Tuesday, April 28, 2009


Over the last week while visiting friends and family in California I have come to more clearly see the exquisite humor in what has happened over these last several months due to our faltering economy.

I have repeatedly commented on how the Federal Government has taken on an even larger role in the economy. Already the largest consumer, it will be even more so with the new budget that will increase Uncle Sam's take from 20% to over 25% of output. Already the central banker, the Federal Reserve System, Uncle Sam now owns a substantial share of the private banking sector. Already the rules maker for the economy, Uncle Sam will now engage in a round of enacting even wider controls over the financial sector. And of course the new role for Uncle Sam, the single largest stock holder in corporate America.

I have reduced this event to a terse comment, "What it took the Bolsheviks a sea of blood to do in Russia, Uncle Sam has done for peanuts." What I mean is that the Bolsheviks seized the means of production by force, while Uncle Sam is doing it for a rather small price.

I say small price because Uncle Sam is doing all this with money borrowed at small cost, in the main for less than 1% interest. And his capacity to borrow is not yet exhausted. I calculate that he can double the national debt without causing serious harm.

So what do we have. Uncle Sam is borrowing funds from the private sector at ridiculously low cost and he is using the funds to buy up the private sector. In other words the private sector is funding the Federal Government to buy it out. As I said, I find this to be exquisite humor.

Leo Cecchini
April 2009

Monday, April 20, 2009


President Obama has stated that economic recovery and future progress must be addressed at the same time as our energy supply and environmental concern, especially global warming. In fact he has linked the three as integral parts of the same problem.

I have no problem with global warming, the earth has been on a warming trend for the last 10,000 years. Now I say this as someone who lives at 18 inches above sea level on an island and has a second home so close to the sea that it is caked in salt residue after strong storms. I know hurricanes, having lost parts of both homes to hurricanes. The island I live on was actually the product of a hurricane in the early 20Th Century. I live my talk and I repeat I am not afraid of global warming, in fact I welcome it since the earth is basically a cold place.

I find that my friends are about evenly split between those who state unequivocally that global warming is a problem and we better do something about it immediately and those who deny that global warming is even occurring. Both sides have plenty of ammunition and supporters. Neither one has won the battle for public opinion. The average Joe is worried by cries that the sky is falling but is equally concerned that stemming global warming will cost him an arm and a leg.

As far as I am concerned the debate is over. The corporate world has now embraced global warming and is using it as the best marketing tool since the American dream of owning a home and a car. We are now constantly barraged by ads urging us to be "green." WalMart proudly announced that it intends selling millions of new light bulbs that use much less energy. Auto makers are flogging ad nauseum their "hybrid, electric, and new fuel" cars. We are urged to eat food grown without chemicals. In fact we are urged to eat less, period.

I wonder how the avid environmentalists view their cause being usurped by the very corporations that they held up as the villains causing all the ecological disasters. How will they deal with a march to global purity led by such bad guys as Exxon, DuPont, Dow, and so on? Talk about unintended results.

Leo Cecchini

April 2009


A reader raised an interesting point, while he finds my articles to give "lucid" explanations of the current economic drama he believes that most readers do not understand financial markets. In looking at how to better explain the way the financial markets work I struck on an idea, why not use the market for diamonds as a way to describe the mechanism?

Diamonds are valued by the familiar "4 Cs" - carat, clarity, cut and color. Let us consider carat or weight and clarity to determine the "intrinsic" value of a diamond while we can consider cut and color to determine the "subjective" value of a diamond.

The carat or weight of a diamond can be accurately determined by a scale. Turning to a mortgage we can call its carat or weight to be its balance due, times its interest rate, times the period for repayment of the loan. This can be readily and accurately calculated.

The clarity of a diamond means how clear it is of imperfections or flaws which can be readily seen with a microscope. Such flaws and imperfections determine the potential for the stone to break and can be accurately measured. Turning to mortgages we can consider "clarity" to be determined by defaults and foreclosures which can also be accurately measured.

The color of a diamond can range from white to blue to lemon to "root beer." The demand for certain colors changes over time and this the value goes up and down according to fashion. Likewise the cut of a diamond can be of several types with demand for a certain cut affecting the value. At present the most sought after cut is the "Leo" diamond (no, I had nothing to do with this, unfortunately). The point here is that cut and color constitute "subjective" valuation of a diamond that can change over a wide range.

Subjective valuation of mortgages has to do with perceptions of their reliability. Thus they are subject to variable measures, rather than constant measures. Last year sub prime mortgages were consider to be the weakest mortgages and their values were smartly reduced, no matter what the "intrinsic" value may have been. Now prime rate mortgages are causing concern and they are being devalued smartly.

Another subject valuation stems from the fact that no one knows the full scope and scale of "securitized debt" built on mortgages. At first we panicked and cut valuations to the bone. However, as we get a better handle on this pile of "toxic assets" we are able to better value them.

I have argued since last summer to drop the "subjective" values derived from "mark-to-market" rules and value mortgages and mortgage based assets to their "intrinsic" value. This was done on April 2 of this year. This change will lead to banks increasing the values of their mortgages and mortgage based assets and thus allowing them to lend again.

P.S. More notes on diamonds:

1. Diamonds are found throughout the world, from the frozen wastes of Canada and Siberia to the steamy jungles of the Congo to the deserts of Namibia to the gentle hills of Arkansas.

2. The main suppliers of diamonds are South Africa and Botswana where they are mined and Namibia where they are culled from the desert sands.

3. For the last 100 years the supply and thus value of diamonds was controlled by the De Beers organization owned by the Oppenheimer family of South Africa. De Beers has now changed to a market strategy of being the "supplier of choice" in the wake of intense competition from Russia and Australia.

4. I once met the late, legendary patriarch of the Oppenheimer family, Harry Oppenheimer on a visit to Washington DC. I caught his attention when in response to his direct question I said I was negotiating the entry of the first American mining company into Mozambique, his back yard.

5. The diamond market rests squarely on its symbiotic relationship with love and marriage. If the demand by women for a diamond as the visible symbol of their marriage should change to some other stone, the market for diamonds would, get ready, drop like a rock.

Leo Cecchini
April 2009

Thursday, April 16, 2009


I should have published this item yesterday but better late than never.

I find the subject of taxes fascinating. If I had not been a diplomat I would most likely have had a career in taxes. Not the most glamorous of professions, in fact an often reviled one. Jesus Christ was reproached for "consorting with prostitutes and tax collectors." But a career with as secure a future as a mortician.

And taxes are the talk of today. I even saw President Obama's tax return spread around on the internet. Most likely you have just sent your return in.

My first thought is what my old tax teacher, who was one of those venerable professors who literally wrote the book on the subject, at least the one we used in his course, who said one warm afternoon, "There are two elements of a good tax, first they collect sufficient revenue and second they are easy to collect." Notice, he did not mention equity, fairness, income distribution and such. Just raise enough to pay the bills and don't waste time collecting them.

Well we know that taxes in the USA today do not raise sufficient funds, we pay allot of public expenses with borrowed funds. We also know that taxes in the USA are not easy to collect, just ask the current head of the IRS, Treasury Secretary Geithner. This has led to endless debate about improving our tax system, indeed it was a core feature of President Obama's election campaign.

I am partial to "taxes" raised by government monopolies. At different times governments have raised funds through government monopolies that sold goods, such as salt, matches, and tobacco to the public. This allows the government to raise taxes whenever it wants and it is easy to collect. However, it is difficult to control, since smugglers have always managed to steal some of the income.

A similar process was that of the Soviet Union. It owned the "means of production" or most of the industry in the country. It took its "taxes" from the sale of the products made. These "taxes" would have been profits in a capitalist system.

In general, however, taxes is a complex subject. I hear many Americans complain about the complex US tax code, they want a simpler formula. I reply that a thick tax code is the tax payer's friend, while a simple tax code favors the collector.

This complexity is made even more so when taken to the international arena. As a diplomat, I had to examine tax systems in other countries and at times help negotiate tax agreements between the USA and other countries. Let me assure you that there are more angles on taxes throughout the world than there stars in the sky.

So what to do? I personally go for the so-called "flat tax" that Steve Forbes used as his banner for his campaign for president a few years ago. As with all income taxes, it is a "direct" tax, rather than an "indirect" tax such as sales taxes. As income goes up, your tax payment increases, as opposed to a consumption tax.

It is generally calculated that for a flat tax to raise sufficient funds in the USA it would be about 15-17% of income. Interesting to note, Vice President Biden's joint tax return for 2008 showed that he paid about 17% of his adjusted income in federal tax. President Obama and his wife paid about 30% of their $2.5 million income in taxes.

Of course the complaint about the flat tax is that it is "regressive" which means it places a higher burden on low incomes than it does on high incomes, i.e taking 15% from an income of $20,000 means more hardship on the payer than taking 15% from an income of $1 million. But remember under our current tax system something less than 50% of income earners pay no tax. So the flat tax need only be applied to the wealthier half of the population.

Now I am sure some will also consider my comments here to be facile and I will admit that they only touch the subject. But when we do go about reorganizing our tax system let us keep in mind the words of my old tax teacher, "Make sure it collects sufficient revenue and that it is easy to collect."

Leo Cecchini
April 2009

Wednesday, April 15, 2009


I have received comments from two readers who disagree with my take on the economy. One says he doesn't agree with anything I say another finds my comments on consumption to be "facile."

I am amused when fans of President Obama dump on his policies. In case I did not make myself crystal clear I support the president's policies except for a couple of technical problems. The president in his address on the economy yesterday noted the initial success of the Feds several programs to revive the credit market, which I have carefully explained in my columns, and fully support. He also emphasized the need to get his stimulus program up and running as soon as possible, which I have also described and support.

President Obama made it clear in his speech that we need to crank up consumption in order to put people back to work. Now I know that the Republicans are calling the stimulus plan "excessive" government spending that will really not put anyone back to work. The also drag out the bugaboo about future indebtedness burdening our progeny. I see the Republican strategy as simply one of shoring up their position for the next election. If the president's plans work they will say they worked because Republican amendments and additions made them better. If they fail the Republicans will be able to say to the voters, "We told you so."

I mentioned in a previous article that I was surprised by the many Obama supporters who oppose his "excessive" spending. I also mentioned that while the president enjoys strong support from the public his programs do not.

So I say to those who commented on my economic views that mine are exactly the same as held by the Obama team and I did not vote for them. And while I am certainly in no position to implement my suggestions, the president and his people can, and will.

Leo Cecchini
April 2009

Tuesday, April 14, 2009


One of the major initiatives of President Obama's plan to correct the economy is his overhaul of Medicare and Medicaid. All agree that the nation's health care is too expensive. We get the same level of health care as is received in Western Europe but at about 2.4 times the cost in Europe.

President Obama wants to get better return on the government's dollar from its expenditures on Medicare. He then points the finger at everyone's favorite whipping boy, the health care insurance companies, e.g. Blue Cross. He believes we can get more for our Medicare dollar by curbing the insurance companies.

Well his plan is what I call "penny wise, pound foolish." As a cost saving measure the president wants to do away with what are called, "Medicare Advantage" plans. Essentially for a fixed payment from Medicare, usually so much per participant per month, the health insurance company agrees to pay for all medical care for the participant. Obama sees a problem here, Medicare pays a fee for the participant, but the participant may not use any health care, or much less than the fee paid. Thus Medicare is paying for a service that is not used.

The problem is that the Obama administration does not understand basic insurance. What it is actually paying is an insurance premium to the health care insurer who then agrees to cover all "losses" which in this case means health care expenses.

What the Obama team also does not understand is that by paying the insurance premium they limit Medicare's exposure for that participant to the premium. If there were no such plan Medicare would have to pay the participant's medical costs, up to very high limits. Thus not paying the premium would in effect set Medicare up for unlimited losses, the very reason we use insurance.

Moreover, the health care insurer provides a limit on the cost of medical care. Those medical services that agree to its fee structure only receive what the insurer will pay. And this is a great savings. My latest medical service procedure was billed by the physician and his group for $5110. Blue Cross paid $2320 and I had to pay $120 in co-payment. In short Blue Cross saved Medicare $1768 and me about $1200.

Clearly the real culprit in sky-high medical costs are the health care providers, not the insurers. In fact the insurers are the only reason that health care costs have not gone even higher. Doing away with the very effective "Medicare Advantage" plan will simply insure that health care costs rise even faster, instead of bringing them under control.

Leo Cecchini
April 2009


A response to my last item about the philosophy of the economy causes me to reflect on the concern about the environment. I am constantly amazed at the hubris of many "environmentalists." They really believe that mere mortals can do more damage to the world than cosmic forces. I suggest they see the latest "end of the world" film, "Knowing," which has mankind destroyed on earth by a massive solar flare. Or perhaps they could reflect on the billions of years of earth's history and the many times it was totally altered by cosmic forces.

Yes, we all want to live in a comfortable, safe, sound environment. I doubt anyone would say no here. The real question is economics, what are the costs and trade offs to achieve a particular environment. It comes as no surprise to me that the best book I have seen on the subject is the one done by a Danish economist named Bjorn Lomborg and titled, "Cool It." Lomborg does not deny that the earth is getting warmer or that man's activities has added to the warming trend. Instead he focuses on the results of the warming and the appropriate response to these.

A central point Lomborg raises is the concern about rising temperatures causing more deaths due to heat. He says yes, this will occur. But that has to be compared to the many more that will not die because of reduced cold. He notes that in Europe about 200,000 die because of excess heat each year while some 1.5 million die from excess cold. For Britain he shows that a 3.6 degree F increase in temperature will mean 2000 more heat deaths but 20,000 fewer cold deaths.

Lomborg's main concern is that the funds and energy being demanded for stemming the rising temperatures could be better used for other major problems that cause more harm to mankind. In short, he views the situation that of an economist, does the end justify the cost?

I go a bit further. I say global warming cannot come too soon. The earth is a cold place. The average temperature of the earth is 60 degrees F or 15 degrees C. At this temperature the unprotected human corpus expires in a matter of minutes or a few hours. Indeed, the largest use of fossil fuels goes to keeping the body warm - building shelter, heating those shelters, manufacturing clothes, producing food and so on. Therefore, upping the average temperature will actually reduce our need for fossil fuels.

My problem with many "environmentalists" is a lack of perspective. Yes, the earth is getting warmer, where's the news, it has been doing this for the last 10,000 years. The issue is what changes will this bring and what is the best way to handle the changes. As Lomborg and I maintain, lowering the deaths from hypothermia is a change for the good and needs no response.

Leo Cecchini
April 2009

Monday, April 13, 2009


Well the economic story is moving past the technical debate about how to stop the downward spiral and start moving up again. We are now into a philosophical debate.

The cover story on the latest issue of TIME magazine was a piece by an author who has apparently made his mark as a latter day Savanarola, the 15th Century monk who tried to cleanse Florence, Italy of excess. Savanarola got rid of the Medicis but was soon burned at the stake for heresy. The TIME writer preaches against the excesses of our modern society and believes the current economic downturn will be the genesis of a more prudent society.

I fundamentally reject notions that we are engaged in excess consumption. In my book there is no excess demand, just short supply. What is wrong with all families owning their own home? What is wrong with wanting a modern home with the attendant conveniences? What is wrong with wanting quality education? What is wrong with wanting more leisure time to enjoy life? What is wrong with wanting to travel and explore the world? What is wrong with wanting good food? And on and on.

Again, my definition of economics is "the science of meeting the perceived needs of the people," with the operative word being "perceived." I eschew the endless debate about what constitutes the "proper level" of consumption. If the consumer wants it, how do we provide it? Of course I leave out demands for illegal items.

The salient feature of human history has been the desire to provide more for our heirs than we had for ourselves. We want a better world for our children. The difference between me and other economists is that they prefer that the parents determine what constitutes a better world, I leave it to the kids to determine what they want.

I expect to see more such talk about how to formulate our revived economy. But this is good, since it means that the bottom has been reached - "Been down so long, looks like up to me."

Leo Cecchini
April 2009


Well the New York Stock Exchange is again bullish, further evidence that suspending "mark-to-market" on April 2 is having a positive effect. But restoring the flow of credit is only half the battle. If we had taken this step last fall we may have avoided the economy's nose dive, but we did not and we now have to deal with widespread unemployment. Yes, restored lines of credit thanks to suspending "mark-to-market", Government action, e.g. the "TARP", the "TALF", are doing their work, they will induce consumption and thus production and thus employment. But we let the problem go too long and this road to recovery will be too slow for the public to accept.

No, we have to get President Obama's stimulus program moving fast. I hear many say that only a small portion of the stimulus will be spent on direct consumption, e.g. building new roads and schools. They complain that "transfer" payments, e.g. extended unemployment payments, are indirect consumption that may or may not occur. Give me a break, someone on unemployment will not use extra cash to pay for essentials? Do you really believe that this person will invest the extra pay in a CD?

The formula is fundamental and easy to understand, inject more funds into the economy, extra funds mean higher consumption than before the injection, higher consumption means higher production, higher production means higher employment. Again, I am not concerned about how the funds are spent, I leave that to those examining quality, I deal with quantity. Just get the money out there as soon as possible.

Leo Cecchini
April 2009

Thursday, April 9, 2009


I reported last week the lifting of "mark-to-market" rules that I have been asking to do since last August. Now I see a rearguard action by the doomsayers based on the difference between "liquidity" and "involvency." The naysayers also warn that, while lifting "mark-to-market" rules have corrected the values for mortgage based assets, we still have problems with securitized non-mortgage debt.

During the "Financial Meltdown of 2008" and the "Great Recession of 2009" I have seen a constant debate between those involved about the exact nature of the financial crisis. Some say it is a lack of "liquidity" and others say it is a matter of "insolvency." Both arguments have merit.

The exact problem is that those valuing the securitized mortgages and the credit default swaps used to insure these investments, variously known as "securitized debt, derivatives, or toxic assets," were obstensibly marking their value to the "market." However, since there was no established market for these assets they marked them to "models" based on the property market.

As the property market went flat and then south, those doing the values devalued the mortgage based assets as much as 90%. This in turn savaged the balance sheets of those holding the assets. With their balance sheets out of kilter the holders, banks and other financial groups, had to borrow to compensate for the lost value of their mortgage based assets. But their balance sheets did not allow this borrowing. So for the "liquidity" crowd the problem was the inability to borrow and for the "solvency" crowd the holders were bankrupt since assets were clearly worth less than debt.

On April 2 the Feds lifted the "mark-to-market" rules that allowed valuations of the mortgage based assets to their maturity or long term value instead of the "market" that did not exist. It has worked immediately. I heard one expert say yesterday that the mortgage based assets had been corrected. However, he warned that there are still problems with non-mortgage securitized debt, essentially student loans, auto loans, credit card debt, and commercial debt that has been bundled and sold as "securitized debt."

I do not see any real problems caused by securitized non-mortgage debt. There is no market to mark against since, as with the securitized mortgages, there is no established market for trading these. But more importantaly, no one is valuing securitized non-mortgage debt to "models" based on the values of the underlying item, i.e. no one is valuing auto loans to the current prices or sales of autos. I suppose one could devalue student loans by saying that graduating students face a more difficult job market and will be less likely to find work. But this has not yet been done. So, unlike the securitized mortgages, there will be no panic devaluing of securitized non-mortgage debt.

No we have passed the first major hurdle. Now to implementing the Obama Stimulus Plan. More on that later.

Leo Cecchini
April 2009

Thursday, April 2, 2009


Well it has taken me since last fall to get the authorities to take action but here it is, the Financial Accounting Standards Board, FASB, has modified the "mark-to-market" rules allowing banks and others to value their "securitized debt" holdings to "models" instead of the "market." I use parentheses since the "markets" they were using were actually "models" based on the property market. The "models" they will now use are the long term or maturity value of the assets, reduced by actual losses.

I expect this to cause an immediate effect on the balance sheets of those holding "securitized debt" instruments. However, given the severe decline in the financial system, it may take some time for these improved balance sheets to translate into increased lending.

The other immediate effect will be to reinforce the Feds move to revive the "securitized debt" industry. Again, the Feds are pouring $400 billion into Fannie Mae and Freddie Mac to generate more mortgages that will be "securitized." The Fed TALF Program will also generate some $ 1 trillion in "securitized debt" based on non-mortgage loans, e.g. student loans, car loans and credit card debt.

While all of this is good, we will still need President Obama's stimulus package to jump start the stalled economy. Taken into account the combination of the various plans to revive the credit market and the direct stimulus to the economy, I would expect the US economy to be back to 2007 levels by the end of this year if not sooner.

Leo Cecchini
April, 2009