Portfolio.com: Chartistry

Which Tech Product Frustrates You the Most?

Wed, 11 Feb 2009 13:00:00 GMT

“Excel as a production system. People do a simple what-if prototype in Excel, but then don’t know when to quit.—Richard Bookstaber, author; financial risk manager

“Remote controls. The phone system at CNN is a close second.”—David Bohrman, Washington bureau chief, CNN.

“The iPhone.”—Evan Williams, CEO, Twitter.

“Digital picture frames.”—Marissa Mayer, vice president of search products and user experience, Google.

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What New Gadget or Web Service Will Break Out This Year?

Wed, 11 Feb 2009 13:00:00 GMT

“The Flip Mino HD video camera is likely to have a great year.”—Jason Kilar, ceo, Hulu.

“Sunglasses that automatically transition to 3-D glasses when you enter a movie theater to watch a movie in 3-D.”—Jeffrey Katzenberg, CEO, DreamWorks Animation SKG.

“Fitbit”—a device that automatically tracks your fitness and sleep.—Evan Williams, CEO, Twitter.

“There will be an explosion in low-cost laptop innovation.”—Ray Ozzie, chief software architect, Microsoft
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What Katy Did

Wed, 11 Feb 2009 13:00:00 GMT

Playing to her audience, a crowd of several thousand in Toronto, pop singer Katy Perry wiggles through the last teasing bars of her latest hit single, “Hot N Cold.” She slides between the open legs of a muscular male dancer and delivers her punch line. “I wish you were straight,” she says, looking the dancer up and down.

She gets an avalanche of applause.

When you’re a former Christian singer whose breakthrough hit is “I Kissed a Girl,” your fans want you to be bad. Or at least campy. Perry, 24, manages well on both fronts. She has girl-next-door looks but paints her Kewpie-doll mouth in bright-red lipstick and favors retro, Bettie Page-like getups. She purposefully belly flopped into an anniversary cake on an MTV awards show in Guadalajara, Mexico, and teased the gay community with her song “Ur So Gay.” (Opening line: “I hope you hang yourself with your H&M scarf.”) As a button-pushing act, Perry sells. To date, she has sold more than a million and a half copies of her debut, One of the Boys, and more than 3 million of the single “I Kissed a Girl.” She has also been nominated for a Grammy.

Yet as the recording industry is remaking itself for the digital age, Perry stands out not just for her faux naughty-girl antics but for her career trajectory. To offset declining budgets and CD sales, labels are beginning to turn to the Web as a cheaper way of discovering new talent. The British pop singer Lily Allen, for example, was discovered on MySpace. The rock band Journey recruited its current vocalist, Arnel Pineda, after seeing him perform on YouTube. At least a half-dozen startups are trying to “crowdsource” the A&R process, Wikipedia-style, by studying what internet users listen to. Even EMI chairman Guy Hands—who took over when the private equity group Terra Firma Capital Partners bought the company—has suggested that the music business use social-networking sites to find new acts.

Perry, instead, is an old-school performer who worked toward her big break for almost a decade. The daughter of born-again Christians who didn’t allow pop music in their home, Perry released her first album—a collection of gospel songs—on a small label in Nashville in 2001. The CD didn’t sell, but Perry wrangled an audition with Glen Ballard, producer of Alanis Morissette’s Jagged Little Pill. Ballard signed Perry to his label, through which she recorded several albums of material that were supposed to come out on Island Def Jam and Columbia. But neither label felt the music Perry had recorded had commercial potential. Def Jam executives, Ballard says, “point-blank told me they didn’t think she was a star.”

By late 2006, frustrated that Columbia wouldn’t release a CD, Perry negotiated an exit deal. To make ends meet, she took a job at a small California company that critiques work by aspiring songwriters. That’s where she was in January 2007 when Capitol Records chairman and CEO Jason Flom (son of legendary corporate lawyer Joseph Flom) called her with an offer. “It was a 917 number, so I picked it up,” she says, referring to one of New York City’s area codes. Though Flom had heard a recording of Perry’s in 2006, it took a while for him to pull the trigger. “We almost made a big mistake,” he told her.

Flom wanted to pair Perry with Dr. Luke, a proven hitmaker who’d written for stars like Carlos Santana and Kelly Clarkson. “It was a tough deal to make because Luke is a very astute guy who wanted very particular things, but I managed to broker something where everyone felt good working together,” Flom says. The matchmaking took. The first single Dr. Luke and Perry collaborated on was “I Kissed a Girl.”

Though Flom declines to give details of the deal, top producers typically receive an advance against future royalties. A pop album like One of the Boys might cost $500,000 to make, and Flom started promoting it early by releasing the track “Ur So Gay” on iTunes. When Madonna mentioned that she liked the song in a radio interview, Perry became a gossip-column item. Capitol, which is a division of EMI Records, stoked interest further by placing a handful of Perry’s songs on the MTV hit series The Hills and in the movie Baby Mama. By the time One of the Boys was released, in June 2008, fans were ready to buy her music. The CD debuted at No. 9 on Billboard’s Top 200 list and went gold in September. “Hot N Cold” finished the year in the No. 1 spot on Billboard’s Top 40 airplay chart.

Last year, Perry admitted to never having actually kissed a girl. But no matter. Her fans today greet her waving tubes of cherry ChapStick—a reference to a line in “I Kissed a Girl”—and there’s even a Katy Perry doll on the market.Related Links
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What Do You Wish Someone Would Invent?

Wed, 11 Feb 2009 13:00:00 GMT

“Cell-phone batteries that last for a monthbetween charges."—Jason Kilar, CEO, Hulu

“An electric energy-storage device to power our cars and homes from handheld devices that could be charged from renewable resources.”—Jon Wellinghoff, commissioner, Federal Energy Regulatory Commission

“Payment via cell phones.”—Marissa Mayer, vice president of search products and user experience, Google.

“Meters that know whether a car is parked at them and garages that network their capacity and rates. Drivers could then specify where they want to park and how far they’re willing to walk and reserve the cheapest space.”—Richard Bookstaber, author; financial risk manager.

“A Google-like image-search engine.”—John Yemma, editor, Christian Science Monitor.
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The Minus Touch

Wed, 11 Feb 2009 13:00:00 GMT

Poor Bernie Madoff.

Yes, of course, I jest. Bernard Madoff, the confessed author of probably the largest financial fraud in history, a man who victimized not just the rich but also the figurative widows and orphans who were cast on the rocks by the various charities he left penniless, is deserving of scant sympathy. But he will probably end up fortune’s fool anyway, reviled not only for his own massive crime but also as the symbol of a deregulated marketplace whose excesses had very little to do with Madoff’s misbehavior.

There is no question that Madoff, a former board member of the National Association of Securities Dealers, has done enough on his own to live in infamy. As an international marketmaker, he ran an apparently legitimate enterprise that acted as elaborate window dressing for a bogus investment-advisory business. Madoff the investment guru provided remarkably steady returns to a number of huge Wall Street funds, which, it turned out, he was paying from the increasing pile of capital invested with him by Wall Streeters and others eager to get in on a good thing. Crime is one of the least celebrated arenas of the human imagination, and the sheer art of Madoff’s enterprise, as intricate as an Escher drawing, deserves a perverse kind of admiration.

Madoff gulled his victims by generating ersatz account statements and trade confirmations, not to mention legitimate 1099s in which profits paid with other people’s money were duly reported as income to the Internal Revenue Service. The pyramid scheme worked as long as rising markets provided Madoff’s investors with more and more to entrust to him. But with the crash last fall, his customers needed their investments back. Faced with nearly $7 billion in redemption claims, Madoff is alleged to have confessed to his sons and the Federal Bureau of Investigation that for years he had paid investors with money that wasn’t there.

Crooks, generally speaking, provide an object lesson of limited value. That is because rules and regulations can never fully protect investors from someone intent on breaking them. The astonishing paper trail Madoff created to hide his crimes suggests that he may well be one of those guys who would have gone wrong no matter what. But Madoff will learn that, invariably, timing is everything. As Warren Buffett is rumored to have remarked, “You cannot tell who is swimming without trunks until the tide goes out.” The laissez-faire markets of the Bush era, the greed-is-good eagerness with which everyone went sprinting into Madoff’s trap, and the fact that Madoff’s crime was exposed by the downturn mean that his name is liable to emerge as a convenient symbol of the ridiculous excesses that resulted in a worldwide market meltdown in the last quarter of 2008.

The events of this period will probably be considered as epochal as the fall of the Berlin Wall. The notions that have guided American business for the past 30 years—that free markets are self-regulating, that unrestrained economic activity always leads to the greatest good, that markets are made up of rational actors, the whole Friedmanian megillah—has been exposed. Information is not freely available in our markets; diligent analysis requires too much time and expense for all but a very few and may not even be possible in a financial environment as vast and intricate as the one we have spawned. Wall Street, it turns out, had more lemmings than sharpies. Even the best and brightest bought into collateralized mortgage obligations, credit default swaps, and Madoff’s pyramid scheme. For the foreseeable future, the certificate of deposit may remain the investment vehicle of choice for individuals, and Treasury bills with zero returns the best option for institutions.

Where we go from the post-Madoff, post-meltdown world is the very complicated question for which no one yet has answers. The Obama administration faces massive challenges, but also an extraordinary opportunity, because the assumptions underpinning the American economy have not been as open to restructuring since Franklin D. Roosevelt entered the White House. But one thing is clear: The market should not dictate policy. There remain only a few right-wing nuts who believe that the goal of all governmental activity should be to leave the market alone. Whatever the changes are, they’re likely to be salutary. And, irony being what it is, Bernie Madoff may be one of the guys we have to thank.Related Links
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The Culturati

Wed, 11 Feb 2009 13:00:00 GMT

Arianna HuffingtonWouldn’t miss: Jamie Foxx and Robert Downey Jr in The Soloist; the SXSW Interactive Festival in Austin. “It is where the coolest of the creative kids hang.”
Also on the calendar: The Long Fall, a new mystery from Walter Mosley.

Frederic de Narp, CEO of Cartier, North AmericaWouldn’t Miss: The Jenny Holzer exhibit at the Whitney Museum in New York City. It’s “a must see for March.”
Also on the calendar: The blog.mode: addressing fashion show at New York’s Metropolitan Museum of Art and the Native Land Stop Eject show at the Cartier Foundation for Contemporary Art in Paris.

Sam Nazarian, CEO of SBEWouldn’t Miss: the Miami International Film Festival and the Mercedez-Benz Los Angeles Fashion week.
Also on the calendar: The New Directors/New Films Festival at the Museum of Modern Art in New York.

Alan Patricof, Managing Director, Greycroft PartnersWouldn’t Miss: Lapham’s Quarterly, edited by former Harper’s editor Lewis Lapham. Each edition covers one subject through stories, essays, poetry, and art.
Also on the calendar: The Irregulars by Jennet Connant, about Roald Dahl’s life as a spy. Last Chance Harvey, starring Dustin Hoffman and Emma Thompson, about two older people who fall in love.

Eric Hippeau, Managing Partner, Softbank CapitalWouldn’t miss: New York Arts of Pacific Asia Show at the armory—the largest Asian art fair in New York.
Also on the calendar: Paquito D’Rivera’s Brazilian Stories concert at Jazz at Lincoln Center in New York. It brings me back to the days I lived in Brazil. The Palm Beach International Boat Show in West Palm Beach.Related Links
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Showing the Money

Wed, 11 Feb 2009 13:00:00 GMT

If you want to give yourself a jolt on one of these winter evenings, go to the Federal Reserve Bank of St. Louis’ website, and check out its chart showing what’s happened to the amount of money in the U.S. economy. What you will see is a flat line that turns, suddenly and sharply, upward.

The chart represents the total amount of money in the economy that the Federal Reserve directly controls—bills and coins as well as the reserves that the biggest banks keep at the Fed. In normal times, the monetary base grows at about the same rate as total spending. Between November 2007 and August 2008, as the economy expanded modestly, it increased from about $850 billion to about $875 billion. Then something remarkable happened. Between the middle of September and the end of last year, as the Fed pumped liquidity into the financial system following the bankruptcy of Lehman Brothers, the monetary base shot up. When other liabilities are thrown in, the amount increased by $1.35 trillion.

Month by month, the acceleration has been stunning. Between August 27 and November 5, the monetary base rose at an annualized rate of almost 500 percent. Between October 8 and December 31, its annualized rate of increase was 922 percent.

The Fed has issued lots of money in previous times of stress, such as in the runup to Y2K, but never before on this scale. History tells us that if a central bank persists in creating money at triple-digit rates, inflation will skyrocket and the currency will lose much of its value. In the German hyperinflation of the 1920s, shoppers had to lug big bags of near-worthless marks to pick up their groceries. Zimbabwe provides a tragic contemporary example. As of November, the annual inflation rate in the ravaged African nation, according to one estimate, was 89,700,000,000,000,000,000,000 percent, which means that prices were doubling every five days.

Nobody is seriously comparing the United States to the Weimar Republic or Zimbabwe. But Ned Schmidt, publisher of the Value View Gold Report, called the Fed’s opening of the monetary spigots a “banana republic” policy, saying it could cause the dollar's value to fall 50 percent. Martin Hutchinson, a commentator at PrudentBear.com, said, “We should expect consumer prices to be increasing at an annual rate of more than 10 percent within 18 months of today.” Expressions of concern weren’t confined to goldbugs and stock market bears. “The Fed can’t just indefinitely create money without creating horrendous problems for the future,” William Poole, a former president of the Federal Reserve Bank of St. Louis and member of the Federal Open Market Committee, told Bloomberg Radio.

Some of the FOMC’s current members also appear to have misgivings. At the committee’s December meeting, they pushed for the establishment of official targets for the monetary base, which would limit Fed chairman Ben Bernanke’s freedom to issue greenbacks as he sees fit. The Fed announced it would consider the matter further, while at the same time confirming its intention to create a lot more money in the months ahead.

What is going on? Are we really headed for double-digit inflation and the end of the dollar’s role as the world’s reserve currency? I doubt it. There is much confusion about what the injection of funds means. When most people hear that the Fed is issuing large quantities of money, they imagine the printing presses cranking up, with sheets of new Andrew Jacksons and Benjamin Franklins rolling off the production line. Actually, the amount of currency in circulation hasn’t risen very much. On September 3, it was about $837 billion; by January 7, it had increased to $885 billion. In an economy where annual spending is about $14.5 trillion, an extra $48 billion in coins and bills is trivial.

Most of the dollars that the Fed has created during the past six months have stayed inside the financial system, where they are propping up such tottering institutions as Citigroup. The rest of the economy shows no sign of excess liquidity or incipient inflation. Current yields on Treasury Inflation Protected Securities indicate that the market expects the inflation rate to be less than 1 percent 10 years from now.

The Fed has, so far at least, pulled off a very delicate trick. Under normal circumstances, the cash it has poured into the market would be inflationary. But with so much of the money being hoarded, that hasn’t happened. In fact, the risk is that the economy will starve from the lack of spending, causing deflation. The Fed’s challenge is to know when to respond, closing the spigots as soon as spending finally opens back up.

Bernanke is making up for past mistakes. With unemployment soaring and output falling, deflation—a general fall in prices—will most likely be a bigger threat to the economy than inflation, and it justifies the Fed taking some risks. Bernanke conceded to me last fall that he initially underestimated the economic threat posed by slumping real estate prices and a collapse in the market for subprime-mortgage securities. Since the start of 2008, however, he has acted aggressively, slashing interest rates and setting up a series of lending programs through which the Fed has allowed stricken financial firms to swap illiquid securities for dollars and Treasurys. He has been so aggressive because the banks have been so stingy with their money.

In allowing Lehman to go under, in September, Bernanke, along with former Treasury Secretary Henry Paulson and his successor, Tim Geithner, who was then head of the New York Fed, unleashed a global financial panic that terrified many Americans, who responded by clamping their wallets shut. The stock market slumped, and the economy went into free fall, leaving Bernanke no choice but to inject more money into the financial system. Had the Fed failed to act, the system would have seized up completely.

The monetary transfusion kept the patient alive, but it wasn’t enough to prevent a dangerous drop in spending, output, and prices. If a deflationary psychology takes hold, consumers will scale back their outlays even further, while borrowers—credit-card users, homeowners, businesses—will find the deflation-adjusted cost of their debts rising. Based on what happened to Japan in the 1990s and this country in the 1930s, we know what this scenario yields: economic stagnation that lasts for years.

It was against this backdrop that the Fed announced in December that it would deploy “all available tools” to revive the economy, including the maintenance of exceptionally low interest rates and the provision of yet more liquidity.

Almost all of the expansion in the monetary base has come in the form of additional bank reserves at the Fed, which aren’t necessarily inflationary. Just like you and me, big banks maintain bank accounts, but theirs are at the Fed. Deposits in these accounts are known as reserves, and banks use them to settle transactions with one another. (If Chase owes Bank of America $50 million, rather than sending a check or wiring the money, it can simply instruct the Fed to debit its account and credit B of A’s account.)

What has happened in recent months is that the Fed, in seeking to keep credit flowing, has greatly expanded its lending programs, allowing banks and other financial institutions to exchange yet more illiquid assets, such as mortgage securities, for dollars. Before the onset of the subprime crisis, the Fed demanded ultrasafe securities like Treasurys as collateral when it extended loans to banks. Today, it has greatly broadened the range of collateral it accepts. The result has been a massive increase in bank reserves. At the end of August 2008, they totaled about $100 billion; by the end of December, they had grown to more than $820 billion.

The Fed isn’t finished yet, not by a long shot. On January 5, in an effort to ease the credit crunch and bring down mortgage rates, it launched a program to buy up to $500 billion in mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, with the aim of encouraging those institutions to make home loans again. It has committed another $200 billion to supporting the purchase of securities backed by student, auto, and credit-card loans, along with loans guaranteed by the Small Business Administration. The Fed said it intended to finance both of these initiatives by creating more new reserves. (Speaking in London in January, Bernanke said this policy should be thought of as “credit easing,” rather than “quantitative easing,” but that is just a matter of labeling.)

One result of all this activity is clear: The Fed and the taxpayers, who provide the central bank’s capital, have been taking on additional credit risk. (As Wall Street cynics like to say, the Fed has been exchanging “cash for trash.”) The inflationary implications are less obvious. When the Fed credits a bank with, say, $100 million in new reserves, the bank faces a choice: It can leave the money at the Fed, earning a modest rate of interest; it can ask the Fed to send over the cash in an armored car; or it can use the money to make additional loans.

The second and especially the third option raise the prospect of the new dollars being used to bid up prices, but so far there is no sign that banks are extending more credit. To the contrary, as anybody who has spoken to a loan officer recently will testify, bank money is harder to get. Since the end of October, the total value of commercial and industrial bank loans outstanding has been falling steadily. This may well lengthen the recession, but from the perspective of individual banks, it is a rational response to the deteriorating economy. Rather than risk making new loans that may never be repaid, they prefer to maintain a high level of reserves at the Fed and pocket the interest.

The reserves also offer a bit of reassurance to bank shareholders, who have been spooked by the long credit crisis.
The fall in bank lending underscores the scale of the task facing Bernanke. The good news is that some of the Fed’s new initiatives are working: Interbank lending rates have fallen significantly, the commercial paper market has revived, and mortgage rates have come down to 5 percent or even lower. Eventually, this improvement in financial conditions should help the economy. Once that happens and the threat of a downward deflationary spiral is removed, the Fed can mop up any excess liquidity in the economy by raising interest rates and scaling back its lending programs.

It would be a major policy error if the Fed were to abandon its newfound radicalism out of a misplaced fear of inflation. Fortunately, this is unlikely to occur. In a recent interview with the Financial Times, Bernanke said, “One of my conclusions from my study of the Great Depression is that people tend to think of orthodoxy as safe. But strategy should depend on the situation. In a severe crisis, orthodoxy can prove to be a very bad strategy.” At various points in the past 18 months, I have criticized the Fed chairman’s actions. Now he is right on the money—in every sense of the phrase.Related Links
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Punk'd by the Web

Wed, 11 Feb 2009 13:00:00 GMT

In his Los Angeles production office, Ashton Kutcher, the star of Punk’d and That ’70s Show, is leaning over a coffee table doing algebra. It’s the day before his production company, Katalyst Media, will launch a game show called Opportunity Knocks, and Kutcher is trying to make a point: Just because he can’t spell his stepdaughter Tallulah’s name doesn’t mean he’s stupid.

“I didn’t name her!” exclaims Kutcher, who is married to Tallulah’s mom, Demi Moore. “It’s not like I sat down with the wife and went through 'Should we have two l’s or one l?' She’s my stepdaughter!... I was never a good speller,” he adds. “I’m a math person.”

Kutcher has a challenge. He’s a model turned actor turned camera pitchman turned successor to Bruce Willis in the Moore household. Getting people in the business world to take him seriously is no easy task. Though he has a track record in Hollywood, producing TV shows and films, he’s now venturing outside his comfort zone to Silicon Valley.

Among his projects: partially bankrolling SaysMe, a website that allows users to create their own advertisements, and helping found Ooma, a phone company. In 2008, he introduced Blah Girls, a website featuring three gossipy cartoon teens. Later this year, he plans to produce an online series with Slide, which makes widgets that work with social-networking sites.

Yet the going has been rough. Within a few months of its launch, Ooma lost key executives and was short on cash. Traffic on SaysMe has dropped noticeably since the presidential election. And when Kutcher unveiled Blah Girls at a conference for tech startups, he got hammered for offering little in the way of new technology. A writer for Inquisitr.com suggested that Blah Girls had been admitted to the conference only because it was backed by a “C-list celebrity.”

Now Kutcher is working to prove his tech bona fides by making Blah Girls a success. So far, his proof consists of a sponsorship by Vitamin Water. Instead of ads, viewers who go to the site or log on via MySpace will see the Blah Girls drinking megabottles of Vitamin Water. If the episodes catch on and travel throughout the Web to social-networking sites, they will generate new revenue with each viewing—a model that has potential, says YouTube founder Chad Hurley. Yet it’s unclear how much money Blah Girls is making since Kutcher declines to provide details. In terms of traffic, Blah Girls in mid-January ranked 103,796 out of almost 200 million sites on the Web, according to Alexa.com, which tracks Web traffic.

Blah Girls, which is centered on three celebrity-obsessed teenagers, may seem like an unusual project for Kutcher. His private life with Moore, Willis, and their children has been chronicled endlessly, often mercilessly, in the tabloids and on gossip sites like TMZ. Yet on Blah Girls, the teens skewer everyone from Kutcher’s peers, like Jennifer Aniston and John Mayer, to children of stars, like Suri Cruise. In one episode, the girls rate celebrities as “hot” or “homeless,” with actress Heidi Montag earning a “homeless” designation because she looks as if she is “made of plastic.”

Kutcher says he got the idea for the show while driving his stepdaughters to school. “Hearing this sort of ‘Oh my God, blah blah blah’ every morning was inspiration for the voices of the characters,” he says. Yet while the Blah Girls repeat some of the more inane tidbits that circulate about actors and actresses, they also poke fun at Hollywood. At one point, they decide to become paparazzi, and Britney, one of the Blah Girls, decks a photographer who blocks her shot of Jessica Simpson.

In the tech world, Kutcher’s willingness to make light of celebrity has cut both ways. While Kutcher was seeking funding, more than one big-name investor turned him down, dismissing him as a lightweight. Even those he didn’t approach, like LinkedIn CEO Reid Hoffman, were skeptical. “I invest in Silicon Valley, not Hollywood,” Hoffman says. But in the end, Kutcher’s red-carpet connections were useful. When he needed $10 million to fund this foray into tech, Kutcher landed his key angel at the 2007 premiere party of Die Hard IV—starring Bruce Willis.Related Links
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Cyber Law 101

Wed, 11 Feb 2009 13:00:00 GMT

IF YOU’VE BEEN SLIMEDWhom to sue: Under Section 230(c) of the Communications Decency Act of 1996, website operators have immunity, so you can’t sue a message-board host; however, it may be possible to go after the commenters directly and find out their identity during the litigation process.

What to claim: If suing for defamation, it’s imperative to show that someone made a false statement that has damaged you, generally by harming your reputation. If you’re a public figure, you need to show “actual malice”—that the comment was made with knowledge that it was false or at least with recklessness as to its truth. (You might also have claims for violation of privacy, copyright infringement, or intentional infliction of emotional distress.)

IF YOU’RE THE COMMENTERIf you’re hidden: The plaintiff may send a subpoena to the website administrator or your internet service provider seeking to learn your identity. You can respond with a motion to quash the subpoena, arguing that your First Amendment right to free speech outweighs the plaintiff’s interest in unmasking you.

If you’re outed:
* Show that the statement is true.
* Argue your comment was just an opinion (a defamatory statement must be factual).
* Claim your statement was clearly satire, parody, or hyperbole, which no reasonable reader would take seriously. The frequency with which schoolyard insults and locker-room epithets fly on the internet may help you in this regard.Related Links
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The Case for Optimism

Wed, 07 Jan 2009 13:00:00 GMT

When it comes to issuing gloomy warnings about the U.S. economy, I’ve established myself as something of an authority (or bore). Ten years ago, I was much exercised about the threat of a stock market bubble; in 2002, I wrote a piece saying that the next crash would come in real estate. Since then, I’ve produced numerous jeremiads, including ones for this column. But for the first time in my memory, I am less pessimistic than the conventional wisdom.

I wouldn’t say that I’m a heady optimist, but I think there is a danger of repeating the mistake that many of us made during the boom: extrapolating current trends to make decisions about the future, failing to take into account how rapidly economic circumstances can change. There’s a risk that we may again overshoot the mark: As the economy goes down, we could be overemphasizing the negative just as we exaggerated the positive on the way up. (View a graphic showing analysts' predictions for 2009 quarterly G.D.P. growth.)

Yes, the short-term outlook is dismal and will remain that way for months. On top of a slumping housing market and credit crunch, we have soaring unemployment, an unprecedented fall in consumer confidence, daily corporate retrenchments, and a dramatic slowdown in the world economy, which is affecting even India and China. The U.S. recession, according to the National Bureau of Economic Research, began in December 2007, which means it’s already the third-longest downturn since 1945. Come May, barring something completely unexpected, this recession will become the longest in postwar history.

So where’s the good news? In any serious downturn, a number of self-reinforcing processes—economists call them adverse feedback loops—start to take hold. To prevent a recession from turning into a depression that lasts for years and years, these feedback loops have to be thwarted on as many fronts as possible, with a variety of policies. Fortunately, these are now being put in place.

In the U.S., we have an energetic new president with a mandate to expand government spending and cut taxes. Equally important, we have the Federal Reserve, chastened by earlier errors, injecting money into the financial system at a rate never seen before. Overseas governments also are busy introducing stimulus packages, slashing interest rates, and propping up their banks. It’s possible the pessimists are right, and all of these initiatives will fail to halt the downward spiral. But that would go against historical precedent. And during the most catastrophic slumps of the past—the Long Depression of 1873 to 1879, the Great Depression of 1929 to 1933, Japan’s “lost decade” of the 1990s—policymakers failed to act decisively until it was too late.

The most visible adverse feedback loop is in the financial industry. Faced with mounting losses on housing-related securities and loans, banks and other institutions are curtailing their lending to preserve capital. Initially, the Fed responded to this problem by cutting interest rates and expanding its role as the lender of last resort to encourage banks not to sit on their capital. This strategy, which amounts to a finger in the dike, prevented a rash of collapses but did nothing to repair the financial industry’s capital base, which has been massively impaired.

By injecting taxpayers’ money into big banks on generous terms and agreeing to have the government take the hit on many of Citigroup’s junky securities, Ben Bernanke and Hank Paulson are well on their way to addressing the problem; in essence, they’re socializing the private sector’s losses. From a political and philosophical perspective, this is an ugly process to behold—who likes bailing out Vikram Pandit and Robert Rubin? Nevertheless, it is probably the only way for the financial industry to move beyond the credit crunch and start over. The Obama administration is likely to expand assistance to the banks, possibly through the creation of a new Resolution Trust Corp., which would take on distressed assets from many financial institutions, perhaps in return for stricter limits on executive compensation and bigger equity stakes than the Bush administration demanded from Citigroup.

In addition, the Fed has agreed to purchase hundreds of billions of dollars’ worth of such dubious securities as “triple-A”-rated mortgage bonds and credit-card receivables and allow financial institutions to swap even trashier paper for cash or Treasurys. The financial crisis is far from over, but with the federal government guaranteeing bank debts, dispensing practically unlimited amounts of credit at close to zero percent interest, and acting as the junk purchaser of last resort, it may well have seized the initiative.

Similarly aggressive moves may soon be under way in the housing market, where the self-reinforcing cycle is continuing into its third year. As prices keep falling, the number of foreclosures increases and abandoned homes flood the market. At the same time, home loans become more difficult and costly to obtain for almost all kinds of borrowers, so potential buyers decide to stay put, and prices fall further. The good news is that Obama appears to be serious about preventing more foreclosures.

One option is to follow the advice of Sheila Bair, the departing head of the F.D.I.C., and restructure millions of delinquent home loans, reducing the principal and lowering the interest charges. For this to happen, changes will need to be made to the bankruptcy code and laws regarding the disposition of securitized mortgages. A more radical approach would be to have Fannie Mae and Freddie Mac, the two government-sponsored mortgage companies—now effectively government agencies—offer refinancing to any homeowner with negative equity, that is, anybody with a home loan bigger than the value of his or her property. And to encourage home buying, Allan Meltzer, an economist at Carnegie Mellon University, has proposed making some down payments tax-deductible.

Unfortunately, even if Obama could wave a magic wand to mend the financial industry and stabilize the real estate market, the recession wouldn’t end overnight. Thanks to another adverse feedback loop—dubbed the Keynesian multiplier, after the dead British economist who is all the rage these days—the trouble has already spread to the rest of the economy. Take Charlotte, North Carolina, a big regional financial center. As locally based companies like Bank of America, LendingTree, and Wachovia lay off thousands of employees, the area’s restaurants, messenger services, and limo companies see their revenues plummet. These businesses, in turn, trim their operations and jettison staff, which reduces the need for produce, bicycles, and town cars. The original fall in demand generates a second-round effect, which generates a third-round effect, and so on. Imagine this happening in towns and cities all across America and you can begin to understand how a recession takes hold.

The usual way to counter a fall in demand in one part of the economy is to boost it in another. This is the principle behind stimulus programs like the one Obama has proposed, which could involve up to a trillion dollars in new expenditures and tax cuts. The arithmetic behind this enormous figure is strikingly straightforward. Since the start of 2007, about $10 trillion in real estate and stock market wealth has been wiped out. If, for every dollar American households have lost, they cut back their expenditures by, say, 5 cents—an assumption that jibes with historical evidence—the total spending shortfall in the economy will be $500 billion a year, or $1 trillion over two years, the likely duration of the stimulus package.

This emergency measure will eventually have to be paid for—as will all the recent bailouts—but the middle of a recession isn’t the time to obsess about budget deficits. A more pressing concern is making sure that additional government outlays are spent rather than saved. It turns out that much of the $150 billion worth of tax rebates authorized by the Economic Stimulus Act of 2008 wasn’t spent. So the 2009 stimulus will be targeted at cash-strapped states, the unemployed, and other recipients who won’t let the money collect dust in their savings accounts. It may be too much to hope for that the package by itself will revive overall spending. However, combined with the $250 billion in consumer savings that the recent drop in gasoline prices will deliver this year, it could well prevent another downward lurch.

As in any deep recession, the ultimate key to recovery will be restoring the confidence of business executives, investors, and consumers. When times are good, most people you meet are upbeat, and it’s easy to dismiss the warnings of worrywarts and cranks like yours truly. As unemployment increases, the odds of running into somebody who was just fired, or whose best friend was just fired, rise exponentially. Gloom spreads like a virus. Eventually, the few remaining optimists are the ones who start to seem crazy.

Breaking this psychological feedback loop is Obama’s toughest task. Luckily, he comes equipped with impressive oratorical skills, a calm and reassuring demeanor, and the rare ability to make Americans feel good about themselves and their country. If, after leveling with the public about what has gone wrong, he can outline a credible and fair strategy for recovery, including the establishment of a tougher and more scrupulous regulatory structure, he could buck up what Keynes referred to as the economy’s “animal spirits”—the optimism that goads entrepreneurs into action.

The model for Obama, inevitably, is Franklin D. Roosevelt, who took office in March 1933, a time when one in four people was out of work and the banking system was in a state of panic. By no means did all the policies that Roosevelt introduced in his famous “hundred days” work out perfectly. But he stabilized the financial system; convinced Americans that, at last, something serious was being done; and conveyed a sense of confidence. Bernanke, a Republican fan of Roosevelt’s, likes to remind people that one of the stock market’s best years of the 20th century was 1933. During Roosevelt’s first term, the inflation-adjusted gross national product expanded more than 25 percent.

It would be wishful thinking to expect such a vigorous upturn between now and 2012. Before we can hope for a sustainable recovery, we have to deal with yet another adverse feedback loop—deflation—which is a recipe for Japanese-style stagnation. As prices start to fall throughout the economy, borrowing money and servicing debt costs more in real terms, putting even more strain on borrowers and financial institutions.

Bernanke is determined not to let deflation gain a foothold. Between September and December, the monetary base—notes and coins in circulation, plus bank reserves at the Fed—jumped by about a third. Without announcing it publicly, the Fed has adopted a policy known as “quantitative easing,” which basically means that it’s flooding the economy with cash. With central banks around the world adopting similar policies, it’s hard to see a global fall in prices persisting for very long.

By the end of this year, if all goes well, there could be tentative signs of an upturn. How seriously do I take this rosy scenario? Recently, I moved some of my savings from cash into stocks. If the past two years have taught us anything, it’s that popular economic wisdom is often mistaken. In venturing into the stock market, I am taking out a long-term call option on the possibility that the doomsayers, my normal self included, are mistaken. I hate to sound like a shill for Wall Street, but in my mind, this is simply sensible diversification.Related Links
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