November 6, 2012 4:50 pm

Economics must heed political risk

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The radicals in academic finance would revamp the basic metric of economic performance. The familiar statistics on gross domestic product would be coupled with an index of financial risk-taking, so that the usual focus on growth would be tempered by a measure of the danger that growth might suddenly implode. This month of all months, one craves an equivalent risk-weighting to reflect political uncertainty.




Amid the marathon reality show of the American elections, the tense theatre of the Chinese transition and the anarchic agitprop of eurozone politics, non-risk-weighted economic forecasts verge on irrelevance. Even with the US election behind us, this is not about to change.





The International Monetary Fund’s recent World Economic Outlook illustrates the point. The IMF dutifully produced a precise forecast: next year the world economy will grow by 3.6 per cent. But it warned its prediction was based on political assumptions: that US politicians would avoid the fiscal cliff; that European politicians would hold the eurozone together. The IMF might have added that its forecast was also hostage to China’s new leadership. Will China reconcile itself to growth at the new rate of 7-8 per cent, accepting that sustainable, domestically led expansion makes the 10 per cent growth rate of 1990-2011 unattainable? Or will it stimulate aggressively, as it did after the Lehman Brothers bust?
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Plainly, the answers to these political questions are far more consequential than fine adjustments to the forecast for housing starts or export growth. In the US, for example, the fiscal cliff involves tax increases and spending cuts worth at least 4 per cent of output next year, or 2.5 percentage points more than the IMF assumes in its base case.




Apply a conservative multiplier of 0.8 and the IMF’s projection of 2.1 per cent US growth is reduced to almost zero. Likewise, China’s post-Lehman stimulus caused the year-on-year growth rate to soar from 6.8 per cent in the fourth quarter of 2008 to 10.7 per cent a year later; another fiscal Tarzan act would play havoc with the outlook. Meanwhile in the eurozone, one plausible analysis of a disorderly break-up projected that output would crater by 13 per cent in Greece and 7 per cent in Germany. Given such effects, the IMF’s point estimate for eurozone growth seems beside the point.




Nobody is more aware of the forecasts’ fragility than the IMF’s own staff, whose report plays out scenarios that deviate wildly from its base case. Suppose, for example, that eurozone authorities fail to contain sovereign and banking stress – a scenario that falls well short of break-up. Capital will flee from Europe’s periphery to the centre and from risky corporates to the remaining comparatively safe sovereigns; beyond Europe’s borders, general risk aversion will create an echo effect. In the IMF’s model, the euro area’s periphery will suffer a 6 per cent contraction in gross domestic product, relative to the base case. The US, Japan, emerging Asia and the Middle East and Africa will be heavily affected, suffering an output loss of about 1 per cent.




According to a new index devised by Scott Baker and Nicholas Bloom of Stanford University and Steven Davis of the University of Chicago, US policy uncertainty appears to be higher now than at recent elections, with the exception of Lehman-tinged 2008. It is also higher than after the stock market crash of 1987, the start of the first and second Gulf wars and the default of Russia and Long-Term Capital Management in 1998 (see chart 1). In Europe, policy uncertainty spiked last November after the Greek leadership proposed a referendum on austerity, but is still far higher than during the Asian crisis or the takeover of Northern Rock (chart 2). And whereas in the past policy uncertainty spiked when governments responded to economic shocks with emergency measures, today’s policy uncertainty is more political in origin. Professor Bloom’s analysis suggests that uncertainty over long-run fiscal policy is the key issue in the US (chart 3).




In China and Europe, as well as in America, politicians are grappling with structural challenges they have ducked for ages: there is therefore little prospect that uncertainty will abate. One clear consequence is that there will be an additional drag on the recovery. Prof Bloom and his co-authors find uncertainty weighs on investment, hiring and output. Lewis Alexander of Nomura estimates that additional uncertainty, defined as a one standard-deviation increase in the dispersion of earnings forecasts for companies in the S&P 500 index, is associated with a 0.5 per cent fall in gross domestic product over one year (see chart 4).




But there is a second consequence of enduring uncertainty, which relates to an old truth about economic forecasting. In acutely uncertain times, precise predictions are of dubious value; the risks around a forecast are more significant than the forecast itself. Although it is fashionable to decry finance and its models, financiers are ahead of the game here. Back in 1966, the future Nobel Prize winner William Sharpe invented a way of combining expected returns from a security with the expected risk of holding it. It is time now to create something similar for economies: a forecast of output divided by a measure of the risks to the forecast; a Sharpe ratio for economic growth.




The writer is a senior fellow at the Council on Foreign Relations and an FT contributing editor



 
Copyright The Financial Times Limited 2012


11/07/2012 12:05 PM

Victory without Triumph

Tough Road Ahead for Obama after Lackluster Win

A Commentary by Gregor Peter Schmitz
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Barack Obama may have won the election, but it is a victory devoid of triumph. The tough win means that the president will have to take small steps to achieve his political goals during his second term in office. This could ultimately pay off for his party in the long run.






Barack Obama made history in 2008. But only now has he completed his personal success story. If American voters had failed to re-elect their first African-American president, it would have tainted Obama permanently with the flaw of something left incomplete, leaving him a historically important president, yet ultimately not a significant one -- the latter distinction being one Americans generally reserve for presidents who make it to a second term.




Had he suffered electoral defeat, Obama might have remained forever the "Black Man Given Nation's Worst Job," as a headline in the satirical website The Onion joked after his election four years ago. He might well have ended up being the right man at the wrong time, having failed because of one of the worst economic crises in United States' history. His defeat could have meant a serious blow to the morale of America's newly self-confident black population.




Obama didn't lose, though. But does this mean the Democratic candidate has achieved a historical triumph?



No, it does not. Obama ran a lackluster election campaign, one distinguished more by harsh attacks on his opponent Mitt Romney than by pride in his own accomplishments. Just how narrow the victory was can be seen in the popular vote count. While the incumbent easily defeated his challenger in the Electoral College, he only managed to eke out a razor thin majority of total votes cast.



"Go vote" ultimately became the mantra at Obama rallies as the campaign drew to a close, a more pragmatic appeal that replaced the earlier, visionary slogans "Hope" and "Change." It was essential to re-elect Obama, because he had not yet completed his difficult task -- this was the pared-down message of the president's campaign for a second term.
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A Weak Opponent




Nor was this absurdly long and absurdly expensive electoral battle a historic duel, not at all comparable to Obama's epic struggle against Hillary Clinton in the 2008 Democratic primaries. Republican candidate Romney proved instead to be an opponent who will quickly be forgotten by history -- an inept, even awkward politician.




Far more historic in this election was the Republican Party's foolishness in failing to make a decisive effort to attract the minority groups that increasingly determine the outcome of American elections. African-American voters were expected to stand by Obama. But Hispanic voters could well have been drawn to the conservatives, given the difficult economic situation in which the US finds itself. But faced with the Republican Party's heavy-handed xenophobia, something Romney cultivated assiduously at least during the primaries, a vast majority of Hispanic Americans cast their votes for the incumbent.




American elections can no longer be won on the strength of white men's votes alone. The Republican Party must recognize that the increasing numbers of immigrants and Americans descended from immigrants not only plan to remain in the country, but they want to be involved in the decision-making process too. Even right-wing hardliner and Fox News television host Bill O'Reilly has acknowledged that "the white establishment is now the minority."




Economic Growth Takes Priority
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But will Obama's second term begin as his first did -- with his policies being blockaded by Republican lawmakers? Republicans still have the majority in the House of Representatives. And it is in no way clear that the Grand Old Party will draw the same conclusion from its 2012 defeat as it did in 1964 when radical Republican candidate Barry Goldwater lost.




Back then, the party made a move to the political middle. But as early as Tuesday evening, some conservatives had already begun blaming their election defeat on Romney for being too moderate and suggesting that his far more radical running mate Paul Ryan might be the party's future hope.




With this in mind, Obama will have to be humble, which would be good for both the president and his party. In contrast to the election in 2008, the results of which the Democrats falsely interpreted as a broad mandate, Obama must for now tackle the issue that is most important to the American people -- jumpstarting the economy and creating more jobs. Around 60 percent of US voters told exit pollsters that this is their most important concern.



Obama, of course, also won't be able to give priority to controversial and divisive projects like his historic health reform. Still, this new modesty could be beneficial, because if Obama manages to preside over an American economy that begins growing once again as many economists predict, then the chances that another Democrat will succeed him in 2016 will increase significantly.




That person could be his former rival Hillary Clinton, who plans to step down from her position as secretary of state and get some rest, which insiders say could mean she is preparing a run for the White House. Perhaps her husband Bill played such an enthusiastic role in Obama's campaign as part of such a succession plan.




If this is the case, 2016 could be another historic election. The country's first black president could be followed by the first woman president, heralding a new progressive age for the United States of America.



The Real Crooks Are The Ones Who Perpetrated This Scam – Not The Shareholders
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November 7, 2012
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By Martin Hutchinson,
Global Investing Strategist, Money Morning






Haters of the big banks cheered when Federal prosecutors decided to sue Bank of America (NYSE: BAC), alleging that they defrauded Fannie Mae and Freddie Mac of at least $1 billion.
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But they shouldn't have. Because no matter how satisfying it might be to see justice done after the financial crash of 2008, the truth is the real crooks have already gotten away.

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Now four years later, the only people that will suffer will be the bank's unfortunate shareholders, not the bad guys who perpetrated the scams that cost a fortune during the mortgage meltdown.
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After all, this wasn't the first lawsuit filed against Bank of America in this mess.
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Last year the Federal Housing Finance Agency filed suit against the bank for similar offenses. And in February the bank agreed to a $1 billion settlement of a case brought by the Brooklyn attorney's office claiming fraud on guarantee claims against the Federal Housing Agency.
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Also in February, the bank and five other mortgage lenders combined to agree to a $25 billion settlement of claims over mortgage fraud.
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Now, according to estimates by Credit Suisse, the final cost to Bank of America of all the lawsuits relating to mortgage fraud during the bubble will come to around $40 billion.
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And guess where that will come from?...
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Not from Bank of America's top management, nor from the loan officers and other middle management who actually perpetrated the frauds.
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Instead, it will come out of the pocket of Bank of America shareholders, who are almost entirely innocent of any wrongdoing.
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The Worst Take Over Deal of All-Time


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The irony is that those shareholders did not even unwittingly invest in a bank that was doing dodgy deals. Almost all the lawsuits and losses come out of Countrywide Financial, a very much more aggressive operation, bought by the foolish Bank of America CEO Ken Lewis in January 2008, under the impression that the combined bank would then be able to dominate the mortgage market.
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That has to be just about the worst takeover deal of all time, by any company - and there have been some lulus.
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Mind you, if the suit is accurate in describing Countrywide's behavior, a lawsuit appears highly justified.

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Countrywide imposed a process called "the hustle" on its mortgage approval process, under which bonuses linked to the quality of loans were replaced with those based solely on volume. What's more, experienced underwriters were removed and replaced with "data entry clerks" and instituted a process to "remove the roadblocks."
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This "hustle" produced a mortgage pool that was 57% defective, according to an internal study.
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However nobody at Bank of America was pushing Countrywide, then an independent company, to engage in sleazy lending practices. That was the job of its CEO Angelo Mozilo.


Mozilo, who made around $600 million from bonuses and the sale of his company to Bank of America, paid a mere $72 million to settle charges against him, and has since walked away scot-free to enjoy his lucrative retirement.
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The Real Crooks of the Mortgage Crisis


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There are other guilty people in the mortgage crash of 2008, notably those who set up the insane system by which the federal government essentially guarantees most mortgages and established two private sector companies to run the system and make profits from it.
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Both Fannie Mae and Freddie Mac were involved in accounting scandals a decade before the crash, yet they were allowed to continue growing while the relevant Congressional pooh-bahs - notably former Senator Chris Dodd (D-CT.) and Rep. Barney Frank (D.-MA) - blocked any attempt to reform them.



So incestuous was the system, that Dodd even got a special-terms "Friends of Angelo" home mortgage from Countrywide.
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And then, in an unbelievable exhibition of chutzpah, Dodd and Frank got their name on the 2,000 page legislation to reform the system after the crash - a reform which, needless to say, has added to the U.S. financial system mountains of bureaucracy and almost no additional soundness.
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The disgrace is that none of the top honchos involved have gone to jail.
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Not Mozilo, not Dodd, not Frank. Not Jon Corzine, whose brokerage MF global had $1.8 billion of customer funds suddenly "disappear."

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Instead, prosecutions have focused on the little guys, the retired Army sergeant described by the Financial Times, who tried to flip houses in Nevada using forged mortgage documents and has been sentenced to 15 months in prison.
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Yes, small-time crooks need to be prosecuted, and there were plenty of them. But there have been no successful prosecutions against the big-time crooks who ran the system - and let's not forget those like Goldman Sachs' trader Fabricio Toure who used subprime mortgages as a tool to stuff dozy European banks with billions in losses.
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Under the current system, only Bank of America shareholders, mostly entirely innocent of wrongdoing, look likely to suffer.
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As a former "insider of insiders" London merchant banker, I can tell you that's not right.


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November 7, 2012 7:12 pm
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Obama shattered the GOP’s delusions
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By Simon Schama
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For a while in the small hours, even after the arithmetic of the electoral college had already doomed his campaign, it seemed Mitt Romney would not concede defeat. Karl Rove, whose perpetual air of self-satisfaction must for once have been tinged with chagrin, was muttering on air that Ohio would have to be recounted; that his home network of Fox had thrown in the towel prematurely



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Hopes of a repeat of Bush-Gore were evidently still glimmering. But this was the last gasp emitted from the echo chamber of delusions within which the Republican elite have sealed themselves for years.





Then Mr Romney came on stage in Boston to make his concession speech. It was gracious but less moving than John McCain’s speech four years ago, a concession so generous and imbued with a sense of the historical moment that it alarmed even his own Republican troops. But in his way, too, Mitt Romney for a moment dropped the mask. Behind it was a chastened man, for once slightly unkempt, the weariness visible. But not much else. Graceful good wishes to the victor, a prayer for the president and the country and then true Romney, a homily that teachers, investors, citizens of strong faith might lead us out of dire straits. And that was it.




Suddenly the man who had tried to be everything to everyone was nothing to anyone, except a tired private equity executive and former governor of a state that had just repudiated him by a huge margin. In the last weeks of the campaign his strategists had imagined they might expand the “battleground map” into the industrial Midwest, concocting a fable – that Barack Obama had sent the auto industry into bankruptcy and was even now outsourcing jobs to China – so at odds with the truth that even Motown executives were compelled to denounce it. Detroit, Milwaukee and Cleveland were not buying it, and so long before Pennsylvania was known to have turned the tide Mr Obama’s way, the Republicans had lost the presidency in the industrial heartland.




What bit the dust on Tuesday was the world of denial in which Republicans have immured themselves ever since the rise of the Tea Party in 2009. This is a universe in which the financial crash was caused by over-regulation; one in which, despite years of brutal drought and violent weather patterns, climate change is a liberal hoax; a country that can correct a vast structural deficit without ever raising additional revenue, while expanding the military budget beyond anything sought by the Pentagon; a belief system in which Mr Obama was the source of all economic ills rather than the steward of the most intractable crisis since the Depression. The mantra was that a business executive would, simply by virtue of that fact, effect a magical rejuvenation of the staggering American economy.




But the most obstinate fantasy to die in this election was that the greatness of the US was somehow inseparably bound to the dominion of the white male. The most egregiously offensive candidates for the Senate, Richard Mourdock in Indiana, who proclaimed that post-rape conceptions must be part of God’s plan, and Todd Akin in Missouri, who spoke of “legitimate rape”, threw away Senate seats that were the GOP’s for the taking. Another illusion was that huge sums poured through Super-PACs would tip the balance in competitive races. Linda McMahon, the professional wrestling tycoon, spent $100m in two elections attempting to become senator for Connecticut and still headlocked herself into disaster.




Built into these assumptions was the conviction that non-white, non-male voters, especially Latinos, could not be mobilised, especially not with the same intensity or numbers they had shown in 2008. The long lines of people waiting hours to vote in Florida and many other places ended that narrow-minded complacency.



Of course the Republican party does not altogether turn its back on this new America. But the harshness of its policy on immigration is a slow-drip suicide for the Republicans, reducing them to becoming the party of the confederacy and the mountain states of guns and God.




The mere fact of Mr Obama’s re-election ought, if the Republicans have an eye for their long-term preservation, give them pause before venturing on the usual manic conspiracy theories or denouncing their nominee for being insufficiently conservative. But you might also hope they listened to his victory speech, which was, for a candidate who has at times been startlingly disengaged from the persuading element of the presidency, one of the great moments in his political career.




For after generously thanking two generations of Romneys for public service, Mr Obama went on to defend democracy itself on one of its climactic days: not in the airy philosophical terms to which he often resorts, but by painting a picture of ordinary people ennobled by the democratic process. In vivid words he painted a picture of countless people knocking on doors, queueing to vote notwithstanding all the obstacles placed in their way by institutions or Mother Nature; living their American identity through these acts of engagement.





Politics, the president said, can sometimes seem small or “silly” (amen to that) before insisting that in the majesty of the multitudes it was as big as anything can get. Then he sounded a theme that has been too often muted in his first term: that the US is a republic in which mutual obligations matter as much as the assertion of rights. And where did America’s true exceptionalism lie? In its unique diversity, which his own person embodies and which might at last be seen as the sign not of its enervation but of its rejuvenated redemption.




The writer is an FT contributing editor



 
Copyright The Financial Times Limited 2012.