Sandy's Aftershocks Hit the Economy

The Wall Street Journal reported this week that the U.S. economy expanded at its fastest rate since 2011 in the third quarter of 2012. The nation's gross domestic product grew at a revised annual rate of 2.7 percent between July throughout September. This rate was revised up from the predicted 2 percent due to growing inventories, strong federal spending, and more consistent exports - all good signs that the economy is growing. 

Unfortunately, this rate will most likely decline in the fourth quarter because of the destruction caused by super-storm Sandy which struck the Northeast shoreline late October. Sandy's force closed many businesses in the Northeast and demolished others. Dallas Fed President, Richard Fisher, says despite the negative effects from Sandy "there's a rebuilding process and we'll have a positive impact in subsequent quarters." 

In addition to Sandy's backlash, fears of the fiscal cliff - a slew of tax increases and spending cuts on track to hit in January - are still looming. Congress has yet to come to up with a solution to attack this fiscal cliff which, if put into action, could send the nation into another recession causing businesses and consumers to hold back spending. 

Federal Reserve chairman Ben Bernanke announced this week that the Fed will enact another round of bond buying in 2013 as a buffer for the looming fiscal cliff. Fed officials have been encouraged by the increased housing market and decreased unemployment rate, but the fiscal cliff is leaving uncertainty in the markets which is stunting economic growth. The Fed acknowledges that these programs aren't as affective as they were during the financial crisis but they do help, especially in the housing markets, and these programs come with manageable risk. Hopefully Congress can come up with a powerful solution to this fiscal cliff which will deter the Fed from purchasing more bonds. This will help businesses and consumers alike feel more confident with the economy and encourage them to spend more. 

Inside Job

In class this week we viewed Sony Pictures’ Inside Job, a documentary about the systemic corruption within the United States’ financial system and how it caused the 2008 market meltdown.

Over the course of the semester, it has become clear that there were many factors, which caused the 2008 market meltdown. However, all of the problems stem from an unregulated financial system. When Ronald Reagan took over the presidency in 1980, he began a deregulatory policy that would continue for 30 years. This policy created a “free-for-all” in the markets. Investment banks bundled mortgages with other loans and debts into collateralized debt obligations (CDO’s), which they sold to investors. In turn, commercial banks began approving loans for anyone that wanted one because either way they were getting paid. People also began investing heavily in over the counter derivatives because they were advertised as a good investment, but in reality they were incredibly toxic.

Isaac Newton’s laws of physics states every action, has an equal and opposite reaction. Even though he used this law applies to physics, it also explains how the financial markets function. Whenever the market heads positively in one direction, it eventually will peak and head equally in the opposite direction.

In 2008, the financial market kept with this trend by correcting itself. However, since the economy had grown so positively large that when it peaked and headed in the negative direction, it had an enormous negative effect. There were some people, like Brooksley Born, who predicted this detrimental market correction and attempted to stunt it. Born discovered how toxic over the counter derivatives were and moved to regulate them.  Unfortunately, Alan Greenspan and others on his team were adamant about keeping the markets unregulated and blocked every attempt Born made to regulate any part of Wall Street. If we want to avoid another financial crisis like this in the future, we need to regulate the markets.

The phrase “too big to fail” applies to the interconnectedness of the investment and commercial banks on a global level. It means that these banks have grown so large that if they fail, they will stall the global economy and therefore the government is forced to bail they out. This is an unsafe public policy, especially without any type of regulation, because then the banks have no moral standard to live up to. Banks can assume that if they’re large enough, it does not matter how many mistakes they make since the government will bail them out if they get into trouble. Policy makers should really look into an effective way to regulate the financial market.

Derivatives played a huge role in the financial crisis of 2008. They are a good example of excessive, over-speculation that needs to be regulated. Investment bankers and investors alike did not fully understand their complexity and sold them off as a sure thing when in reality, they were incredibly toxic.

In theory an unregulated market makes sense, but unfortunately when you add in human emotion the system falls apart. As we have seen through readings, this video and other videos we’ve viewed throughout the semester, investors become easily blinded by greed and therefore overlook potential problems within the system. They also neglect to share information in order to get ahead of others which is why it is necessary for the government to enact some form of regulation. 

Top 5 11/4/12 - 11/10/12

New Households Sprout Up: As Recession Era Fears Ease, Confident Consumers Take Steps to Rent or Buy by Robbie Whelan, November 7, 2012, Section 1 Page 3, www.wsj.com Americans are renting or buying homes at the fastest rate in more than six years indicating recession anxiety is subsiding. The U.S. added 1.15 million households over the past year according to the Census Bureau's September report. Household information is tied tightly to employment growth which means more students are finding jobs post college graduation, more adult children are leaving their parent's homes, and more couples feel confident about their future to get married and purchase a home. However, the overall growth rate is due mainly to renters, mostly recent college graduates. The number of homes lived in by renters has increased by more than five million since 2006 to 39.6 million. 

Focus Shits to "Fiscal Cliff": After Obama Victory, Political Leaders Strike Conciliatory Tone; Dow Falls 312 by Naftali Bendavid, Damian Paletta, and David Wessel, November 8, 2012, Section 1 Page 1 www.wsj.com With the election behind us, focus has shifted to the "fiscal cliff" - automatic federal-spending cuts and tax increases - which will hit in January unless congress and President Obama can agree on another way to reduce the budget deficit. There is great concern over the fiscal cliff because if these spending cuts and tax increases are implemented, many economists and investors fear it will lead the U.S. back into a recession and would intensify anxiety about the functionality of the U.S. political system. Uncertainty over political turmoil could lead to more stock market trouble which we saw on Wednesday when the Dow Jones Industrial Average fell 312.95 points, or 2.4%. This was the largest decline in both points and percentage terms since June. It shows how investors are still weary about trusting the markets.

Greek Lawmakers Pass Austerity Deal by Alkman Granitsas and Gordon Fairclough, November 8, 2012, Section 1 Page 16, www.wsj.com Greek lawmakers narrowly passed a multibillion-euro austerity package this past Thursday with a 153-128 vote. The package is an effort to win more bailout funds from the European Union but these measures also threaten deepening the country's already severe recession. Controversy surrounded the austerity package which would cut pensions and public-sector wages, forcing federal businesses to lay off thousands of civil servants. Less people in the work force will discourage people from spending money either out of fear of being laid off or those who already have been laid off and no longer have a source of income.

Blue Chips Finish in the Black by Alexandra Scaggs, November 9, 2012, online, www.wsj.com The Dow Jones Industrial average made investors and business nervous earlier in the week when it dropped 312.95 points, or 2.4% after the conclusion of the election. This was the largest decline in both points and percentage terms since June. However, the Dow rose 4.07 points, less than 0.1% throughout the week to finish on the positive end. President Obama has said there will be a conclusion about the fiscal cliff by the year end, but any deal would result in higher taxes on high-income households. Despite the fluctuating markets, the rest of the economy looks promising with high consumer confidence and positive readings on wholesale inventories indicating a spike in spending during the holiday months. 

Fed Releases "Stress Test" Instructions by Dan Fitzpatrick, November 10, 2012, Section 2 Page 2, www.wsj.com  On Friday, the Federal Reserve began the next round of annual "stress tests" for big banks. These test began in 2009 at the peak of the financial crisis. This process allows the Fed to supervise the "health" of the nation's largest banks in order to insure they are not investing in toxic investments. The new round of stress tests also included is a new opportunity for banks to change their proposals to pay dividends of buyback shares before the Fed decides to approve or reject their capital plans. After the Fed conducts these tests they will release summary results - including capital rations, losses and revenues - for the nation's 19 largest banks. This information will allow investors to see where their investment bank stands an whether or not it is healthily investing, forcing banks to hold themselves accountable as to not loose clients.

The Economy's Reaction to Another Obama Term

Before the presidential election many businesses and investors worldwide watched the debates with unease. Depending on who was elected would determine which spending, taxing, and health care policies would be put into place. The two candidates - Democrat, Barack Obama and Republican, Mitt Romney - held vastly different fiscal plans for the nation and businesses and investors were concerned with how each policy would affect them. 

Generally after the conclusion of a presidential election, the stock markets see a jump the next day. This would make sense since an election decision would dispel previous uncertainty. However, I was confused when this article appeared in the Wall Street Journal Wednesday morning after President Obama's re-election: Economic Unease Looms After Election 

The U.S. economy has shown improvements in recent months. Unemployment finally dropped below 8 percent to 7.9 percent (it originally dropped to 7.8 percent but rose again as more people started looking for work), stock prices are up, and the housing market is starting to grow. However, the system is still fragile with many European countries fighting their own recessions. 

U.S. stock futures have fallen and the dollar has weakened since Obama's re-election on Tuesday. Many businesses are concerned about what the new administration plans to do about the "fiscal cliff" - more than $600 billion in tax increases and spending cuts to go into effect in 2013. Businesses believe that if this plan goes into effect it could send our economy into another recession. Many businesses have decided to hold back on capitol spending and hiring plans until a deal is made to disband this fiscal cliff. 

On Tuesday, the Dow Jones Industrial Average jumped 133 points, but after the election concluded the Dow dropped again by 312.95 points, 2.36%. This was the biggest point and percentage decline since November 9, 2011. The decline is directly correlated with concern over the fiscal cliff. Hopefully, congress will be able to set aside their differences soon in order to come up with a solution to avoid another market meltdown.

Sandy Leaves Millions Without Power and Some Worrying About the Economy

From the Wall Street Journal article "Sandy Hits Coast, Floods New York" by Jamila Trindle, Michael R. Crittenden, and Michael Howard Saul

Hurricane Sandy hit the East Coast hard on Monday flooding streets in lower Manhattan and wiping away the New Jersey shoreline. Approximately 5.2 million people were left without power across the region Monday night. This is the largest power outage seen since the New York blackout in 2003. Officials predict it will take at least a week to return power to all residents.

A record breaking 13-foot seawater surge flooded New York's Brooklyn Battery tunnel, a major traffic area, as well as portions of the city's subway system. Officials say it will take at least a week for the subway to be up and running again. The subway is a crucial form of transportation for New Yorkers. Many people rely on the subway so much that they do not even have driver's licenses. With the subway down it will be extremely difficult for many people to attend work. 

With businesses, homes, and roads destroyed up and down the coast line, there is concern on how badly the aftermath of this super storm will affect the U.S. economy. According to catastrophe-risk modeling firm EQECAT, damages are expected to affect 20% of the population, which is approximately 62 million people.

The cost of these damages will range from $10 billion to $20 billion compared to Hurricane Irene which cost $10 billion in damages last year. This will add more strain to an economy that is struggling to improve. Even though the disaster will create construction and electrician jobs, many others will be out of work because their companies' buildings no longer exist.

State and local governments will need to use their savings to help pay for repairs to government property such as buildings, national parks, roads etc. Repercussions of this government spending may lead to tax increases in the Northeast to cover repair costs. However, if people are out of work and not making money then they will not be able to afford a tax increase.

In situations like these it is always good to look for the silver lining. Thankfully, damages from Sandy will not be as expensive as Hurricane Katrina which cost $110 billion dollars back in 2005. Hopefully local, state, and federal governments can put their differences aside to work together in an organized and efficient manner to get this crisis behind us as soon as possible.

Inside the Meltdown

In class this week we discussed the Federal Reserve and watched the Frontline production, Inside the Meltdown. The film uncovered how the economy crumbled so fast after the housing bubble burst in 2007 and why Fed chairman Ben Bernanke and Secretary of Treasury Henry Paulson were forced to take action.

The film posed a puzzling question: should the banks have been allowed to fail - causing another great depression - or did the Fed do the right thing by intervening?

I am a firm believer in people taking responsibility for their actions so part of me is in favor of a policy involving moral hazard. However, when the consequences of those actions are so large that they will be detrimental to millions of innocent people, intervention is necessary. Even though the Fed and government eventually got involved they did not approach the situation in the best possible way.

I think there should have been a complete audit of the banking system - investment and commercial - once the Fed realized how much trouble Bear Stearns was in. I realize it was a rather chaotic time and quick decisions were necessary, but if the Fed and the government had a better understanding of the crisis then they could have attacked it more effectively. 

The Fed believed that by bailing out Bear Stearns they would fix the entire toxic system. However, that was not the case and bailout after bailout pushed Henry Paulson to enact a policy of moral hazard with Lehman Brothers. Unfortunately for the market, Lehman Brothers was in worse shape than Bear Stearns and their failure caused the stock market to stall which stalled the entire economy. Banks lost confidence with the market and were refusing to lend any money. When people and businesses cannot get loans to buy houses, cars, start a business, etc. then they aren't spending money and in turn are not stimulating the economy. Also, when there is lack of confidence in the stock market then people want their money out quickly and stop investing which also hinders the economy. Maybe if Paulson had compared Bear Stearns' problems to Lehman Brothers at the beginning they would have let Bear Stern fail instead, or decided to bail out all of the banks with systemic risk, lessening the negative impact on the economy.

It seems throughout this financial crisis that a lack of knowledge is what continues to get the market into trouble. I can appreciate and understand why Wall Street does not want to be regulated, but if they aren't willing to share information then I don't believe they have earned that privilege. As we saw in the article "Swallowed by the London Whale", Ina Drew lost $6 billion dollars for JPMorgan and Chase because she was investing in these risky investments. Unfortunately, Drew and her team were unaware how toxic these investments were because they weren't given all of the details.

People like Alan Greenspan are huge advocates for an open, unregulated market. In theory this system makes sense, but unfortunately when you add in human emotion the system falls apart. Investors become easily blinded by greed and therefore overlook potential problems within the system. They also neglect to share information in order to get ahead. This is why it is necessary for the government to enact some form of regulation. I do not believe the system should be completely nationalized, but regulations with policies of full disclosure are necessary for the prevention of another market meltdown. 

The Warning, "Swallowed by the London Whale"

In class this week we watched the PBS production The Warning, which focused on the lack of regulation on Wall Street, particularly in the area of over-the-counter (OTC) derivatives. We also read the New York Times magazine article, “Swallowed by the London Whale”, which showed how investing in these OTC derivatives negatively affected JPMorgan and Chase.

As defined by the International Swap Dealers Association (ISDA), a derivative is a risk transfer agreement in which the value is determined by the value of an underlying asset. This underlying asset could either be an interest rate, a physical commodity, a company’s equity shares, an equity index, a currency, or any other tradable instrument parties can agree upon.

Derivatives fall into three categories: OTC, listed derivatives or futures, and cleared derivatives. An OTC derivative is negotiated privately between two parties and then booked directly. OTC derivatives are private swaps that take place in secrecy. As we saw in The Warning and in the New York Times article this posed a huge problem for investors. Even though OTC derivatives appeared to be a good investment, investors did not have all of the facts and ended up taking on too much monetary risk without fear of consequences. An open market is key to trading in order for investors to make knowledgeable and responsible trades. However, this wasn’t - and still isn’t - the case. Instead what remained was an accepted belief among investors that the markets were honest. Wall Street had too much freedom and they took advantage of that freedom which cost many companies and banks a lot of money.

There are many different views towards the regulation of Wall Street. People like Alan Greenspan believe government intervention in the markets will hurt the markets more than help them. This means sometimes allowing companies to fail in order for them to learn from their mistakes. Greenspan and his followers remained adamant about blocking all forms of governement regulation, including fraud. The then chair of the CFTC, Brooksley Born, had a different opinion. She looked heavily into OTC derivatives and saw how detrimental that time bomb would be if it went off.

Born uncovered the massive amounts of money flowing into and out of these OTC derivative trades and the lack of transparency within these black boxes. She was fearful of how risky these trades were and how much money they were handling. When the OTC derivatives market reached $595 trillion, Born was forced into action despite the resistance of big leaguers like Alan Greenspan. She petitioned for more regulation but unfortunately no one headed her warning and Born resigned.

JPMorgan and Chase is just one example of secret trading gone wrong. The company lost $6 billion dollars because they were taking great risks without completely weighing the consequences of those risks. However, blame is not to be placed purely on JPMorgan. Markets were holding back key information that investors at JPMorgan overlooked.

I believe some middle ground needs to be met. Greenspan's belief makes sense, but it does not account for human emotion. When people are given too much power, especially when it comes to money, people can get greedy and selfish. Companies do need to take some risk in order to receive reward, but they cannot effectively take those risks without all the facts. It would be like throwing a dart at a dark board you've never seen with your eyes closed.