This week brings us the confirmation hearings on President Obama’s nomination of Ben Bernanke to a second four-year term as chairman of the Federal Reserve. The recent progress in Congressional efforts to audit the Federal Reserve will certainly spice up the confirmation hearings. If that weren’t enough, Bernanke saw fit to write a commentary piece for Sunday’s edition of The Washington Post, expressing his opposition to any attempts to limit the Fed’s power and subject it to an audit. Here is some of what he had to say in that column:
These measures are very much out of step with the global consensus on the appropriate role of central banks, and they would seriously impair the prospects for economic and financial stability in the United States. The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution’s ability to foster financial stability and to promote economic recovery without inflation.
Well, he should have known what would be coming next . . . the avalanche of criticism pointing out how the Fed played a major role in causing the crisis. As you will see below, that response was swift. Worse yet, Bernanke’s theme of “we learned our lesson” will surely inspire harsh interrogation at the confirmation hearings:
The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis. We have extensively reviewed our performance and moved aggressively to fix the problems.
Dean Baker did not waste any time before ripping into Bernanke’s essay. Baker’s Beat the Press blog at The American Prospect website regularly upbraids Bernanke for his responsibility in causing the economic crisis. Baker’s retort to the Washington Post piece was published at the Talking Points Memo website. The final paragraph of Baker’s essay reflected his outrage that the Post would publish Bernanke’s rant without an opposing response:
The arrogance of this column is almost beyond belief. This man is incredibly lucky to still have his job at time when millions of other workers have lost theirs as a direct result of his incompetence. A serious news outlet would not have printed such a ridiculously self-serving piece without at least securing an opposing opinion. Of course, Bernanke’s piece appeared in the Washington Post.
Dean Baker’s primary criticism of Bernanke is based on the Fed chair’s failure to control the 8-trillion-dollar housing bubble before it burst, nearly destroying the entire economy:
We had further losses in demand associated with the bursting of a bubble in non-residential real estate. In total, the loss in bubble-driven demand was well over $1 trillion a year. All of it an entirely predictable outcome of the collapse of a housing bubble.
The simple reality is that there is nothing in the Fed’s bag of tricks that will allow it to easily replace over $1 trillion in annual demand. In short, the bubble guaranteed the economic disaster that we are now experiencing, end of story.
At the Naked Capitalism website, Yves Smith dealt a hefty load of thorough criticism on the Bernanke article. She began with the verdict against Bernanke and built an impressive argument supporting her opinion:
What is interesting is how much the tables have turned. The Obama effort to make the Fed into the uber bank regulator has become a rout, with decent odds that the Fed will have its powers reduced, and an increasing possibility that Bernanke might not be reconfirmed (which is frankly the right outcome, no CEO who presided over a similar disaster would still be in charge).
Smith did not restrict her criticism to the Fed’s failure to control the housing bubble. Here are some of her points:
For instance, the Fed was the architect of the “let a thousand flowers bloom” policy towards derivatives, and made inadequate (one might say no) effort to understand new financial technology. Bernanke himself rationalized burgeoning consumer debt, claiming that consumer balance sheets were in good shape. Hun? This is Japan circa 1989 thinking.
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Yes, I am told the Fed is now making all the banks disclose their derivatives positions to them, but the Fed lacks the analytical capacity to do much with this information (and I am further told the Fed staff understands that too). So that does not fit my notion of “tougher oversight.” And the rest is just empty promises.
In response to Bernanke’s claim that Congressional efforts to rein-in the authority of the Fed are “very much out of step with the global consensus on the appropriate role of central banks,” Ms. Smith pounced:
Notice how Bernanke invokes a “global consensus,” which is wonderfully vague and ignores the fact that the pre-crisis “global consensus” of minimally regulated markets and financial institutions, is precisely what caused the crisis. Moreover, even if the Fed’s mandate in theory was appropriate, its governance structure is not. The Bank of England and the ECB are not peculiar largely private institutions, accountable to almost no one, as the Fed now is. The Fed’s insistence on secrecy regarding many of its emergency operations is unwarranted and deeply troubling. And “the Fed played a major role in arresting the crisis” ignores the fact that the Fed played a major role in creating it, namely, via negative real interest rates for a protracted period. And he is declaring the Fed’s policies to be successful when the jury is still out.
Brenanke’s claim that the idiotic bank stress tests “marked a turning point in public confidence in the banking system” invited a well-deserved attack. Here’s how Yves Smith handled it:
The worst is the folks at the Fed clearly believe the bogus stress tests were a meaningful exercise. That alone should disqualify them from getting a bigger role in bank supervision. And if you read their pronouncements, they plan to continue to use them, and have the process run by … monetary economists! Pray tell, what do they know about bank operations? Help me! And some of the help the Fed has enlisted in the stress test exercise includes the consulting firm McKinsey, which has the biggest banking practice in the consulting industry. Think McKinsey is going to devise anything that might be rough on its biggest meal tickets?
Remember that these negative reactions to the Bernanke article are just what appeared on Sunday. By the time the confirmation hearings begin on December 3, you can be sure that Bernanke’s own words from the Post column will be used against him. We may find that his decision to write this piece was a crucial turning point leading to a decision against his confirmation.
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November 23, 2009
Last February, Republican Congressman Ron Paul introduced HR 1207, the Federal Reserve Transparency Act of 2009, by which the Government Accountability Office would be granted authority to audit the Federal Reserve and present a report to Congress by the end of 2010. On May 21, Congressman Alan Grayson, a Democrat from Florida, wrote to his Democratic colleagues in the House, asking them to co-sponsor the bill. The bill eventually gained over 300 co-sponsors. By October 30, Congressman Mel Watt, a Democrat from North Carolina, basically “gutted” the bill according to Congressman Paul, in an interview with Bob Ivry of Bloomberg News. Watt subsequently proposed a competing measure, which was aided by the circulation of a letter by eight academics, who were described as a “political cross-section of prominent economists”. Ryan Grim of The Huffington Post disclosed on November 18 that the purportedly diverse, independent economists were actually paid stooges of the Federal Reserve:
But far from a broad cross-section, the “prominent economists” lobbying on behalf of the Watt bill are in fact deeply involved with the Federal Reserve. Seven of the eight are either currently on the Fed’s payroll or have been in the past.
After HR 1207 had been undermined by Watt, an amendment calling for an audit of the Federal Reserve was added as amendment 69B to HR3996, the Financial Stability Improvement Act of 2009. The House Finance Committee voted to approve that amendment on November 19. This event was not only a big win for Congressmen Paul and Grayson — it also gave The Huffington Post’s Ryan Grim the opportunity for a “victory lap”:
In an unprecedented defeat for the Federal Reserve, an amendment to audit the multi-trillion dollar institution was approved by the House Finance Committee with an overwhelming and bipartisan 43-26 vote on Thursday afternoon despite harried last-minute lobbying from top Fed officials and the surprise opposition of Chairman Barney Frank (D-Mass.), who had previously been a supporter.
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“Today was Waterloo for Fed secrecy,” a victorious Grayson said afterwards.
Scott Lanman of Bloomberg News pointed out that this battle was just one of many legislative onslaughts against the Fed:
The Fed’s powers and rate-setting independence are under threat on several fronts in Congress. Separately yesterday, the Senate Banking Committee began debate on legislation that would strip the Fed of bank-supervision powers and give lawmakers greater say in naming the officials who vote on monetary policy.
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Paul and other lawmakers have accused the Fed of lax oversight of banks and failing to avert the financial crisis.
Federal Reserve Chairman Ben Bernanke is feeling even more heat because the Senate Banking Committee will begin hearings concerning Bernanke’s reappointment as Fed Chair. The hearings will begin on December 3, the same day as President Obama’s jobs summit. Senate Banking Committee chair, Chris Dodd, revealed to videoblogger Mike Stark that Bernanke’s reappointment is “not necessarily” a foregone conclusion.
Let’s face it: the public has finally caught on to the fact that the mission of the Fed is to protect the banking industry and if that is to be accomplished at the public’s expense — then so be it. Back at The Huffington Post, Tom Raum explained how this heightened awareness of the Fed’s activities has resulted in some Congressional pushback:
Many lawmakers question whether the Fed’s money machine has mainly benefited financial markets and not the broader economy. Lawmakers are also peeved that the central bank acted without congressional involvement when it brokered the 2008 sale of failed investment bank Bear Stearns and engineered the rescue of insurer American International Group.
Tom Raum echoed concern about the how the current increase in “anti-Fed” sentiment might affect the Bernanke confirmation hearings:
Should Bernanke be worried?
“Not only should be worried, he’s clearly ratcheted up his game in terms of his communications with Congress,” said Norman Ornstein, a senior fellow at the American Enterprise Institute.
Ornstein said the Fed bashing this time is different from before, with “a broader base of support. And it’s coming from people who in the past would not have hit the Fed. There’s a lot of populist anger out there — on the left, in the center and on the right. And politicians are responsive to that.”
Populist anger with the Fed will certainly change the way history will regard former Fed chairman, Alan Greenspan. Fred Sheehan’s new book: Panderer to Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, could not have been released at a better time. At his blog, Sheehan responded to five questions about Greenspan, providing us with a taste of what to expect in the new book. Here is one of the interesting points, demonstrating how Greenspan helped create our current crisis:
The American economy’s recovery from the early 1990s was financial. This was a first. The recovery was a product of banks borrowing, leveraging and lending to hedge funds. The banks were also creating and selling complicated and very profitable derivative products. Greenspan needed the banks to grow until they became too-big-to-fail. It was evident the “real” economy — businesses that make tires and sell shoes — no longer drove the economy. Thus, finance was given every advantage to expand, no matter how badly it performed. Financial firms that should have died were revived with large injections of money pumped by the Federal Reserve into the banking system.
It’s great to see Congress step up to the task of exposing the antics of the Federal Reserve. Let’s just hope these efforts meet with continued success.
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October 15, 2009
Reading the news these days can cause so much aggravation, I’m surprised more people haven’t pulled out all of their hair. Regardless of one’s political perspective, there is an inevitable degree of outrage experienced from revelations concerning the role of government malfeasnace in causing and reacting to the financial crisis. We have come to rely on satire to soothe our anger. (For a good laugh, be sure to read this.) Fortunately, an increasing number of commentators are not only exposing the systemic problems that created this catastrophe – they’re actually suggesting some good solutions.
Robert Scheer, editor of Truthdig, recently considered the idea that the debate over healthcare reform might just be a distraction from the more urgent need for financial reform:
The health care issue should never even have been brought up at a time when the economy is reeling and we are running such immense deficits to shore up the banks. Instead of fixing the economy by saving Americans’ homes and jobs, we are preoccupied with pie-in-the-sky rhetoric on a hot issue that should have been addressed in calmer times. It came up now because, despite all the hoary partisan posturing, it is a safer subject than the more pressing issue of what to do with Citigroup, AIG and General Motors, which the taxpayers happen to own but do not control. While Treasury Secretary Timothy Geithner plots in secret with the top bankers who got us into this mess, we are focused on the perennial circus of so-called health care reform.
There is an odd disconnect between the furious public debate over health care reform, with its emphasis on the cost of an increased government role, and the nonexistent discussion about the far more expensive and largely secretive government program to bail out Wall Street. Why the agitation over the government spending $83 billion a year on health care when at least 20 times that amount has been thrown at the creators of the ongoing financial crisis without any serious public accountability? On Wednesday, the Wall Street Journal reported that employees of the financial industry that we taxpayers saved are slated to be paid a record $140 billion this year.
Remember, taxpayers: That $140 billion is your money. The bailed-out institutions may claim to have repaid their TARP obligations, but they also received trillions in loans from the Federal Reserve — and Ben Bernanke refuses to disclose which institutions received how much.
William Greider wrote a superb essay for the October 26 issue of The Nation, emphasizing the importance of the work undertaken by the Financial Crisis Inquiry Commission, led by Phil Angelides, as well as the investigation being done by the House Committee on Oversight and Government Reform:
Even if Congress manages to act this fall, the debate will not end. Obama’s plan does not begin to get at the rot in the financial system. Wall Street’s most notorious practices continue to flourish, and if unemployment rates keep rising through 2010, the public will not set aside its anger. The Angelides investigators could put the story back on the front page.
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Beyond Ponzi schemes and deceitful mortgage lending, a far larger crime may lurk at the center of the crisis — wholesale securities fraud. “Risk models” reassured unwitting investors who bought millions of bundled mortgage securities and derivatives like credit-default swaps. But as Christopher Whalen of Institutional Risk Analytics has testified, many of the models lacked real-life markets where they could be tested and verified. “Clearly, we have now many examples where a model or the pretense of a model was used as a vehicle for creating risk and hiding it,” Whalen said. “More important, however, is the role of financial models for creating opportunities for deliberate acts of securities fraud.” That’s what investigators can examine. What did the Wall Street firms know about the reliability of these models when they sold the securities? And what did they tell the buyers?
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Surely the political system itself is a root cause of the financial crisis. The swollen influence of financial interests pushed Congress and presidents to repeal regulation and look the other way as reckless excesses developed. Efforts to restore a more reliable representative democracy can start with Congress. The power of money could be curbed by new rules prohibiting members of key committees from accepting contributions from the sectors they oversee. Regulatory agencies, likewise, need internal designs to protect them from capture by the industries they regulate.
The Federal Reserve, having failed in its obligations so profoundly, should be reconstituted as an accountable federal agency, shorn of the excessive secrecy and insider privileges accorded to bankers. The Constitution gives Congress, not the executive branch, the responsibility for managing money and credit. Congress must reassert this responsibility and learn how to provide adequate oversight and policy critique.
Reforming the financial system, in other words, can be the prelude to reviving representative democracy.
At The Huffington Post, Robert Borosage warned that the financial industry is waging a huge lobbying battle to derail any attempts at financial reform. Beyond that, the banking lobbyists will re-write any legislation to make it more favorable to their own objectives:
The banking lobby is nothing if not shameless. They hope to use the reforms to WEAKEN current law. They are pushing to make the federal standard the ceiling on reform, stripping the power of states to have higher standards. Basically, they are hoping to find a way to shut down the independent investigations of state attorneys general like New York’s Eliot Spitzer and Andrew Cuomo or Illinois’ Lisa Madigan.
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Historically, the banks, as Senator Dick Durbin decried in disgust, “own the place.” And they’ve succeeded thus far in frustrating reform, even while pocketing literally hundreds of billions in support from taxpayers.
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But this time it could be different. Backroom deals are no longer safe. Americans have been fleeced of trillions in the value of their homes and their savings because of Wall Street’s reckless excesses. Then as taxpayers, they were extorted to ante up literally trillions more to forestall economic collapse by bailing out the banking sector. Insult was added to that injury when the Federal Reserve refused to tell the Congress who got the money and on what terms.
Legislators would be well advised to understand the cozy old ways of doing business are no longer acceptable. Americans are livid and paying attention. Legislators who rely on Wall Street to finance their campaigns and then lead the effort to block or dilute reforms will discover that their constituents know what they have been up to. Organizations like my own Campaign for America’s Future, the Sunlight Foundation, Americans for Financial Reform, Huffington Post bloggers will make certain the word gets out. Legislators may discover that Wall Street’s money is a burden, not a blessing.
The most encouraging article I have seen came from Dan Gerstein of Forbes. His perspective matched my sentiments exactly. Looking through President Obama’s empty rhetoric, Mr. Gerstein helped provide direction and encouragement to those of us who are losing hope that our dysfunctional government could do anything close to addressing our nation’s financial ills:
The Changer-in-Chief long ago gave up on the idea of dismantling and remaking the crazy-quilt regulatory system that Wall Street (along with its Washington enablers) rigged for its own enrichment at everyone else’s expense.
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Instead, Team Obama opted to move around the deck chairs within the existing bureaucracy, daftly hoping this conformist approach would be enough to prevent another titanic meltdown.
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In the end, though, the key to success will be countering Wall Street’s influence and putting the politicians’ feet to the ire. Members of Congress need to know there will be consequences for sticking with the status quo. . . . Make clear to every incumbent: Endorse our plan and we’ll give you money and public support; back the banks, and we will run ads against you telling voters you are for corrupt capitalism.
As I have said before, this is all about power. Right now, Wall Street has the political playing field to itself; it has the money, the access it buys and the fear it implies. And the public is on the outside, looking incredulous that this rigged system is still in place more than a year after it was exposed. But if the frustrated middle can organize and mobilize a focused, non-partisan revolt of the revolted — as opposed to the inchoate and polarizing tea party movement — that whole dynamic will quickly change. And so too, I’m confident, will the voting habits of our elected officials.
Fortunately, individuals like Dan Gerstein are motivating people to stand up and let our elected officials know that they work for the people and not the lobbyists. Larry Klayman, founder of Judicial Watch, has just written a new book: Whores: Why And How I Came To Fight The Establishment. The timing of the book’s release could not have been better.
On Thursday, October 1, Federal Reserve chairman Ben Bernanke testified before the House Financial Services Committee. That event demonstrated how the Fed has fallen into the crosshairs of critics from both ends of the political spectrum. A report in Friday’s Los Angeles Times by Jim Puzzanghera began with the point that the Obama administration has proposed controversial legislation that would expand the Fed’s authority, despite bipartisan opposition in a Congress that is more interested in restricting the Fed’s influence:
Worried about the increased power of the complex and mysterious Fed, and upset it did not do more to prevent the deep recession, Capitol Hill has focused its anger over the financial crisis and its aftermath on the central bank. The Fed finds itself at the center of a collision of traditional political concerns – conservatives’ fears of heavy-handed government intervention in free markets, and liberals’ complaints of regulators who favor corporate executives over average Americans.
More than two-thirds of the House of Representatives has signed on to a bill that would subject the central bank to increased congressional oversight through expanded audits. A key senator wants to strip the Fed of its authority to regulate banks. And the chairman of the House Financial Services Committee wants to rein in the Fed’s emergency lending power, which it used to help engineer the sale of Bear Stearns Cos. and bailout American International Group Inc.
The article noted the observation of Jaret Seiberg, a financial policy analyst with Concept Capital’s Washington Research Group:
“The Fed is running into unprecedented opposition on Capitol Hill,” he said.
“In the Senate, there’s open hostility toward any expansion of the Federal Reserve’s authority. And in the House, you certainly have Republicans looking to focus the Fed solely on monetary policy and strip it of any larger role in financial regulation.”
Mr. Puzzanghera’s report underscored how the Fed’s interventions in the economy during the past year, which involved making loans (of unspecified amounts) and backing commercial transactions, have drawn criticism from both sides of the aisle. The idea of expanding the Fed’s authority to the extent that it would become a “systemic risk regulator” has been criticized both in Congress and by a former member of the Federal Reserve Board of Governors:
House Republicans want to scale back the Fed’s power so the bank focuses on monetary policy. And many have opposed the administration’s proposal to give the Fed the new role of supervising large financial institutions, such as AIG, that are not traditional banks but pose a risk to the economy if they fail.
“I’m not alone with my concerns about the Fed as a systemic regulator,” said Rep. Scott Garrett (R-N.J.). Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) has similar concerns, as do others on his panel. In fact, Dodd has proposed stripping the Fed of all of its bank oversight functions as part of his plan for creating a single banking regulatory agency.
Former Fed Gov. Alice M. Rivlin also said it would be a mistake to increase the Fed’s regulatory powers because it would distract from the central bank’s monetary policy role.
“Do we want to augment the regulatory authority of the Fed? . . . My answer is no,” said Rivlin, a senior fellow at the Brookings Institution. “My sense is many people would be nervous about that augmentation.”
The colorful Democratic chairman of the House Financial Services Committee, Barney Frank, recently published a report card on the committee’s website, criticizing the Fed’s poor record on consumer protection. The report card contrasted what Congressional Democrats had done to address various issues (categorized under the heading: “Democrats Act”) with what the Fed has or has or has not done in dealing with those same problems.
Meanwhile, Republican Congressman Ron Paul of Texas, is making the rounds, promoting his new book: End The Fed. A recent posting at The Daily Bail website includes a YouTube video of Ron Paul at a book signing in New York, which resulted in a small parade over to the New York Fed. Although the Daily Bail piece reported that Paul’s book had broken into the top ten on Amazon’s list of bestsellers — as I write this, End The Fed is number 15. I would like to see that book continue to gain popularity. Perhaps next time Chairman Bernanke testifies before a committee, he will know that something more than his own job is on the line. It would be nice to see him make history as the last Chairman of the Federal Reserve.
I’ve seen quite a few articles and broadcasts from “mainstream” news sources during the past few weeks that have actually made me feel encouraged about the public’s response to the financial crisis and our current economic predicament. Six months ago, the dirty picture of what caused last year’s near-meltdown and what has continued to prevent the necessary reforms, was something one could find only by reading a relatively small number of blogs. Michael Panzner wrote a book entitled Financial Armageddon in 2006, predicting what many “experts” later described as unforeseeable. Mr. Panzner now has a blog called Financial Armageddon (as well as another: When Giants Fall). At his Financial Armageddon website, Mr. Panzner has helped ease the pain of the economic catastrophe with a little humor by educating his readers on some novel measurements of our recession level — such as the increased use of hair dye and “The Hot Waitress Index”. (He ran another great posting about the increasing number of disastrous experiences for people who tried to save money by cutting their own hair.) Meanwhile, Matt Taibbi has continued to serve as a gadfly against crony capitalism. Zero Hedge keeps us regularly apprised of the suspicious activities in the equities and futures markets, which are of no apparent concern to regulatory officials. Some bloggers, including Jr Deputy Accountant, have criticized the manic money-printing and other inappropriate activities at the Federal Reserve — which resists all efforts at oversight and transparency. One no longer experiences the stigma of “conspiracy theorist” by accepting the view that our financial and economic problems were caused primarily by regulatory failure.
On September 23, Dan Gerstein wrote a piece for Forbes, about the impressive, 25-page article concerning last year’s financial crisis, written by James Stewart for The New Yorker, entitled: “Eight Days”. At the outset, Mr. Gerstein noted how the New Yorker article provided the reader with some shocking insight on someone we all thought we knew pretty well:
But the biggest eye-opener was that the most incisive and damning questions raised by any of our leaders during this existential crisis came from none other than the era’s top free-market cheerleader in Washington, George W. Bush.
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Paulson and Bernanke alerted Bush that AIG was about to fail, warned of the massive ripple effect AIG going bust would have on the global economy, and explained why the Fed could not intervene with an insurance company to stop this systemic threat. In response, Bush asked “How have we come to the point where we can’t let an institution fail without affecting the whole economy?”
The question raised by President Bush is still tragically apt, since nothing has been accomplished in the past year to break up or downsize those institutions considered “too big to fail”. Mr. Gerstein’s experience from reading the New Yorker article helped reinforce the understanding that our current situation is not only the result of regulatory failure, but it’s also a by-product of something called “regulatory capture” — wherein the regulators are beholden to those whom they are supposed to regulate:
Once disaster was averted and the system stabilized, Paulson, Geithner and Bernanke had no excuse for not laying down the law to Wall Street — figuratively and literally — in the ensuing weeks. By that I mean restructuring the deals we struck with the banks to get far better returns for taxpayers and rewriting the rules governing the financial system to prevent them from ever thinking they could gamble risk-free with our money again.
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There’s no apparent sense of apartness or independence between regulator and regulated. To the contrary, there’s a power imbalance in the wrong direction, with the regulators dependent on and even at the mercy of the regulated. What does it say about the integrity and even the sanity of this system when the doctors have to ask the inmates how to restructure their treatments?
I was particularly impressed by Dan Gerstein’s closing remarks in the Forbes piece. It was encouraging to see another commentary in a mainstream media source, consistent with the ranting I did here, here and here. Mr. Gerstein expressed dismay at the lack of attention given to the unpleasant truth that we live in a plutocracy which won’t be changed until the people demand it:
That’s why I was so disappointed to find Stewart’s epic article buried in the elite pages of the New Yorker. It should have been serialized on the front pages of every newspaper in the country last week, so every American would be reminded in full detail of just how warped and rigged our financial system has been — and why it still is. Maybe then it might sink in that getting mad won’t get us even in the power struggle with the financial elites for control of our economy, and that change won’t happen until taxpayers demand it. You want public accountability for Wall Street? Let’s start with an accountable public.
Each time an article such as Dan Gerstein’s “Too Close For Comfort” gets widespread exposure, we move one step closer to the point where we have an informed, accountable public. It’s unfortunate that his commentary was buried in the elite pages of Forbes. That’s why I have it here. Spread the word.
Last year’s financial crisis and our current economic crisis have exposed some pretty ugly things to an unsuspecting public. As news reporters dig and as witnesses are called to testify, these investigations are turning over a very large rock, revealing all the colonies of maggots and fungus infestations, just below ground level, out of our usual view. The voters are learning more about the sleaziness that takes place on Wall Street and in the halls of Congress. Hopefully, they will become motivated to demand some changes.
A recent report by American Public Media’s Steve Henn revealed how the law prohibiting “insider trading” (i.e. acting on confidential corporate information when making a transaction involving that company’s publicly-traded stock) does not apply to members of Congress. Remember how Martha Stewart went to prison? Well, if she had been representing Connecticut in Congress, she might have been able to interpose the defense that she was inspired to sell her ImClone stock based on information she acquired in the exercise of her official duties. Mr. Henn’s report discussed the investment transactions made by some Senators after having been informed by former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, that our financial system was on the verge of a meltdown. After quoting GOP House Minority Leader John Boehner’s public acknowledgement last September that:
We clearly have an unprecedented crisis in our financial system. . . .
On behalf of the American people our job is to put our partisan differences aside and to work together to help solve this crisis.
Mr. Henn proceeded to explain how swift Senatorial action resulted in a bipartisan exercise of greed:
The next day, according to personal financial disclosures, Boehner cashed out of a fund designed to profit from inflation. Since he sold, it’s lost more than half its value.
Sen. Dick Durbin, an Illinois Democrat, who was also at that meeting sold more than $40,000 in mutual funds and reinvested it all with Warren Buffett.
Durbin said like millions of others he was worried about his retirement. Boehner says his stock broker acted alone without even talking to him. Both lawmakers say they didn’t benefit from any special tips.
But over time members of Congress do much better than the rest of us when playing the stock market.
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The value of information that flows from the inner workings of Washington isn’t lost on Wall Street professionals.
Michael Bagley is a former congressional staffer who now runs the OSINT Group. Bagley sells access and research. His clients are hedge funds, and he makes it his business to mine Congress and the rest of Washington for tips.
MICHAEL Bagley: The power center of finance has moved from Wall Street to Washington.
His firm is just one recent entry into Washington’s newest growth industry.
CRAIG HOLMAN: It’s called political intelligence.
Craig Holman is at Public Citizen, a consumer watchdog. Holman believes lobbyists shouldn’t be allowed to sell tips to hedge funds and members of Congress shouldn’t trade on non-public information. But right now it’s legal.
HOLMAN: It’s absolutely incredible, but the Securities and Exchange Act does not apply to members of Congress, congressional staff or even lobbyists.
That law bans corporate insiders, from executives to their bankers and lawyers, from trading on inside information. But it doesn’t apply to political intelligence. That makes this business lucrative. Bagley says firms can charge hedge funds $25,000 a month just to follow a hot issue.
BAGLEY: So information is a commodity in Washington.
Inside information on dozens of issues, from bank capitol requirements to new student loan rules, can move markets. Consumer advocate Craig Holman is backing a bill called the STOCK Act. Introduced in the House, it would force political-intelligence firms to disclose their clients and it would ban lawmakers, staffers, and lobbyists from profiting on non-public knowledge.
Mr. Henn’s report went on to raise concern over the fact that there is nothing to stop members of Congress from acting on such information to the detriment of their constituents in favor of their own portfolios.
I understand, and share, concern that the financial crisis has revealed weaknesses in our regulatory and supervisory agencies as well as in the activities of private financial institutions. There has been criticism of the Federal Reserve itself, and even proposals to remove responsibilities other than monetary policy, strictly defined, from the Fed.
Mr. Volcker discussed a number of suggestions for regulatory changes to prevent a repeat of last year’s crisis. He criticized Treasury Secretary “Turbo” Tim Geithner’s approach toward what amounts to simply baby-sitting for those financial institutions considered “too big to fail”. Here is some of Mr. Volcker’s discussion on that point:
However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.
Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?
Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?
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What all this amounts to is an unintended and unanticipated extension of the official “safety net”, an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase.
This concern is often discussed as the “moral hazard” issue. William Black, Associate Professor of Economics and Law at the University of Missouri – Kansas City published an excellent paper concerning this issue on September 10. He made some great suggestions as to how to deal with these “Systemically Dangerous Institutions”:
Historically, “too big to fail” was a misnomer – large, insolvent banks and S&Ls were placed in receivership and their “risk capital” (shareholders and subordinated debtholders) received nothing. That treatment is fair, minimizes the costs to the taxpayers, and minimizes “moral hazard.” “Too big to fail” meant only that they were not placed in liquidating receiverships (akin to a Chapter 7 “liquidating” bankruptcy). In this crisis, however, regulators have twisted the term into immunity. Massive insolvent banks are not placed in receivership, their senior managers are left in place, and the taxpayers secretly subsidize their risk capital. This policy is indefensible. It is also unlawful. It violates the Prompt Corrective Action law. If it is continued it will cause future crises and recurrent scandals.
* * *
Under the current regulatory system banks that are too big to fail pose a clear and present danger to the economy. They are not national assets. A bank that is too big to fail is too big to operate safely and too big to regulate. It poses a systemic risk. These banks are not “systemically important”, they are “systemically dangerous.” They are ticking time bombs – except that many of them have already exploded.
Mr. Black then listed twenty areas of reform where these institutions would face additional regulatory compliance and restrictions on their activities, including a ban on “all new speculative investments”. Paul Volcker took that issue a step further with his criticism of “proprietary trading” by these institutions, which often can result in conflicts of interest with customers, since these banks are trading on their own accounts while in a position to act on the confidential investing strategies of their clients.
Paul Volcker made a point of emphasizing the need to clarify the overlapping jurisdictions of the Securities and Exchange Commission and the Commodity Futures Trading Commission (CFTC). On September 18, David Corn wrote a piece about the CFTC, describing it as:
… a somewhat obscure federal agency, but an important one. Its mission is to protect consumers and investors by preventing misconduct in futures trading that could distort the prices of agricultural and energy commodities. In 2000, the CFTC wanted to regulate credit default swaps — complicated and privately traded financial instruments that helped grease the way to the subprime meltdown — but Republican Sen. Phil Gramm, then the chair of the Senate Banking Committee, Fed chair Alan Greenspan and Clinton administration officials (including Lawrence Summers, now President Obama’s top economic adviser) blocked that effort. Had the CFTC been allowed to police swaps, the housing finance crisis that begot the economic crash of last year might not have been as bad. So the CFTC is a critical agency. And under Obama’s proposal for more robust financial regulation — which he talked about during a Wall Street visit on Monday — the CFTC would have greater responsibility to make sure no one was gaming the financial system. Consequently, the composition of the CFTC is more significant than ever.
Mr. Corn expressed his concern over the fact that the Obama administration had nominated Scott O’Malia, a Republican Senate aide, to be a commissioner on the CTFC:
For the past seven years, he’s been a GOP staffer in the Senate. But before that he was a lobbyist for Mirant, an Atlanta-based electricity company. According to House and Senate records, while at Mirant O’Malia was registered to lobby for greater deregulation at a time when his company was exploiting the then-ongoing deregulation of the energy market to bilk consumers. Remember the Enron-driven electricity crisis in California of 2001, when Enron and other companies were manipulating the state’s deregulated electricity markets, causing prices to go sky-high, creating rolling black-outs and triggering a statewide emergency? Mirant was one of those other companies. According to state investigators, Mirant deliberately held back power to force prices up.
After the crisis, Mirant was investigated by various federal and local agencies and became the target of a number of lawsuits. It ultimately agreed to pay California about half a billion dollars to settle claims it had screwed the state’s residents. It also was fined $12.5 million — by the CFTC! — for attempting to manipulate natural gas prices.
Mr. O’Malia had previously been nominated for this position by President George W. Bush. Nevertheless, Washington Senator Maria Cantwell helped block the nomination. As a result, David Corn was understandably shocked when O’Malia was re-nominated for this same position by the Obama administration:
Yet Obama has brought it back. Why would a president who craves change in Washington and who wants the CFTC to be a tougher watchdog do that?
The answer to that question is another question: Does President Obama really want the CFTC to be a tougher watchdog or just another “lap dog” like the SEC?
After all the promises of the needed regulatory “clean-up” to prevent another financial crisis, can we really trust our current leadership to accomplish anything toward that goal?
We expect those politicians aiming for re-election, to make a point of keeping their campaign promises. Many elected officials break those promises and manage to win another term anyway. That fact might explain the reasoning used by so many pols who decide to go the latter route — they believe they can get away with it. Nevertheless, many leaders who break their campaign promises often face crushing defeat on the next Election Day. A good example of this situation arose during the Presidential campaign of George H.W. Bush, who assured America: “Read my lips: No new taxes!” in his acceptance speech (written by Peggy Noonan) at the 1988 Republican National Convention. Although he didn’t enact any new taxes during his sole term in office, he also promised the voters that he would not raise existing taxes after telling everyone to read his lips. When he broke that promise after becoming President, he was confronted with the “read my lips” quote by everyone from Pat Buchanan to Bill Clinton.
Back on July 15, 2008 and throughout the Presidential campaign, Barack Obama promised the voters that if he were elected, there would be “no more trickle-down economics”. Nevertheless, his administration’s continuing bailouts of the banking sector have become the worst examples of trickle-down economics in American history — not just because of their massive size and scope, but because they will probably fail to achieve their intended result. Although the Treasury Department is starting to “come clean” to Congressional Oversight chair Elizabeth Warren, we can’t even be sure about the amount of money infused into the financial sector by one means or another because of the lack of transparency and accountability at the Federal Reserve. (I seem to remember the word “transparency” being used by Candidate Obama.) Although we are all well-aware of the $750 billion TARP slush fund that benefited the banks to some degree, speculation as to the amount given (or “loaned”) to the banks by the Federal Reserve runs from $2 trillion to as high as $6 trillion. So far, the Fed has managed to thwart efforts by some news organizations to learn the ugly truth. As Pat Choate reported for The Huffington Post:
Bloomberg News filed a federal lawsuit in November 2008 in the U.S. District Court, Southern District of New York (Manhattan) challenging that stonewalling and won the case. Chief U.S. District Judge Loretta Preska on August 24 ruled that the Fed had “improperly withheld agency records” giving it a week to disclose daily reports on its loans to banks and other financial institutions.
Three days later, Federal Reserve lawyers asked the courts for a delay so that they could make an expedited appeal of her decision. Several major banks, operating through an organization named “The Clearing House,” filed a supporting brief with the appeals court, claiming that the Federal Reserve had provided its members emergency funds under an agreement not to identify the recipients or the loan terms.
The Clearing House brief described its members as, “[T]he most important participants in the international banking and payments systems and among the world’s largest intermediaries in interbank funds transfers.” They include ABN Amro Bank, N.V. (Dutch), Bank of America, The Bank of New York Mellon, Citibank, Deutsche Bank Trust (Germany), JP MorganChase Bank, UBS (Switzerland), and Wells Fargo.
* * *
Why are the Fed and the banks fighting so hard to keep the loan details secret? Congress and taxpayers cannot know until they have the information the Federal Reserve is keeping from them, but several plausible explanations exist.
One is that the Fed has taken a great deal of worthless collateral and is propping up failed companies and banks. A second is that the information will make the issue of paying out huge Wall Street bonuses in 2009 politically radioactive, particularly if it turns out the payments are dependent on these federal loans.
Finally, the Federal Reserve probably does not want that information to be part of the forthcoming Senate hearings on the re-confirmation of Ben Bernanke, current Chairman of the Federal Reserve.
President Obama’s failure to keep his campaign promise of “no more trickle-down economics” is rooted in his decision to rely on the very same individuals who caused the financial crisis — to somehow cure the nation’s economic ills. These people (Larry Summers, “Turbo” Tim Geithner and Ben Bernanke) have convinced Mr. Obama that “trickle-down economics” (i.e. bailing out the banks, rather than distressed businesses or the taxpayers themselves) would be the best solution.
On Saturday, Australian economist Steve Keen published a fantastic report from his website, explaining how the “money multiplier” myth, fed to Obama by the very people who caused the crisis, was the wrong paradigm to be starting from in attempting to save the economy. Here’s some of what Professor Keen had to say:
While economic outsiders like myself, Michael Hudson, Niall Ferguson and Nassim Taleb argue that the only way to restart the economic engine is to clear it of debt, the government response, has been to attempt to replace the now defunct private debt economic turbocharger with a public one.
In the immediate term, the stupendous size of the stimulus has worked, so that debt in total is still boosting aggregate demand. But what will happen when the government stops turbocharging the economy, and waits anxiously for the private system to once again splutter into life?
I am afraid that all it will do is splutter.
This is especially so since, following the advice of neoclassical economists, Obama has got not a bang but a whimper out of the many bucks he has thrown at the financial system.
In explaining his recovery program in April, PresidentObama noted that:
“there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask”.
He justified giving the money to the lenders, rather than to the debtors, on the basis of “the multiplier effect” from bank lending:
the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth. (page 3 of the speech)
This argument comes straight out of the neoclassical economics textbook. Fortunately, due to the clear manner in which Obama enunciates it, the flaw in this textbook argument is vividly apparent in his speech.
This “multiplier effect” will only work if American families and businesses are willing to take on yet more debt: “a dollar of capital in a bank can actually result in eight or ten dollars of loans”.
So the only way the roughly US$1 trillion of money that the Federal Reserve has injected into the banks will result in additional spending is if American families and businesses take out another US$8-10 trillion in loans.
* * *
If the money multiplier was going to “ride to the rescue”, private debt would need to rise from its current level of US$41.5 trillion to about US$50 trillion, and this ratio would rise to about 375% — more than twice the level that ushered in the Great Depression.
This is a rescue? It’s a “hair of the dog” cure: having booze for breakfast to overcome the feelings of a hangover from last night’s binge. It is the road to debt alcoholism, not the road to teetotalism and recovery.
Fortunately, it’s a “cure” that is also highly unlikely to work, because the model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.
* * *
I’ve recently developed a genuinely monetary, credit-driven model of the economy, and one of its first insights is that Obama has been sold a pup on the right way to stimulate the economy: he would have got far more bang for his buck by giving the stimulus to the debtors rather than the creditors.
* * *
The model shows that you get far more “bang for your buck” by giving the money to firms, rather than banks. Unemployment falls in both case below the level that would have applied in the absence of the stimulus, but the reduction in unemployment is far greater when the firms get the stimulus, not the banks: unemployment peaks at over 18 percent without the stimulus, just over 13 percent with the stimulus going to the banks, but under11 percent with the stimulus being given to the firms.
* * *
So giving the stimulus to the debtors is a more potent way of reducing the impact of a credit crunch — the opposite of the advice given to Obama by his neoclassical advisers.
This could also be one reason that the Australian experience has been better than the USA’s: the stimulus in Australia has emphasized funding the public rather than the banks (and the model shows the same impact from giving money to the workers as from giving it to the firms — and for the same reason, that workers have to spend, so that the money injected into the economy circulates more rapidly.
* * *
Obama has been sold a pup by neoclassical economics: not only did neoclassical theory help cause the crisis, by championing the growth of private debt and the asset bubbles it financed; it also is undermining efforts to reduce the severity of the crisis.
This is unfortunately the good news: the bad news is that this model only considers an economy undergoing a “credit crunch”, and not also one suffering from a serious debt overhang that only a direct reduction in debt can tackle. That is our actual problem, and while a stimulus will work for awhile, the drag from debt-deleveraging is still present. The economy will therefore lapse back into recession soon after the stimulus is removed.
You can be sure that if we head into a “double-dip” recession as Professor Keen expects, the President will never hear the end of it. If only Mr. Obama had stuck with his campaign promise of “no more trickle-down economics”, we wouldn’t have so many people wishing they lived in Australia.
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 with
Speaker of the House
Nancy Pelosi
Thursday, September 24, 2009
6:30pm ~ 8:00pm
At the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.
$5,000 PAC
$2,400 Individual
Again, 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.
Comments Off on The Forgotten Urgency Of Financial Reform
September 10, 2009
With all the fighting over healthcare reform and the many exciting controversies envisioned by its opponents, such as: death panels, state-sponsored abortions and illegal aliens’ coming to America for free breast implants, the formerly-urgent need for financial reform his slipped away from public concern. Alan Blinder recently wrote a piece for The New York Times, lamenting how the subject of financial reform has disappeared from the Congressional radar:
After all we’ve been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic. Why is the pulse of reform so faint?
Blinder then discussed five reasons why. My favorite concerned lobbying:
Almost everything becomes lobbied to death in Washington. In the case of financial reform, the money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it.
Mr. Blinder expressed concern that these three important changes would be left out of any financial reform legislation: a) resolving the problem of having financial institutions that are “too big to fail”, b) cleaning up the derivatives mess and c) creating a “systemic risk regulator”. (All right — I rearranged the order.)
In case you’re wondering just what the hell a “systemic risk regulator” is, Blinder provided the readers with a link to one of his earlier articles, which said this:
The main task of a systemic-risk regulator is to serve as an early-warning-and-prevention system, on the prowl for looming risks that extend across traditional boundaries and are becoming large enough to have systemic consequences.
* * *
Suppose such a regulator had been in place in 2005. Because the market for residential mortgages and the mountain of securities built on them constituted the largest financial market in the world, that regulator probably would have kept a watchful eye on it. If so, it would have seen what the banking agencies apparently missed: lots of dodgy mortgages being granted by nonbank lenders with no federal supervision.
If the regulator saw those mortgages, it might then have looked into the securities being built on them. That investigation might have turned up the questionable triple-A ratings being showered on these securities, and it certainly should have uncovered the huge risk concentrations both on and off of banks’ balance sheets. And, unless it was totally incompetent, the regulator would have been alarmed to learn that a single company, American International Group, stood behind an inordinate share of all the credit-default swaps — essentially insurance policies against default — that had been issued.
Blinder shares the view, expressed by Treasury Secretary “Turbo” Tim Geithner, that the Federal Reserve should serve as systemic risk regulator, because “there is no other alternative”. Unfortunately, President Obama is also in favor of such an approach. The drawback to empowering the Fed with such additional responsibility was acknowledged by Mr. Blinder:
On the other hand, some members of Congress are grumbling that the Fed has already overreached, usurping Congressional authority. Others contend that it has performed so poorly as a regulator that it hardly deserves more power.
Federal Reserve Chairman Ben Bernanke discussed this issue himself back on March 5, in a speech entitled: “Financial Reform to Address Systemic Risk”. Near the end of this speech, Bernanke discussed the subject objectively, although he concluded with a pitch to get this authority for his own realm:
Some commentators have proposed that the Federal Reserve take on the role of systemic risk authority; others have expressed concern that adding this responsibility would overburden the central bank. The extent to which this new responsibility might be a good match for the Federal Reserve depends a great deal on precisely how the Congress defines the role and responsibilities of the authority, as well as on how the necessary resources and expertise complement those employed by the Federal Reserve in the pursuit of its long-established core missions.
It seems to me that we should keep our minds open on these questions. We have been discussing them a good deal within the Federal Reserve System, and their importance warrants careful consideration by legislators and other policymakers. As a practical matter, however, effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role. . . . The Federal Reserve plays such a key role in part because it serves as liquidity provider of last resort, a power that has proved critical in financial crises throughout history. In addition, the Federal Reserve has broad expertise derived from its wide range of activities, including its role as umbrella supervisor for bank and financial holding companies and its active monitoring of capital markets in support of its monetary policy and financial stability objectives.
This rationale leads me to suspect that Mr. Bernanke might be planning to use his super powers as: “liquidity provider of last resort” to money-print away any systemic risks that might arise on his watch in such a capacity. This is reminiscent of how comedian Steve Smith always suggests the use of duct tape to solve just about any problem that might arise in life.
In the September 8 edition of The Wall Street Journal, Peter Wallison wrote an article entitled: “The Fed Can’t Monitor ‘Systemic Risk’”. More important was the subtitle: That’s like asking a thief to police himself. Wallison begins with the point that President Obama’s inclusion of granting such powers to the Fed as the centerpiece of his financial regulatory reform agenda “is a serious error.” Wallison seemed to share my concern about Bernanke’s “duct tape” panacea:
The problem is the Fed itself can create systemic risk. Many scholars, for example, have argued that by keeping interest rates too low for too long the Fed created the housing bubble that gave us the current mortgage meltdown, financial crisis and recession.
Vesting such authority in the Fed creates an inherent conflict of interest. Mr. Wallison explained this quite well:
Tasking the Fed with that responsibility would bury it among many other inconsistent roles and give the agency incentives to ignore warning signals that an independent body would be likely to spot.
Unlike balancing its current competing assignments — price stability and promoting full employment — detecting systemic risk would require the Fed to see the subtle flaws in its own policies. Errors that are small at first could grow into major problems. It is simply too much to expect any human institution to step outside of itself and see the error of its ways when it can plausibly ignore those errors in the short run. If we are going to have a systemic-risk monitor, it should be an independent council of regulators.
When the dust finally settles on the healthcare reform debate, perhaps Congress can approach the subject of financial reform . . . if it’s not too late by that point.
TheCenterLane.com offers opinion, news and commentary on politics, the economy, finance and other random events that either find their way into the news or are ignored by the news reporting business. As the name suggests, our focus will be on what seems to be happening in The Center Lane of American politics and what the view from the Center reveals about the events in the left and right lanes. Your Host, John T. Burke, Jr., earned his Bachelor of Arts degree from Boston College with a double major in Speech Communications and Philosophy. He earned his law degree (Juris Doctor) from the Illinois Institute of Technology / Chicago-Kent College of Law.
The Pushback Against Bernanke
November 30, 2009
This week brings us the confirmation hearings on President Obama’s nomination of Ben Bernanke to a second four-year term as chairman of the Federal Reserve. The recent progress in Congressional efforts to audit the Federal Reserve will certainly spice up the confirmation hearings. If that weren’t enough, Bernanke saw fit to write a commentary piece for Sunday’s edition of The Washington Post, expressing his opposition to any attempts to limit the Fed’s power and subject it to an audit. Here is some of what he had to say in that column:
Well, he should have known what would be coming next . . . the avalanche of criticism pointing out how the Fed played a major role in causing the crisis. As you will see below, that response was swift. Worse yet, Bernanke’s theme of “we learned our lesson” will surely inspire harsh interrogation at the confirmation hearings:
Dean Baker did not waste any time before ripping into Bernanke’s essay. Baker’s Beat the Press blog at The American Prospect website regularly upbraids Bernanke for his responsibility in causing the economic crisis. Baker’s retort to the Washington Post piece was published at the Talking Points Memo website. The final paragraph of Baker’s essay reflected his outrage that the Post would publish Bernanke’s rant without an opposing response:
Dean Baker’s primary criticism of Bernanke is based on the Fed chair’s failure to control the 8-trillion-dollar housing bubble before it burst, nearly destroying the entire economy:
At the Naked Capitalism website, Yves Smith dealt a hefty load of thorough criticism on the Bernanke article. She began with the verdict against Bernanke and built an impressive argument supporting her opinion:
Smith did not restrict her criticism to the Fed’s failure to control the housing bubble. Here are some of her points:
In response to Bernanke’s claim that Congressional efforts to rein-in the authority of the Fed are “very much out of step with the global consensus on the appropriate role of central banks,” Ms. Smith pounced:
Brenanke’s claim that the idiotic bank stress tests “marked a turning point in public confidence in the banking system” invited a well-deserved attack. Here’s how Yves Smith handled it:
Remember that these negative reactions to the Bernanke article are just what appeared on Sunday. By the time the confirmation hearings begin on December 3, you can be sure that Bernanke’s own words from the Post column will be used against him. We may find that his decision to write this piece was a crucial turning point leading to a decision against his confirmation.