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Scary Economic News

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The information which I’m passing along to you today might come as a shock to those listening to the usual stock market cheerleaders, who predict good times ahead.  Let’s start with economist John Hussman of the Hussman Funds.  For quite a while, Dr. Hussman has been warning us to avoid drinking the Kool-Aid served by the perma-bulls.  In his latest Weekly Market Comment, Hussman offers yet more sound advice to those under the spell of brokerage propagandists:

I want to emphasize again that I am neither a cheerleader for recession, nor a table-pounder for recession.  It’s just that given the data that we presently observe, an oncoming recession remains the most probable outcome.  When unseen states of the world have to be inferred from imperfect and noisy observable data, there are a few choices when the evidence isn’t 100%.  You can either choose a side and pound the table, or you can become comfortable dwelling in uncertainty, and take a position in proportion to the evidence, and the extent to which each possible outcome would affect you.

With most analysts dismissing the likelihood of recession, I have been vocal about ongoing recession concerns not because I want to align myself with one side, but because the investment implications are very asymmetric.  A slow but steady stream of modestly good economic news is largely priced in by investors, but a recession and the accompanying earnings disappointments would destroy some critical pillars of hope that investors are relying on to support already rich valuations.

Yale Professor Robert Shiller is the guy who invented the term “irrational exuberance”, which was title of his bestselling book – published in May of 1996.  Although the widely-despised, former Federal Reserve Chairman, Alan Greenspan is often credited with creating the term, Greenspan didn’t use it until December of that year, in a speech before the American Enterprise Institute.  Shiller is most famous for his role as co-creator of the Case-Shiller Home Price Indices, which he developed with his fellow economists Karl Case and Allan Weiss.  While many commentators decried the idiotic economic austerity programs which have been inflicted across Europe, Professor Shiller investigated whether austerity is at all effective in spurring economic growth, seeking a better understanding of austerity’s consequences.  In a recent essay on the subject, Dr. Shiller cited the work by Jaime Guajardo, Daniel Leigh, and Andrea Pescatori of the International Monetary Fund, who recently studied austerity plans implemented by governments in 17 countries in the last 30 years.  The conclusion reached by Professor Shiller should sober-up the “rose-colored glasses” crowd, as well as those aspiring to implement similar measures in the United States:

The austerity plans being adopted by governments in much of Europe and elsewhere around the world, and the curtailment of consumption expenditure by individuals as well, threaten to produce a global recession.

*   *   *

There is no abstract theory that can predict how people will react to an austerity program.  We have no alternative but to look at the historical evidence.  And the evidence of Guajardo and his co-authors does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.

Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all.  But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.

The really scary news concerning the state of the global economy came in the form of a report published by the World Bank, entitled Global Economic Prospects (Uncertainties and vulnerabilities).  The 157-page treatise was written by Andrew Burns and Theo Janse van Rensburg.  It contains more than enough information to induce a serious case of insomnia.  Here are some examples:

The world economy has entered a very difficult phase characterized by significant downside risks and fragility.

*   *   *

The downturn in Europe and weaker growth in developing countries raises the risk that the two developments reinforce one another, resulting in an even weaker outcome.  At the same time, the slow growth in Europe complicates efforts to restore market confidence in the sustainability of the region’s finances, and could exacerbate tensions.

*   *   *

While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains.  In particular, the willingness of markets to finance the deficits and maturing debt of high-income countries cannot be assured.  Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out.  The world could be thrown into a recession as large or even larger than that of 2008/09.

*   *   *

In the event of a major crisis, activity is unlikely to bounce back as quickly as it did in 2008/09, in part because high-income countries will not have the fiscal resources to launch as strong a countercyclical policy response as in 2008/09 or to offer the same level of support to troubled financial institutions.

*   *   *

Developing countries need to prepare for the worst

In this highly uncertain environment, developing countries should evaluate their vulnerabilities and prepare contingencies to deal with both the immediate and longer-term effects of a downturn.

If global financial markets freeze up, governments and firms may not be able to finance growing deficits.

*   *   *

One major uncertainty concerns the interaction of the policy-driven slowing of growth in middle-income countries, and the financial turmoil driven slowing in Europe.  While desirable from a domestic policy point of view, this slower growth could interact with the slowing in Europe resulting in a downward overshooting of activity and a more serious global slowdown than otherwise would have been the case.

In other words, Europe’s economic austerity programs could turn another round of economic contraction into a global catastrophe (as if we needed another).

This is what happens when economic policymaking is left to the plutocrats and their tools.  “Those who fail to learn from the past are doomed to repeat it.”  It appears as though we are well on our way to a second financial crisis – with more severe consequences than those experienced as a result of the 2008 episode.


Psychopaths Caused The Financial Crisis

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Two months ago, Barry Ritholtz wrote a piece for The Washington Post in rebuttal to New York Mayor Michael Bloomberg’s parroting of what has become The Big Lie of our time.  In response to a question about Occupy Wall Street, Mayor Bloomberg said this:

“It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp.”

Ritholtz then proceeded to list and discuss the true causes of the financial crisis.  Among those causes were Alan Greenspan’s Federal Reserve monetary policy – wherein interest rates were reduced to 1 percent; the deregulation of derivatives trading by way of the Commodity Futures Modernization Act; the Securities and Exchange Commission’s “Bear Stearns exemption” – allowing Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns to boost their leverage as high as 40-to-1; as well as the “bundling” of sub-prime mortgages with higher-quality mortgages into sleazy “investment” products known as collateralized debt obligations (CDOs).

After The Washington Post published the Ritholtz piece, a good deal of supportive commentary emerged – as observed by Ritholtz himself:

Since then, both Bloomberg.com and Reuters each have picked up the Big Lie theme. (Columbia Journalism Review as well).  In today’s NYT, Joe Nocera does too, once again calling out those who are pushing the false narrative for political or ideological reasons in a column simply called “The Big Lie“.

Purveyors of The Big Lie are also big on advancing the claim that the “too big to fail” beneficiaries of the TARP bailout repaid the money they were loaned, at a profit to the taxpayers.  Immediately after her arrival at CNN, former Goldman Sachs employee, Erin Burnett made a point of interviewing a young, Occupy Wall Street protester, asking him if he was aware that the government actually made a profit on the TARP.  Unfortunately, the fiancée of Citigroup executive David Rubulotta didn’t direct her question to Steve Randy Waldman – who debunked that propaganda at his Interfluidity website:

Substantially all of the TARP funds advanced to banks have been paid back, with interest and sometimes even with a profit from sales of warrants.  Most of the (much larger) extraordinary liquidity facilities advanced by the Fed have also been wound down without credit losses.  So there really was no bailout, right?  The banks took loans and paid them back.

Bullshit.

*   *   *

During the run-up to the financial crisis, bank managers, shareholders, and creditors paid themselves hundreds of billions of dollars in dividends, buybacks, bonuses and interest.  Had the state intervened less generously, a substantial fraction of those payouts might have been recovered (albeit from different cohorts of stakeholders, as many recipients of past payouts had already taken their money and ran).  The market cap of the 19 TARP banks that received more than a billion dollars each in assistance is about 550B dollars today (even after several of those banks’ share prices have collapsed over fears of Eurocontagion).  The uninsured debt of those banks is and was a large multiple of their market caps.  Had the government resolved the weakest of the banks, writing off equity and haircutting creditors, had it insisted on retaining upside commensurate with the fraction of risk it was bearing on behalf of stronger banks, the taxpayer savings would have run from hundreds of billions to a trillion dollars.  We can get into all kinds of arguments over what would have been practical and legal. Regardless of whether the government could or could not have abstained from making the transfers that it made, it did make huge transfers.  Bank stakeholders retain hundreds of billions of dollars against taxpayer losses of the same, relative to any scenario in which the government received remotely adequate compensation first for the risk it assumed, and then for quietly moving Heaven and Earth to obscure and (partially) neutralize that risk.

The banks were bailed out.  Big time.

Another overlooked cause of the financial crisis was the fact that there were too many psychopaths managing the most privileged Wall Street institutions.  Not only had the lunatics taken over the asylum – they had taken control of the world’s largest, government-backed casino, as well.  William D. Cohan of Bloomberg News gave us a peek at the recent work of Clive R. Boddy:

It took a relatively obscure former British academic to propagate a theory of the financial crisis that would confirm what many people suspected all along:  The “corporate psychopaths” at the helm of our financial institutions are to blame.

Clive R. Boddy, most recently a professor at the Nottingham Business School at Nottingham Trent University, says psychopaths are the 1 percent of “people who, perhaps due to physical factors to do with abnormal brain connectivity and chemistry” lack a “conscience, have few emotions and display an inability to have any feelings, sympathy or empathy for other people.”

As a result, Boddy argues in a recent issue of the Journal of Business Ethics, such people are “extraordinarily cold, much more calculating and ruthless towards others than most people are and therefore a menace to the companies they work for and to society.”

Professor Boddy wrote a book on the subject – entitled, Corporate Psychopaths.  The book’s publisher, Macmillan, provided this description of the $90 opus:

Psychopaths are little understood outside of the criminal image.  However, as the recent global financial crisis highlighted, the behavior of a small group of managers can potentially bring down the entire western system of business.  This book investigates who they are, why they do what they do and what the consequences of their presence are.

Matt Taibbi provided a less-expensive explanation of this mindset in a recent article for Rolling Stone:

Most of us 99-percenters couldn’t even let our dogs leave a dump on the sidewalk without feeling ashamed before our neighbors.  It’s called having a conscience: even though there are plenty of things most of us could get away with doing, we just don’t do them, because, well, we live here.  Most of us wouldn’t take a million dollars to swindle the local school system, or put our next door neighbors out on the street with a robosigned foreclosure, or steal the life’s savings of some old pensioner down the block by selling him a bunch of worthless securities.

But our Too-Big-To-Fail banks unhesitatingly take billions in bailout money and then turn right around and finance the export of jobs to new locations in China and India.  They defraud the pension funds of state workers into buying billions of their crap mortgage assets.  They take zero-interest loans from the state and then lend that same money back to us at interest.  Or, like Chase, they bribe the politicians serving countries and states and cities and even school boards to take on crippling debt deals.

Do you think that Mayor Bloomberg learned his lesson  .  .  .  that spreading pro-bankster propaganda can provoke the infusion of an overwhelming dose of truth into the mainstream news?   Nawwww  .  .  .


 

Some Quick Takes On The Financial Crisis Inquiry Report

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The official Financial Crisis Inquiry Report by the Financial Crisis Inquiry Commission (FCIC) has become the subject of many turgid commentaries since its January 27 release date.  The Report itself is 633 pages long.  Nevertheless, if you hope to avoid all that reading by relying on reviews of the document, you could easily end up reading 633 pages of commentary about it.  By that point, you might be left with enough questions or curiosity to give up and actually read the whole, damned thing.  (Here it is.)  If you are content with reading the 14 pages of the Commission’s Conclusions, you can find those here.  What follows is my favorite passage from that section:

We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.  More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had stripped away key safeguards, which could have helped avoid catastrophe.  This approach had opened up gaps in oversight of critical areas with trillions of dollars at risk, such as the shadow banking system and over-the-counter derivatives markets.  In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor.

In order to help save you some time and trouble, I will provide you with a brief roadmap to some of the commentary that is readily available:

Gretchen Morgenson of The New York Times introduced her own 1,257-word discourse in this way:

For those who might find the report’s 633 pages a bit daunting for a weekend read, we offer a Cliffs Notes version.

Let’s begin with the Federal Reserve, the most powerful of financial regulators.  The report’s most important public service comes in its recitation of how top Fed officials, both in Washington and in New York, fiddled while the financial system smoldered and then burned.  It is disturbing indeed that this institution, defiantly inert and uninterested in reining in the mortgage mania, received even greater regulatory powers under the Dodd-Frank law that was supposed to reform our system.

(I find it disturbing that Ms. Morgenson is still fixated on “mortgage mania” as a cause of the crisis after having been upbraided by Barry Ritholtztwice – for “pushing the Fannie-Freddie CRA meme”.)

At her Naked Capitalism blog, Yves Smith focused more intently on what the FCIC Report didn’t say, as opposed to what it actually said:

The FCIC has also been unduly close-lipped about their criminal referrals, refusing to say how many they made or giving a high-level description of the type of activities they encouraged prosecutors to investigate.  By contrast, the Valukas report on the Lehman bankruptcy discussed in some detail whether it thought civil or criminal charges could be brought against Lehman CEO Richard Fuld and chief financial officers chiefs Chris O’Meara, Erin Callan and Ian I Lowitt, and accounting firm Ernst & Young.  If a report prepared in a private sector action can discuss liability and name names, why is the public not entitled to at least some general disclosure on possible criminal actions coming out of a taxpayer funded effort?  Or is it that the referrals were merely to burnish the image of the report, and are expected to die a speedy death?

At his Calculated Risk blog, Bill McBride corroborated one of the Report’s Conclusions, by recounting his own experience.  After quoting some of the language supporting the point that the crisis could have been avoided if the warning signs had not been ignored, due to the “pervasive permissiveness” at the Federal Reserve, McBride recalled a specific example:

This is absolutely correct.  In 2005 I was calling regulators and I was told they were very concerned – and several people told me confidentially that the political appointees were blocking all efforts to tighten standards – and one person told me “Greenspan is throwing his body in front of all efforts to tighten standards”.

The dissenting views that discount this willful lack of regulation are absurd and an embarrassment for the authors.

William Black wrote an essay criticizing the dissenters themselves – based on their experience in developing the climate of financial deregulation that facilitated the crisis:

The Commission is correct.  Absent the crisis was avoidable.  The scandal of the Republican commissioners’ apologia for their failed anti-regulatory policies was also avoidable.  The Republican Congressional leadership should have ensured that it did not appoint individuals who would be in the impossible position of judging themselves.  Even if the leadership failed to do so and proposed such appointments, the appointees to the Commission should have recognized the inherent conflict of interest and displayed the integrity to decline appointment.  There were many Republicans available with expertise in, for example, investigating elite white-collar criminals regardless of party affiliation.  That was the most relevant expertise needed on the Commission.

At this point, the important question is whether the efforts of the Financial Crisis Inquiry Commission will result in any changes that could help us avoid another disaster.  I’m not feeling too hopeful.



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Listening To Smart People

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As the mid-term election cycle reaches its climax, we find ourselves exposed to an increasing amount of stupid pronouncements by desperate politicians, overworked commentators and plain-old idiots, who managed to attract the interest of television news personnel.  I was particularly amused by the recent outburst from Juan Williams about the fact that he gets nervous when he sees people in “Muslim garb” boarding a plane in which he is a passenger.  NPR saw fit to fire him for making a remark described as “inconsistent with our editorial standards and practices”.  Despite the widespread hand-wringing over the “bigoted” nature of the statement, I was more focused on its stupidity.  Does Juan Williams seriously believe that terrorists would board a plane dressed in Muslim garb?  I would assume that all terrorists learn in Jihad 101 that the traditional garb for airborne martyrdom is the Adidas warm-up suit.  Wearing “Muslim garb” for such an occasion would serve only as an offer to be waterboarded.

Another example of election year asininity is the thought that someone could get elected to the Senate by claiming that the incumbent opponent of said candidate “actually voted to use taxpayer dollars to pay for Viagra for convicted child molesters and sex offenders”.  It was beginning to appear as though stupid has become the “new normal”.

Finally, some fresh air came along when a few news outlets reminded us that there are still some smart people among us.  The Los Angeles Times was kind enough to publish an interview with Elizabeth Warren, conducted by Jim Puzzanghera.  President Obama decided to appoint Professor Warren to launch the newly-created Consumer Financial Protection Bureau out of fear that a protracted confirmation battle would ensue if he appointed her as director of that agency.  With non-stop news coverage currently focused on the recent disclosures of fraudulent conduct extending from the mortgage origination process right through the foreclosure process, it would seem that the election-eve interview would provide an opportunity to assail the targets of the new agency.  When asked whether she would support the scattergun approach of seeking a nationwide foreclosure moratorium “while bank paperwork problems are being worked out”, Professor Warren gave us a glimpse of some traits we haven’t seen in a while:  restraint and common sense.  Here is her response to that tough question:

This agency will not veer from its support of American families, whether it’s in the foreclosure crisis or elsewhere.  But no one would want this agency … to act before it had collected all of the necessary data and thought through the options.  The (state) attorneys general are moving fast, and at this moment, I think that’s the right response … with emphasis on “at this moment.”

Professor Warren wasn’t the only smart person to draw some curiosity from the ADD-addled news media this week.  My favorite stock market guru, Jeremy Grantham, released his latest Quarterly Letter on Tuesday.  Its Halloween-based theme made it impossible to overlook.  As usual, Mr. Grantham gave us his unique, brilliant perspective in exposing how the Federal Reserve’s reckless (if not actually criminal) monetary policy helped cause the financial crisis and how Chairman Bernanke’s anticipated move toward more quantitative easing could make a bad situation worse.  Here are a few gems from Grantham’s must-read essay:

And these are most decidedly not normal times.  The unusual number of economic and financial problems has put extreme pressure on the Fed and the Administration to help the economy recover.  The atypical disharmony in Congress, however, has made the Federal government dysfunctional, and almost nothing significant – good or bad – can be done. Standard fiscal stimulus at a level large enough to count now seems impossible, even in the face of an economy that is showing signs of sinking back as the original stimulus wears off. This, of course, puts an even bigger burden on the Fed and induces, it seems, a state of panic.  Thus, the Fed falls back on its last resort – quantitative easing.  This has been used so rarely that its outcome is generally recognized as uncertain.

*   *   *

And of all of the many mistakes of the current Administration, the worst, in my opinion, are directly related to this fiasco:  the inexplicable choice of Geithner, who was actually placed at the scene of the crime in New York and whose fingerprints were on the murder weapon, and the reappointment of  … gulp … Bernanke himself, about whose reappointment much juicy Republican criticism was made, all of it completely justified in my view.  There may, however, be a small ray of hope.  The recent Fed appointee, Vice Chair Janet Yellen, said not long ago, “Of course asset bubbles must be taken seriously!”  She also said, “It is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage and excessive risk taking.”  Yes, sir!  Or rather, madam!  A promising start.  These sentiments, of course, are completely contrary to the oft-repeated policies of Greenspan and his chief acolyte, Bernanke.  Perhaps she will slap some good sense into her boss on this issue.

*   *   *

Since it is customary in polite society to apologize for causing distress, on behalf of the Fed, let me apologize for the extraordinary destructiveness of its policies for the last 15 years.  Bernanke’s version of an apology, delivered in January this year to the American Economic Association, was to claim that the Fed’s monetary policy during the 2000-08 period was appropriate, and that there were no major failings, such as missing the housing bubble completely, that were worth mentioning.  This stubbornness in the face of clear data is right up there with efficient market believers.  And very impolite indeed.

Now I have to go back to waiting another three months for Jeremy Grantham’s next Quarterly Letter.  As always, the current one will be tough to beat.  In the mean time, it’s nice to know that there are some smart people around, capable of providing solutions to our most pressing problems.  If only those vested with the authority to implement those ideas were paying attention   .   .   .



More Good Stuff From David Stockman

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August 2, 2010

The people described by Barry Ritholtz as “deficit chicken hawks” have their hands full.  Just as some Democrats, concerned about getting campaign contributions from rich people, were joining the ranks of the deficit chicken hawks to support extension of the Bush tax cuts, people from across the political spectrum spoke out against the idea.  As I pointed out on July 19, President Reagan’s former director of the Office of Management and Budget (OMB) – David Stockman – spoke out against extending the Bush tax cuts for the wealthy, during an interview with Lloyd Grove of The Daily Beast:

The Bush tax cuts never should’ve been passed because, one, we couldn’t afford them, and second, we didn’t earn them  …

The infamous former Federal Reserve chairman, Alan Greenspan, had already spoken out against the Bush tax cuts on July 16, during an interview with Judy Woodruff on Bloomberg Television.  In response to Ms. Woodruff’s question as to whether the Bush tax cuts should be extended, Greenspan replied:  “I should say they should follow the law and let them lapse.”

When Alan Greenspan appeared on the August 1 broadcast of NBC’s Meet The Press, David Gregory directed Greenspan’s attention back to the interview with Judy Woodruff, and asked Mr. Greenspan if he felt that all of the Bush tax cuts should be allowed to lapse.  Here is Greenspan’s reply and the follow-up:

MR.GREENSPAN:  Look, I’m very much in favor of tax cuts, but not with borrowed money.  And the problem that we’ve gotten into in recent years is spending programs with borrowed money, tax cuts with borrowed money, and at the end of the day, that proves disastrous.  And my view is I don’t think we can play subtle policy here on it.

MR. GREGORY:  You don’t agree with Republican leaders who say tax cuts pay for themselves?

MR. GREENSPAN:  They do not.

The drumbeat to extend the Bush tax cuts has been ongoing.  Federal Reserve chairman, Ben Bernanke, claimed on July 23, that those tax cuts would be one way of providing stimulus for the economy – provided that such a move were to be offset “with increased revenue or lower spending.”  Increased revenue?  Does that mean that people – other than those earning in excess of $250,000 per year – should make up the difference by paying higher taxes?

On July 31, David Stockman came back with a huge dose of common sense, in the form of an op-ed piece for The New York Times entitled, “Four Deformations of the Apocalypse”.  It began with this statement:

IF there were such a thing as Chapter 11 for politicians, the Republican push to extend the unaffordable Bush tax cuts would amount to a bankruptcy filing.  The nation’s public debt — if honestly reckoned to include municipal bonds and the $7 trillion of new deficits baked into the cake through 2015 — will soon reach $18 trillion.  That’s a Greece-scale 120 percent of gross domestic product, and fairly screams out for austerity and sacrifice.  It is therefore unseemly for the Senate minority leader, Mitch McConnell, to insist that the nation’s wealthiest taxpayers be spared even a three-percentage-point rate increase.

The article included a boxcar full of great thoughts – among them was Stockman’s criticism of the latest incarnation of voodoo economics:

Republicans used to believe that prosperity depended upon the regular balancing of accounts — in government, in international trade, on the ledgers of central banks and in the financial affairs of private households and businesses, too.  But the new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance — vulgar Keynesianism robed in the ideological vestments of the prosperous classes.

Mr. Stockman took care to lay blame at the foot of the man he described in the Lloyd Grove interview as an “evil genius” – Milton Friedman – who convinced President Nixon in 1971 to “to unleash on the world paper dollars no longer redeemable in gold or other fixed monetary reserves.”

Despite the fact that tax cuts are considered by many as the ultimate panacea for all of America’s economic problems, David Stockman set the record straight about how the religion of taxcut-ology began:

Through the 1984 election, the old guard earnestly tried to control the deficit, rolling back about 40 percent of the original Reagan tax cuts.  But when, in the following years, the Federal Reserve chairman, Paul Volcker, finally crushed inflation, enabling a solid economic rebound, the new tax-cutters not only claimed victory for their supply-side strategy but hooked Republicans for good on the delusion that the economy will outgrow the deficit if plied with enough tax cuts.

By fiscal year 2009, the tax-cutters had reduced federal revenues to 15 percent of gross domestic product, lower than they had been since the 1940s.

Stockman’s discussion of “the vast, unproductive expansion of our financial culture” is probably just a teaser for his upcoming book on the financial crisis:

But the trillion-dollar conglomerates that inhabit this new financial world are not free enterprises.  They are rather wards of the state, extracting billions from the economy with a lot of pointless speculation in stocks, bonds, commodities and derivatives.  They could never have survived, much less thrived, if their deposits had not been governmentguaranteed and if they hadn’t been able to obtain virtually free money from the Fed’s discount window to cover their bad bets.

On the day following the publication of Stockman’s essay, Sarah Palin appeared on Fox News Sunday – prepared with notes again written on the palm of her hand – to argue in support of extending the Bush tax cuts.  Although her argument was directed against the Obama administration, I was fixated on the idea of a debate on the subject between Palin and her fellow Republican, David Stockman.  Some of those Republicans vying for their party’s 2012 Presidential nomination were probably thinking about the same thing.




Ignoring David Stockman

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July 19, 2010

With mid-term elections approaching, politicians are fearful of making any decisions or statements that may offend their wealthy contributors.  Accordingly, the prospect of allowing the Bush tax cuts to expire has become a source of outrage among Republicans.  In fact, many Democrats are afraid to touch this subject as their number of wealthy benefactors continues to shrink.

On July 11, Chris Wallace posed this question to Arizona Senator John Kyl on Fox News Sunday:

Senator, let me just break in, because I want to pick up on exactly the point that you just brought up, particularly, the Bush tax cuts for the wealthy.  That is part of the big Republican growth agenda, let’s keep, not let expire, the Bush tax cuts for the wealthy.

The fact is those would cost $678 billion over 10 years.  At a time Republicans are saying that they can’t extend unemployment benefits unless you pay for them, tell me, how are you going to pay that $678 billion to keep those Bush tax cuts for the wealthy?

Kyl responded with:  “Chris, that is a loaded question.”  Kyl continued to dodge the question, despite persistent follow-up from Wallace.  The Senator eventually escaped with this curious response:  “. . . you should never raise taxes in order to cut taxes.”  The apparent logic behind this statement was that you should never raise taxes on the wealthy in order to cut taxes for the middle class.

Senate Republican leader Mitch McConnell stepped up to reassure his party’s wealthy contributors that there would be a fight to keep those tax cuts in place – even if some of their old heroes thought the cuts were a bad idea.  Daniel Enoch of Bloomberg Businessweek put it this way:

U.S. Senate Republican Leader Mitch McConnell spoke out against former Federal Reserve Chairman Alan Greenspan’s call to let tax cuts that were passed during the administration of President George W. Bush expire.

One would expect that since Ronald Reagan has become a patron saint of the Republican Party, the opinions of Reagan’s former budget director, David Stockman, might influence current opinion within the GOP.  Nevertheless, in a recent interview with Lloyd Grove of The Daily Beast, Stockman stepped on what has become a “third rail” for Republicans:

Stockman, a nominal tax-cutting supply-sider when he worked for Reagan, has been crusading in recent weeks for President Obama to let George W. Bush’s tax cuts expire — something that will happen automatically absent congressional intervention.

“The only thing Obama needs to do is say, ‘Gentlemen and Ladies of the Congress, don’t send me a tax bill because I don’t want one,’ ” Stockman tells me.  “He can take the political hit.  That’s his job.  That’s change you can believe in.  That would put $300 billion back into the coffers, beginning in 2011 and 2012, and it would erase one of the biggest policy blunders in history.  The Bush tax cuts never should’ve been passed because, one, we couldn’t afford them, and second, we didn’t earn them…  The lower half of American families don’t pay income tax, and they’re the people who ought to be given a break here.  By allowing these tax cuts to expire, you’re putting the burden on the top half of the income earners.  What is more fair than that?  So why does Obama want to extend, as apparently the White House has been saying, the tax cuts for $150,000-a-year families?  So the wife can buy her 19th Coach bag?”

Of course, we all know the answer to that question.   It’s because Obama is every bit as motivated as his adversaries to tailor his own policies toward generating campaign contributions.




Still Wrong After All These Years

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June 21, 2010

I’m quite surprised by the fact that people continue to pay serious attention to the musings of Alan Greenspan.  On June 18, The Wall Street Journal saw fit to publish an opinion piece by the man referred to as “The Maestro” (although – these days – that expression is commonly used in sarcasm).  The former Fed chairman expounded that recent attempts to rein in the federal budget are coming “none too soon”.  Near the end of the article, Greenspan made the statement that will earn him a nomination for TheCenterLane.com’s Jackass of the Year Award:

I believe the fears of budget contraction inducing a renewed decline of economic activity are misplaced.

John Mauldin recently provided us with a thorough explanation of why Greenspan’s statement is wrong:

There are loud calls in the US and elsewhere for more fiscal constraints.  I am part of that call.  Fiscal deficits of 10% of GDP is a prescription for disaster.  As we have discussed in previous letters, the book by Rogoff and Reinhart (This Time is Different) clearly shows that at some point, bond investors start to ask for higher rates and then the interest rate becomes a spiral.  Think of Greece.  So, not dealing with the deficit is simply creating a future crisis even worse than the one we just had.

But cutting the deficit too fast could also throw the country back in a recession.  There has to be a balance.

*   *   *

That deficit reduction will also reduce GDP.  That means you collect less taxes which makes the deficits worse which means you have to make more cuts than planned which means lower tax receipts which means etc.  Ireland is working hard to reduce its deficits but their GDP has dropped by almost 20%! Latvia and Estonia have seen their nominal GDP drop by almost 30%!  That can only be characterized as a depression for them.

Robert Reich’s refutation of Greenspan’s article was right on target:

Contrary to Greenspan, today’s debt is not being driven by new spending initiatives.  It’s being driven by policies that Greenspan himself bears major responsibility for.

Greenspan supported George W. Bush’s gigantic tax cut in 2001 (that went mostly to the rich), and uttered no warnings about W’s subsequent spending frenzy on the military and a Medicare drug benefit (corporate welfare for Big Pharma) — all of which contributed massively to today’s debt.  Greenspan also lowered short-term interest rates to zero in 2002 but refused to monitor what Wall Street was doing with all this free money.  Years before that, he urged Congress to repeal the Glass-Steagall Act and he opposed oversight of derivative trading.  All this contributed to Wall Street’s implosion in 2008 that led to massive bailout, and a huge contraction of the economy that required the stimulus package.  These account for most of the rest of today’s debt.

If there’s a single American more responsible for today’s “federal debt explosion” than Alan Greenspan, I don’t know him.

But we can manage the Greenspan Debt if we get the U.S. economy growing again.  The only way to do that when consumers can’t and won’t spend and when corporations won’t invest is for the federal government to pick up the slack.

This brings us back to my initial question of why anyone would still take Alan Greenspan seriously.  As far back as April of 2008 – five months before the financial crisis hit the “meltdown” stage — Bernd Debusmann had this to say about The Maestro for Reuters, in a piece entitled, “Alan Greenspan, dented American idol”:

Instead of the fawning praise heaped on Greenspan when the economy was booming, there are now websites portraying him in dark colors.  One site is called The Mess That Greenspan Made, another Greenspan’s Body Count.  Greenspan’s memoirs, The Age of Turbulence, prompted hedge fund manager William Fleckenstein to write a book entitled Greenspan’s Bubbles, the Age of Ignorance at the Federal Reserve.  It’s in its fourth printing.

The day after Greenspan’s essay appeared in The Wall Street Journal, Howard Gold provided us with this recap of Greenspan’s Fed chairmanship in an article for MarketWatch:

The Fed chairman’s hands-off stance helped the housing bubble morph into a full-blown financial crisis when hundreds of billions of dollars’ worth of collateralized debt obligations, credit default swaps, and other unregulated derivatives — backed by subprime mortgages and other dubious instruments — went up in smoke.

Highly leveraged banks that bet on those vehicles soon were insolvent, too, and the Fed, the U.S. Treasury and, of course, taxpayers had to foot the bill.  We’re still paying.

But this was not just a case of unregulated markets run amok.  Government policies clearly made things much worse — and here, too, Greenspan was the culprit.

The Fed’s manipulation of interest rates in the middle of the last decade laid the groundwork for the most fevered stage of the housing bubble.  To this day, Greenspan, using heavy-duty statistical analysis, disputes the role his super-low federal funds rate played in encouraging risky behavior in housing and capital markets.

Among the harsh critiques of Greenspan’s career at the Fed, was Frederick Sheehan’s book, Panderer to Power.  Ryan McMaken’s review of the book recently appeared at the LewRockwell.com website – with the title, “The Real Legacy of Alan Greenspan”.   Here is some of what McMacken had to say:

.  .  .  Panderer to Power is the story of an economist whose primary skill was self-promotion, and who in the end became increasingly divorced from economic reality.  Even as early as April 2008 (before the bust was obvious to all), the L.A. Times, observing Greenspan’s post-retirement speaking tour, noted that “the unseemly, globe-trotting, money-grabbing, legacy-spinning, responsibility-denying tour of Alan Greenspan continues, as relentless as a bad toothache.”

*   *   *

Although Greenspan had always had a terrible record on perceiving trends in the economy, Sheehan’s story shows a Greenspan who becomes increasingly out to lunch with each passing year as he spun more and more outlandish theories about hidden profits and productivity in the economy that no one else could see.  He spoke incessantly on topics like oil and technology while the bubbles grew larger and larger.  And finally, in the end, he retired to the lecture circuit where he was forced to defend his tarnished record.

The ugly truth is that America has been in a bear market economy since 2000 (when “The Maestro” was still Fed chair).  In stark contrast to what you’ve been hearing from the people on TV, the folks at Comstock Partners put together a list of ten compelling reasons why “the stock market is in a secular (long-term) downtrend that began in early 2000 and still has some time to go.”  This essay is a “must read”.  Further undermining Greenspan’s recent opinion piece was the conclusion reached in the Comstock article:

The data cited here cover the major indicators of economic activity, and they paint a picture of an economy that has moved up, but only from extremely depressed numbers to a point where they are less depressed.  And keep in mind that this is the result of the most massive monetary and fiscal stimulus ever applied to a major economy.  In our view the ability of the economy to undergo a sustained recovery without continued massive help is still questionable.

As always, Alan Greenspan is still wrong.  Unfortunately, there are still too many people taking him seriously.




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Financial Reform Might Actually Happen

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April 12, 2010

The long-overdue need for financial reform is finally getting some serious attention in Washington.  As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.

On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”.  At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:

What happens if we do nothing?

What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen?  It will be a body blow to many banks, especially in Europe.  Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk.  In the next crisis, we will not have the tools available to stem the tide that we did the last time.  Rates are already low.  Do you think we could pass another TARP?  The Fed’s balance sheet is already bloated.  It could get much worse unless we get financial reforms that have some bite.

All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time.  Fix the big things. Credit default swaps. Too big to fail.  Leverage. Then worry about the details.

Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized.  Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:

Let me be clear.  There are a lot of things not to like about the Federal Reserve System.  I think it was Milton Friedman who said we would be better off with a computer determining monetary policy.  A quote from an interview with him is instructive.  When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:

“Yes.  Of course it depends very much on how the computer is programmed.  I am not saying that any computer program would do.  In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year.  There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions.  One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge.  We have seen that in the history of our own Federal Reserve System.

Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s.  He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”.  Nevertheless, the solution he embraced was simple:

The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach:  Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds.  Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.

“Bankers would hate it.  It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square.  If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.

His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.

Bankers would scream about the need to protect their proprietary-trading information.  And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2.  To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.

Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one.  The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk.  They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system.  In fact, COR is the core of the whole scheme.

The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary.  Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:

Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)?  Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?

Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.

Regardless of what the final product will include – one thing is becoming increasingly likely:  Some semblance of financial reform legislation will eventually become enacted.  It won’t be perfect but anything will be better than what we have now.  (Well, almost anything  .  .  .)




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Getting It Reich

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April 8, 2010

Robert Reich, former Secretary of Labor under President Clinton, has been hitting more than a few home runs lately.   At a time when too many commentators remain in lock-step with their favorite political party, Reich pulls no punches when pointing out the flaws in the Obama administration’s agenda.  I particularly enjoyed his reaction to the performance of Larry Summers on ABC television’s This Week on April 4:

I’m in the “green room” at ABC News, waiting to join a roundtable panel discussion on ABC’s weekly Sunday news program, This Week.

*   *   *

Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?

*   *   *

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin.

*   *   *

I dislike singling out individuals for blame or praise in a political system as complex as that of the United States but I worry the nation is not on the right economic road, and that these individuals — one of whom advises the President directly and the others who continue to exert substantial influence among policy makers — still don’t get it.

The direction financial reform is taking is not encouraging.  Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives.  Neither bill adequately prevents banks from becoming insolvent because of their reckless trades.  Neither limits the size of banks or busts up the big ones.  Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds.

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism.

Is it because our elected officials just don’t understand what needs to be done to prevent another repeat of the financial crisis – or is the unwillingness to take preventative action the result of pressure from lobbyists?  I think they’re just playing dumb while they line their pockets with all of that legalized graft. Meanwhile, Professor Reich continued to function as the only adult in the room, with this follow-up piece:

Needless to say, the danger of an even bigger cost in coming years continues to grow because we still don’t have a new law to prevent what happened from happening again.  In fact, now that they know for sure they’ll be bailed out, Wall Street banks – and those who lend to them or invest in them – have every incentive to take even bigger risks.  In effect, taxpayers are implicitly subsidizing them to do so.

*   *   *

But the only way to make sure no bank it too big to fail is to make sure no bank is too big.  If Congress and the White House fail to do this, you have every reason to believe it’s because Wall Street has paid them not to.

Reich’s recent criticism of the Federal Reserve was another sorely-needed antidote to Ben Bernanke’s recent rise to media-designated sainthood.  In an essay quoting Republican Senator Jim DeMint of South Carolina, Reich transcended the polarized political climate to focus on the fact that the mysterious Fed enjoys inappropriate authority:

The Fed has finally came clean.  It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank’s bad loans – in order to smooth Bear Stearns’ takeover by JP Morgan Chase.  The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed.  The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.

The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook.  But the public never knew.  There was no congressional oversight.  It was all done behind closed doors. And the New York Fed – then run by Tim Geithner – was very much in the center of the action.

*   *   *

The Fed has a big problem.  It acts in secret.  That makes it an odd duck in a democracy.  As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

You probably thought that Ron Paul was the only one who spoke that way about the Federal Reserve.  Fortunately, when people such as Robert Reich speak out concerning the huge economic and financial dysfunction afflicting America, there is a greater likelihood that those with the authority to implement the necessary reforms will do the right thing.  We can only hope.




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Building A Consensus For Survival

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March 29, 2010

In my last posting, I focused on the fantastic discourse in favor of financial reform presented by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, in a speech before the U.S. Chamber of Commerce.  In addition to Hoenig’s speech, last week brought us a number of excellent arguments for the cause that is so bitterly opposed by Wall Street lobbyists.  On the same day that Thomas Hoenig delivered his great speech to the U.S. Chamber of Commerce, Deputy Treasury Secretary Neal Wolin also addressed that institution to argue in favor of financial reform.  I enjoyed the fact that he rubbed this in their faces:

That is why it is so puzzling that, despite the urgent and undeniable need for reform, the Chamber of Commerce has launched a $3 million advertising campaign against it.  That campaign is not designed to improve the House and Senate bills.  It is designed to defeat them.  It is designed to delay reform until the memory of the crisis fades and the political will for change dies out.

The Chamber’s campaign comes on top of the $1.4 million per day already being spent on lobbying and campaign contributions by big banks and Wall Street financial firms.  There are four financial lobbyists for every member of Congress.

Wolin’s presentation was yet another signal from the Treasury Department that inspired economist Simon Johnson to begin feeling optimistic about the possibility that some meaningful degree of financial reform might actually take place:

Against all the odds, a glimmer of hope for real financial reform begins to shine through.  It’s not that anything definite has happened — in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on — at least on the issue of consumer protection.  Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble             financial innovation and sophisticated risk management.”

Yep.  That was our old pal and former New York Fed President, “Turbo” Tim Geithner, making the case for financial reform before the American Enterprise Institute.  (You remember them — the outfit that fired David Frum for speaking out against Fox News and the rest of the “conservative entertainment industry”.)  Treasury Secretary Geithner made his pitch for reform by reminding his conservative audience that longstanding advocates of the “efficient market hypothesis” had come on board in favor of financial reform:

Now, the recognition that markets failed and that the necessary solution involves reform; that it requires rules enforced by government is not a partisan or political judgment.  It is a conclusion reached by liberals and by conservative skeptics of regulation.

Judge Richard Posner, a leader in the conservative Chicago School of economics, wrote last year, that “we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

And consider Alan Greenspan, a skeptic of the benefits of regulation, who recently said, “inhibiting irrational behavior when it can be identified, through regulation,   . . .   could be stabilizing.”

No wonder Simon Johnson is feeling so upbeat!  The administration is actually making a serious attempt at doing what needs to be done to get this accomplished.

Meanwhile, The New York Times had run a superb article by David Leonhardt just as Geithner was about to address the AEI.  Leonhardt’s essay, “Heading Off the Next Financial Crisis” is a thorough analysis, providing historical background and covering every angle on what needs to be done to clean up the mess that got us where we are today — and to prevent it from happening again.  Here are some snippets from the first page that had me hooked right away:

It was a maddening story line:  the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times.  Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.

*   *   *

In a way, this issue is more about human nature than about politics.  By definition, the next period of financial excess will appear to have recent history on its side.

*   *   *

One way to deal with regulator fallibility is to implement clear, sweeping rules that limit people’s ability to persuade themselves that the next bubble is different — upfront capital requirements, for example, that banks cannot alter.  Thus far, the White House, the Fed and Congress have mostly steered clear of such rules.

Congratulations to David Leonhardt for putting that great piece together.  As more commentators continue to advance such astute, sensible appeals to plug the leaks in our sinking financial system, there is a greater likelihood that our lawmakers will realize that the economic risk of doing nothing far exceeds the amounts of money in those envelopes from the lobbyists.




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