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Special Economic Report

Med-Jones-Financial-Crisis-Report-2008-2009

The Expert Who Predicted Financial Crisis | Economic Crisis | Recession  | Med Jones, The Expert Who Predicted Financial Crisis | Economic Crisis | Recession
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Assessing Obama's Economic Policies

An exclusive interview with Med Jones,
the expert who predicted the financial crisis

 

 

CEO Q > Why did the world’s top economists and even noble prize winners miss the crisis?

Med Jones > Experts missed the crisis because of three reasons (1) wrong economic decision models (2) groupthink mindset and (3) the lack of information and misinformation in the media. In such an environment, few have the insight and the courage to tell it as it is, and risk being ridiculed by other industry experts. It is not enough to know the facts, what is needed is the ability to see the big global picture and understand the dynamic interplay of key economic forces. Also, just because a person gets an award in one area of economic science it does not make him/her a master of that domain. Economists need to redefine their profession, schools need to redefine their curriculums, and the media needs to redefine its reporting sources and processes.

From a critical thinking perspective, there are two main reasons that caused mainstream economists and Wall Street media to miss the financial crisis of 2008. The first is the NIH (Not Invented Here) bias, which is an organizational phenomenon manifested as an unwillingness to adopt an idea because it originates from unknown outsiders. It is a form of social cognition bias that leads to errors in group judgments, such as missing out on new opportunities or risks. The second reason is a cognition bias known as the Confirmation Bias, which is the tendency to search for, filter, or interpret information in a way that confirms existing preconceptions. The Confirmation Bias is recognized as an individual cognition bias, but when met with NIH bias it appears to develop into a social bias very similar to the Groupthink syndrome. 

CEO Q > Who is responsible for this crisis?

Med Jones > The government and politicians from both parties, the Federal Reserve and the financial sector. Greed, lack of regulation, lack of information and misinformation in the media, incompetence, lack of transparency, and lack of corporate governance, are all factors that contributed to the state that we are in.

CEO Q > That is a very hard criticism of the government and the Federal Reserve?

Med Jones > Most of the global investment firms and stock markets follow the US Economic Indicators. Markets can gain and lose 10-20 % of their value based on the statements of the Federal Reserve Chairman and the Treasury Secretary. Throughout 2007 and half of 2008, Bernanke, the Fed Chairman, repeatedly stated that the economy was strong until it crashed in September 2008. Henry Paulson, the ex Treasury Secretary, said the US financial system was healthy, only a few months before its collapse. Why should you believe them now? If they knew what was going on, then they were participating in propaganda. If they didn’t know then it is simply incompetence. Which one is worse?

Tim Geithner, the current Treasury Secretary claims that the US financial institutions are healthy and that they all passed the 'stress test'. At the same time he agrees with his German counterpart not to release any information that could potentially hurt the banks. These anecdotal examples are proof that they are either hiding information from the markets or do not fully understands what is happening. Government officials should be accountable for their statements and actions. They should say it as it is and not try to manipulate the sentiments of the investors.

Did you know that Allen Greenspan, the previous Fed Chairman who until 2007 was considered the world’s top economist, looks at oddball indicators such as men’s underwear sales to determine the economic health and trends while at the same time, in his assessment of the health of US economy, he ignored the most important fundamentals such at debt-to-GDP ratio, investment and trade-deficits, the risk of over extended-leverage, and the role of prolonged low-interest rates in the formation of housing and financial bubbles. He even stated that he did not know there was so much gambling in the financial markets.

As you stated, except for a handful people, no mainstream economist from any government or any Ivy league university predicted the crisis. And when a few of us did, we were either ignored or ridiculed. So, do you think they know what they are doing now? At best they are learning now through very expensive trial and error.

It has been proven that the existing economic forecast and investment decision models used by top government officials, market analysts and financial firms are flawed. They lack on risk management, make faulty assumptions, and/or put more weight on less relevant decision criteria than on the core fundamentals. They have misled investors and policy makers as often as they have helped them. The lessons here are:

  • Investors should not rely too much on economists who missed the crisis. They rarely agree on anything, anyway.
  • Economists need to redefine their profession and decision making models.
  • The government must redefine the qualifications of the Federal Reserve Chairman, the Treasury Secretary and their teams.
  • The government should audit their Central Banks or the Federal Reserve.

The economy will recover despite Bush’s and Obama’s policies not because of them.

 

CEO Q > To be fair, you have to give credit to the Federal Reserve Chairman and Treasury Secretary for saving the economy from total collapse!

Med Jones > The banks and the companies that were bailed out will give them credit. Their policies saved some companies at the expense of others and the price is yet to be paid by all of us. Henry Paulson, the ex-Treasury secretary, was the architect of the financial bailout during the Bush Administration. He is the ex-CEO of Goldman Sachs, he bailed out Goldman Sachs with $10B while letting their main competitor, Lehman Brothers, go down. Wall Street is the largest contributor to the Obama campaign with Goldman Sachs, Citigroup, JPMorgan Chase, UBS, and Morgan Stanley as the top donors. They are the largest beneficiaries of the bailout money.

The top aid of Tim Geithner’s- the current Treasury Secretary under Obama Administration, is Mark Patterson- a Goldman Sachs lobbyist. He oversees the government’s $700 billion financial bailout program. Patterson’s appointment is a clear violation of Obama’s promise to bar lobbyists from his government. Ask the government for the details of the bailout program, where did the money go? No one will or can tell you.

Markets cannot function effectively and efficiently without independent policies, reliable and transparent information. Investors need to lobby their government representatives for unified regulations to protect local and global investors against conflict of interest via more disclosures, transparency, competency, and accountability acts, especially for government appointed officials.

CEO Q > Do you think this crisis was the result of a conspiracy designed by some of the elites in Washington, the Federal Reserve, and the Financial Sector?

Med Jones > I do not believe it was a conspiracy; no one group of people is powerful enough to control the results of such crisis. However, I have no doubt that there was a concerted effort by the industry elite and their lobbies. They used the period of confusion and lack of information during the market shock to scare the politicians to pass laws that let the tax payers pay for their mistakes; they used the fear and confusion that happened right after a mass shock to pass their agendas. This happened right after September 11 to push for the Iraq war by the military industrial complex and during the current financial crisis to push for the bailouts by Wall Street firms.

A mass shock is a well known opportunity for passing unpopular agendas to serve special interests groups. Even politicians with good intentions cannot do much about what they do not know. What do you expect the government to do when their advisors tell them, "we will have to bailout XYZ or we risk total collapse of the US economy and social unrest". But now the fear has subsided and the picture is clearer.

The real question will be how the government officials will handle the economy and the financial sectors. Will they just look the other way or will they take back the control. By the way, this is not only true in the US, this power struggle is more or less the same all over the world.

 

They used the fear and confusion that happen right after a mass shock to pass their bailout agenda

 

CEO Q > What do you think is the solution?

Med Jones > The solution is multi-dimensional; governance, transparency, competency, and accountability should be at the heart of new and comprehensive financial and political reforms. The Federal Reserve must be audited and must report to the Congress. Or a better solution is for the government to bypass the banks and print and lend money directly to home and business owners, thus eliminating the middle man and providing lower cost of money directly to the economy and stabilizing the real estate market and helping struggling businesses. But we all know that is unlikely to happen in DC because of the strong financial lobbies.

CEO Q > So you are for strong market regulations?

Med Jones > The prevailing view that free markets are self-regulating is false. Free market economists relied on internal risk management models but nobody listened to risk managers when the risk takers were making all the profits in the banks.

Markets are imperfect and regulators are also imperfect: they’re also subject to decision errors and political influences. Market over-regulation can kill growth. You have to recognize that markets are inherently unstable. So, how best to avoid risk? You have to become an informed investor and focus on the fundamentals. This is the best risk management strategy. The government can help with disclosure and accountability acts.

CEO Q > What about the regulation of executive compensation?

Med Jones > Markets taught us that a CEO can destroy a global multi-billion dollar company and still leave with hundreds of millions of dollars in compensation. The dotcom and the subprime bubbles made a medium percentage of managers and brokers very wealthy, while destroying the businesses, the retirement funds, investors’ wealth and the lives of many hardworking people.

To understand the culture of Wall Street, the CEO of Merrill Lynch, John Thain, lost $27 Billion and paid $4 Billion in bonuses to its management. According to news reports, after the bailout, he spent $1.2 million on office decoration with $1,400 for a trash can. So much for ethics and respect of the investors’ agency, and so much for establishing confidence in the financial system and government tracking of bailout money. Is there a greater anecdote for the dysfunction of our investment industry and regulations?

 

 

Free markets are not self-regulating

 

 

CEOs, Board of Directors, and Investment Managers are agents of the investors. The current lack of regulations allow the abuse of the agency by some agents for short term personal gains. There is a need for regulating the agency relationship. As investors we have to ask ourselves why we shouldn’t have full disclosure on the fees of mutual funds and their proxy voting records.

I’m not saying that all agents are bad; in fact many of them are trustworthy. We need protection against the bad ones. I do not advocate a cap on investment advisors’ fees or CEO compensation. What I’m saying is that (internally) compensation should be tied to the right set of performance parameters and (publicly) reporting should have more disclosures to protect the investors.

Investors should at least get involved through shareholders’ voting for the selection and the compensation of the leadership and board of governance in the companies that they invest in. Knowing how boards function, I can tell you that they do not always work for the best interest of the investors.

CEO Q > What is the best strategy to rescue the U.S. economy?

Med Jones > The answer is still the same. I said before and I’m saying it again. The financial rescue plan or the economic stimulus package did soften the fall but it will not correct the economy, it will only delay the correction, and therefore, the real recovery too. The most cost effective and quickest method to stimulate the U.S. economy is to support job creation through investing in the creation of new businesses and innovation development. U.S. Census Bureau statistics show that 98 percent of all U.S. firms have less than 100 employees. These 27 million small businesses create over 85 percent of all new jobs and employ over 56 percent of all private sector workers. The main focus of development programs should be innovation development, export and employment support through enterprise creation and growth. I said this before back in 2008. This solution would be much less of a burden to the taxpayers, it can be implemented without new legislation, and would have a much faster positive impact on the economy. It can be based on existing federal programs designed to direct federal funds to small businesses. The medium Business Reauthorization Act of 1997 stipulates that a minimum of 23 percent of all federal prime and sub-contracts be awarded to small businesses.

 

 

Boards of Directors do not always
work for the best interest of the investors.

 

 

Oversight is critical to the success of the implementation of any rescue program. Effective and efficient program execution is necessary to avoid waste, fraud, and the abuse of loopholes to divert these funds to special interest groups.

If the objective of President Obama is to lead the economic recovery through the middle class, then the job creation initiative through small business and innovation development, would be hitting three birds with one stone. The birds are; sustainable job creation, middle class support, and increasing U.S. businesses competitiveness through innovation development. This initiative would have a significant and immediate positive impact on the national economy.

The European Commission has invested hundreds of billions of dollars in innovation and enterprise creation since 2002. I personally was on the steering board of 3 innovation EU research consortiums from 2002-2006. I saw the impact of these investments first-hand. The result of the EU innovation support policies is that they quantum-leaped U.S. companies in Telecom, Aerospace, and several other industries. The Euro today is almost 50% more valuable than the US dollar, thanks in part to their strong industries.

CEO Q > What solutions would you recommend?

Med Jones > The U.S. economic problems are multidimensional, therefore the solution should address all the dimensions of the problems, with careful balance between short-term and long-term impact. Economists from different schools and political parties can argue for opposing options. Each option has a benefit and a price to pay. In my opinion, there are several ethical issues for raising taxes on hardworking citizens to pay for the bailout of a group of investors, managers and companies who gambled with their money and made bad decisions. The fallout from subsidizing bad behavior can be serious, but ethics and politics are not the subject of this discussion.

In order to succeed, the solution should be pragmatic, not ideological. The solution should not be led by either the liberal or the conservative socioeconomic schools. It is not reasonable to try to avoid market correction. Instead, the policies should focus on making the recovery faster, to enhance the competitiveness of U.S. industries, and to improve the business environment to attract more investments.

The following is a partial list of strategies to establish trust in the US economy and reverse the cycle:

  • Let free markets correct themselves, while at the same time have proactive and rapid response policies.
  • The purpose of intervention should not be to favor one group over the other or to control the markets. The goal should be to minimize speculation and market shocks, thus maintaining a healthy business and investment environment which supports the global competitiveness of national industries and businesses.

Investments:

  • Rather than bailing out the failed banks with tax payers money and assuming toxic assets, establish a government bank to lend directly with low interest rates to home and business owners. This will stabilize the housing markets and prevent bankruptcy and the credit crunch.
  • Increase FDIC cap from $100K to $300K, this will establish trust in the banking systems.
  • Provide tax holidays for new industries.
  • Create tax-free zones for exports and tourism.
  • Lower interest rates and tax rates for smaller and new businesses and foreign investments. This is important in order to attract capital, start new companies and create new jobs.

Governance:

  • Regulate to protect investors and consumers, but avoid over-regulation to slow or kill growth.
  • Investment and credit rating agencies should answer to investors, not bankers, like the auditors they should have liabilities for bad performance.
  • Raise banks’ mandatory reserves.
  • Regulate to limit speculative-gambling investing.
  • Reduce the cost of compliance and simplify Sarbanes-Oxley. What is needed is accountability not bureaucracy.

Political Reforms:

  • Keep state and federal spending in check. Reduce government size and expenses drastically.
  • Change income tax to flat sales tax or value added tax (VAT). This will encourage investments and discourage consumerism.
  • Change the way the government does business by creating performance-based job functions linked to business metrics and socioeconomic scorecards similar to the private sector with the focus on effectiveness, efficiency and competitiveness.
  • Conduct public performance reviews of Representatives and Senators. Elections and re-elections should be tied to detailed states and national metrics to minimize wasteful spending and the abuse of national resources by special interest groups.
  • Instituting term limits on Congress and the Senate would reduce the abuse of power and the long-term access of lobbyists to politicians. Or limit campaigns funding to individuals and smaller amounts.
  • Audit the Federal Reserve.
  • Reduce healthcare system costs. The high costs of the healthcare system come from 3 areas: labor, insurance and pharmaceuticals. The best way to overcome them is (1) open immigration policies for doctors and nurses to improve the healthcare labor supply/demand ratio, (2) limit compensation caps on lawsuits (3) open the markets to global competition by importing medicine and technology from other countries (4) regulate the Insurance Industry (5) reduce patents duration and empower generic drugs. The worst 3 things a government can do are to (a) keep the status quo (b) raise taxes to fund a universal healthcare system.
  • Reduce educational system costs and accreditation bureaucracy, allowing the private sector and online programs to compete more effectively.
  • There are other options such as forming a North American Union or opening immigration doors to more productive professions, but those are politically difficult options.

 

The worst two things a government can do are to:
(a) keep the status quo
(b) raise taxes to fund a universal healthcare system

 

Continue the Interview at:

 

 

 

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About Med Jones

Med Jones is the president of International Institute of Management. He is recognized as one of the few experts who predicted the US financial and economic crises of 2008. In January 2007, he challenged the US President's State of the Union Address, Federal Reserve Chairman and mainstream economists. The original warnings and predictions can be found at:

Jones is a non-partisan technocrat. He can be reached at medjones.com

 

 

 

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