Tuesday, October 21, 2008

Financial Meltdown: Been There, Done That

Foreclosures and bank failures dominate the headlines. Politicians are in a tizzy over whom to blame. It’s not 2008, but 1932 and the devil du jour is not some Wall Street CEO, but Chicago financier Samuel Insull, whose securities became worthless during the Great Depression, leaving 600,000 investors in the lurch.

Insull, whose utilities empire failure – the largest in American history at the time (more recently eclipsed by the bankruptcy of Lehman Brothers Holdings, Inc.) -- launched a raft of New Deal reforms and is little remembered some 150 years after his birth. Yet his startling rise from Thomas Edison’s factotum to the billionaire mogul of one of the nation’s largest utility combines, holds many lessons for today.

Unlike the CEOs of today, who walk away from corporate shipwrecks with tens of millions of dollars in compensation, Insull died broke after lending his own money and going into debt to save his companies before they fell into receivership in 1932. Having felt he had done all he could to rescue them with his personal capital, he left the country until he was extradited from Turkey to the U.S. to stand trial in 1934. When he returned to the Windy City, he was more infamous than Al Capone and tried in the same courtroom and by the same judge as ``scarface.’’ Insull never went to prison as juries recognized that Insull effectively went down with his ship; the utilities mogul was later acquitted of fraud in three separate trials.

Like today’s hedge funds and even the seized mortgage entities Freddie Mac and Fannie Mae, Insull’s pyramid of holding companies that provided power and light to some 6,000 communities across the Eastern and Midwestern U.S., were little understood and barely regulated. The accounting for his empire was opaque and annual reports from the 1920s told investors little about how his empire was capitalized. Because they were pyramided and cross-financed with other holding company stock, his entities were the collateralized mortgage obligations of that time – and became just as toxic to investors.

Insull’s legacy is a chiaroscuro tablet. While he succeeded in helping to bring electricity into the homes of some 72 million people by 1927, his holding company failures became a touchpoint for the New Deal securities legislation. FDR’s reforms separated investment from commercial banks. Utility holding companies were dismembered and broken up. Stock offering prospectuses became much more detailed in their capital underpinnings and risks.

With the repeal of the Glass-Steagall Act in 1999 and the scrapping of the Public Utility Holding Company Act in 2006, two linchpins of the New Deal investor protection era were severed. The utility industry has re-consolidated somewhat and over the past decade Wall Street investment banks went hurtling into a lightly regulated environment that promoted everything from troubled auction-rate securities to subprime mortgage pools. Eliminating some of the heart of the New Deal protections has changed the entire landscape of high finance.

With the recent tumult on Wall Street, pure investment banks will cease to exist and regulators will have even more oversight over opaque financial vehicles. The rescue legislation recently passed by Congress comes full circle back to FDR’s era as buying mortgage assets, creating new layers of oversight and expanding federal deposit insurance seeks to protect savers and investors.

Unlike the 1930s, the combined forces of the U.S. Treasury, Congress, President, Federal Reserve, foreign central banks and the American taxpayer have been united as strange and often unwilling bedfellows to prevent a global financial system collapse (although we’re not completely out of the woods yet).

As the executives who captained the current debacle beat a hasty retreat, a natural question emerges: How can we best learn from both the Insull and current eras to strengthen the integrity of markets and investments?

One of the answers can be derived from the extensive disclosure and enhanced oversight that emerged from both crises. Once investors have a clear and comprehensive look at what they’re buying, they can better gauge risk and make prudent decisions. While you can never take greed out of the equation in investing, sunlight in the form of transparency is more than a disinfectant, it can illuminate any number of perils.

Thursday, October 9, 2008

Mainstream Economy Falters, Solar Economy Shines

I've found a huge pocket of sunshine between the thunderheads dominating the financial news.

Congress actually did something sensible and greenlighted a raft of alternative energy incentives in its latest bailout, oh I'm sorry, RESCUE package last week. The remarkable irony is that this was a separate piece of legislation that some crafty senators attached to the "take or leave it" buffet of banking, mental health parity (a good thing, actually) and sloppy pork offerings passed under duress of market collapse on Friday.

Well, the markets didn't think it was enough and proceeded to wipe out another $1 trillion in equity. Now it's up to central bankers to pump money into the frozen credit markets. Bankers won't lend because they're afraid that borrowers won't pay them back. A lot of this is pure panic, but somebody has got to get the money flowing again. Or else payrolls will be logjammed, companies won't buy supplies and millions will get laid off. A recession is all but certain, the severity of which is open to a heap of speculation.

The bright spot is that the US Federal Reserve and Treasury, Bank of England, European Central Bank, Japanese Central Bank and People's Bank of China are almost on the same page on the core problem. They are flooding the banking system with money, which will help. It's also encouraging that China, Australia, Brazil, Western Europe and the Gulf States are flush. Russia has some reserves, although its stock market is shut down for the moment.

The credit freeze is akin to two boys at the mouth of a cave. They essentially know what's in the cave, but are frozen in space, saying to the other, "you go first, NO, you go first." And so it goes.

As we move toward the light, this may mark the end of the carbon era and the beginning of the solar age. It's about time. Some fairly decent tax incentives came out of Congress, which were obscured by the serious business of fixing the mortgage securities debacle, which will take years to resolve.

In the meantime, though, you can reap a break to put up a small windmill, install geothermal heating systems, buy energy-efficient and solar appliances. Here's a summary of the incentives, courtesy of the American Solar Energy Society (www.ases.org):

Congress passes the most powerful solar legislation in history
Solar provisions will extend the solar investment tax credit
for eight years, removes the $2000 monetary cap

Homeowners battling against soaring energy prices and a struggling economy just gained a powerful new tool to help harness free, renewable energy from the sun, the wind and other sustainable resources.

The U.S. House and Senate just passed historic legislation that will massively increase the use of solar energy all across the America. Renewable energy provisions in H.R.1424 include an eight year extension of the 30% solar tax credit and removal of the monetary cap for residential solar electric installations. The President signed it into law on October 3.

The solar provisions in this bipartisan legislation will help position the U.S. as a global leader in the booming solar marketplace, generating thousands of green-collar jobs, promoting energy independence, and helping to tackle climate change.

"Renewable energy and energy efficiency are our economic drivers,” said Brad Collins, Executive Director of the nonprofit American Solar Energy Society. “I applaud members of Congress for coming together to extend the renewable energy tax credits that will strengthen the new energy economy and generate green jobs at a time when they’re needed most.”

Key provisions of this legislation will:

* Extend the investment tax credit for residential and commercial solar installations for eight years (it was previously set to expire at the end of 2008)

* End the $2,000 cap on the investment tax credit for residential solar electric installations placed into service after December 31, 2008.

* Allows filers of the alternative minimum tax to claim solar investment tax credits

* Allows public utilities to claim the solar investment tax credits

* Authorize $800 million in new clean renewable energy bonds and creates a new category of tax credit bonds called Qualified Energy Conservation Bonds to finance state and local initiatives to reduce carbon emissions

* Extends deductions for energy efficient commercial buildings

* Establishing a new tax credit for purchasers of plug-in electric-drive vehicles

* Extends research and development tax credits

What This Means to You

Given that energy prices (with the probable exception of crude/heating oil) will remain high in the short term, these write-offs will partially offset the cost of solar heating and electric units. There are systems available that provide both heat and hot water, so those are the best deals. They even work efficiently during the frigid winters of the Upper Midwest (I've seen this so I can verify their utility).

If you want to dabble in small wind turbines or geothermal, keep in mind the initial price tags are high and the paybacks much longer. Geothermal makes much more sense if you are building a new home on a site that permits additional excavation. As with any alternative energy appliance, see if your state offers a matching tax break. Most do. See www.dsireusa.org.