Monday, March 30, 2009

Case studies shine some light on the credit crisis

By John Authers, Investment editor
Published: March 27 2009 18:52 | Financial Times

MBAs get a bad press. The great ideas they learnt at business school are now held – with some justice – to have caused last year’s financial implosion.

But even if it is over-simplified, the business school case study has its merits as a way to learn. You are presented with a few typed pages, with some numerical exhibits. Often these are presented from one person’s point of view. You are the marketing manager and your product’s market share is declining. How do you respond? The case offers a few options for solving the problem.

Students split up into groups and argue through the case, aided by clear results from Excel spreadsheets. The professor ends by revealing what happened to the marketing manager in real life.

The attempts to deal with the financial crisis are at a delicate stage. The issues are mind-bendingly complex. How will business schools present it in years to come?

Tim Geithner is the US Treasury secretary. Confidence in the banking system has collapsed. Banks cannot trade so-called “toxic” assets; nobody knows how much these assets are worth. What should he do?

Students would have two choices, which are the same choices that policymakers have had for a year now. Either the government can decide which institutions are insolvent and take them over. Or it can buy toxic assets. This assumes that the problem is illiquidity – if only there were buyers in the market, there would be sellers, and there would be a price. If money enters, the market can resume.

How would MBA students approach it? They would start by going through the data on a spreadsheet. After a few hours, they would still have no clue what the assets were worth. This undercuts either approach – the government might be getting involved in a bottomless pit or it may be making a drastic intervention where none is needed. Investors may not get involved if they have no idea what an asset is worth.

They would also be convinced that nationalising is a last resort – the case material makes clear that it is a difficult operation.

So maybe there is a solution that straddles the two. Use government funds to buy toxic assets, but do it in a way that prompts the private sector to get involved. Banks open their assets for inspection and private sector fund managers can work out what the assets are worth. This will either solve the problem or show beyond doubt that something more drastic is needed. Either would represent progress.

Such a plan is what Mr Geithner unveiled this week, to a negative response from academics and a positive response from the stock market.

What would the professor say next? My greatest fear is that he would introduce the concept of “adverse selection”, the risk that arises when information is not shared equally between buyer and seller. For example, those who know they may need insurance are more likely to buy it.

Posterity may yet turn the Geithner plan into the definitive study of adverse selection. The risk is that banks will only put on offer the assets that they believe to be truly worthless and that buyers, fearing this, will not buy from them. If this happens, then the plan will merely have wasted time; if adverse selection can be overcome, then it should at least be a step towards ending the crisis.

Here is another case study. Jane Doe is an investor. It is the end of March 2009. How should she allocate her investments?

Over the past few months, MBA students have had a crash course in stock market history. Everyone now knows that moments when all hope has been abandoned (and such a moment occurred early in March) generally turn out to be the best long-term buying opportunities.

The rally since then has seen the S&P 500 rebound by almost 25 per cent in three weeks. March could be the best month for US stocks since 1974.

Commodity prices, led by oil and industrial metals, are recovering. So are cyclical stocks – both signs that the market is pricing in an economic recovery. The bond market is no longer priced for deflation.

But the case study has bearish points. Credit has barely recovered since the worst of the crisis last autumn and barely budged when the Geithner plan was announced. It is still pricing in unprecedented defaults.

MBA students also now know that the most reliable long-term indicators for market timing, such as cyclically adjusted price/earnings multiples, are not yet as cheap as they were at the bottom of previous bear markets.

Two weeks ago, short interest – the proportion of shares that had been borrowed and then sold, to bet they would go down – was as high as at any time since the crisis began. So this looks like a trading bounce, as traders take profits. History’s great bear markets have all been punctuated by big rallies.

So an MBA student would counsel caution, not making a big bet either way. Posterity will judge.

Ultimately, the solution to this case depends on the outcome of the first – if the Geithner plan gets closer to resolving the banking mess, stocks may never return to the lows of March. If it just delays progress, history shows that stocks could still go much lower.

Saturday, March 28, 2009

New bail-out, new divergence

By Michael Mackenzie in New York
Published: March 27 2009 15:35 | Financial Times

A new bail-out plan from the US Treasury and once again, a divergence of opinion between equity and fixed income investors.

The equity crowd eagerly snapped at the bone thrown by Tim Geithner this week. His unveiling of the public-private investment plan (PPIP) revealed a few more details than his hazy statement in February, which had sent stocks tumbling.

But fixed income investors were less taken by Mr Geithner’s latest offering, a stance that has long defined their behaviour since the credit and mortgage crisis emerged in August 2007.

The substantial rally in banking stocks has been accompanied by a far more tentative rebound in the various derivative indices for leveraged loans and subprime mortgages, which the PPIP is expected to grease.

The mechanics of the PPIP also illustrate just how broken finance has become since the onset of the crisis. Not only do some bankers expect a bonus in the bad years, private investors require a hefty lay up from the taxpayer before they take a punt and buy impaired assets.

Beyond the irony that the Treasury is relying on securitisation and leverage to resolve a banking crisis that is based on excessive borrowing and owning securitised assets, the PPIP is trying to resolve a paradox between banks and investors.

There is a substantial gap between the price at which banks want to sell their loans and mortgages, and the price investors are willing to pay for them.

The PPIP is attempting to get the market for impaired mortgages and loans moving by clarifying a clearing price for these assets. The Treasury hopes that investors, bearing little risk as the taxpayer is on the hook, will close the gap between the bid and offer for these assets.

Complicating the standoff associated with setting a market price is the likelihood that banks will cherry pick their portfolios of loans and sell the bad stuff.

As one trader put it this week: “Why should a bank give hedge funds an opportunity to clean up?”

For an investor, buying lemon loans will not translate into lemonade. They also need loans with some upside to sweeten the deal.

More than 18 months into this mess, the Treasury still acts as if the problem facing markets is a lack of liquidity, not one of solvency. Since the demise of Lehman Brothers last September, fixed income investors have voted for insolvency. Ominously, the peak in corporate and consumer bankruptcies for this current recession and ensuing torching of bank loans, is likely still to be a long way in the future.

Such an outlook is not priced in to the equity market, given the rally in banking stocks this month. But the fixed income market suggests a lot of these assets are nearly worthless.

This is where things could get very nasty. Here we have the taxpayer being set up to transfer funds to investors and banks; but there is no guarantee that financial institutions will play ball.

Lurking behind this is the fear that the sale of loans and mortgages at prices set under the PPIP will reveal that some institutions are insolvent.

Banks are still in a position to play for more time. Should they fail the Treasury’s highly publicised stress tests, which should be completed by the end of April, banks will have another six months to try to raise private capital. They can remain zombies throughout that period.

One big unanswered question is how tough the Federal Deposit Insurance Corporation will be with those banks and whether it will force them to sell loans and raise more capital ahead of that schedule.

For all its shortcomings, the PPIP may be an act of Kabuki theatre that moves us one step closer to knowing the full cost of Wall Street’s collective failure. That might then open the door to what has been an unpalatable prospect for regulators: the outright nationalisation of banks. In these circumstances, maybe everyone might at least agree with such an extreme outcome.

Thursday, March 26, 2009

Le "show" de Nicolas Sarkozy devant les députés UMP

LEMONDE.FR | 25.03.09 | 19h41 • Mis à jour le 25.03.09 | 21h01

U n exercice comme il les aime, dès qu'il y a de la friture sur la ligne avec sa majorité. Après les dissonances exprimées ici ou là sur l'OTAN, le bouclier fiscal, la gestion de la crise, Nicolas Sarkozy avait convoqué les députés de l'UMP à l'Elysée, mercredi 25 mars, à l'heure du déjeuner. Le problème est que cela fonctionne de moins en moins. Certains ne prennent même plus la peine d'y aller. Les autres commentent les propos présidentiels comme s'il s'agissait d'un sketch, se remémorant les meilleurs passages, en retenant les "bons mots". Exemples choisis, à la manière de Cyrano.

Matamore. "En France, on avait trois handicaps : les 35 heures, les grèves et la fiscalité. On a réglé les 35 heures. Quand il y a une grève comme celle du 19, le pays n'est pas paralysé. Sur le bouclier, ma capacité à reculer n'est pas d'un millimètre. Prenez-moi bien en photo : je ne créerai pas une nouvelle tranche d'impôt, on n'abandonnera pas le bouclier fiscal."

Pugnace. "On ne peut pas imaginer des bonus dans les entreprises aidées par l'Etat. Le Medef a jusqu'au 31 mars pour nous faire des propositions. Je ne peux pas accepter que Laurence Parisot dise qu'elle n'a pas le désir d'évoquer le partage des profits. Mais on ne peut pas faire boire un âne qui n'a pas soif. Si le Medef y va pas, on ira par la loi."

Princier. "Je veux une liste des paradis fiscaux et les faire sanctionner. Je ne veux plus que les banques travaillent avec les Caïmans, Hongkong et Macao. Sinon, je démissionnerai de mon poste de coprince d'Andorre. Monaco doit aussi s'aligner : j'en parlerai au prince Albert. Même la Suisse a cédé."

Pédagogue. "On est le dernier pays à avoir l'ISF. Bon courage pour savoir qui est riche. Si on supprime le bouclier, on tapera sur les classes moyennes. On a deux impôts sur le revenu et l'ISF. Sinon, ça laisse à penser à ceux qui ont de l'argent qu'on va leur demander d'expier. Moi, je préfère qu'ils investissent."

Décomplexé. "On a un complexe en France avec ceux qui réussissent, qui gagnent de l'argent. Je parie que le candidat PS en 2012 ne voudra pas revenir sur ce qu'on a fait sur les droits de succession. Ne tombez pas dans le piège de la social-démocratie."

Fataliste : "Pas une seule réforme ne nous apporte pas d'emmerdes."

Volontariste : "Moi, je vais dans les entreprises toutes les semaines et je monte sur la caisse."

Moraliste : "Une famille doit s'occuper de ses vieux."

Radical : "Quand un préfet fait mal son travail, il dégage. C'est normal. Et qu'est-ce qu'on dit des directeurs de rédaction qui perdent des lecteurs ? Eux, ils sont pas changés."

Optimiste : "La crise nous rend notre liberté. Elle nous donne la possibilité de renouveler notre corpus idéologique, ça nous fait réfléchir. La période est formidable. C'est nous qui conduisons le bateau. On n'a pas le droit d'avoir peur. Je me fais taper dessus, mais j'ai la banane. On a besoin de nous et ça paiera."

A la sortie du show présidentiel, les critiques étaient unanimes : "Un bon spectacle."

Patrick Roger

Obama’s bank plan could rob the taxpayer

By Jeffrey Sachs

Published: March 25 2009 23:14 Financial Times

The Geithner-Summers plan, officially called the public/private investment programme, is a thinly veiled attempt to transfer up to hundreds of billions of dollars of US taxpayer funds to the commercial banks, by buying toxic assets from the banks at far above their market value. It is dressed up as a market transaction but that is a fig-leaf, since the government will put in 90 per cent or more of the funds and the “price discovery” process is not genuine. It is no surprise that stock market capitalisation of the banks has risen about 50 per cent from the lows of two weeks ago. Taxpayers are the losers, even as they stand on the sidelines cheering the rise of the stock market. It is their money fuelling the rally, yet the banks are the beneficiaries.

The plan’s essence is to use government off-budget money to overpay for banks’ toxic assets, perhaps by a factor of two or more. This is done by creating a one-way bet for private-sector bidders for the toxic assets, then cynically calling it “private sector price discovery”. Consider a simple example: a toxic asset with face value of $1m pays off fully with probability of 20 per cent and pays off $200,000 with probability of 80 per cent. A risk-neutral investor would pay $360,000 for this asset.

Along comes the government and says it will finance 90 per cent of the investor’s purchase and, moreover, do so as a non-recourse loan. Non-recourse means the government’s loan is backed only by the collateral value of the toxic asset itself. If the pay-out is low, the loan is defaulted and the government ends up with the low pay-out rather than full repayment of the loan.

Now the investor is prepared to bid $714,000 (with rounding) for the same asset. The investor uses $71,000 of his/her own money and $643,000 of the government loan. If the asset pays off in full, the investor repays the loan, with a profit of $357,000. This happens 20 per cent of the time, so brings an expected profit of $71,000. The other 80 per cent of the time the investor defaults on the loan, and the government ends up with $200,000. The investor just breaks even by bidding $714,000, as we would expect in a competitive auction.

Of course, the investor has systematically overpaid by $354,000 (the bid price of $714,000 minus the market value of $360,000), reflecting the investor’s right to default on the loan in the event of a poor pay-out of the toxic asset. The overpayment equals the expected loss of the government loan. After all, 80 per cent of the time (in this example) the government loses $443,000 (the $643,000 loan minus the $200,000 repayment). The expected loss is 80 per cent of $443,000, equal to $354,000.

The idea of “private sector price discovery” is therefore flim-flam. There would be price discovery if the government’s loan had to be repaid whether or not the asset paid off in full. In that case, the investor would bid $360,000. But under the Geithner-Summers plan the loan is precisely designed to be a one-way bet, for the purpose of overpricing the toxic asset in order to bail out the bank’s shareholders at hidden cost to the taxpayers.

The banks could be saved without saving their shareholders – a better deal for taxpayers and without the moral hazard of rescuing shareholders from the banks’ bad bets. Most simply, the government could provide loans to buy the toxic assets on a recourse basis, therefore without the hidden subsidy. Alternatively, the plan could give the taxpayers an equity stake in the banks in return for cleaning their balance sheets. In cases of insolvency, the government could take over the bank, the much dreaded nationalisation, albeit temporary. At the end of the Bush administration, Congress voted for the $700bn (€517bn, £479bn) troubled asset relief programme (Tarp) on the assurance the taxpayer would get fair value for money (for example, by taking equity stakes in the rescued banks). The new plan does not offer that.

Tim Geithner, Treasury secretary, and Lawrence Summers, director of the White House national economic council, suspect that they cannot go back to Congress to fund their plan and so are raiding the Federal Reserve, the Federal Deposit Insurance Corporation and the remaining Tarp funds, hoping that there will be little public understanding and little or no congressional scrutiny. This is an inappropriate institutional use of the Fed, the FDIC and the Tarp. Mr Geithner and Mr Summers should at the very least explain the true risks of large losses by the government under their plan. Then, a properly informed Congress and public could decide whether to adopt this plan or some better alternative.

Jeffrey Sachs is director of The Earth Institute at Columbia University

Copyright The Financial Times Limited 2009

Tuesday, March 17, 2009

University of Arizona in the Crosshairs

Tuesday, March 17, 2009

A Research University Copes With Budget Cuts and Skeptical Lawmakers


Tucson, Ariz.

To be at the University of Arizona these days is to be, in some ways, under siege.

The flagship university in one of the nation’s fastest-growing states may have to eliminate some 600 jobs and merge dozens of programs to deal with two rounds of budget cuts imposed since June, and now the governor is telling the university and other state agencies to prepare for cuts of as much as 20 percent for the next fiscal year.

The university had already begun last summer to look for ways to significantly overhaul its operations, but those changes alone won’t be enough to offset the reductions in state aid.

University leaders feel their core mission is at stake, as they struggle to make a case for the public value of a research university to a governor and key legislators who have found success in life without having earned a four-year degree.

The reductions threaten to become so severe that some higher-education officials say they may even violate a requirement in the State Constitution that public higher education be “as nearly free as possible.” To offset the loss in state aid, the university may decide it needs to raise tuition, which has already increased by nearly 10 percent per year over the past decade.

For their part, legislators say their hands are tied. Laws direct how two-thirds of the state’s budget must be spent, leaving the Legislature little choice but to cut from discretionary dollars that go to higher education in order to close billions of dollars of budget gaps. Relief could come from the federal stimulus package or proposed state tax increases, but some lawmakers still say universities should be more efficient by, for example, making better use of technology and distance learning to provide more degrees at a lower cost to students and the state.

Exceptional Struggles

Arizona is hardly alone in facing tough choices. All but a handful of states are projecting budget shortfalls, and universities across the nation are facing similar—though typically smaller—cuts.

The extent of the economic troubles Arizona faces, however, is extraordinary. The revenue shortfall for the 2009-10 budget is estimated to be 28 percent of the state’s general fund, the second-highest percentage gap in the nation, behind Nevada, according to the National Conference of State Legislatures. State tax revenue in Arizona is not expected to rebound to 2007-8 levels until the 2011-12 fiscal year, according to a recent report from the state’s Joint Legislative Budget Committee.

So far, the state’s universities have taken more than their share of budgetary pain. At the beginning of this fiscal year, lawmakers trimmed nearly 5 percent from the higher-education budget. Then, facing a midyear gap of $1.6-billion in January, legislators cut an additional 13 percent, or $141-million, from the state’s three public universities, the largest dollar amount cut from any single area in the state budget. The estimated budget gap for the next fiscal year, which begins July 1, is $3-billion.

One problem with the state’s finances is that more than 45 percent of its revenue comes from sales taxes, which are normally bolstered by large numbers of tourists and by retired residents. That proportion jumps to nearly 60 percent when levies on alcohol, insurance premiums, and amusements like movies or sporting events are included, according to the U.S. Census Bureau.

Consumer retrenchment has hit the state hard: Sales-tax revenue was down 16 percent in December from the same month the year before and is more than 10 percent lower for the first six months of the budget year compared with the same time period a year ago, according to the Arizona Department of Revenue.

The bursting of the mortgage bubble has halted new-home and commercial construction, driving up the state’s unemployment rate to 7 percent in January. While that is below the national average, Arizona lost more than 166,000 jobs over the past year, the sixth-highest number in the nation, according to the U.S. Bureau of Labor Statistics.

Political Hurdles

In the face of the state’s economic struggles, Arizona legislators from both parties say there is no choice but to make sacrifices. But some areas, like elementary and secondary education, are more protected than colleges because the Legislature is required to follow spending formulas for them, said State Sen. Jonathan Paton, a Republican and graduate of the University of Arizona. What’s more, he said, the rate of increase in spending required by those formulas will outpace the projected rate of increase in state revenue in each of the next several years.

The Senate minority leader, Jorge Luis Garcia, a Democrat with degrees from both the University of Arizona and Arizona State University, said higher education was a priority for members of his party, but it still did not take precedence over services like health care for low-income families.

Tommy Bruce, president of the University of Arizona’s student association, understands that the state has other needs, but he argued that cuts in higher education undermine the state’s future. “When it comes down to it, our state needs to get creative about ensuring long-term economic growth,” he said.

Some students and administrators on Arizona’s public campuses, and even some lawmakers, say there is a persistent bias against the universities in the Legislature. Some lawmakers believe that higher education is a private benefit and not the responsibility of government, said Robert N. Shelton, president of the University of Arizona.

A small but influential group of Republicans in both chambers has taken strong stances against the universities, calling appropriations to help pay for research partnerships between businesses and colleges “corporate welfare” and railing against the salaries of some university leaders.

Other university advocates say that negative views of higher education in the Legislature are the result of some members’ limited college experiences. A number of key legislators, including the Senate president and majority leader, do not hold bachelor’s degrees. Gov. Janice K. Brewer, a Republican, also does not have a bachelor’s degree, although she earned a professional certificate as a radiological technician.

“I think that unless you have lawmakers that have a history with higher education, it’s going to be harder to get them interested in it, and the value of it,” Senator Paton said.

Rep. Vic Williams, a Republican who lists a GED and “some college” in his biography, said the question of whether lawmakers without four-year degrees were biased against the universities was “inappropriate” and “inflammatory.” But he asked college officials to work with legislators to find a balanced solution to the state’s budget shortfall.

Higher-education advocates also face an uphill battle with some lawmakers who have degrees but also have strong ideas about how the universities are, or should be, operating.

“If you saw someone traveling to work in the morning on an ox pulling a cart, that’s my mental image of the education system,” said State Sen. John Huppenthal, a Republican and chairman of the Senate Education Accountability and Reform Committee. Mr. Huppenthal, who has an M.B.A. from Arizona State University, said he wasn’t “hostile fiscally” to universities, but he was skeptical of the individual economic benefits of a college degree.

Rep. Rich Crandall, a Republican and the chairman of the House Education Committee who holds degrees from Brigham Young University and the University of Notre Dame, said he understood the economic benefits that large universities have on their communities and might be in favor of increasing some taxes to repair the state budget. But he said institutions need to do more to improve, such as by making more courses available online. “The question becomes, Are you adapting to the changing world?” he said.

Pulling Back in Tough Times

The University of Arizona is adapting to dwindling state aid by dumping degree programs that graduate too few students and limiting programs to areas in which the university thinks it can become a national leader. The goal of the university’s approach is to cut spending on administrative operations and increase overall revenue by ensuring that it is competitive for research money in key areas. The university had nearly $270-million worth of federally financed research in 2007.

“I think we’re finally going to make hard decisions … and say we can’t just be a great university in all areas,” said Paul R. Portney, dean of the university’s Eller College of Management. Mr. Portney leads a group of deans who are planning what programs the university will keep or jettison as it develops a new area of focus on environmental research and policy.

The state’s Board of Regents, which governs the University of Arizona and the state’s two other public universities—Arizona State and Northern Arizona Universities—has also approved the institutions’ request to bolster revenue by increasing limits on the proportion of undergraduates from out of state from 30 percent to 40 percent, beginning next fall. Tuition for out-of-state students is more than three times the price for in-state students at all three institutions.

But there are some things the University of Arizona says it won’t do. Despite pressure from lawmakers, the university won’t dilute its focus on research by adding more online and distance learning, says Meredith Hay, the executive vice president and provost. The university is one of 62 top research universities that are members of the Association of American Universities. It’s the only one in Arizona.

“The core of our experience … is getting students into the laboratory experience and working with professors,” Ms. Hay said. “It’s that face-to-face experience.”

The full extent of the university’s effort to reinvent itself is still being planned by Ms. Hay and a group of deans, who began to solicit suggestions from faculty and staff members in October. So far administrators have decided to consolidate four of the university’s 20 colleges—Fine Arts, Humanities, Science, and Social and Behavioral Sciences—into one College of Letters, Arts, and Science.

University officials expect their plan to save as much as $12-million over two years. But the savings, which equal less than 2 percent of the state’s appropriations to the university, go only a small way toward offsetting expected cuts.

Declining Morale on the Campus

To deal with the Legislature’s midyear cuts, the University of Arizona says it will have to eliminate 600 positions through attrition and layoffs, merge or consolidate as many as 50 academic and administrative programs, and cut all program budgets by 5 percent.

No final decisions have been made about which majors will be dropped, but several degrees in physics, secondary education, and the fine arts are being considered because they have produced too few graduates in recent years. Ms. Hay said the university was concerned that a classroom with five students, for example, was not cost-efficient.

But the short-term budget cuts and the long-term plans being made to trim the university’s offerings are taking a toll on the campus.

“Morale is obviously really down,” said Maurice J. Sevigny, dean of the College of Fine Arts. “We’re running out of things to consolidate.”

Jeff Goldberg, interim dean of the College of Engineering, said that in some cases the university would be limiting students’ options without saving much money because even if the majors are dropped, many of the courses will remain. For example, majors in engineering mathematics and engineering physics, which are both being considered for elimination, rely on existing courses in both engineering and mathematics.

Cuts in programs may also drive some students away, including nonresidents the university wants to attract. “I have friends who are from out of state who won’t be continuing,” said Elma Delic, a sophomore studying journalism. “If they have to pay so much and so many things are being cut, then they say it isn’t worth it anymore.”

Even officials who oversee the plan are concerned about whether the reduced number of faculty members and pared academic offerings will meet the educational needs of a state with few institutions and a lot of students.

The population of Arizona grew by 23 percent from 2000 to 2007, according to the U.S. Census Bureau, and the number of high-school graduates is projected to increase by about 29 percent over the next decade.

“It’s a very challenging time,” Ms. Hay said. “We’re ultimately decreasing numbers of faculty at the same time we’re increasing enrollment.”

Possible Resolutions

As they consider how to respond to the economic situation, lawmakers say the dire economic conditions could make it politically feasible to support tax increases.

To close the budget gap for next year, Governor Brewer, who took over in January when President Obama tapped her predecessor, Janet Napolitano, to be his Secretary of Homeland Security, has told lawmakers she supports a $1-billion increase in taxes in each of the next three years, along with $1-billion in spending cuts. The governor proposes to cover the final billion of the state’s shortfall for the 2010 fiscal year with federal stimulus money.

Ms. Brewer has not recommend specific tax increases, but two possibilities floated by legislators in recent weeks include allowing the state’s property tax to go back into effect after being suspended for three years and increasing the sales tax by 1 cent.

While the flagging economy could give lawmakers political cover, any tax increase would require approval by two-thirds of the Legislature, and many lawmakers from both parties have signed a no-new-tax pledge.

If there is no long-term fix for higher-education financing, the Board of Regents is considering a plea to voters or the courts for more state money. Officials of the board said they might pursue a ballot measure that would ask voters to dedicate tax dollars to universities, or they may look into suing the state, charging that it is violating the Arizona Constitution by inadequately supporting higher education.

Fred DuVal, a regent, said the decision to make one of those moves could come within a year.

“At the point when we move from a state-supported system to a state-assisted system, do we have a constitutional violation?” Mr. DuVal asked. “The goal is not to drop a bomb on the Legislature. It’s a move to hold the Constitution out as a model.”

Saturday, March 14, 2009

Les Norvégiens choqués par les pertes du Fonds du pétrole

LE MONDE | 12.03.09 | 14h36 • Mis à jour le 12.03.09 | 14h36

Ils avaient beau s'y attendre, les Norvégiens ont tout de même été choqués quand mercredi 11 mars le président de la Banque centrale de Norvège, Svein Gjedrem, leur a révélé l'ampleur des pertes subies en 2008 par le Fonds d'Etat de retraite-étranger, alias le Fonds du pétrole, l'un des plus gros fonds souverains au monde : 633 milliards de couronnes (71,4 milliards d'euros).

La banque, responsable de sa gestion, a reconnu "un résultat historiquement bas". Si le Fonds a augmenté à 2 275 milliards de couronnes grâce à l'apport exceptionnellement élevé de 384 milliards de recettes en hydrocarbures, le rendement a reculé de 23,3 % en 2008, du jamais-vu depuis la création du Fonds en 1990 et les premiers dépôts en 1996. Dix années d'intérêts ont été effacées.


Ce fonds a été créé afin de garantir les retraites des générations futures et d'éviter la surchauffe de l'économie norvégienne. Gros acheteur d'obligations et d'actions, il est ainsi actionnaire de 7 900 compagnies internationales, possède 0,77 % du marché mondial des actions et est le premier actionnaire européen. Les principales participations en actions sont détenues dans Shell (15,2 milliards de couronnes), Nestlé, BP, ExxonMobil et Total (11,3 milliards de couronnes).

De telles pertes auraient-elles pu être évitées en cette période de crise financière mondiale ? "Ma principale réponse est qu'il n'y a pas eu beaucoup d'endroits où se cacher", a répliqué M. Gjedrem.

C'est le mandat même du Fonds qui est critiqué car sa gestion est de plus en plus active. 70 milliards de couronnes ont ainsi été perdus à cause des choix actifs opérés par les gestionnaires. "Une gestion active ne fonctionne que si le trader est plus intelligent et a plus d'informations que le reste du marché", note Per Valebrokk, chroniqueur du site économique, qui ajoute que, visiblement, les traders norvégiens n'ont été ni plus intelligents ni mieux informés. Certains, comme Lars Haakon Søraas, un analyste financier, réclame le renvoi de l'équipe et propose de suivre désormais un indice de référence décidé par le ministère des finances.

Même si le Fonds, qui est un placement à long terme, sera sans doute gagnant sur la durée estiment d'autres experts, de nombreux Norvégiens sont en colère. Selon eux, l'Etat providence n'est pas à la hauteur d'un pays aussi riche, avec des hôpitaux, des écoles ou des routes en mauvais état. Depuis des années, cette contestation fait le fonds de commerce d'un parti populiste de droite devenu la deuxième formation du royaume.

Olivier Truc
Article paru dans l'édition du 13.03.09

Monday, March 9, 2009

Seeds of its own destruction

By Martin Wolf
Published: March 8 2009 19:13 Financial Times

Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.

“The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” Thus quipped Ronald Reagan, hero of US conservatism. The remark seems ancient history now that governments are pouring trillions of dollars, euros and pounds into financial systems.

“Governments bad; deregulated markets good”: how can this faith escape unscathed after Alan Greenspan, pupil of Ayn Rand and predominant central banker of the era, described himself, in congressional testimony last October, as being “in a state of shocked disbelief” over the failure of the “self-interest of lending institutions to protect shareholders’ equity”?

In the west, the pro-market ideology of the past three decades was a reaction to the perceived failure of the mixed-economy, Keynesian model of the 1950s, 1960s and 1970s. The move to the market was associated with the election of Reagan as US president in 1980 and the ascent to the British prime ministership of Margaret Thatcher the year before. Little less important was the role of Paul Volcker, then chairman of the Federal Reserve, in crushing inflation.

Yet bigger events shaped this epoch: the shift of China from the plan to the market under Deng Xiaoping, the collapse of Soviet communism between 1989 and 1991 and the end of India’s inward-looking economic policies after 1991. The death of central planning, the end of the cold war and, above all, the entry of billions of new participants into the rapidly globalising world economy were the high points of this era.

Today, with a huge global financial crisis and a synchronised slump in economic activity, the world is changing again. The financial system is the brain of the market economy. If it needs so expensive a rescue, what is left of Reagan’s dismissal of governments? If the financial system has failed, what remains of confidence in markets?

It is impossible at such a turning point to know where we are going. In the chaotic 1970s, few guessed that the next epoch would see the taming of inflation, the unleashing of capitalism and the death of communism. What will happen now depends on choices unmade and shocks unknown. Yet the combination of a financial collapse with a huge recession, if not something worse, will surely change the world. The legitimacy of the market will weaken. The credibility of the US will be damaged. The authority of China will rise. Globalisation itself may founder. This is a time of upheaval.

How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.

In the US, core of the global market economy and centre of the current storm, the aggregate debt of the financial sector jumped from 22 per cent of gross domestic product in 1981 to 117 per cent by the third quarter of 2008. In the UK, with its heavy reliance on financial activity, gross debt of the financial sector reached almost 250 per cent of GDP.

Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard argue that the era of liberalisation was also a time of exceptionally frequent financial crises, surpassed, since 1900, only by the 1930s. It was also an era of massive asset price bubbles. By intervening to keep their exchange rates down and accumulating foreign currency reserves, governments of emerging economies generated huge current account surpluses, which they recycled, together with inflows of private capital, into official capital outflows: between the end of the 1990s and the peak in July 2008, their currency reserves alone rose by $5,300bn.

These huge flows of capital, on top of the traditional surpluses of a number of high-income countries and the burgeoning surpluses of oil exporters, largely ended up in a small number of high-income countries and particularly in the US. At the peak, America absorbed about 70 per cent of the rest of the world’s surplus savings.

Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.

Throughout, the financial sector innovated ceaselessly. Warren Buffett, the legendary investor, described derivatives as “financial weapons of mass destruction”. He was proved at least partly right. In the 2000s, the “shadow banking system” emerged and traditional banking was largely replaced by the originate-and-distribute model of securitisation via constructions such as collateralised debt obligations. This model blew up in 2007.

We are witnessing the deepest, broadest and most dangerous financial crisis since the 1930s. As Profs Reinhart and Rogoff argue in another paper, “banking crises are associated with profound declines in output and employment”. This is partly because of overstretched balance sheets: in the US, overall debt reached an all-time peak of just under 350 per cent of GDP – 85 per cent of it private. This was up from just over 160 per cent in 1980.

Among the possible outcomes of this shock are: massive and prolonged fiscal deficits in countries with large external deficits, as they try to sustain demand; a prolonged world recession; a brutal adjustment of the global balance of payments; a collapse of the dollar; soaring inflation; and a resort to protectionism. The transformation will surely go deepest in the financial sector itself. The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it. As Mr Volcker remarked during a speech last April: “Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the marketplace.”

In a recent paper Andrew Haldane, the Bank of England’s executive director for financial stability, shows how little banks understood of the risks they were supposed to manage. He ascribes these failures to “disaster myopia” (the tendency to underestimate risks), a lack of awareness of “network externalities” (spill overs from one institution to the others) and “misaligned incentives” (the upside to employees and the downside to shareholders and taxpayers).

After the crisis, we will surely “see finance less proud”, as Winston Churchill desired back in 1925. Markets will impose a brutal, if temporary, discipline. Regulation will also tighten.

Less clear is whether policymakers will contemplate structural remedies: a separation of utility commercial banking from investment banking; or the forced reduction in the size and complexity of institutions deemed too big or interconnected to fail. One could also imagine a return of much banking activity to the home market, as governments increasingly call the tune. If so, this would be “de-globalisation”.

Churchill called also for industry to be “more content”. In the short run, however, the collapse of the financial system is achieving the opposite: a worldwide industrial slump. It is also spreading to every significant sector of the real economy, much of which is clamouring for assistance.

Yet if the financial system has proved dysfunctional, how far can we rely on the maximisation of shareholder value as the way to guide business? The bulk of shareholdings is, after all, controlled by financial institutions. Events of the past 18 months must confirm the folly of this idea. It is better, many will conclude, to let managers determine the direction of their companies than let financial players or markets override them.

A likely result will be an increased willingness by governments to protect companies from active shareholders – hedge funds, private equity and other investors. As a defective financial sector loses its credibility, the legitimacy of the market process itself is damaged. This is particularly true of the free-wheeling “Anglo-Saxon” approach.

No less likely are big changes in monetary policy. The macro economic consensus had been in favour of a separation of responsibility for monetary and fiscal policy, the placing of fiscal policy on autopilot, independence of central banks and the orientation of monetary decisions towards targeting inflation. But with interest rates close to zero, the distinction between monetary and fiscal policy vanishes. More fundamental is the challenge to the decision to ignore asset prices in the setting of monetary policy.

Many argue that Mr Greenspan, who succeeded Mr Volcker, created the conditions for both bubbles and subsequent collapse. He used to argue that it would be easier to clean up after the bursting of a bubble than identify such a bubble in real time and then prick it. In a reassessment of the doctrine last November, Donald Kohn, Fed vice-chairman, restated the orthodox position, but with a degree of discomfort.

Mr Kohn now states that “in light of the demonstrated importance to the real economy of speculative booms and busts (which can take years to play out), central banks probably should always try to look out over a long horizon when evaluating the economic outlook and deliberating about the appropriate accompanying path of the policy rate”. Central banks will have to go further, via either monetary policy or regulatory instruments.

Yet a huge financial crisis, together with a deep global recession, if not something far worse, is going to have much wider effects than just these.

Remember what happened in the Great Depression of the 1930s. Unemployment rose to one-quarter of the labour force in important countries, including the US. This transformed capitalism and the role of government for half a century, even in the liberal democracies. It led to the collapse of liberal trade, fortified the credibility of socialism and communism and shifted many policymakers towards import substitution as a development strategy.

The Depression led also to xenophobia and authoritarianism. Frightened people become tribal: dividing lines open within and between societies. In 1930, the Nazis won 18 per cent of the German vote; in 1932, at the height of the Depression, their share had risen to 37 per cent.

One transformation that can already be seen is in attitudes to pay. Even the US and UK are exerting direct control over pay levels and structures in assisted institutions. From the inconceivable to the habitual has taken a year. Equally obvious is a wider shift in attitudes towards inequality: vast rewards were acceptable in return for exceptional competence; as compensation for costly incompetence, they are intolerable. Marginal tax rates on the wealthier are on the way back up.

Yet another impact will be on the sense of insecurity. The credibility of moving pension savings from government-run pay-as-you-go systems to market-based systems will be far smaller than before, even though, ironically, the opportunity for profitable long-term investment has risen. Politics, like markets, overshoot.

The search for security will strengthen political control over markets. A shift towards politics entails a shift towards the national, away from the global. This is already evident in finance. It is shown too in the determination to rescue national producers. But protectionist intervention is likely to extend well beyond the cases seen so far: these are still early days.

The impact of the crisis will be particularly hard on emerging countries: the number of people in extreme poverty will rise, the size of the new middle class will fall and governments of some indebted emerging countries will surely default. Confidence in local and global elites, in the market and even in the possibility of material progress will weaken, with potentially devastating social and political consequences. Helping emerging economies through a crisis for which most have no responsibility whatsoever is a necessity.

The ability of the west in general and the US in particular to influence the course of events will also be damaged. The collapse of the western financial system, while China’s flourishes, marks a humiliating end to the “uni-polar moment”. As western policymakers struggle, their credibility lies broken. Who still trusts the teachers?

These changes will endanger the ability of the world not just to manage the global economy but also to cope with strategic challenges: fragile states, terrorism, climate change and the rise of new great powers. At the extreme, the integration of the global economy on which almost everybody now depends might be reversed. Globalisation is a choice. The integrated economy of the decades before the first world war collapsed. It could do so again.

On June 19 2007, I concluded an article on the “new capitalism” with the observation that it remained “untested”. The test has come: it failed. The era of financial liberalisation has ended. Yet, unlike in the 1930s, no credible alternative to the market economy exists and the habits of international co-operation are deep.

“I’ve a feeling we’re not in Kansas any more,” said Dorothy after a tornado dropped her, her house and dog in the land of Oz. The world of the past three decades has gone. Where we end up, after this financial tornado, is for us to seek to determine.

This is the first part of an FT series entitled the Future of Capitalism