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Private Equity next ?

January 3rd, 2009 · No Comments · Markets


THE ECONOMY

The Ultimate Bubble?

At a lavish conference in Monaco, the game was guessing which big private-equity firm will be first to go bust. But the smoke and mirrors that wrecked the global economy might actually save the likes of K.K.R. and Blackstone.

by MICHAEL WOLFFFebruary 2009

Now you see it: Blackstone’s Stephen Schwarzman and K.K.R.’s Henry Kravis. Photo illustration by John Corbitt.

Here’s a parlor game, played best by the people who are in it: Which private-equity firm’s going bust first? Carlyle? Fortress? K.K.R.? Cerberus? Apollo? Could it even be mighty Blackstone, with its vast real-estate holdings? Which of these one-word-branded enterprises (the word should emphasize strength, opacity, and preferably be culled from mythology—though no one in private equity, rest assured, reads his Bulfinch’s) that make up what’s been called the world’s “shadow banking system” will collapse and, in the domino pattern of this financial crisis, take the other firms with it?

There’s an urgency to this question because no big firm has actually gone bust—yet. All of the behemoth investment groups that sit on top of trillions of dollars of the largest capital accumulation outside the public markets remain suspended over the global economy like awfully big shoes waiting to drop. The wait increases both the suspense and the bitchiness of the game: somehow every private-equity guy (private-equity guys have been among the most unpopular figures of the great bubble) feels he’s been more prudent and responsible than all the others. Given the credit crunch, no private-equity deals are getting done now—chances are that what you’re doing with your idle hours as a P.E. man is trying to figure out who deserves to crash and burn before you.

Michael Wolff

More Michael Wolff on VF.com. Photograph by Mark Schäfer.

For reasons that, at this particular moment in economic time, make little sense—and border on the totally embarrassing—I was in Monaco recently at a business conference that attracted many private-equity types who are still traveling grandly on the 2 percent fees private-equity firms pay themselves on the money they’ve raised. At my table in the ballroom of the Hôtel de Paris, in Monte Carlo, at a dinner hosted by Prince Albert of Monaco, there was a gentleman whose company, backed by private equity, had gone public and risen to $130 a share, but had, through the terrible autumn, dropped to $17. To my left there was a gentleman from K.K.R.—the seminal name in the corporate-buyout business, having survived and profited off a quarter-century’s worth of bubbles and busts. Actually, the gentleman joined K.K.R. after the collapse of Lehman Brothers, where he had been for many years. (By my quick calculation, in all that time of being compensated with Lehman stock, he probably lost between $30 and $120 million in the collapse. Still, he seemed to have homes in London, Dubai, and New York.) I asked, lowering my voice, “So … who’s on the brink?”

“Carlyle,” he responded darkly. Indeed, Carlyle Capital Corporation, the arm of the Carlyle Group that invests in mortgage-backed securities, had defaulted last spring on more than $16 billion.

The gentleman on my other side was Norman Pearlstine, the former editor in chief of Time Inc., who’d gone to Carlyle, it was widely assumed, to lead a buyout of Time, but who had recently forsaken his adventure in private equity and gone back into the news business—this time as the chief content officer at Bloomberg.

Still another gentleman of my acquaintance, at an adjacent table to which I shortly hopped—a European manager of private-equity money, who’d taken in nearly a billion dollars in new investments just before the bubble burst—said in response to my question about the brink, “Oh, it’s K.K.R. who’s going to go over quickly.” (I briefly thought of the K.K.R. man, having left Lehman and now with the prospect of going down on a second Titanic—that must keep you up at night, even in London, Dubai, and New York.)

“Well, who is O.K.?”

“If you have cash—if you’re not fully invested.”

“You’re O.K. if you have cash?”

“Well, I wouldn’t go that far.”

“But if you are fully invested?”

“Oh, dead.”

And yet, it seemed important to contrast the existential predicament of private-equity funds—the most debt-ridden enterprises in the history of finance, with some $4 trillion due to lenders in the next year (it is mathematically impossible, given the downturn, for even a fraction of that to be paid back in a timely fashion)—with the fact we were sitting here in Monaco, in a scene that might well have occurred at the very top of the market. To the naked eye, nothing had changed.

When I was 11, my father, a businessman who, in his day, took a dubious risk or two, gave me a key lesson in finance and life which I knew was meaningful without understanding it. “You’re not bankrupt,” he said, “until people know you’re bankrupt.”

By which he meant, I’ve come to understand, that money is a complicated reality. It’s a master illusionist’s game. The artifice is everything. Transparency is the enemy of making it really big—which is one reason the word “private” got joined to “equity.”

This may have something to do with the message I got when I called up Stephen Schwarzman, the head of the Blackstone Group, and the most successful of all private- equity players. At the top of the market, in June 2007, when Blackstone went public (a top-of-the-market irony was to have firms specializing in taking companies private doing it with public money), he was, briefly, the richest man in New York, stepping over Michael Bloomberg, but now may be down to his last billion.

“Mr. Schwarzman’s office,” said the receptionist, “is no longer taking calls.”

“Ever?”

“Not for the foreseeable future, I’ve been told.”

This might seem to be a sort of going to ground, or holing up in a single room, as you are surrounded by creditors and police, the gun in your hand. Blackstone, which with Fortress Investment Group went public a year and a half ago, is now at a fraction of its former value—whereas K.K.R. has altogether failed in its efforts to go public.

And those other kinds of funds, hedge funds—which make short-term investments in securities rather than, like private-equity funds, long-term investments in companies—are, everywhere, shutting their doors. Investors in those funds are, sensibly, demanding their money back—or what’s left of it.

And yet, even though you might not be able to get through to Mr. Schwarzman, the greater point is that he is still in his office. His thousand or so employees around the world are still there, too. Indeed, few people in private equity—in the middle of the greatest financial crisis of the era, even as everybody in private equity awaits the collapse of everyone else in private equity—have actually lost their jobs. Even with no business to be done, it’s business as usual. This is an extraordinary demonstration of denial, or of a dreamworld, or of an alternative reality—or of my father’s dictum. Nobody knows if the world’s great P.E. firms are out of business—the guys who run these firms may not even know.

No cheap trick: Carlyle’s David Rubenstein and Quadrangle’s Steve Rattner. Photo illustration by John Corbitt.

In the finance world in recent years, to work at an investment bank, to be part of the great, well-paid army of people who service financial transactions, was to be a schlub. A relative zero. A body. The brains were creating their own equity and growing it. The guys at Lehman and Bear Stearns deserved in a sense to lose their jobs because, well, they weren’t in private equity—weren’t bright enough or farsighted enough to be. In a never-ending re-invention of relative masters of the universe, it was private-equity guys who came to sit on top: David Rubenstein, at the Carlyle Group; Blackstone’s Schwarzman; K.K.R.’s Henry Kravis; T.P.G.’s David Bonderman; Quadrangle Group’s Steven Rattner. These are the master illusionists, the guys who combined social skills and salesman talents and media savvy and quickness with numbers and expensive suits to make vast personal fortunes and to redefine the craft or magic of modern finance.

But remember: histories of financial collapses are as much about who holds on to their money, or even who profits from the mess, as about who loses it. Nobody remembers my grandfather, who lost his fortune (in the cereal business) in 1932. Everybody remembers Joseph Kennedy, who held on to his and, given the great opportunities when you’re the only one with money, vastly grew it during the Depression.

Indeed, if the private-equity business is, by all logic, looking at imminent catastrophe and ruination, it can also see the best possible environment in our time for investing—a world in which sound and necessary businesses have lost two-thirds or more of their value, a world in which public companies can be bought up by private money for a pittance. This is heaven on earth for the brave and the greedy.

It is also, in fact, the very model of private equity. Most of the powerhouse firms that, in the last five or six years, have come to dominate the corporate world were firms that found themselves with money in the bank when the market collapsed in 2001. In the private-equity formula, a $2 billion company which, at the bottom of the market, had lost half of its value—making it a $1 billion company—could be bought with $100 million in cash and $900 million in debt. When the market rebounded, and the company’s value was restored, the private-equity firm, taking a billion in profit, would have a 1,000 percent return on its investment, keeping 20 percent of the profit for its troubles. (That’s 2-and-20 in private-equity parlance—2 percent annual fee on the money that’s been raised; 20 percent of any profit.) Since private-equity money is raised on the basis of how well your last deal (or last fund) performed, this became self-perpetuating—big returns got you more money. (The more you borrowed, the bigger your returns would be.)

This moment might be like that—vast private-equity funds eyeing, across the commercial landscape, nothing but devalued properties.

Except that, as much as that is the case, it is not the same at all.

Rubenstein, Kravis, Bonderman, Rattner, and Schwarzman, holed up in his office, could still—with many of us taking great satisfaction in this—go bankrupt.

For one thing, the modus operandi and reason for being of private equity is borrowed money, and there is none to be had— zilch. Gone. Even Schwarzman, practically speaking, can’t get a loan.

For another, while firms have raised vast pools of capital—the success of a firm is judged largely on the amount of money it has raised—this capital is not actually in the bank. It’s “on call”—and it’s entirely unclear what happens if, for instance, the Carlyle Group, with $40 billion theoretically available, calls on someone (wealthy individual, pension fund, well-endowed university, or, in that hall-of-mirrors locution, a fund of funds) who has lost the will or wherewithal to meet the call. (Permira, the big U.K. P.E. fund, has voluntarily let some investors take money back.)

And, perhaps most important, the very premise on which a P.E. fund buys an asset—that is, a reasonable ability to ascertain its current value—is gone. Nobody knows what anything is worth—therefore you’d be a fool to buy it.

This last point is, unfortunately, germane not only to what you buy but also to what you own.

To wit: private-equity firms now own all these businesses which not only have dramatically declined in value but are, practically speaking, worthless—their value doesn’t exceed their debt. What’s more, as consumer spending plunges, there isn’t enough business to support the debt.

Quadrangle, Rattner’s firm, which specializes in media deals, bought Maxim magazine for $250 million a year ago—borrowing most of the money to do the deal. This was already a deal burdened by the hubris of private equity—that is, the company that owned the magazine (and specialized in publishing magazines) was unloading it precisely because it understood the market for laddie magazines had peaked (a year before, the company had spurned a much higher offer). But Quadrangle, even though it had no experience in the publishing business, assumed that with its business prowess (P.E. types who seldom have managed anything nevertheless believe themselves to be consummate managers) it could cut costs and raise cash flow and expand into new lines of business—Quadrangle envisioned Maxim-themed movies and restaurants and tchotchke shops. This general hubris and belief in business prowess come because, while P.E. firms have so often been Keystone Kop sorts of managers, the economy has over and over again proved their competence. Or, at any rate, the rising economy meant that all sorts of mistakes would be covered by a rich resale price. In a sense, with the market constantly rising, you could do nothing wrong—until now. Accordingly, the Maxim business went from making $28 million to making $8 million annually, which is not enough to pay the costs of the debt it incurred. Hence, Quadrangle Group, which recently admitted defeat and closed its hedge-fund arm (sometimes called, confusingly, the Quadrangle Fund, which, when I was in Monaco, meant that a rumor swept the Hôtel de Paris that Quadrangle itself had collapsed), is now trying to give Maxim back to its creditors.

At Apollo, Leon Black’s troubled firm, they’ve lost $365 million on Linens ‘n Things. And they’re in trouble with more than $3 billion in other investments.

Still, that’s nothing. After all, Cerberus paid $7.4 billion for Chrysler. Chrysler!

And Blackstone, at the top of the market—indeed doing the last big deal of the bull market—paid $26 billion for Hilton Hotels. (Hotels, where private-equity guys spend most of their time, form a big part of the P.E. mythology. Not only has Blackstone become the biggest hotelier in the world, owning at various times mass-market chains such as La Quinta and Extended Stay America as well as Claridge’s, in London—reportedly Mr. Schwarzman’s favorite home away from home—but the Carlyle Group is named after the Carlyle Hotel in New York, David Rubenstein’s favorite hotel.) Actually, Lehman Brothers, Bear Stearns, and a few other banks paid $26 billion for Hilton—they lent Blackstone the money. Or, in fact, because Lehman and Bear have collapsed and their debts have been bailed out by the U.S. government, you’vepaid for the Hilton hotels—with their dramatically devalued real estate on which their empty rooms sit.

This is bad. Private equity is in no better position than any bank or hedge fund or insurance company which has seen the values of its holdings collapse.

It would seem unfair then, to say the least, that this very situation that has brought the world to the brink of ruin—financial schemes founded on artifice and lack of clarity and someone else’s money—could actually save private equity.

The same act of illusion that got us all into this mess could get private-equity firms out of it. (Actually, they might deserve their money if they can get out of this.)

Take the value, or the negative value, of the companies a P.E. firm owns. Hedge funds and banks have to re-state the value of their assets on a day-to-day basis. A private-equity firm heretofore concerned only with the trade—selling what it owns as soon as advantageously possible—suddenly becomes a benign owner. The very language of these guys changes, from “exit,” their fondest word, to “managing for the long term,” “patience,” “building.” “We’re holders,” they say. Their worthless companies become future jewels. “The market may be down, but we believe in the underlying value” … blah blah.

Then there’s the debt—the mountains of debt. The major private-equity firms are, with a little critical interpretation, like subprime-mortgage holders. In order for the banks to get the business of private-equity firms, they gave deals they should never have given. Actually, loans to P.E.-backed companies are, in many instances, far worse and far more risky than subprime loans, which at least can be foreclosed on. The major P.E. firms in the riskiest of deals have gotten the most liberal terms possible—they almost can’t go belly-up. What’s more, it is important to remember that, if the private-equity game is played correctly, you don’t have that much money in any single deal. The lenders are on the hook. (The partners at Quadrangle can wash their hands of Maxim and still show up at work the next day.) You’re not. If it does well, you benefit disproportionately; if it goes south, you suffer minimally.

Michael Wolff

More Michael Wolff on VF.com. Photograph by Mark Schäfer.

What’s more, unlike a hedge fund or a bank, which are only ever investors, a P.E. firm can suddenly become a manager (again ignoring the fact that these people know nothing about managing). They can slash, burn, reduce, maximize cash flow. Here too the language changes—from the glories of rates of return to the hard but satisfying work of management: “We’ve pulled on our boots.” Indeed, the complaint of all companies owned by private-equity firms is that, previously left alone by their remote investor-owners, they are now enduring the attention of the private-equity guys who have so much less to do (and no idea what they are doing).

As for the theoretically vast pools of capital that could, if you’re not careful, evaporate before your eyes—and therefore expose you as a bankrupt and pull you down—the way to avoid that possibility is simply not to make the call. The Carlyle Group’s $40 billion on call remains a $40 billion asset (which they brag ceaselessly about) if nobody has to deliver it up. Indeed, the only thing that you’re really calling is your 2 percent—which, on $40 billion, is $800 million. In other words, you can wait it out. You have the luxury which no one else in a panic has—you can be patient.

And then not being able to borrow. That’s tough. Except that, in a reversal of ironic magnitude, the debt that has supported private equity has so crippled the lenders that they are now selling that debt at a vast discount—and private equity is buying it. You know that $900 million I borrowed from you guys? I’ll buy the obligation back for $400 million. You get the picture. K.K.R. has started a new fund dedicated to buying other people’s debt.

What’s more, it is possible to dispense with the very notion of the private-equity business—ownership itself. Steve Rattner’s firm increasingly becomes no longer an investor but an adviser. (Quadrangle advises Michael Bloomberg and invests his money.) Rattner, in other words, having risen from the ranks of investment bankers to being an owner of corporate assets himself, is so masterful that he knows when to revert back to being a stockbroker.

The precariousness of it all is obvious to every private-equity manager—which is why they see their competitors imminently going down. One big front-page bankruptcy of a P.E.-owned company—say, Hilton, or the commercial-property company Blackstone bought from Sam Zell (enabling him to buy theChicago Tribune, which has gone bust)—will create new demands for, and congressional oversight committees insisting on, fair accounting treatment for portfolio value. If the value of the private-equity market is re-stated like the value of the stock market (its mirror image), a reasonable panic ensues—Carlyle loses its $40 billion and everybody else can’t get at what they themselves have got on call.

And yet, being comfortable with there being no there there is the talent. That’s the private-equity genius:We’ve figured out how to buy companies without putting up the money; we’ve figured out how to run them without knowing anything about them. The situation has just gotten more fluid—the banks don’t have money to give us, and God himself couldn’t turn a profit at most companies now. But somewhere, sometime soon, if we can just bluff it out, there is opportunity. Amazing opportunity.

Michael Wolff is a Vanity Fair contributing editor.

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The Death of Deep Throat and the Crisis of Journalism

January 2nd, 2009 · No Comments · Geopolitics

 

The Death of Deep Throat and the Crisis of Journalism

 

December 22, 2008

By George Friedman

Mark Felt died last week at the age of 95. For those who don’t recognize that name, Felt was the “Deep Throat” of Watergate fame. It was Felt who provided Bob Woodward and Carl Bernstein of The Washington Post with a flow of leaks about what had happened, how it happened and where to look for further corroboration on the break-in, the cover-up, and the financing of wrongdoing in the Nixon administration. Woodward and Bernstein’s exposé of Watergate has been seen as a high point of journalism, and their unwillingness to reveal Felt’s identity until he revealed it himself three years ago has been seen as symbolic of the moral rectitude demanded of journalists.

In reality, the revelation of who Felt was raised serious questions about the accomplishments of Woodward and Bernstein, the actual price we all pay for journalistic ethics, and how for many years we did not know a critical dimension of the Watergate crisis. At a time when newspapers are in financial crisis and journalism is facing serious existential issues, Watergate always has been held up as a symbol of what journalism means for a democracy, revealing truths that others were unwilling to uncover and grapple with. There is truth to this vision of journalism, but there is also a deep ambiguity, all built around Felt’s role. This is therefore not an excursion into ancient history, but a consideration of two things. The first is how journalists become tools of various factions in political disputes. The second is the relationship between security and intelligence organizations and governments in a Democratic society.

Watergate was about the break-in at the Democratic National Committee headquarters in Washington. The break-in was carried out by a group of former CIA operatives controlled by individuals leading back to the White House. It was never proven that then-U.S. President Richard Nixon knew of the break-in, but we find it difficult to imagine that he didn’t. In any case, the issue went beyond the break-in. It went to the cover-up of the break-in and, more importantly, to the uses of money that financed the break-in and other activities. Numerous aides, including the attorney general of the United States, went to prison. Woodward and Bernstein, and their newspaper, The Washington Post, aggressively pursued the story from the summer of 1972 until Nixon’s resignation. The episode has been seen as one of journalism’s finest moments. It may have been, but that cannot be concluded until we consider Deep Throat more carefully.

Deep Throat Reconsidered

Mark Felt was deputy associate director of the FBI (No. 3 in bureau hierarchy) in May 1972, when longtime FBI Director J. Edgar Hoover died. Upon Hoover’s death, Felt was second to Clyde Tolson, the longtime deputy and close friend to Hoover who by then was in failing health himself. Days after Hoover’s death, Tolson left the bureau.

Felt expected to be named Hoover’s successor, but Nixon passed him over, appointing L. Patrick Gray instead. In selecting Gray, Nixon was reaching outside the FBI for the first time in the 48 years since Hoover had taken over. But while Gray was formally acting director, the Senate never confirmed him, and as an outsider, he never really took effective control of the FBI. In a practical sense, Felt was in operational control of the FBI from the break-in at the Watergate in August 1972 until June 1973.

Nixon’s motives in appointing Gray certainly involved increasing his control of the FBI, but several presidents before him had wanted this, too, including John F. Kennedy and Lyndon Johnson. Both of these presidents wanted Hoover gone for the same reason they were afraid to remove him: He knew too much. In Washington, as in every capital, knowing the weaknesses of powerful people is itself power - and Hoover made it a point to know the weaknesses of everyone. He also made it a point to be useful to the powerful, increasing his overall value and his knowledge of the vulnerabilities of the powerful.

Hoover’s death achieved what Kennedy and Johnson couldn’t do. Nixon had no intention of allowing the FBI to continue as a self-enclosed organization outside the control of the presidency and everyone else. Thus, the idea that Mark Felt, a man completely loyal to Hoover and his legacy, would be selected to succeed Hoover is in retrospect the most unlikely outcome imaginable.

Felt saw Gray’s selection as an unwelcome politicization of the FBI (by placing it under direct presidential control), an assault on the traditions created by Hoover and an insult to his memory, and a massive personal disappointment. Felt was thus a disgruntled employee at the highest level. He was also a senior official in an organization that traditionally had protected its interests in predictable ways. (By then formally the No. 2 figure in FBI, Felt effectively controlled the agency given Gray’s inexperience and outsider status.) The FBI identified its enemies, then used its vast knowledge of its enemies’ wrongdoings in press leaks designed to be as devastating as possible. While carefully hiding the source of the information, it then watched the victim - who was usually guilty as sin - crumble. Felt, who himself was later convicted and pardoned for illegal wiretaps and break-ins, was not nearly as appalled by Nixon’s crimes as by Ni xon’s decision to pass him over as head of the FBI. He merely set Hoover’s playbook in motion.

Woodward and Bernstein were on the city desk of The Washington Post at the time. They were young (29 and 28), inexperienced and hungry. We do not know why Felt decided to use them as his conduit for leaks, but we would guess he sought these three characteristics - as well as a newspaper with sufficient gravitas to gain notice. Felt obviously knew the two had been assigned to a local burglary, and he decided to leak what he knew to lead them where he wanted them to go. He used his knowledge to guide, and therefore control, their investigation.

Systematic Spying on the President

And now we come to the major point. For Felt to have been able to guide and control the young reporters’ investigation, he needed to know a great deal of what the White House had done, going back quite far. He could not possibly have known all this simply through his personal investigations. His knowledge covered too many people, too many operations, and too much money in too many places simply to have been the product of one of his side hobbies. The only way Felt could have the knowledge he did was if the FBI had been systematically spying on the White House, on the Committee to Re-elect the President and on all of the other elements involved in Watergate. Felt was not simply feeding information to Woodward and Bernstein; he was using the intelligence product emanating from a section of the FBI to shape The Washington Post’s coverage.

Instead of passing what he knew to professional prosecutors at the Justice Department - or if he did not trust them, to the House Judiciary Committee charged with investigating presidential wrongdoing - Felt chose to leak the information to The Washington Post. He bet, or knew, that Post editor Ben Bradlee would allow Woodward and Bernstein to play the role Felt had selected for them. Woodward, Bernstein and Bradlee all knew who Deep Throat was. They worked with the operational head of the FBI to destroy Nixon, and then protected Felt and the FBI until Felt came forward.

In our view, Nixon was as guilty as sin of more things than were ever proven. Nevertheless, there is another side to this story. The FBI was carrying out espionage against the president of the United States, not for any later prosecution of Nixon for a specific crime (the spying had to have been going on well before the break-in), but to increase the FBI’s control over Nixon. Woodward, Bernstein and above all, Bradlee, knew what was going on. Woodward and Bernstein might have been young and naive, but Bradlee was an old Washington hand who knew exactly who Felt was, knew the FBI playbook and understood that Felt could not have played the role he did without a focused FBI operation against the president. Bradlee knew perfectly well that Woodward and Bernstein were not breaking the story, but were having it spoon-fed to them by a master. He knew that the president of the United States, guilty or not, was being destroyed by Hoover’s jilted heir.

This was enormously important news. The Washington Post decided not to report it. The story of Deep Throat was well-known, but what lurked behind the identity of Deep Throat was not. This was not a lone whistle-blower being protected by a courageous news organization; rather, it was a news organization being used by the FBI against the president, and a news organization that knew perfectly well that it was being used against the president. Protecting Deep Throat concealed not only an individual, but also the story of the FBI’s role in destroying Nixon.

Again, Nixon’s guilt is not in question. And the argument can be made that given John Mitchell’s control of the Justice Department, Felt thought that going through channels was impossible (although the FBI was more intimidating to Mitchell than the other way around). But the fact remains that Deep Throat was the heir apparent to Hoover - a man not averse to breaking the law in covert operations - and Deep Throat clearly was drawing on broader resources in the FBI, resources that had to have been in place before Hoover’s death and continued operating afterward.

Burying a Story to Get a Story

Until Felt came forward in 2005, not only were these things unknown, but The Washington Post was protecting them. Admittedly, the Post was in a difficult position. Without Felt’s help, it would not have gotten the story. But the terms Felt set required that a huge piece of the story not be told. The Washington Post created a morality play about an out-of-control government brought to heel by two young, enterprising journalists and a courageous newspaper. That simply wasn’t what happened. Instead, it was about the FBI using The Washington Post to leak information to destroy the president, and The Washington Post willingly serving as the conduit for that information while withholding an essential dimension of the story by concealing Deep Throat’s identity.

Journalists have celebrated the Post’s role in bringing down the president for a generation. Even after the revelation of Deep Throat’s identity in 2005, there was no serious soul-searching on the omission from the historical record. Without understanding the role played by Felt and the FBI in bringing Nixon down, Watergate cannot be understood completely. Woodward, Bernstein and Bradlee were willingly used by Felt to destroy Nixon. The three acknowledged a secret source, but they did not reveal that the secret source was in operational control of the FBI. They did not reveal that the FBI was passing on the fruits of surveillance of the White House. They did not reveal the genesis of the fall of Nixon. They accepted the accolades while withholding an extraordinarily important fact, elevating their own role in the episode while distorting the actual dynamic of Nixon’s fall.

Absent any widespread reconsideration of the Post’s actions during Watergate in the three years since Felt’s identity became known, the press in Washington continues to serve as a conduit for leaks of secret information. They publish this information while protecting the leakers, and therefore the leakers’ motives. Rather than being a venue for the neutral reporting of events, journalism thus becomes the arena in which political power plays are executed. What appears to be enterprising journalism is in fact a symbiotic relationship between journalists and government factions. It may be the best path journalists have for acquiring secrets, but it creates a very partial record of events - especially since the origin of a leak frequently is much more important to the public than the leak itself.

The Felt experience is part of an ongoing story in which journalists’ guarantees of anonymity to sources allow leakers to control the news process. Protecting Deep Throat’s identity kept us from understanding the full dynamic of Watergate. We did not know that Deep Throat was running the FBI, we did not know the FBI was conducting surveillance on the White House, and we did not know that the Watergate scandal emerged not by dint of enterprising journalism, but because Felt had selected Woodward and Bernstein as his vehicle to bring Nixon down. And we did not know that the editor of The Washington Post allowed this to happen. We had a profoundly defective picture of the situation, as defective as the idea that Bob Woodward looks like Robert Redford.

Finding the truth of events containing secrets is always difficult, as we know all too well. There is no simple solution to this quandary. In intelligence, we dream of the well-placed source who will reveal important things to us. But we also are aware that the information provided is only the beginning of the story. The rest of the story involves the source’s motivation, and frequently that motivation is more important than the information provided. Understanding a source’s motivation is essential both to good intelligence and to journalism. In this case, keeping secret the source kept an entire - and critical - dimension of Watergate hidden for a generation. Whatever crimes Nixon committed, the FBI had spied on the president and leaked what it knew to The Washington Post in order to destroy him. The editor of The Washington Post knew that, as did Woodward and Bernstein. We do not begrudge them their prizes and accolades, but it would have been useful to know who handed them the story. In many ways, that story is as interesting as the one about all the president’s men.

 

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Reboot the FCC

December 30th, 2008 · No Comments · Technology

Reboot the FCC

We’ll stifle the Skypes and YouTubes of the future if we don’t demolish the regulators that oversee our digital pipelines.

Lawrence Lessig

Newsweek Web Exclusive

Economic growth requires innovation. Trouble is, Washington is practically designed to resist it. Built into the DNA of the most important agencies created to protect innovation, is an almost irresistible urge to protect the most powerful instead.

The FCC is a perfect example. Born in the 1930s, at a time when the utmost importance was put on stability, the agency has become the focal point for almost every important innovation in technology. It is the presumptive protector of the Internet, and the continued regulator of radio, TV and satellite communications. In the next decades, it could well become the default regulator for every new communications technology, including, and especially, fantastic new ways to use wireless technologies, which today carry television, radio, internet, and cellular phone signals through the air, and which may soon provide high-speed internet access on-the-go, something that Google cofounder Larry Page calls “wifi on steroids.”

If history is our guide, these new technologies are at risk, and with them, everything they make possible. With so much in its reach, the FCC has become the target of enormous campaigns for influence. Its commissioners are meant to be “expert” and “independent,” but they’ve never really been expert, and are now openly embracing the political role they play. Commissioners issue press releases touting their own personal policies. And lobbyists spend years getting close to members of this junior varsity Congress. Think about the storm around former FCC Chairman Michael Powell’s decision to relax media ownership rules, giving a green light to the concentration of newspapers and television stations into fewer and fewer hands. This is policy by committee, influenced by money and power, and with no one, not even the President, responsible for its failures.

The solution here is not tinkering. You can’t fix DNA. You have to bury it. President Obama should get Congress to shut down the FCC and similar vestigial regulators, which put stability and special interests above the public good. In their place, Congress should create something we could call the Innovation Environment Protection Agency (iEPA), charged with a simple founding mission: “minimal intervention to maximize innovation.” The iEPA’s core purpose would be to protect innovation from its two historical enemies—excessive government favors, and excessive private monopoly power.

Since the birth of the Republic, the U.S. government has been in the business of handing out “exclusive rights” (a.k.a., monopolies) in order to “promote progress” or enable new markets of communication. Patents and copyrights accomplish the first goal; giving away slices of the airwaves serves the second. No one doubts that these monopolies are sometimes necessary to stimulate innovation. Hollywood could not survive without a copyright system; privately funded drug development won’t happen without patents. But if history has taught us anything, it is that special interests—the Disneys and Pfizers of the world—have become very good at clambering for more and more monopoly rights. Copyrights last almost a century now, and patents regulate “anything under the sun that is made by man,” as the Supreme Court has put it. This is the story of endless bloat, with each round of new monopolies met with a gluttonous demand for more.

The problem is that the government has never given a thought to when these monopolies help, and when they’re merely handouts to companies with high-powered lobbyists. The iEPA’s first task would thus be to reverse the unrestrained growth of these monopolies. For example, much of the wireless spectrum has been auctioned off to telecom monopolies, on the assumption that only by granting a monopoly could companies be encouraged to undertake the expensive task of building a network of cell towers or broadcasting stations. The iEPA would test this assumption, and essentially ask the question: do these monopolies do more harm than good? With a strong agency head, and a staff absolutely barred from industry ties, the iEPA could avoid the culture of favoritism that’s come to define the FCC. And if it became credible in its monopoly-checking role, the agency could eventually apply this expertise to the area of patents and copyrights, guiding Congress’s policymaking in these special-interest hornet nests.

The iEPA’s second task should be to assure that the nation’s basic communications infrastructure spectrum— the wires, cables and cellular towers that serve as the highways of the information economy—remain open to new innovation, no matter who owns them. For example, “network neutrality” rules, when done right, aim simply to keep companies like Comcast and Verizon from skewing the rules in favor of or against certain types of content and services that run over their networks. The investors behind the next Skype or Amazon need to be sure that their hard work won’t be thwarted by an arbitrary decision on the part of one of the gatekeepers of the Net. Such regulation need not, in my view, go as far as some Democrats have demanded. It need not put extreme limits on what the Verizons of the world can do with their network—they did, after all, build it in the first place—but no doubt a minimal set of rules is necessary to make sure that the Net continues to be a crucial platform for economic growth.

Beyond these two tasks, what’s most needed from the iEPA is benign neglect. Certainly, it should keep competition information flowing smoothly and limit destructive regulation at the state level, and it might encourage the government to spend more on public communications infrastructure, for example in the rural areas which private companies often ignore. But beyond these limited tasks, whole phone-books worth of regulation could simply be erased. And with it, we would remove many of the levers that lobbyists use to win favors to protect today’s monopolists.

America’s economic future depends upon restarting an engine of innovation and technological growth. A first step is to remove the government from the mix as much as possible. This is the biggest problem with communication innovation around the world, as too many nations who should know better continue to preference legacy communication monopolies. It is a growing problem in our own country as well, as corporate America has come to believe that investments in influencing Washington pay more than investments in building a better mousetrap. That will only change when regulation is crafted as narrowly as possible. Only then can regulators serve the public good, instead of private protection. We need to kill a philosophy of regulation born with the 20th century, if we’re to make possible a world of innovation in the 21st.

Lessig is a professor at Stanford Law School and the author of five books, including most recently “Remix: Making Art and Commerce Thrive in the Hybrid Economy.”

URL: http://www.newsweek.com/id/176809

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Richard Fisher : Historical Perspectives on the Current Economic and Financial Crisis

December 29th, 2008 · No Comments · Markets

Historical Perspectives on the Current Economic and Financial Crisis

(With Reference to Paul Volcker, Washington Irving, Walter Bagehot, Mother Caris, Rube Goldberg and Bismarck)
Remarks before the World Affairs Council of Dallas/Fort Worth and the Dallas Committee on Foreign Relations
Dallas, Texas
December 18, 2008

Thank you, Mr. Mayor. I am especially honored that you would take time from leading our great city to introduce me so generously and to suffer through my speech.

We have witnessed the unfolding of historic economic developments during this tumultuous year. I can think of no better groups than the World Affairs Council of Dallas/Fort Worth and the Dallas Committee on Foreign Relations with whom to discuss the year’s events and lessons learned.

The most cogent description of this year’s economic developments might best be summarized by a woman who, having just commiserated with her accountants, put it this way: “This has been like the divorce from hell: My net worth has been cut in half and I’m still stuck with my husband.” The mood and pace of the economy have shifted from near bliss to acrimony and an almost palpable sense of betrayal. Many of our fellow citizens feel trapped in an unsustainable situation.

In the third quarter of 2007, we recorded our 25th consecutive quarter of economic growth. Unemployment hit a low of 4.4 percent in March. And the stock market closed at an all-time high, with the S&P 500 Index finishing the day of Oct. 9, 2007, at 1,565. To be sure, there were some signs of friction developing from the passion of the time—most noticeably a heating up of headline inflation, which reached its peak at a 9.6 percent annualized rate in June of this year. And there were fissures developing in the superstructure of the credit markets—most noticeably in the housing market, but also on the balance sheets and business books of major creditors and various consumers. But to the outside world, all was well. Even for Bernard Madoff, who, according to Bloomberg news, was getting $50 manicures before entertaining friends and clients at the Palm in the Hamptons or on his 55-foot yacht appropriately named “Bull.”1

In 2008, the gears shifted. You all know the events that have transpired, and I will not belabor them. They are neatly encapsulated in the most recent data. Our gross domestic product is no longer growing, but shrank half of a percent in the third quarter. By my estimate, it is on pace to contract another annualized 4 to 5 percent in the current quarter with further contraction likely through at least the first half of next year. Industrial production is falling sharply; consumption is cascading downhill; demand has evaporated as businesses and consumers alike pull in their horns and de-lever from excess indebtedness that fueled the prior boom. Unemployment has increased to 6.7 percent at the last reading and appears to me to be headed in the direction of, and possibly past, 8 percent.

Bankers and other creditors, having noted that the horse long ago bolted from the confines of prudence, are now shutting the proverbial barn doors. The credit intermediation process has become dysfunctional. Once ubiquitous, credit has become quite expensive—if you can get it. As for stocks, the S&P 500 Index closed last night at 904, 42 percent off its Oct. 9 peak and has become historically and hysterically volatile.

I will not venture to predict the behavioral future of our manic-depressive friend, Mr. Market. But I do know the consequences of his intemperate disposition. Faced with an unforgiving stock market and creditors that have become tighter than a new pair of shoes, businesses are doing what they can to stay profitable: As demand for their products shrinks, they are slashing every cost factor under their control to preserve their profit margins. They are demanding that suppliers cut their prices. They are addressing their cost of labor by cutting “head count.” They are delaying capital expenditures. They are watching their receivables and stretching out their payables. And they are taking every step they can to clean up their balance sheets. (If you know the basics of accounting, you will appreciate the black humor of my dear friend, Janet Yellen, the president of the San Francisco Fed. She recently quipped that when looking at the balance sheets of consumers or banks or many other companies these days, nothing on the left is left and nothing on the right is right.)

And sadly, as we all have read, the only things adorning Mr. Madoff’s hands these days are handcuffs, and he dines in less glamorous surroundings.

There are plenty of armchair quarterbacks who now claim to have seen all this coming. Indeed, we must acknowledge that many in the financial community, including at the Federal Reserve, failed to either detect or act upon the telltale signs of financial system excess.

Paul Volcker told me recently that in his day, he knew that a bank was headed for trouble when it grew too fast, moved into a fancy new building, placed the chairman of the board as the head of the art committee and hired McKinsey & Co. to do an incentive compensation study for the senior officers.

Paul Volcker is the wisest of men. Yet, I believe the following provides a more fulsome and insightful description of what we recently experienced. This is a long quote, so bear with me, as it perfectly captures the circumstances that led up to our current predicament:

“Every now and then the world is visited by one of these delusive seasons, when ‘the credit system’ … expands to full luxuriance: everyone trusts everybody; a bad debt is a thing unheard of; the broad way to certain and sudden wealth lies plain and open; and men … dash forth boldly from the facility of borrowing.

“Promissory notes, interchanged between scheming individuals, are liberally discounted at the banks…. Everyone talks in [huge amounts]; nothing is heard but gigantic operations in trade; great purchases and sales of real property, and immense sums [are] made at every transfer. All, to be sure, as yet exists in promise; but the believer in promises calculates the aggregate as solid capital….

“Speculative and dreaming … men … relate their dreams and projects to the ignorant and credulous, dazzle them with golden visions, and set them maddening after shadows. The example of one stimulates another; speculation rises on speculation; bubble rises on bubble….

“Speculation … casts contempt upon all its sober realities. It renders the [financier] a magician, and the [stock] exchange a region of enchantment…. No ‘operation’ is thought worthy of attention that does not double or treble the investment. No business is worth following that does not promise an immediate fortune….

“Could this delusion always last, life … would indeed be a golden dream; but [the delusion] is as short as it is brilliant.”2

That was not written by Martin Wolf of the Financial Times or Paul Gigot of the Wall Street Journal or David Brooks of the New York Times or Lee Cullum in theDallas Morning News. It was written by Washington Irving in his famous Crayon Papers about the Mississippi Bubble fiasco of 1719.

Irving, mind you, had never heard of a subprime mortgage or a credit default swap or any of the other modern financial innovations that are proving so vexing to credit markets today. But he understood booms propelled by greed and tomfoolery and what happens when what one old colleague called “irrational exuberance” is replaced by irrational fear—when what was a sure thing yields to uncertainty. Uncertainty is the ultimate enemy of decisionmaking, forcing an otherwise robust credit system into a defensive crouch. (A fellow being interviewed on television not long ago was asked what positions he would advise his clients to take to ride out the current storm. He replied “cash and fetal.”)

With uncertainty in full fever, cash is hoarded, counterparties are viewed with suspicion and no business appears worthy of financing. The economy, starved of the lifeblood of capital, staggers and begins to weaken.

So what have we done about it?

Well, we could have let nature run its course. P. G. Wodehouse, my favorite comedic author, used to say that “there is only one cure for gray hair. It was invented by a Frenchman. It is called the guillotine.” Or we could just ignore it and mandate that it simply not be discussed, as the Latvian government has done recently by decreeing that the Security Police arrest any economists who question the security of its banks or the value of its currency (the lat).

My colleagues at the Federal Reserve and I are red-blooded Americans. We refuse to be fatalistic. (Besides, those of us who have hair have seen it turn gray this past year.) We believe in the power of ideas and listen carefully to our critics. And though in normal times, central bankers appear to be the most laconic genus of the human species, in times of distress, we believe in the monetary equivalent of the Powell Doctrine. We believe that good ideas, properly vetted and appropriately directed with an exit strategy in mind, can and should be brought to bear with overwhelming force to defeat threats to economic stability.

Let me go back in history once more. The basic playbook for how a central bank, as the economy’s lender of last resort, deals with a financial crisis was written in the early 19th century by two men named Henry Thornton and Walter Bagehot.

Bagehot’s prescription to counter a panic bears repeating: “The holders of the cash reserve must be ready not only to keep it for its own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man’ wherever the security is good.”

Bagehot describes the response of the Bank of England to the Panic of 1825 by quoting its governor as follows: “We lent by every possible means and in modes we had never adopted before; we took stock on security, we purchased Exchequer bills, we made advances on those bills, we not only discounted outright but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the bank….”3

All the while bearing in mind the advice rendered by Thornton, writing in 1802: “It is by no means intended to imply that it would become the [Central] Bank to relieve every distress that the rashness of bankers [and financiers] may bring upon themselves…. The relief should neither be so … liberal as to exempt those who misconduct their business … nor so scanty and slow as deeply to involve the general interests. These interests, nevertheless, are sure to be pleaded by every distressed person whose affairs are large, however indifferent or even ruinous may be their state.”4

If you are looking for a cognitive road map of what the Fed has been up to as we navigate between the need to “advance most freely for the liabilities of others, lend to bankers and merchants, and ‘to this man and that man’ whenever the security is good” and the equally compelling need to fend off moral hazard of relieving “those who misconduct their business,” you might dust off your Bagehot and Thornton.

Of course, the panics of the 18th and 19th centuries were different in size and shape than those of recent times. The nature of financial crises changes with time, reacting to the dynamic contours of the economy and financial evolution. Thus we must learn from experience, augmenting the theories and models that come from the study of past remedies.

I have just finished reading Ken Follett’s magnificent book World Without End.5 It is a massive tome that runs for 1,014 pages. (I was tempted to rename it Book Without End.) It deals with the Black Plague that crippled England and Europe in the 14th century. In those days, the monks were the intelligentsia, and those who practiced medicine were sent to Oxford to learn from the theorists of ancient Greece. The nuns were the nurses. In the middle ages, women were not allowed to attend Oxford, so they learned from doing.6 While the monks adhered to the Oxford-taught, old orthodoxy of studying the “humors,” of bleeding, and of invoking the dictum of fiat voluntas tua (“Thy will be done”), the nuns adapted their techniques according to what actually worked. The punch line of World Without End is that the community where the story takes place is spared the worst effects of the Plague by a savvy nun named Mother Caris, who applies experience and adapts established methods and theories to address the needs of the time.

We at the Federal Reserve have dusted off our Thornton and Bagehot and then some. We have been neither “scanty nor slow” in addressing the pathology of our economy and financial system. We have “lent by every possible means and in modes … consistent with the safety of the bank.” And just two days ago, we made clear that despite having reduced the target range for the federal funds rate to between zero and 0.25 percent—the old orthodoxy—we will not shy from pursuing every practicable means of supporting the functioning of financial markets and stimulating the economy back to a steady state by employing new techniques that fit the current circumstance.

Like Mother Caris, we have learned from the experience of crises more recent than the ancient debacles of the Mississippi Bubble or the Panic of 1825. We have studied the mistakes made by other lenders of last resort who failed to properly deploy their forces in times of distress, such as the Federal Reserve in the 1930s and the Bank of Japan in the 1990s. And we have reviewed the actions taken by others more successful, such as those of the Swedish Riksbank in response to their banking crisis of the early 1990s. Thus, starting on Dec. 12 of last year, when the base interest rate was 4.25 percent, we began expanding our balance sheet by providing access to credit for longer terms to eligible depository institutions to alleviate funding pressures in the system.

In rapid order, over the course of a year, we took at least eight major initiatives: (1) We established a lending facility for primary securities dealers, taking in new forms of collateral to secure those loans; (2) we initiated so-called swap lines with the central banks of 14 of our major trading partners, ranging from the European Central Bank to the Bank of Canada and the Banco de México to the Monetary Authority of Singapore, to alleviate dollar funding problems in those markets; (3) we created facilities to backstop money market mutual funds; (4) working with the U.S. Treasury and the FDIC, we initiated new measures to strengthen the security of certain banks; (5) we undertook a major program to purchase commercial paper, a critical component of the financial system; (6) we began to pay interest on reserves of banks; (7) we announced a new facility to support the issuance of asset-backed securities collateralized by student loans, auto loans, credit card loans and loans guaranteed by the Small Business Administration; and (8) at the end of November, we announced we stood ready to purchase up to $100 billion of the direct obligations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks, as well as $500 billion in mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae.

And, as you all know, in a series of steps, the Federal Open Market Committee (FOMC) reduced the fed funds rate, a process which I fully supported once it became clear that the inflationary tide was ebbing. Simultaneously, and again in a series of steps, the Board of Governors lowered the rate it charges banks to borrow from our “discount window” so as to lower their cost of credit. That rate now rests at 0.5 percent.

All of this has meant expanding our balance sheet. When I finished Ken Follett’s book last Friday night, the total footings of the Federal Reserve had expanded to $2.254 trillion—an almost three-fold increase from when we started the year. And I believe we made it quite clear in our press release after Monday and Tuesday’s meeting of the FOMC that we stand ready to grow our balance sheet even more should conditions warrant. For example, we will expand purchases of mortgage-backed securities, should we feel such purchases would be productive.

You will note that the emphasis of our activities has been on expanding the asset side of our balance sheet—the left side, which registers the securities we hold, the loans we make, the value of our swap lines and the credit facilities we have created. We feel this is the correct side to emphasize. The right side of our balance sheet records our holdings of banks’ balances, Federal Reserve Bank notes or cash (currently over $830 billion) and U.S. Treasury balances.

When the Japanese economy went into the doldrums, the Bank of Japan emphasized the right side of its balance sheet by building up excess reserves and cash, only to find that accumulation did too little to rejuvenate the system.

As I said earlier, in times of crisis many feel that the best position to take is somewhere between cash and fetal. But it does the economy no good when creditors curl up in a ball and clutch their money. This only reinforces the widening of spreads between risk-free holdings and all-important private sector yields, further braking commercial activity whose lifeblood is access to affordable credit. We believe that emphasizing the asset side of the balance sheet will do more to improve the functioning of credit markets and restore the flow of finance to the private sector. In the parlance of central banking finance, I consider this a more qualitative approach to “quantitative easing.” It is bred of having learned from the experience of our Japanese counterparts, much as Mother Caris learned from watching others’ unsuccessful attempts at curing the Black Plague in her community of Kingsbridge.

I realize that by straying from our usual business of holding plain vanilla Treasuries as assets and by shifting policy away from simple titrations of the fed funds rate, we have raised a few eyebrows. One observer has posited that we have migrated from the patron saint of Milton Friedman to enshrining Rube Goldberg.

I rather like Rube Goldberg. I recall fondly the complex devises his protagonist, the felicitously named Professor Lucifer Gorgonzola Butts, would deploy to perform different tasks. If you turn to Wikipedia, you will find one of my favorites: the self-operating napkin. As described therein, it was activated when a soup spoon (Exhibit A) is raised to the mouth, pulling on a string (B), thereby jerking ladle (C) which throws cracker (D) past parrot (E), who jumps after it, tilting perch (F), upsetting seeds (G) into pail (H), whose new extra weight pulls cord (I), which opens and lights automatic cigar lighter (J), setting off skyrocket (K), which causes sickle (L) to cut string (M) and allows pendulum (N) with attached napkin (O) to swing back and forth, thereby wiping face.

I assure you the Federal Reserve has not abandoned the wisdom of Milton Friedman or Walter Bagehot or any of the other patron saints of central banking. But these are complex, trying times. Our economy faces a tough road. We are the nation’s central bank and we are duty bound to apply every tool we can to clean up the mess that has soiled the face of our financial system and get back on the track of sustainable economic growth with price stability. The men and women of the Federal Reserve spend every waking hour doing their level best to perform their duty. Even if we have to deploy a little Rube Goldberg engineering to get the task done.

Some of our innovative contraptions have begun to work. For example, the London interbank offered rate, known by its acronym LIBOR, has come down handsomely. This is important as most variable-rate subprime and Alt-A mortgages that will be reset in the immediate future are based on LIBOR. Our purchase of government-sponsored enterprise (GSE) mortgage-backed securities has reduced the interest rate on 30-year, fixed-rate mortgages to 5.19 percent, a record low, according to Freddie Mac data that start in 1971. And our commercial paper and money market fund facilities have improved the tone of the all-important commercial paper market.

You cannot read a great deal into the initial response to an FOMC meeting. The markets need time to digest the signals being sent, especially when we are declaring a new regime change. That said, I found it encouraging that one of my favorite, well-run companies, Disney, was able to issue $1 billion in five-year notes yesterday, priced to yield 4.7 percent—some 30 basis points lower than most mavens on Wall Street had expected. If we are successful, issuers of corporate debt should see the cost of debt reduced over time. According to this morning’s Wall Street Journal, the credit-default swaps index, which tracks the cost of insuring against the default of high-quality, investment-grade bonds, has fallen 16 percent in the past three days.7 So, so far, so good.

Yet despite these accomplishments, we have miles to go before we sleep.

Please bear in mind that the Federal Reserve is only one arrow in the quiver that can be deployed to restore the nation’s economic vitality. The power to stimulate activity through taxing and spending of federal monies lies with the Congress of the United States, and all eyes are on the fiscal stimulus package that will be worked out by the new president and the legislative branch. As a representative only of the monetary authority, I will refrain from commenting on the business of the fiscal authorities. With one exception: Whatever they decide to do, it is imperative that they withstand demands for protectionism—action that is within their purview as collectors of tariffs and writers of trade legislation. What made the Great Depression regrettably “great” was the Smoot–Hawley Act, with which everyone in this audience is familiar. You may be less familiar with the Long Depression that began when a flowering of new lending institutions that issued mortgages for municipal and residential construction in the capitals of Vienna, Berlin and Paris turned a cropper and began the financial panic of 1873.

If you study that debacle, you will quickly determine that what transformed a severe global downturn into a depression that lasted until 1896 was action taken by Chancellor Otto von Bismarck in 1879 to abandon Germany’s free trade policy. His actions were followed in quick succession by France and then by Benjamin Harrison, who won the U.S. presidential election of 1888 by running on a protectionist platform. As world economic growth slows and economic conditions in the United States toughen, our elected representatives and newly elected commander-in-chief must resist with every fiber of their political beings the temptation to compound our travails by embracing protectionism. For if they fail to do so, the economic situation we now are working so hard to overcome will seem like a cakewalk.

With that cautionary note, I think I have said enough, Mr. Mayor. If you wish, I would be happy to take questions from the audience—as long as everybody keeps their shoes on.

About the Author

Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

Notes

  1. “Madoff Enjoyed $50 Pedicures, 9.8 Handicap, Boat Called ‘Bull,’” by Mark Clothier and Oshrat Carmiel, Dec. 17, 2008,http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aQv4Kmx.cs78.
  2. “A Time of Unexampled Prosperity,” by Washington Irving, in The Crayon Papers, 1890.
  3. Lombard Street, by Walter Bagehot, 1825.
  4. An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, by Henry Thornton, 1802.
  5. World Without End, by Ken Follett, New York: Penguin, 2007.
  6. When I arrived at Oxford 650 years later, there were women studying there, but they were kept in separate colleges and were small in number. The joke among women then was “Come to Oxford where the odds are good but the goods are odd.”
  7. “Sentiment Shifts to Corporate Debt,” Wall Street Journal, Dec. 18, 2008.

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US Equities Market - Another higher low

December 14th, 2008 · No Comments · Markets

Despite a barrage of grim news eg: failure of autobailout in the Senate, the market rallied. Generally an indication that a bottom is probably in. Dec 12 was also a full moon day.

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Robert Gates : Reprogramming the Pentagon for a New Age

December 7th, 2008 · No Comments · Geopolitics

 One of my favourite people writing a excellent peice.

A Balanced Strategy

Reprogramming the Pentagon for a New Age

By Robert M. Gates

From Foreign Affairs , January/February 2009

Summary: The Pentagon has to do more than modernize its conventional forces; it must also focus on today’s unconventional conflicts — and tomorrow’s.

Robert M. Gates is U.S. Secretary of Defense.

The defining principle of the Pentagon’s new National Defense Strategy is balance. The United States cannot expect to eliminate national security risks through higher defense budgets, to do everything and buy everything. The Department of Defense must set priorities and consider inescapable tradeoffs and opportunity costs.

The strategy strives for balance in three areas: between trying to prevail in current conflicts and preparing for other contingencies, between institutionalizing capabilities such as counterinsurgency and foreign military assistance and maintaining the United States’ existing conventional and strategic technological edge against other military forces, and between retaining those cultural traits that have made the U.S. armed forces successful and shedding those that hamper their ability to do what needs to be done.

 

UNCONVENTIONAL THINKING

The United States’ ability to deal with future threats will depend on its performance in current conflicts. To be blunt, to fail — or to be seen to fail — in either Iraq or Afghanistan would be a disastrous blow to U.S. credibility, both among friends and allies and among potential adversaries.

In Iraq, the number of U.S. combat units there will decline over time — as it was going to do no matter who was elected president in November. Still, there will continue to be some kind of U.S. advisory and counterterrorism effort in Iraq for years to come.

In Afghanistan, as President George W. Bush announced last September, U.S. troop levels are rising, with the likelihood of more increases in the year ahead. Given its terrain, poverty, neighborhood, and tragic history, Afghanistan in many ways poses an even more complex and difficult long-term challenge than Iraq — one that, despite a large international effort, will require a significant U.S. military and economic commitment for some time.

It would be irresponsible not to think about and prepare for the future, and the overwhelming majority of people in the Pentagon, the services, and the defense industry do just that. But we must not be so preoccupied with preparing for future conventional and strategic conflicts that we neglect to provide all the capabilities necessary to fight and win conflicts such as those the United States is in today.

Support for conventional modernization programs is deeply embedded in the Defense Department’s budget, in its bureaucracy, in the defense industry, and in Congress. My fundamental concern is that there is not commensurate institutional support — including in the Pentagon — for the capabilities needed to win today’s wars and some of their likely successors.

What is dubbed the war on terror is, in grim reality, a prolonged, worldwide irregular campaign — a struggle between the forces of violent extremism and those of moderation. Direct military force will continue to play a role in the long-term effort against terrorists and other extremists. But over the long term, the United States cannot kill or capture its way to victory. Where possible, what the military calls kinetic operations should be subordinated to measures aimed at promoting better governance, economic programs that spur development, and efforts to address the grievances among the discontented, from whom the terrorists recruit. It will take the patient accumulation of quiet successes over a long time to discredit and defeat extremist movements and their ideologies.

The United States is unlikely to repeat another Iraq or Afghanistan — that is, forced regime change followed by nation building under fire — anytime soon. But that does not mean it may not face similar challenges in a variety of locales. Where possible, U.S. strategy is to employ indirect approaches — primarily through building the capacity of partner governments and their security forces — to prevent festering problems from turning into crises that require costly and controversial direct military intervention. In this kind of effort, the capabilities of the United States’ allies and partners may be as important as its own, and building their capacity is arguably as important as, if not more so than, the fighting the United States does itself.

The recent past vividly demonstrated the consequences of failing to address adequately the dangers posed by insurgencies and failing states. Terrorist networks can find sanctuary within the borders of a weak nation and strength within the chaos of social breakdown. A nuclear-armed state could collapse into chaos and criminality. The most likely catastrophic threats to the U.S. homeland — for example, that of a U.S. city being poisoned or reduced to rubble by a terrorist attack — are more likely to emanate from failing states than from aggressor states.

The kinds of capabilities needed to deal with these scenarios cannot be considered exotic distractions or temporary diversions. The United States does not have the luxury of opting out because these scenarios do not conform to preferred notions of the American way of war.

Furthermore, even the biggest of wars will require “small wars” capabilities. Ever since General Winfield Scott led his army into Mexico in the 1840s, nearly every major deployment of U.S. forces has led to a longer subsequent military presence to maintain stability. Whether in the midst of or in the aftermath of any major conflict, the requirement for the U.S. military to maintain security, provide aid and comfort, begin reconstruction, and prop up local governments and public services will not go away.

The military and civilian elements of the United States’ national security apparatus have responded unevenly and have grown increasingly out of balance. The problem is not will; it is capacity. In many ways, the country’s national security capabilities are still coping with the consequences of the 1990s, when, with the complicity of both ends of Pennsylvania Avenue, key instruments of U.S. power abroad were reduced or allowed to wither on the bureaucratic vine. The State Department froze the hiring of new Foreign Service officers. The U.S. Agency for International Development dropped from a high of having 15,000 permanent staff members during the Vietnam War to having less than 3,000 today. And then there was the U.S. Information Agency, whose directors once included the likes of Edward R. Murrow. It was split into pieces and folded into a corner of the State Depa