Lessons From The Current Crisis - Macroeconomics

Economics has been bashed thoroughly, by me, and loads of other commentators for failing to be remotely useful in predicting or solving this current crisis. Is it totally useless? To be fair, many of the economic concepts and ideas are useful in addressing and commenting on business issues and strategies, even till today. Its problem is its predictive element and is it still relevant?

In Businessweek International, they had 3 economists to share their insights on lessons from the current crisis:

1) Hyun Song Chin, Princeton University - He thinks that the Fed should pop credit bubbles early by raising interest rates. Shin faults macroeconomists for developing models that didn't allow for the possibility of risks such as a bubble in lending or deterioration of credit standards.

2) Roger Farmer, UCLA - He thinks that the Fed should make large scale purchases of equities to restore investor confidence and get the economy back on track. He thinks that the Obama's administration doing that would be more effective than deficit spending. He frets that if the government puts more money in the public's pockets via spending or tax cuts, people won't spend it as long as they feel poor because of stock market losses. Similar ideas have been tried before in HK, Taiwan and Japan - but had been relatively effective in HK and Taiwan.

3) Thomas Sargent, NYU - To him, the economy is volatile because households and businesses hold fragile beliefs that shift quickly. In the 70s Sargent stood by "rational expectations" which says that ordinary people can correctly anticipate the range and likelihood of possible future outcomes. He now thinks that theory was oversimplification. In real life, households and businesses are highly uncertain. These fragile beliefs though may shift back positively again through unexpected positive events.

In my view, macroeconomics has failed to predict or solve this crisis because:

a) the models are not sophisticated enough. They did not have the capacity to assess the "effects of derivatives", how the leveraged balance sheets (or rather off balance sheet items) pumps liquidity through the system, and the consequences when this liquidity is eroded.

b) the assumption of the "rational man" is flawed, I totally agree with the "fragile beliefs man" theory. That being the case, the importance of "confidence" in expectations has been understated, and maybe difficult to be incorporated into models.

c) the assumption that the markets is efficient is again flawed, apparently markets are not efficient but rather random and unpredictable, and will have extended periods where the markets can be totally inefficient.


p/s photo: Suki Chui Suk Mun & Shirley Yeung Si Kei

Markets Can See Some Catalysts

US lawmakers are likely to hand Barack Obama the first major win of his week-old presidency on Wednesday, overriding chiefly Republican objections to pass an US$825-billion economic stimulus plan. The US House of Representatives was expected to approve the package, a centerpiece of Mr Obama's efforts to resurrect lost US jobs and kickstart stalled US growth, in the late afternoon or early evening largely along party lines. Key US Senate committees have begun shaping their chamber's version of the bill, as Democrats and the White House say they hope to speed the final measure through the US Congress and to the White House by mid-February.

The House vote was to come one day after the Democratic president made his first work visit to the capitol, wooing defiant Republicans with closed-door assurances that he hears their complaints and shares some of their worries. 'Nobody is more worried about the deficit and the debt than me. I will be judged by the legacy I have left behind,' Obama told House Republicans. The appeal came hours after Republican leaders, looking for more tax cuts and less spending, directed their troops to oppose the Democratic bill, which provides about US$550 billion in spending and US$275 billion in tax cuts.

Publicly, Mr Obama said he recognised 'legitimate' Republican gripes with his approach but argued waves of jobs losses and punishing economic news dictated urgent action and not political gamesmanship. 'I don't expect one hundred per cent agreement from my Republican colleagues,' Mr Obama said as fevered political maneuvering on Capitol Hill contrasted with the euphoria of his inauguration there a week before. 'But I do hope that we can all put politics aside and do the American people's business,' the president said in a time-honored appeal for Washington to overcome its bitter partisan divisions. Mr Obama may need Republican support for political cover if the stimulus plan, now widely popular with the US public, fails to achieve its sought-for effects.

The president wants thumping congressional majorities for the stimulus, the first big test of his presidency, to give him momentum for other priorities and to make good on his vow to be a bipartisan leader. Republicans lack the votes to defeat the stimulus bill on their own, but could slow its progress, especially in the Senate. The Congressional Budget Office estimates that $169 billion of the $825 billion in stimulus will hit the economy before the end of September and that the bulk of it will show up in 2010 and 2011. - AFP
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WSJ: A measure to allow judges to reduce the principal amounts of mortgages for troubled borrowers in bankruptcy cleared a key hurdle Tuesday when it was approved by a U.S. House panel. The legislation, which is progressing quickly in Congress, would amount to the most aggressive step yet by the federal government to help strapped borrowers avoid foreclosure. Proponents contend it will act like a stick, spurring mortgage servicers to complete more loan modifications. Meanwhile, the banking industry warns that it will raise mortgage costs for all borrowers.

The measure was approved on a 21-15 vote after its House sponsor, Judiciary Chairman John Conyers, D-Mich., agreed to changes that would narrow its scope. "While bankruptcy reform may not provide all of the answers to this crisis, surely it provides a common sense and practical approach to helping stop the spiral of home foreclosures," Conyers said in remarks before his panel.

Under the legislation, borrowers would be eligible to have a bankruptcy judge reduce the principal balance on their home loan - a move known as a "cram down." Current law allows cram downs for mortgages on vacation properties, but not for those on primary residences.

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CNBC: A Senate committee approved $342 billion in tax cuts on Tuesday as part of a larger plan to stimulate the economy. The Senate Finance Committee voted 14 to 9 to approve the legislation after amending the original proposal to make sure middle-class taxpayers aren't hit by the alternative minimum tax this year. All Republicans on the committee opposed the package except for Sen. Olympia Snowe, R-Me. The bill includes a $500 individual tax credit, tax breaks for businesses to hire workers and buy equipment, and tax incentives for energy efficiency.
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In Tokyo, the Nikkei Stock Average climbed 4.9% to 8061.07 Tuesday, also getting a boost from the Ministry of Economy, Trade and Industry, which said it is considering a plan to provide public funds to companies beyond banks that have been hardest hit by the financial crisis. The fact that governments are beginning to look beyond the banking sector to revive the economy is a major step to begin to understand the gravity of the issues.
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The biggest catalyst has to be the report that the government is creating a plan to buy up toxic assets from firms in an effort to stabilize the shaky banking system. What that means is that there will probably be a person in charge mediating on the price to buy off the toxic assets from the banks. Right now, no private funds are willing to buy as there is no certainty on the price. This is the 'bad bank" plan, the bad bank will end up with the toxic assets. In reality we are going via the RTC method whereby we are consolidating the toxic assets, we are just ONE step shy of nationalising some of the banks - which may not be a bad thing. In fact, if Geithner takes the nationalisation path, I am certain the markets would rise further.

p/s photos: Sara Malakul Lane

Report Card On The RM7 Billion

You can get a good idea of the "thinking and strategy" behind the plans being announced, and make an assessment of whether they "know" the problems ahead, have a good appreciation of the problems ahead, and whether they are tackling them with the right medicine. I would rank them from A to E, A being excellent, C being neutral and E being flawed.

The government yesterday cut its economic growth forecast for 2009 to 3.5% from 5.4% and announced several measures to keep the economy ticking, including putting more money in the hands of the people, creating more jobs and boosting the construction and real estate sectors. (A+, The statement show a very sobering and realistic acceptance of the cascading effects from the global financial tsunami. In fact many other countries have only downgraded growth for next year minimally. The 200 basis points downgrade shows a willingness to err on the side of caution, which is good).

Deputy Prime Minister and Finance Minister Datuk Seri Najib Razak, in winding up the debate in parliament on Budget 2009, also gave a commitment that "a big number" of government procurements will, from now, be done via either an open or limited tender process to ensure it gets "value for money". Contracts targeted at bumiputera companies will also be put to competitive bidding among bumiputera firms. Direct negotiations will, however, continue on a discretionary basis. (A, Hard not to be cynical, the words sounded right, will give him benefit of the doubt for 6 months and see if reality mirrors the message. Even a 75% figure for open tender will be a blast).

While the country's fundamentals remained strong, Najib said Malaysia would still be impacted by the current global financial turmoil and economic downturn. This left the government with no choice but to follow other countries and pursue an expansionary fiscal policy to ensure continued economic expansion, albeit at a slower pace. As a result, the government's budget deficit for 2009, originally projected at 3.6%, has been revised to 4.8%, which is the rate anticipated for this year. Inflation, currently running at around 8%, will dip to between 3% and 4% next year, if crude oil price remains at the current level, he said. (A, a responsible statement, and yet aggressive view for a higher budget deficit in 2009. Its fair, committed, responsible tactic without iviting major problems in the future for the country's balance sheet. Whoever is advising najib is doing really well so far).

Najib unveiled an additional RM7.0 billion fiscal stimulus that will be funded by the savings obtained from the recent cut in petrol subsidies. The money will be spent, among others, on:

• RM1.5 billion to set up an Investment Fund to attract more private investments (C, too vague).
• Building RM1.2 billion worth of low- and medium-cost houses (C, good but not good enough. There are plenty of property projects which people have paid deposits but may be in grave danger of being abandoned, look into them as well).
• RM500 million to upgrade police stations, army camps and quarters (C+, smaller construction projects to boost activity, ok la, at least they stayed on the right course by having no mega projects).
• RM600 million to build roads, bridges and community halls in kampungs (B, this is in addition to the latest budget, still better than nothing).
• RM500 million to upgrade schools and hospitals (B, same as above, keep it smallish and spread around the country).

To boost consumer spending, he said employees can opt to cut their contribution to the Employees Provident Fund to 8% from 11% in 2009 and 2010. If all EPF contributors do that, it will free RM4.8 billion a year for them to use (E, reprehensible and irresponsible. Why do you have to boost spending by consumers via their OWN SAVINGS. Already we have a retirement scheme which is really insufficient to care for the MAJORITY of Malaysians. You still want the public to chip in to keep domestic activity going. Its forsaking the future for the present, when the future is already not good enough. The government MUST always regard EPF savings as something sacred and immovable, and must be a very last ditch effort. Once you reduce, it will be very hard to put it back up again. People have to learn to live with a certain mandatory savings rate. If anything, the savings rate should go higher (not at the present time) as the employer and employee contributions should equal 25% sometime within the next 5 years onwards in order for EPF to remain meaningful for Malaysians to retire on).

Najib also said government employees would now enjoy bigger car loans, ranging from RM55,000 to RM70,000 compared with the current RM45,000 to RM60,000. And those with existing housing loans can extend the repayment period to 30 years from 25 years. (C+, while that is good, the government should also think of how these loans would tie down public servants. If the government is intent on improving efficiency and reduce manpower over the next 5 years, such "tie downs" will make it very hard to streamline staffing issues. How to cut 5% of workforce when all of them have these loans dangling everywhere. There are a few firms already extending generous personal loans for government servants only, using direct debit of their salary as paying installments. This instills a mentality that a civil service job is forever. How to improve efficiency properly? These personal loans in addition to their other loans do make their disposable income very tight indeed. You can forecast the compounding ill-effects from this scenario).

Najib also announced steps to boost the construction and property development industry by:
• Removing the import duty for cement and long iron and steel products and exempting the companies from applying for Approved Permits (APs) (B+, I would have given it an A if this WAS MADE PERMANENT. We cannot and should not do things on an adhoc basis, take away now, put back later. It allows for many subsidised industries to always run to the government crying for help whenever the situation does not suit them. All industries, worth having, should learn to compete regionally and globally, or else they don't deserve to exist, we can very well just import from Thailand or Indonesia... just like Singapore. There is really no need to have a steel or cement or auto industry... we are really too small a nation).
• Allowing a foreign individual or entity to buy commercial properties priced above RM500,000 without requiring FIC approval if it is for own use (B+, again, make it permanent, no more flip-flops).

To create jobs, the government through GLCs like Khazanah and PNB will launch a Graduate Employability Management Scheme (GEMS) that will train 12,000 graduates over the next two years (B, has the ability to be really useful, only because Khazanah is involved. Learn to have good spreadsheet skills, pass a basic understanding of accounting, do simple financial modelling, learn how to do power points, improve business English, conducting yourself professionally, learn about priorities and tasks completion scheduling, improve thinking like an entrepreneur and innovator, take up courses to improve your marketability ...).

Stating that the "export-led" strategy used during the 1997/98 crisis cannot be used now because other countries are also slipping into recession, he said the government has to focus on boosting domestic activities. (A, good understanding and good strategy. It would have been too easy and too simplistic to revert to a 4.0 to the USD strategy to export our way out. It would have set our economy back 5-10 years as sunset industries will find more reasons to live, and value add industries will find things hard).

One step to raise revenue and spur domestic economic activity is for the government to maximise returns on its assets, including land that has not been developed, especially those in strategic locations. He cited the Rubber Board land in Sungai Buloh as well as government land in Jalan Cochrane and Ampang Hilir in Kuala Lumpur as examples. Tenders will be opened to private companies and GLCs to develop the parcels of land based on guidelines set by the government. (A, about time, but again everytime you announce such a plan, there will be 2,500 vultures at your door... which would make these plans a D- ... keep it transparent, relevant and open).

If I was on the 4th floor, and they still listens to 4th floor boys ... I would push for:
a) reviving abandoned property projects with capital injections, it will free up capital and improve liquidity in many thousands of property buyers left in the lurch
b) going around and making sure property developers currently selling or building are properly capitalised to avoid any projects being abandoned
c) fast track the removal of import and excise duties on cars to 0% by end of the year, now that will put a lot more cash into people's hands ... AP holders get their money back and current dealers with stock will go through a mediation process to get back a minimal portion of the losses, or get an export subsidy to send the used cars to other less developed countries
d) implement a gradual removal of oil and gas subsidy for commercial firms, listed and unlisted companies: 50% reduction in subsidy effective Jan 2010, and complete removal on Jan 2012. Everybody knows how to spend, but we also need to know where to save so that we can spend wisely. Subsidy for commercial firms have to go. The savings will be used more diligently to invest in other value add areas. Need to move up the value chain if everybody is to have higher wages.

p/s photo: Elanne Kong