September 14, 2009
As I write this, President Obama is preparing another fine-sounding, yet empty speech. His subject this time is financial reform. You may recall last week’s lofty address to the joint session of Congress, promoting his latest, somewhat-less-nebulous approach to healthcare reform. He assured the audience that the so-called “public option” (wherein a government-created entity competes with private sector healthcare insurers) would be an integral part of the plan. Within a week, two pieces of political toast from the Democratic Party (Nancy Pelosi and Harry Reid) set about undermining that aspect of the healthcare reform agenda. This is just one reason why, on November 2, 2010, the people who elected Democrats in 2006 and 2008 will be taking a “voters’ holiday”, paving the way for Republican majorities in the Senate and House. The moral lapse involving the public option was documented by David Sirota for Danny Schechter’s NewsDissector blog:
House Speaker Nancy Pelosi for the first time yesterday suggested she may be backing off her support of the public option – the government-run health plan that the private insurance industry is desperately trying to kill. According to CNN, Pelosi and Senate Majority Leader Harry Reid “said they would support any provision that increases competition and accessibility for health insurance – whether or not it is the public option favored by most Democrats.”
This announcement came just hours before Steve Elmendorf, a registered UnitedHealth lobbyist and the head of UnitedHealth’s lobbying firm Elmendorf Strategies, blasted this email invitation throughout Washington, D.C. I just happened to get my hands on a copy of the invitation from a source – check it out:
From: Steve Elmendorf [mailto:steve@elmendorfstrategies.com]
Sent: Friday, September 11, 2009 8:31 AM
Subject: event with Speaker Pelosi at my home
You are cordially invited to a reception withSpeaker of the House
Nancy PelosiThursday, September 24, 2009
6:30pm ~ 8:00pmAt the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.$5,000 PAC
$2,400 IndividualAgain, Elmendorf is a registered lobbyist for UnitedHealth, and his firm’s website brags about its work for UnitedHealth on its website.
The sequencing here is important: Pelosi makes her announcement and then just hours later, the fundraising invitation goes out. Coincidental? I’m guessing no – these things rarely ever are.
I wrote a book a few years ago called Hostile Takeover whose premise was that corruption and legalized bribery has become so widespread that nobody in Washington even tries to hide it. This is about as good an example of that truism as I’ve ever seen.
Whatever President Obama proposes to accomplish in terms of financial reform will surely be met with a similar fate. Worse yet, his appointment of “Turbo” Tim Geithner as Treasury Secretary and his nomination of Ben Bernanke to a second term as Federal Reserve chairman are the best signals of the President’s true intention: Preservation of the status quo, regardless of the cost to the taxpayers.
On this first anniversary of the demise of Lehman Brothers and the acknowledgment of the financial crisis, many commentators have noted the keen observations by Simon Johnson, a former chief economist at the International Monetary Fund, published in the May, 2009 issue of The Atlantic. The theme of Johnson’s article, “The Quiet Coup” was that the current economic and financial crisis in the United States is “shockingly reminiscent” of those experienced in emerging markets (i.e. banana republics and proto-capitalist regimes). The devil behind all the details in setting these systems upright after a financial crisis is the age-old concept of moral hazard or more simply: sleaze. In making the comparison of the United States to the emerging market countries he encountered at the IMF, Mr. Johnson began this way:
But there’s a deeper and more disturbing similarity: elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Here are a few more passages from “The Quiet Coup” that our political leaders would be well-advised to consider:
Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.
* * *
The second problem the U.S. faces—the power of the oligarchy— is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.
Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.
Mr. Johnson pointed out the need to overhaul our current antitrust laws – not because any single institution controls so much market share as to influence prices – but because the failure of any one “to big to fail” bank could collapse the entire financial system.
One of my favorite reporters at The New York Times, Gretchen Morgenson, observed the anniversary of the Lehman Brothers failure with an essay that focused, in large part, on a recent paper by Edward Kane, a finance professor at Boston College, who created the expression: “zombie bank” in 1987. This month, the Networks Financial Institute at Indiana State University published a policy brief by Dr. Kane on the subject of financial regulation. In her article: “But Who Is Watching Regulators?”, Ms. Morgenson summed up Professor Kane’s paper in the following way:
This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things: the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.
Although you may have seen widely-publicized news reports about an “overwhelming number” of academicians opposing the current efforts to require transparency from the Federal Reserve, Professor Kane provides a strong argument in favor of Fed transparency as well as scrutiny of the Treasury and the other government entities enmeshed the complex system of bailouts created within the past year.
At thirty-eight pages, his paper is quite a deep read. Nevertheless, it’s packed with great criticism of the Federal Reserve and the Treasury. We need more of this and when someone of Professor Kane’s stature provides it, there had better be people in high places taking it very seriously. The following are just a few of the many astute observations made by Dr. Kane:
Agency elitism would be evidenced by the extent to which its leaders use crises to establish interpretations and precedents that cover up its mistakes, inflate its powers, expand its discretion, and extend its jurisdiction. According to this standard, Fed efforts to use the crisis as a platform for self-congratulation and for securing enlarged systemic-risk authority sidetracks rather than promotes effective reform.
* * *
A financial institution’s incentive to disobey, circumvent or lobby against a particular rule increases with the opportunity cost of compliance. This means that, to sort out the welfare consequences of any regulatory program, we must assess not only the costs and benefits of compliance, but include the costs and benefits of circumvention as well.
* * *
Realistically, every government-managed program of disaster relief is a strongly lobbied and nontransparent tax-transfer scheme for redistributing wealth and shifting risk away from the disaster’s immediate victims. A financial crisis externalizes – in margin and other collateral calls, in depositor runs, and in bank and borrower pleas for government assistance – a political and economic struggle over when and how losses accumulated in corporate balance sheets and in the portfolios of insolvent financial institutions are to be unwound and reallocated across society. At the same time, insolvent firms and government rescuers share a common interest in mischaracterizing the size and nature of the redistribution so as to minimize taxpayer unrest.
In principle, lenders and investors that voluntarily assume real and financial risks should reap the gains and bear the losses their risk exposures generate. However, in crises, losers pressure government officials to rescue them and to induce other parties to share their pain.
The advocates of crony capitalism and their tools (our politicians and regulatory bureaucrats) need to know that we are on to them. If the current administration is willing to facilitate more of the same, then it’s time for some new candidates to step forward.
The Window Of Opportunity Is Closing
September 17, 2009
In my last posting, I predicted that President Obama’s speech on financial reform would be “fine-sounding, yet empty”. As it turned out, many commentators have described the speech as just that. There weren’t many particulars discussed at all. As Caroline Baum reported for Bloomberg News:
Although the President had originally voiced support for expanding the authority of the Federal Reserve to include the role of “systemic risk regulator”, Ms. Baum noted that Allan Meltzer, professor of political economy at Carnegie Mellon University, believes that Mr. Obama has backed away from that ill-conceived notion:
Ms. Baum took that criticism a step further with her observation that the mission undertaken by any systemic risk regulator would not likely fare well:
At this point in the economic crisis, with Federal Reserve chairman Ben Bernanke’s recent declaration that the recession is “very likely over”, there is concern that President Obama’s incipient attempt at enacting financial reform may already be too late. A number of commentators have elaborated on this theme. At Credit Writedowns, Edward Harrison made this observation:
More important, the following point by Mr. Harrison has been expressed in several recent essays:
At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:
On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:
At The Washington Post, Brady Dennis discussed the Pecora Commission of the early 1930s, which investigated the causes of the Great Depression, and ultimately provided a basis for reforms of Wall Street and the banking industry. Mr. Dennis pointed out how the success of the Pecora Commission was rooted in the fact that populist outrage provided the fuel to help mobilize reform efforts, and he contrasted that situation with where we are now:
Unfortunately, we appear to be at a point where it is too late to develop regulations against many of the excesses that led to last year’s financial crisis. Beyond that, many people who allowed the breakdown to occur (Bernanke, Geithner, et al.) are still in charge and the players who gamed the system with complex financial instruments are back at it again, with new derivatives — even some based on life insurance policies. Perhaps another harbinger of doom can be seen in this recent Bloomberg article: “Credit Swaps Lose Crisis Stigma as Confidence Returns”. Nevertheless, from our current perspective, some of us don’t have that much confidence in our financial system or our leadership.