Investing, Markets and Government: Of Finance and The Fed

Brucenomics: why I’m writing this blog

Most active investors eventually become interested in “economics.” They believe they can see how the economy affects the financial market they are trying to make money in. I’m an investor who is interested the opposite thing. I want most to understand how investing and investments affect the economy, and how in turn the economy affects each of us, especially those who are self-employed.

Even though I have a Masters in Economics from the University of Wisconsin, I’m a babe in the woods when it comes to understanding the connections between investing and economics. But here goes one brief observation and an example.

Forecasters and Fixers

Before you listen to anyone’s “forecasts” about markets or the economy, especially to the rosy ones, think again. There’s no guarantee the United States economy will ever return to what it was. The financial crisis has exacerbated global shifts in wealth. It’s even possible that the economic indicators everyone relies on so much to predict a return to to the way things were may not be accurate anymore.

And before your accept proposals for fixing this or that aspect of government, just recall how little anyone really knows about how these things work. There’s a reason for that. It’s all very complicated and interconnected.

For example, there are those now who want to get the Federal Reserve under more Congressional scrutiny. Could they be people who want to weaken the Fed in order to shrink the size of the federal government? Indeed they could be. Ron Paul is one example.

And then there are those who want to increase the powers of the SEC and other federal regulatory bodies. But stop and ask yourself, aren’t these the same agencies, even the very same people, who just missed the boat? Mary Shapiro, 29th Chair of the SEC, for example, was the one who investigated Bernard Madoff and didn’t smell a whiff of anything wrong.

Besides the fact that the horse is out of the barn already, here’s one core issue I see with all this rage to regulate government agencies right now.

If we have strong congressional oversight of administrative agency officials, then won’t policy for those agencies just keep swinging back and forth every time elections put a new party in power? And what about the immense power of lobbyists who are providing money and pressure in Washington?

I spent about a year in federal civil service. It was all I could stand. Since then, the closest thing I’ve experienced to working in our federal government is working in our state university systems. I spent fifteen years of my life working as a librarian in two of them.

The University of Wisconsin system seemed well organized and fairly rational. But the humungous University of California system, and UC Berkeley in particular, is the most labyrinthine, political, nonprofit “corporation” you could ever imagine.

In the UC system whole departments of study disappear overnight or find themselves relegated to the worst building on campus. Similarly, in Washington, departments, offices, and bureaus of this or that regularly disappear or are eviscerated. Federal and state civil servants may have “security,” but their actual work and working conditions sure don’t.

To me there seems no way to get any kind of stability in a workplace when politics dominates an organization.

So what about letting “the market” run the financial system instead of politics? First off, there isn’t any such thing as “the market.” There are many financial markets not only in the U.S., but also in the world, and they have complicated interrelationships and strong effects on each other and on our government.

Investing, Markets, and Government

In the news you’ll see all kinds of contradictory “forecasts” of where “the market” is going right now. No one can agree on whether “bull” or “bear” is the word. So let’s clarify the issues. When they say “the market” they usually mean equities, and more specifically, they mean corporate stocks.

But we all know there are other kinds of financial markets: bond markets (state, municipal, and corporate), commodity markets (from corn to diamonds), money markets, currency markets, mortgage markets (residential and commercial), and lots of specialty markets like art and auction markets.

In addition, the financial crisis uncovered a whole host of previously little-known  “off-exchange markets” for rich investors. These market investments bypass traditional exchanges for stocks, commodities, and currencies like The New York Stock Exchange, Chicago Board of Trade, or Forex. I’ve been writing about these unregulated off-exchange investments for almost a year now, and I’ll be posting more about them on this blog.

So here’s my example. The news is full of stories about the U.S. government and how it’s handling the financial crisis among the banks.

The first problem for understanding what the news is saying is that there are two kinds of banks: regular “banks” like the ones where most of us make deposits and write checks, and “investment banks.”

The latter type of banks include the ones who spectacularly failed, e.g., Lehman Brothers, or were bought out, e.g., Bear Stearns and Merrill Lynch, or are being raked over the coals for surviving this past year, e.g., Goldman Sachs.

One thing that gets confusing is that both institutions are referred to as “banks” in the news. But they aren’t the same: the rules for each are not the same, and they don’t even serve the same functions or types of customers.

Investment banks do a range of things most regular banks don’t do. One of them is to sell “securitized” loans to “institutional investors.” Institutional investors are big investors such as mutual funds, private pension funds, and public employee retirement plans. Securitized loan investments collapsed during the financial crises.

Likewise many institutional funds’ investments in and based on commercial real estate developments also tanked and are still in the toilet. California’s employee pension fund, Calpers, is a notable example of an institutional fund that got burned badly by the financial crisis.

I suspect that hidden “dark pool” (private exchange) and off-exchange investments sold by investment banks and other large lenders are affecting corporations, the stock market, and the economy much more than what happened with regular banks and their customers.

In short, there are actually two markets when it comes to investing: the institutional-investor market and the individual-investor market. Clearly the biggest force affecting the economy is the institutional-investor market. Investment banks and other “shadow banking” institutions, such as insurance companies and hedge or private equity funds, serve investors in this market.

Thus, to my eye at this point it seems that the FDIC is focused largely on regular banks and their customers. The Treasury Department and the SEC seem to be most focused on the investment banks, insurance companies, and off-exchange investors and their customers.

The Federal Reserve seems to have a finger in every pie, which is perhaps why conservatives are targeting it for reform, so we can all return to an era of smaller government and letting the “the market” rule our economy

I’m keeping an open mind, but right now, to me it seems ridiculous to talk about “the market” as either a solo entity or as something separate from “the government.”

All kinds of financial markets as well as all kinds of government entities that regulate and support those markets heavily influence our economy. Under the word “economy” lays fascinating panoply of investments and government activities that can affect each and every one of us in a major way.

For more examples of how various markets and government actions affect us personally, drop by Brucenomics.com again soon.

Copyright © 2009 Nancy K. Humphreys