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EU-phoria Fades

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The most recent “light at the end of the tunnel” for the European sovereign debt crisis was seen on Friday June 29.  At a summit in Brussels, leaders of the European Union member nations agreed upon yet another “plan for a plan” to recapitalize failing banks – particularly in Spain.  The Summit Statement, which briefly summarized the terms of the plan, explained that an agreement was reached to establish a supervisory entity which would oversee the European banking system and to allow recapitalization of troubled banks without adding to sovereign debt.  By owning shares in the ailing banks, the European Stability Mechanism would no longer have a senior creditor status, in order to prevent investors from being scared away from buying sovereign bonds.

The bond markets were relieved to know that once again, taxpayers would be paying for the losses sustained by bondholders.  The reaction was immediate.  Spanish and Italian bond yields dropped faster than William Shatner’s pants when he passed through airport securitySpain’s ten-year bond yield dropped to 6.51 percent on June 29 from the previous day’s closing level of 6.87 percent.  Italy’s ten-year bond yield sank to 5.79 percent from the previous closing level of 6.24 percent.

Global stock indices went parabolic after the news from Brussels on June 29.  Nevertheless, many commentators expressed their skepticism about the latest plan.  Economist John Hussman of the Hussman Funds discussed the shortcomings of the proposal in his Weekly Market Comment:

The upshot here is that Spain’s banks are undercapitalized and insolvent, but rather than take them over and appropriately restructure them in a way that requires bondholders to take losses instead of the public, Spain hopes to tap European bailout funds so that it can provide capital directly to its banks through the European Stability Mechanism (ESM), and put all of Europe’s citizens on the hook for the losses.Spainhas been trying to get bailout funds without actually having the government borrow the money, because adding new debt to its books would drive the country further toward sovereign default.  Moreover, institutions like the ESM, the ECB, and the IMF generally enjoy senior status on their loans, so that citizens and taxpayers are protected.  Spain’s existing bondholders have objected to this, since a bailout for the banks would make their Spanish debt subordinate to the ESM.

As a side note, the statement suggests that Ireland, which already bailed its banks out the old-fashioned way, will demand whatever deal Spain gets.

So the hope is that Europe will agree to establish a single bank supervisor for all of Europe’s banks.  After that, the ESM – Europe’s bailout fund – would have the “possibility” to provide capital directly to banks.  Of course, since we’re talking about capital – the first buffer against losses – the bailout funds could not simply be lent to the banks, since debt is not capital.  Instead, it would have to be provided by directly purchasing stock (though one can imagine the Orwellian possibility of the ESM lending to bank A to buy shares of bank B, and lending to bank B to buy shares of bank A).  On the question of whether this is a good idea, as opposed to the alternative of properly restructuring banks, ask Spain how the purchase of Bankia stock has been working out for Spanish citizens (Bankia’s bondholders should at least send a thank-you note).  In any event, if this plan for a plan actually goes through, the bailout funds – provided largely by German citizens – would not only lose senior status to Spain’s government debt; the funds would be subordinate even to the unsecured debt held by the bondholders of Spanish banks, since equity is the first thing you wipe out when a bank is insolvent.

It will be interesting to see how long it takes for the German people to figure this out.

The criticism expressed by Charles Hugh Smith is particularly relevant because it addresses the latest move by the European Central Bank to lower its benchmark interest rate by 25 basis points (0.25%) to a record low of 0.75 percent.  Smith’s essay, entitled “Sorry Bucko Europe Is Still in a Death Spiral” consisted of sixteen phases of the death spiral dynamic.  Here are the final seven:

10. Transferring bad debt to central banks does not mean interest will not accrue: interest on the debt still must be paid out of future income, impairing that income.

11. Lowering interest rates does not create collateral where none exists.

12. Lowering interest rates only stretches out the death spiral, it does not halt or reverse it.

13. Centralizing banking and oversight does not create collateral where none exists.

14. Europe will remain in a financial death spiral until the bad debt is renounced/written off and assets are liquidated on the open market.

15. Anything other than this is theater.  Pushing the endgame out a few months is not a solution, nor will it magically create collateral or generate sustainable “growth.”

16. The Martian Central Bank could sell bonds to replace bad debt in Europe, but as long as the MCB collects interest on the debt, then nothing has changed.

The Martians would be extremely bent when they discovered there is no real collateral for their 10 trillion-quatloo loan portfolio in Europe.

Of course, Mr. Smith is forgetting that the Martians could call upon those generous taxpayers from planet Zobion for a bailout   .   .   .


 

Why Bad Publicity Never Hurts Goldman Sachs

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My last posting focused on the widely-publicized research conducted by Stéphane Côté, PhD, Associate Professor of Organizational Behavior at the University of Toronto’s Rotman School of Management, who worked with a team of four psychologists from the University of California at Berkeley to conduct seven studies on a rather timely subject.  Their article, “Higher social class predicts increased unethical behavior” was published in the February 27 issue of the Proceedings of the National Academy of Sciences (PNAS).  The following excerpt from the abstract of their paper provides the general theme of what their efforts revealed:

.   .   .  investigation revealed upper-class individuals were more likely to exhibit unethical decision-making tendencies (study 3), take valued goods from others (study 4), lie in a negotiation (study 5), cheat to increase their chances of winning a prize (study 6), and endorse unethical behavior at work (study 7) than were lower-class individuals.

I began my discussion of that paper by looking back at a Washington Post opinion piece entitled, “Angry about inequality?  Don’t blame the rich”.  The essay was written last January by James Q. Wilson (who passed away on March 2).  On March 4, William K. Black took a deeper look at the legacy of James Q. Wilson, which provided a better understanding of why Wilson would champion the “Don’t blame the rich” rationale.  As Bill Black pointed out, Wilson was a political scientist, known best for his theory called “broken windows” – a metaphor based on a vacant building with a few broken windows, which quickly has all of its windows broken because petty criminals feel emboldened to damage a building so neglected by its owners.  Bill Black emphasized that Wilson was exclusively preoccupied with minor, “blue collar” crimes.  Black noted that in a book entitled, Thinking About Crime, Wilson expressed tolerance for “some forms of civic corruption” while presenting an argument that criminology “should focus overwhelmingly on low-status blue collar criminals”.  Bill Black went on to explain how Wilson’s blindness to the relevance of the “broken windows” concept, as it related to “white collar” crime, resulted in a missed opportunity to attenuate the criminogenic milieu which led to the 2008 financial crisis:

Wilson emphasized that it was the willingness of society to tolerate relatively minor blue collar crimes that led to social disintegration and epidemics of severe blue collar crimes, but he engaged in the same willingness to tolerate and excuse less severe white collar crimes.  He predicted in his work on “broken windows” that tolerating widespread smaller crimes would lead to epidemic levels of larger crimes because it undermined community and social restraints.  The epidemics of elite white collar crime that have driven our recurrent, intensifying financial crises have proven this point.  Similarly, corruption that is excused and tolerated by elites is unlikely to remain at the level of “a few deals.”  Corruption is likely to spread in incidence and severity precisely because it undermines community and the rule of law and it is likely to grow more pervasive and harmful the more we “tolera[te]” it.

*   *   *

Taking Wilson’s “broken windows” reasoning seriously in the elite white collar crime context would require us to take a series of prophylactic measures to restore integrity and strengthen peer pressures against misconduct.  Indeed, we have implicitly tested the applicability of “broken windows” reasoning in that context by adopting policies that acted directly contrary to Wilson’s reasoning.  We have adopted executive and professional compensation systems that are exceptionally criminogenic.

*   *   *

Fiduciary duties are critical means of preventing broken windows from occurring and making it likely that any broken windows in corporate governance will soon be remedied, yet we have steadily weakened fiduciary duties.  For example, Delaware now allows the elimination of the fiduciary duty of care as long as the shareholders approve.  Court decisions have increasingly weakened the fiduciary duties of loyalty and care.  The Chamber of Commerce’s most recent priorities have been to weaken Sarbanes-Oxley and the Foreign Corrupt Practices Act.  We have made it exceptionally difficult for shareholders who are victims of securities fraud to bring civil suits against the officers and entities that led or aided and abetted the securities fraud.

*   *   *

In the elite white collar crime context we have been following the opposite strategy of that recommended under “broken windows” theory.  We have been breaking windows. We have excused those who break the windows.  Indeed, we have praised them and their misconduct.  The problem with allowing broken windows is far greater in the elite white collar crime context than the blue collar crime context.

To find a “poster child” example for the type of errant fiduciary behavior which owes its existence to Wilson’s misapplication of the “broken windows” doctrine, one need look no further than Matt Taibbi’s favorite “vampire squid”:  Goldman Sachs.  One would think that after Taibbi’s groundbreaking, 2009 tour de force about Goldman’s involvement in the events which led to the financial crisis . . .  and after the April 2010 Senate Permanent Subcommittee on Investigations hearing, wherein Goldman’s “Fab Four” testified about selling their customers the Abacus CDO and that “shitty” Timberwolf deal, the firm would at least try to keep a lower profile these days.  Naaaaw!

Goldman Sachs has now found itself in the crosshairs of a man, formerly accused of carrying water for the firm – Andrew Ross Sorkin.  Sorkin’s March 5 DealBook article for The New York Times upbraided Goldman for its flagrant conflict of interest in a deal where the firm served as an adviser to an oil (and natural gas) pipeline company, El Paso, which was being sold to Houston-based Kinder Morgan for $21.1 billion.  Goldman owned a 19.1 percent stake in Kinder Morgan at the time.  Andrew Ross Sorkin quoted from the script which Goldman CEO, Lloyd Blankfein read to El Paso’s CEO, Douglas Foshee, wherein Blankfein confirmed that Foshee was aware of Goldman’s investment in Kinder Morgan.  It was refreshing to see a bit of righteous indignation in Sorkin’s discussion of the dirty details behind this transaction:

When the deal was announced, buried at the end of the news release was a list of Wall Street banks that had advised on the deal, including Goldman Sachs.  Goldman received a $20 million fee for playing matchmaker for El Paso.  The fee, of course, was not disclosed, nor was the Kinder Morgan stake owned by Goldman Sachs’s private equity arm, worth some $4 billion.  Nor did the release disclose that the Goldman banker who advised El Paso to accept Kinder Morgan’s bid owned $340,000 worth of Kinder Morgan stock.

Now, however, a court ruling in a shareholder lawsuit has laid bare the truth:  Goldman was on every conceivable side of the deal.  As a result, El Paso may have unwittingly sold itself far too cheaply.  Mr. Blankfein may have said he was “very sensitive to the appearance of conflict,” but the judge’s order ruling “reluctantly” against a motion to block the merger made it clear that Goldman’s conflicts went far beyond mere appearances.

Here’s just one example:  In an effort to help mitigate its clear conflict, Goldman Sachs recommended that El Paso hire an additional adviser so that El Paso would be able to say that it had received completely impartial advice.  Goldman did not say it would step down, and lose its fee, it simply suggested that El Paso hire one more bank – in this case, Morgan Stanley.

After explaining that Goldman included a provision in the deal that Morgan Stanley would get paid only if El Paso agreed to the sale to Kinder Morgan, Sorkin expressed this reaction:

Goldman’s brazenness in this deal is nothing short of breathtaking.

Goldman’s conflict of interest in the El Paso deal was also the subject of an article by Matthew Philips of Bloomberg BusinessWeek.  Mr. Philips reminded us of whom we have to thank for “helping Greece dupe regulators by disguising billions of dollars’ worth of sovereign debt”:

New details have also emerged about Goldman’s role in helping Greece hide its debt so it could qualify for membership in the European Union.  In a Bloomberg News story out this week, Greek officials talk about how they didn’t truly understand the complex swaps contracts they were buying from Goldman bankers from 2001 to 2005, and that each time Goldman restructured the deal, things got worse for Greece.

The story reads like a cautionary tale of a homeowner who keeps returning to the same contractor to repair the damage done by the previous fix-it job.  At one point, Goldman prohibited Greece’s debt manager, Christoforos Sardelis, from seeking outside price quotes on the complicated derivatives Goldman was selling to Greece.

*   *   *

Yet Goldman’s sullied reputation doesn’t appear to be negatively impacting its business.  In fact, Goldman is outpacing its Wall Street competition recently in key areas of business.  In 2011, Goldman was the top adviser for both global M&A and equity IPOs.  A Bloomberg survey of traders, investors, and analysts last May showed that while 54 percent of respondents had an unfavorable opinion of Goldman, 78 percent believed that allegations it duped clients and misled Congress would have no material effect on its business.

In other words:  Goldman Sachs keeps breaking windows and nobody cares.  Thanks for nothing, James Q. Wilson!


Israel for Dummies

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I don’t pretend to be an expert on Middle East politics.  I usually rely on the perspective of Steve Clemons at The Washington Note, who provides candid, unvarnished commentary on the complicated issues in that region.  Since December of 2008, I have been following the accomplishments of Jeremy Ben-Ami, the Executive Director of J Street, which he describes as “the political arm of the pro-Israel, pro-peace movement”.

Concern over the threat to Israel from Iran’s nuclear ambitions has been a hot topic during this election year.  Nevertheless, on February 27, Andrew Jones wrote a piece for The Raw Story, which included some disclosures published by Wikileaks concerning Iran’s uranium enrichment efforts:

Growing concerns over Iran’s nuclear facilities may prove to be all for naught.  Officials from the global intelligence company Stratfor allegedly discussed that Israel may have already destroyed the Iranian nuclear facility, according to one of the emails released by Wikileaks Monday.

In one of the over five million emails leaked, the conversation centered on Israeli Defense Minister Ehud Barak praising the news of deadly munitions blasts at a base of Iran’s elite Revolutionary Guards.

“I think this is a diversion.  The Israelis already destroyed all the Iranian nuclear infrastructure on the ground weeks ago,” one intelligence official wrote in an email dated November 14, 2011. “The current ‘let’s bomb Iran’ campaign was ordered by the EU leaders to divert the public attention from their at home financial problems.  It plays also well for the US since Pakistan, Russia and N. Korea are mentioned in the report. ”

This scenario makes sense.  Iran would not likely admit to having been humiliated by Israel .  Beyond that, the European Union plutocrats would enjoy nothing more than a decent sideshow to distract attention from their economic austerity fiasco.

For years, I have been waiting for someone to write a book called Israel for Dummies.  Too many American teevee pundits seem completely ignorant about Israel’s internal political strife and its impact on the prospects for peace with the Palestinians.  It appears as though someone has finally written that book.  I recently came across a great piece written by Noah Millman for The American Conservative.  Mr. Millman wrote a review of a new book entitled, The Unmasking of Israel by Gershom Gorenberg.  As Millman explains, the book takes us back to the early days of Israel, with David Ben-Gurion at the helm, bringing us to the present-day, never-ending conflict with the Palestinians.  Here are some highlights from Noah Millman’s book review:

Rather, the thrust of the book, as the title states, is to demonstrate that the series of decisions made during and after the 1967 War that resulted in the occupation of the West Bank and Gaza set in motion a process that has progressively “unmade” the State of Israel.  Indeed, the progressive expansion of the settlement enterprise has so eroded the foundations of the signature achievement of political Zionism – Israel as we now know it – that not merely a “Jewish democratic state” but the state as such is now imperiled.

*   *   *

Since 1967, Gorenberg relates, the settlement enterprise has undermined the Israeli state top to bottom.  It has fostered secrecy and corruption in government.

*   *   *

Again the story is familiar.  Less so is the framing. Gorenberg, though he is outraged by the plight of the Palestinians, is not really writing about that plight.  Nor is he writing from an anti-Zionist perspective.  Rather, he is writing from a deeply Zionist point of view.  Zionism, we tend to forget, was not a self-defense movement.  It was a nationalist movement. Nationalism tells a people a story about what it means to be free – that being free means being part of a self-conscious, self-governing, sovereign, and independent collective.  Losing consciousness of one’s national group, being governed by other groups, failing to achieve independence and sovereignty on par with other nations – these are signs of unfreedom.  Of immaturity. The Jews before Zionism were, from the perspective of this narrative, either an exceptionally immature nation or not a nation at all.  The goal of Zionism was not simply – or even primarily – to provide for a “safe haven” for Jews fleeing persecution by the Czar or the Nazis.  The goal was the spiritual rejuvenation of the Jewish people by molding them into a nation like other nations and achieving independent statehood.

This is a narrative frame that, in broad strokes, Gorenberg accepts, which is why he is properly seen as a Zionist.  Indeed, the whole argument of the book is that by holding onto and settling the territories captured in 1967, Israel has reverted to a mode of existence that Zionism was supposed to help the Jews grow out of. By undermining the authority of the state, the settlement enterprise has revived modes of being and of argument that, from Gorenberg’s perspective, the Jewish people should have grown out of when they acquired the power and responsibility of a state. Indeed, that was the whole point, from a moral perspective, of acquiring state power in the first place.  The settlement enterprise doesn’t just undermine the moral case for Israel because it’s an injustice (plenty of states have perpetrated injustices – indeed, far worse injustices – without undermining the case for statehood as such) but because it is evidence that Zionism failed in what was arguably its primary objective.

As an aside:  Be sure to read the Comment stream following Millman’s piece.  It included some astute remarks and a good debate.

One American’s experience in attempting to get a better understanding of the Israeli – Palestinian conflict was chronicled on the Al Jazeera website.  Punk rock icon, Jello Biafra of The Dead Kennedys discussed his decision to cancel a show he was scheduled to perform at the Barby Club in Tel Aviv with his new band (Jello Biafra and the Guantanamo School of Medicine).  His bandmates had decided to boycott Israel in order to support the Boycott Divestment and Sanctions (BDS) movementWikipedia lists this explanation of the BDS movement’s three main goals:

  1. Freeing all Palestinian territories from Israeli influence since 1967 and dismantling the Israeli West Bank barrier;
  2. Acting towards the rights of the Arab-Palestinian citizens of Israel; and
  3. Promoting the interests of Arab Palestinian refugees in reference to the United Nations General Assembly Resolution 194 of 1948.

Jello Biafra’s account of what followed his decision to cancel the Tel Aviv gig made for some interesting reading:

So with the rollercoaster still in my stomach and my head, I flew solo to Israel instead.  The mission:  to check things out myself and hopefully at least get closer to some kind of conclusion on whether artists boycotting Israel, especially me, was really the best way to help the Palestinian people.

*   *   *

I also got an invitation from a self-proclaimed fan to “come meet the Israeli right” and see the settlements through their eyes, complete with a wine-tasting party.

Many people I met on my trip to Israel feel that the boycott has damaged the Israeli opposition more than it has anyone else and “helped silence the peace camp in Israel”.  A veteran journalist I met later told me, “the best way to contribute to peace is to try and work to understand both sides” and that he felt that boycotts strengthen extremists by keeping people apart.

*   *   *

One of the few things both Israelis and Palestinians seem to agree on is that one of the main obstacles to peace these days is the settlers.

Today the illegal settlements are completely out of control, with 300,000 settlers planted across the Green Line in the West Bank and another 200,000 beyond the Green Line in East Jerusalem. Borders are creatively moved and enforced by the infamous wall, started by the ideas of Yitzhak Rabin and greatly expanded by Ariel Sharon.  It’s a black eye on the face of Israel’s reputation today, considered so even among many of Israel’s citizens and supporters.

Some people told me that if the wall had been built along the Green Line, it might have actually worked.  But Sharon then used it as a land grab, creatively and maniacally routing it through the middle of Palestinian towns, Palestinian farmland and across Palestinian roads, in a deliberate attempt to make the West Bank such a splattered Swiss-cheese hodgepodge of impassable walls and checkpoints that a free Palestinian state could never get off the ground.

Any fantasy that Palestinians could one day be broken down to stay on “their side” of the wall and live happily ever after is ridiculous.  It flies in the face of all human instinct and human rights. It is never going to happen.  Like the Berlin Wall, it is destined to fall sooner rather than later.

*   *   *

A boycott of products made in settlements has begun inside Israel.  There is also a growing boycott by artists refusing to cross the Green Line and perform for the settlers.  A fancy venue has opened in one of the largest settlements in Ariel.  Many artists refuse to perform there.

*   *   *

Yet bringing down this regime by boycott may be a much higher mountain to climb than the boycott of South Africa.  The 1985 musician boycott of Sun City (a posh, government-owned golf resort and casino in South Africa) was just a promotional tool for the financial boycott, where banks, universities and corporations caved into pressure to pull their investments out of South Africa and broke the back of the white apartheid regime.

*   *   *

I am not saying the same tactics that brought down apartheid South Africa can’t be done.  I am just saying that there are different and heavier obstacles this time and people need to be ready for them.

South Africa never had anything like the AIPAC (American Israel Public Affairs Committee) lobby, which is now considered more of a lobby for Likud than for the Israeli people.  Nevertheless, they have a stranglehold over almost every member of Congress of both parties, using Joe McCarthy-type tactics to smear anyone they don’t like as anti-Jewish – and get them voted out of office.

*   *   *

I will not perform in Israel unless it is a pro-human rights, anti-occupation event that does not violate the spirit of the boycott.  Each artist must decide this for themselves. I am staying away for now, but am also really creeped out by the attitudes of some of the boycott hardliners, and hope someday to find a way to contribute something positive here.  I will not march or sign on with anyone who is more interested in making threats than making friends.

As for the Arab Spring, I cross my fingers on one hand and bite my nails with the other.

I have a lot to learn and a long way to go.

We all have a lot to learn.  Jello Biafra’s humility is refreshing.  If only our politicians were so humble  .  .  .


 

Plutocracy Is Crushing Democracy

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It’s been happening here in the United States since onset of the 2008 financial crisis.  I’ve complained many times about President Obama’s decision to scoff at using the so-called “Swedish solution” of putting the zombie banks through temporary receivership.  One year ago, economist John Hussman of the Hussman Funds discussed the consequences of the administration’s failure to do what was necessary:

If our policy makers had made proper decisions over the past two years to clean up banks, restructure debt, and allow irresponsible lenders to take losses on bad loans, there is no doubt in my mind that we would be quickly on the course to a sustained recovery, regardless of the extent of the downturn we have experienced.  Unfortunately, we have built our house on a ledge of ice.

*   *   *

As I’ve frequently noted, even if a bank “fails,” it doesn’t mean that depositors lose money.  It means that the stockholders and bondholders do.  So if it turns out, after all is said and done, that the bank is insolvent, the government should get its money back and the remaining entity should be taken into receivership, cut away from the stockholder liabilities, restructured as to bondholder liabilities, recapitalized, and reissued.  We did this with GM, and we can do it with banks.  I suspect that these issues will again become relevant within the next few years.

The plutocratic tools in control of our government would never allow the stockholders and bondholders of those “too-big-to-fail” banks to suffer losses as do normal people after making bad investments.

As it turns out, a few of those same banks are flexing their muscles overseas as the European debt crisis poses a new threat to Goldman Sachs and several of its ridiculously-overleveraged European counterparts.  Time recently published an essay by Stephan Faris, which raised the question of whether the regime changes in Greece and Italy amounted to a “bankers’ coup”:

As in Athens, the plan in Rome is to replace the outgoing prime minister with somebody from outside the political class.  Mario Monti, a neo-liberal economist and former EU commissioner who seems designed with the idea of calming the markets in mind, is expected to take over from Berlusconi after he resigns Saturday.

*   *   *

Yet, until the moment he’s sworn in, Monti’s ascension is far from a done deal, and it didn’t take long after the markets had closed for the weekend for it to start to come under fire.  Though Monti, a former advisor to Goldman Sachs, is heavily championed by the country’s respected president, many in parliament have spent the week whispering that Berlusconi’s ouster amounts to a “banker’s coup.”  “Yesterday, in the chamber of deputies we were bitterly joking that we were going to get a Goldman Sachs government,” says a parliamentarian from Berlusconi’s government, who asked to remain anonymous citing political sensitivity.

At The New York Times, Ross Douthat reflected on the drastic policy of bypassing democracy to install governments led by “technocrats”:

After the current crisis has passed, some voices have suggested, there will be time to reverse the ongoing centralization of power and reconsider the E.U.’s increasingly undemocratic character. Today the Continent needs a unified fiscal policy and a central bank that’s willing to behave like the Federal Reserve, Bloomberg View’s Clive Crook has suggested.  But as soon as the euro is stabilized, Europe’s leaders should start “giving popular sovereignty some voice in other aspects of the E.U. project.”

This seems like wishful thinking.  Major political consolidations are rarely undone swiftly, and they just as often build upon themselves.  The technocratic coups in Greece and Italy have revealed the power that the E.U.’s leadership can exercise over the internal politics of member states.  If Germany has to effectively backstop the Continent’s debt in order to save the European project, it’s hard to see why the Frankfurt Group (its German members, especially) would ever consent to dilute that power.

Reacting to Ross Douthat’s column, economist Brad DeLong was quick to criticize the use of the term “technocrats”.  That same label appeared in the previously-quoted Time article, as well:

Those who are calling the shots in Europe right now are in no wise “technocrats”:  technocrats would raise the target inflation rate in the eurozone and buy up huge amounts of Greek and Italian (and other) debt conditional on the enactment of special euro-wide long-run Fiscal Stabilization Repayment Fund taxes. These aren’t technocrats:  they are ideologues – and rather blinders-wearing ideologues at that.

Forget about euphemisms such as:  “technocrats”, “the European Union” or “the European Central Bank”.  Stephen Foley of The Independent pulled back the curtain and revealed the real culprit  .  .  .  Goldman Sachs:

This is the most remarkable thing of all:  a giant leap forward for, or perhaps even the successful culmination of, the Goldman Sachs Project.

It is not just Mr Monti.  The European Central Bank, another crucial player in the sovereign debt drama, is under ex-Goldman management, and the investment bank’s alumni hold sway in the corridors of power in almost every European nation, as they have done in the US throughout the financial crisis.  Until Wednesday, the International Monetary Fund’s European division was also run by a Goldman man, Antonio Borges, who just resigned for personal reasons.

Even before the upheaval in Italy, there was no sign of Goldman Sachs living down its nickname as “the Vampire Squid”, and now that its tentacles reach to the top of the eurozone, sceptical voices are raising questions over its influence.

*   *   *

This is The Goldman Sachs Project.  Put simply, it is to hug governments close.  Every business wants to advance its interests with the regulators that can stymie them and the politicians who can give them a tax break, but this is no mere lobbying effort.  Goldman is there to provide advice for governments and to provide financing, to send its people into public service and to dangle lucrative jobs in front of people coming out of government.  The Project is to create such a deep exchange of people and ideas and money that it is impossible to tell the difference between the public interest and the Goldman Sachs interest.

*   *   *

The grave danger is that, if Italy stops paying its debts, creditor banks could be made insolvent.  Goldman Sachs, which has written over $2trn of insurance, including an undisclosed amount on eurozone countries’ debt, would not escape unharmed, especially if some of the $2trn of insurance it has purchased on that insurance turns out to be with a bank that has gone under.  No bank – and especially not the Vampire Squid – can easily untangle its tentacles from the tentacles of its peers. This is the rationale for the bailouts and the austerity, the reason we are getting more Goldman, not less.  The alternative is a second financial crisis, a second economic collapse.

The previous paragraph explains precisely what the term “too-big-to-fail” is all about:  If a bank of that size fails – it can bring down the entire economy.  Beyond that, the Goldman situation illustrates what Simon Johnson meant when he explained that the United States – acting alone – cannot prevent the megabanks from becoming too big to fail.  Any attempt to regulate the size of those institutions requires an international effort:

But no international body — not the Group of -20, the Group of Eight or anyone else — shows any indication of taking this on, mostly because governments don’t wish to tie their own hands. In a severe crisis, the interests of the state are usually paramount. No meaningful cross-border resolution framework is even in the cards.  (Disclosure:  I’m on the FDIC’s Systemic Resolution Advisory Committee; I’m telling you what I tell them at every opportunity.)

What we are left with is a situation wherein the taxpayers are the insurers of the privileged elite, who invest in banks managed by greedy, reckless megalomaniacs.  When those plutocrats are faced with the risk of losing money – then democracy be damned!  Contempt for democracy is apparently a component of the mindset afflicting the “supply side economics” crowd.  Creepy Stephen Moore, of The Wall Street Journal’s editorial board, has expounded on his belief that capitalism is more important than Democracy.  We are now witnessing how widespread that warped value system is.


Straight Talk On The European Financial Mess

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The European sovereign debt crisis has generated an enormous amount of nonsensical coverage by the news media.  Most of this coverage appears targeted at American investors, who are regularly assured that a Grand Solution to all of Europe’s financial problems is “just around the corner” thanks to the heroic work of European finance ministers.

Fortunately, a number of commentators have raised some significant objections about all of the misleading “spin” on this subject.  Some pointed criticism has come from Michael Shedlock (a/k/a Mish) who recently posted this complaint:

I am tired of nonsensical headlines that have a zero percent chance of happening.

In a subsequent piece, Mish targeted a report from Bloomberg News which bore what he described as a misleading headline:  “EU Sees Progress on Banks”.  Not surprisingly, clicking on the Bloomberg link will reveal that the story now has a different headline.

For those in search of an easy-to-read explanation of the European financial situation, I recommend an essay by Robert Kuttner, appearing at the Huffington Post.  Here are a few highlights:

The deepening European financial crisis is the direct result of the failure of Western leaders to fix the banking system during the first crisis that began in 2007.  Barring a miracle of statesmanship, we are in for Financial Crisis II, and it will look more like a depression than a recession.

*   *   *

Beginning in 2008, the collapse of Bear Stearns revealed the extent of pyramid schemes and interlocking risks that had come to characterize the global banking system.  But Western leaders have stuck to the same pro-Wall-Street strategy:  throw money at the problem, disguise the true extent of the vulnerability, provide flimsy reassurances to money markets, and don’t require any fundamental changes in the business models of the world’s banks to bring greater simplicity, transparency or insulation from contagion.

As a consequence, we face a repeat of 2008.  Precisely the same kinds of off-balance sheet pyramids of debts and interlocking risks that caused Bear Stearns, then AIG, Lehman Brothers and Merrill Lynch to blow up are still in place.

Following Tim Geithner’s playbook, the European authorities conducted “stress tests” and reported in June that the shortfall in the capital of Europe’s banks was only about $100 billion.  But nobody believes that rosy scenario.

*   *   *

But to solely blame Europe and its institutions is to excuse the source of the storms.  That is the political power of the banks to block fundamental reform.

The financial system has mutated into a doomsday machine where banks make their money by originating securities and sticking someone else with the risk.  None of the reforms, beginning with Dodd-Frank and its European counterparts, has changed that fundamental business model.

As usual, the best analysis of the European financial situation comes from economist John Hussman of the Hussman Funds.  Dr. Hussman’s essay explores several dimensions of the European crisis in addition to noting some of the ongoing “shenanigans” employed by American financial institutions.  Here are a few of my favorite passages from Hussman’s latest Weekly Market Comment:

Incomprehensibly large bailout figures now get tossed around unexamined in the wake of the 2008-2009 crisis (blessed, of course, by Wall Street), while funding toward NIH, NSF and other essential purposes has been increasingly squeezed.  At the urging of Treasury Secretary Timothy Geithner, Europe has been encouraged to follow the “big bazooka” approach to the banking system.  That global fiscal policy is forced into austere spending cuts for research, education, and social services as a result of financial recklessness, but we’ve become conditioned not to blink, much less wince, at gargantuan bailout figures to defend the bloated financial institutions that made bad investments at 20- 30- and 40-to-1 leverage, is Timothy Geithner’s triumph and humanity’s collective loss.

*   *   *

A clean solution to the European debt problem does not exist. The road ahead will likely be tortuous.

The way that Europe can be expected to deal with this is as follows.  First, European banks will not have their losses limited to the optimistic but unrealistic 21% haircut that they were hoping to sustain.  In order to avoid the European Financial Stability Fund from being swallowed whole by a Greek default, leaving next-to-nothing to prevent broader contagion, the probable Greek default will be around 50%-60%.  Note that Greek obligations of all maturities, including 1-year notes, are trading at prices about 40 or below, so a 50% haircut would actually be an upgrade.  Given the likely time needed to sustainably narrow Greek deficits, a default of that size is also the only way that another later crisis would be prevented (at least for a decade, and hopefully much longer).

*   *   *

Of course, Europe wouldn’t need to blow all of these public resources or impose depression on Greek citizens if bank stockholders and bondholders were required to absorb the losses that result from the mind-boggling leverage taken by European banks.  It’s that leverage (born of inadequate capital requirements and regulation), not simply bad investments or even Greek default per se, that is at the core of the crisis.

Given the fact that the European crisis appears to be reaching an important crossroads, the Occupy Wall Street protest seems well-timed.  The need for significant financial reform is frequently highlighted in most commentaries concerning the European situation.  Whether our venal politicians will seriously address this situation remains to be seen.  I’m not holding my breath.


 

Preparing For The Worst

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November 19, 2009

In the November 18 edition of The Telegraph, Ambrose Evans-Pritchard revealed that the French investment bank, Societe Generale “has advised its clients to be ready for a possible ‘global economic collapse’ over the next two years, mapping a strategy of defensive investments to avoid wealth destruction”.   That gloomy outlook was the theme of a report entitled:  “Worst-case Debt Scenario” in which the bank warned that a new set of problems had been created by government rescue programs, which simply transferred private debt liabilities onto already “sagging sovereign shoulders”:

“As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse,” said the 68-page report, headed by asset chief Daniel Fermon.  It is an exploration of the dangers, not a forecast.

Under the French bank’s “Bear Case” scenario, the dollar would slide further and global equities would retest the March lows.  Property prices would tumble again.  Oil would fall back to $50 in 2010.

*   *   *

The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar.  Ageing populations will make it harder to erode debt through growth.  “High public debt looks entirely unsustainable in the long run.  We have almost reached a point of no return for government debt,” it said.

Inflating debt away might be seen by some governments as a lesser of evils.

If so, gold would go “up, and up, and up” as the only safe haven from fiat paper money.  Private debt is also crippling.  Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.

To make matters worse, America still has an unemployment problem that just won’t abate.  A recent essay by Charles Hugh Smith for The Business Insider took a view beyond the “happy talk” propaganda to the actual unpleasant statistics.  Mr. Smith also called our attention to what can be seen by anyone willing to face reality, while walking around in any urban area or airport:

The divergence between the reality easily observed in the real world and the heavily touted hype that “the recession is over because GDP rose 3.5%” is growing.  It’s obvious that another 7 million jobs which are currently hanging by threads will be slashed in the next year or two.

By this point, most Americans are painfully aware of the massive bailouts afforded to those financial institutions considered “too big to fail”.  The thought of transferring private debt liabilities onto already “sagging sovereign shoulders” immediately reminds people of TARP and the as-yet-undisclosed assistance provided by the Federal Reserve to some of those same, TARP-enabled institutions.

As Kevin Drawbaugh reported for Reuters, the European Union has already taken action to break up those institutions whose failure could create a risk to the entire financial system:

EU regulators are set to turn the spotlight on 28 European banks bailed out by governments for possible mandated divestitures, officials said on Wednesday.

The EU executive has already approved restructuring plans for British lender Lloyds Banking (LLOY.L), Dutch financial group ING Groep NV (ING.AS) and Belgian group KBC (KBC.BR).

Giving break-up power to regulators would be “a good thing,” said Paul Miller, a policy analyst at investment firm FBR Capital Markets, on Wednesday.

Big banks in general are bad for the economy because they do not allocate credit well, especially to small businesses, he said. “Eventually the big banks get broken up in one way or another,” Miller said at the Reuters Global Finance Summit.

Meanwhile in the United States, the House Financial Services Committee approved a measure that would grant federal regulators the authority to break up financial institutions that would threaten the entire system if they were to fail.  Needless to say, this proposal does have its opponents, as the Reuters article pointed out:

In both the House and the Senate, “financial lobbyists will continue to try to water down this new and intrusive federal regulatory power,” said Joseph Engelhard, policy analyst at investment firm Capital Alpha Partners.

If a new break-up power does survive the legislative process, Engelhard said, it is unlikely a “council of numerous financial regulators would be able to agree on such a radical step as breaking up a large bank, except in the most unusual circumstances, and that the Treasury Secretary … would have the ability to veto any imprudent use of such power.”

When I first read this, I immediately realized that Treasury Secretary “Turbo” Tim Geithner would consider any use of such power as imprudent and he would likely veto any attempt to break up a large bank.  Nevertheless, my concerns about the “Geithner factor” began to fade after I read some other encouraging news stories.  In The Huffington Post, Sam Stein disclosed that Oregon Congressman Peter DeFazio (a Democrat) had called for the firing of White House economic advisor Larry Summers and Treasury Secretary “Timmy Geithner” during an interview with MSNBC’s Ed Schultz.  Mr. Stein provided the following recap of that discussion:

“We think it is time, maybe, that we turn our focus to Main Street — we reclaim some of the unspent [TARP] funds, we reclaim some of the funds that are being paid back, which will not be paid back in full, and we use it to put people back to work.  Rebuilding America’s infrastructure is a tried and true way to put people back to work,” said DeFazio.

“Unfortunately, the President has an adviser from Wall Street, Larry Summers, and a Treasury Secretary from Wall Street, Timmy Geithner, who don’t like that idea,” he added.  “They want to keep the TARP money either to continue to bail out Wall Street  … or to pay down the deficit.  That’s absurd.”

Asked specifically whether Geithner should stay in his job, DeFazio replied:  “No.”

“Especially if you look back at the AIG scandal,” he added, “and Goldman and others who got their bets paid off in full … with taxpayer money through AIG.  We channeled the money through them.  Geithner would not answer my question when I said, ‘Were those naked credit default swaps by Goldman or were they a counter-party?’  He would not answer that question.”

DeFazio said that among he and others in the Congressional Progressive Caucus, there was a growing consensus that Geithner needed to be removed.  He added that some lawmakers were “considering questions regarding him and other economic advisers” — though a petition calling for the Treasury Secretary’s removal had not been drafted, he said.

Another glimmer of hope for the possible removal of Turbo Tim came from Jeff Madrick at The Daily Beast.  Madrick’s piece provided us with a brief history of Geithner’s unusually fast rise to power (he was 42 when he was appointed president of the New York Federal Reserve) along with a reference to the fantastic discourse about Geithner by Jo Becker and Gretchen Morgenson, which appeared in The New York Times last April.  Mr. Madrick demonstrated that what we have learned about Geithner since April, has affirmed those early doubts:

Recall that few thought Geithner was seasoned enough to be Treasury secretary when Obama picked him.  Rubin wasn’t ready to be Treasury secretary when Clinton was elected and he had run Goldman Sachs.  Was Geithner’s main attraction that he could easily be controlled by Summers and the White House political advisers?  It’s a good bet.  A better strategy, some argued, would have been to name Paul Volcker, the former Fed chairman, for a year’s worth of service and give Geithner as his deputy time to grow.  But Volcker would have been far harder to control by the White House.

But now the president needs a Treasury Secretary who is respected enough to stand up to Wall Street, restabilize the world’s trade flows and currencies, and persuade Congress to join a battle to get the economic recovery on a strong path.  He also needs someone with enough economic understanding to be a counterweight to the White House advisers, led by Summers, who have consistently been behind the curve, except for the $800 billion stimulus.  And now that is looking like it was too little.  The best guess is that Geithner is not telling the president anything that the president does not know or doesn’t hear from someone down the hall.

The problem for Geithner and his boss, is that the stakes if anything are higher than ever.

As the rest of the world prepares for worsening economic conditions, the United States should do the same.  Keeping Tim Geithner in charge of the Treasury makes less sense than it did last April.