Michael porter is a Harvard University Business School Professor.  I thought his discussion with Charlie Rose was really interesting.

The one thing I keep wondering about, however, that everyone seems to take for granted, is that Capitalism is supremely beneficial.  On the one hand, it’s clearly leveling the playing field in many ways.  On the other, it’s creating huge gaps between the haves and have nots and is the likely at the root of our environmental issues.   But, it’s what we’ve got and it clearly isn’t going where anytime soon because most of the rest of the world is adopting it, too.   So here we are.  Where do we go from here?

Here are my notes from the Rose Porter discussion…

We aren’t addressing our economic problems. Number one is public education. The cruelty of globalization is that we no longer have the benefit of being American. We’ve talked about bettering education for decades but have made limited progress.  In K-12, the issue is one of quality.  K-12 education in the U.S. simply isn’t good enough because most of our students aren’t getting a good enough education.

It is true that we still have the best university system in the world. The problem is access. America has made zero progress in the proportion of our citizens that have a college degree while other countries have been moving way ahead. And, it’s becoming more difficult for Americans to afford higher education and nothing has been done to address this. People from other countries who get their education in the U.S. do not stay because opportunities are better at home. It might help to staple a visa to every American diploma.

Other issues: tremendous excessive costs of doing business in America; lack of a security net (people who are out of a job are in deep trouble); very high cost health care system; and history of energy inefficiency. These are all well known issues but we have made very little progress in any of them. We also have some strengths we need to reinvest in. Our sense of competition, science and technology, and entrepreneurship. This is the perfect agenda for a new administration, but the last few presidential transitions have not produced the necessary consensus to make these things happen.

Porter thinks that the economic crisis might be one of our best hopes for changing the political discussion. The issues are so universal and serious that the petty differences are no longer viable. Henry Kissinger was on just before Porter and said that the economic crisis may likewise offer a unique opportunity to create new adaptability and relationships among the major powers in the world. (He was funny - he told Rose that he had sat at the table many times and optimism was not one of his characteristics, but he feels somewhat optimistic as far as the ability to create something new out of the current crisis.)

Crisis creates an unfreezing process and allows hard things to be done because people become more open. The problem is having the leadership to make this change. Porter thinks the President-elect is off to a good start.

The fact that those in politics can’t agree about the U.S. automobile situation is probably a good thing because this is a very difficult situation. At the gut level, people in America understand that something is broken and that the companies are not competitive and are out of sync with reality. On the other hand, it is a huge industry with huge ripple effects. The closer the auto plan can become a true restructuring plan, the more it is the right thing to do and will be backed by most Americans. But as long as it is seen as a transitional plan, the American people aren’t going to buy it.

Federal Government has moved remarkably fast and has made a remarkable effort at being thoughtful and balanced. Our system is rising to a higher level and learning by its own mistakes. It is very unlikely that there will be people going forward who claim no regulation is good. There is a worry, however, that we will take on too much regulation and become overly bureaucratic. The challenge is to strike a balance.

Capitalism has suffered because of the long term economic crisis we are undergoing. This crisis will cause others to doubt the system, but just about any other system we know about is not going to produce the standard of living increases that ours is and that is troubling.

Bill Ackman, CEO of Pershing Square Capital Management, was on Charlie Rose.   This interview explained a lot for me!  Here’s my rough summary…

Hedge funds didn’t become a real industry until about 7 years ago.  Right now, most are down 20-30% and Ackman contributes this to short selling being made illegal in September.     This was something that was perfectly legal for many years and it has caused hedge funds to lose tremendous amounts of money.

A hedge fund is an investment partnership.  The difference between a hedge fund and a mutual fund is that the manager of a hedge fund is compensated largely based on performance.  The manager gets 20% of the profits and usually has a very large investment alongside his investors.  Also, a fee of 1-2% is charged for assets managed. They are more expensive than mutual funds and they aren’t regulated because the number of investors are limited and have to be accredited (they have to meet a certain net worth standard).

“Going long” means making an investment - buying a stock on the exchange - you make money if the stock goes up.  “Going short” is borrowing a stock and selling it on the hope that you can buy it back at a lower price.  Investors make money if the stock goes down.

The problem with the government shutting down the short selling for a while was that the government changed the rules of the game with no warning.  If the government had said, “we are going to phase out short selling over a period of time” it wouldn’t have been so disastrous for an industry.  But if you have investors who are committed to their partners to stay balanced - they don’t want to be more than a certain amount long vs. the amount they are short - you lose the ability to insure yourself.  Short selling is a way to protect yourself from the market going down.  By taking away that very important tool, managers got imbalanced and were forced to sell their long positions.  Hedge fund investors are not large short sellers shorting stocks.  Most short selling is done through derivatives.   The rest is done through credit default swap.

You can short a stock and bet that a stock will decline in value.  Another way to make a similar bet is to buy an insurance policy on a company defaulting.  That insurance policy is called a credit default swap and it trades on the over-the-counter market.  You can call up Morgan Stanley and they will make you a price on the probability of GE, for instance, defaulting.  That probability has been perceived to be very low over a long period of time so the cost of the insurance is low.  But if you had the view that GE’s credit would deteriorate, you could buy that insurance policy and sell it at a later date.   Think about being able to sell the insurance policy on your home.  When you first buy it, the cost is low.  But if a brush fire occurred in your neighborhood, your insurance policy would become more valuable.  You’d be able to sell it for much more than what you bought it for.  Credit default swaps are a way to hedge, or make a bet, on a company’s credit worthiness - either to the positive or to the negative.

The Credit Swap Market can be a very profitable business because the major banks have not taken a side - they don’t bet against or in favor of a particular company’s credit but they acted as an intermediary.  It is an over-the-counter market rather than a market on an exchange, so the spread between the price to buy a contract and the price to sell a contract was quite wide.  Dealers made very wide profits by acting in the middle.  It’s a very efficient way to make a bet.

He first started noticing something fishy going on through MBIA, a bond insurer.   MBIA started out in a very low risk business.  But as markets become more competitive, bond insurers are forced to take on more risks to keep their share holders happy.  In the early ’90s, most of the bond markets went public.   They had demands from their share holders and management was compensated with options, so they started looking for other avenues for profit.  They had a AAA rating so Wall Street suggested they guarantee corporate risk, like mortgages, and so they entered a market they knew less well.  They are very leveraged companies.

What struck Ackman when he first opened the annual report of one of these companies was that it had a triple A rating but over 100 to 1 in leverage and that didn’t compute because 30 or 40 to 1 is high.

He says the criticism of the ratings agencies is deserved.   They perform what is almost a regulatory function.  They determine the credit worthiness of a bond and so they got an almost sovereign like status but they were for-profit entities.  The for-profit nature of what is a quasi-regulatory body pushed them for production.  Trying to meet next quarter’s earnings can cause someone to sign off on a rating that wasn’t deserved.    You say, “yes it’s triple A” even though there are a few bad mortgages thrown into the mix, you get paid a $600,000 fee.  You say no, you don’t make any money.

Regulators around the world deferred to the rating agencies.  This allowed for securities that shouldn’t have been sold to spread around the world.

The average mutual fund has done much worse than the average hedge fund.  People tend to demonize hedge funds because they managers are so well compensated.  The focus should be less on the manager than who they manage money for.  Investors are the Carenegie Hall’s of the world, the St. Luke’s Hospitals, the state pension funds, etc.   The SEC did a good job of destroying opportunistic capital by putting on a short selling ban without notice.  It caused a loss of confidence in the U.S. securities market.   The reason you invest in the U.S. markets rather than in foreign markets is because you have confidence that the rules won’t be changed, but they were changed.   People that would normally be jumping in to take advantage of what Buffett calls the best opportunity to invest in his life time is that they can’t - they are on the defense because they are getting redemptions.

Credit default swaps have historically been largely unregulated and Ackman thinks they should be regulated.  It’s a combination of the credit default swaps and the rating agencies that got us into trouble.   The institutions that have created the most systemic risk are AIG, Fannie Mae, Freddie Mac, MBIA, etc.  They all had triple A ratings.  Unlike the other participants in the market, they got a free pass.  They didn’t have to post collateral.  Now that they’ve been downgraded, they have to post collateral.  It’s like someone writing hurricane insurance and when the hurricane hits, they don’t have the money.

We have a system where it is not illegal to run out of money.  We can reorganize companies - the bankruptcy system.  In the case of Freddie and Fannie, it’s called conservativeship.  Paulson did the right thing by putting them into conservativeship, but he stopped there.  He didn’t reorganize them.   They became government run companies no longer traded on the exchange.  The equity holders and option plans for managers have been wiped out and they have too much debt.

What the government should have done was combine Fannie and Freddie, because they perform the same function, and make them as efficient as possible.   Take the 1.6 trillion of debt and convert 20% of it into equity so you have raised 320 billion dollars.  That way they could re-emerge as listed companies on the stock exchange and they could go back to writing business as strong, well-capitalized companies.   Frannie and Freddie have all the money they need.    The problem is too much is debt, too little is equity.  You just need to restore the balance.

Ackman put together a presentation for Paulson and his plan was seriously considered, but they ultimately opted to go with something else.

Ackman thinks the $700 billion dollars has so far been spent well.  $250 billion going into the banks is a very important first step.   Also, the cost of funding for businesses has come down which is a positive.  But he is concerned about GM.  The way to solve the problem is not to lend more money to GM.   GM should reorganize - they should do a pre-packaged bankruptcy.   The equity holders have been largely wiped out already.   You could buy all of GM at $2 billion and you would be over-paying.  The debt needs to be reduced to a level the company can support and the debt holders in exchange for giving up their debt claim will end up owning the business.   You want a GM that can compete.  You don’t want to lend government tax payer money to an insolvent company so that they can pay interest to the people who lent the money five years ago.  That’s not a solution to the problem.  The government money would be better spent to retrain employees for other jobs, infrastructure, etc.

The bankruptcy word scares people, but it’s simply another system.

Ackman thinks Lehman could have been saved but the management loved the institution too much to take the money on terms they thought was unfair and they had no idea what it would cost the institution.  There was a South Korean buyer who might have been in place for a while.  And Buffett made a proposal that was rejected.

Ackman agrees that investment banks as we have known them are gone forever.   They essentially became hedge funds because they were so highly leveraged.

He’s also optimistic about the new administration.   Having a leader who can inspire the people is huge because the markets are driven by confidence.  We have a solvent government and we borrow on our own currency.

I don’t know why I’ve been so obsessed with understanding economics of late because honestly, I don’t think my understanding is going to help anything.   But, I persist…

I took two basic economics classes in college - macro & micro economics.   I remember next to nothing about those classes except that they were my least favorite classes…. EVER!!   I detested my instructor who was an arrogant young, T.A. (not a Prof.).    Thinking it might help to have the basic information presented by an actual professor with decent credentials, I recently ordered a Great Courses class on Economics led by Professor Whaples at Wake Forest University to see if that might help my dismal view.   I finally started watching the first few lessons last night and realize that one of the problems with Economics I had in college is still problematic for me.

Here is my specific issue:  Whaples says that he and the vast majority of economists assume we are all rational utility maximizers:

People act in a consistent manner, with a reasonably well-defined notion of what they like and what their objectives are and with a reasonable understanding of how to attain those objectives.

But is this true??  Are we rational utility maximizers?

This was the assumed sociological model in the nineteenth century.  But sociology has long since moved beyond it and psychology has provided all sorts of studies that show we are not, in fact, rational utility maximizers.

Cognitive psychology has shown that we consistently deviate from the rational choice thanks to cognitive bias.   We think our personal experience captures the “truth”, but that’s not necessarily so!  It has been repeatedly shown that human beings are overly confident about their judgments, especially when individuals hold strong convictions.  Also, our conscious desires are very often at odds with our unconscious desires.   We tend to distort our perceptions to see what is we want to see and then make our choices based on our distorted  perception.  Perhaps our choices are reasonable based on culturally skewed perspectives, and maybe this is why the rational utility maximizer model seems to work so well.  But this still seems problematic to me, although I can’t quite put my finger on why.

Whaples says Economists recognize that there are factors that inhibit rational choice and that these are called  “market imperfections”.   Whaples hasn’t gone into this yet but I seem to remember being taught that the way to minimize market imperfection is to teach people how to be rational utility maximizers.   (Thus, the primary function of public education is to produce effective consumers and producers.)  So couldn’t we say that our current economic system is based on an inherent economic bias that people should be rational utility maximizers rther than upon a “truth” that people are rational utility maximizers?

My husband has an MBA so I’m always asking him economic questions and presented him with this one.  He jokingly replied, “You are being un-American!”   But I’m not trying to say we shouldn’t try to be rational utility maximizers.    Perhaps that is an important American duty.

It’s just a musing…  if classic economics understood the rational utility maximizer model as descriptive knowledge, what does it mean to Economics that the model is now primarily viewed as prescriptive knowledge from a social sciences point of view?

As I said, I’ve only just started the lessons.  Hopefully Whaples will go into some of this and help me understand how Economics has adapted to current models of human behavior because I can’t believe it would simply ignore them.

David Smick was on the Charlie Rose show after Paul Krugman the other day.  He wrote The World is Curved as a play on Tom Friedman’s famous book, The World is Flat. (Just noticed the other day in Barnes that Friedman has a new book out called Hot, Flat and Crowded about why we need a Green Revolution - looks interesting.)

Charlie Rose said that The World is Flat was the first chapter in the globalization effort and that The World is Curved is the second.   It is so named because it’s about the hidden dangers you can’t see over the horizon.  The subtitle is “The Hidden Dangers of the Global Economy” which he says aren’t so hidden now.  He’s been warning for years that the lack of regulation added to the lack of transparency is a cocktail for disaster and that is now exactly what we have - a disaster.

Smick really helped me to understand some of what is going on because he used analogies I could grasp onto.   For instance, in explaining how we got into the current situation, he explained it this way:

It all started with the fall of the Berlin Wall because virtually every emerging country, China, India, etc.) wanted to become capitalists like the U.S.  It turned out they were pretty good at it.    A global ocean of capital (of excess savings) was created which was looking for investment and most of it wanted to come to the U.S.

This inspired Wall Street, 10 years later, to decide they didn’t want to do traditional loans anymore.   What they did instead was like making a giant salad out of mortgages.  You dice them all up into small pieces, toos them together, and put then into salad bowls.  Then you sell the individual salad bowls all over the world as Mortgage Backed Securities.   There is only one problem, every once in a while there is a speck of lettuce with toxic waste on it (a sub-prime defaulting mortgage).  If you eat that piece, you are dead.

So if that’s the only problem, how could some banks that lent money to poor people lead to the worst financial crisis in 70 years?  Because the Global Investment Community quit ordering lettuce.  They declared a buyers strike on the sophisticated instrument (the salad) and suddenly the banks were left with the salad and no buyers.

It’s not that the world doesn’t have money, it’s that the money is sitting on the side lines.  There are 6 trillion dollars alone in market funds waiting for us to reform the system and waiting for confidence to return.

I don’t get the impression that Smick particularly likes Paulson’s handling of the situation.  He seems to be more impressed with Bernanke.  The $700 billion has only been moderately helpful so far.  It’s at least taken depression off the table.  He says the problem is that the Treasury hasn’t said, “here is how banks are going to lend in the future.”

If you look to the Japan 1990s scenario, they injected 10% of their GDP into the banking system hoping this would get banks to lend to businesses and individuals but it didn’t happen.  The problem was that short term interest was extremely low (almost 0%) while long term interest was still quite high.  Banks, instead of lending to businesses, would just borrow from the Central Bank and buy long-term government paper.  The spread was a guaranteed profit with no risk and this caused Japan to go into a black hole.

We have got to create trust and confidence.  We need to create transparency and Paulson ought to be creating targeted mechanisms that encourage lending to the small business sector and individuals.

Also, we have learned that you cannot trust the financial sector to self-regulate.  And, it’s not fair to trust regulators either because they are no match for the Wall Street Investors.   We need a public/private consortium and it needs to be global.

Regarding Alan Greenspan, Smick says he became a victim of his own PR machine.  He became the great maestro.  U.S. Regulatory said that they had misgivings but decided to trust him because he was the great maestro and said it was OK.  Smick doesn’t fault Greenspan for keeping interest rates at 1% for so long.  He faults him for not bringing in Regulatory Administrators once a week to remind them that the interest rate was set at an artificially low level and that he was keeping it low for specific reasons but they should not be making loans to people who assume they will be keeping that rates that low for very long.

There will be all kinds of unintended consequences from this bail out.  One will be a a dramatic re-evaluation of assets (up until 1 1/2 years ago, Financial Services made up 40% of all Corporate profits and 30% of stock market profits).   Another unintended consequence will be the de-funding of state and local governments.  If you can go to the bank and get a better return on a guaranteed federal investment, why would anyone buy a municipal bond?

Smick has one stern warning:  Any solution has to be global.

Charlie Rose has had one notable economist on his show after another.  Today he had two, one of them Paul Krugman who won the Nobel Prize in Economics this year.

He says he was made a Nobel Laureate because he presented a view of world trade that hadn’t previous been explored.  Now it seems like common sense but it wasn’t at the time.   Our basic view used to be that countries trade because they are different.  But that’s no longer true - trade goes on between countries who seem to be very similar so it becomes difficult to come up with a fundamental reason why some people should be making some products and not others.   Krugman put together the New Trade Theory which talks about how small, accidental advantages get built into larger advantages which persist over time.  For instance, all carpet production used to be located around Dalton, Georgia.  This traces back to a teenage girl who made a tufted bedspread as a wedding gift in 1895.  It seems obvious now, but this was a completely new realization at the time.

As far as the current economic situation, he agrees the government had no choice.  But Krugman thinks the Treasury made a really bad mistake by not rescuing Lehman Brothers.   He thinks they could have found a way to save it and most of his fellow Economists were certain they would find a way.  It was completely surprising that they decided to let it go.   The reason this is so devastating is that when Lehman was allowed to fail, all confidence disappeared from the system.  On the other hand, it created the political conditions for a more comprehensive solution.

Krugman says the right answer was to recapitalize the system but he hasn’t liked Henry Paulson’s handling of this.  The Treasury was not going to recapitalize the system at first. They were going to buy the assets and troubled mortgages (the toxic waste) off of the institutions and this didn’t make any sense.  They couldn’t make a good case for how this would work and it cost them time.  Paulson wasted three weeks on this decision before he finally changes his mind.   The wait created an even greater lack of confidence.

Krugman was frustrated with Bernanke because he didn’t offer any counter-weight to Paulson’s misguided strategy on the bail out in the beginning.  He sounded more like Paulson’s “yes boss”.  Chris Dodd, Chairman of the Senate Banking Committee, came out very quickly with a proposal for turning it into a capital injection, and Bernanke said “no, we don’t need to do that”, which couldn’t have been what he believed was right.   Barney Frank, in the House of Representatives, had a similar plan.

We learned from the Japanese experience in the ’90s that the thing to do is provide capital injections to the bank early.  Don’t worry too much about inflation.  Worry about that later.  The higher inflation rate allows for more wiggle room.

Krugman feels confident about Obama as President because he says “off-script” you can tell he knows what he’s talking about.  He’s been cautious, but Krugman thinks he’s had to be cautious because the economic situation is extremely complicated and very difficult to explain.   He assures us we can expect good stuff if he’s elected.

Krugman agrees that we need an additional stimulus package on top of the bailout and thinks there will be two:  A bi-partisan stimulus Nov. 5; and then another, bigger one after the change of Presidency.   Krugman’s opinion is that tax cuts and rebates should not be the core of this stimulus package.   When Bush did this, people didn’t spend the money and we need people to spend the money.

He warns that the recession will likely last a long while and that it will be deep (if not a depression).   The last recession was officially only 8 months long but it actually took 2 1/2 years for the labor market to recover.   High unemployment, which started in 2001, did not improve until the summer of 2003.  White House fact sheets on the economy always talk about jobs gained since 2003.  But the fact is, jobs were significantly down from 2001 - 2003.  They never bother to mention the 2 1/2 year recession prior to 2003 when making that statement.

The nature of recessions has changed.  We used to have recessions because there was inflation and the Fed raised interest rates which created a housing crashed.  They would let the rates come down again and the housing market stabilized.   This time, the recession has been created because a private sector has had irrational exuberance.  The bubble has burst and it’s much more difficult to get the economy to move again after a bubble burst than it is in an old-fashioned recession.  It’s going to take a while.

Krugman says we had something we called capitalism from the 1930s to about 1980 which was a fairly heavily regulated system.  The rich were taxed fairly high, but it was still a market economy.   Then came the Regan era which was the age of deregulation.  We are probably going to have to go back to the way things were from 19390s to 1980.  Krugman says that really not such a terrible thing.

Krugman thinks that if Obama wins the presidency, he needs to call for something like a new, New Deal.  Not everything has been bad these past couple of decades but we lost sight of having a society that works for everybody.  We lost sight of a society that provides some basic security and insurance against chaos in the financial markets.  We need to recapture some of those values that made us successful.

Alan Greenberg is former CEO of Bear Stearns.  Bear Stearns was one of the largest global investment banks and securities trading and brokerage firms until it collapsed in March.   Greenberg started at Bear Stearns in 1949 as clerk, making something like $30/week, and worked his way up through the ranks, becoming CEO in 1965 (according to his interview with Charlie Rose).    He watched what he had spent so many years to build, destroyed in a couple of week.  He joined JP Morgan Chase as VP of Bear Stearn’s retail business for JP Morgan.

Greenberg says he already sees signs that the market is turning around.  For instance, the Municipal Bond market was in terrible shape 2 weeks ago but now it isn’t just stable, it’s on its way up.  The Commercial Paper Market has stabilized and is operating again.   And everyone was scared to death of Derivatives, but that has been largely thanks to misunderstanding.   They are recovering, too.

Greenberg says we will definitely get through this and it will likely come as a surprise to people how quickly we do get through it.  We’ve definitely made some mistakes over the past few years, our image is not what once was throughout the world, but he says America is still by far the best place in the world.

He describes the model of the investment bank as a firm that buys securities; keeps them; then helps their clients by taking securities off their hands, making committments, and then lending money until they can sell bonds.   This model doesn’t work anymore and it won’t work in the future.  The reason it doesn’t work is because it can’t withstand rumors.

If you are a bank, you are protected - a run on the bank isn’t going to happen. But if you are a Wall Street Firm, a run will kill you.  Charlie Rose asked Greenberg if the run on Bear Stearns was a conpsiracy to bring it down.  Greenberg said he didn’t know, but did say that when there are rumors about solvency and losses, they are a killer.  He’s not saying there was a conspiracy or that Alan Schwartz ganged up on them (not sure I fully understand what that means, yet), however.  There were a lot of questions Charlie Rose asked that he said he wouldn’t answer.  Maybe he’ll answer them at some later date but he can’t answer them now (in part, it seems, because of the litigation that is currently underway).

He doesn’t think Bear Stearns could have been saved.  If Goldman Sachs couldn’t be saved, then Bear Stearns couldn’t.  (Over the weekend, both Morgan Stanley and Goldman Sachs became banks and raised the additional capital to stop what was happening to them.)  The new model will be banks and banks that own banks.

Charlie Rose had an hour interview with U.S. Treasury Secretary, Henry Paulson, on the economy on Tuesday (at least Tuesday for us - Charlie Rose comes on at midnight here).

Rose asked Paulson if he wished he had come to the decision to capitalize the banks earlier.  Paulson replied that it wouldn’t have made any difference.  He says they came to Congress as early as they could to get the legislation - that there was no chance of getting it from Congress any earlier than they did.

Of course, Pelosi was on The Charlie Rose Show last week and she said the opposite - that Congress wanted to do this earlier than was recommended to them by the Treasury and that she had to call Paulson to find out about what was going on - that he didn’t call her.   It’s very confusing!  Paulson didn’t discredit Pelosi, but didn’t have an adequate response, either.

He tried to explain why Lehman Brothers was different than Bear Sterns and AIG and I kind of understand it, but not totally.   Bear Sterns was diagnosed as having a quick liquidity problem.  The Fed has some authorities but with certain stipulations - the loans need to be secured.  I’m not sure I fully understand why the Lehman Brothers loans could not be viewed as secured but Bear Sterns and AIG could.  If it’s a matter of liquidity, you sell and there is little change in the market.  JP Morgan was willing to finance some of the loans for Bear Sterns.

Lehman Brothers, on the other hand, tried to broker a deal but it fell through so the Fed had no power to help out.  They had it let it go into bankruptcy.  But AIG was viewed as a liquidity problem like Bear Sterns so the Fed could loan it 85 billion dollars?   That still confuses me.  What makes AIG different from Lehman Brothers?  (Like I said, economics is not my forte!  I have much to learn.)

Paulson agrees that the Bail Out Package (although he claims he has never called it that) has not been properly communicated to the American people.  The problem is he wants to inspire confidence, but at the same time, he has to present it as a crisis so he can get the votes he needs for the proper legislation.

He thinks we took the right action, that it was a bold move, and that it is working.  But we will have challenging months ahead.  It’s going to be very difficult.  We have a resilient economy, but it’s going to take time.   Economic collapse was prevented, the money hasn’t hit the banks yet which will undoubtedly give the banks more confidence once it does.  The credit freee is already beginning to melt.  There are plenty of reasons for the American people to be confident.

He won’t say that he disagrees with Bernanke.  I wasn’t sure exactly what he meant by this but assume it has to do with Bernanke saying we will need an additional stimulus package?  Paulson says he’s not necessarily opposed to the additional stimulus package, but he’s focused on the plan before him.  He also says he is not aware of any differences between he and Sheila Bair.   He thiks she has been innovative and will continue to come up with good ideas but warns that we are going to have foreclosures for a long time to come.  Right now we are looking in the millions in terms of foreclosure.

Paulson says it is true that the current regulatory system is hopelessly outdated.  It’s not just a matter of too little regulation.  It’s totally wrong regulation.  But the current economic crisis isn’t just due to the Subprime lending issue and regulatory breakdown.   It’s also due to huge global imbalances.

President Bush said “The banks and Wall Street got drunk.”  Paulson agreed with him and said they got drunk on all the capital that was flowing in from foreign countries with imbalances.  Our system is out of whack.  We’ve got a stable disequilibrium.  It’s stable until it isn’t stable anymore.

Charlie Rose asked Paulson if he’d stay on after his term was up.  Paulson does not want to continue.  Can you blame him?  What a mess.  But he does say he’ll spend every last day he has helping someone else learn the ropes so the transition will be as painless as possible.

More historical notes from Chapter 1 of The Limits of Power…

• By the end of Reagan’s presidency, 41 percent of the oil consumed domestically came from abroad.  The U.S. status as a creditor nation ended in the Reagan era.  By 1986, U.S. assets owned by foreignors exceeded the assets that Americans owned abroad.  Consumer debt likewise increased.
• It was Reagan’s willingness to spend without limit that helped bring the Cold War to a peaceful conclusion.  But it was also the willingness to spend without limits that created an increasingly debt-ridden and energy-dependent nation - and one mixed up with the Islamic world.
• Reagan spent billions funneling weapons to support Afghanistan against the Russians.  But the Afghanistani people were not interested in global security as Reagan advertised.  As soon as the Russians left, the Taliban emerged victorious.  The Taliban provided security for Al Quaeda.   Osama bin Laden planned his holy war against the U.S. from Afghanistan.   With the collapse of the Soviet Union and it’s removal from the area, “Central Asia suddenly became valuable real estate to the U.S.”  (Oliker and Shlapak).  Americans have paid very little attention to this story.   Instead, we compartmentalize history into post-9/11 and pre-9/11 and are oblivious to the consequences of Reagan’s collaboration with the mujahideen.   History will hold George W. Bush primarily accountable for the Iraq War.  But Ronald Reagan led the way.
• All Presidents have paid lip service to our dependence on oil, Bush going so far as to say “America is addicted to oil.”  But none have taken meaningful measures to do anything about it.  George H.W. Bush said in 1992 that “The American way of life is not negotiable”, and so it seems.
• Under Clinton, oil imports increased by more than 50% and the trade imbalance nearly quadrupled.  Gross federal debt grew by almost $1.5 trillion.  This was all during the dot.com years so Americans didn’t pay attention.  Life was easy for most in the U.S.  Clinton was dropping thousands of bombs on Iraq where half a million Iraqi children died as a result.  Madeleine Albright’s response - “I think this is a very hard choice, but the price - we think the price is worth it.”   American soldiers weren’t getting killed so we looked the other way.  But America imposed massive suffering on the Iraqi people right along with Hussein.
• Donald Rumsfeld summarized the prevailing view of 2001 about Iraq:  “We have two choices.  Either change the way we live, ore we must change the way they live.  We choose the latter.”  Between 2000-2004, no politician of national stature voiced a contrary view.  Iraq was to become the first Arab Democracy with the intention to transform  the Islamic world from Morocco all the way through Pakistan and Central Asia to Indonesia and the Southern Philippines.  Mark Danner wrote that this response was “comprehensive, prophetic, evangelical.  The Islamic world needed to “be made new”.  This was an imperial vision on a truly colossal scale.
• Rather than ask Americans to tighten their belts to achieve this, Bush told them to go on as though nothing was happening.  “Get on board.  Do your business around the country.  Fly and enjoy America’s great destination spots.  Get down to Disney World in Florida.”  (That made me so mad!!!  It was so Brave New Worldish.)  Even as late as 2006, he was encouraging people to do more shopping while  .5 percent of the population was sent off to bear the brunt of the sacrifice.  99.5% of Americans endorsed the distrubution of sacrifice with only a handful of dissenters.  They prescribed to a limited-liability version of patriotism - they displayed bumper stickers.  Woo hoo!
• During the Bush administration, the Pentagon’s annual budget reached $700 billion.  The annual trade imbalance reached $818 billion.  By 2007, the Iraq war had cost over $500 billion dollars with estimates saying the final bill would reach at least $2 trillion.  These numbers were widely reported and there was nervous speculation among some that this would create an economic collapse comparable in magnitude to the Great Depression.  But the American people continued to look the other way, indicating the extent to which habits of profligacy had become entrenched.
• We have long thought of ourselves as a super power, but we have forfeited command of our own destiny.  Expansionism has squandered our wealth and power and it has put our freedom at risk.   It makes the ideals to which Jefferson and Polk, Lincoln and McKinley, TR and FDR subscribed not only obsolete but pernicious.

I think it’s really good news that Colin Powell is now endorsing Obama, even if his reputation was somewhat tarnished by his role in building the case in 2003 that Iraq had weapons of mass destruction.   I’d love to know the story on that, though.  Even before the Persian Gulf War, Powell had always been opposed to a forcible overthrow of Hussein and he clashed with members of Bush’s cabinet on the issue and finally gave in.  What made him give in if he was skeptical about the information given to him?   Powell saw it as a painful blot on his record and pushed for reform in the intelligence community.  Apparently, this didn’t go over real well with Bush because Powell was asked to resign.  Powell announced his resignation intending to stay on through the first term, but he was immediately replaced by Condoleezza Rice which makes some people think Powell was too moderate for the Bush administration.  Whatever the case may be, Powell’s endorsement should deflate some of the claims that Obama doesn’t have enough foreign policy experience because I think Powell’s foreign policy knowledge is still highly respected even if there is a blot on his reputation.

I wonder what it will mean to have a Democratic House and a Democratic Presidency if Obama is elected?

I watched an interesting Charlie Rose interview with Nancy Pelosi, Speaker of the House of Representatives.  She claims that it will create a stronger bi-partisanship which seems sort of counter-intuitive.    She says that right now, the Republicans we have in office are not the Grand Old Party Republicans used to be - they are the radical right and it is radicalism that is inhibiting bi-partisanship in the White House.  That makes sense!

It was interesting to hear her perspective on the financial situation.   Typically Paulson calls her on a regular basis but for some reason hadn’t called her in a while so she phoned him, told him she was hearing some disturbing news about the economy, and could they get together around 9:00 the next day to discuss it.  Paulson, paused, and said it couldn’t wait.  They had to get together that afternoon.  Why did she have to call him to find out what was going on? She’s the second most powerful person in the U.S., for goodness sakes!

Now Paulson’s doing what everyone wanted done in the first place - taking over Mortgage Securities.   But she believes, as do many economists, that the White House is dragging its feet.  She agrees with Sheila Bair, Chairman of the FDIC, that the Federal Government isn’t doing enough to address home foreclosures which is the root of the problem and that the current plan doesn’t go far enough.  Bair sounded the bell early on that we were potentially headed for a disaster.  (Warren Buffet, by the way, is very impressed by Bair.)

Bair thinks government has to be involved right now but that the level at which it is currently involved is not good.  Government intervention in the future should be confined to stronger regulations.  She says there is a difference between free markets and free-for-all markets.  We did not have regulations in place that applied across the board - Mortgage Lending being the obvious example.  She says the new Congress is going to have to concern themselves with restructuring regulations.

Bair is likewise confused as to why the political consensus did not act as quickly as it needed to act.  Even now, she says it’s not really on board with going in and helping borrowers.  This doesn’t make any sense to her because politicians represent their people.  Bair says it is false that she is at odds with Bernanke and Paulson.  She’s been as critical of herself as anyone.

Pelosi says that the economic expert consensus is that we need to inject 2-3% of the GDP back into our economy which is about $200-$300 billion.  The House of Representatives has passed a $61 billion package to try and help rebuild the American infrastructure, but President Bush is not on board for the recovery package which she claims this is pretty much par for the course.

Here is how the package breaks down:

• About $30 billiion would go directly toward an innovative “green” rebuilding of America’s infrastructure.  (The Association of General Projects say there are 5000 projects just waiting for the funding to put people to work.)
• About $15 billion would provide state aid for senior citizens and children.
• $6 billion would go toward unemployement insurance because there are 3 1/2 million people currently claiming unemployment.  (It’s the highest it’s been in 5 years.)
• $2 1/2 billion would go toward emergency food assistance.

Pelosi agrees with Bacevich’s assessment that the American periphery has been far more important than the American interior.     We spend $10-12 billion dollars a month to fund the war in Iraq but the House can’t get Presidential approval on a $61 billion dollar package for America’s infrastructure.  Our country is in survival mode at the moment while Iraq has a budget surplus.   We are paying to build Iraq’s infrastructure but the President won’t sign off on the package to build our own.

Pelosi says there are two flag ship issues the new Congress will need to address and those are Energy Independence and the Global Climate Crisis.  These remain flagship issues even in the face of the current economic crisis because they have to do with everything.  Both have to do with the economy, national security, environmental health and especially moral responsibility.  We also have to get to the point where we see health care as a right, not a privelege.  Everything is in place to make this happen, it’s simply a decision we have to make.

We can invest in the infrastructure with green technology.  Pelosi rejects the notion (she says it’s a notion, not an idea) that the price at the pump will come down if you drill off shore now.  It will come down, but in 10 years and by 2 cents.  It’s not going to make a significant difference.  We can’t ignore renewables because that is the future.

Plus, we tax payers give oil companies subsidies to drill off shore.  The oil belongs to the American People so why do we pay big oil companies subsidies when they are already making something like 20 billion a quarter each in profits?    We should get part of that profit and invest it in renewable energy sources.  We’re only talking about $2 billion a year but the oil companies claim that can’t afford it.  They can afford it, of course.  But it’s easy to see why big oil want to allow for investment in renewable energy.   But whose oil is this?  It’s the American People’s oil.  Why aren’t we subsidiing it rather than getting profit from it?  That profit could go toward helping rebuilt the American infrastructure with green technologies.

I felt really confident after listening to Pelosi that we have what it takes to rejuvenate our country.  It’s all in place.  We just have to decide, as a nation, to do it.  Times are definitely interesting.

I’ve been making my way through Andrew Bacevich’s recent book, The Limits of Power, The End of American Exceptionalism.  I’m painting, not just highlighting it, so thought I’d better step back and make sure I’m understanding his position before I continue.  (It always helps to write it out).

Andrew Bacevich is professor of International Affairs at Boston University.   He’s a graduate of West Point and was career Army from 1970 to the early 1990s when he retired as Colonel.  He served in Vietnam, in the Gulf War, and was appointed various places around the world throughout his career.  He holds a PhD in American Diplomatic History from Princeton and he describes himself as a Catholic Conservative.  He is an Obama Republican (Obamacan).  He admonishes the Bush administration’s war policies as being “immoral, illicit, and imprudent”.  Reagan laid the groundwork for these war policies.

The premise…

We are simultaneously entering into three crises - economic, political, and military.  Counter to the American tendency to reflexively assign these crises to leaders who we think are hell-bent on denying us peace, we need to face reality and remove our blinders and see the world as it is rather than how we want it to be.

We think of ourselves as a peaceful people and consider our intentions benign, yet we have had the hubris and the sanctimony to believe that we have the right to remake the world in America’s image.   But American values and beliefs are not universal, however much we’d like them to be.

Americans have increasingly equated comfort with self-indulgence and we haven’t been able to keep up with our appetite for self-gratification - we’ve had to go beyond our borders to satisfy that appetite.  Our appetite for freedom has grown as well, but our view of freedom has gotten confused with gratification which has likewise increased our inclination for empire.   Americans used to see empire as the antithesis of freedom, but today we view it as the prerequisite of freedom.

Our exercise of freedom is centered on consumption and individual autonomy; and it is contributing to the gradual erosion of our national power.   We never cease to expect more, yet we continue to contribute less.   Since 9/11, the American demand that the world beyond our borders accommodate the American way of life has become more insistent than at any time in history.

Bacevich says the central paradox of our time is this:  While the defense of American freedom seems to demand that the U.S. troops fight in places like Iraq and Afghanistan, the exercise of that freedom at home undermines the nation’s capacity to fight.  Bacevich warns that “history will not judge kindly a people who find nothing amiss in the prospect of endless armed conflict so long as they themselves are spared the effects.  Nor will it view with favor an electorate that delivers political power into the hands of leaders unable to envision any alternative to perpetual war.”   We’ve lost control of our destiny through the insistence that the world accommodate the United States.  We need to reassert control of our destiny and end our condition of dependency and abandon the imperial delusion.   We also need to reexamine exactly what freedom entails.

A few historical notes from Chapter 1…

• profligate - completely given up to dissipation and licentiousness; wildly extravagant
• Reagan portrayed himself as a conservative but he was a faux Republican.  He was the modern prophet of profligacy, the politician who gave moral sanction to the empire of consumption.
• Self-gratification is the current defining feature of the American way of life;  over the years freedom has become associated with abundance.
• Crediting the U.S. with a “great liberating tradition” transforms history into a morality tale and allows us to dodge serious moral analysis.   The main objective of U.S. policy has always been expansion, not liberation,  Historically and presently, this expansion has been achieved by any means necessary.
• The primary obligation of the American Presidency is to pay homage to the tradition of American exceptionalism.
• In 1979, President Jimmy Carter warned Americans that we had strayed from being a nation of hard-working, strong families and close-knit communities and had become a nation of people who worship self-indulgence and consumption.  He warned that this path would lead to fragmentation and self-interest.  This speech was met with derision and lost him his second term because the Reagan administration promised the American people that they could have more and that they needn’t worry themselves with the critical self-reflection Carter had preached.
• During the Carter years, the federal deficit averaged $54.5 billion annually.  Even after Reagan promised to “put the American economic house in order”,  the deficit skyrocketed during his two terms to $210.6 billion and federal spending doubled.   The federal government grew by nearly 5%. The Reagan Revolution was not about fiscal responsibility or small government; the Reagan Revolution was about giving the American people what they wanted: more.  Carter asked Americans for critical self-awareness; Reagan’s promise of more obviated self-awareness.
• Under Reagan, minimum security requirements achieved a status akin to invulnerability (Star Wars) which required permanent global military supremacy.  These are the underpinnings of George W. Bush’s post 9/11 war on terror.
• “In Washington, confidence that a high-quality military establishment, dexterously employed, could enable the United States, always with high-minded intentions, to organize the world to its liking had essentially become a self-evident truth.  In this malignant expectation - not in any of the conservative ideals for which he is retrospectively venerated - lies the essence of the Reagan legacy”.

More later (meanwhile, watch the Bacevich-Bill Moyers interview)…