assets in excess of $500 billion failed. The negative consequences of the latter period, while severe for some, never reached the levels of today, let alone the 1930s.

The fragility of the economy is obvious. Many economists have lowered expectations for GDP for the balance of this year and for 2011. Employment is anemic. The risk of a double-dip exists. The Fed is considering extending quantitative easing. Interest rates are being kept low. Countries around the world are competing for the lowest currency valuation – a race of questionable wisdom, in my opinion. What does that mean for global growth? If we are all exporters, who buys? Confidence is AWOL. Thus far the only inflation we are experiencing is in commodity prices, harming the poor, as the Wall Street Journal makes clear in an article this morning, “Middle Class Slams Brakes on Spending”. While spending for upper and middle income people is lower, driven by fear, “The lowest earners spent 15.4% more on food last year than in 2007, shelling out more on cereals, meat and processed vegetables.” It raises another question, are our fiscal and monetary policies helping or hurting?

I am not an analyst and don’t pretend to have answers. Banks may have moved beyond the worst of their write-offs, but a second half may lie ahead? I don’t know. The market does, however, look ahead and perhaps we should take comfort in its recent performance, but one thing I do know – markets never move in straight lines.

Tuesday, October 5, 2010

"Change Breeds Fear, but also Opportunity"

Sydney M. Williams

Thought of the Day
“Change Breeds Fear, but also Opportunity”
October 5, 2010

A friend, a hedge fund manager, recently observed that some of the characters in the movie No Country for Old Men were recognizable. Anton Chigurh (Javier Bardem), in his ruthless search for his $2 million, reminds my friend of some on Wall Street who let nothing come between them and a trade. But the character Sherif Ed Tom Bell (Tommy Lee Jones) catches the spirit of a country in flux – of men and women who thought they knew right from wrong and now find themselves uncomfortable in a place they don’t understand.

Stocks are traded with dizzying speed. Vituperative accusations emanate from Washington and are echoed in the Press, dividing the people, so making bipartisan efforts all but impossible. Congress has written and the President has signed healthcare and financial reform legislation, each a couple of thousand pages long – bills not understood by the electorate and most likely not understood by those who voted for them. Turmoil has become our common condition. Over a year into recovery (according to the NBER the recession ended in June 2009) unemployment remains just under its peak; recovery appears feeble. People are frightened – scared of the future and for their jobs.

This fear and uncertainty was addressed in the New York Times on Sunday by Robert Shiller, one of the country’s most renowned economists. He is professor of economics and finance at Yale and co-founder of the Case-Shiller Home Price Index. Even more important, from my perspective, he is an unassuming and thoroughly decent man. His column, “Economic View: The Survival of the safest”, dealt with the painful problem of persistent unemployment.

Professor Shiller writes that “business confidence has been shaken…people in all walks of life are nervous about trusting one another.” He quotes from a book by Truman Bewley, Why Wages Don’t Fall During a Recession (Harvard, 1999). Mr. Bewley’s concern is why, in times of rising unemployment, do wages not fall and why does the labor market not “clear”. Unlike commodities, the price of labor does not adjust when demand is less. Instead, businesses resort to sudden, mass layoffs of “non-essential” personnel. That action allows the business to survive and permits them to keep favored employees on. Managers argue that idled workers don’t “spoil the atmosphere”. Typically, Professor Shiller notes, “managers often lay off more people than necessary, to ensure they don’t have to repeat the ordeal anytime soon.”

The result of such action is a decline in morale. Those without jobs feel unworthy; while those with jobs insulate themselves against sentimentality and worry that they may be next. The (to me, sensible) concept of maintaining a full workforce, but paying everybody proportionally less, is rarely considered.

Truman Bewley quotes the manager of a large manufacturing company whom he interviewed in July of this year: “There is more uncertainty, and everybody is afraid.” Professor Shiller concludes: “Sometimes the private sector needs help from the government, and this is one of those times. We need to break the cycle of protracted unemployment and sagging morale through big government programs to create millions of jobs.” That may be necessary, though I am a skeptic. Even so, I recognize that there is plenty of infrastructure work that needs to be done; for example, no self-respecting third world country would have permitted New York’s Madison Avenue to fall into the disrepair it has.

But, in order to achieve long term success, we need people to learn “how to fish”. We must acknowledge that improvements in productivity have the effect of outdating certain jobs, so education and reeducation must be a continuing process. We need vocational schools. We must train people to compete in a global environment. Along those lines, President Obama, at yesterday’s meeting of the President’s Economic Advisory Board, announced the formation of a new program, “Skills for America’s Future”. The proposal is to link top companies with community colleges, in hopes of bolstering job skills. That’s a positive step, though it should be expanded to include vocational schools and small and mid-size companies as well.

More than anything, the President’s focus should be attempting to instill in the people a “can-do” attitude, lifting their self confidence, reminding them that they, individually – not the government – are the most critical factor in determining success. Dependency, whether it is on drugs, medication, alcohol or the government is ultimately debilitating. Certainly there are times when medication is needed and there are times when government must lend a hand; of course, there are the sick, the elderly, the disabled and others who are unable to look after themselves. But for the vast majority of people it is a restoration of confidence and an acknowledgment of the wisdom in the words President Kennedy uttered in his 1961 Inaugural: “Ask not what your country can do for you – ask what you can do for your country.”

To borrow and alter Rahm Emanuel’s phrase, crises present opportunities. Even “old men” can find a place to call home. Innovation and aspiration are innate elements of most successful people. These traits should be encouraged and nourished, for the growth of our economy will depend more on those who seize opportunity than on a bureaucracy embedded along the banks of the Potomac.

Monday, October 4, 2010

"Kayaking on the Marsh Creeks"

Sydney M. Williams
October 4, 2010


Note from Old Lyme

Kayaking on the Marsh Creeks

“A river is more than an amenity, it is a treasure.”
Oliver Wendell Holmes (1841-1935)

“If there is magic on this planet, it is contained in water.”
Loren Eiseley (1907-1977)

On weekends, looking out at the Duck River, I see kayakers, at times in packs of a half dozen, other times alone. Some are obviously beginners, others old pros. They are young and old, men and women. They have in common a love of the marsh, a wish to be with nature, a desire for the outdoors and exercise, and a sense of serenity. Like Ulysses and the Sirens, but with no worries that I could be any more irrational than I already am, the kayakers lure me toward the water.

For almost twenty years I have been sculling along the broader reaches of these marsh creeks. However, in sculling from my floating dock I must accede to the tides, as the dock at low tide is mired in mudflats, and to the early mornings, for that is when the water is still, or nearly so. As a form of exercise, rowing, unlike kayaking, is almost Zen-like, using all muscle groups, requiring intense concentration, focusing on position and on each stroke – especially the moment where one has rolled forward, feathered the oars back, readying for the “catch”. A miscalculation can cause a rower to “catch a crab”, sending him tumbling into the water, an occurrence that has been my fate more than once.

Ten years ago my children gave me a kayak. I bought a second to keep it company, for kayaking, unlike sculling, can be a social pastime. And, it is possible to go out anytime, as long as the tide is in. Kayaks are small and maneuverable, allowing me to follow small creeks which connect the larger ones. On a warm late summer day I find myself alone on the water, marveling at the luck that has brought me to this place where we have a home, about two miles north of the mouth of the Connecticut River. In 1993, the Nature Conservancy designated this delta as one of forty “biologically important ecological systems” in the Western Hemisphere – known as “last great places”. It 1997 the entire Connecticut River was designated by President Clinton as one of America’s “Heritage Rivers”. More recently, the River’s estuary and tidal lands were listed as one of 1759 wetlands of international importance by the Ramsar Convention on Wetlands – and one of only 15 in the United States.

Other than kayakers what one encounters most often are crabbers, men and women drifting in row boats, their engines idling, as they drag up their traps laden, or so they hope, with Fiddler, Hermit or Blue Crabs. Their activity is pleasant and comforting to witness. It is an ancient rite, stretching back to the earliest settlers and to the Indians who preceded them.

In my kayak, I paddle silently, slipping past a pair of male Double-Crested Cormorant, wings extended in intimidation, while their lady friends sit near by; I approach an Eastern Mud Turtle, sunning himself (or herself?) on a log. As well, the sun warms my back. My double-bladed paddle moves slowly in a graceful arc, as quietly as is possible. Water Striders skim jerkily across the surface of slow moving creeks, searching for even smaller insects on which to dine. Unlike a scull, a kayak allows one to “smell the roses”, to let the mind wander, to think creatively. In this interlude with nature, New York and the turmoil of Wall Street seem distant.

My grandchildren enjoy a kayak outing. With one of my children, we take two of the little ones, donning life vests, making sure they are wearing bathing suits and walk to the river. They are small enough so that a grandchild fits on each lap. Rowing is a little less free, as my arms must extend in front of the child on my lap. While wary at first, the children soon love being in the kayaks and out on the water. Unaware of the need to maintain balance, however, the children twist and turn their bodies, shouting across the water at one another, urging their rower to move faster – turning our meandering voyage into a race. But it is delightful to observe them, as they listen to seagulls and watch ducks diving for dinner.

Once again, returning alone to the water it is easy to follow small marsh creeks and sense that one is alone in the universe, or that time has stepped back three hundred years. Sitting low in a kayak with marsh grasses at eye level and the only sound being the splash of your paddle, the call of a seagull, or the whisper of the breeze as it softly pulls back the Salt-Water Cordgrass, one can imagine what it might have been like for the first explorer.

While I love the company of others, and especially that of my family, in truth I am addicted to being alone, to silence and to the proximity of nature when I am on the water.

"May 6 Revisitare"

Sydney M. Williams

Thought of the Day
May 6 Revisitare
October 4, 2010

Mrs. O’Leary’s cow, assuming she survived, I am sure felt badly for kicking over the lantern which allegedly ignited the Chicago fire 129 years ago this coming Sunday. Waddell & Reed (allegedly responsible for the May 6 crash) has similarly expressed remorse, saying they did not intend to “disrupt” the market when they sold $4.1 billion (75,000) in E-Mini S&P 500 futures contract in an algorithmic program trade designed to be executed “without regard to price or time”, at a pace not to exceed 9% of trading volume. However, the fact that high frequency traders (HFTs) traded 27,000 similar contracts in just 14 seconds, meant that staying within their volume parameters was not a problem, as these contracts, like a “hot potato”, were passed back and forth between HFTs – and disruption was indeed a consequence.

Some of the comments about the report seem incredulous. On Friday, Dow Jones Newswires wrote: “Manoj Narang of Tradeworx, a New Jersey-based firm that runs a high-frequency trading fund, said the report underlined that high-frequency traders were not responsible for the market’s plunge. ‘High-frequency trading on its own could never prevent a stampede for the exits like what we saw on May 6,’ Narang said. ‘That’s purely a phenomenon created by herd-like behavior by long term investors’.” Really? It beggars credibility to believe that most long term investors have the wherewithal to react within seconds. Only a computer driven program could react so quickly.

However, not having read the full 104 page report, perhaps the CFTC (Chicago Futures Trading Commission) and the SEC did place the blame solely at the feet of Waddell & Reed. However, the New York Times, on Saturday reported: “As they (HFTs) detected they had amassed excessive ‘long’ positions, they began to sell aggressively, which caused the mutual fund’s algorithm in turn to accelerate its selling.” While Waddell & Reed may have lit the blaze, the numbers of futures contract sold within seconds suggest that HFTs poured gasoline on the fire.

High frequency traders have long claimed that they provide liquidity in a market otherwise deprived. Since their trading, along with other computer-driven programs, account for an estimated 70% of all trading, it appears that the only beneficiary of the liquidity they provide is to one another. The most redeeming aspect of what they do is the enormous profits they generate for themselves. Not only does society not benefit from what they do, in fact they sew the seeds of destruction of a capital system integral to our way of life.

Lost in the reports on the Report, from what I read, is any mention of the importance of capital markets: the markets exist as a means of raising money for businesses and government, providing the opportunity for investors and savers to generate returns on their investments, and allowing for the exchange of investments for cash. Anything that promotes such activity should be encouraged; anything that hampers the essential purposes of these markets should be discouraged. Critical to any investment, of course, is a sense of confidence. The events on May 6 wracked confidence in our capital markets. The Report from the SEC and the CFTC, to the extent it left the HFTs untouched, has done little in my opinion to assuage that loss of confidence.