Open to the public, too

The USGA begins its championship season next week with local qualifying for the 108th U.S. Open. Though this stage is only the first, it is still one of golf's best kept secrets. Here is a link to a list of the sites that will host an eighteen hole qualifier during the weeks between May 5 and May 19. 

 

Competitive golf has few shoot-outs, and this format has both subtle and noticeable differences from multi-round events. There is more of a match-play feel. If you are not beating your playing partners, chances are you will not get through. Such is the case for all tournament golf, but the shoot-out makes that fact more overt, more palpable. It is worth checking out if time permits.

 

With luck, the host clubs will allow spectators who are not members to follow some of the players. Certain sites may have Nationwide, PGA or European Tour players who are not exempt into the sectional stage. Even if a site does not have any notable names attempting to qualify there, anyone who appreciates golf ought to inquire about going to watch anyway.

Stab at Journalism

The Economist magazine in conjunction with the Marjorie Deane foundation offers an annual internship to aspiring journalists interested in writing on topics of finance and economics. I figured I took a shot despite my paucity of journalistic experience. The blog and an unremarkable stint on my high school newspaper are the extent of my experience. So, this is what I managed to cobble together. The specific news item is old, but the broader subject of an interventionist Federal Reserve is still quite topical. Though it is likely that someone sprightlier, with better style, sources and credentials to boot, will wind up spending summer in London, I am proud of what I wrote. Hence, I am taking another chance and submit for the approval of my very narrow and sporadic readership. Enjoy.

 

Feed your Fed 

 

Washington D.C. On March 31, citing needs to revitalize competitiveness and to fix the ills of the American economy, Treasury Secretary Henry Paulson unveiled “The Optimal Financial Regulatory Model.” In a speech, he outlined plans to provide the Fed, “…with a different, yet critically important regulatory role with broad powers focusing on the overall financial system.” 

 

The administration is keen on granting the Fed more authority to examine the practices and the accounts of hedge funds and investment banks. Mr. Paulson said, “The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability.” Strangely, he has chosen an inauspicious time in the history of the institution to raise its profile, for the Fed did much to precipitate instability.

 

Loose monetary policy made credit too available, and that is to blame for much of what is wrong. Cheap money has been causing inflation, simultaneously depressing the value of the dollar. The resulting rolling asset bubbles have caused unnecessary employment displacement. 

 

At issue is whether the Fed as super-regulator is indeed the “optimal” choice. By pumping up the value of the Fed, this proposal comes off as a no-confidence vote in existing regulatory bodies. Critics of the administration claim adequately funding agencies such as the Justice Department Antitrust division, Securities and Exchange Commission, and Federal Trade Commission makes more pragmatic sense, but the language in Mr. Paulson’s speech points to a clear favorite.

“The premise of our optimal structure is that clarity of mission and objective will lead to strengthened regulation and improved capital markets efficiency,” added Mr. Paulson. Yet, closer scrutiny reveals the more likely chance that “clarity” will result in muddle and inefficiency for three reasons. 

 

First, bigger does not preclude better, especially if the objective is to streamline. Increased influence over financial market activity conflicts with the first order statutory missions of the Fed to maintain price stability, full employment, and an elastic currency. These areas command priority; adding to the load will only make the Fed unwieldy. 

 

Secondly, ‘Fed policing’ is useless without enforcement. Instead of agents, it would have the authority to go where it deems necessary. However, the blanket warrant will have to pass legal muster, and this is unlikely. In practice, even with greater supervisory powers but without an enforcement mechanism, the Fed would still have to coordinate efforts with other agencies. This means fundamental changes to the intellectual and professional cultures of the Fed where economists will start behaving as bureaucrats. Consequently, the Fed stands to jeopardize its status as a credible, politically independent institution. 

 

Lastly, new powers for the Fed do not deter moral hazard on the part of investors, borrowers and creditors. Supervising hedge funds and investment banks may even exacerbate risky behavior if the Fed extends to them some of the privileges and rights as retail banks. Such new powers in no way provide a deterrent to the behavior of aggressive firms. Moreover, that sort of behavior was a response to the loose credit conditions the Fed created in the first place. Nothing in the new model addresses the root cause of the systemic fracture. 

 

Though Mr. Paulson concluded his speech by saying, “As a nation we have placed great faith in the powers of market discipline,” there were no allusions to a potential, painful, endogenous market correction. Further deferring the consequences of a fifteen year borrowing binge will cause deeper damage that even a beefed-up Fed could not forestall. Little wonder that the most attractive models are the thinnest.

Of water and leverage

Though there is no way to eliminate completely downturns in markets, the ongoing credit crunch has proven a major truth that ought to have already been known and ought not have been taken for granted: neither borrowers nor lenders can operate without a leverage ratio.

Both consumers and firms use credit to facilitate investment. Basic macroeconomics shows investment provides greater returns than savings. However, there are two competing orthodoxies: savings as collateral provides a good entrepot to a loan, and sometimes borrowing costs alone justify borrowing. In the latter case, if the Federal Reserve lowered interest rates, even if a balance sheet is already heavily geared, there would be a greater economic opportunity cost to inaction. Yet, a steadfast adherence to this aspect of basic economics while ignoring the need for market correction has partly precipitated the current malaise.

For households, debt to income ratios are and have been alarmingly high since the internet bubble days of the late 1990s. To stave off the effects of recession after the market crash in 2001, lowering interest rates kept firms and households afloat, but they had unintended knock-on effects such as flipping the yield curve, perpetuating the cheap money period, which fueled the housing bubble. What are we left with?

A cheap currency, for starters, may be good for boosting exports, but newfound competitiveness of American commodities abroad will never become big enough to dent the trade deficit. Secondly, laxer lending conditions allowed displacement of risk, but a market can absorb only so much wealth or debt. Moreover, even the modelers of fancy financial instruments are not entirely certain about who will be left holding the bag and when. Picture a lake filled with various sized boats. Imagine a fleet of submarines got into the lake and began offensive maneuvers. Pretend all the boats try to tack against the onslaught. Some displacements would naturally be greater than others, and would suck the smaller vessels down into the wake of the largest. If there are enough torpedoes, no ship is too big to sink. That is the extent of the credit crunch.

Perhaps the most alarming thing about the subprime fiasco is that a significant majority of mortgagees pay the banks on time. To put this in perspective, subprime loans, at their height, still amounted to only 2.6% of the aggregate mortgage market. This shows how scary the level of contagion is. What would motivate creditors to loan the money in the first place and then repackage blocks of these loans to hedge the risk of default?

The answer to both questions lies in American bankruptcy laws which favor the borrower over the creditor. However, by trying to displace risk, creditors in essence became borrowers themselves, and this has left some of them scrambling for a spot at the Fed's discount window. For investment and commercial banks, adopting a generally accepted leverage ratio provides institutions with much needed credibility in the wake of misdeeds and bungles of the past fifteen years. Moreover, the ratio provides an objective standard for pricing and assumption of risk.

Innovation of financial instruments is a good thing, on balance. Availability of credit is a good thing, in toto. However, without having if not de jure, at least de facto leverage ratios to provide a necessary constraint, then knee-jerk regulation and government bail-outs are the alternative. Economically, this means death. Without a credible penalty within the market for reckless practices, then moral hazard prevails. To restore economic order, some will lose, few will disproportionately gain. However, the lesson all should learn is that avoiding recession is a quest for the Holy Grail. Rather, the objective all ought to strive for is to become recession proof. That is, to paraphrase Warren Buffett, either not to swim naked in the first place, or at least have the bathing suit we doffed close in hand, because the tide always goes out.