Lessons From the Financial Crisis

BOSTON — What did the financial crisis teach central bankers?

The Federal Reserve chairman, Ben S. Bernanke, said Tuesday that the great lesson was the need to juggle two jobs: the traditional work of managing the pace of inflation and the forgotten job of maintaining financial stability.

Mr. Bernanke’s speech largely amounted to a defense and explanation of the Fed’s conduct during the crisis. The lessons he described included the propriety of the Fed’s existing approach to monetary policy and the necessity of its various innovations, including lending dollars to other countries.

But the Fed chairman acknowledged, as he has before, that the Fed and other central banks had neglected the work of financial supervision.

“The crisis has forcefully reminded us that the responsibility of central banks to protect financial stability is at least as important as the responsibility to use monetary policy effectively,” Mr. Bernanke said at an annual policy conference hosted by the Federal Reserve Bank of Boston.

One of the great questions left by the housing crash is whether the Fed could have popped the bubble at an earlier stage, limiting the damage. Mr. Bernanke said Tuesday that the Fed does have a responsibility to address emerging problems, something that central bankers long described as impossible or inappropriate.

Mr. Bernanke said, however, that he agreed with “an evolving consensus” that this work required different tools than those for monetary policy.

“In my view, the issue is not whether central bankers should ignore possible financial imbalances — they should not — but, rather, what ‘the right tool for the job’ is to respond to such imbalances,” he said.

The Fed, by adjusting interest rates, can deflate the economy, but there is no obvious mechanism for focusing the impact on a specific asset class, like housing.

Instead, Mr. Bernanke said that the tools of financial regulation were the best means for maintaining financial stability, through limits and requirements on the ways financial institutions lend and borrow.

Mr. Bernanke said that the crisis had tested what he described as the consensus model of monetary policy but that in his view it had emerged largely unscathed.

He described this model as “flexible inflation targeting,” meaning that the Fed seeks to maintain a steady rate of increase in prices and wages of about 2 percent a year, with a willingness to make short-term adjustments to encourage employment growth, and an emphasis on communication and transparency.

He closed with a reminder that it would take some time to fully understand the lessons of the crisis. Perhaps he was thinking of his own academic career, devoted to the mechanics of the Great Depression, 80 years ago. Or perhaps it was a recognition that this crisis remains very much in progress.

The Top 1%: Executives, Doctors and Bankers

The “99-percenters” protesting at Occupy Wall Street should think about occupying the C-suites across America as well, at least if their primary complaint is about income inequality.

CATHERINE RAMPELL

Dollars to doughnuts.

That is one implication of this fascinating paper on the occupations of the top 1 percent of Americans, which I came across via Mike Konczal. The paper is by Jon Bakija of Williams College, Adam Cole of the Treasury Department and Bradley T. Heim of Indiana University, and is based on tax data from 2005 (so, before the financial crisis).

Dollars to doughnuts.

It finds that about a third of Americans in that top percentile were executives, managers and supervisors who work outside of finance. The next biggest share, at 15.7 percent, went to medical professionals, followed by those in financial services with 13.9 percent.

The share of 1-percenters who work in finance has been rising, as you can see. In 1979, the earliest year analyzed, just 7.7 percent of those at the top percentile worked in finance, about half the share in 2005.

As we’ve written many times over, the total share of income going to the top 1 percent has increased in recent decades. In 2005, the top 1 percent of earners received 16.97 percent of total income distributed to all households across the United States.

The C-suiters accounted for about a third of that chunk received by the top percentile. Put another way, the nonfinance executives, managers and supervisors at the very top of the income distribution received 6.35 percent of all income received by all Americans in 2005.

A Recession in Our Minds

Are we in a recession in our minds?

Americans certainly seem unhappy about the prospects for the economy. Consumer sentiment remains near its lowest levels since 2009. And those daily indicators of investor confidence — the markets — have painted a very pessimistic picture; the Standard & Poor’s 500-stock index, seen as a broad indicator of the market, is down 8 percent for the year.

But economic data based on what people are actually doing tells a slightly different story. There is no measure by which the economy seems robust, but economic indicators published recently — measuring activity in manufacturing and service, vehicle sales and construction spending — were relatively positive, beating analysts’ expectations. By most measures, the economy is growing, while measures of the national mood are at recession levels.

This disconnect is illustrated starkly in an analysis by Jeffrey Kleintop, chief market strategist for LPL Financial. Mr. Kleintop compared the University of Michigan’s Consumer Sentiment Index, which surveys people about their outlook on the economy, and the Conference Board’s Leading Economic Index, which looks primarily at hard economic indicators like how many hours people are working and what manufacturers are ordering. The gap between these two indexes is at a record high, a mirror image of the late 1990s, when optimism about Silicon Valley inflated the tech bubble.

So why do people feel the economy is doing so much worse than it is? In part, say some economists, it is because of increased cynicism about the ability of the president and Congress to handle the economy. Indeed, the University of Michigan’s consumer confidence index shows a sharp drop this summer during the debt crisis debate. While it has improved slightly since then, it still remains at its lowest levels since early 2009. Economists say that the lack of confidence is also driven by structural changes to the American economy: unemployment has remained high even as the economy has grown slowly, while wages have stagnated for those who are working.

On Friday, the Labor Department will release its monthly report on jobs, which has a particularly visceral impact on ordinary Americans. Last month, the report showed zero job growth nationwide.

“There’s a lot of economic indicators like industrial production, or durable goods orders, that economists put a lot of weight on. Individuals just have no idea what they mean,” Mr. Kleintop said. “When you talk about a change in jobs they get that, they understand what it means. It’s very intuitive. And they take that information and they extrapolate that to everything.”

Another bad report on job growth on Friday will make it hard for consumers and businesses to gain the confidence they need to spend money, analysts say.

There is some evidence that people are capable of saying one thing and doing something else. For instance, even in these times of gloom, sales of many items that could be considered indulgences are rising. On Thursday, Nordstrom and Saks Fifth Avenue said their monthly same-store sales were helped by sales of luxury items. But some experts say they believe that a negative outlook on the economy is ultimately a self-fulfilling prophecy.

“If you talk about recession enough, you can have a recession,” said Andrew Goldberg, a strategist with J.P. Morgan Chase Asset Management.

The stock market can also be pushed downward by a collective lack of confidence, and many analysts describe the market’s behavior in recent weeks as “emotional,” rather than a rational response to the news investors were getting about the economy. The negativity of investors is largely being driven by events in Europe, where policy makers’ lack of decisive action to help Greece confront its debt problems has led to acute fears of a widespread financial crisis.

Attitudes on Wall Street eventually filter back to those on Main Street. According to an analysis by JPMorgan Chase, a 10 percent year-over-year decrease in the S.&P. 500 amounts to a decline of 2.7 percent in the University of Michigan’s consumer sentiment index.

A bad stock market is particularly worrisome because it affects the attitudes of those who have the most money to spend, Mr. Goldberg said. He noted that households whose incomes are in the top 20 percent of the country own about 80 percent of the shares traded on American markets. They also make up about 60 percent of consumer spending, a major driver in the economy. So if this group feels poorer, it has a disproportionate impact, potentially dragging down the population as a whole.

Risks, Rescues and Remorse

Warren Buffett rode to the rescue of Bank of America today, as he did for Goldman Sachs in the dark days of September 2008.

FLOYD NORRIS

Notions on high and low finance.

B of A will pay less to be saved, but that can be explained by the fact there is less panic to contend with this time. This time the rumors were that the bank needed to raise capital; back then, the rumors were that Goldman was the next Lehman Brothers.

Notions on high and low finance.

The terms of the two deals are similar. Berkshire Hathaway, Mr. Buffett’s company, invests $5 billion in straight preferred stock, and gets a warrant allowing him to invest another $5 billion in common stock at a set price. The preferred stock is perpetual, but the company can buy it back at a premium whenever it wishes to do so.

At Goldman he got a 10 percent coupon on the preferred, and it would cost Goldman a 10 percent penalty to buy it back. At B of A, he gets 6 percent coupon and a 5 percent premium for a buyback.

The warrants are different, and reflect that B of A was in a better position. B of A stock closed on Wednesday at $6.99. The warrants are at $7.142857. So at least B of A gets a little premium to market price at the time of the deal if the warrants are exercised.

Goldman shares were at $125.05 when the deal with Mr. Buffett was announced. His warrant was at $115 per share. He got a discount exercise price.

How has Mr. Buffett done at Goldman? Fine on the preferred. Not so fine on the warrant. Goldman bought the preferred back in April. Add in the interest and the repurchase premium, and Berkshire made $1.75 billion over two and a half years. Anything it collects on the warrants will be gravy, but at the moment there is none available. Goldman shares trade around $110.

The warrants had five-year terms, so Berkshire has until October 2013 to exercise them.

Mr. Buffett did do a little better on one term of the warrants at B of A. They are 10-year warrants, twice as long as at Goldman. So he has a lot longer time for the share price to work out.

When Mr. Buffett made his first Wall Street rescue, of Salomon Brothers amid a scandal two decades ago, he was reported to have called his investment a Treasury bill with a lottery ticket attached. He would get a solid return if the company merely survived, and a great one if it prospered.

Seen that way, this is not nearly as risky as a bet as a purchase of B of A stock would be. That may be the essential point that led the early euphoria to fade. B of A stock leaped to $8.80 soon after the opening this morning, but was under $8 by 11 a.m.

It is a sign of both the prestige of Mr. Buffett and of the fragility of markets that either of these deals were available to him.

Of course, there are risks in being a rescuer. A rescuer needs to use cash it can afford to lose, and it needs to have the judgment and courage to refuse to throw good money after bad if things do not go according to plan.

In August 2007, Countrywide Financial, a major home lender, was bailed out by B of A, which invested $2 billion in convertible preferred stock. It was convertible at a discount to current market value. B of A stock rose on the news.

A few months later, with Countrywide in deeper trouble, B of A agreed to take over the whole company for stock then worth $4 billion. The deal closed July 1, 2008. By then B of A was trading for about half what it was worth when it first invested in Countrywide. It had a lot further to fall.

It was one of the worst mergers ever. B of A has yet to reach the bottom of the sinkhole of legal liability created by Countrywide’s reckless lending policies.

But for that rescue by Bank of America, this one — of Bank of America — would not be necessary.

For Some Banks, Prices Are Below 2008

FLOYD NORRIS

Notions on high and low finance.

Which banks don’t you trust?

Notions on high and low finance.

Share prices have plunged since mid-July for banks around the world as a result of all kinds of worries. For most, but not all, banks, the good news is that at least their prices are well above the lows they hit during the credit crisis in 2008 and 2009.

Here is the performance of some major banks, showing their stock price changes through early afternoon in the United States, from the low daily closing price in 2008 or 2009, and from the end of 2010. All figures are in local currencies, so they do not reflect currency changes.

Mizuho Financial, Japan: -24% from 2008-’09 low, -26% since the beginning of 2011

Sumitomo Mitsui, Japan, -16%, -24%

Mitsubishi UFJ, Japan, -8%, -20%

Credit Suisse, Switzerland, -4%, -42%

Crédit Agricole, France, 0%, -36%

Bank of China, China, +4%, -9%

Commerzbank, Germany, +5%, -57%

Sumitomo Mitsui, Japan, +7%, -24%

Bank of New York Mellon, U.S., +7%, -36%

Société Générale, France, +16%, -48%

Industrial and Commercial Bank of China, +23%, -3%

UBS, Switzerland, +35%, -12%

Lloyds Bank, Britain, +42%, -57%

Banco Santander, Spain, +52%, -23%

UniCredit, Italy, +54%, -42%

Banco Paribas, France, +58%, -31%

Hang Seng Bank, Hong Kong, +61%, -15%

Nordea Bank, Sweden, +66%, -27%

HSBC, Britain, +68%, -22%

Morgan Stanley, United States, +76%, -40%

Deutsche Bank, Germany, +76%, -30%

Bank of America, United States, +122%, -48%

Citigroup, United States, +170%, -24%

Wells Fargo, United States, +191%, -24%

Barclays, Britain, +194%, -42%

The banks that scared us the most in 2008 and 2009, like Citigroup and Bank of America, have lost a lot of value this year, but at least they are way above the lows of the last crisis. But some major European banks are down to their old lows, and some Japanese banks have plunged to new lows.

The Fed Splits

FLOYD NORRIS

Notions on high and low finance.

There is more than meets the eye to the split at the Federal Reserve. There must be.

Notions on high and low finance.

The Fed’s statement Tuesday afternoon says that the majority “currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

Three dissenters said that they “would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

Now there’s something to fight over. I say we need low rates “at least through mid-2013.” You say “an extended period.”

All this sounds like much ado about very little, but the Fed majority is all but promising that rates will stay low for nearly two years. We used to think “an extended period” could mean a few months.

In reality, the statement was an implicit invitation to traders to drive rates down further on the two-year Treasury note, and that happened immediately. Before the announcement the two-year rate was around 0.27 percent. Now it is 0.19 percent. That is a record low. Two weeks ago it was over 0.4 percent.

The initial stock market reaction was negative, presumably because there was some hope that the Fed would do more — like start another quantitative easing program, QE3. Instead there is a promise that the Fed “will maintain its existing policy of reinvesting principal payments from its securities holdings. The committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”

In other words, they might do a QE3. Or they might not.

Perhaps the dissenters really want to essentially say something like “We’ve done all we can, and if the economy is still lousy, that is for someone else to deal with.” And the majority is unwilling to do that.

As it is, the Fed has signed on to the widespread perception that the economy is getting worse. But it is not doing a whole lot.

The fact that the Fed chairman, Ben S. Bernanke, now has three dissenters is a sign that the Fed, like one or two other Washington institutions you might be able to name, is less and less able to speak with one voice.

What Will Stop the Drop?

What will stop this?

Let’s look at some of the things that have not worked.

The Group of 7 finance ministers promised to act together in a cooperative way.

President Obama assured us that he wanted to cooperate with Republicans.

FLOYD NORRIS

Notions on high and low finance.

It would be wonderful — and most likely would lead to a rebound — if there were evidence that genuine cooperation was going to arrive, and that governments would act together to try to both fix the financial systems and avoid new downturns. But so far there is no indication that any such thing will happen.

Notions on high and low finance.

If that cannot be, some bold leadership from someone — preferably someone with the ability to borrow lots of money — would be welcome. But the president seems unwilling to do anything but issue pleas that fall on deaf ears. Chancellor Angela Merkel has grudgingly moved but is unwilling or unable to try to persuade Germany that it must step up far more than it has.

Picking one cause for the recent slide is not easy. But in retrospect one should not rule out the European bank stress tests, whose results came out on July 20. This time, we were promised, the tests would be credible. But when they arrived, we learned that Europe was still assuming that European sovereign debts were risk-free. The collapse started soon after that.

I am in no position to crow — I was more optimistic about the economy than most were last year, and I was wrong. But it now appears clear that the financial crisis never really ended. The amount of capital wasted in the boom years continues to drag economies down. But there is no real discussion of how to deal with that.

An important lesson that leaders grasped in 2008 and 2009 was that free enterprise was not going to work without a decently functioning financial system. It is a lesson that may need to be learned again.

It was just six months ago today that American financial stocks hit their recent highs. Since then, the collapse has not spared any bank. But the ones hit particularly hard have had some combination of the following:

1. Leftover liabilities from the bad old days of lending without much regard for credit quality, secure in the knowledge that loans could be sold to someone else before they went bad.
2. A lot of European sovereign debt.
3. Doubts about the level, or accuracy, of the bank’s capitalization.
4. Particularly for some regional banks in the United States, commercial real estate loans that should never have been made.

The KBW bank indexes for the United States and Europe contain 24 stocks each. More than a third of them have lost more than a third of their value in six months.

They are:

1. Bank of America, U.S., down 55.4%
2. Commerzbank, Germany, down 55.3%
3. Lloyds Banking, Britain, down 49.5%
4. Société Générale, France, down 45.4%
5. National Bank of Greece, Greece, down 45.2%
6. Regions Financial, U.S., down 43.5%
7. Barclays, Britain, down 43.3%
8. Citigroup, U.S., down 42.8%
9. Suntrust, U.S., down 42.6%.
10. Intesa Sanpaolo, Italy, down 42.2%
11. Crédit Agricole, France, down 40.6%
12. New York Community Bancorp, U.S., down 39.0%
13. Unicredit, Italy, down 38.7%
14. Royal Bank of Scotland, Britain, down 37.8%
15. Bank of New York Mellon, U.S., down 36.1%
16. Fifth Third, U.S., down 35.1%
17. Credit Suisse, Switzerland, down 33.6%.

Figures are based on dollar prices, rather than local currency quotes, and were calculated by Bloomberg.

Predictably, the Shorts Are Blamed

This just in from the Associated Press:

FLOYD NORRIS

Notions on high and low finance.

Notions on high and low finance.

ATHENS, Greece — Greece has banned short selling on the stock market for two months from
Tuesday, after shares on the Athens Stock Exchange plunged to their lowest level in more than 14 years.
The bourse’s general index sank below the 1,000-point mark Monday, closing down 6 percent at 998.24 — the lowest level since January, 1997 — as financial markets were buffeted by worries over the U.S. economy following a downgrade of the country’s debt.

Can you think of any problems other than vicious speculation by the shorts?

Legal Payday

FLOYD NORRIS

Notions on high and low finance.

My column this week concerns a class-action lawsuit on behalf of investors damaged by the collapse of Lehman Brothers. The defendants include Lehman’s former officers and directors, as well as its auditor and 51 investment banks that underwrote Lehman securities.

Notions on high and low finance.

I don’t know how much, if anything, the investors will eventually get, although the fact that Judge Lewis A. Kaplan of United States District Court refused to dismiss a large part of the case may make settlements more likely.

Nor do I know how much will be collected in legal fees. The plaintiffs’ lawyers are typically paid only if they prevail, but the defense lawyers are presumably being paid by the hour.

I count 42 lawyers — 12 for the plaintiffs and 30 for the defendants — who have filed appearances in the case. There may, of course, be more lawyers working on the case back at the office. You can only imagine the fees being collected when the judge holds a hearing.

For the plaintiffs:

Bernstein Litowitz Berger & Grossmann (six lawyers filed appearances with the court)

Barroway Topaz Kessler Meltzer & Check. (six)

For various defendants:

Allen & Overy (two)

Boies, Schiller & Flexner (two)

Fried Frank Harris Shriver & Jacobson (two)

Kasowitz Benson Torres & Friedman (two)

Simpson Thacher & Bartlett (four)

Cleary Gottleib Steen & Hamilton (three)

Gibson, Dunn & Crutcher (three)

Willkie Farr & Gallagher (one)

Proskauer Rose (four)

Dechert (three)

Latham & Watkins (four)