Saturday, November 5, 2011

Yes, Africa can end poverty…but will we know when it happens?

Africa Can... - End Poverty

Today poverty data are available for almost all countries in the world1.  Because a country's success is measured by the number of people it lifts out of poverty, identifying best performers is a fair exercise only if poverty indicators are fully comparable. One indicator used is the share of the population whose consumption (or income) level is below a nationally defined poverty line or the US 1.25 dollar PPP per day. But even if policy makers and other stakeholders can count on readily available statistics, the poverty numbers should not be taken at face value.


Data are useful if they give us a sense of reality


Poverty data are based on a set of arbitrary assumptions that may lead to erroneous conclusions.

 In the graph, Tanzania ranks among the poorest countries in Sub-Saharan Africa when poverty is defined by the US$1.25 per day threshold, but among the least poor when the national poverty line is the yardstick.


Click on the graph to see it bigger



Each of these indicators is constructed differently. For example, to update its national poverty line in 2007, had Tanzania used its official Consumer Price Index - as Uganda did – instead of a survey-based price index, its poverty headcount would have been 18 percent rather than 33 percent. To compute its poverty line, Uganda assumes that a person needs 3000 kilo calories per day, which is 40 percent higher than the threshold used in Angola or Mozambique. This mechanically leads to higher poverty rates in the first country, keeping everything else constant.


When it comes to the international $1.25 a day poverty headcount, countries measure consumption differently some including durables which others totally exclude2.  Those differences arise from technical decisions that may be driven by data limitations but could also reflect political interference to influence the results.


The heart of the matter


Over the last two decades, most developing countries have launched household surveys to better understand households' consumption patterns and measure poverty3.  This quest for data suffers from the lack of a recent population census (e.g., Madagascar's latest 2010 household survey's sample is based on the 1993 census). Often questionnaires are imported from other contexts without specific context in mind, such as the large fraction of illiterate households who may have difficulties in responding to a lengthy and complex questionnaire (illiteracy rates are as high as 74 percent in Mali or 64 percent in Ethiopia). And if one questionnaire yields poor results, it is often changed substantially in the next survey, with no regard for comparability.


Assuming the collected data are reliable, we still have a problem because measuring poverty involves the construction of (1) a consumption aggregate that captures a household's total consumption, and (2) a poverty line that is the consumption level below which a household is deemed poor.


To be meaningful, a consumption aggregate should include the major spending categories of each household. Yet, in Tanzania, it excludes important expenditure such as health, education and utilities. Some surveys include housing (Angola, Uganda); others don't (Sudan). Related to the measurement of consumption is the adjustment for cost of living differences. Because prices vary across time and locations, consumption has to be normalized using a price index. Here, again practices differ with some countries using prices collected through the survey (unit values or community level prices) and others using national indices, based on prices collected through different surveys of rural and urban markets4.  There is still no consistent methodology to measure consumption across countries and within countries over time.


The second calculation is to define the national poverty line. Again, the methodologies differ widely across countries. The kilo calorie threshold adequate for human functioning on which the food poverty line is anchored varies from 2100 in Angola to 2400 in Malawi and 3000 in Uganda. The reference group used to derive the consumption basket of the poor ranges from the bottom 28% of the population in Sierra Leone to 70% in Angola, while other countries like Malawi choose households in the middle of the consumption distribution. The international poverty lines makes this issue very simple, by just assuming that everyone in the country needs the same amount of money per capita to live on.


In short, there are no two countries in Sub-Saharan Africa whose poverty headcounts can be considered comparable and very few where the headcounts can even be considered comparable over time within the country5
 
Africa's poverty statistics tragedy calls for action


First, consumption and poverty measurement should be harmonized across countries. As with National Accounts, one single approach has to be defined, under the auspices of international institutions, to iron out technical differences6.  This will make comparisons across countries more meaningful and at the same time help minimize political interferences because technical options would be pre-determined to a large extent.


Second, the frequency of data collection for poverty measurement should be increased. One should be able to distinguish between transitory and structural poverty. The financial situation of many households varies significantly from one year to the next. The 2010 household survey in Madagascar was rightly influenced by the unstable political conditions and indicated an increase of 9 percentage points in the poverty rate compared to 20057.  Similarly, climatic conditions can shift poverty levels. Poverty has certainly temporarily risen in the Horn of Africa because of the major drought suffered by these countries. It is frequently argued that periodic surveys are impossible because of their costs (US$1-2 millions). But this figure represents such a marginal share of official aid toward developing countries that they could be funded easily.


Wouldn't it be more persuasively powerful to have reliable, frequent and comparable poverty statistics that properly capture the reality on the ground and would rightly inform policy makers on the impact of the full range of their poverty alleviation policies? Ending the statistical tragedy could go a long way to ending the human tragedy.


"The issue of poverty is not a statistical issue. It is a human issue."
James Wolfensohn


------------------------------------------
Notes:
1. See for example, the World Development indicators, www.worldbank.org

2. This indicator also assumes no difference between rural and urban needs and the national CPI is always used as deflator without taking account regional variations.
3. For the layman, the concept of poverty is simple -- a household is poor if it does not have enough income to make ends meet. This simple idea could however not be applied in reality because income data are very difficult to collect in the developing world. For this reason, economists have developed an alternative approach based on consumption needs: a household who is able to fill its basic needs is therefore out of poverty. This approach is now well accepted worldwide.
4. Consumer Price indexes are usually urban while survey prices also include prices faced by the rural population which, in most countries in Sub-Saharan Africa, represents the majority.
5. This annex shows for few countries the various decisions made for the construction of the consumption aggregate and poverty line.
6. The SHIP initiative of the World Bank Chief Economist for the Africa region is one step towards the right direction.
7. The Government was not recognized by the International community and aid was temporally suspended by most donors.


Bonus file: Differences among african countries when measuring poverty (excel file)

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Kenya rising and Germany falling: A tale of two populations

Africa Can... - End Poverty

Today, October 31, 2011 our planet reaches a new milestone: we are 7 billion people on earth.


In the past, when the world's population was a fraction of what it is today, the expansion of humanity was a source of alarm and many apocalyptic tales. More than 200 years ago, Thomas Malthus, one of the leading scholars and economists at that time predicted that the world would simply run out of food. Then, we were less than one billion people.


Now I want to take you on a journey into the future.

Demography is a great 'time machine' because demographers' predictions have been surprisingly accurate. At a global level, rapid population growth is here to stay, partly because those who will be driving future growth (tomorrow's moms and dads) have already been born. By 2025, the world will already have crossed the 8 billion mark, and a billion more will have been added by 2044. However, the factors behind future population growth will be fundamentally different, and the trend will vary across continents. In the past, population growth was mainly due to increasing numbers of children. Today, fertility is declining but we are still growing, for two reasons. People are living longer.  And thanks to the previous population boom and higher survival rates, there are many more young families having (albeit fewer) kids.


Africa and Europe are at the two extremes of the big geographic shift. Africa, the fastest growing continent, will almost double its population – from some 900 million today to almost 1.8 billion – by 2050. Then the continent will be home to more than 20% of the world's population, up from 10 percent in 1970 and 15 percent today. By contrast, Europe will dramatically lose its population share. As the 'old continent' struggles to maintain a population at the current level of 500 million (albeit ever older than today), Europeans will see their share decline from 18 percent in 1970 to 8 percent by 2030.


These big demographic shifts give me an opportunity to compare two of the countries I know best: my home country Germany and my country of residence Kenya. When I was born in 1971, Germany had 7-times more people than Kenya: 78 Million Germans (who lived in two countries at that time) versus 11 Million Kenyans. Today, Germany is only twice Kenya's size – 82 million compared 41 million. By 2040, both countries will have approximately 74.5 million people. From then on, Kenya will probably remain forever larger than my home country, but not necessarily richer, even though the gap in living standards is likely to narrow.


How is it possible that Kenya will catch up so quickly?


Kenya mirrors Africa's population growth. The population has doubled over the last 25 years, to about 41 million people, and rapid population growth is set to continue. Kenya's population will grow by around 1 million per year – 3,000 people every day – and reaching about 75 million by 2040.
 
Germany is among a group of 19 countries that are actually expected to shrink. Japan and Russia are the only other major economies with the same fate –– but Germany is shrinking faster (it's ranked 8th in the list of "shrinkers", with Japan and Russia 14th and 15th  respectively). Most of the other countries in this category are in Eastern and Central Europe (top of the league is Georgia shrinking by 1% every year, followed by Moldova and Lithuania).


The contrast is even more dramatic if we focus on the working age populations (defined as those between 16 and 64 years old). Today, Kenya has 22 million.  By 2040, this figure will have more than doubled to 50 million, which means that adults – not children – will account for the bulk of Kenya's population growth. Germany by contrast will travel in the opposite direction: from 54 million today (out of which 40 million actually are in employment) to 41 million by 2040. By the time Kenya's babies become adults, 20 or so years from today, your country will have a larger workforce than mine (see figure).


Figure: In some 20 years, Kenya will have a larger workforce than Germany (click on it to see it larger)

Projections by the World Bank demographic team based on UN Population Prospectus 2010


Kenya's future pattern of population growth can be a force of good.  More people on the same space will translate into higher urbanization, which tends to create more economic opportunities. If people live longer and have fewer children, they earn more and can invest more per child. A large urbanized and well-educated population tends to generate a strong middle class and a vibrant private sector. As a result, economic development may be easier to achieve and sustain–though it is not guaranteed.  If Kenya wants to reap the benefits of this demographic dividend, fertility will have to decline further, ideally below three children per family. This is already the case in cities, but not in rural areas (where it remains at five children). The country also needs to provide services (roads, rail, schools, hospitals) to a rapidly growing and urbanizing country on a much larger scale.
 
Kenya and Germany face opposite challenges: one country has too many, the other too few youth. Germany is already facing a lack of skilled labor, while Kenya will soon have an abundance of it. The win-win solution is allowing more Kenyans to migrate to Germany which could benefit both economies, especially if Kenyans continue to send remittances back home.

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Who is Kenya fighting?

Baobab

ACCORDING to Kenya, it is not at war with Somalis but with the al-Qaeda-linked Shabab militia that controls most of south Somalia. Theoretically that may be true. But with several thousand troops on the ground, and with air, special forces and intelligence support from America, Britain, Ethiopia and France, the Kenyan message of peace for all Somalis rings somewhat hollow.

The Shabab are adept at propaganda. They lie about battle statistics. They have been accused of dressing up their own dead fighters to look like civilian casualties. Baobab recently asserted that in Somalia the untested Kenyan military needed to be competent and the jihadists inept. Kenya failed the first test by invading Somalia during the rainy season: its assault has already got stuck in the mud. The Shabab fighters are enured to the mosquitoes, thorniness and dysentry of bush fighting. The Kenyans may fare less well. None of this may matter. Kenya has geography and firepower on its side. Somalia has no Tora Bora in which the Shabab can hide. Even if its fighters scuttle to the mangrove swamps, they are likely to be picked off as they emerge.

Yet the Kenyans seem already to have squandered more of their advantage with their alarmingly muddled reporting of recent fighting. On October 30th, the Kenyan military spokesperson, Major Emmanuel Chirchir, announced that a Kenyan air strike on the Somali town of Jilib had killed 10 Shabab fighters and injured 47. He was adamant that no children or women among the casualties—just militants. The next day a report emerged from Médicins sans Frontières (MSF), a medical charity, stating they had attended five dead in their clinic in Jilib: three children, one woman, and one man. MSF said 45 people had been wounded, 31 of them children, 9 of them women, all with shrapnel injuries.

The Kenyan military explained that they had hit a Shabab lorry filled with ammunition, which had driven towards a crowd where Shabab officials were handing out food rations to displaced people. The Kenyans had no video to back up their claim, but even if true what matters is that the Shabab were handed a propaganda victory by dodgy Kenyan reporting. They will use the images of ruptured children for their ends.

Chastened, Kenya now says it will be in Somalia for as long as it takes to obliterate the jihadists, years, if necessary, say the senior Kenyan brass. Things will escalate further if Kenyans launch their promised assault on Kismayo and the Shabab respond by using weapons allegedly flown in by Eritrea and with threatened major terrorist strikes in Nairobi and beyond.

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EU aid guidelines uphold the rights of vulnerable groups, but older people's rights are not mentioned

Eldis Ageing Populations
Older people are some of the poorest of the world's poor, where 100 million older men and women live on less than a dollar a day. This paper ...
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Sunday, October 30, 2011

EuropeAid publishes to IATI

Publish What You Fund

EuropeAid (the Commission Directorate General which deals with development and cooperation) has published its aid information to the International Aid Transparency Initiative (IATI) Registry, demonstrating commitment to aid transparency ahead of the High Level Forum on Aid Effectiveness in 6 weeks'...

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Global Lens: Breaking the Cycle with Micro-Insurance

Innovations for Poverty Action Blog
Amos Odero

The second post in our series comes from Amos Odero, a Research Associate on the Urban Micro-Insurance Project in Nairobi, Kenya.

"Jua Kali" means "under the hot sun" in Swahili. The term refers to the millions of Kenyans working in small businesses as artisans, mechanics, and vendors under trying conditions, even without shelter from the elements. The Jua Kali sector encompasses small-scale entrepreneurs and workers who lack access to credit, property rights, training, and good working conditions.

Kamukunji Jua Kali is an association of informal sector workers in the Kamukunji area of Nairobi who specialize mainly in crafting metal ware, such as pots, pans, wheelbarrows, boxes, farm implements and other household items. This vibrant community is composed of metalwork sheds made out of metal sheets, as well as other related enterprises such as street food vendors, brokers who act as middlemen between customers and manufacturers, and transporters of raw materials and purchased products. The work sheds are not your usual factory, as workers do not have safety equipment (gloves, hard hats, goggles, boots, etc.) and work in what would be considered a risky environment. Despite the presence of such risks and a high prevalence of health problems in areas such as Kamukunji, demand for health insurance is still low.

IPA's Urban Micro-Insurance Project (UMIP) seeks to address this issue by testing three different interventions aimed at boosting health insurance take-up: experiencing insurance first-hand, information brochures, and workshops. In a broader context, UMIP is investigating the vicious cycle by which poverty leads to stress, stress leads to temporal discounting (discounting the future for the present; short-sighted decision-making), and temporal discounting leads to suboptimal behavior, which reinforces poverty. The question we are considering is: can micro-insurance decrease stress and break the cycle?

To help answer this question, UMIP will randomly choose a control group and two treatment groups: the micro-insurance group, and a group that receives an unconditional cash transfer (UCT) equal to the cost of the micro-insurance. The UCT controls for the income effect associated with providing insurance, allowing us to make an even comparison between groups who have received the same value of benefits. It also lets us evaluate the welfare impact of UCTs!

Since we aim to quantify the welfare benefits of health insurance, our outcomes of interest include traditional economic variables (e.g., income), health variables, and mental health variables. We will measure the latter using neurobiological stress markers that can be analyzed by looking at hormone levels found in blood and saliva.

We have a small office right in the middle of Kamukunji Jua Kali. There are two interview spaces where UMIP Field Officers bring respondents for 90 minute interviews and saliva sample collection, followed by a visit to our office where we have a phlebotomist who draws a small blood sample.

Jua Kali artisans busy at work making buckets and pans out of metalJua Kali artisans busy at work making buckets and pans out of metal. Photo Credit: Amos Odero, IPA.

The noisiest shed at Jua Kali makes pots and frying pans for cooking 'chapati,' a Kenyan delicacy. It is a flat bread, much like Indian roti. Within the shed, several men hammer away at circular sheets of metal to shape them into pots and pans. The hammering is in unison, almost musical and so loud you can hardly speak to the person next to you. Each worker is paid by the number of pans he makes in a day, so there is virtually no resting time. This makes it a challenge for us to interview respondents from this workplace, as they can cancel appointments without notice or leave midway through an interview to attend to work. We also have to get clearance from the shed leader to interview the workers. Luckily, our assistant project managers have good relationships with the shed leaders and refusals are minimal.

UMIP was piloted throughout 2010. Expansion soon followed in March 2011 and will conclude in early 2013. Innovations for Poverty Action Kenya (IPAK) collaborates with principal investigators Johannes Haushofer (Harvard/MIT), Matthieu Chemin (McGill), and Joost de Laat (World Bank) in carrying out the study.

At the moment, we are finalizing the baseline and preparing to hand out micro health insurance and unconditional cash transfers to randomly selected respondents from the 866 individuals we have recruited so far. We look forward to following up with them over the next year and seeing what we discover about the impact of micro insurance on the welfare of the Jua Kali.

Read more about IPA projects in health insurance and/or in Kenya.

Global Lens #1: Adapting to Life Across Cultures, October 4

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Cheat Sheet: What’s Happened to the Big Players in the Financial Crisis

ProPublica: Articles and Investigations

by Braden Goyette

Widespread demonstrations in support of Occupy Wall Street have put the financial crisis back into the national spotlight lately.

So here's a quick refresher on what's happened to some of the main players, whose behavior, whether merely reckless or downright deliberate, helped cause or worsen the meltdown. This list isn't exhaustive -- feel welcome to add to it.

Mortgage originators

Mortgage lenders contributed to the financial crisis by issuing or underwriting loans to people who would have a difficult time paying them back, inflating a housing bubble that was bound to pop. Lax regulation allowed banks to stretch their mortgage lending standards and use aggressive tactics to rope borrowers into complex mortgages that were more expensive than they first appeared. Evidence has also surfaced that lenders were filing fraudulent documents to push some of these mortgages through, and, in some cases, had been doing so as early as the 1990s. A 2005 Los Angeles Times investigation of Ameriquest – then the nation's largest subprime lender – found that "they forged documents, hyped customers' creditworthiness and 'juiced' mortgages with hidden rates and fees." This behavior was reportedly typical for the subprime mortgage industry. A similar culture existed at Washington Mutual, which went under in 2008 in the biggest bank collapse in U.S. history.

Countrywide, once the nation's largest mortgage lender, also pushed customers to sign on for complex and costly mortgages that boosted the company's profits. Countrywide CEO Angelo Mozilo was accused of misleading investors about the company's mortgage lending practices, a charge he denies.  Merrill Lynch and Deutsche Bank both purchased subprime mortgage lending outfits in 2006 to get in on the lucrative business. Deutsche Bank has also been accused of failing to adequately check on borrowers' financial status before issuing loans backed by government insurance. A lawsuit filed by U.S. Attorney Preet Bharara claimed that, when employees at Deutsche Bank's mortgage received audits on the quality of their mortgages from an outside firm, they stuffed them in a closet without reading them. A Deutsche Bank spokeswoman said the claims being made against the company are "unreasonable and unfair," and that most of the problems occurred before the mortgage unit was bought by Deutsche Bank.

Where they are now: Few prosecutions have been brought against subprime mortgage lenders. Ameriquest went out of business in 2007, and Citigroup bought its mortgage lending unit. Washington Mutual was bought by JP Morgan in 2008. A Department of Justice investigation into alleged fraud at WaMu closed with no charges this summer. WaMu also recently settled a class action lawsuit brought by shareholders for $208.5 million. In an ongoing lawsuit, the FDIC is accusing former Washington Mutual executives Kerry Killinger, Stephen Rotella and David Schneider of going on a "lending spree, knowing that the real-estate market was in a 'bubble.'" They deny the allegations.

Bank of America purchased Countrywide in January of 2008, as delinquencies on the company's mortgages soared and investors began pulling out. Mozilo left the company after the sale. Mozilo settled an SEC lawsuit for $67.5 million with no admission of wrongdoing, though he is now banned from serving as a top executive at a public company. A criminal investigation into his activities fizzled out earlier this year. Bank of America invited several senior Countrywide executives to stay on and run its mortgage unit. Bank of America Home Loans does not make subprime mortgage loans. Deutsche Bank is still under investigation by the Justice Department.

Mortgage securitizers

In the years before the crash, banks took subprime mortgages, bundled them together with prime mortgages and turned them into collateral for bonds or securities, helping to seed the bad mortgages throughout the financial system. Washington Mutual, Bank of America, Morgan Stanley and others were securitizing mortgages as well as originating them. Other companies, such as Bear Stearns, Lehman Brothers, and Goldman Sachs, bought mortgages straight from subprime lenders, bundled them into securities and sold them to investors including pension funds and insurance companies.

Where they are now: This spring, New York's Attorney General launched a probe into mortgage securitization at Bank of America, JP Morgan, UBS, Deutsche Bank, Goldman Sachs and Morgan Stanley during the housing boom. Morgan Stanley settled with Nevada's Attorney General last month following an investigation into problems with the securitization process.

As part of a proposed settlement with the 50 state attorneys general over foreclosure abuses, several big banks were offered immunity from charges related to improper mortgage origination and securitization. California and New York have withdrawn from those talks.

The people who created and dealt CDOs

Once mortgages had been bundled into mortgage-backed securities, other bankers took groups of them and bundled them together into new financial products called Collateralized Debt Obligations. CDOs are composed of tiers with different levels of risk. As we've reported, a hedge fund named Magnetar worked with banks to fill CDOs with the riskiest possible materials, then used credit default swaps to bet that they would fail. Magnetar says that the majority of its short positions were against CDOs it didn't own. Magnetar also says it didn't choose what went its own CDOs, though people involved in the deals who spoke to ProPublica contradict this account.

American International Group's London-based financial products unit was among the entities that provided credit default swaps on CDOs. Though the business of insuring the risky securities made AIG large short-term profits, it eventually brought the company to the brink of collapse, prompting an $85 billion government bailout.

Merrill Lynch, Citigroup, UBS, Deutsche Bank, Lehman Brothers and JPMorgan all made CDO deals with Magnetar. The hedge fund invested in 30 CDOs from the spring of 2006 to the summer of 2007. The bankers who worked on these deals almost always reaped hefty bonuses. From our story:

Even today, bankers and managers speak with awe at the elegance of the Magnetar Trade. Others have become famous for betting big against the housing market. But they had taken enormous risks. Meanwhile, Magnetar had created a largely self-funding bet against the market.

When banks found CDOs hard to sell, some of them, notably Merrill Lynch and Citibank, bought each other's CDOs, creating the illusion of true investors when there were almost none. That was one way they kept the market for CDOs going longer than it otherwise would have. Eventually CDOs began purchasing risky parts of other CDOs created by the same bank. Take a look at our comic strip explaining self-dealing, and our chart detailing which banks bought their own CDOs.

Goldman Sachs and Morgan Stanley also made similar deals in which they created, then bet against, risky CDOs. The hedge fund Paulson & Co helped decide which assets to put inside Goldman's CDOs.

Where they are now: Overall, the banks and individuals involved in CDO deals haven't been convicted on criminal charges. The civil suits against them have produced fines that aren't very big compared to the profits they made in the leadup to the financial crisis. JP Morgan paid $153.6 million to settle an SEC suit alleging they hadn't disclosed to investors that Magnetar was betting against Morgan's CDO. Citigroup just agreed to pay a $285 million fine to the SEC for betting against one of its mortgage-related CDOs. The lawsuit doesn't mention dozens of similar deals made by Citi.

Magnetar is still thriving (the deals they made weren't illegal according to the rules at the time). In 2007, Magnetar's founder took home $280 million, and the fund had $7.6 billion under management. The SEC is considering banning hedge funds and banks from betting against securities of their own creation. As of May 2010, federal prosecutors were investigating Morgan Stanley over their CDO deals, and Goldman Sachs paid $550 million last year to settle a lawsuit related to one of theirs. Only one Goldman employee, Fabrice Tourre, has been charged criminally in connection to the deals.

Though recorded phone calls suggest that former AIG CEO Joseph Cassano misled investors about the credit default swaps that contributed to his company's troubles, the evidence wasn't airtight, and federal probes against him fell apart in 2010. Cassano's lawyers deny any wrongdoing.

The ratings agencies

Standard and Poor's, Moody's and Fitch gave their highest rating to investments based on risky mortgages in the years leading up to the financial crisis. A Senate investigations panel found that S&P and Moody's continued doing so even as the housing market was collapsing. An SEC report also found failures at 10 credit rating agencies.

Where they are now: The SEC is considering suing Standard and Poor's over one particular CDO deal linked to the hedge fund Magnetar. The agency had previously considered suing Moody's, but instead issued a report criticizing all of the rating agencies generally. Dodd-Frank created a regulatory body to oversee the credit rating agencies, but its development has been stalled by budgetary constraints.

The regulators

The Financial Crisis Inquiry Commission [PDF] concluded that the Securities and Exchange Commission failed to crack down on risky lending practices at banks and make them keep more substantial capital reserves as a buffer against losses. They also found that the Federal Reserve failed to stop the housing bubble by setting prudent mortgage lending standards, though it was the one regulator that had the power to do so.

An internal SEC audit faulted the agency for missing warning signs about the poor financial health of some of the banks it monitored, particularly Bear Stearns. [PDF] Overall, SEC enforcement actions went down under the leadership of Christopher Cox, and a 2009 GAO report found that he increased barriers to launching probes and levying fines.

Cox wasn't the only regulator who resisted using his power to rein in the financial industry. The former head of the Federal Reserve, Alan Greenspan, reportedly refused to heighten scrutiny of the subprime mortgage market. Greenspan later said before Congress that it was a mistake to presume that financial firms' own rational self-interest would serve as an adequate regulator. He has also said he doubts the financial crisis could have been prevented.

The Office of Thrift Supervision, which was tasked with overseeing savings and loan banks, also helped to scale back their own regulatory powers in the years before the financial crisis. In 2003 James Gilleran and John Reich, then heads of the OTS and Federal Deposit Insurance Corporation respectively, brought a chainsaw to a press conference as an indication of how they planned to cut back on regulation. The OTS was known for being so friendly with the banks -- which it referred to as its "clients" -- that Countrywide reorganized its operations so it could be regulated by OTS. As we've reported, the regulator failed to recognize serious signs of trouble at AIG, and didn't disclose key information about IndyMac's finances in the years before the crisis. The Office of the Comptroller of the Currency, which oversaw the biggest commercial banks, also went easy on the banks.

Where they are now: Christopher Cox stepped down in 2009 under public pressure. The OTS was dissolved this summer and its duties assumed by the OCC. As we've noted, the head of the OCC has been advocating to weaken rules set out by the Dodd Frank financial reform law. The Dodd Frank law gives the SEC new regulatory powers, including the ability to bring lawsuits in administrative courts, where the rules are more favorable to them.

The politicians

Two bills supported by Phil Gramm and signed into law by Bill Clinton created many of the conditions for the financial crisis to take place. The Gramm-Leach-Bliley Act of 1999 repealed all the remaining parts of Glass-Steagall, allowing firms to participate in traditional banking, investment banking, and insurance at the same time. The Commodity Futures Modernization Act, passed the year after, deregulated over-the-counter derivatives – securities like CDOs and credit default swaps, that derive their value from underlying assets and are traded directly between two parties rather than through a stock exchange. Greenspan and Robert Rubin, Treasury Secretary from 1995 to 1999, had both opposed regulating derivatives.  Lawrence Summers, who went on to succeed Rubin as Treasury Secretary, also testified before the Senate that derivatives shouldn't be regulated.

It's worth noting the substantial lobbying efforts that accompanied the deregulation process. According to the FCIC [PDF], between 1999 and 2008 the financial industry spent $2.7 billion lobbying the federal government, and donated more than $1 billion to political campaigns. While deregulation took place mainly under Clinton's watch, George W. Bush is faulted for not doing more to catch the out-of-control housing market.

As president of the New York Fed from 2003 to 2009, Timothy Geithner also missed opportunities to prevent major financial firms from self-destructing. As we reported in 2009:

Although Geithner repeatedly raised concerns about the failure of banks to understand their risks, including those taken through derivatives, he and the Federal Reserve system did not act with enough force to blunt the troubles that ensued. That was largely because he and other regulators relied too much on assurances from senior banking executives that their firms were safe and sound.

Henry Paulson, Treasury Secretary from 2006 to 2009, has been criticized for being slow to respond to the crisis, and introducing greater uncertainty into the financial markets by letting Lehman Brothers fail. In a 2008 New York Times interview, Paulson said he had no choice.

Where they are now: Gramm has been a vice chairman at UBS since he left Congress in 2002. Greenspan is retired. Summers served as a top economic advisor to Barack Obama until November 2010; since then, he's been teaching at Harvard. Geithner is currently serving as Treasury Secretary under the Obama administration.

Executives of big investment banks

Executives at the big banks also took actions that contributed to the destruction of their own firms. According to the Financial Crisis Inquiry Commission report [PDF], the executives of the country's five major investment banks -- Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley kept such small cushions of capital at the banks that they were extremely vulnerable to losses. A report compiled by an outside examiner for Lehman Brothers found that the company was hiding its bad investments off the books, and Lehman's former CEO Richard S. Fuld Jr. signed off on the false balance sheets. Fuld had testified before Congress two years before that the actions he took prior to Lehman Brothers' collapse "were both prudent and appropriate" based on what he knew at the time. Other banks also kept billions in potential liabilities off their balance sheets, including Citigroup, headed by Vikram Pandit.

In 2010, we detailed how a group of Merrill Lynch executives helped blow up their own company by retaining supposedly safe – but actually extremely risky –  portions of the CDOs they created, paying a unit within the firm to buy them when almost no one else would.

The New York Times' Gretchen Morgenson described how the administrative decisions of some top Merrill executives helped put the company in a precarious position, based on interviews with former employees.

Where they are now: In 2009, two Bear Stearns hedge fund managers were cleared of fraud charges over allegedly lying to investors. A probe of Lehman Brothers stalled this spring. Merrill Lynch was sold to Bank of America in the fall of 2008. As for the executives who helped crash the firm, as we reported in 2010, "they walked away with millions. Some still hold senior positions at prominent financial firms." Dick Fuld is still working on Wall Street, at an investment banking firm. Vikram Pandit remains the CEO of Citigroup.

Fannie Mae and Freddie Mac

The government-sponsored mortgage financing companies Fannie Mae and Freddie Mac bought risky mortgages and guaranteed them. In 2007, 28 percent of Fannie Mae's loans were bought from Countrywide. The FCIC found [PDF] that Fannie and Freddie entered the subprime game too late and on too limited a scale to have caused the financial crisis. Non-agency-securitized loans had an increased share of the market in the years immediately preceding the crisis.

Many believe that The Community Reinvestment Act, a government policy promoting homeownership for low-income people, was responsible for the growth of the subprime mortgage industry. This idea has largely been discredited, since most subprime loans were made by companies that weren't subject to the act

Still, Fannie and Freddie engaged in reckless behavior and sustained heavy losses as a result. The SEC slammed Fannie Mae for improper accounting under the leadership of Frank Raines in the years preceding the financial crisis. A report by the Office of Federal Housing Enterprise Oversight found that Fannie and Freddie didn't accurately disclose the risks they were taking and "deliberately and intentionally manipulat[ed] accounting to hit earnings targets." [PDF]

Richard Syron and Daniel Mudd were at the helm of Freddie and Fannie, respectively, when they began to buy large numbers of subprime loans. Current and former Freddie Mac employees have accused Syron of ignoring warnings about the health of the loans the company was buying. Syron and Mudd maintain they could not have foreseen the rapid decline in the housing market.

Where they are now: As borrowers defaulted on mortgages they'd insured, Fannie and Freddie received a nearly $200 billion federal government bailout, and the government took over their operations. They are close to a settlement in an SEC lawsuit, and will neither admit nor deny that they failed to inform investors about risks of exposure to subprime mortgages. The Dodd Frank financial reform law stated that serious reforms of Fannie and Freddie are needed, but didn't address how they should be carried out. A report from Treasury Secretary Geithner called for the government to "ultimately wind down" the two mortgage giants. [PDF] In the meantime, taxpayers have been shouldering their legal fees. Former Freddie and Fannie executives Richard Syron and Daniel Mudd received Wells notices this spring, a sign that the SEC is considering legal action against them.

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The difference between management and leadership

Seth's Blog

Managers work to get their employees to do what they did yesterday, but a little faster and a little cheaper.

Leaders, on the other hand, know where they'd like to go, but understand that they can't get there without their tribe, without giving those they lead the tools to make something happen.

Managers want authority. Leaders take responsibility.

We need both. But we have to be careful not to confuse them. And it helps to remember that leaders are scarce and thus more valuable.

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The paradox of expectations

Seth's Blog

Low expectations are often a self-fulfilling prophecy. We insulate ourselves from failure, don't try as hard, brace for the worst and often get it.

High expectations, on the other hand, will inevitably lead to disappointment. Keep raising what you expect and sooner or later (probably sooner) it's not going to happen. And we know that a good outcome that's less than the great one we hoped for actually feels like failure.

Perhaps it's worth considering no expectations. Intense effort followed by an acceptance of what you get in return. It doesn't make good TV, but it's a discipline that can turn you into a professional.

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Charity Navigator 2.0 in Context

Tactical Philanthropy

This is a guest post by Ken Berger, president and CEO of Charity Navigator.

By Ken Berger

Ken BergerOn September 20th of this year, Charity Navigator (CN) launched a significant change to our rating system (called CN 2.0). In follow-up, Sean has kindly offered me the opportunity to put this event in the context of CN's present and future. In addition, it offers me the chance to address some criticisms from the "three C's" (critics, competitors and charities with lower ratings).

In 2010, CN formed an Advisory Panel. Sean is a member, along with a number of other members of the Alliance for Effective Social Investing, nonprofit operators, academicians and other experts in the nonprofit arena. We shared with them our preliminary thinking on the new Accountability and Transparency dimension and used much of their feedback, along with all our staff and our Board, in the final product you see today on our site. The end result is a dimension we have weighted a full 50% of the rating score for each nonprofit. As a consequence, there has been a major shift in the rating of many nonprofits we evaluate. A few statistics to prove the point:

  1. We saw roughly 40% (around 600 out of 1500 nonprofits) lose their four stars rating, and another 20% gain it (around 300) with a net loss of 20% of four star rated nonprofits in our system.
  2. 49% of the nonprofits we rate saw a change in their overall star rating (around 2,650). 19% saw a decline in overall score and 30% an increase.
  3. There was an 8% increase in the number of nonprofits rated good (3 stars) or better.

Overall, the collective response of our site users has been positive, if not thrilled with the new information. Nonprofits as always, given the nature of "winners and losers" at ratings, have been both positive and negative. However, the vast majority do not question the importance of a good portion of this information. After all, the Nonprofit Panel (formed by Independent Sector) spent years to devise a set of Principles of Good Governance and Ethical Practices that encompass a good part of the territory covered by our new rating dimension.

One of the most striking results of this change in the rating system is the amazing response of many nonprofits (both "winners and losers" in the new rating system). This is a far cry from when we began operations ten years ago and you could hear a pin drop when we asked for information! The number of new governance and ethical practices implemented by nonprofits we evaluate, as well as posting of information on their web sites, has already totaled over 1,000 and continue apace. Here and here are two examples of web site pages that reflect these types of changes.

As noted earlier, some of the members of the Alliance for Effective Social Investing have been helpful advisors to CN in thinking through how we have been moving forward. Below is a chart that reflects one iteration of some Alliance member's thinking on the critical qualities that define a high impact organization.

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The basic point is that all these dimensions must be present to maintain a high performing or high impact organization. Therefore, for those who question the importance of financial health in measuring a nonprofit's performance, I refer them to our advisors, as well as to any nonprofit CEO or CFO who must constantly concern him or herself with the financial efficiency and sustainability of the organization. To say results are all that matters is to deny the question of whether the organization will be able to afford to operate and provide those same results for the long haul.

Regarding overhead, show me a nonprofit that uses 70% of its funds for overhead and and I'm 90% sure it is an organization that is either clueless or focused on lining someone's pockets rather than serving others. People may disagree on what the best metric of overhead should be, but to say overhead is dead or a red herring is to deny a useful indicator of where many thieves and scoundrels dwell. I have worked in enough nonprofits with unethical leaders to say without question that we need to get serious about their existence as more than a rarity (see the book Silence, by Gary Snyder). This is not meant to imply that we think our financial metrics can not be improved upon! I refer you to a blog post I wrote a while back on the limits of focusing on overhead alone. In addition, we have recently formed a task force of financial experts to think through possible changes to our traditional financial metrics.

As to the value of Accountability and Transparency (CN 2.0), if a nonprofit does not have strong governance and ethical practices it greatly increases the risk that someone will rip them and their donors off. Therefore, good impact today can once again be of short duration if you do not have such practices and oversight in place. Furthermore, measures of transparency such as posting critical information on the nonprofit's web site, provides all stakeholders with a chance to monitor the organization to at least some degree. That further mitigates against unethical behavior that could take a nonprofit on the road to ruin.

Of course results are the key and the central quality that every nonprofit should be focused on! However, to suggest that results (impact, outcomes and the like) are the only concern a nonprofit should be focused on reflects a fundamental denial of what is necessary to sustain those results. My thirty years of operating nonprofits provides me with an endless stream of examples of how critical all three dimensions are to assuring ongoing high performance and ultimately impact.

Looking ahead we are now in the second year of developing the third dimension of our rating system which evaluates the quality of results reporting of nonprofits (which we are calling CN 3.0). Thanks to seed funding from the Hewlett Foundation, we have been testing a number of possible prototypes for how we will go about this analysis. In addition, we have secured the help of a number of graduate schools and volunteers from around the country to do background research as well as try out the prototypes we have developed.

We are hopeful that we can formally announce what the selected tool will look like by next year and then begin the process of compiling this data on all of the nonprofits we evaluate. However, we intend to continue to conduct basic research and continuously improve the results reporting metrics as we learn. For example, it is conceivable that we will measure results differently at least to some degree, by nonprofit cause area, based on the aforementioned research.

Furthermore, as always, we will provide this information at no cost to our users. In addition, we will provide our four star seal at no cost to the nonprofits who receive it. Therefore, the added effort that will be required to analyze nonprofits performance in all three dimensions requires us to scale up our operations significantly. We plan to do this with the growing support we anticipate from voluntary donations from our users, foundation funding and earned income. In addition, we hope to recruit a significant number of volunteers to expand our capacity to deepen our rating system (to CN 3.0) and broaden our coverage (we have a goal to roughly double the number of nonprofits we evaluate from 5,500 to 10,000).

Looking further down the road, we hope that some day we and our competitors will truly collaborate by aggregating data to deepen our rating system even further. However, that is a blog for another day.

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European Debt: The Big Picture

The Baseline Scenario

By Simon Johnson

For everyone struggling to get their arms around the debt crisis in Europe, Bill Marsh in today's New York Times offers literally a compelling picture, with graphic illustration for the key issues.

The picture is big, 18×21 inches. Either you need a very large computer screen or a hard copy of the paper (pp. 6-7 in the SundayReview section, "It's All Connected: A Spectator's Guide to the Euro Crisis).

The main debt linkages across borders for which we have data are all here – and the graphic pulls your eye appropriately to the centrality of Italy in whatever happens next.  (On why eurozone policy towards Italy now matters so much – and what are the options – see my recent paper with Peter Boone, "Europe on the Brink".)

But you might think also about what is not in the NYT graphic because we lack reliable information.  For example, what is the exposure of US financial institutions to European debt, directly or indirectly, through derivatives transactions of any kind?

The opaqueness of derivative markets means that most investors can only guess at what could happen.  Most of the relevant regulators and supervisors with whom I have talked seem also to be largely in the dark – remember the experience of AIG in 2008.

Cross-border bank exposures through loans and other holdings are publicly disclosed – data from the Bank for International Settlements are represented by the arrows in the NYT graphic.  These data are surely not perfect, but they do convey the main points and they tell you where to focus attention.

Why do we not require publication of similar data, preferably by financial institution, for all derivative transactions – including both gross and supposedly net exposures across borders?


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BusinessWeek is Wrong: Small Businesses Create Most Net New Jobs

The Big Picture

Dr. Bill Dunkelberg is the Chief Economist for the National Federation of Independent Business.

~~~

A recent Bloomberg article entitled "Small-Business Job Engine Myth Hampers Effort to Lift Employment" (September 29) reports "…the notion that small business is the force behind prosperity is not true." The author cites statistics such as "Hourly wages at the largest companies, those with more than 2,500 employees, average around $27, compared with $16 in companies with payrolls of fewer than 100" to prove that small businesses are of little value. Out of 6 million employer firms, only 3,900 are this large. If this is such a good deal, why aren't all firms of that size? Maybe a barber shop with 2,500 chairs is not economical and too large to serve a local market? Maybe wages are better at larger firms because they are specialized (high tech, manufacturing) and require better skilled workers (which not everyone is)? Markets pay for skills. And maybe an economy full of these firms would not be able to provide the kinds of goods and service or convenience we like (no more "7-11"s, we just need a few 2,500 worker grocery stores to drive to?).

"Most small firms are restaurants, skilled professionals or craftsmen (doctors, plumbers), professional and general service providers (clergy, travel agents, beauticians), and independent retailers……most of these companies are going to remain small." I guess the author thinks this is bad. Notice that if all those big firms hired 500 new workers in a month, a very unlikely outcome even in good times, that would add about 2 million new jobs, just a few more than filed initial claims for unemployment last month (1.6 million, it was 1.2 million per month in 2000, a year of record HIGH employment)!

He quotes the view a professor at Case Western Reserve: "Because the average existing firm is more productive than the average new firm, we would be better off economically if we got rid of policies that encouraged a lot of people to start businesses instead of taking jobs working for others." Now, statistically, new firms are less productive than existing firms since it takes time to build the business to capacity, maturity. So I guess any new firm that starts must start at "maturity" or we should reject it. Bill Gates should have worked for someone else since Microsoft couldn't be started at the mature level it has today.

Nonsense, but this is the kind of misdirected thinking that is shaping policy. This assumes that Microsoft was not the result of many firms trying to compete to make the best operating system, but that somehow someone would identify Gates as the "right one" and every other entrepreneur should go to work for someone else. I guess government is supposed to do this (like with solar panels), making sure that once Gates is picked, he gets enough taxpayer money to open at "maturity" size.

More fundamentally, the author does not understand the main driver of job growth, and confuses our current problem of weak demand (not all the barber chairs are filled) with the factors that cause job growth (population growth), the need for more barber shops and the jobs this creates.

An economy with no population growth has no job growth in the long run (business cycles like our current situation can create lower employment temporarily). More people need more barber shops, clinics and all those small firms the author berates. Yes, those firms don't grow big very often, but it is the proliferation of these firms that accounts for the fact that over the past 20 years, 2/3ds of the net new jobs are created by small firms. Sure, more manufactured goods are needed too, but those are produced with fewer and fewer workers over time (productivity) and are not big job generators.

So here are the facts about small businesses:

• 99.7% of all employers are small (under 500 employees)
• 90% have fewer than 20 employees
• produce 65% of the new jobs in the last 17 years
• produce more than half of private GDP
• make up 97.5% of identified exporters
• produce 13 times more patents per employee than large patenting firms
Source: SBA

The author snipes "So much for being seedbeds of innovation." Yet small business is the R&D for the economy, where new ideas, products, processes are tested in the market. Good ideas are rewarded with profits, the others "re-price" their assets and try again. So what if "many go bust"? These are trials, looking for the best managers and ideas, letting markets (consumers) pick the winners, not the government.

In a growing U.S. economy 500,000 businesses terminate each year, but 600,000 new ones are started, and lots of people are employed and gain experience and training in the process. That's where the greatness of our economy comes from.

And a P.S., small firms don't need tax incentives to hire, they need customers. So get it together in Washington and restore consumer confidence, 131 million workers spending more is a great stimulus and reason to hire which will solve the unemployment problem.

~~~

Source:
Rethinking the Boosterism About Small Business
By Charles Kenny
BusinessWeek, September 28, 2011   
http://www.businessweek.com/magazine/rethinking-the-boosterism-about-small-business-09282011.html

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