Reflection off a car window in a very small town.
______

Europe Stumbles Toward Serious Crisis and America Worries

A major reason the stock market is tanking is the problems of the economies of the southern countries in Europe and how they threaten the European Union. It terrifies us. The countries are Portugal, Italy, Greece and Spain ( not too affectionately known as PIGS) and their economies are riddled with debt, deficits and a serious lack of competitiveness. The core question is whether other European Nations are going to come to their aid or whether a scenario like that in Iceland might emerge and actually threaten the whole economy of the European Union. That latter prospect scares us the most.

The scare is real because there is a good chance that Germany and France, who already have little political sympathy for the PIGS, just might stand aside and let them sink. Better heads realize that would serious threaten the Europe Union itself and put a damper on world economic recovery. Widespread sovereign defaults among the southern nations would make Iceland look like a tempest in a tea cup.

Though not in the European Union, England's and Ireland's economies are also in terrible shape and they are close by and economically well integrated. We, in America, are very concerned. The financial systems of the European Union countries are too tightly integrated to sensibly allow a collapse. Indeed, those countries' economies and ours are similarly integrated. The threat is real.

Greece is in the biggest trouble probably followed by Portugal, Spain and then Italy. The problem with stepping in to help these countries is that they have been perceived by other EU countries as lacking fiscal discipline, running big current account deficits and having high unemployment and anti-competitive policies. More recently, the UK and Ireland have been thought of as additional PIGS so the acronym has become PIIGGS. These problems are serious.

The analogy here is to the situation we had in our financial markets. Are the Europeans dealing with "moral hazard" because the PIGS in truth are simply "too big to fail" without being bailed out? The possible mess for the European Union might be a bit like the situation we would have faced in our fiancial markets had we allowed not ony Lehman Brothers to fail, but also Goldman Sachs, Morgan Stanley, Wells Fargo, Morgan Chase, Merrill Lynch, Bear Sterns, Citicorp, and Bank of America or a good number of them to fail. Imagine the mess and the consequences.

However, at present no consortium of countries is stepping forward and neither is the European Union itself prepared to seriously prop up or bail out the economies of these PIGS countries. The continuing resentment is tremendous and the situation is precarious. Too, there has been much political infighting in the EU over major EU political reforms and economic policy, but to little useful avail in regard to these problems.

What has happened instead is the EU has put on a considerable PR show, attempting to persuade the rest of the world that it is containing its problems and there is no real threat of the EU breaking up. Too, there has been a lot of talk about the "European Project" and the recently ratified Lisbon Treaty on trade, government and economic union, but critics argue that the EU has ignored its underlying economic problems and spent too much time on internal bickering. The worry is, without action, the other southern countries could go the way Greece is headed or worse.

The perceived lack of unity even over how to solve Greece's problems and to prevent them from spreading has spooked investors who are worried about sovereign defaults. The Euro has hit its lowest level against the dollar since May 2009. Juergen Michels, an economist at Citigroup in London, states the concern most succinctly, 'It is quite clear the EU doesn't have a plan for dealing with the crisis.'

Problems are heightened because the credibility of European economic policy makers is on the line. This is a test case of the ability of the new European Commission, the EU's new executive branch of government, and the Euro Group (all finance ministers) to impose the measures necessary to avert the crisis. Too many in these two groups, however, are thinking about austere fiscal discipline and new regulations, more appropriate for booming economies, and about other more cosmetic measures, instead of the possible need for serious bailouts of the southern countries analogous to what we did on Wall Street.

On the serious economic problems, the EU largely has its head in the sand and is in denial. For that reason, others, both here and abroad, are worried.
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My cat, waiting for me to return.
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The Labor Market Is Improving, No Matter How BLS Muddies the Water

First, the 4Q GDP growth rate comes in at 5.7%, and was seriously downplayed.Now, we have unemployment, according to BLS figures, coming in at a quite unexpected 9.7%, which nobody predicted. The stock market continues its nosedive.

Most economists, including yours truly, expected unemployment to come in at 10%, if not slightly worse. Face it. This number is a pleasant surprise, when viewed with other data from the labor market. Coupled with the preliminary 4Q GDP growth number, we have significant indications that the economy is in fact improving, no matter how much that defeats the expectations of many.

However, there is a serious cloud over this new unemployment number. The Bureau of Labor Statistics (BLS) changed horses on us in mid-stream and in several regards. The changes generate uncertainty and fuels the tiresome debate about whether we have a real recovery or not.

The lesser part of what happened is the BLS revised the earlier jobs number for December, with the result being to show the economy lost 150,000 jobs in December instead of the 85,000 initially reported. The current figure for January is different. It is 20,000 jobs lost... far less. These jobs number come from the BLS' business establishments survey of about 400,000 businesses.

The unemployment number comes from a different source: the BLS household survey, a monthly survey of about 60,000 households. However, there were changes there, too.

Here is what the BLS says about changes in the two surveys: "In addition, establishment survey data have been revised as a result of the annual benchmarking process and the updating of seasonal adjustment factors. Also, household survey data for January 2010 reflect updated population estimates."

Over longer time frames, the two different survey numbers are more consistent. For this January, however, they diverged.

The establishment survey showed a loss of 20,000 payroll jobs in January which is a marked improvement over December, but the household survey showed an increase in the employment level of 541,000, for the new 9.7% unemployment rate.

The troublesome factor is the household survey reflects this updated population estimate, which in all likelihood reduces the confidence level of the sample size used in the household survey. It may also impact the denominator, numerator or both of the unemployment figure. It is hard for me to say. The short of it is there is a cloud over the number. However, if we look at the jobs data, there is improvement in that the rate of drop in the number of jobs has fallen substantially.

Under both the new and the old system, I suspect that what we have nonetheless is a small drop in the unemployment rate for January. But it is criminal for the BLS to muddy the waters the way it has, without a good comparative explanation. It fosters distrust.

The economist who came the closest to predicting the new unemployment figure was Carl Riccadonna at Deutsche Bank, with a figure of 9.8%. As Mr. Riccadonna sees it, "Companies just can't meet demand requirements with their existing labor force, so they have to increase the number of workers. This report does seem to indicate the economy is moving in the right direction." I tend to agree.

Indeed, this is in fact more evidence of a V-shaped recovery than not, as unlikely as that seems to be. At some point, our prejudices and misconceptions have to give way to the data, mine included. I remain skeptical, but that is my natural mental posture anyway. I'm a bit of a disbeliever, like the old saw has it for those from Missouri.
And some economic improvement seems not just limited to us. Capital spending in Europe is also on the upswing. As one commentator put it, the European data show a capital spending up trend that is hard to deny. Too, most countries report that their economic momentum is picking up, so the improvement is not limited just to the U.S.

Other data indicate as well that conditions in the labor market are improving. Contrary to expectations, the U.S., factory payrolls figure increased 11,000 in January, a bigger jump than seen for many years. The median forecast called for a drop of 20,000. That is a 30,000 person difference, which is significant. It should be noted however, that government payrolls dropped by 8,000 (a development that might make many cheer were they able to believe it was permanent). The payroll pick up was largely in manufacturing where capital spending is also improving.

Comparably important as the drop in the unemployment rate, factories report a modest increase in the length of the workweek. Too, temporary workers grew by 52,000 which is quite significant. Also, the overall American workweek lengthened. These are significant collateral developments that portend future improvement in the unemployment rate, being precursors of the rate.

The truth is, I believe, notwithstanding the BLS mess, things are picking up a bit not only in the labor market, but also in the U.S. economy.
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Home Sweet Home. My Fair Weather Mariner 39 (aka Westsail 39 or 11.9m), is a fast, narrow, heavily ballasted (43% of displ), high-aspect (6:1), stiff, comfortable, ocean performance cruiser designed by Bob Perry that goes to wind well (30 deg w/ good headway), balances up easily and is also good up and down the Beaufort scale. It can be rigged as a cutter or a sloop. I use it as a sloop because it is easier to handle and points higher. The more you sail on oceans, the more you want a boat that can balance up and sail well in almost all circumstances. Many don't. Here the boat is about half prepared for a hurricane (cyclone, in the southern hemisphere). I don't get it fully prepared now because I would have to take things down and store them below and that would clutter up the interior living space.
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Obama's Administration Is Between Economic Rocks and Hard Places

Obama's administration is struggling to maintain economic grow, get a handle on the deficit and get and implement (1) his Financial Crisis Responsibility Fee (read, tax), (2) reforms of the banking system and (3) new financial regulations for Wall Street, most of which will have to pass Congress. This is a very tall order considering the disarray the Democrats are in after their big loss in Massachusetts and Obama's reduced political capital. Not only do the reforms and regulations hang in the balance, but so does the Senate Health Care Bill or any health care bill, for that matter. The deficit hawks are circling and if some had their way, Social Security would be looted to reduce the deficit. There are some serious nuts running loose, with big dollars and some support. Worse, elections are in the offing.

Although Obama has acted decisively and forcefully on the tax, reform and regulatory proposals, the truth sadly is support is waning on many of these issues. The mid-term and presidential elections in November 2010 and 2012 are constraining the political will of Congress to do what it should. It is sort of a time out to take voters' pulses and see if positions can be enlarged or entrenched. Sad, but true. The political tail is again wagging the dog. It is bad enough we have to deal with a Congress that is too "bought off" to be effective, but to suffer them running for office so soon just leaves them away from their desks too long. (Then again, maybe that is a good thing.)

Obama wants the Financial Crisis Responsibility Fee imposed. By its accusatory name you might guess it is going to be opposed by those accused who would bear its burden, namely, the largest financial institutions with the most non-depository liabilities to be taxed.The tax is expected to run for at least ten years and is intended to recoup some of the losses from the TARP program incurred to bail out those same institutions. But that is just to recoup expected TARP losses.

The problem remains of how do we prospectively deal with the losses expected from relatively uncontrolled systemic risk generated by these behemoths in the future. Several taxes are on the table to get revenues for a resolution fund as a sort of way to have these big financial institutions have monies available to clean up their own messes instead of leaning on the taxpayers, present and future. One thought is a Bonus Tax which has a real nice political ring to it. Problem is, as more bonuses are getting paid in stock which must be held on to for a while, rather than cash, how does the government collect it: run a delayed collection system? It is hard and not very practical.

Another way to go that is gaining popularity is a Tobin tax or a tax on all or most all financial transactions. This would be levied to create a resolution or clean-up-the-mess fund to cover bailout costs for those too big to fail in future crises. But can you see all those funds just sitting there surrounded by outstretched hands that cannot wait to meddle with them? Too, why should all fiancial transactions be covered. I did not do anything to have Wall Street develop systemic risks. The whole point here is to force Wall Street to set aside funds to cover its own debacles instead of taxpayers. Internalize the problem, if you will. Needless to say, Wall Street thinks these are all seriously bad ideas. Their candid response, which you will never hear, is why shouldn't the taxpayers bail us out if we can get away with it. We think that is a good idea. Candor, however, is not Wall Street's strong suit.

The trick is how to get Wall Street to pick up its own tab in the future. That issue is being given a lot of thought these days. Wall Street on the other hand is lining up its ducks to fight anything that stands a chance of working.
Then we have the Volcker structural reforms for financial institutions and also his and others regulatory reforms. Those have been written about by me and others so I do not go into them again here, except to say, again, Wall Street does not much like them and so therefore don't the Senate and House Banking Committees (or House equivalent). Actually, Wall Street should be glad no one is presently proposing to adopt more radical reform like breaking up too-big-to-fail financial institutions and reenacting Glass-Steagall. That, they really wouldn't like.

In all truth, on the deficit, Obama and the Administration cannot really get a handle on it now, try as they might. If some of the crazy proposals floating around out there to do so were adopted, we would spin right back down into recession. Fortunately, Obama and his Advisors know that. So the trick is to look like you are trying hard to do something when in fact you are doing next to nothing at all. Sort of like the $33 billion hiring and pay raise incentive program. A bit of cosmetic dustup, if you will. The problem is there is not much heart to do anything serious right now. Everyone has their eye on the electorate and upcoming elections and is too afraid to take much of a position.

Obama is actually a stand out in not pandering to this view. But what is one man to an ocean?
_______

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The elderly struggle to make a living.
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How to Get Volcker's Banking Reforms and Regulations Through Congress

Many are not happy with the extent and speed of our recovery. That is understandable. However, I think it is a mistake and a waste of energy to grouse about the better data as they come in. Too many do. Our energies should be directed elsewhere, where they might make a difference. Read this article if you will then, as a rallying cry against those who would block Paul Volcker's good enough reform proposals in the Senate and House Banking Committees. These Committees' members are already posturing to stymie the reforms and regulations proposed, being the good bought off lackeys they are. Let me develop these themes.

Yes, there is much reasonable concern regarding the economy, but there is also the further point that, what do those complaining realistically expect from an economy (1) that was so far down the toilet a heart beat ago, and (2) that remains materially screwed up in too many regards. Railing against what little good news we get is no help at all. It is a waste of energy. It really is not going to change a thing. Deleveraging is slow, tough and it makes it hard to increase aggregate demand. Wall Street is no help in this scheme of things either. People continue to suffer in the meantime. The problem is recovery is the only place we can go to get some relief here, so we should not knock what good news we get. That is my view.

Wall Street, which has rewarded itself well for all of its misdeeds, was a major part of our problem during the recession from which we are emerging. Most agree that the housing bubble and Wall Street's manipulation of it caused the recession. Then, to top it off, the big banks and investment houses on Wall Street received buckets of money from the U.S. government to bail them out -- almost as a reward for getting so much wrong and their own mistakes. Most do not think that is appropriate, except for Wall Street itself and those sitting on the Senate and House Banking Committees, virtually all of whom have been "bought off" by Wall Street. My concern is this: if we cannot get a handle on Wall Street now, I think our problems will be multiplied many fold down the road in the next collapse and our banking system will remain compromised and dysfunctional. Reforms for the banking sector and regulations for Wall Street are imparative. If we had had them this time around, the recession would have been much, much milder. But what we should not do now is grouse about how slow and painful our recovery is. Action, not a doom and gloom attitude, is what we really need. We need to get something done for us, for a change.

There is an area where we can all do something that might significantly matter. But before I get to that, first let me provide some background.

Paul Volcker did an Op-Ed piece in the New York Times a bit back (http://www.nytimes.com/2010/01/31/opinion/31volcker.html), outlining the Administration's proposals for (a) reform of banking in the U.S. and (b) the regulation of Wall Street. The article is quite good and readable and I recommend you read and try to understand it. I have spelled out and outlined Volcker's article on this site in another article near this one. Those proposals, while not perfect, were actually very good. Several of us here wrote articles on the proposals and thought so. The general consensus of those who understand the situation is basic agreement. Well, we were not the only people to learn about those proposals. The House and Senate Banking Committees got wind of them too. Being bought off by the banking industry, they not surprisingly don't like them. They are too "populist." Here is the real reason they don't like the proposals, in a nutshell.

The finance industry - including banks, investment firms, insurance companies and real estate companies - has given $42 million in campaign contributions to lawmakers and their leadership political action committees since the current election cycle began in November 2008. The industry has concentrated its contributions on members of the House and Senate Banking committees and the congressional leadership. Just the 94 members of the Senate Banking Committee and the House Committee on Financial Services, both of which are considering the new reform and regulatory proposals for the finance industry, have received nearly $15 million of those campaign contributions. These fellows are seriously bought off. "Owned," if you will.

The names of the committees' members and what each got in detail can be quickly seen at http://www.citizen.org/congress/regulations/articles.cfm?ID=19085 but those getting over $100,000 are the following:

Financial Industry Donations to Members of Senate Banking and House Financial Services Committees

Sen. Charles E. Schumer (D-N.Y.) $2,274,799
Sen. Chris Dodd (D-Conn.) $781,598
Sen. Michael F. Bennet (D-Colo.) $616,704
Sen. Richard C. Shelby (R-Ala.) $548,050
Rep. Spencer Bachus (R-Ala.) $458,700
Rep. Jim Himes (D-Conn.) $439,573
Sen. Robert F. Bennett (R-Utah) $407,025
Sen. Evan Bayh (D-Ind.) $404,220
Rep. Carolyn B. Maloney (D-N.Y.) $403,250
Rep. Barney Frank (D-Mass.) $394,549
Rep. Melissa Bean (D-Ill.) $393,875
Rep. Paul E. Kanjorski (D-Pa.) $385,197
Sen. David Vitter (R-La.) $326,041
Rep. Jeb Hensarling (R-Texas) $325,079
Sen. James W. DeMint (R-S.C.) $320,130
Sen. Mike Crapo (R-Idaho) $303,971
Rep. Ed Royce (R-Calif.) $294,685
Rep. Ron Klein (D-Fla.) $282,131
Rep. Kevin McCarthy (R-Calif.) $280,025
Sen. Bob Corker (R-Tenn.) $251,043
Rep. Paul W. Hodes (D-N.H.) $243,700
Rep. Dan Maffei (D-N.Y.) $226,482
Rep. Erik Paulsen (R-Minn.) $225,613
Rep. John H. Adler (D-N.J.) $222,848
Rep. Bill Foster (D-Ill.) $203,103
Rep. Gregory W. Meeks (D-N.Y.) $193,305
Rep. Judy Biggert (R-Ill.) $187,407
Sen. Robert Menendez (D-N.J.) $184,600
Rep. Dennis Moore (D-Kan.) $184,422
Rep. Randy Neugebauer (R-Texas) $178,060
Rep. Patrick McHenry (R-N.C.) $176,046
Rep. Walter Clifford Minnick (D-Idaho) $171,203
Rep. Gary Peters (D-Mich.) $167,833
Rep. Scott Garrett (R-N.J.) $167,360
Rep. Edwin G. Perlmutter (D-Colo.) $160,613
Rep. John Campbell (R-Calif.) $157,101
Rep. Suzanne Kosmas (D-Fla.) $152,986
Rep. Lynn Jenkins (R-Kan.) $152,440
Rep. Michael N. Castle (R-Del.) $147,000
Rep. Travis W. Childers (D-Miss.) $142,340
Rep. Michele Bachmann (R-Minn.) $142,300
Rep. Thad McCotter (R-Mich.) $141,763
Rep. Tom Price (R-Ga.) $135,350
Rep. Leonard Lance (R-N.J.) $133,573
Rep. Michael E. Capuano (D-Mass.) $130,700
Rep. Christopher J. Lee (R-N.Y.) $126,048
Sen. Jim Bunning (R-Ky.) $117,920
Rep. Brad Sherman (D-Calif.) $117,850
Sen. Jeff Merkley (D-Ore.) $115,900
Sen. Sherrod Brown (D-Ohio) $113,450
Sen. Jon Tester (D-Mont.) $111,150

Source: Center for Responsive Politics (available at www.OpenSecrets.org). The complete and a more broken down list is available there and on the website below.

Remember, this list doesn't include monies the financial industry has contributed to the House and Senate leaders not on these committees. That is a wholly different set of buckets of cash.

Now if readers want to be dismayed and complain about something, consider the reaction of House and Senate Banking Committees members to Volcker's good reform and regulatory proposals and start writing some nasty letters to those these "sell outs," telling them to get "unbought" and vote in the "public interest" for the Volcker reform proposals or they will be out in the cold next elections. We need to rally here or big banking is going to shove it to us . . again.

For what you can do, see http://www.citizen.org/congress/regulations/articles.cfm?ID=19085. Click on the top heading "take action" and there is a laundry list there of how specifically you can help and what the many alternatives for action are for you to do something. Guidance is available there as well.

Hearing from Ma and Pa Fricket in Des Moines, Iowa might be one thing, but hearing from articulate and knowledgeable people could be something else entirely. We need to help ourselves here. Big banking sure won't and Uncle Sam is too handicapped.
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Lest nary a toe catch the sun and be browned
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The Economy is Recovering, So Why All the Moaning and Groaning?

To listen to people, Brad Delong for one, you would think we have no recovery and are sliding deeper into recession. The level of moaning and whining is though the roof. You would think, from the sound of it that the 4Q 2009 GDP figure came in at -5.7%, instead of +5.7%, much better than almost everyone's upwardly revised estimate. Too, we are acting like corporate earnings are tanking across the board. Recall that as recently as last December, 2009, many were still estimating 4Q GDP growth at 1.8% to 2.2%. 5.7% is really good, especially given the corpse we were very recently.

I believe the central reason for all the moaning and groaning over the economy and the Q4 GDP figure is something the famous economist, A.C. Pigou once said. It was basically to the effect that --

Optimism is born and grows as a normal child, but after the big crash, Pessimism is born fully grown.

I think that describes us collectively pretty well. I call it the "Pigou syndrome." Many suffer from it. We are stuck in a pessimist mode of thinking and see not much good with anything, although improvement is right under our noses.

So here's the conventional analysis: Yeah, it was 5.7%, but it is just mostly inventory rebuilding, with a few other minor, but unworthy things thrown in, nothing to take encouragement from. How quickly we forget the nasty and large negative growth figures we recently experienced. Our economy is like a huge and vast ship. It is foolishness to expect it turn on a dime, but that in fact is pretty close to what it is doing and certainly that is what too many want and expect. This is not sensible.

So efforts to rebuild depleted inventories contributed 3.4 percentage points to GDP, the most in two decades. Many view this as a gloomy proposition. However, what is reasonable to expect here? Inventories were drawn down. If businesses expected the recession to continue, they would not have rebuilt inventories. This figure would have come in much lower or even negative.

Another way to look at what we have here is this: businesses, realizing that market demand is developing strongly and quickly along the lines of a V shaped recovery, don't want to get caught with their pants down and so they quickly are rebuilding their inventories. If they had thought the outlook was stinky, they would not be rebuilding so quickly. Those businesses see better things ahead. Many, many eyes looking forward at all parts of the economy are involved here, not just the twenty or so sets of eyes belonging to various gloomy economic gurus.

Too, residential construction was up about 5.7% in Q4; so was consumer confidence. Consumer spending, which comprises about 68% of the economy, rose at a 2% pace, more than anticipated. Sure, durable goods decreased 0.9 percent, but they were just taking a breather from jumping 20.4% the quarter before. Nondurable goods increased 4.3% which is not shabby. Services increased 1.7%. Real nonresidential fixed investment increased 2.9% in the fourth quarter, in contrast to a decrease of 5.9% in the third. Equipment and software increased 13.3% in 4Q and real exports of goods and services increased 18.1% last quarter.

So what if unemployment did not drop. We know it is a lagging economic indicator, so what should we reasonably expect at this stage of the recovery? A dip of three percentage points? This is nonsense. First, hours worked needs to increase and then employment needs to increase and only then can we reasonably expect the unemployment figure to start to drop. I think we are being unrealistic and silly about this.

There is so much improvement, but still we act like the sky is falling and all is doom and gloom. We have what I call the "Pigou syndrome," described above. We need to get over it, adjust to the improvement in the data and have a bit of patience.
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With a very rosey dash.
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5.7% GPD Growth Figure for 4Q 09 Proves Many Wrong

The U.S. economy grew at 5.7% annual rate in the fourth quarter. This is the highest rate of GDP growth since 2003. This figure is up from 2.2 percent in 3Q 2009. The rise is well ahead of most expectations, especially those of pessimists. The contention is that the gain was substantially driven by rebuilding business inventories, but that is by no means all of it. There is also some good solid growth in there along with some residual effect of Obama's stimulus program. However, most earlier estimates of the GDP growth ranged from 2.8% to 4.5% taking those predictable factors into account.

The stock market shrugged off the good news and the DOW continued its correction toward the 10,000 range. The market seems to be getting it backwards these days, but we will have to wait and see. Many doubters are out there, but as sellers, it is interesting to see them prevail now. Keep in mind this is the preliminary figure. A second estimate or revision will follow and then we will get a third and final figure. Pessimists can still have hope for the possibility of future downward revisions.

Face it. This figure is not at all bad. Several points can be raised to detract from it, but even so, it stands out as a very good development, considering all the problems faced by our economy. It could have been much worse in light of those problems. That so many were wrong here is a further interesting point. Too many held to their earlier forecasts in the range of 1.8% to 2.2% and it is clear now they missed the mark in a major way. The figure also exceeded the 4.8% median forecast of the economists surveyed by Bloomberg News. The figure goes far to explain why Bernanke's confirmation should prevail.

A separate report has also showed that consumer sentiment as well as a barometer of business activity rose more than forecast in January. Some at least are getting it. As Bruce Kasman, at J.P. Morgan Chase and one of the very few who correctly forecast the gain in GDP, put it, "We are getting on to something that is pretty sustainable." Kasman sees continued growth in this same vein because both consumers and businesses are both starting to spend. Keep in mind here these figures are actual data which look backwards toward where we have been.

Further preliminary assessments show consumer spending, which comprises about 76% percent of the overall economy, rose at about a 2.1% rate after economists had projected a 1.8% gain, according to one survey. Efforts to rebuild depleted inventories are said to have contributed 3.4 percentage points to GDP figure, with some of the rest being the residual from the stimulus program. The inventory rebuild is the most in two decades. No one wants to be caught empty handed so the implicit forecast of businesses collectively here is highly favorable toward growth.

Other good news is the dollar rose and the trade gap narrowed for the quarter. Prices rose about 0.6%, significantly less than most economists had predicted here. This is not a banner day for most economists.

As to others, if there is a moral in this, it is that ideological biases can and did this time seriously cloud the judgment of those who have them. They sat to far to the down side. The old saw of "just you wait . . . " is failing big time here. Those people need to get with the current data, try to understand it and leave their biases at home.
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It stood out, to my eye.
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A Comprehensive Guide to Financial Reform

Volcker wrote an Op-Ed piece for the N.Y. Times the other day and discussed some of the financial reforms he thinks are necessary for our economy. Others are already in the works.

He first argues no one can seriously contend that substantial reform is not necessary, a point on which I disagree. The big banks certainly like things the way they are, but that aside and aside from the reforms the Administration is already looking at, Volker has a number in mind himself.

But first, the reforms the Administration is already considering are these:

1. Appropriate capital and liquidity requirements for banks. Friedman and some Austrians have also sensibly suggested a reserve requirement of 1:1. That should be seriously considered here, too.

2. Better official supervision of banks by governmental officials. This seems more like a cosmetic no-brainer. The question is how and in what regards.

3. Improved risk management by financial institutions. It is all well and good to say this, but when very high profit alternatives come along, sound risk management tends to go out the window in good times. How to prevent this is a big question.

4. Better board oversight for financial institutions. Why should board members change their behavior? They don't get sued enough, thrown in jail or even have their hands slapped. Why should they do differently?

5. A review of accounting approaches toward financial institutions. A key question here is how to wean banks off abandonment of the mark to market rule and get them back to the point where they cannot write their own balance sheets.

A common thread I discern here is how to control the aggressive mind set of risk taking investment bankers who already invaded the banking industry, with the demise of Glass- Steagall. Dealing with it will be tough. When the shadow banking system collapsed, the surviving houses converted to banks and along the way taught banks how to misbehave as well. The question is what to do about it.

Volcker targets in on these issues as being important in righting the system, but probably the central concern, as he sees it, is the issue of moral hazard from the extensive and successful efforts to rescue large banks too "big to fail." Is it not a mistake to protect and shield managements, board members and stockholders from their own transgressions at taxpayer expense? Why should the big banks be given this competitive advantage smaller ones don't get. But what should we do here?

Volcker basically says we need closer and better regulation and supervision to balance the moral hazard, improved capital requirements and impose stronger leveraging restrictions, but that we also need to limit or stop the proprietary activities of banks, like trading for their own accounts, owning or sponsoring hedge funds and owning other private equity funds, among other similar activities.

The risks which arise from these more speculative activities are better suited for other financial institutions, in Volcker's view, that government should not have to protect, but can let fail. However, that said, look what happened when the investment house of Lehman Brothers failed. Other houses and banks thought they might be next. They paniced, called in positions and triggered the financial crisis that, with falling aggregate demand from the housing crash, led to the Great Recession.

I suggest two things. So far, this looks a lot like a proposal to reinstate key aspects of Glass- Steagall, and, two, prohibiting these activities by banks - mostly just the largest four or five are involved - may not be enough to prevent a large new shadow banking system from developing and pulling down the whole financial sector again, just as it did this time. The appetite for risk and profit on Wall Street is not to be underestimated. Watch Goldman Sach convert back to a house.

The point is that all investment houses and other financial concerns will have to be tightly regulated and supervised, too, but without the safety net that the government will provide the banks. They need to understand that up front and going in. Investment bankers are hard to regulate. They play fast and loose. Regulations with big teeth will be needed. Money gets their attention.

As Volcker explains it, many capital market companies, both because of their typically more limited size and more stable sources of finance, could not present a credible claim to be "too big" or "too interconnected" to fail. In fact, sizable numbers of such institutions fail or voluntarily cease business in troubled times with no adverse consequences for the viability of markets. But then again, what if they become quite large and all fail at once, like Lehman Brothers, Merrill Lynch and Bear Sterns?

Volcker recognizes this problem too, but I am not sure his solution is satisfactory:

"There are a limited number of investment banks (or perhaps insurance companies or other firms) the failure of which would be so disturbing as to raise concern about a broader market disruption. In such cases, authority by a relevant supervisory agency to limit their capital and leverage would be important, as the president has proposed."

In other words we regulate and supervise them aggressively, too. But this does not get us out of the woods and certainly puts a lot of strain on the mechanism of regulation where a common view is regulators become the captives of those regulated.

Volcker's answer to this position is we have a new "resolution authority" that can basically do what FDIC proceedings could have done for banks, including intervention and supervision when necessary. That new authority could go further, if appropriate and:

" . . . assume control for the sole purpose of arranging an orderly liquidation or merger. Limited funds would be made available to maintain continuity of operations while preparing for the demise of the organization . . . Stockholders and management would not be protected. Creditors would be at risk, and would suffer to the extent that the ultimate liquidation value of the firm would fall short of its debts. To put it simply, in no sense would these capital market institutions be deemed "too big to fail."

In other words, we take Lehman Brothers, Bear Sterns, Merrill Lynch and others all through bankruptcy-like reorganizations all at once and don't expect major disruptions in the financial markets. I don't think so. We need more here.

The more here is Volcker wants a designated agency " preferably the Federal Reserve" to be "charged with reviewing and appraising market developments, identifying sources of weakness and recommending action to deal with the emerging problems." It brings to mind how Greenspan handled or did not, these matters. Is the Fed the appropriate agency? The idea obviously is to nip problems in the bud before they become serious, but can this be done effectively when times are booming? I have my doubts.

Other reforms Volcker has in mind include more effective arrangements for clearing and settlement, restrictions on how derivatives may be used, what to do with large interstate insurance companies and how to rebuild an efficient and effective mortgage loan market, given the shamble ours is in now. Volcker also wants international cooperation and coordination of many of these matters.

Finally, Volcker let us know he understands what the real problems of reform are:

"I've been there 'as regulator, as central banker, as commercial bank official and director' for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to lay off tough regulation will remain most notably in the fair weather that inevitably precedes the storm."

We shall have to wait and see. I remain concerned, even if we can get the needed reforms and they are not blocked by the investment bankers, their paid cronies and their lobbyists.
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