Smith Faculty Opinion Article	December 20, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Business as Usual: the Energy Bill, Subprime Mess and Recession Watch

The stock market remains unsettled, as the nations economic problems grow. Washington from the White House to Capitol Hill to the Federal Reserve gives us lots of bustle but no truly comforting action.

The Democrats pushed through an energy bill that will likely leave the nation in the desperate grasp of Middle East oil exporters. Wall Street banks continue to sell out their shareholders to Chinese and Middle East investors to pay for their big bonuses. The Federal Reserve cracks down on predatory lending on Main Street, when the real crooks work on Wall Street. The recession watch continues.

Working at a university only a subway ride from the seats of political power gives this observer a new appreciation for the apathy that accelerates the decline of empire. Nero was an amateur fiddler compared to the musicians in Washington serenading the nation into complacency.

Energy Bill

The Democrats in Congress pushed through the first increase in U.S. automobile mileage standards in 32 years.

Dont cheer loudly.

The 35 mile-per-gallon standard to be achieved by 2020 is far less than what is possible. Along with new light bulb and appliance standards, the nations energy use will be cut by 8 percent at some distant moment, likely, beyond my lifetime.

The bill also requires the production of about 2.4 million barrels a day of ethanol, and overall the energy bill could reduce U.S. petroleum consumption by 4 million barrels a day by 2030. Over the last 23 years, petroleum consumption has increased by about 5.5 million barrels a day, despite improvements in mileage standards, automobile and appliance technology, and conservation.

Being optimistic, in 2030 we will be just as dependent on imported oil as before. Factor in falling production from U.S. oil fields, the situation gets worse.

We could do a lot better. More hybrids, electric vehicles, lighter vehicles, better furnaces, and more nuclear power are attainable, and the Chinese are likely to turn in those directions in greater force than we do. Then we can buy our cars from the Middle Kingdom just like our coffee makers.

Got to love Washingtons unquenchable thirst for breakneck change!

Subprime Mess

Chinas sovereign investment fund will take a $5 billion stake in Morgan Stanley. Morgan joins Citigroup, UBS and others. Having sold financial alchemy to investors and shareholders in the form of engineered securities, they must now seek foreign funds to restore their capital.

At the most fundamental level, to justify huge compensation packages, Wall Street bankers and private equity gurus have been overvaluing mortgage-backed bonds, auto loans, and other securities that finance private equity acquisitions.

The culpability of bond rating agencies in these shenanigans is revealed by the fact that in just one day Standard & Poors was forced to cut its rating of one of the major insurers of bonds, ACA Financial Guaranty Corporation, from A to CCC.

One is left to ponder what new data S&P econometricians unearthed to warrant such a dramatic and sudden recalibration? Sadly, more downgrades are likely to follow as the bond insurance industry may fail.

The party line on Wall Street is that the subprime mess was a one time lapse. At S&P some adjustments in the econometric models that determine the risk of default will be needed.

If all that is true, why cant outfits like Cerberus and their bankers unload the bonds that are needed to finance its shrewd takeover of Chrysler? Why do bond investors no longer trust the promises of private equity wizards like John Snow and buy more of their paper?

That is the crisis of confidence in Americas capital markets. The meltdown threatening the bond market from a wholesale failure of bond insurers is the modern analog of a 1930s run on the bank. Just much worse.

Back in Washington, the Federal Reserve cracked down on predatory lending practices of mortgage writers. That is a necessary exercise, but the real game is on Wall Street. Neither Ben Bernanke nor Henry Paulson seem to grasp that or have the stomach to take on the big, powerful and corrupt that eat cake and drink champagne in the Empire State.

Hence, if Wall Street is to reform, it must reform itself. The man of the hour would have to be new Citigroup CEO Vikram Pandit, who promises a top down clean up where he works. However, have you heard him talking about miscalibrated compensation and perverse incentives on Wall Street?

I also dont know many alcoholics volunteering to attend their first AA meeting.

By the time Mr. Pandit is finished cleaning up Citigroup, you can be darn sure all the redundant mail room clerks will be gone, but so too will be another big chunk of shareholder equity, sold to Beijing, the Saudi Royal family and other guardians of western capitalism and democratic values.

Recession Watch

Despite the profound misjudgment of the nations bankers and financial regulators, the U.S. economy remains vibrant and has some chance of avoiding a recession. November retail sales and industrial production numbers were encouraging. Although the October and November robust gains in jobs are likely to be revised down, the nations payrolls and wage income keep growing.

A weaker dollar against the euro has yielded a modest gain in non-petroleum exports equal to about $95 billion or 0.7 percent of GDP. These figures are so small because the dollar remains overvalued against the Chinese yuan. Henry Paulson does not have the stomach to endorse U.S. actions to combat Beijings $400 billion subsidies on foreign purchases of yuan that prop up Chinese exports and shutter U.S. factories.

Hence, to avoid recession, Americans are going to have to keep on spending. This will require borrowing at much higher rates on credit cards, now that easy home mortgages are gone. On the face of things, economists would say that is not likely but most economists dont have much of a life and dont go out to the malls. The parking lots are filling again, retail sales are up, and cash registers are jingling.

When Visa and Master Card fail under the weight of non payments, the Chinese sovereign debt fund can buy the rest of Citigroup. Given the way Mr. Pandit and his pals behave, they deserve such beneficent employers.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.