Charlie Rose

NoPardonforMichaelMilken  11/20/2008 05:15 PM Report

hrc, Interns for the Charlie Rose Show are expected to offer a higher level of praise than merely "great, well balanced." Pick up the praise or you'll no longer be a member of the Charlie World of the Hamptons, the Upper East Side, and all things viewer-supported.

hrc  11/19/2008 09:55 PM Report

Great, well balanced show, cut short again but good stuff. I picked up on some fears of socialism or some drastic shift left. Well, please let's not speculate too far ahead. Firstly somebody has to take ownership of the problem, that's the government. Taking governmental action is not in itself a move left. I'd like to thank all who participated in this show, I found it quite interesting on many levels.

tartufe  11/18/2008 06:24 PM Report

No pardon for NoPardon. The apparent and too extensive defense of hedge funds sounds like it comes hand hewn from the nations two top slime-ball wise-guys Bernanke and Paulson. When finance needs exotic designs to extract your money you can bet it has an erotic element cause you're going to be screwed without being kissed. If it takes more than a paragraph to define and defend it, it's ipso facto suspect. Disingenuous!

NoPardonforMichaelMilken  11/18/2008 03:27 PM Report

As for Sebby Mallaby, Mz. Amity's pal in the Conservative Think Tank World According to Scaife, Coors, Walton, and Adelson, the old chap co-authored a piece that appeared in the January/February 2007 issue of Foreign Affairs championing hedge funds as fighters for truth, justice, and the Ayn Rand/Milton Freidman Way.

Hedge funds, Sebby neglected to tell us, offer the economic force that is driving America straight to, well, $800 billion bailouts, the Cayman Islands, and a litany of offshore tax havens.

I particularly enjoyed this bit of twisted, albeit well-compensated logic, from Sebby: "But the fear of hedge funds is overblown, based more on ignorance or simplistic caricatures than on actual knowledge. Many of the proposals for new regulation are so vague as to be impossible to evaluate or are poorly suited to address the supposed problems at issue. And even the most serious cause for concern -- that hedge-fund operations might generate a "systemic risk" for the financial system as a whole -- is neither limited to the hedge-fund sector nor best addressed through regulation of it. Rather than seeing hedge funds as sources of dangerous financial fires, in fact, it is more accurate to see them as the financial system's benevolent fire fighters -- and to let them have the tools they need to do their jobs well."

Please, take a gander at the whole piece. Then ask yourself why Charlie Rose allowed Sebby old boy to appear on a taxpayer-funded, citizen-owned television network and spin his tripe?

How much did they pay you, Charlie? And was the First National Bank of Grand Cayman again the drop point?

Hands Off Hedge Funds

By Sebastian Mallaby

Foreign Affairs

January/February 2007

From Foreign Affairs , January/February 2007

Summary: The massive growth of hedge funds has sparked warnings of instability and demands that the industry be regulated. But the fear of hedge funds is overblown, based on a misunderstanding of their role in the international financial system. In reality, hedge funds do not increase risk; they manage it -- and policymakers, rather than clamping down, should make sure hedge funds have the tools to perform this function well.

Sebastian Mallaby is a Washington Post columnist and the author of The World's Banker: A Story of Failed States, Financial Crises, and the Wealth and Poverty of Nations.

LOCUSTS OR FIRE FIGHTERS?

Imagine two successful companies. Both are staffed by very smart people; both are innovative; both have an impact far beyond their industry, improving the productivity of the capitalist system as a whole. But the first, based near San Francisco, is the subject of adoring newspaper profiles, whereas the second, based in the New York area, is usually vilified.

Actually, you do not have to imagine any of this, because it describes a double standard that already exists. The first company in the story is a technology firm; the second is a hedge fund. As any newspaper reader knows, technology firms are the leading edge of the U.S. knowledge economy; they made possible the productivity revolution of the past decade. But the same could just as well be said of hedge funds, which allocate the world's capital to the companies, industries, and countries that can use it most productively.

Of course, that is not how hedge funds are viewed most of the time. The recent implosion of Amaranth Advisors -- a hedge fund that lost $6 billion in a matter of days thanks to one Ferrari-driving 32-year-old trader (and his greedy bosses' abandonment of proper risk management) -- has rekindled the fears that attended the collapse of Long-Term Capital Management in 1998, an event that even then Federal Reserve Chair Alan Greenspan believed "could have potentially impaired the economies of many nations, including our own."

In the United States, the Securities and Exchange Commission (SEC) has tried to regulate the sector further -- a 2004 SEC rule requiring the registration of hedge-fund advisers was vacated by a federal court in 2006 -- and continues to be interested in increasing oversight. The attorney general of Connecticut, a state in which many hedge funds are headquartered, has set up a special unit to prosecute hedge-fund abuses and decries what he regards as the "regulatory black hole" in which these funds exist. In East Asia, governments still blame hedge funds for their supposed role in the 1997-98 financial crisis. And in Europe, Franz Müntefering, Germany's deputy chancellor, has complained that hedge funds "remain anonymous, have no face, fall like a plague of locusts over our companies, devour everything, then fly on to the next one."

Such antipathy seems likely only to intensify as hedge funds continue their extraordinary growth. In the eight years since Long-Term Capital collapsed, the volume of money managed by U.S. hedge funds has risen from about $300 billion to well over $1 trillion, according to HedgeFund Intelligence. In Europe and Asia, meanwhile, assets under hedge-fund management have grown to $325 billion and $115 billion, respectively, and London has emerged as a hedge-fund center second only to the New York area. The total assets in the hedge-fund sector remain much smaller than those in banks and pension funds. But whereas hedge-fund assets have quintupled in eight years, the world's stock of equities, tradable debt, and bank deposits has only doubled, according to data from the McKinsey Global Institute. Moreover, because the sector as a whole is leveraged and some funds trade intensively, hedge funds are thought to account for a third of the turnover in U.S. equities and an even higher share in more exotic financial instruments.

The fear of the growing influence of hedge funds is compounded by the aura of mystery that surrounds them. Whereas financial markets thrive on transparency, hedge funds are limited in what they can disclose to the public at large. They are sold through privately distributed prospectuses that describe the funds' investment parameters, terms of investment, redemption rules, and the like. But even some of the fund-of-funds managers who have emerged as expert intermediaries between hedge funds and investors have only a general idea of the trading strategies that some of their component funds pursue.

The suspicion is pervasive enough to make a new regulatory push seem probable. This past October, Senator Chuck Grassley (R-Iowa), the outgoing chair of the Senate Finance Committee, complained in a letter to Treasury Secretary Henry Paulson that ordinary Americans are increasingly exposed to hedge funds via their pension plans and demanded to know why the funds are allowed to get away with secrecy. Press coverage is suffused with the supposition that more regulation would be welcome, and even an October survey of private economists conducted by The Wall Street Journal found that a majority favored tougher oversight. Industry leaders who once might have urged regulators to leave them alone now plead instead only that restrictions should avoid being too onerous. And European regulators are as keen to subject hedge funds to controls as their American counterparts.

But the fear of hedge funds is overblown, based more on ignorance or simplistic caricatures than on actual knowledge. Many of the proposals for new regulation are so vague as to be impossible to evaluate or are poorly suited to address the supposed problems at issue. And even the most serious cause for concern -- that hedge-fund operations might generate a "systemic risk" for the financial system as a whole -- is neither limited to the hedge-fund sector nor best addressed through regulation of it. Rather than seeing hedge funds as sources of dangerous financial fires, in fact, it is more accurate to see them as the financial system's benevolent fire fighters -- and to let them have the tools they need to do their jobs well.

MYTHS AND FACTS

Along with the growth of the hedge-fund sector has come variation that makes generalizations difficult. Hedge funds are private investment pools allowed to operate with a great deal of freedom and flexibility, including having the ability to leverage their assets through borrowing and to bet that stocks will fall as well as rise. Some use intensely mathematical methods; others pursue stock-picking strategies that depend on human judgment about the quality of corporate managers. Some borrow and trade aggressively; others do not. Arbitrage funds take no view on markets' fundamental value but exploit price misalignments between equivalent assets; other funds trade on convictions about value, using various methods of assessing it.

If hedge funds are not actually an army of undifferentiated attack clones, neither are they entirely unregulated, despite the popular image. Like any other investors, hedge-fund managers are subject to prosecution for insider dealing or fraud; they are overseen by the SEC if they have broker or dealer affiliates; they may be regulated by the Commodity Futures Trading Commission if they trade futures or by the Federal Energy Regulatory Commission if they trade energy contracts; their borrowing is indirectly monitored by the Federal Reserve; and so on. Further regulation may or may not be appropriate, but any benefits it might bring would have to be measured against the risks of impeding innovation in the capital markets -- an outcome that would be about as desirable as stifling innovation in Silicon Valley.

Popular resentment of hedge funds begins with the suspicion that they earn too much. The founder-owners of the most successful firms do take home several hundred million dollars annually, much more than top Wall Street executives. Reporting from the epicenter of this gold rush, the Stamford Advocate observed recently that six local hedge-fund managers pocketed a combined $2.15 billion in 2005. Such payouts are the result of hedge funds' unique fee structures, which combine large annual management fees with a share of annual investment profits.

But the sophisticated investors who pay such fees do so voluntarily, because they believe that the returns they will receive will more than compensate for those fees. Hedge-fund managers who do poorly or do not outperform relevant indices will soon have no money left to manage: in 2005, 848 hedge funds went out of business. And high performance fees can be less corrupting than the alternative. Since they rely only on management fees, for example, mutual-fund companies have an incentive to focus on boosting the volume of the money under their management rather than on their investment performance.

The extraordinary earnings of the top hedge-fund managers reflect the workings of a daunting star system. Every year, hundreds of smart analysts sign up to join the industry, just as thousands of aspiring movie stars arrive in Hollywood. Only a few do enough to justify the high fees charged: come up with an insight into how a certain company or currency has been mispriced, see illogical discrepancies between the prices of sets of financial assets, and so forth. And those who do come up with such breakthroughs not only make fortunes for themselves and their clients. By buying irrationally cheap assets and selling irrationally expensive ones, they shift market prices until the irrationalities disappear, thus ultimately facilitating the efficient allocation of the world's capital.

If some are concerned about hedge-fund managers' compensation, others are concerned about their integrity. Arguing for its rule requiring hedge-fund advisers to register themselves and be subject to inspections, the SEC cited 51 fraud cases involving hedge funds between 2000 and 2004 and claimed that at the time of the rule's adoption, in 2004, 400 hedge funds and at least 87 hedge-fund advisers were under investigation.

An industry of around 9,000 hedge funds is indeed bound to harbor some criminals. But insider trading is already illegal, and prosecutors have the tools to go after offenders in hedge funds without new regulations. The number of fraud cases suggests that regulators are not shy about using these powers, and hedge funds regularly experience inquiries from the SEC when they happen to trade heavily in a stock ahead of a price-moving announcement. Moreover, some of what politicians and journalists label "hedge-fund abuses" involve leaks of inside information from investment banks rather than from hedge funds, making the hedge-fund managers who receive the leaks accomplices rather than the chief offenders.

Still other critics attack hedge funds for the consequences of their buying and selling decisions. Thus, Germany's deputy chancellor compared hedge funds to locusts because of their role in hostile takeovers of German companies, and some Britons vilified George Soros because his hedge fund upended the British government's economic policy in 1992. And after the East Asian crisis in the late 1990s, Malaysia's prime minister, Mahathir bin Mohamad, lamented that "all these countries have spent 40 years trying to build up their economies and a moron like Soros comes along with a lot of money to speculate and ruins things."

The common assumption underlying such criticisms is that politicians know and seek the public good, whereas market forces, represented here by hedge funds, seek only profits, without regard to any costs or consequences that might follow. But German politicians' objections to hostile takeovers have little to do with any rational conception of the public good, and a lot to do with their cozy relationship with incumbent captains of industry. And although the European Exchange Rate Mechanism (ERM) may have appealed to British Prime Minister John Major, anxious to differentiate himself from his Europe-bashing predecessor, Margaret Thatcher, his country's membership in the ERM made no economic sense after Germany refused to raise taxes to pay for unification, thus generating interest rates high enough to threaten recession in the United Kingdom. By betting against the pound and helping to destroy the ERM, Soros ended up making money not by economic vandalism but by liberating Britons from their leaders' unsustainable choices. As the economist Melvyn Krauss and the former hedge-fund manager Michael Simoff have written, hedge funds may be a disruptive force -- but they disrupt what needs disrupting.

RISK MANAGEMENT

Hedge funds are sometimes accused of destabilizing capital markets. This is the fear that goes back to the collapse of Long-Term Capital Management: that the implosion of a major hedge fund could be devastating not merely for its investors but for the broader financial system as well. Regulators in both the United States and Europe have expressed some variant of this worry, and not without reason. But the dangers created by hedge funds need to be balanced against the many ways in which the funds actually reduce risk.

Contrary to popular mythology, hedge funds are not precipice dwellers. In the United States and Europe, regulations restrict access to hedge funds to rich individuals and institutions on the theory that the funds are too risky for the average investor. But because most hedge funds hold a portfolio of positions and can go short as well as long -- borrowing stocks and selling them, in the hopes of buying them back after their prices have fallen -- they can be less volatile than individual stocks or standard mutual funds. After the technology bubble burst, investors discovered that holding supposedly sedate stock-index funds could make for a bumpy ride; meanwhile, hedge funds as a group delivered strong positive returns over the period. The best way for large investors to avoid the precipice is to hold a diversified portfolio of investments, in which hedge funds can certainly play a part.

Moreover, hedge funds collectively do not so much create risk as absorb it. The funds can be viewed as quasi insurers; by shouldering risks that others wish to avoid, they remove a potential obstacle to business. For example, banks have to limit their lending for fear that borrowers might default. But hedge funds are willing to buy credit derivatives that transfer the default risk from the banks to themselves -- freeing the banks to finance more economic activity. Similarly, companies may reduce their cross-border activities if there is a limit to the foreign currency exposure they are willing to take on. Hedge funds help to manage that exposure by trading in the currency derivatives that companies use to insure themselves.

Hedge funds can also reduce the danger that economies will overrespond to shocks. If a currency or stock market starts to plummet, the best hope for stability lies in self-confident, deep-pocketed investors willing to bet that the fall has gone too far, and hedge funds are well designed to perform this function. Whereas mutual-fund managers must be cautious about bucking conventional wisdom because the returns they generate are measured against market indices that reflect the consensus, hedge funds are rewarded for absolute returns, which allows their managers to engage in independent thinking. Moreover, many hedge funds have "lock-up" rules that prevent investors from withdrawing money on short notice; when crises strike, the funds have the freedom to be buyers.

This does not mean that they will extend a safety net every time a market falls. But in 1988, the Brady Commission report on the stock-market collapse of the previous year found that hedge funds had been net buyers during the crash. And contrary to Mahathir's fulminations, it was banks that caused the flight of "hot money" from East Asia during the 1997-98 crisis -- with hedge funds being among the first to go back in.

Finally, hedge funds can reduce the chances that markets will rise to unsustainable levels in the first place. Unlike most other investors, they can profit from falls in the market as well as from rises. Their ability to short stocks has given rise to a cottage industry of specialist funds that scour the financial press for glowing corporate profiles and bet against the hype. Hedge-fund managers can make mistakes or fall prey to groupthink, just as anybody else can, but they have greater flexibility and more incentives than other investors to buck trends rather than follow them.

NIGHTMARE ON WALL STREET?

If hedge funds reduce and manage risk in all these ways, what of the systemic risk that concerns regulators? That risk is real -- but restrictions on hedge funds are the wrong way to deal with it.

From a policy perspective, it does not matter if one hedge fund goes down. The fund's investors take a hit, but they were presumably aware of the risks all along. Ordinary citizens may be increasingly exposed to hedge funds via their retirement plans, as Senator Grassley says, but large corporate pension funds allocate on average only about one percent of their assets to hedge funds, so that exposure is trivial. What matters is whether a collapse has knock-on effects, particularly for the banking system more generally.

Banks are exposed to hedge funds in part because they lend to them. When Long-Term Capital Management collapsed in 1998, it emerged that banks had lent it enough to be left with significant losses. But the answer to this problem is not to regulate hedge funds but to do better at supervising the already regulated banks. This is what the Federal Reserve Bank of New York and its European counterparts have done. Since Long-Term Capital Management's collapse, banks have lent hedge funds only money that the banks could afford to lose. In the late 1990s, hedge-fund borrowing peaked at about 2.5 times capital (meaning that every dollar in the sector was supplemented by an additional 2.5 dollars of borrowed money); today, according to JP Morgan, the borrowing amounts to only a little more than the capital in the sector.

Banks are also exposed to the possibility that trouble at one hedge fund will create trouble at others. Hedge funds tend to invest on margin: they borrow money so that they can buy stocks, bonds, or various derivative contracts, and the lending banks then retain those financial instruments as collateral. If an investment loses value, the bank issues a margin call, demanding that the hedge fund pony up fresh capital to replenish the collateral; this can force a fund to sell its holdings just as they are losing value. If a hedge fund is a big player, the pressure of its selling could potentially drive prices down further -- triggering another round of margin calls and another round of forced selling. If such a vicious cycle drove down the value of a particular part of the market, others who invested in it could also see their assets wiped out.

The nightmare scenario involves a host of hedge funds making similar bets. If the bets turn out to be wrong, a fund could unravel, causing the others to unravel in turn -- and banks that could comfortably swallow the default of one or two funds might find themselves overwhelmed by the default of dozens. The banks themselves, moreover, may have made similar bets through their own proprietary trading desks, meaning that their own capital would be taking a hit just when it was needed to cushion losses on hedge-fund lending. When Timothy Geithner, the president of the New York Federal Reserve Bank, sounded a warning about hedge funds this past September, this is what was worrying him.

Geithner was not, however, saying that the nightmare scenario is likely. In financial markets, there has to be someone on both sides of each trade; if a group of hedge funds is betting heavily on a fall in energy prices or the convergence of Latin American interest rates, somebody else must be betting just as heavily on the opposite outcome. Viewed globally, this system of wagers is a giant zero-sum game. In order to be worried, you have to believe that one side of some risky bet is concentrated in a particular corner of the financial system, and that it could collapse without the other parts of the system coming to the rescue.

Such a possibility is real, but it does not justify a clampdown on hedge funds. To the contrary, the proliferation of hedge funds actually diminishes the risk of the nightmare scenario, and so regulation that discouraged the creation of new funds would be counterproductive. The more hedge funds there are, the less likely it is that they will all be concentrated on one side of a given trade, and the more likely it is that if trouble at one hedge fund initiates a downward spiral in a particular corner of the market, falling prices will draw in other funds smelling a bargain.

This is precisely what happened after Amaranth's collapse this past September: the fund had to sell its positions fast, and others (including other hedge funds) were only too happy to accept the resulting discount. Because they are global, opportunistic, and nimble, hedge funds are likely to pile into any market where the distress of other institutions creates anomalous pricing.

It is true that if hedge funds become very large, they pose a more serious risk. If Amaranth had lost $26 billion rather than $6 billion, it might have been harder for other market players to take over its trading positions. Troubling concentrations of risk can occur within banks as much as within hedge funds: part of the nightmare scenario lies in the direct risk to the banks from their own proprietary trading desks, and banks such as Morgan Stanley have been building up their asset-management business by buying stakes in hedge funds. But imposing some arbitrary regulatory cap on the size of hedge funds would unjustly penalize successful firms. The best safeguard against the risk posed by large funds is the presence of other large funds.

THE AGE OF UNCERTAINTY

If it is wrong to discourage the formation of new hedge funds and wrong to impose a limit on funds' size, what of other possible regulatory options? Some call for limits on funds' borrowing. But that might curtail their ability to act as opportunistic buyers in a crisis: it would ration the fire fighters' access to the fire hydrants.

Others call for more disclosure, which would allow lenders and regulators to gauge whether funds are crowding dangerously onto one side of a particular trade. But periodic snapshots of a fund's positions might reveal little if it trades intensively, and even extensive disclosures can fail to reveal a fund's real risks. In a 2005 paper for the National Bureau of Economic Research, Nicholas Chan, Mila Getmansky, Shane Haas, and Andrew Lo demonstrated how a hedge fund could report strong and consistent returns over 96 months and still present a risk of sudden implosion. A further reason to be cautious in demanding disclosure is that hedge-fund privacy can serve a useful purpose. Without a right to privacy, funds could not be sure of capturing the value of their intellectual property, as there is no patent protection for trading strategies. Forcing disclosure indiscriminately on all funds could thus damage their incentive to discover and correct market inefficiencies.

Rather than forcing more disclosure, it would be better to allow the market to promote it. As the hedge-fund industry has grown, it has gradually become more transparent. Brokers that supply leverage to hedge funds have grown more insistent on understanding their clients' risks. Proliferating funds of funds demand at least a general description of their exposure from the hedge-fund managers to whom they entrust capital. These pressures give hedge funds an incentive to disclose more than they have in the past, since the more they reveal, the more readily they can raise capital. And in some cases, funds may choose to reveal a lot. In November, Fortress Investment Group, which manages private equity funds and hedge funds, took the radical step of seeking a public listing, with all the disclosure requirements that come with it. Other funds may decide that secrecy is so important to their business model that it is worth accepting higher costs of capital, and they should be free to make that judgment.

In the end, the critics of hedge funds would do well to remember why this sector has emerged as such a force. Until the late 1960s, the financial world was quaintly stable: exchange rates were inflexible, interest rates were regulated, and the whole system was anchored by a fixed gold price. But that world collapsed when inflation drove the dollar off the gold standard and currencies and interest rates began to float; from then on, it became impossible to amass savings without facing financial uncertainty. Tools for coping with that uncertainty -- deep markets in futures, options, and other derivative instruments -- sprang up in response to the newly volatile environment. And hedge funds emerged as the masters of these tools, providing quasi insurance to investors and firms and introducing a healthy dose of contrariness into financial markets. For this, they are accused of generating risk. But their real systemic function is to manage it -- and it is their very success in doing so that has generated both their profits and their phenomenal growth.

NoPardonforMichaelMilken  11/18/2008 03:09 PM Report

Finally, Mz. Amity does not merely restrict her literary skills to natural disasters and the governmental response, patriotism, and, of course, the Biography of George W. Bush. Mz. Amity, the long-time Missus Seth Halperin, also dabbles in Conservative economics and Texas financial wizardry. Mz. Amity, you see, is also a defender of Phil Gramm, the former U.S. senator from the Lone Star State who called Americans "whiners" early this year when some of us expressed concerns about our economy.

On July 12, Mz. Amity attacked the notion that anything could be wrong with the U.S. economy. Mz. Amity expressed her support for Mr. Gramm and his lovely wife (and ex-Enron hack), Wendi, on the pages of the Washington Post.

Seems, according to Freddy Hiatt's Chop Shop, Mz. Amity also made a factual mistake. Small bother. What's a factual mistake between Texas bidnessmen, their wives, and their loyal minions?

Nice to know that Mz. Amity stated back in July 2008 that there was nothing wrong with the U.S. economy that four more years of Conservative deregulation could not cure.

Now with the economy in the toilet, and Mr. Gramm's reputation in ruins, one wonders why Charlie Rose allowed Mz. Amity, who was so incorrect about the U.S. financial picture four months ago, to appear on his PUBLICLY FUNDED, TAXPAYER-OWNED talk show?

How much they paying you, Charlie? And did the drop again occur at the First National Bank of Grand Cayman?

Correction to This Article

This op-ed on former senator Phil Gramm's recent remarks on the economy referred to him incorrectly as a former chairman of the Senate Finance Committee. He chaired the Senate Banking Committee.

Phil Gramm Is Right

By Amity Shlaes

Washington Post

Saturday, July 12, 2008; A13

"In serious consideration for ambassador to Belarus." That's the role John McCain joked that former senator Phil Gramm might have in a McCain administration. Gramm is McCain's most senior economic adviser, the one best qualified to lead the finance team of a McCain presidency. Now, however, Gramm faces political exile because he made the mistake of telling the truth.

What prompted the abrupt demotion? The short answer is what might be called Campaign Econ. Campaign Econ says the American economy is a certain way because Americans think it is. Campaign Econ competes with real economics and often wins -- with damage that extends way beyond, say, the political career of either Phil Gramm or John McCain.

Consider what happened this week. While speaking with the Washington Times, Gramm said that the country was not in a true recession but a "mental recession." He also said, "We have sort of become a nation of whiners" and "You just hear this constant whining, complaining about a loss of competitiveness, America in decline."

Gramm was right about the recession and stood by his recession comments on Thursday. A recession is two consecutive quarters in which the economy shrinks, and last quarter it grew. But no matter. Voters feel they are in a recession, and so they are, at least according to Campaign Econ.

Gramm's second sin was political. Calling voters whiners is to shame them. He later rephrased this comment, saying it was not voters he meant but politicians. That's because shaming voters is something American politicians simply don't do. Campaign Econ is unabashedly populist, and to seek to elicit shame is regarded as unpardonably elitist. Earlier this year, the McCain team was already terrified of seeming elitist. His advisers convinced themselves that the closeness of the primary contest was due to a lack of generosity. In January, when the McCain folks were desperate to win the Michigan primary, they ground their teeth down as Mitt Romney pandered to the auto industry. Romney's promise of unlimited support for carmakers won him that primary -- but not the nomination. Still, since then, McCain's advisers have sought to prove that he understands Campaign Econ; consider their proposal of a summer gas tax holiday.

That Campaign Econ is also calibrating Barack Obama's economic team goes without saying. The view among the nation's political advisers, from far left to far right, is that the economy is in a Katrina. Anyone who disagrees has no role in the 2008 presidential contest.

Campaign Econ is certainly understandable. Gas prices are ruining vacation plans and killing businesses. Many Americans have lost or are about to lose their homes to foreclosure or in distress sales. The federal government may not be talking about it much yet, but inflation plagues the country. The weak dollar is altering our everyday calculations. For many, this is not a happy summer.

Still, to liken the current moment to the Great Depression, or even the early 1980s, as Campaign Economists have, is to whine, just as Gramm said. During the Depression, people lost their homes even though they had borrowed only 10 percent of the purchase price. People losing their homes today frequently have borrowed 90 percent or more. The country approached double-digit unemployment in the early 1980s. This week, even as McCain was trying to talk his campaign past Gramm's comments, joblessness stood at a historically modest 5.5 percent.

And Campaign Econ has costs. The first is that talk of a downturn -- or "mental recession," as Gramm put -- can itself generate a downturn. Keynesian economists say this is so because consumer spending slows when people are afraid. But there's also a non-Keynesian dynamic. Grumbling leads to costly government rescues that scare markets and slow growth.

Second, as evidenced by the plummeting prices of Fannie Mae and Freddie Mac shares, serious trouble may be closer than we think. The plunging stock of the government-sponsored mortgage companies reminds us that those entities urgently require restructuring. Wall Street figures and the Senate Finance Committee that Gramm used to chair are already talking about how to structure a bailout. But this task is about stopping recession, not luxuriating in it.

Social Security and Medicare also need rewriting -- and Gramm put forth one of the better proposals on Social Security in the 1990s.

In short, to fix it all, we need a frank conversation about the economy. McCain, in fact, inaugurated one back in 2006 when he gave a speech that was downright Gramm-like at the Economic Club of New York.

In that speech, McCain said that on entitlements, hard choices were necessary. He concluded: "Any politician who tells you otherwise, Democrat or Republican, is lying."

This was McCain at his best. Many voters knew it, too.

The way to strengthen the economy right now is to elect leaders who dare to talk about problems in precise and even technical terms -- and then act on them. McCain has that capacity, but only if he can transcend Campaign Econ.

Amity Shlaes is a senior fellow in economic history at the Council on Foreign Relations and the author of "The Forgotten Man." She recently spoke at a meeting hosted by the Mercatus Center and the Texas Public Policy Foundation, which is chaired by Wendy Gramm, wife of Phil Gramm.

NoPardonforMichaelMilken  11/18/2008 03:00 PM Report

Ten days later,Mz. Amity changed her veritable tune slightly on President Bush's response to Katrina. In her FINAL COLUMN for the Financial Times, Mz. Amity maintained that Mr. Bush had done a wonderful job handling Katrina.

Instead, federalism caused all that suffering and death. Federalism, per Mz. Amity, and the general incompetence of government, bureaucracy, all critics of Mr. Bush, anti-Americanism, and those suffering from Bush Derangement Syndrome.

Here's Mz. Amity's FINAL COLUMN for the Financial Times. (Wonder why the FT never brought her back? Must be some sort of anti-Conservative MSM conspiracy against the wife of Seth Halperin.)

Blame delays in New Orleans on federalism

By Amity Shlaes

Financial Times

Published: September 12 2005 03:00

Incompetence has been the word used the world over to describe the rescue from Hurricane Katrina. The US Federal Emergency Management Agency and its parent, the new, giant Department of Homeland Security, did not respond fast enough. Worse yet, President George W. Bush did not respond fast enough. This, the commander-in-chief who wages lightning wars?

The critics are right on one point. There was hesitation. That hesitation at times represented incompetence. But it was also something else: what we might call the Federalist Pause.

The Federalist Pause is that little intake of breath, that clearing of the political throat that American leaders instinctively demonstrate before plunging forward. Mr Bush provided a classic demonstration of the pause last week when he considered invoking a little-known law, the Insurrection Act, to take over Louisiana - and chose not to, out of deference to the authority of Kathleen Blanco, the governor. The pause can be lethal. It may have been last week. But there are reasons for it.

The habit of the pause goes back more than two centuries, to the founding fathers. Even centralisers among them did not see Washington's role as handling events like Katrina. Towns, counties or, at the very highest, states were responsible for citizen safety. Washington could not intrude uninvited.

Sound principles were behind such federalism. The first was local sovereignty: a rescuing Washington was a threatening Washington. There was also the matter of moral hazard: if localities knew they could count on Washington, they would not take care to stay out of harm's way. Most Americans, moreover, nursed a suspicion that Washington's bureaucracies might not do important work as well as local authorities did.

There was also a fear of the opposite: that an efficient centralised government would prove so compelling as to make its expansion impossible to check. Inefficiency, the bungling of co-ordination efforts, might even be a good thing, if it slowed the rise of tyrants. Whenever confronting emergency - from uprisings of native Americans to epidemics of influenza - officials thought twice about whether the rescue job was truly Washington's.

The example of federalism in action most relevant to Katrina was the Mississippi flood of 1927. The flood covered whole states. Waters raging up to 100 feet high drove 1.5m from their homes. The flood destroyed 2m acres of crops, the region's livelihood.

President Calvin Coolidge paused - and decided the flood was not the president's job. To manage the rescue he sent Herbert Hoover - his own version of Rudy Giuliani, who got New York back to work after the attacks of four years ago. But the Mississippi rescue was different from the sort expected today. Hoover, the commerce secretary, had no giant government cheques. His role was more that of broker than funder. He negotiated among states; his Red Cross drive raised $15m. When Hoover needed something, he found donors or simply commandeered goods. Sawmills along the river hammered out 1,000 rough wooden boats. Outboard motor manufacturers supplied 1,000 motors (of which only 120 were returned). The Pullman Company provided Hoover with his own train cars - including a dining car - so that he might inspect his refugee camps.

The 1927 rescue was greatly flawed. Bigoted rescuers treated blacks as second-class citizens or worse. Blacks found themselves stranded on levees. Malaria and typhoid plagued camps. Still, the rescue provided a model of leadership that could have been useful this time around. Hoover became so famous he claimed the presidency with ease the following year.

Today the US federal government plays a much larger role on the national stage than it did in 1927. Yet some would like to see it even more powerful. They blame, in effect, the Federalist Pause for the hurricane deaths, pointing out that, even now, Fema is not supposed to be a "first responder" - it must wait for an invitation to act. Governor Blanco and Washington were unable to co-ordinate and, if Washington controlled everything, there would be no need for co-ordination.

If the system were more centralised, Michael Chertoff of the Department of Homeland Security or Michael Brown of Fema would have acted faster. Or so the argument goes.

Every philosophy has its weakest moment. Federalism's worst moment is the natural disaster. One could say that Katrina, with its body bags, is proof that Washington must become stronger in future. Still, to argue that Mr Bush should have jumped into New Orleans like a crisis dictator is to superimpose a European sensibility on an American crisis. Mr Bush is commander-in-chief when it comes to war but, when it comes to disasters, he is still only a chief executive in a system of checks and balances.

Observing Louisiana, one can hear the counter-arguments. Because the Feds were responsible for the levees, in effect, no one was. If there were no Fema to call, Ray Nagin, the mayor, might have loaded people on to his own city's buses and moved them out on the Sunday before the storm.

As for the value of increased federal bureaucracy, a bureaucracy with a mandate larger than Herbert Hoover ever dreamed of - the Department of Homeland Security - is getting poor marks for its Katrina rescue. New Orleans is a tragedy, but a larger tragedy still would be to sacrifice federalism in its name.

NoPardonforMichaelMilken  11/18/2008 02:56 PM Report

A few things to keep in mind about Amity Shlaes.

First, per Mz. Amitz, George W. Bush did a marvelous job responding to Hurricane Katrina. And anyone who dares to question Mr. Bush's performance regarding Katrina is an anti-American, anti-democracy, anti-freedom partisan attack dog who suffers from Bush Derangement Syndrome.

Bush was prepared for the hurricane

By Amity Shlaes

Financial Times

Published: September 2 2005 03:00

It is early to be getting partisan about New Orleans. We are still too close to the awfulness of the hurricane: as I write the death toll from the waters is approaching 200. The US is absorbing the news of the annihilation of an entire American city. Still, the big political question about Hurricane Katrina is already being posed by the bloggers: is President George W. Bush's foreign policy affecting the federal government's response to New Orleans? Did America react differently to Katrina because it was thinking about Iraq?

The answer of course is yes. In some ways, foreign commitments are limiting the US's ability to respond. Instead of buttressing the levees or arresting looters today, the 5,000 troops from the Louisiana national guard are parked at Camp Liberty outside Baghdad, watching the video clips of the crowds at the Superdome just like the rest of us. Mississippi guardsmen are also in Iraq, attached to the 2nd Marine Expeditionary Force. In the national mind, Katrina, Iraq, and the potential for a terror strike are all competing for attention.

Still, Iraq has not caused the US to botch Katrina - either the preparation or response. On the contrary, the fact that the country and President Bush personally were already mobilised for disaster has saved lives.

Go back, for just a moment, to the 2000 elections. A debate moderator asked Mr Bush, the presidential candidate, what he would do when confronted with an emergency. Mr Bush - then Texas governor - gave a reply about a flood in Del Rio, Texas, that now seems touching both for its emotion and the small scale on which he was thinking: "A fellow and his family got completely uprooted. The only thing I knew was to get aid as quickly as possible with state and federal help, and to put my arms around the man and his family and cry with them. That's what governors do." And that was just about as far as Mr Bush's thoughts went. After all, among Mr Bush's advisers were federalists who deplored the concept of expanding Washington's power. They recognised that weather emergencies, like wars, often provide the excuse for just such expansion. Faced with a Katrina in the summer of 2001, the president, thinking as a federalist, might have been slower to call for Washington's intervention. He might have said: this is a job for Kathleen Blanco, the governor of Louisiana. With a little help from Washington. And that, alas, probably would not have been sufficient.

September 11 changed Mr Bush and the country. Many of Mr Bush's critics remarked that he looked like a deer in the headlights in that moment at the primary school when aides first whispered to him the news of the aircraft hijackings. But Mr Bush grew into a new role of leader in emergencies, and so did the federal government. In addition to its old Federal Emergency Management Agency, it created the Office of Homeland Security to co-ordinate local, state and federal responses.

The level of preparedness for a giant storm may not have been obvious outside the country. But the US was prepared for Katrina. All the old and new federal offices worked together and confronted the storm early. Nearly two days before Katrina hit New Orleans, the president made millions available to Louisiana by declaring the state an official disaster area. In a press conference on Sunday morning, he instructed the country to listen for any alerts - and warned straightforwardly that he could not "stress enough the danger this hurricane poses to Gulf coast communities". On Sunday too, Alabama and Mississippi received access to cash when they in turn were declared disaster areas. Citizens of New Orleans with special needs were instructed to go to the Superdome. Sunday also brought a mandatory evacuation order from the mayor of New Orleans. The hurricane made landfall only on Monday morning.

tartufe  11/18/2008 01:39 AM Report

REMant - You wrote, "Increasing money thus means perpetuating scarcity and the social order that thrives on it, and postponing achivement of a republican socialism which would certainly follow as plenty increases and prices diminish. The argument that competition provides necessary checks perpetuates a doctrine of survival of the least rational, and delays the development of really rational individuals. This has yet to sink into the world's financial elite, who seem to think they are a new version of God's anointed.

"The economy at present, it seems to me, is making the right decisions, despite the Treasury and the Federal Reserve. I'm sure it will continue to do so, though I am not sure those authorities will make it any easier."

Firstly, you confused me with, "Increasing money thus means perpetuating scarcity," followed by - in the same sentence - "as plenty increases and prices diminish."

Wont prices inflate when money is increased? And wont plenty diminish to not-enough?

Conceptually pertinent when treasury wise-guys socialize everything not nailed down with increased money.

Please address why dollar values aren't plummeting world-wide. Is it a "relative" thing? Why aren't commodities a la gold, silver, copper et al skyrocketing? Need some Econ 101. Thanks.

REMant  11/18/2008 12:44 AM Report

Let me start with a little bit about banks. Fractional reserve lending once meant that a bank could lend out more than its capital, but this did not assume that the bank's capital was there for lending, as some now have it. The capital was the reserve, held in gold or silver, or in some instances secured notes. The deposits were not capital, anymore than a firm's income is. Early public banks, and the Bank of England before the Napoleonic Wars, were prohibited from lending more than their capital. It was then thought that since people wanted an annuity rather than their money in most cases it would be good business to lend out some of those time deposits. As long as time deposits are not mixed up with demand deposits, this is reasonable and you could then consider that you needn't keep reserves to cover them. Of course, this piece of brilliance was discovered as a matter of necessity, when the bank's reserves were dwindling. And when this country was founded, it not having much, if any, reserves at all, banks were created entirely on a system of deposits being considered capital and even these deposits were many times merely IOUs. It was not until 1837, during the Jacksonian-era that specie reserves were specified, and our clone of the Bank of England closed. But without the control of a central bank or other regulatory authority, smaller bank excess tended to form an unstable system. That would have been okay in an environment with a lot of competitors, but as banks grew in size the instability threatened the entire economy fairly frequently leading to calls for a restoration of a central bank, and esp to the new idea that as lender of last resort it would be in a position to insure any losses, thus providing a "more elastic currency." Too, gold and silver fluctuated in price as more of it was mined, which bothered some ppl, since "price stability" early emerged as a desideratum, tho not as much as preventing the loss of specie through trade deficits. Rather than seeing tight credit as the result of too little return on investment, it was seen as being too little money for the "needs of business." It was all bound up with the mvt to "rationalize" industry, which Keynes later rightly called socialisation, the expansion of markets and the emergence of the US as the greatest creditor nation, seeking higher returns in less-developed countries. The former involved the elimination of competition thru monopolization by the establishment of cartels and trusts (and in current parlance, vertical and horizontal integration to control supply and distribution), and the last, war with Spain and in China. Many of the new combinations were brought about by easy money, itself in part from foreign investment, which resulted in more frequent panics and stock mkt collapses in the years just prior. The Federal Reserve System, established in 1913 as a result of this campaign is the capital or reserves for the banks now, not gold in individual banks. If you want cash, the bank sends to the local Fed Reserve bank for it and draws it out of the account it keeps there. You can redeem the cash for gold if you want, but not at any fixed price. The Fed expands the money supply by buying (usually) govt bonds with money it prints, and the money, eventually being deposited in a bank, goes back to the Fed as a bank deposit. This is the way the Fed "insures" the banking system. For lesser bank failures, the FDIC keeps a real insurance fund created by mandated assessment, which also covers non-System banks. Actually banned in 1934, ownership of gold has been legal since 1974, but the use of gold as money is still prohibited.

This mode of thought and behavior is mercantilism, and was predominantly that of the Republican party, while that of competition and hard money is the free-trade position, and was the Democrats', who were additionally agrarian, and largely opposed to industrialization. It is fair to say these 19th and early 20th c positions are now largely reversed. Mercantilism is the one that deserves the name capitalism, not the other. And it is fair to say that it has strong tendencies, as Tocqueville foresaw, to authoritarianism or totalitarianism.

Before modern central banking, in the free-trade era, under the gold standard, when paper money was fully redeemable in gold at a fixed price upon demand, a set of rules developed to regulate trade imbalances, which insured that gold remained well distributed and in vaults in the various countries. Inflation was not considered much of a problem unless a nation felt that it had to depreciate the currency by discontinuing redemption, usually to pay for a war, or earlier, clip the coins. The depreciation acted as a tax, and by no means an unfair one, distributively. The dominant world currency, the British pound, served most countries as well as gold, but WWI and the consequent flight of gold to the US, made it impossible for the pound to retain its status, and the attempt to recover it during the 20's and 30's was a primary cause of the Depression. The Bretton Woods conference in 1944 effectively set the US dollar in its place. But the big powers used their central banks in an attempt to expand their spheres of influence and control other country's economies from the start, the US no less than the others. As long as they control the money supply American mercantilists are in favor of expanding markets, but they are not free-traders. The US was forced to abandon completely any pretext to gold in the inflation at the end of the Vietnam War and we now have a system of free-trade in money, and "floating" exchange rates. Since then both govt spending and monetary creation, by depreciating the dollar has produced a large rise in the price of commodities, real estate and other currencies, and because of the dollar's dominance as the world's reserve currency it has meant that many other countries pay for our prodigality, even while it sometimes appears we are paying them. In that time the US has gone from being the world's largest creditor, to the world's largest debtor, sustained only by the rest of the world's interest in supporting the dollar and our military, tho some would call it extortion. So it will be seen that central bank "insurance" amounts to spreading the loss as a tax.

The proposal to create an international central bank would do little to solve the essential problem unless accompanied by not only a powerful, but also a virtuous world govt, which is probably more than can be hoped for, and a better route would be to encourage the growth of sounder and more competitive currencies around the world, best done by better trade cooperation in smaller spheres.

The effect of too cheap money is at worst like an addiction, a temporary fix that only increases dependence and dissolution; at best it prevents ppl from growing up. The experience of Spain, which, if nothing else, brought home the quantity of money theory to 18th c Europeans, ought to be reflected on again. Here was a country that had control of the richest source of gold and silver the world had known, and still went bankrupt. From this Hume concluded that money was nothing in itself, and that value in the long run depended on productivity. With no reserve of savings, the more money is increased, the more real economic growth is slowed, and diverted into unproductive competition, which then has been met with calls for more money, in a vicious cycle that stagflation only approximates as name for. Increasing money thus means perpetuating scarcity and the social order that thrives on it, and postponing achivement of a republican socialism which would certainly follow as plenty increases and prices diminish. The argument that competition provides necessary checks perpetuates a doctrine of survival of the least rational, and delays the development of really rational individuals. This has yet to sink into the world's financial elite, who seem to think they are a new version of God's anointed.

The economy at present, it seems to me, is making the right decisions, despite the Treasury and the Federal Reserve. I'm sure it will continue to do so, though I am not sure those authorities will make it any easier. If I were the Chinese, remembering the bad advice the Brits gave us in the 20's and 30's, and the American attempt at control of their currency in 1903, I'd take any advice now with a few grains of salt, but as I said a half-dozen times already, they are in this too, whether they like it or not.