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Sunday, November 27, 2016

Castro is Dead but Politics Still Reign

by Roy C. Smith

Fidel is dead at 90; Raul still rules. When will things really start to change in Cuba?

Fidel Castro has been a world celebrity since leading his revolutionary army into the City of Havana in 1959 and subsequently ruling the country as a Communist state to the great annoyance of the United States. Under a mantle of “Socialismo,” Fidel improved public education and health care under a 30-year satellite arrangement with the Soviet Union, but left Cuba, once the jewel of the Caribbean, as a totalitarian economic ruin.

Fidel became ill a few years ago and turned power over to his brother, Raul, now 85, who is the less flamboyant and more practical of the two. After the USSR voted itself out of business in 1991, Cuba was left on its own and nearly starved until rescued a second time by another socialist country – Venezuela – which exchanged valuable oil subsidies for the services of Cuban doctors. Now Venezuela is on the verge of collapse, and Raul knows that any future that the Castro’s Cuba may have will depend on economic reforms achieved through a vibrant private sector.

So, Raul undertook several economic reforms even before the announcement of “normalization” of relations by Barack Obama and Raul Castro in December 2014. But the reforms were cautious and limited to the retail sector. No big businesses from abroad would be invited in (with a few exceptions for non-US companies in the hotel and port-management businesses).

Since then two years have passed and not much has happened. 300,000 more American tourists have visited the island, and remittances from Cubans living abroad have increased significantly, but the “Embargo” of US-Cuban commercial activity, constituted by a series of legislative actions beginning in the 1960s, remains in place and Cuba has done little to reform its economic practices to attract the transformational foreign direct investment that it badly needs.

Raul is afraid that if he moves too fast to free things up, Socialismo will be swept away just as Communism was in Russia, Eastern Europe, and China. Indeed, the main argument in the US for repealing the embargo is to effect regime change through economic means that political isolation could not accomplish.

There are those in Cuba who would speed things up, particularly in the agricultural sector (Cuba imports 70% of its food, despite large quantities of arable but uncultivated land), but in industrial sectors also. But as long as Raul breathes, even after he is replaced by a successor in 2018, he will determine the pace of change. Presently it is pretty slow.

And there are those in America who believe Raul is as ruthless and brutal a dictator as Fidel, and resist doing anything that will ease the economic pressure on Cuba that the embargo provides. They say that the regime change they are seeking will occur because of the embargo, and the Castro’s should not be rewarded by repealing it. The Republican majority in Congress has favored retaining the embargo, insisting that it cannot be lifted until Cuba becomes more democratic and agrees to settle claims for property seized after the revolution. Reince Priebus, Mr. Trump’s chief of staff, said after Fidel’s death was reporte, that the President-elect was inclined to reverse Mr. Obama’s Cuban initiatives unless more progress was seen on the Cuban side.

As we are becoming more accustomed to Mr. Trump, we are learning that everything is negotiable. The Deal King has simply announced his opening position, which he expects will lead to some give and take, followed by an announcement of an improved agreement.

But, maybe things will move along anyway. Both sides are under considerable pressure from public opinion to put the past behind and open things up. Cuban can do some of this by encouraging major investments by European or Asian companies not subject to the embargo – there is much to do on many fronts. If this happens, US companies will lobby fiercely for repeal of the embargo so they don’t lose out.

Still the Cuban market is small, Cuba has no money to modernize it, and investors still see plenty of political risk. In the long run, it is hard to know whether the new Cuba will look like Singapore, another island entrepot economy servicing its neighbors, or Puerto Rico, an economy that has never lived up to its golden potential when becoming a US territory (entitled to citizenship) at the same time that Cuba became independent in 1902.

Tuesday, November 15, 2016

What Will Mr. Trump Do With the Banks?


By Roy C. Smith

Based on comments last week by Donald Trump, “dismantling” the Dodd-Frank Act of 2010 will be among the first things attempted. What would that mean?

Trump’s position on banks has never been one to encourage them. He has railed against bailouts and the easy treatment of bankers. He is for breaking up the banks and agreed with Senator Bernie Sanders that the Glass-Steagall Act of 1933, that forced a separation between the banking and securities businesses, should be restored.
But he was never a supporter of Dodd-Frank. It was too much regulation, too complex, too expensive and too stifling of banks’ important role in extending credit to business. The Republican Party Platform that he ran on (and largely dictated) called for Dodd-Frank to be repealed and Glass-Steagall reintroduce
The argument supporting repeal is that Dodd-Frank has proven to be vastly more complex and expensive than expected ($36 billion to date, according to one estimate) and is no longer necessary now that the capital adequacy rules of Basel III have come into effect and the Federal Reserve has developed its stress tests and other rules to tighten its control over the banks.
Large US banks also argue that laws that restrict only US banks, but not foreign banks, injure US banks’ ability to compete globally. Smaller banks argue that they had nothing to do with the crisis, and the many constraints of Dodd-Frank shouldn’t extend to them.
Dodd-Frank would have to be replaced by something – Americans are still angry at the banks and distrustful of them. So why not Glass-Steagall? It was simple (only 37 pages long), inexpensive, and provided for stability and safety of the US banking system for 66 years? A Trumpian “deal” swapping Glass-Steagall for Dodd-Frank, which would also involve breaking up the banks, brilliantly delivers three campaign promises in one stroke.
Could Trump get such a deal through Congress? Probably.
Dodd-Frank passed in 2010 in the Senate by a vote of 59-39; the filibuster rule requiring 60 votes in the Senate was not invoked even though the Republicans strongly opposed it. Today, Republicans have a majority in both houses of Congress that probably would support a swap if asked to do so.
Will Trump do this? Hard to say.
Republican Jeb Hensarling (R, Texas) is chairman of the House Financial Services Committee, and someone who has been mentioned recently as a potential Treasury Secretary. He is an arch foe of Dodd-Frank, and the author last June of an alternative approach which gives banks a choice – they can elect to operate in a much less regulated environment if they have the highest so-called Camel ratings (strength measures by bank supervisors) and maintain equity capital worth at least 10% of total bank assets, a much higher requirement than Basel III.
It is not clear what regulatory regime would apply to those not opting out of it if Dodd-Frank were repealed, or if the option element would be retained. Nor is it clear that large, systemically important banks would be better off under his plan than keeping things as they are.
Also, there is the advice of Paul Atkins to be considered. He is a respected former SEC commissioner and a Trump transition team member for financial regulation. Indications are that he would prefer dismantling over repeal, i.e., amending Dodd-Frank to shed it of its most objectionable parts, but keeping the structure that everyone has been working with for the past six years in place.
This, however, could be a huge undertaking. The 2,300-page law has sixteen “titles” covering a wide variety of regulatory activities that have required the writing of 390 new regulations by the several different federal agencies. These alone have so far produced 22,000 additional pages of new rules, and there are still some yet to come. Opening this can of worms up to piecemeal amendment (and hundreds of lobbyists) would be very messy and time consuming at best. Still, it may be the preferred way experienced officials like Adkins would like to proceed with the issue.
Will they listen to Adkins? Maybe not.
There will be pressure from the political side to just dump Dodd-Frank and start over. That would eliminate the hated (by Republicans) Consumer Financial Protection Bureau, and the Financial Stability Oversight Council, living wills, the Volcker Rule, and many other provisions. It would also make uncertain all the rules written by regulatory agencies under the law, but it would certainly shake things up.
A swap deal will certainly be tempting for Trump’s first bold legislative thump.
How would we cope with the re-imposition of Glass-Steagall?
The law would have to be modernised (e.g., do “securities” include government obligations, tradable bank loans and derivatives?) but it could be done. But, only the largest US banks (five or six) would be affected meaningfully. They would have to spin off their investment banking subsidiaries as they did in the 1930s. Most of the banks would object to this strenuously, but at least two of them, Citigroup and Bank of America, longtime too-big-to-manage underperformers trading well below book value, would be better off breaking up. Neither are likely to do so on their own.
If the banks were to spin off their investment banking units, like Lehman Brothers was spun off from American Express in 1994 after a disastrously unsuccessful merger was finally acknowledged as such, the US investment banking industry would suddenly bounce back to five highly-focused competitors: Newly relaunched Salomon Brothers, Merrill Lynch and JP Morgan units would be competing head-to-head again with Goldman Sachs and Morgan Stanley (shorn of their Bank Holding Company status), and Citibank, Chase Manhattan and Bank of America could go back to competing with Wells Fargo for national commercial and retail banking prominence.
The blunt force of politics is not usually the best way for economic policy to be made, but maybe this time it is.
From eFinancial News, Nov. 15, 2016

Wednesday, November 9, 2016

A Stunning Result, but Wait and See

By Roy C. Smith

It’s a bigger shock than Brexit. The polls had it totally wrong, with bookmakers giving odds of 83% for a Clinton victory a day before the election. A nationwide wave of unseen Republican support appeared unexpectedly and elected the most negatively regarded and controversial candidate to run for the office in modern times.

The result was not only surprising, it turned out to be worse than any of the so-called elite establishment types regarded as their nightmare scenario: Donald Trump not only becomes president, but Republicans retain their majorities in the House of Representatives and the Senate, giving the new administration legislative powers to pass all sorts of controversial measures promised during the campaign.

Markets will go haywire for a while because of the uncertainties. It is hard to guess where economic policies and outcomes might end up, but as often happens when jolts like this occur, markets overdo it. In fact, as unappealing as Mr. Trump may be to some, his actions could be beneficial to the economy and cause markets to give him another look.

First, Mr. Trump’s domestic economic policies are not too different from those offered by Speaker of the House of Representatives Paul Ryan, whose “Better Way” conservative approach to tax reform and other economic measures are essentially reasonable in a Ronald Reagan sort of way. Such policies, like Reagan’s in 1981, might very well provide the boost the slow-growth economy of the Obama years needs. Senate Democrats may try to force a 60% vote to pass these plans, but popular presidents can often find ways to get the few missing votes they need.

Second, Mr. Trump’s promise to undo much of the Obama era regulation by executive order – which has been considerable in energy, environmental, financial and pharmaceutical sectors -- would be very welcome in business sectors.

Third, Mr. Trump’s approach to trade and immigration may not result in the dire outcomes the campaign has led us to expect. He is likely to force a confrontation with Mexico on issues related to NAFTA and “the Wall” (i.e., the border), and with China on imports, but these will lead to negotiations to gain some improvement in the status quo. Richard Nixon did the same when he imposed a 10% tariff on Japanese imports in 1973 that ended in some voluntary quotas and a victory for American workers. Nixon said that being seen as unpredictable increased his bargaining power. Trump supporters believe his proactive negotiating style learned in the take-no-prisoners New York real estate markets is his true comparative advantage. It’s all about deals; if something doesn’t work, try something else.

Mr. Trump is also likely to get his nomination for the vacant Supreme Court position approved, bringing the court back to nine justices. The list of nominees he has already put forward is not really controversial at all. But, Mr. Trump’s intention to “repeal and replace” the Affordable Care Act (Obamacare) is unlikely to happen soon. There is no replacement plan as yet, and the Act is popular enough to make getting the 60 votes in the Senate unlikely.

Of course there is a lot to worry about with Mr. Trump in the most powerful office in the world, starting with who his advisers will be and whether he will listen to them. He likes powerful personalities like Chris Christie, the New Jersey governor who chairs his transition committee, Rudolf Giuliani, a former mayor of New York, and Newt Gingrich, a former Speaker of the House of Representatives. They were all made in the Trump mold – brash, bullying and confrontational, but they are people who got things done. Though Mr. Trump makes a lot of his own decisions without relying on others very much, these largely have to do with managing his own image and persona. He has learned to delegate the rest of what he has to look after to competent, if low visibility associates.

The list of names he has presented so far as potential cabinet members or senior advisers contains very few individuals (beyond the three mentioned) with experience of high level public service. Up until now, many of those with the necessary skills and experience have been reluctant to be associated with Mr. Trump, but having won, he is in a much better position to attract the talent for his administration that he will need.

In the end, Mr. Trump will be confined by the checks and balances of the American constitution, and the standards of presidential conduct that the American public expects. He has been given an opportunity to serve his country that few ever receive, an opportunity that cannot succeed without public support, which he will have to earn the hard way – by delivering results sufficient to retain the support. He has invoked the insatiable gods of populism to get elected, and will have to satisfy them once in office.

At this point neither we nor the gods know what we have got on our hands. Democracies can produce unexpected leaders when electorates are afraid, unhappy or excited.  Some of those leaders came from backgrounds offering no training for Presidential office at all, including Jimmy Carter, Ronald Reagan, Bill Clinton, George W. Bush and Barack Obama and we survived them. Today, we are giving Donald Trump, the first businessman to be elected president since 1928, a chance to see what he can do. So let’s wait and see.