ANTHONY ROLFE JOHNSON REMEMBERED

by Bill Breakstone, Somers, NY, July 29, 2010

The English lyric tenor Anthony Rolfe Johnson died on July 21, 2010 in London at the age of 69 from Alzheimer’s disease.

Mr. Rolfe Johnson was a relative latecomer to opera and oratorio stages, not beginning his formal training until the age of 30. He was widely regarded as a leading exponent of the early music and baroque repertoire, though he also performed music from the classical to contemporary periods, including the operas of Benjamin Britten.

He arrived on the music scene just as the Handel revival entered full swing, and had long associations with two of the music world’s leading conductors of that music, namely Sir Neville Mariner and Sir John Elliot Gardiner, and made many prize-winning recordings with each of the works of Monteverdi, Bach and Handel.

He was by far my favorite tenor in this repertoire. Though Handel’s most famous arias were composed for castrato and soprano voices, he did leave behind many brilliant pieces for tenors. The arias Where Er’e You Walk from Semele and Waft Her Angels To The Sky from Jeptha are as fine as any Handel conceived, and Rolfe Johnson’s interpretations were of an unmatched level of artistry and tonal beauty. Likewise, two of the tenor arias in Solomon for Zadok, Sacred raptures cheer my breast and Golden columns fair and bright are among my favorite Handel excerpts, and Rolfe Johnson’s interpretations were of the highest caliber.

It was some 15 years ago that my mother died from Alzheimer’s, thus I know well the tragedy of this terrible disease. To witness the demise of one of the world’s most accomplished vocal artists to this withering affliction must have been heartbreaking for his family, friends and musical colleagues. He will be sorely missed, but happily remembered for the artistry he attained.

A WEEKEND WITH THE CARAMOOR VIRTUOSI

Reviewed by Bill Breakstone, Somers, NY
July 26, 2010

The Caramoor Virtuosi perform two programs each summer at the festival for which the group is named, and each year they invariably encounter bad weather. Such was the case Friday night, July 24th, as thunderstorms rolled through Katonah prior to and during the concert, forcing management to move the affair from the Spanish Courtyard to the Venetian Theatre for the second year in a row.

The instrumentalists for this ensemble change from time to time depending on availability. Its Music Director, cellist Edward Arron, is the one steady member. Joining him this weekend were his wife, pianist Jeewon Park, violinists Jesse Mills and Arnaud Sussman, violists Max Mandel and Yura Lee, and cellist Priscilla Lee.

Year after year, the Virtuosi always come up with fresh chamber music programs, be the music older classics or newer contemporary pieces. They specialize in works that are seldom performed, and this weekend hit the jackpot. Friday evening’s concert offered three compositions—Schubert’s Adagio and Rondo Concertante in F Major for Violin, Viola, Cello and Piano, D. 487; Shostakovich’s Piano Quintet in G minor, Op. 57; and Beethoven’s String Quintet in C Major, Op. 29.

These three varied works offer stark contrasts, from Schubert’s broad melodic strokes, the dark, somber mood of the Shostakovich Quintet, and the beautifully molded Beethoven, a perfect example of his early period, written contemporaneously with his “Pastoral” Piano Sonata, Op. 26.

The performances were all outstanding, each player obviously relishing each note and phrase of the three pieces. These young musicians are a joy to listen to and watch. Caramoor should make their appearances a weekly affair during the Festival, and take advantage of the excellent acoustics in the Venetian Theatre, far preferable in my opinion to the dry sound that mars performances in the Spanish Courtyard.

The weather was more agreeable on Sunday afternoon, but the attendance was regrettably sparse for what turned out to be a memorable concert. The old saying goes “you can’t tell a book by its cover.” Such could certainly apply to Sunday’s program. There were no blockbuster chamber pieces offered; just three works of relative obscurity—Dvorak’s Op. 47 Bagatelles for Two Violins, Cello and Harmonium; Selections form Viaggio in Italia for Two Violins, Viola and Two Cellos by Giovanni Sollima; and the Concerto in D Major, Op. 21 for Violin, Piano and String Quartet by Ernest Chausson.

The charming Dvorak Bagatelles opened the program and acquainted the audience with an instrument seldom encountered in the concert hall—the harmonium, a sort of miniature organ but without that instrument’s percussive effects. The five pieces were upbeat and brisk, with the exception of the very brief No. 4, Cannon: Andante con moto.

The five movements from Sollima’s Viaggio in Italia, a 14 movement composition composed in 2000 and lasting in total 75 minutes, are all intensely rhythmical and genuinely lyrical, if in a contemporary vein. They were extremely interesting, and further proof that contemporary music these days can be listenable. It was a credit to the performers that they bring this music to audience’s attention.

The music of Chausson is having a virtulal rebirth this year. Usually, all we hear from this late 19th Century (1855-1899) French composer are his art songs. In June, the New York Philharmonic and Sir Andrew Davis, with soprano Susan Graham, presented Chausson’s Poeme de l’Amour et de la Mer, a lavish diptych-with-interlude in which Wagnerian opulence mingles with daubs of nascent impressionism.

Here at Caramoor, we were treated to another large-scale composition by the Frenchman, the Concerto for Piano and String Quartet. The work is seldom performed, no doubt due to its unusual combination of instruments. It is a fiendishly difficult piece, thoroughly absorbing, and magnificently performed by six consummate string players. The two violinists, Jesse Mills and Arnaud Sussman, are both virtuosi of the highest artistry. And enough can not be said of the rest of the ensemble: violinist Yura Lee, violist Max Mandel, cellist Edward Aaron and pianist Jeewon Park.

The three works were all new to these ears, and made quite an impression. The concert was further proof that programmers need not rely solely on the old favorites of the repertoire. It was just a shame that a larger audience was not able to enjoy this kind of brilliant music making.

STRONG SECOND QUARTER CORPORATE EARNINGS--NOW WHERE ARE THE JOBS?

by Bill Breakstone, Somers, NY, July 23, 2010

A new Gallup poll was released on July 21st showing the confidence levels of the American public towards various institutions. The military ranked the highest at an approximate 79% approval rating. The Congress earned the lowest level of confidence, at 11%. Next to last was big business, at 13%.

The lack of confidence in the Congress is readily understandable. It is nearly impossible to get any meaningful legislation through, especially in the Senate. Likewise, the mistrust in business, after the near economic catastrophe, is also easy to understand.

We are now in the thick of the earnings season, and the reports coming out from the S&P 100 corporations thus far have been mostly brilliant. The New York Times today reports that “More than 140 companies have now reported results for the second quarter, and, by and large, the news has been good. On average, profits have increased by about a third.” Amazon’s profit rose by 45%; the New York Times Company second quarter profit more than doubled as it posted its first gain in three years; Apple has almost doubled its revenue in the last two years; Microsoft’s revenue total of $16.04 billion surpassed the $15.27 billion predicted by analysts, posting a 48 percent rise in net income; United Parcel Service said its second quarter net income increased 90 percent; the 3M Company said its quarterly net income rose 43 percent; Eaton Corporation reported quarterly net income of $226 million versus $29 million in 2009; AutoNation posted a 29 percent increase in second quarter net income; AT&T’s earnings rose 26%; and Ford easily beat profit and revenue expectations.

All this is wonderful news, no? So why are Americans so lacking in confidence when it comes to big business? The answer is that despite the improved picture in corporate revenue and earnings, unemployment remains unacceptably high. The official rate now stands at 9.5%, but the real rate is closer to 17%. Thus, American corporations are rebounding nicely, yet they are not adding jobs, even though inventory has been drawn down. Business is doing more with less. Instead of increasing their work forces, they are having employees work longer hours, great for those with a job, but terrible for those seeking employment. Add to that the growing outsourcing of work, and you end up with a stagnant labor market.

No one seems to have an answer to this dilemma. One would think that if business keeps improving, sooner or later jobs will be added. However, the drag of the housing market, which has now entered a “double-dip” of its own and is a main driver of the economy, does not bode well for the labor market. Nor does the general slowdown in auto sales, now that the incentives have run their course.

I guess we can only keep our fingers crossed and abide by the advice given yesterday by Fed Chair Bernanke—keep the stimulus in place until the economy recovers further and significant jobs are added and unemployment declines to a more manageable level.

A WEEKEND AT GLIMMERGLASS--THE SUBLIME & THE RIDICULOUS

Reviewed by Bill Breakstone, Somers, NY, July 20, 2010

My friend Phebe and I drove up to Cooperstown, NY this past Saturday for two opera performances at The Glimmerglass Festival—Mozart’s The Marriage of Figaro on Saturday evening and Handel’s seldom-performed Tolomeo on Sunday afternoon.

The Figaro was as fine a production and performance as I’ve ever attended, made all the more remarkable by the fact that Glimmerglass, despite its reputation for memorable offerings, is limited in funding and utilizes new or newer talent that do not have the performance experience of world-class singers who are regulars at major houses like The MET, Covent Garden or La Scala.

Donald Eastman designed the sets, which were perfectly fitted to this smallish stage and complimented the action to a tee. The costumes evoked the period of the 1880s in France, in particular Renoir’s famous painting Luncheon of the Boating Party (1881).

The excellent cast included New Yorker Patrick Cafizzi as Figaro, Muscovite Lyubov Petrova as Susanna, Aurhelia Varak, from Lyon, France as a most captivating Cherubino, Iowan Mark Schnaible as the Count and Detroit native Caitlin Lynch as the Countess. They, and the supporting cast, all possess outstanding voices and innate acting abilities. Varak was perhaps the best Cherubino I have seen on any stage, and Schnaible’s Count had all the qualities of a young Sam Ramey.

English conductor David Angus led a briskly paced performance from first note to last, eliciting brilliant playing from the Glimmerglass Opera Orchestra. Jonathan Kelly provided an excellent continuo accompaniment on a reproduction forte piano.

Here was Mozart’s masterpiece and genius in all its glory. How many times have I attended performances of Figaro over the 40 years of opera going? Never has the humour of the play been so readily approachable. What an evening of theater!

Unfortunately, the same could not be said, from this reviewer’s standpoint, of Sunday’s production of Handel’s Tolomeo. General & Artistic Director Michael MacLeod introduced the performance noting that this premiere was the first professional North American production of the work.

Not much is said of Tolomeo by Handel scholars Winton Dean and Donald Burrows in their books, other than it was produced near the end of the Royal Academy of Music era in London in 1728, and had roles written for the famous “Dueling Divas” Francesca Cuzzoni and Faustina Bordoni, and the legendary castrato Senesino. One can only speculate as to what extraordinary vocal gifts Senesino possessed; the two sopranos no doubt exemplified the finest in opera seria vocal technique, but we modern listeners to baroque opera do have many fine examples of this type of singing.

The arias written for these three roles, at least those that we heard obviously played to the talents of these three artists. In this performance, sopranos Julie Boulianne as Elisa and Joelle Harvey as Seleuce executed their demanding vocal pyrotechnics admirably, though their ornamentations of the da capo repeats left much to be desired. Tolomeo was sung by male soprano Anthony Roth Costanzo, and though his voice was a very interesting true soprano as against a countertenor, it simply lacked the power and freedom that a contralto would bring to this role.

However, the singing, nor the excellent conducting of baroque specialist Christian Curnyn, was not the problem with this production. The evil lay in the concept of the director Chas Rader-Shieber and its execution by costume designer Andrea Hood. The opera was treated as pure camp, a comedy a la Figaro, but with none of Da Ponte’s comic genius or Mozart’s matching comedic music. The libretto by Nicola Francesco Haym is the most convoluted of any of Handel’s operas; it is near impossible to make sense of any of it at all. As for the costumes and make-up, I have hardly ever seen anything so vulgar.

An absolutely awful evening, or half-evening, as by intermission, we had had enough! After close to 50 years, it finally came to the point where an early exit was preferable to continuing the misery.

The Kalichstein-Laredo-Robinson Trio at Tanglewood, July 15, 2010

Reviewed by Bill Breakstone, Somers, NY

There are many fine piano trios performing these days, but none is more accomplished than this K-L-R threesome. For their Tanglewood evening, they put together an engaging grouping of three trios, a seldom performed but masterful one by Haydn, and two masterpieces of the trio literature, Shostakovich’s Trio No. 2 in E Minor, Op. 67; and Mendelssohn’s Trio No. 2 in C Minor, Op. 66.
The Haydn dates, of course, from the classical period, when most composers chose to duplicate the trio idea in terms of number of instrumentalists on the one hand, with the number of movements in the works, namely three. Some of Beethoven’s early piano trios included a fourth movement, but his mature ones reverted back to three.
This Haydn Trio includes a rather long opening movement, with an extended development section that is the equal of anything Mozart wrote in this form. A brief and lyrical adagio second movement is followed by a sprightly Rondo: Presto, a finger-snapping delight.
The Shostakovich is a wonder of a work, the eerie introduction of the first movement, in the highest string register, gradually developing in the “Allegro energico e con fuoco”, an apt description of this most serious movement. The second movement “Allegro non troppo”, truly a scherzo, is fiendishly difficult, even its trio section unrelenting in both pace and demands placed on the performers. The third movement “Largo”, a passacaglia, is dark and severe; the final “Allegretto—Adagio” is in Sonata-Rondo form, and mixes Bohemian and Russian harmonies and rhythms in what has sometimes been called the “Jewish” part of the trio. In my opinion, this tag is unwarranted. What Shostakovich’s religious background and beliefs were are vague at best. Grove’s has absolutely nothing to say on the subject. What some describe as “Jewish” to me is nothing more than Slavic, as in Bohemian, versus Russian. In any case, the contrasts make for exciting music. I have heard this work performed many times, and this performance was as good as any.
The concert closed with the Mendelssohn, a wondrous work throughout that closes with an “Allegro appassionato” that remains one of the great movements of the chamber repertoire. How can one not be moved by the two beautiful themes, the second of which melds perfectly with that Bach chorale that Mendelssohn makes so natural in its placement and connection to that second theme. Again, the performance was brilliant, a perfect combination of lyrical playing and perfect execution. There were quite a few famous instrumentalists in the audience—Yo Yo Ma and Emanuel Ax among them—and they were all smiles backstage afterwards. The performers themselves were exhausted, but totally happy with their evening’s challenging work.

The Boston Symphony Chamber Players at Tanglewood, July 14, 2010

Reviewed by Bill Breakstone, Somers, NY

In the 1800s, performance practice usually dictated that major works be performed at the beginning of concert programs, followed by less substantial, though still serious fare. The rationale went that the major works needed the full concentration of the audience, which often waned as the evening progressed.

Thus the concert at The Tanglewood Festival on Tuesday evening harked back to earlier times, as the major work on the program, Brahms’ B Minor Clarinet Quintet, Op. 115, led of the evening’s performances. Thus autumnal composition received a warm and totally appropriate reading by The Boston Symphony Chamber Players and principal clarinetist William Hudgins.

The Brahms was followed by a spirited performance of Mozart’s Oboe Quartet in F Major, K. 370. Composed in the same month as his brilliant G Major String Quartet, K. 387, the work calls for virtuosic oboe playing, which BSO principal oboist John Ferrillo amply provided.

After intermission, The BSO players treated the audience to the rarely performed “Bachianas brasileiras” No. 6 for flute and bassoon by Villa-Lobos, brilliantly performed by flutist Elizabeth Rowe and bassoonist Richard Svoboda; and the recent contemporary composition “Plain Song, Fantastic Dances” by American composer Michael Gandolfi, who currently teaches composition at The New England Conservatory of Music. This 20-minute work is scored for violin, viola, cello, double bass, clarinet, horn and bassoon. What a combination of instruments! And how totally effective. The first movement is an elaborated and improvised Gregorian chant, dark in mood and skillfully developed. It is followed by a tango with improvisations, very bluesy and light. The final movement, “Quick Step,” is much longer and contains some fine contrapuntal writing. A coda brings back the opening theme from the first movement.

All in all, wonderfully varied and magnificently performed chamber music. A really fun evening.

ROUBINI ON FINANCIAL REFORM

Bill Breakstone, July 14, 2010


INTRODUCTION

The New York Times carried a featured article by Louis Uchitelle in the Sunday Business Section on July 10th about former Fed Chairman Paul Volker and his views on the Financial Reform Bill currently before Congress. Volker, who is now Chairman of President Obama’s Economic Recovery Advisory Board, was the author of the so-called Volker Rule, which places limits on the activities of Wall Street commercial and investment banks. Though the restrictions were much watered down in the final version of the Bill, they are still endorsed by Volker, though less wholeheartedly than the original version.

Two additional articles appeared in the Times on Tuesday, July 13th, one by Andrew Ross Sorkin about former Treasury Secretary Hank Paulson’s views on the Financial Reform Bill now before the Senate, and assured of passage after Monday’s decision by three Republican senators to vote in favor of the legislation; the other about the EU Central Bank’s new restrictions on executive compensation, a measure that should be mirrored here in the U.S., but has not even been proposed at this point and with the power of the banking lobby, would have little chance of even making it onto the table.

A quite famous economist has recently written extensively on economic crises in an excellent new book entitled Crisis Economics: A Crash Course in the Future of Finance. Its author is Nouriel Roubini, often referred to as “Dr. Doom” for his dire predictions leading up to the present crisis; its co-author is Stephen Mihm, a professor of history at the University of Georgia. Roubini is a professor of economics at New York University’s Stern School of Business. He is a frequent guest on cable network business programs, and I find him extremely difficult to follow. His speech is so rapid fire and his foreign accent so marked that in person he is nearly unintelligible. However, Roubini is absolutely brilliant, and his thoughts shine in print like the brightest searchlight on a sea of turmoil.

Crisis Economics is indeed a crash course on our economic troubles, the past history of economic crises, and a detailed examination of today’s world economy. With the economic news coming in rapid fire succession these days, especially that pertaining to reform legislation as noted above, an examination of Roubini’s work is particularly pertinent.

Chapter 8 is the heart of this study, and contains “First Steps” that should be considered to prevent a recurrence of the disaster. What follows is an overview of its contents.


COMPENSATION REFORM

“The biggest problem with compensation is not the amount of money involved; it’s the way this compensation is structured and delivered. Absent any direct or indirect oversight from shareholders, traders and bankers have every incentive to do crazy things that maximize their short-term profits and bonuses (like rustling up a bunch of toxic CDOs [credit default obligations] and leaving them hanging on the bank’s balance sheet). By the time the bank blows up, the traders and bankers have already spent the money on fast cars and that summer place in the Hamptons. And if recent history is a guide, it’s easier to get money back from Bernie Madoff than it is to claw back a trader’s bonus.”

New Restrictions on Stock Bonuses
“When employees are compensated with restricted stock, provisions should be put in place that force them to hold these shares for an even longer time than is now customary. Currently, many vesting periods are limited to a few years; they should be extended. Employees should be restricted from selling the stock until their retirement, or at the very least, for well over a decade.”

Change the Bonus Culture
“The bigger issue is the bonus culture of Wall Street, in which employees are compensated when their bets pay off, but are not penalized when those bets cost the firm money. This system encourages risk taking that generates oversize ‘alpha’ returns in the short term, with little consideration of long-term consequences.”

“One way to fix this mess would be to create bonus pools that aren’t calculated on short-term returns but are based on a longer time horizon—say, three years or so. Instead of rewarding its employees for making their particularly canny bets, a firm averages their performance over the course of several years.

Compensate With the Products They Create and Sell
“The problem of compensation has a more diabolical solution: to compensate traders and bankers not with money or with stock but with the very same esoteric securities that they’re cooking up in their laboratories. Traders and bankers would get bonuses, but in a very specific form: a little slice of, say, that CDO that they had a hand in making. If traders cook up toxic securities, they get paid with the same. The thinking here is that if traders know that the proverbial chickens will come home to roost in their bonus package, they may be a little bit more careful about the eggs they lay.”

Across-the-Board Implementation
“Whatever change in compensation is ultimately adopted should be implemented across the board. If one major financial firm adopts some version of compensation reform but no one else does, employees from the more prudent firm will likely flock to high-rolling firms, where they’ll be better compensated.”

“That means government must be involved. In the United States, only the federal government has the power to reform the compensation system in comprehensive fashion. It has plenty of justification for doing so: the government—or more to the point, the taxpaying public—has effectively bailed out and backstopped the entire financial system and has a cogent interest in making sure it doesn’t have to do it again.”


REFORMING THE SECURITIZATION PROCESS

“Compensation is hardly the only problem that cries out for reform; the elaborate system of securitization that helped cause the recent crisis must be fixed as well. In the originate-and-distribute model of securitization, a potentially risky asset—a subprime mortgage, for example—was pooled with similar assets and turned into securities that would be sold to investors better able to tolerate the risk.”

“One obvious flaw with this system was that it reduced incentives for anyone to actually monitor the creditworthiness of the borrower. Instead, the various players in the securitization process pocketed a fee while transferring most, if not all, of the risk to someone else. Everyone was complicit in this chain: the mortgage broker who handled the initial loan; the home appraiser, who had every incentive to give inflated values; the bank that originated the mortgage and used it to make mortgage-backed securities; the investment bank that repackaged these securities into CDOs and far more esoteric investments; and the rating agencies that bestowed coveted AAA ratings along the way; and the monolines [insurers a la MBIA] that insured those toxic tranches.”

"Any solution to the problem of securitization must somehow force these different players to more carefully consider the risks involved. In other words, each player must somehow be encouraged to pay more attention to the quality of the underlying loans. One way to do so is to force intermediaries—the originating bank and the investment banks—to hold on to some of the MBSs [mortgage backed securities] or CDOs in question. Forcing them to retain some risk, the thinking goes, will induce them to de a better job of monitoring the creditworthiness of the original borrowers (and leaning on the mortgage brokers and others who serve the first link in the chain).”

"[But] forcing firms to retain risk won’t do much to resolve an even more pressing problem: the fact that securitization has, despite government subsidies, all but ceased. Securitization in the go-go years was a bit like sausage making before the creation of the Food and Drug Administration [FDA]: no one knew what went into the sausage, much less the quality of the meat. And so it remains today: financial institutions can still churn out the sausage, but given what we know might (or might not) go into these things, is it any surprise that investors have lost their appetites? What we need are reforms that deliver the peace of mind that the FDA did when it was created.”

Standardization
“At the present time, there is little standardization in the way asset-backed securities are put together. Information [deal structures and monthly service performance reports] should be standardized and pooled in one place. We must have some way to compare these different kinds of securities so that they can be accurately priced. Standardization, once achieved, would inevitably create more liquid and transparent markets for these securities. That’s well and good, but a few caveats also come to mind. First, bringing transparency to plain-vanilla asset-backed securities is relatively easy; it’s more difficult to do so with preposterously complicated securities like CDOs, much less chimerical creations like the CDO2 the CDO3.”

Regulating the CDO Market
“For that reason, securities like CDOs must be heavily regulated if not banned. In their present incarnation, they are too estranged from the assets that give them value and are next to impossible to standardize. Thanks in large part to their individual complexity, they don’t transfer risk so much as mask it under the cover of esoteric and ultimately misleading risk-management strategies.”

“The most important angle of securitization reform, then, is the quality of the ingredients. In the end, the problem with securitization is less that the ingredients were sliced and diced beyond recognition but that much that went into these securities was never very good in the first place. Put differently, the problem with originate-and-distribute lies less with the distribution than with the origination. What matters most is the creditworthiness of the loans issued in the first place. The existing regulations and guidelines must be beefed up and given real teeth to ensure that what ends up in the securitization pipeline isn’t toxic.”


REFORMING RATINGS

“In the United States, three major private rating agencies—Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings—wield remarkable power, slapping grades on everything from mortgages to corporate bonds to sovereign debt of entire nations. These grades reflect the likelihood that the borrower or borrowers will default on their debt, and they are central to how financial markets ascertain risk. In effect, ratings are a way to outsource due diligence.”

Inherent Conflicts of Interests
Originally, rating agencies were paid by investors, who paid them to evaluate potential investments. That was too easy for investors to get around, so the agencies business model changed. By the 1980s, the issuers of debt had assumed the responsibility of paying the agencies for the rating of the debt they were issuing. Now the agencies were insured against losing revenue when investors “cheated the system.”

“This arrangement, however, created a massive conflict of interest. Banks looking to float some securities could shop around the agencies to find the best rating. A rating agency that looked at a proposed offering and slapped a subprime rating on it risked losing business. Increasingly, the rating agencies had an interest in giving the customers what they wanted—and if a customer wanted a AAA rating for an MBS made up of subprime mortgages, there’s a good chance that’s what it got.”

“As if that weren’t bad enough, the rating agencies started to generate revenue from other, equally problematic sources. A bank putting together a structured financial product would go to one of the rating agencies and pay for advice on how to engineer that product to attract the best possible rating from the very agency the bank would ultimately pay to rate its securities. This service was described as “consulting” or “modeling.” Perhaps. In fact, it was a bit like a professor’s accepting a fee in exchange for telling students how to get an A on an exam. That’s not kosher.”

Possible Solutions
First, “agencies must be forbidden to offer any consulting or modeling services. They should exist for one purpose: to assign a rating to a debt instrument. That’s it; anything more introduces a possible conflict of interest.” This prohibition should be strictly enforced by the SEC.

Second, “it also makes sense to open up the competition in this privileged realm. Unfortunately, the SEC makes it very difficult for new companies to obtain that coveted NRSRO” [Nationally Recognized Statistical Rating Organization] designation, which is required for rating agencies to operate. In one of the many paradoxes often found in the regulatory world, to achieve that designation requires a certain level of experience enumerated in years of practice. Yet without the designation, new entries can not obtain that experience. Thus, “the SEC needs to lower the barriers to entry, so that more competition—free market competition, if you will—enters into this vitally important industry.”

Third, “and more radical still would be to take away the semiofficial role that the rating agencies now enjoy. Everything from SEC regulations to world-wide capital requirements governed by international financial agreements [Basel I and II] formally recognize the NRSROs [those rating agencies carrying the imprimatur of the NRSRO] as the only place from which ratings can be obtained. That recognition invests them with disproportionately, if not excessive, power. Taking that power away would be another way of opening up competition.”

Fourth, “an even more comprehensive reform would be to force the rating agencies to return to their original business model, in which investors in debt—not the issuers of it—pay for the ratings."


DEALING WITH DERIVATIVES

Warren Buffett, in 2002, refereed to derivatives as “financial weapons of mass destruction.” He warned: “They carry dangers that, while now latent, are potentially lethal.” He forecast “the derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.” How right he was!

Now back to Roubini’s text:

“A derivative is simply a bet on the outcome of some future event: a movement in interest rates, oil prices, corn prices, currency values, or any number of other variables. They go by various names—swaps, options, futures—and they’ve worked just fine for decades, enabling people to “hedge” against risk.”

The Credit Default Swap Market
“But in recent years derivatives have grown into something altogether different, thanks to the rise of several new varieties, such as the credit default swap (CDS). It superficially resembled insurance in that it allowed a buyer to purchase protection in the event that a debtor defaulted on his obligations. If that happened, the seller of the “insurance” would be on the hook to help the buyer recoup his losses. However, unlike an insurance contract, the purchaser of a CDS didn’t have to actually own a chunk of the asset that was the subject of the bet. Worse, anyone who had placed a bet that someone would default had every incentive to make this happen. In these cases, purchasing a CDS was akin to buying homeowner’s insurance on a house that you didn’t actually own—and then trying to set fire to it.”

“The CDS market grew from next to nothing to astonishingly large. By the time the crisis broke in 2008, the notational value of CDSs (the amounts of money being insured) topped out at $60 trillion.”

When Brooksley Born, head of the Commodities Futures Trading Commission (CFTC) attempted to regulate the CDS market back in 1998, the financial powers in Washington and on Wall Street read her the riot act. Worse, the Congress passed the Commodity Futures Modernization Act that exempted CDSs and other over-the-counter (OTC) derivatives from regulation by the CFTC! Thus, the stage was set for the enormous expansion of the derivatives market, exactly what Born was warning against.

The Toxicity within the CDS Market
Danger number one: CDSs traded on the OTC market. “The key phrase here is “over the counter.” It might seem to be the opposite of “under the table,” but in fact “under the table” is as good a definition as any of an OTC transaction. OTC transactions are ones in which the derivative contract is signed by two private parties—typically a “bilateral contract,” to which no one else is privy. The lack of transparency is complete: no one knows the extent of anyone else’s exposure, much less where it’s concentrated.” This was exactly what the CFTC was proposing to reform, then so brutally stopped in its tracks. It is also what the current financial reform legislation is attempting, finally, to create: transparency in the derivatives marketplace.

Danger number two: counterparty risk, the chance that the institutions that had sold this “insurance” would be unable to make good on their promises, particularly during a systemic financial crisis. Read AIG! Or, as Roubini writes, “In effect, counterparty risk created a financial system that was not only too big to fail, but too interconnected to fail.” AIG’s inability to make good on its derivative contracts threatened every counterparty it had, Goldman, Citi, Morgan, and right on down the line.

Derivatives have been at the epicenter of a number of other financial crises—the 1987 stock market crash; the 1994 collapse of the Orange County, CA pension fund; the 1998 failure and bailout of LTCM; and the boom and bust in oil prices in 2008.

“Given this rap sheet, banning derivatives may seem like a good idea. But it’s not: most derivatives operate without ill effect. What we need to do is control the excesses that certain derivatives can cause.”

Controlling Excesses in the Derivatives Market
“First we must correct the problem of transparency. True, some derivatives have long been traded over the counter without problems—like plain-vanilla interest rate swaps—and could reasonably remain that way. But CDSs are another story altogether. These must be brought into the light of day and subjected to rigorous regulation by the SEC and the CFTC.” Choices of action include (1) forcing credit derivatives onto the kind of central exchange similar to where simpler derivatives are bought and sold; (2) registering the more esoteric credit derivatives in a central clearinghouse and making certain that the parties to a derivatives contract have sufficient collateral to make good on their promises; (3) insuring that investors in CDS contracts have an “insurable interest”: a direct stake in the outcome; (4) banning insurance companies from selling these guarantees—the only ones trafficking in these instruments should be hedge funds and other high-risk players in the financial markets, and they should be subject to rigorous margin and collateral requirements via a clearinghouse; and, finally (5) changing the relative responsibilities of the SEC and CFTC. These agencies regulate different slices of the derivatives market, effectively dividing regulatory authority. Consolidating the responsibility for overseeing all derivatives within a single agency would permit a more systematic approach to regulating and supervising derivatives and, more important, reducing the potential threat they pose to the stability of the international financial system.”

“These suggestions are not a cure-all. Derivatives have gone from being a means of hedging risk to a purely speculative instrument that permits often naïve investors—pension fund managers, for example—to assume massive amounts of leverage and risk. Increasingly exotic, opaque, and impenetrable to non-specialists, they pose a very serious danger to the financial system that the foregoing reforms alone will not cure. For this reason, the new generation of derivatives should be the subject of far more systematic and ruthless scrutiny by regulators.”


THE BASEL ACCORDS

“The continued existence of derivative contracts, especially those of an exotic nature such as CDSs, pose a risk to global economic stability. That stability has to be shored up worldwide. That means examining some of the global guidelines that shape how banks do business. The quaint Swiss city of Basel is home to an important institution that plays a vital role in that regard: the Basel Committee on Banking Supervision. While its recommendations are nonbinding, it nonetheless carries a great deal of weight. Much of the financial system as it existed on the eve of the crisis was a creature of the Basel Committee’s guidelines.”

Basel I
“Those guidelines, or accords, have evolved over the years. The first accord, known as Basel I, asked banks to differentiate between the various classes of assets they held in order to better asses the relative risk posed by holding them. This risk assessment would affect how much capital a bank had to hold. Basel I had a few other stipulations. Banks that operated in multiple countries had to hold capital equivalent to 8 percent of their risk-weighted assets.”

“The first Basel accord went into effect in the 1980s, and by 1992 most of the G-10 had adopted its recommendations. Many emerging market economies voluntarily adopted these guidelines too, as a demonstration of financial stability and prudence. Unfortunately, standards that made sense for advanced industrial economies proved more difficult for emerging economies to maintain, particularly in times of crisis, and proved their undoing.”

“No less troubling, bankers had found ways to hide risk that Basel I did not anticipate—for example, by securitizing assets. These sleights of hand gave bank balance sheets the appearance but not the reality of stability. Bankers had obeyed the letter but not the spirit of the Basel I guidelines.”

Basel II
“These failures led to Basel II. While its predecessor had filled a mere 37 pages, the new accord was almost ten times as long. It gave much more precise technical guidelines on weighing the relative risk of various assets; suggested methods for making these calculations; expanded the definition of risk to encompass other perils; sought to close various loopholes by which banks had hidden risk; urged regulators to move more aggressively to monitor compliance with capital reserve requirements; and spelled out terms by which banks would make their financial condition public. Though many European nations wanted Basel II to apply to all banks, the United States, Canada, and the United Kingdom successfully argued that it should apply only to large international banks.”

G-10 member nations had hammered out a final version of Basel II in 2006 that went to the individual members for implementation when the crisis hit. It immediately became apparent that the new accord had serious flaws. “Simply stated, Basel II assumed that the world’s financial system was more stable that it actually was. This was a serious mistake.”

“The crisis underscored several realities. One, banks needed higher-quality capital and more of it. Two, the “Capital buffer” that many banks had established was nowhere near large enough to shelter them from the kind of shock delivered by the housing bust and the credit crisis. Three, the quality of capital as defined by Tier 1 and Tier 2 could deteriorate significantly in a time of crisis.”

Basel III
Roubini’s book went to press prior to the most recent round of conferences in Switzerland, which are being held on July 14th and 15th. Basel III attempts to address the flaws mentioned in the preceding analysis by the author. New guidelines will force banks to top up their capital and curb risks in order to avert a repeat of the financial crisis. They will also address such issues as accounting standards and globally agreed rules on how to measure the value of bank assets and liabilities. The new reserve requirements, as they now stand, are much higher than those contained in legislation already approved by the Obama administration and to be voted upon in the coming days, and bankers around the world are already up in arms, saying that they will choke off the economic recovery. The Bank of England Chief Cashier, Andrew Bailey, said Basel III must be a “robust standard” but the timing of implementation could be “handled quite sensibly. Achieving financial stability by killing the economy is not something we want to do.”


CONCLUSIONS

“Skeptics might reasonably point out that if investors want to pay through the nose for the privilege of alpha—or schmalpha—returns, that’s their business. But the rise of a small coterie of incredibly powerful, opaque financial firms has generated a far more unsettling problem. These firms now house a staggering assortment of financial functions: everything from securities origination and underwriting, market making and dealing, prop trading , private equity, hedge funds, and asset management to bread-and-butter banking. The interconnections among the handful of surviving firms, have created a system that is extraordinarily vulnerable to systemic risk.”

“Moving most trading from OTC markets that rely on market makers/dealers to exchanges would reduce these rent-extracting distortions but, more important, would radically reduce the counterparty risk that makes the financial institutions too interconnected to fail. Indeed, the more that transactions occur on exchanges, the less the system becomes interconnected as counterparty risk is significantly reduced.”

“Not only do we need to reduce the too big to fail problems by making each institution smaller, we also need to unbundled financial services within financial institutions to reduce the too-interconnected-to-fail problem: with exchanges, broker dealers would be involved only in the efficient execution of trades for clients, not in market making/dealing, which is rife with conflicts of interest, lack of price transparency, and large systemic counterparty risk. So we need to go back to Glass-Steagel, and even beyond it, to a financial system in which both institutions and their activities are unbundled to make them less too big to fail and too interconnected to fail.”

“In short, the concentration of financial power has created a system that is too interconnected to fail. The proposals outlined in this chapter represent the first steps toward curing these problems. But far more radical reforms must be implemented if the financial system is to achieve any semblance of stability in the coming years.”

That’s another chapter. You can read it on your own.

NAVIGATING THROUGH TROUBLED ECONOMIC WATERS

Bill Breakstone, July 5, 2010


BACKGROUND

The United States is currently dealing with three crises—economic, financial and political in nature.

First, on the economic front, we face a period of prolonged joblessness. Officially, the high mark in unemployment was reached in April of this year, at a mark of 10.1%. Since then, the rate has declined to where it now stands at 9.5 percent. However, as the lead editorial in this morning’s New York Times points out: “Even a drop in the unemployment rate, from 9.7 percent in May to 9.5 percent in June, represents a pullback, not an improvement. The rate fell because 652,000 people left the work force last month. Since they were neither working nor looking for work, they were not counted as unemployed. If they had been counted, the jobless rate in June would have been 9.9 percent.” Further, the official data does not take into account those who are working in temporary positions who would prefer full-time employment.

There also is an escalating decrease in aggregate demand. Retail sales are falling, new and existing home sales have resumed their decline, significantly, and auto sales over the past six weeks have fallen off a cliff after rising substantially due to economic incentives which have now expired. To add to these woes, consumer confidence levels have declined significantly.

Our second crisis is of a financial nature. The stock market has dropped to near bear market levels, loosing 16.5 percent since reaching their mid-April highs. A partial explanation of this decline is that the markets are pervaded by a level of uncertainty as to in what direction the economic policymakers are heading, both in America and on the world stage. Prominent in this regard is the apparent emphasis on the part of European Union countries to focus on debt reduction and austerity programs that may stifle the economic recovery overseas.

The third item in the equation is a political crisis here in the United States which has been marked by legislative paralysis and watered-down legislation that will have a less-then-desired effect on regulatory reform. The Congressional opposition is focused on regaining the majority position through the mid-term November elections and the 2012 Presidential elections thereafter. In the process, they are putting aside national priorities and the economic well-being of the Nation to pursue purely political objectives.


THE GREAT DEBATE

Yesterday, Fareed Zacharia hosted two guests in a prolonged 40-minute segment of his excellent program GPS. His lead-in went as follows:

“I believe that we are all watching a major policy experiment unfold, perhaps the most important in decades. You see, the governments of the world’s largest economies seem to be set to begin withdrawing the money that they had started spending last year to rescue their economies. This is happening in the United States, China, Europe, and it is turning into a test of two profoundly different views of economics.”

“The first that is apparently being adopted by the G-20 countries says we have to start paying down our debts because otherwise the cost of borrowing money will get prohibitively high. Today it’s Greece, tomorrow it’s us.”

On the other side are those who are saying this is crazy. Cutting government spending will put the economy in a tailspin. It will lower growth, lower confidence, and it will produce persistent and rising unemployment.”

“So should the government worry more about unemployment today or the bond markets tomorrow?”

“The two most important intellectuals in this debate are Paul Krugman, the Nobel Prize-winning economist, New York Times columnist, Princeton professor on the one hand, and Niall Ferguson, the Harvard historian, business school professor and author, on the other.”

Krugman was first to be questioned. Putting the current state of affairs in perspective, he said “This is—really, this is—we’re –we’ve just experienced the—probably the—only the third really global financial crisis, again, 1873, 1929, and now this one. And we’re responding to it in ways that almost guarantee, unless we do a u-turn on policy, guarantee that this is going to be another period like that.” [The crises of 1873 and 1929 were both categorized as Depressions.]

Asked why he worries so much about unemployment, other than the human cost, Krugman explained: “If a worker’s been out of the workforce for three, four years, it’s going to be very hard for that person to get back in. The job references will be bad. The—the experience will—will be lost. We’ve seen that happen in European countries that had high unemployment and by the time they finally started to get it down again some of the unemployment have basically become structural . . . . if we don’t deal with this now, we may find that 7, 8 percent unemployment is the new normal. The other thing is that each—each year that we go on like this, we’re drifting closer to deflation.”

“We came into this crisis with underlying inflation, around 2.5 percent, which is good. You want a little bit of inflation, gives you more flexibility. That’s now down under 1 percent. It quite easily could be negative by the end of next year.”

Zacharia then stated “I think a lot of people have trouble with, with the United States running a budget deficit of 10% of GDP, with debt to GDP ratios moving up into the 60, 70 percent range, . . . . and yet you’re saying that what we need is more—significantly more government spending” to insure the economic recovery lasts.

To which Krugman replied: “We do have a long-run budget problem. So, you know, the starting point is to acknowledge that, that there is a problem, that if you ask about the state of the U.S. public finances 15 years from now, under current policy, it looks pretty grim. So something has to be done.”

“The question is what about now? And if we skimp on supporting the economy now, first of all, we deepen these problems. We make higher unemployment. We reduce the long-tern prospects. Secondly, we do amazingly little to improve our long-run budget position. . . . . Yes, let’s—let’s have serious fiscal adjustment but not until the economy has recovered.”

Critics on the other side of this economic argument have said that Krugman was advocating that public policy should be aimed at getting people to borrow again, even if they were borrowing too much in the first place. Why pump up an unsustainable situation? These people, these companies should be coming back down to more manageable levels of debt, and that’s just going to take a while.

To which Krugman replied: “But why should lots of perfectly good, productive capacity and millions of perfectly productive workers who have things to do that we all need be left unemployed while we do that adjustment? . . . . Why should we have mass unemployment of schoolteachers, of automotive workers, of—you know, of all these parts of the economy that had nothing to do with the bubble but are now caught up in the tailspin as the economy suffers the aftermath of the bubble? Why should these people be left unemployed?”


A BRIEF DIVERSION INTO ECONOMIC THEORY

Nouriel Roubini is a renowned economist, oftentimes referred to as “Dr. Doom” among his colleagues for his persistent warnings of the financial collapse over the period leading up to our current crisis. He is currently a professor of economics at NYU’s Stern School of Business. Along with his associate, Stephen Mihm, is has authored the current economic bestseller Crisis Economics.

Chapter 2 of their book briefly tells the story of what they call “Crisis Economists.” We read about John Stuart Mill, Karl Marx, John Maynard Keynes, and Milton Friedman and Anna Schwartz, whose economic theories are well-known to economic specialists and lay people as well. No need here to make a long essay even more so.

The authors also go on a bit about economists generally referred to as “The Austrian School,” far less well known and read, but equally important, especially in regards to the current debate we’re addressing here. Proponents of their line of thought include Carl Menger, Ludwig von Meises, Eugen von Bohm-Bawerk, the more well-known Frederich Hayek, and his student, Joseph Schumpeter.

The ideology of “The Austrian School” is highly pertinent to the comments that will follow from Zacharia’s other guest, Harvard’s Niall Ferguson, thus some extended quotes from Crisis Economics are appropriate:

“Being an Austrian economist today is tantamount to holding libertarian economic beliefs. Indeed, a deep skepticism of government intervention in the economy—especially in the monetary system—is a pillar of the Austrian School.”

Though he was hardly a libertarian, Joseph Schumpeter developed a powerful theory of entrepreneurship that is often distilled down to a pair of powerful words: creative destruction. In Schumpeter’s worldview, capitalism consists of waves of innovation in prosperous times, followed by a brutal winnowing in times of depression. This winnowing is to be neither avoided nor minimized: it is a painful but positive adjustment, whose survivors will create a new economic order.”

“Austrian School economists make a historical case that the policy response to the recent crisis will eventually give us the worst of all worlds. Instead of letting weak, overleveraged banks, corporations, and even households perish in a burst of creative destruction, thereby allowing the strong to survive and thrive, governments around the world have meddled, creating an economy of the living dead: zombie banks that cling to life with endless lines of credit from central banks; zombie firms like General Motors and Chrysler that depend on government ownership for their continued survival; and zombie households across the United States, kept alive by legislation that keeps creditors at bay and that spares them from losing homes they could not afford in the first place. In the process, private losses are socialized: they become the burden of society at large and, by implication, of the national government, as budget deficits lead to unsustainable increases in public debt.”

”Economists of the Austrian persuasion are also deeply skeptical of the rush to regulate that so often occurs in the wake of a crisis. In their view, too much regulation was the cause of the crisis in the first place, and adding more will only make future crises worse.”

“From the Austrian perspective, the fear now is that the United States is heading down the road that Japan paved in the 1990s, when it responded to its own slow-motion financial crisis by propping up zombie banks and corporate firms and by dropping interest rates to zero, flooding the economy with yet more easy money. The government also ran enormous fiscal deficits to finance the kind of stimulus spending that Keynes prescribed. Instead of allowing “creative destruction,” the Japanese built bridges to nowhere that merely put enormous amounts of debt on the shoulders of the national government. The result, the Austrians maintain, was Japan’s Lost Decade.”

Quite a line of thought, no? AND completely devoid of any concern for human suffering! Compare it to Keynesian theory, where concern for the innocent victims of financial catastrophe is paramount.


BACK TO THE GREAT DEBATE

Fareed Zacharia now points out to his next guest, Niall Ferguson: “So you have an economy that seems to be slowing. Private sector job creation is very low. The consumer, who is 70 percent of the American economy, is spending a little bit more than he or she was a year ago but not enough to get us out of the woods. Interest rates are very low, so the Federal Reserve can’t really pull interest rates lower. What is really left than a second stimulus?”

To which Ferguson answers: “The question which is absolutely crucial here, Fareed, is what is the next move going to be? Are we going to try and play that Keynesian card again and have another fiscal stimulus, or are we just going to come to terms with the reality that there probably have to be tax increases and spending cuts pretty soon if the United States is to retain some kind of fiscal credibility in the international bond market?”

“So in some ways, if you think of a financial crisis as a chain reaction, as something that goes from one phase to another without ending happily and quickly, we’re entering a new and really quite scary phase. Europe is already in this phase. The fiscal crisis, which is the next big phase of the crisis, is happening there now. The worry is that at some point in the next two years something similar is going to happen here and the U.S. is not going to have a Keynesian stimulus option anymore.”

“I would say that the U.S. has a kind of stay of execution while the European crisis unfolds, but at some point the nasty arithmetic will get any country, even the United States, which is seen as, of course, the most attractive, the most safe haven country to invest in. I’ve been saying for a while that U.S. treasuries are a safe haven the way Pearl Harbor was a safe haven in early 1941. It’s safe until it’s not safe. It’s safe until the bond market says wait a second, this isn’t sustainable, we’d like a risk premium. Once you suddenly find your interest payments rising, it’s very quickly a—a shift into a death spiral, a kind of tailspin in which things compound. The Greeks have been there. Spain is there now. Japan could be next. The U.K.’s teetering on the brink. And at some point I think in the next couple of years, the reality will be that the Paul Krugman recipe ends up having costs that exceed the benefits.”


AN ALTERNATIVE PATH FORWARD

Zacharia credits both Krugman and Ferguson with valid points worthy of consideration. However, he sees another choice, and he is far from alone in his position.

“I think the case for government spending in the short term is pretty strong. The private sector is simply not hiring yet. Consumers are also being very cautious. You can’t motivate either of them any further with the traditional tools that used to be used, lowering interest rates, because interest rates are already close to zero. If the government were to slash spending in this atmosphere, it would probably send the economy into a tailspin.”

“So I have a proposal, a kind of grand bargain. Have a second stimulus that is targeted, temporary and effective, and most important, announce the second stimulus coupled with an announcement from the president of a 10-year plan to tackle the budget deficit. This would include significant reductions in entitlement spending, cuts in wasteful subsidies like agriculture, and a new gas tax and a small national sales tax. These measures would dramatically adjust the budget deficit, and they would assure markets that the United States has gotten serious about living within its means in the medium to long run.

“Some will say that we can’t calibrate policy that carefully, that we’re not capable of that level of sophistication. This cannot be true. We are living through an incredibly difficult set of economic challenges, the worst in generations. We have to be able to put forth the best solutions, not simply the ones that are politically feasible.”

“I refuse to accept that the only government in the world that can act sensibly for the long run is a dictatorship in Beijing. President Obama has said that the real need is not for big government or small government but smart government. So here’s his chance to demonstrate that proposition.”


OTHER VIEWS

An article in this morning’s New York Times quotes Mark Zandi, the chief economist at Moody’s Economy.com, as advising the House Budget Committee last week: “It is important—in fact I’d say it’s vital—that you continue to provide additional temporary stimulus to the economy.” But he added, “Once the economy is on a sound footing, it is critically important that you do pivot as quickly as possible and address the long-term fiscal situation.”

The article then goes further: “David M. Walker, the president of the Peter G. Peterson Foundation, an organization that has focused on cutting long-term deficits, said the “myth that we cannot address our current economic crisis and our long-term fiscal crisis at the same time” had become an obstacle to bipartisan agreement. In our view, the answer is to continue to pursue selected short-term initiatives designed to stimulate the economy and address unemployment, but to couple these actions with specific, meaningful actions designed to resolve our long-term structural deficits,” Mr. Walker testified last week to the National Commission on Fiscal Responsibility and Reform, the bipartisan panel named by Mr. Obama.”

Finally, the advice of Roubini and Mihm in Crisis Economics:

“The insights of both schools [Keynesianism and the Austrian School, and really the deficit hawks as well] can be synthesized and brought to bear on the problems we face now; indeed, the successful resolution of the recent crisis depends on a pragmatic approach that takes the best of both camps, recognizing that while stimulus spending, bailouts, lender-of-last-resort support, and monetary policy may help in the short term, a necessary reckoning must take place over the longer term in order to achieve a return to prosperity.”

THE ECONOMY & THE MARKETS

by Bill Breakstone, July 2, 2010

Former Fed Chairman Alan Greenspan appeared on the CNBC program Squawk Box yesterday morning. Hosts Joe Kiernan, Becky Quick and Carl Quintenella, and guests sat in awe as Greenspan made his comments on the state of the economy. Why these TV talking heads should be so humbled by a former official who had such a lack of foresight and philosophical intelligence in dealing with the lead-up to our financial crisis is baffling to me. In any case, the former “guru” of the financial world had little of substance to say, other than he thought that Wall Street was not a good economic indicator going forward. He stressed the importance of the asset value of 401K’s instead, which have increased significantly over the past year.

Well, Alan is getting up there in years, and it seems he relies more on his former reputation rather than on his present insights. The relative value of investor assets speaks of past appreciation. The movement of markets, on the other hand, is an indication of how the financial community views future prospects, even if they are short- rather than long-term.

Greenspan’s thoughts are not what drive me to write this essay. Rather, it is the concerns that many economists and legislators have about our present economic and social outlook.

Robert Samuelson wrote an interesting and highly pertinent op-ed in the Washington Post on June 28th. He wrote: “Almost everyone wants the world’s governments to do more to revive ailing economies. No one wants a “double dip” recession.” Unemployment among OECD countries currently stands at 46.5 million people, up about 50 percent since 2007. “Lengthy unemployment may erode skills, leading to downward mobility or permanent joblessness. But what more can governments do? It’s unclear. We may be reaching the limits of economics. . . . . Granted, the initial response to the crisis (sharp cuts in interest rates, bank bailouts, stimulus spending) probably averted a depression. But the crisis also battered the logic of all major theories: Keynesianism, monetarism and “rational expectations.” Economics has become a shaky science.”

“Consider the matter of budgets. Would bigger deficits stimulate the economy and create jobs, as standard Keynesianism suggests? Or do exploding government debts threaten another financial crisis?”

“The Keynesian logic seems airtight. If consumer business spending is weak, government raises demand through tax cuts or spending increases. But in practice, governments’ high debts impose financial and psychological limits. The ratio of government debt to the economy (gross domestic product) is 92 percent for France, 82 percent for Germany and 83 percent for Britain, reports the Bank for International Settlements in Switzerland.”

This means that the benefits of higher deficits can be lost in many ways: through higher interest rates if greater debt frightens investors; through declines in private spending if consumers and businesses lose confidence in governments’ ability to control budgets; and through a banking crisis if bank capital—which consists heavily of government bonds—declines in value. There’s a tug of war between the stimulus of bigger deficits and the fears inspired by bigger deficits.”

In America, the current administration is concerned about both alternatives, but leans toward its present focus on continuing the fragile recovery and dealing with the deficit two years or so down the road. On the other hand, EU countries have decided to deal with the deficit and their budgets now.

Samuelson comments: “That’s lunacy, writes Martin Wolf, chief economic commentator for the Financial Times. Concerted austerity may destroy the economic recovery. Exactly, echoes Nobel Prize-winning economist and New York Times columnist Paul Krugman, who argues that the U.S. economy needs more stimulus and bigger deficits. “Penny-pinching at times like this . . . . ,” he writes, “endangers the nation’s future.”

“Not so, counters Harvard economist Ken Rogoff. President Obama’s stimulus package may have “helped calm the panic” in 2009, but boosting spending now—raises “the risk of having a debt crisis down the road.” Deficits should be trimmed gradually, he argues.”

Well, more stimulus spending at this point is totally out of the question, despite Krugman’s advice. It’s just a political impossibility, and Obama and his economic team are well aware of that. But as Samuelson says: “The disconnect between theory and reality seems ominous. The response to the initial crisis was to throw money at it—to lower interest rates and expand budget deficits. But with interest rates now low and deficits high, what happens if there’s another crisis?”

Increasing frustration is being aired by economists and financial commentators who lean to the Keynesian side of the argument, as evidenced by Paul Krugman’s op-ed in this morning’s New York Times. As of the opening of Wall Street markets this morning, the S&P index had declined 12% from its mid-May highs, and as I write this at 2:40 P.M., the S&P is off another .65% and the Dow off .70%, both indicators edging closer to bear market levels. More and more people on the Street are seeing the feared “double-dip” as a likely scenario, despite Fed Chair Bernanke’s view that such is highly unlikely. Remember, Bernanke was wrong before—he failed to realize prior to the 2008 crash that the economy was headed towards dire straits.

David Leonhardt wrote a lengthy front-page article in yesterday’s New York Times that highlights the differing views among economic experts as to the best approach that world governments are taking in response to the continuing financial crisis. He looks back to government policy from 1933 to 1937, when economic recovery was short-circuited by increased taxes and budget balancing, which all economists now agree extended the Great Depression until spending leading up to WWII turned the tide. Differences exist between world economies then and now, but no one is sure if the differences are at all meaningful. As I asked in a previous article some three weeks ago, “Is history repeating itself?”

No one has a definitive answer to that question, but the markets are indicating that the path world governments are now pursuing is deeply troubling. And despite the fact that Greenspan discounts the meaning of market movements as a leading economic indicator, we must “listen to what the Street is saying.”



As Leonhardt writes at the conclusion of his piece “We are left to hope that we have absorbed just enough of the 1930s lesson.”

FOCUS ON AFGHANISTAN

Bill Breakstone, July 1, 2010

Last week, American Afghan policy leapt back into the headlines after the Rolling Stone article, the firing of General Stanley McChrystal, and the appointment of General David Petraeus as his replacement. In the days following these events, the media has given our Afghan policy intense scrutiny: featured articles in The Economist, The Washington Post, The Wall Street Journal, The New York Times, an hour-long debate on Meet the Press and Fareed Zakaria’s GPS on CNN, and intense coverage on MSNBC’s Morning Joe, among others. Many commentators have noted that the media attention given the personnel changes “on the ground” have served an extremely beneficial role, in that they have focused attention on policy, and the new command’s role in its implementation.

The three key questions that need answering are: (1) Why are we there?; (2) What have we accomplished so far; (3) Why is progress so slow; and (4) What policy changes need to be made?


Background

The United States and NATO forces invaded Afghanistan after 9/11 with the primary objectives of depriving Al-Qaeda its sanctuary and ending the Taliban controlled regime, enabling the election of a representative government representing the Afghan people. Those initial objectives were achieved. However, the Taliban and Al-Qaeda reorganized in Pakistani sanctuaries and began an insurgency that lasts to this day, and has grown stronger over the past years, threatening the stability of the new democratically elected Afghan regime and virtually establishing control of a vast amount of territory in the rugged Afghan countryside.

Senator John McCain said on Meet the Press:”It’s clear the Taliban is a very extremist and very fanatical element, and I think this is true with all insurgencies. But I think you will also find that the majority of the people in Afghanistan do not want the return of the Taliban.” If anyone doubts McCain’s belief, they should just read the novels by Khaled Hosseini The Kite Runner and A Thousand Splendid Suns.

Many opponents of the war argue that there are now fewer than 200 Al-Qaeda operatives in Afghanistan today; that may well be true. They, like the Taliban, fled to sanctuaries in Pakistan. However, anyone who believes that should the Taliban return to power in Kabul Al-Qaeda forces would not be back in force is extremely naïve and mistaken, as almost every strategist will point out.

Sebastian Junger, author of the recent book War, said on Meet the Press: Let’s remember some history here. Al-Qaeda was in Afghanistan when they attacked on 9/11. They’re in Pakistan right now because we’re in Afghanistan. You know, if we pulled out, what they have is what they had before 9/11. They have—I mean, when they’re in Pakistan, they’re in the tribal territories. It’s not a—it’s not an area that’s connected very well to the rest of the world. In Afghanistan, they had an airport, they had an economy, and they had a failed state that had no extradition treaties with the rest of the world. So they can do what they want, and there is no way to get at them short of military force. So we pull out—you’re right, they’re in Pakistan, but we pull out, they’re going to be right back in Afghanistan. They have not attacked the West successfully since they had to vacate Afghanistan. “ To which, Tom Ricks added: “I think if you want an endless war, leave Afghanistan right now, and you’ll find us having to go after Al-Qaeda again and again there for decades.”

[Note: Sebastian Junger’s War is a story of war that is much more than a war story. As a correspondent for Vanity Fair magazine, Junger made five trips to Afghanistan’s Korengal Valley in 2007 and 2008, embedded with the 2nd Platoon, Battle Company of the storied 173rd Airborne Brigade. Thomas E. Ricks writes on defense topics and international affairs. He is a Pulitzer Prize winning former reporter for the Wall Street Journal and the Washington Post. He is the author of the best-selling Fiasco: The American Military Adventure in Iraq and its follow-up The Gamble: General David Petraeus and the American Military Adventure in Iraq, 2006-2008. Neither of these writers could be considered “hawks”; both are admired journalists praised for their exhaustive research and impartial stances. Indeed, Ricks Fiasco was a scathing criticism of American foreign Mid-east policy and military leadership.]


The COIN Strategy

Counter Insurgency Strategy (COIN) depends on “in-country” leadership: militarily, diplomatically, and politically. It can only succeed if we win the hearts and minds of the citizens of the country we are trying to help. Most importantly, that includes the national government, the local governments, and the tribal leaders. As Fareed Zakaria said on Sunday “the counterinsurgency strategy depends upon a very close joint implementation of military, political, economic and diplomatic efforts. That is at the heart of it.”

In Afghanistan, those elements are sorely lacking. Retired Army General Barry McCaffrey, on Meet the Press, described the Afghan quagmire as “a political dilemma, not a military one. We have a goofy, incompetent Afghan government. We’re trying to build an Afghan security force and get it done in a very short period of time. None of this is going to work the way we’re going about it. So, again, back to, I think, the congresswoman’s [Barbara Lee—D/CA, of the House Foreign Affairs Committee] remarks, you either got to pull out in a stated time frame with huge negative consequences, potentially, to Pakistan, the Afghans themselves, U.S. foreign policy; or you, you announce that we’re in there until we have a stable political system in Afghanistan.”

As Leslie Gelb wrote in an excellent article in The Daily Beast on June 16th, “Karzai is firing the few officials Americans deem honest and capable. His government barely functions. His army makes very slow progress. His police operation is virtually hopeless. Even as U.S./NATO forces make some headway here and there, little comes in behind them to solidify gains.”

Furthermore, the Afghan government in essence has refused thus far to fully “sign on” to the COIN strategy, and has put individual priorities ahead of national interests and the peoples’ security and welfare. President Karzai is with us one day, hedging his bets the next, back on board and touring Kandahar with American generals the next, then finally negotiating with Pakistan to “cut a deal” with the Taliban. Meanwhile, in Kandahar there is a corrupt local government with Walid Karzai, the President’s brother, at its head. Concurrently, the Taliban sits, waits and carries out terrorist acts against coalition forces and the local population. As Thomas Ricks said, also on Meet the Press, relating a conversation he had with a Taliban leader, “You have the watches; we have the time.”


The Draw-down Deadline

In Afghanistan, as my real estate colleagues and attorneys know, time is of the essence, and a major impediment to the COIN strategy. The deadline for the start of troop withdrawal is August of 2011, 13 months from now. It is becoming increasingly clear that such a relatively tight time frame will be inadequate, and President Obama this week has begun to back away from this deadline. Following in lockstep behind him, General Petraeus, in his testimony before the Senate Armed Services Committee yesterday, emphasized that the August 2011 date marks only the start of a transitional period of “contingent-based” military draw-downs.

Senator McCain, and others, takes the position that the Afghan leadership, cognizant of the Obama administration’s August 2011 timeline for the troop drawdown, feels that they have to begin making plans for that eventuality. Thus, Karzai’s feelers to Pakistan about possibly bringing Taliban elements into the Kabul government. In Iraq, the tide turned in favor of coalition forces due in part to the “Sunni Awakening.” There is no parallel in Afghanistan. If Afghans believe that U.S. and NATO forces will be leaving in a relatively short period of time, why should they cooperate with the Americans and risk having their heads chopped off by the Taliban when allied troops are gone.

Richard Haass, President of the Council on Foreign Relations, stated in a June 23rd article that: “The administration’s preference is that U.S. forces should withdraw only at a pace that conditions on the ground justify. This either means that over the next twelve months the effectiveness of Afghan government forces will increase dramatically, both in absolute terms and relative to the Taliban—or that a large number of U.S. forces will remain fighting in Afghanistan for many years to come. Everything about Afghanistan points to the latter as being more likely. The United States has embarked on a policy of state-building in a country with little tradition of a strong state. Making matters worse is that the Afghan government is riddled with corruption and the Taliban has the benefit of a sanctuary in Pakistan, which remains as much of a problem as it is a partner. . . . . The President was wise to act swiftly to replace his theater commander; he should act no less decisively in reviewing the policy.” Or, as an article in The Economist states: “Mr. Obama owes it to the West and to the Afghan people to determine whether COIN can in fact succeed under his best general. The Afghan war may yet end in an ignominious retreat. But nobody should welcome such an outcome.”


Where Do We Go From Here?

The United States and its allies face multi-faceted challenges in Afghanistan and Pakistan.

As stated above, we have a totally unreliable partner in Karzai and the Afghan government, characterized by ineptness and corruption; the elections last year were questioned by many for fraud, lending an air of illegitimacy to the mix.

Pakistan exerts little control over the territory used by Al-Qaeda and the Taliban as sanctuaries. Islamabad has neither the commitment nor the military resources to rid those regions of terrorist extremists. Their overriding concern is with India. However, with Taliban attacks inside Pakistan increasing, threatening their internal stability, their stance may change.

Diplomatically, three courses of action are possible, if not probable. First, promote a change of leadership in Kabul that would be more committed to the needs of the Afghan people. Second, come to terms with the Pakistani government that would permit U.S. and NATO forces to overtly attack the terrorists in their sanctuaries. Lastly, set up highest level diplomatic meetings with the foreign ministers of Pakistan, India and Secretary of State Clinton in the hope of gaining mutual assurances that neither country would act against the other should Allied forces take action in Pakistan’s Northwest Provinces, Wariristan and Balochistan.


New Allied Leadership in Afghanistan

Tom Ricks, in his Washington Post op-ed of June 27th wrote that in reaction to the repeated friction between U.S. generals, diplomats and the Iraqi government, “General Petraeus and Ambassador Ryan Crocker were determined to coordinate their actions. Word went out to subordinates that neither of them would tolerate infighting between civilian and military officials. When the two returned to testify before Congress in September 2007, they showed a united front, key in winning them more time for the war at a moment when congressional leaders such as Sen. Joseph R. Biden Jr. were saying it was time to “stop the surge and start bringing our troops home.”

“In Kabul, alas, Petraeus will find no such useful ally in the American ambassador. Instead, the top U.S. diplomat there is Karl W. Eikenberry, who relentlessly opposed McChrystal’s initiatives. Unlike Crocker, Eikenberry has no strong base in the State Department and is not steeped in the history and culture of the region. Rather, he is a retired general who in fighting with McChrystal over the past year used many of the same arguments that another American commander, John Abizaid, had used in opposing Petraeus’s approach in Iraq.”

“On top of that, Petraeus will have to deal with Richard C. Holbrooke, who seems to have achieved little as special presidential envoy for Afghanistan and Pakistan. And the general will face a host government even more troublesome than what he dealt with in Baghdad. Indeed, the two biggest problems the United States faces in Afghanistan are the Karzai government and the Pakistani government—and neither of those really can be addressed by military options.

One wonders whether Crocker can be persuaded to accept an invitation from President Obama to replace Eikenberry, thus bringing the military/diplomatic team that was so successful in Iraq to bear on the Afghan and Pakistani regimes.