Japan Heads for Worst Recession as Output Tumbles (Update1)

By Jason Clenfield and Toru Fujioka

Jan. 30 (Bloomberg) — Japan headed for its worst postwar recession as factory production slumped an unprecedented 9.6 percent, NEC Corp. said it will cut more than 20,000 workers and Hitachi Ltd. forecast a record loss.

The December drop in output eclipsed the previous record of 8.5 percent set only a month earlier, the Trade Ministry said today in Tokyo. NEC, Japan’s biggest personal-computer maker, forecast its first loss in three years.

The Nikkei 225 Stock Average slumped 10 percent this month, extending last year’s record 42 percent drop as the global recession smothered demand for Japanese cars and electronics. Mounting losses forced companies to fire workers in December, spurring the biggest jump in the unemployment rate in 41 years.

“Japan’s economy is falling off a cliff,” said Junko Nishioka, an economist at RBS Securities Japan Ltd. in Tokyo. “There’s really nothing out there to drive growth.”

The International Monetary Fund said this week that Japan’s gross domestic product will shrink 2.6 percent this year, the bleakest projection for any Group of Seven economy except the U.K. That contraction would be Japan’s worst since World War II.

“We’re in a very grave situation,” Economic and Fiscal Policy Minister Kaoru Yosano said in Tokyo today. “Japan is being hit by this wave of weakening global demand.”

Parliamentary gridlock has stymied the ruling Liberal Democratic Party’s efforts to pass a 10 trillion yen ($111.2 billion) stimulus package. The Bank of Japan, which last month lowered interest rates to 0.1 percent, has little room to counter the slump other than by purchasing corporate debt to ease a credit squeeze, which it started to do today.

‘Just Horrendous’

“The numbers are just horrendous,” said Tehmina Khan, an economist at Capital Economics Ltd. in London. “In Japan the political problems and the gridlock that they’ve got means they are totally unable to stimulate the economy.”

Hitachi forecast a 700 billion yen ($7.8 billion) annual loss and said it may eliminate 7,000 jobs. NEC reversed its full- year projection to a loss of 290 billion yen as demand for chips plunged and the value of its shareholdings tumbled.

Companies that posted quarterly losses today included Mizuho Financial Group Inc., the bank with the biggest subprime writedowns in Asia; Daiwa Securities Group Inc., Japan’s second- largest brokerage; and Nippon Oil Corp. Honda Motor Co. cut its annual profit forecast 57 percent.

‘Getting Scarier’

“It’s getting scarier and scarier to ponder what will happen around March,” when the fiscal year ends, said Hiroshi Morikawa, a senior strategist at Tokyo-based MU Investments Co. “Deeper cuts in capital investment and workforces will probably be needed.”

The month-on-month decline in production was steeper than the 8.9 percent economists predicted and the biggest since the figures were first compiled in 1953. Companies planned to lower output a further 9.1 percent in January and 4.7 percent in February.

“There’s a global synchronized recession and manufacturers are responding aggressively,” said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. “That’s going to have a profound impact” on economic growth.

The jobless rate soared to 4.4 percent from 3.9 percent, the government said. Household spending slid 4.6 percent, a 10th monthly drop, as people grew more concerned about job security.

Nikkei Slides

The Nikkei sank 3.1 percent today, adding to last year’s record 42 percent drop. The yen traded at 89.45 per dollar from 89.99 before the economic reports were published. The currency’s 18 percent gain in the past year has compounded exporters’ woes by eroding the value of their profits earned overseas.

“The jobless rate could rise to around 5 percent, giving us more reasons not to expect consumer spending to support the economy,” said Noriaki Matsuoka, an economist at Daiwa Asset Management Co. in Tokyo.

Nishioka at RBS estimated GDP fell at an annual 14 percent pace from October through December. That would exceed a 13.1 percent drop in the first quarter of 1974 to become the sharpest on record. Economists predict a report later today will show the U.S. economy, Japan’s biggest market, shrank an annualized 5.5 percent pace last quarter, the biggest drop since 1982.

The slump may last more than three years and exceed the 1980 to 1983 downturn to become the longest on record, according to Hiroshi Yoshikawa, a Tokyo University professor who heads a government panel that dates the economic cycle. The panel yesterday said the recession began in November 2007.

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net; Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

Last Updated: January 30, 2009 04:46 EST

http://www.bloomberg.com/apps/news?pid=20601068&sid=aQboi41NmpiE&refer=economy

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Morgan Stanley Wealth-Management President to Leave (Update1)

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By Joshua Fineman

Jan. 28 (Bloomberg) — Morgan Stanley’s Ellyn McColgan, president of global wealth management, will leave the firm this month, less than a year after joining.

McColgan, 55, is leaving “to pursue other opportunities,” a company memo said. McColgan joined New York-based Morgan Stanley after working as president of distribution and operations at Fidelity Investments.

The departure announcement comes after Morgan Stanley and Citigroup Inc.’s Smith Barney unit agreed to form a joint venture earlier this month, forming the biggest retail broker with more than 20,390 brokers and $1.7 trillion in assets. The venture, which Morgan Stanley will control with a 51 percent stake, will be led by Morgan Stanley Co-President James Gorman and managed by Citigroup’s global wealth-management chief, Charles Johnston.

“With the planning for the new Morgan Stanley Smith Barney joint venture under way, Ellyn has decided to explore other leadership opportunities in the industry, and we respect this decision,” Gorman and Chief Executive Officer John Mack wrote in the memo.

McColgan worked at Fidelity for 17 years until she resigned in August 2007. She previously ran Fidelity’s brokerage arm, the second largest in the U.S. based on client assets and accounts.

Morgan Stanley will pay Citigroup $2.7 billion for control of the new company. It has an option to increase its stake after three years and to take full control after five years.

To contact the reporter on this story: Joshua Fineman in New York at jfineman@bloomberg.net.

Last Updated: January 28, 2009 17:35 EST

http://www.bloomberg.com/apps/news?pid=20601103&sid=aWMICbyTHg9g&refer=us

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Wall Street Bonuses May Go Way of Dodo Amid Bailouts (Update2)

By Dawn Kopecki and Christine Harper

Jan. 30 (Bloomberg) — The Wall Street bonus, considered a sacred ritual, may become the industry’s biggest casualty as governments worldwide bail out financial institutions.

UBS AG was told to reduce bonuses after the Swiss government gave the country’s biggest bank a $59.2 billion lifeline. Bank of America Corp. is under pressure to scale back payouts after New York Attorney General Andrew Cuomo subpoenaed executives earlier this week for information on compensation and President Barack Obama said just yesterday that bonuses handed out by banks represent “the height of irresponsibility.”

The current system of “asymmetric compensation,” in which people are rewarded when they do well and aren’t required to return the rewards when they lose money, is detrimental to society and needs to change, said Nassim Taleb, a professor at New York University and author of “The Black Swan: The Impact of the Highly Improbable,” in an interview.

The worst economic crisis since the Great Depression, a $700 billion taxpayer bailout in the U.S. and the demise of three of the biggest securities firms — Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. — didn’t deter investment banks from offering year-end rewards to employees on top of their salaries.

Financial companies in New York City paid cash bonuses of $18.4 billion last year, the sixth-most in history, even as they posted record losses, according to data compiled by the office of state Comptroller Thomas DiNapoli. The payouts are split among everyone from managing directors to secretaries.

Drain the Pool

“We won’t arrive at a situation where there are no bonuses,” Stephen Green, chairman of HSBC Holdings Plc, said at a press conference in Davos today. “There are always parts of companies that are profitable, and if somebody’s been working in a profitable business in a market where bonuses are a normal part of compensation, it’s difficult sometimes to say you won’t have any bonuses in that business.”

NYSE Euronext Chief Executive Officer Duncan Niederauer said today in Davos that “some compensation models need to be completely overhauled.” He added that this would be difficult to legislate and companies will have to take the lead.

“While a number of people clearly do create wealth by brain power, by use of the company’s balance sheet and by other resources, other people have been receiving incentives for basically turning up,” Barclays Plc Chairman Marcus Agius said at the World Economic Forum. “That I don’t think is very smart. An incentive system properly designed and fairly calibrated is absolutely fundamental.”

Claw Back

Credit Suisse Group AG’s investment bank decided last month to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds by using them to pay employees’ year-end bonuses.

The Zurich-based company’s leveraged loans and commercial mortgage-backed debt will fund executive compensation packages. The new policy applies only to managing directors and directors, the two most senior ranks at Credit Suisse, according to a Dec. 18 memo sent to employees.

Credit Suisse, along with New York-based Morgan Stanley and UBS, also have added so-called clawback provisions that set aside portions of workers’ bonuses that can be recouped in later years if an employee leaves or is found to have behaved in ways that are harmful to the company.

Subpoena for Thain

Zurich-based UBS cut its 2008 bonus pool by more than 80 percent to less than 2 billion Swiss francs ($1.75 billion) after the company was forced to accept government funds in October. Chief Executive Officer Marcel Rohner, his 11 colleagues on the executive board and Chairman Peter Kurer won’t get any variable pay for last year.

Former Merrill Lynch CEO John Thain was asked this week by the New York attorney general’s office for information about payouts made before the largest brokerage firm was acquired by Charlotte, North Carolina-based Bank of America. The U.S. Treasury agreed earlier this month to provide $20 billion of capital and $118 billion in asset guarantees to Bank of America, the country’s biggest mortgage lender, to help absorb losses at New York-based Merrill.

Wall Street firms need to “show some restraint and show some discipline,” Obama said yesterday, with Treasury Secretary Timothy Geithner and Vice President Joe Biden at his side.

Obama Plan

Obama’s team is drafting a package of measures to address the credit crunch and details may be announced next week, people familiar with the matter said. Geithner met over the past two days with Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. chief Sheila Bair and other regulators to work out the plan.

The initiative may feature a concerted effort to remove toxic assets that clog lenders’ balance sheets. The FDIC probably will run a so-called bad bank to take on some of the securities; others will be insured by the government against losses while remaining on lenders’ books, the people said. Further capital injections for the biggest banks also are under consideration.

Senator Banking Committee Chairman Christopher Dodd vowed yesterday to use “every possible legal means to get the money back.” The Connecticut Democrat plans to summon executives whose companies received taxpayer aid to testify before his committee and explain their bonuses.

“You’re never going to get any support for the continued tough decisions we have to make if this kind of behavior continues,” Dodd said. “We can’t be underwriting to the tune of billions of dollars, whether it was used directly or indirectly. This infuriates the American people.”

Job Reductions

The Treasury Department has injected about $200 billion into banks across the country through its Troubled Asset Relief Program. Banks and financial companies have eliminated 265,000 jobs in less than two years.

Charles Elson, director of the University of Delaware’s John Weinberg Center for Corporate Governance, said it would be “very difficult” for the Treasury to recoup bonuses.

“Usually these bonuses were contractually made and paid out based on a formula unless you can show bad faith, some intentional misconduct,” Elson said. “These are situations where monies were paid under a contract, and the worst you can accuse these people of is making very bad decisions.”

People such as Robert Rubin, who received more than $100 million while serving as chairman of New York-based Citigroup Inc.’s executive committee, should be punished for their failure to understand the risks their institutions were taking, said Taleb, author of “The Black Swan.” A spokesman for Rubin declined to comment.

‘Don’t Fly’

“These people make excuses, after the fact, saying that nobody saw it coming and that you couldn’t predict it,” Taleb said in an interview. “That’s no excuse. If you know there are storms, don’t fly. And if you fly, fly with someone who knows about storms.”

Unless Rubin and others are required to return their bonuses or are punished in some way, Taleb said a regrettable system emerges “where profits are privatized and losses are nationalized.”

Treasury has the authority under legislation that created TARP to issue regulations that claw back excessive executive compensation, and that may give the administration some authority to go after excessive pay, said Larry Hamermesh, a corporate law professor at Widener University in Wilmington, Delaware.

“It was pretty clear from TARP that the secretary of the Treasury was supposed to establish a provision for executive claw-back,” Hamermesh said in a phone interview. “How the secretary has implemented that isn’t clear.”

The Treasury could require companies that request additional funds to repay excessive bonuses as a condition of the further financing, Hamermesh said.

“If they come around to ask again, they could say, ‘We’re going to deny it unless they cough up the bonuses,’” he said.

To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Christine Harper in Davos at charper@bloomberg.net.

Last Updated: January 30, 2009 07:20 EST

 http://www.bloomberg.com/apps/news?pid=20601103&refer=us&sid=axmX3rJ5Nur0

Cutler to DC

Harvard economist David Cutler is joining the Obama administration. There is little doubt that the new economic team is made up of some of the best and the brightest our profession has to offer.

http://gregmankiw.blogspot.com/

Cutler To Serve Obama In D.C.
Economics professor tapped to serve in Obama administration

Published On Friday, January 30, 2009  1:56 AM

By NOAH S. RAYMAN and ELYSSA A. L. SPITZER
Crimson Staff Writers

Noted health care economist and former Dean of the Social Sciences David M. Cutler ’87 will become the latest Harvard professor to serve in the Obama administration, he said in an interview late last night.

Cutler joins three other members of the economics department already headed to Washington—rounding out a group that includes professors Jeremy C. Stein and Jeffrey B. Liebman, as well as former University President Lawrence H. Summers, who heads the National Economic Council.

“I think that people who have the opportunity to help their country and the world need to, at times, do that,” Cutler said of his leave.

Cutler was one of the chief architects of President Barack Obama’s health care plan—a hot-button issue during the presidential campaign—and said he will continue to work on health care policy in D.C.

Cutler first came to Harvard in 1991 as an assistant professor, received tenure in 1997, and recently finished a 5-year stint overseeing the Faculty’s social science departments as divisional dean.

Outside academia, Cutler has served on President Clinton’s Council of Economic advisers and on the National Economic Council, in addition to advising both Bill Bradley’s and John Kerry’s presidential bids. He has been consulting with Obama since at least April 2007.

Cutler, who specializes in health care and public economics, is a vocal proponent of increasing America’s health care spending, arguing in his most recent book, “Your Money or Your Life: Strong Medicine for America’s Health Care System,” that such spending has been worthwhile despite its high costs.

“He had a strong voice in developing President Obama’s health policy ideas, so I am expecting [the policy he implements] will continue down the general lines President Obama outlined,” said Richard G. Frank, a professor of health care policy at Harvard.

Asked about transitioning from academia to a government position, Cutler noted that his academic work is applicable to the real world.

“Health care policy as a field is one where academics are integrated into policy debates much more than in other areas,” Cutler said.

Cutler had planned to be on sabbatical for the spring semester prior to his appointment and said he plans to return to Harvard after his time in Washington.

Raj Chetty ’00, who accepted a tenure offer from Harvard just months ago, will fill Cutler’s place in the department while he is on leave.

“A central function of Harvard is to develop new ideas that are important, and…developing those ideas can involve translating them to real world policy,” said Economics Department Chair James H. Stock, who received Cutler’s official leave form yesterday. “In that sense an important part of what we do here at Harvard is to provide leadership…in the public sector and the public domain.”

“Sometimes you believe in something and the time is right,” Cutler said of his decision to move south.

—Staff writer Noah S. Rayman can be reached at nrayman@fas.harvard.edu.

—Staff writer Elyssa A.L. Spitzer can be reached at spitzer@fas.harvard.edu.

http://www.thecrimson.com/article.aspx?ref=526242

• JANUARY 30, 2009

Sovereign Debt Risk Looms Large This Year

The U.S. shouldn’t consume all the available lending.

By ULRICH VOLZ

Last week, Standard & Poor’s rating agency downgraded Spain’s and Portugal’s long-term sovereign debt because of their deteriorating public finances. A week earlier, S&P downgraded Greece’s sovereign credit rating and issued a warning to Ireland that its rating is under threat too.

The rediscovery of risk is not limited to the euro zone, and it doesn’t end with the United Kingdom either. The era of easy credit came to an abrupt end last summer and has given way to a withdrawal of funds from almost all corners of the developing world. A flight to safety and liquidity — which essentially means a flight to U.S. Treasurys — has become the dominant strategy of investors all around the world.

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To prevent a potentially devastating credit crunch in the developing world, members of the G-20, the group comprising the world’s 20 major economies, should consider establishing a temporary Global Expenditure Support Fund. Such a fund, first proposed by Indonesian President Bambang Yudhoyono at the G-20 summit in Washington last November, would be used to support budget and project financing in countries that traditionally rely on market sources for their financing requirements but are facing harsh difficulties due to the breakdown and disruption of financial markets.

How bad are the credit markets? The rollover of corporate and government debt has been severely disrupted by the seizing up of international capital markets, and the issuance of new debt has been nearly impossible since September. In addition, domestic bond markets, which have gained in importance in many developing and emerging-market countries over recent years, have suffered badly from the withdrawal of funds by international investors.

The Philippines successfully raised $1.5 billion in 10-year bonds recently. This was the first public offshore bond placement by a developing or emerging economy in the entire Asia-Pacific region since September. This might be interpreted as a glimmer of hope and an eventual unfreezing of credit markets. Unfortunately, the thaw will likely be short-lived.

In the months to come, access to international finance could worsen rather than improve for many countries. Given that the governments of virtually all major developed economies are preparing for large fiscal stimulus packages to counter recession, there is a clear danger that the issuance of debt by high-rated industrialized countries will crowd out demand for developing or emerging-market country debt.

The U.S. government alone is expected to issue about $2 trillion in 2009; the other big developed countries might place another $1 trillion of government bonds. This means that a large numbers of issuers will have to fight for a limited pool of capital, threatening developing and emerging economies’ access to the international credit markets.

Capital is desperately needed by many this year. Russia has to renew about $600 billion. Ukraine and Hungary, which have already tapped the International Monetary Fund (IMF) for loans, have to roll over about $30 billion and $15 billion in debt respectively. The Latin American Shadow Financial Regulatory Committee, a group of finance experts led by Harvard economist Ricardo Hausmann, estimates that Latin American governments will have to rollover about $250 billion in debt. India and China face external debt payments of $260 billion and $2.4 trillion respectively. According to ING Wholesale Banking, emerging-market governments and corporations need to repay some $6.8 trillion of debt, including bonds, loans, interest payments and trade finance. All these sums mentioned do not include the debt that these countries would need to take on if they were to try fiscal stimulus like the industrialized countries plan to do.

So far, only the Seychelles and Ecuador have defaulted on their sovereign debt since the start of the credit crisis in August 2007. But chances are rising that they will not remain the only ones in the coming year. In particular, central and eastern European countries — whose governments accumulated large foreign debt while credit was cheap — are under increasing pressure to access fresh finance. Unlike Brazil, Russia, India and China, they have no comfortable foreign-reserve pillow to fall on.

The repricing of risk and the shortage of liquidity in international capital markets has made it increasingly difficult for even well-managed emerging markets to access external financing. To avoid the credit crisis from turning into a full-blown debt crisis, greater international support is warranted.

That is not to say that there’s been no international support up to now. The IMF has responded quickly and extended about $50 billion of emergency credit to Hungary, Ukraine, Iceland, Pakistan and Hungary. Belarus, Serbia, Turkey and El Salvador are next in line. The Fund also created a new short-term liquidity facility for economically stable countries to obtain credit without hard conditions. With an additional $100 billion provided by the Japanese government, the IMF’s ammunition has increased considerably, but given the anticipated financing needs of the developing and emerging economies the $250 billion it now has at its disposal will not be enough.

Additional short-term liquidity has been provided by the Federal Reserve and the European Central Bank (ECB). The Fed has approved bilateral currency swap agreements with more than a dozen foreign central banks to ensure their dollar liquidity. For its part, the ECB has agreed on swap and repo arrangements with Hungary and Denmark.

The World Bank has also provided crisis support and announced its readiness to disburse up to $100 billion over the next three years to developing countries. Furthermore, the World Bank’s International Finance Cooperation has created new facilities to help the private sector.

Yet more will be needed, especially if emerging and developing economies want to implement counter cyclical measures aimed at ensuring sustained economic growth and continue efforts to achieve the United Nation’s Millennium Development Goals, which include halving extreme poverty around the world and halting the spread of HIV/AIDS by 2015.

The G-20 should thus seriously consider Indonesian President Yudhoyono’s proposed Global Expenditure Support Fund to fill the void left by the credit crunch. According to his proposal, G-20 nations would contribute to the fund, and countries with a good track record on fiscal sustainability and a demonstrated commitment to economic development and poverty reduction would be eligible to access the funds over the next two to three years. A similar idea presented by Harvard’s Prof. Hausmann is to establish an Emerging Markets Fund to purchase assets from governments and corporations of emerging and developing economies that have demonstrated good governance. The funds could be disbursed by the World Bank and the regional development banks.

In their Washington declaration, the G-20 members assured that they will “help emerging and developing economies gain access to finance in current difficult financial conditions, including through liquidity facilities and program support.” This is the time to let deeds follow words.

Mr. Volz is a senior economist at the German Development Institute in Bonn, Germany.

http://online.wsj.com/article/SB123327870587231645.html?mod=googlenews_wsj

Obama Calls Wall Street Bonuses ‘Shameful’

By SHERYL GAY STOLBERG

Published: January 29, 2009

WASHINGTON — President Obama fired a warning shot at Wall Street on Thursday, branding bankers “shameful” for giving themselves $18.4 billion in bonuses as the economy was spinning out of control and the government was spending billions to bail out many of the nation’s most prominent financial firms.

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Speaking from the Oval Office with Treasury Secretary Timothy F. Geithner by his side, Mr. Obama lashed out at the industry over a report, compiled by the New York State comptroller, Thomas P. DiNapoli, which found that over all, financial executives received the same level of bonuses as they had in 2004, when times were more flush.

It was a pointed and unusual flash of anger — if a premeditated one — from the president, and it suggested that he intended to use his platform to take a hard line against excesses in executive compensation.

“That is the height of irresponsibility,” Mr. Obama said angrily. “It is shameful, and part of what we’re going to need is for folks on Wall Street who are asking for help to show some restraint and show some discipline and show some sense of responsibility.

“The American people understand that we’ve got a big hole that we’ve got to dig ourselves out of, but they don’t like the idea that people are digging a bigger hole even as they’re being asked to fill it up,” Mr. Obama said, adding that “there will be time for them to make profits and there will be time for them to make bonuses. Now is not that time.”

News of the report, and Mr. Obama’s remarks, came a day after the president met privately at the White House with business leaders, including Richard D. Parsons, the new chairman of the board of Citigroup. This week, Citigroup, which received an infusion of taxpayer money last year, canceled its plans, at the administration’s urging, to buy a $50 million business jet.

Mr. Obama did not spare the company in his remarks on Thursday, although he did not mention Citi by name. “Secretary Geithner already had to pull back on one institution that had gone forward with a multimillion-dollar plane it purchased at the same time as they are receiving TARP money,” he said, using the acronym for the government’s $700 billion Troubled Assets Relief Program, intended to rescue shaky financial firms. “We shouldn’t have to do that, because they should know better.”

Mr. DiNapoli’s report was compiled based on the annual December-January bonus season, mostly through personal income tax collections. In an interview published on Thursday, he said it was unclear if banks had used taxpayer money for bonuses.

“The issue of transparency is a significant one,” Mr. DiNapoli said in the interview, “and there needs to be an accounting about whether there was any taxpayer money used to pay bonuses or to pay for corporate jets or dividends or anything else.”

Earlier Thursday, the White House press secretary, Robert Gibbs, said Mr. Obama had a one-word reaction to the report: “Outrageous.” He announced in advance that Mr. Obama would put forth his views in person, which he did at the end of a meeting with Mr. Geithner.

http://www.nytimes.com/2009/01/30/business/30obama.html

Economic View

Six Errors on the Path to the Financial Crisis

ALAN S. BLINDER

Published: January 24, 2009

WHAT’S a nice economy like ours doing in a place like this? As the country descends into what is likely to be its worst postwar recession, Americans are distressed, bewildered and asking serious questions: Didn’t we learn how to avoid such catastrophes decades ago? Has American-style capitalism failed us so badly that it needs a radical overhaul?

David G. Klein

The answers, I believe, are yes and no. Our capitalist system did not condemn us to this fate. Instead, it was largely a series of avoidable — yes, avoidable — human errors. Recognizing and understanding these errors will help us fix the system so that it doesn’t malfunction so badly again. And we can do so without ending capitalism as we know it.

My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.

WILD DERIVATIVES In 1998, when Brooksley E. Born, then chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into the derivatives world, top officials of the Treasury Department, the Federal Reserve and the Securities and Exchange Commission squelched the idea. While her specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?

SKY-HIGH LEVERAGE The second error came in 2004, when the S.E.C. let securities firms raise their leverage sharply. Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the S.E.C. and the heads of the firms thinking? Remember, under 33-to-1 leverage, a mere 3 percent decline in asset values wipes out a company. Had leverage stayed at 12 to 1, these firms wouldn’t have grown as big or been as fragile.

A SUBPRIME SURGE The next error came in stages, from 2004 to 2007, as subprime lending grew from a small corner of the mortgage market into a large, dangerous one. Lending standards fell disgracefully, and dubious transactions became common.

Why wasn’t this insanity stopped? There are two answers, and each holds a lesson. One is that bank regulators were asleep at the switch. Entranced by laissez faire-y tales, they ignored warnings from those like Edward M. Gramlich, then a Fed governor, who saw the problem brewing years before the fall.

The other answer is that many of the worst subprime mortgages originated outside the banking system, beyond the reach of any federal regulator. That regulatory hole needs to be plugged.

FIDDLING ON FORECLOSURES The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms.

Yet the Treasury and Congress fiddled while homes burned. Why? Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles. Sadly, the problem should now be much smaller than it is.

LETTING LEHMAN GO The next whopper came in September, when Lehman Brothers, unlike Bear Stearns before it, was allowed to fail. Perhaps it was a case of misjudgment by officials who deemed Lehman neither too big nor too entangled — with other financial institutions — to fail. Or perhaps they wanted to make an offering to the moral-hazard gods. Regardless, everything fell apart after Lehman.

People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rule book out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not?

After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.

TARP’S DETOUR The final major error is mismanagement of the Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly.

To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.

Six fateful decisions — all made the wrong way. Imagine what the world would be like now if the housing bubble burst but those six things were different: if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Lehman were not allowed to fail, and if the TARP funds were used as directed.

All of this was possible. And if history had gone that way, I believe that the financial world and the economy would look far less grim than they do today.

For this litany of errors, many people in authority owe millions of Americans an apology. Richard A. Clarke, former national security adviser, set a good example when he told the commission investigating the 9/11 attacks that he wanted victims’ families “to know why we failed and what I think we need to do to ensure that nothing like that ever happens again.” I’m waiting for similar words from our financial leaders, both public and private.

Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=1&em

FINANCIAL CRISIS WATCH January 28, 2009, 5:06PM EST text size: TT
The Bank Bailout Is Broken
But the Obama Administration and Congress are starting to grapple with the enormity of the problems in the financial system

http://www.businessweek.com/magazine/content/09_06/b4118000455725.htm?chan=top+news_top+news+index+-+temp_top+story

By Jane Sasseen

January 26, 2009
Getting Down To Business

Last year, as the U.S. financial system began to unravel, former Treasury Secretary Hank Paulson used to talk about the bazooka in his pocket. It was a metaphor designed to calm investors anxious about the government’s willingness to spend massive taxpayer dollars to save the financial system if really needed. But Paulson’s weapon jammed. For despite an array of lending programs by the Federal Reserve and the $700 billion Troubled Asset Relief Program (TARP) passed by Congress during his tenure, Wall Street firms and banks still collapsed left and right last fall.

Now the Obama Administration is effectively saying: Forget the bazooka, let’s bring out the heavy artillery. The President’s economic advisers believe it is time to hit the reset button on existing bailout programs, and think big. There’s no choice given the deepening recession that’s driving up jobless rates and home and credit-card defaults. All that in turn is contributing to multibillion-dollar quarterly losses at the likes of Citigroup (C) and Bank of America (BAC).

“BAD BANK” COULD COST $2 TRILLION
One big piece of that effort, of course, is the controversial $819 billion package of spending and tax cuts that were approved by the Democratic-controlled House of Representatives on Jan. 28. At the same time, the Fed is ramping up programs to buy securities backed by car, credit-card, and student loans as well as mortgage-backed paper to help thaw the credit markets.

Fixing the banks, Obama advisers argue, will require a more innovative approach than the capital injections into lenders that the Bush team settled on. Fed lending and government cash transfers help, but Bush’s advisers backed away from tackling the array of toxic assets that have caused a massive erosion of capital on bank balance sheets and have made extending loans to all but the most creditworthy borrowers unthinkable. “Money is moving throughout the system, but there is increasing recognition that these institutions don’t have enough capital to withstand the losses from all the crazy loans they have,” says Frederick Cannon, a banking analyst with Keefe, Bruyette & Woods (KBW).

New Treasury Secretary Timothy F. Geithner is exploring the creation of a government-funded “bad bank” to buy up mortgage-backed securities and other troubled assets from banks in hopes of boosting their capital levels so they can begin lending again. Daniel Clifton, Washington policy analyst for Strategas Research Partners, says Treasury is considering starting the bank with $100 billion from TARP, then adding leverage from the Fed and the Federal Deposit Insurance Corp. so $1 trillion in funding is available to buy bad assets. Ultimately, he adds, Administration officials believe they could need up to $2 trillion.

Fixing the banks will almost certainly require far more than $700 billion in TARP funds. Goldman Sachs (GS) analyst Andrew Tilton figures U.S. financial institutions will suffer more than $1 trillion in loan losses—about half of which have been recognized so far. The problem isn’t only with residential mortgages. Add in commercial real estate and other poorly performing loan categories, and the banks may hold some $5 trillion in “troubled assets” on their books, he says. New York University’s bearish economics professor, Nouriel Roubini, estimates that additional private and public capital of $1 trillion to $1.4 trillion will be needed to recapitalize the banks.

GUARANTEES VS. ASSET PURCHASES
Another idea being considered by Treasury and White House officials would offer banks federal guarantees that limit their losses on bad assets backed by dud loans, as with Citi and BofA. While this might cost taxpayers as much as buying the banks’ assets, guarantees would allow the Administration to avoid the difficult and politically risky step of potentially overpaying for assets now trading at fire-sale prices. In extreme cases, authorities also could put capital directly into the banks in exchange for common equity—pulling off a thinly veiled nationalization of the worst banks.

Analysts say a combination of remedies is likely. “They’ll need to create a mix of options,” says Karen Shaw Petrou of Washington research firm Federal Financial Analytics. Prying more money out of Congress for expanded bank bailouts will be tough. Yet it’s hard to see the economy recovering without healthy banks. Getting there won’t come cheap.

Sasseen is Washington bureau chief for BusinessWeek.