TheCenterLane.com

© 2008 – 2024 John T. Burke, Jr.

Kill The Whales

October 8th, 2009 Posted in Uncategorized
Oct, 08 2009
Comments Off on Kill The Whales

October 8, 2009

Those whales are back in the news again — this time due to calls for their slaughter.  In case you’re wondering what kind of person would advocate the killing of whales, I would like to identify two people who recently spoke out in favor of such action.  The first of these individuals is one of my favorite columnists at The New York Times, Gretchen Morgenson, winner of the Pulitzer Prize in 2002 for her “trenchant and incisive” coverage of Wall Street.  The second is the chair of the Federal Deposit Insurance Corporation, Sheila Bair.  Two women want to have whales killed?  Yes.  However, the “whales” in question are those infamous financial institutions considered “too big to fail”.  On October 3, Gretchen Morgenson wrote a piece for The New York Times, entitled:  “The Cost of Saving These Whales” in which she defined “to big to fail” institutions as “banks that are so big and interconnected that their very existence threatens the world”.   She discussed the problems caused by the continued existence of those whales with this explanation:

During the credit bust, our leaders embraced the too-big-to-fail policy, reluctantly bailing out large institutions to save the system from collapse, they said.  Yet even as the crisis has abated, these policy makers have shown little interest in cutting financial monsters down to size.  This is especially disturbing given that some institutions have grown even larger as a result of the mess.

It is perverse, of course, to reward big banks’ mistakes with bailouts financed by beleaguered taxpayers.  But the too-big-to-fail doctrine benefits the banks in other ways as well:  the implication that an institution will not be allowed to fall gives it significant cost advantages over smaller, perhaps more responsible competitors.

On October 4, Sheila Bair of the FDIC gave a speech before the International Institute of Finance at their annual meeting in Istanbul, Turkey.  At the outset, she pointed out that “the first task” in creating “a more resilient, transparent, and better-regulated financial system” would be to scrap the “too big to fail” doctrine.  She went on to explain how to go about killing those whales:

To do this we need a resolution regime that provides for the orderly wind-down of banking and other financial enterprises without imposing costs on the taxpayers.

The solution must involve a practical and effective mechanism for the orderly resolution of these institutions similar to that used for FDIC-insured banks.

This new regime would not permit taxpayer funds to be used to prop up a firm or its management.  Instead, senior management would be replaced, and losses would be borne by the stockholders and creditors.

On September 23, 2009 Treasury Secretary “Turbo” Tim Geithner testified before the House Financial Services Committee to explain his planned financial reform agenda.  Here’s what Turbo Tim had to say about the plan for dealing with the “too big to fail” problem:

First, we cannot allow firms to reap the benefits of explicit or implicit government subsidies without very strong government oversight.  We must substantially reduce the moral hazard created by the perception that these subsidies exist; address their corrosive effects on market discipline; and minimize their encouragement of risk-taking.

So, in other words … the government subsidies to these institutions will continue, but only if the recipients get “very strong government oversight”.  In his next sentence Geithner expressed his belief that the moral hazard was created “by the perception that these subsidies exist” rather than the FACT that they exist.  Geithner’s scheme of continued corporate welfare for the biggest financial institutions is consistent with what we learned about him from Jo Becker and Gretchen Morgenson in their New York Times article back on April 26.  That essay gave us some great insight about Turbo Tim’s blindness to moral hazard:

Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session.  What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer.  He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.

The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars.

“People thought, ‘Wow, that’s kind of out there,’” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward.  Mr. Geithner says, “I don’t remember a serious discussion on that proposal then.”

But in the 10 months since then, the government has in many ways embraced his blue-sky prescription.  Step by step, through an array of new programs, the Federal Reserve and Treasury have assumed an unprecedented role in the banking system, using unprecedented amounts of taxpayer money, to try to save the nation’s financiers from their own mistakes.

And more often than not, Mr. Geithner has been a leading architect of those bailouts, the activist at the head of the pack.  He was the federal regulator most willing to “push the envelope,” said H. Rodgin Cohen, a prominent Wall Street lawyer who spoke frequently with Mr. Geithner.

Geithner’s objective of putting the prosperity of the banks ahead of any concern for the taxpayers was again demonstrated in this AFP report from October 6:

On proposed changes to the financial system, Geithner said it was “legitimate” for banks to be influential and admitted that reform could “pose risks to financial innovation.”

Nevertheless, he stressed that “the most important issue is that if stability (of financial institutions) is not guaranteed, it will become harder to raise capital.”

On October 6, Newsweek published an interview conducted by Nancy Cook with William Black, a former federal regulator during the Savings & Loan crisis and a professor of economics and law at the University of Missouri – Kansas City.  The interview included a discussion of the government’s response to the financial crisis.  One remark made by Mr. Black reinforced my opinion about Turbo Tim:

“Some of the things Bernanke did were very bad, but he is in sharp contrast to Geithner who has been wrong about everything in his career.  When Geithner was once answering a question in response to Ron Paul, he said, ‘I’ve never been a regulator.’  He was then the President of the New York Federal Reserve, and he purports that he was never a regulator?  That is a demonstration of what is wrong with the Federal Reserve banks if the head of the unit doesn’t think he’s a regulator.  He’s a disaster.”

It should come as no surprise that Richard Carnell, a Professor at Fordham Law School and former Assistant Treasury Secretary for President Clinton, would have this to say about Geithner’s financial reform agenda, when asked for his comments by Kim Thai of Fortune:

The plan includes useful reforms.  But it’s also naive, timid, misguided, politically inept, and intellectually dishonest.

It places naive faith in regulation.  Yet regulation failed disastrously over the past decade.  Bank regulators had ample powers to keep banks safe but did too little, too late.  They let banks use $12-13 in borrowed money for every $1 in shareholders’ money.  The administration’s response?  Give regulators more powers.

[The plan] preserves a preposterous tangle of overlapping regulators.  And it didn’t arrive until June, seven months after the election.  By then the crisis had faded and special interest politics had come roaring back.

It entrenches bailouts for large financial institutions.  Voters know that’s rotten policy.  It makes firms like General Electric divest their banks.  That serves no purpose.  It’s like trying to ward off the Mexican Mafia by fortifying the Canadian border.  Small wonder voters remain skeptical.

It appears as though Turbo Tim is not up to the job of killing those whales.  Perhaps the President should find someone who is.



wordpress visitor


, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

More Heat For The Federal Reserve

October 5th, 2009 Posted in Uncategorized
Oct, 05 2009
Comments Off on More Heat For The Federal Reserve

October 5, 2009

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.



wordpress visitor


, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

The Broken Promise

September 21st, 2009 Posted in Uncategorized
Sep, 21 2009
Comments Off on The Broken Promise

September 21, 2009

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.



wordpress visitor


, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

The Window Of Opportunity Is Closing

September 17th, 2009 Posted in Uncategorized
Sep, 17 2009
Comments Off on 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:

At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.

“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City.  (“You will not stay out until 2 a.m. again.”)

*   *   *

Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill.  But his words rang hollow.

*   *   *

But you can’t, with words alone, alter the perception — now more entrenched than ever — that the government won’t allow large institutions to fail.

How do you convince bankers they will pay for their risk-taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?

They learn by example.  The system of privatized profits and socialized losses has suited them fine until now.

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:

“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said.   “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”

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:

Bankers Outfox Regulators

It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size.  Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit.  When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.

What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.

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:

If you are looking for reform in the financial sector, the moment has passed.  And only to the degree that the underlying weaknesses in the global financial system are made manifest and threaten the economy will we see any appetite for reform amongst politicians.  So, as I see it, the Obama administration has missed the opportunity for reform.

More important, the following point by Mr. Harrison has been expressed in several recent essays:

Irrespective, I believe the need for reform is clear.  Those gloom & doom economists were right because the economic model which brought us to the brink of disaster in 2008 is the same one we have at present and that necessarily means another crisis will come.

At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:

Some observers say it’s OK that a year has gone by without reform; we don’t want to get it wrong.  But the political reality is that as the urgency passes, it’s harder to pass reforms.

“We have lulled ourselves into the mind-set that we are out of the woods, when we aren’t,” says Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University School of Law.  “I don’t think time is our friend here. We risk losing the sense of urgency so that nothing happens.”

*   *   *

Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, thinks the unofficial deadline for financial-sector reform is now October 2010 — right before the next congressional elections.

That leaves lawmakers a full year to get the job done.

But given all the details they have to work out — and the declining sense of urgency as stocks keep ticking higher — you have to wonder how much progress they’ll make.

On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:

You are kidding yourself if you think real reform is coming to the financial sector before the mid-term elections, especially with healthcare, two wars and the need to ensure recovery still on politicians’ plates. Obama could go for real reform in 2011 — or in a second term in 2013.  But, unless economic crisis is at our door, there isn’t a convincing argument which says reform is necessary.

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:

“Pecora’s success was his ability to crystallize the anger that a lot of Americans were feeling toward Wall Street,” said Michael Perino, a law professor at St. John’s University and author of an upcoming book about the hearings. “He was able to create a clamor for reform.”

But Pecora also realized that such clamor was fleeting

*   *   *

“We’ve passed the moment when there’s this palpable anger directed at the financial community,” Perino said of the current crisis.  “When you leave the immediate vicinity of the crisis, as you get farther and farther away in time, the urgency fades.”

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.



wordpress visitor


, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

The Forgotten Urgency Of Financial Reform

September 10th, 2009 Posted in Uncategorized
Sep, 10 2009
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.



wordpress visitor


, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

Ron Paul Struts His Stuff

August 17th, 2009 Posted in Uncategorized
Aug, 17 2009
Comments Off on Ron Paul Struts His Stuff

August 17, 2009

Republican Congressman Ron Paul of Texas has become quite a popular guy, lately.  Back on February 26, he sponsored his own bill, the Federal Reserve Transparency Act, (HR 1207) which would give the Government Accountability Office authority to audit the Federal Reserve and its member components, requiring a report to Congress by the end of 2010.  On July 29, a Rasmussen poll revealed that 75 percent of those surveyed were in favor of auditing the Federal Reserve, with only 9 percent opposed to such a measure.  Lew Rockwell’s website recently featured an article by Anthony Gregory, discussing the Rasmussen poll results and the popularity of Ron Paul’s proposed legislation:

While much of the hostility toward Obama’s domestic policy might be seen in partisan terms, distrust of the Fed completely transcends typical ideological or partisan lines.  While all Congressional Republicans support Ron Paul’s bill to audit the Fed, so do more than a hundred Democrats, demonstrating the impact of the wide public outrage over the Washington-Wall Street shenanigans since the financial downturn.

The Federal Reserve, a centerpiece in the bipartisan establishment, an essential component in both war finance and economic management, is now the least trusted government agency.  More than two thirds of Americans do not believe the Fed is doing a good job.  Two years ago, virtually no one even talked about the Fed; it was an obscure institution assumed to be necessary, wise and uninteresting.  Anyone who brought it up was accused of being outside the sphere of respectable opinion.  Now its champions are on the defensive, and they are desperately scrambling to restore public awe for the central bank behind the curtain.

But the opposition to Obama’s economic policies, both on the right and on the anti-corporate left who view his ties to the banking industry with suspicion, along with a growing disappointment on the left as it concerns civil liberties and war, may eventually constrain Obama.

The mistrust of the Fed, discussed by Mr. Gregory, was based on a Gallup Poll, also conducted during July, which revealed that the Federal Reserve is now “the least trusted” of all government-related entities.

Despite protests from the academic world and an unsupportive editorial from The Washington Post, support for Ron Paul’s bill continues to gain momentum.  Howard Rich, Chairman of Americans for Limited Government, wrote a favorable commentary on this proposal, pointing out that he initially thought it was a rather strange idea.  He eventually looked at the situation with this rationale:

From its founding in 1913, the Fed has existed as an island of almost total independence — setting interest rates, managing inflation and regulating banks according to the will of its Chairman and seven-member Board of Directors.

It cannot be audited. Its ledger is not disclosed. Its meetings are private. Its decisions are not up for debate.

Of course, this ongoing shroud of secrecy ignores the fact that the Fed — as it exists today — is a completely different animal than it was even two years ago.

No longer merely a “regulatory” agency, the Fed has used the current economic crisis as an excuse to dramatically expand its role.  With zero transparency, accountability and effectiveness, it has printed and loaned trillions of dollars since mid-2007 in a costly and unsuccessful effort to mitigate fallout from the sub-prime mortgage crisis.

The question of where those trillions of dollars went is exactly what is on the minds of most people demanding more accountability from the Fed.  Was any favoritism involved in determining what banks received how much money?  Dean Baker wrote an opinion piece for The Guardian, arguing against the re-appointment of Ben Bernanke for another term as the Fed chairman.  The subject of favoritism in the Fed’s response to last fall’s financial meltdown was apparently a matter of concern to Mr. Baker:

By this measure, Bernanke’s performance is very poor.  He has refused to provide the public, or even the relevant congressional committees, with information on the trillions of dollars in loans that were made through the Fed’s special lending facilities.  While anyone can go to the Treasury’s website and see how much each bank received through Tarp and under what terms, Bernanke refuses to share any information on the loans that banks and other institutions received from the Fed.

Where we do have information, it is not encouraging.  At the peak of the financial crisis in October, Goldman Sachs converted itself from an investment bank into a bank holding company, in part so that it could tap an FDIC loan guarantee programme.  Remarkably, Bernanke allowed Goldman to continue to act as an investment bank, taking highly speculative positions even after it had borrowed $28bn with the FDIC’s guarantee.

The idea that the Federal Reserve could loan trillions of dollars to unidentified beneficiaries on secret terms has resulted in outrage from across the political spectrum.  In his rebuttal to The Washington Post‘s editorial criticizing Ron Paul’s Fed transparency initiative, Independent (and self-avowed socialist) Senator Bernie Sanders of Vermont had this to say:

This legislation wouldn’t undermine the Fed’s independence, and it wouldn’t put Congress in charge of monetary policy.  An audit is simply an examination of records or financial accounts to check their accuracy.

We must not equate “independence” with secrecy.  No matter how intelligent or well-intentioned the Fed chairman and his staff may be, it isn’t appropriate to give a handful of people the power to lend an unlimited supply of money to anyone it wants without sufficient oversight.

Absolute power corrupts absolutely.  The American people have a right to know what is being done with their hard-earned taxpayer dollars.  This money does not belong to the Fed; it belongs to the American people.

The tremendous upsurge in support for the Federal Reserve Transparency Act was obviously what motivated Ron Paul to write an essay on the matter for Sunday’s edition of The Philadelphia Inquirer.  With such a strong wind at his back, he confidently trashed the arguments of his opponents and began the piece with this assertion:

The Federal Reserve’s unprecedented intervention into the U.S. economy has inflamed more Americans than almost any other issue in recent memory.

Congressman Paul then proceeded to pound away at the criticism of his bill, reminding me of a boxer, who sees blood flowing down into his opponent’s eyes:

The most conservative estimates place the potential cost of the Federal Reserve’s bailouts and guarantees at about $9 trillion. That is equivalent to more than 60 percent of the U.S.economy, all undertaken by one organization, and almost all of those transactions are exempt from congressional oversight and public scrutiny.

The Fed and its apologists are using bogeymen to deflect criticism.  If the Fed were audited, they argue, monetary policy would be compromised as Congress tries to direct the Fed’s actions, and the Fed’s record of economic stability and low inflation would come to an end.  Nothing could be further from the truth.

*   *   *

The Fed’s mismanagement created the Great Depression, the stagflation of the 1970s, and now our current economic crisis. Over the nearly100 years of the Fed’s existence, the dollar has lost nearly 95 percent of its purchasing power.  A “mild” rate of inflation of 2 percent per year means that a baby born today will see the dollar’s purchasing power erode by a further 75 percent over his lifetime.  If this boondoggle is the Fed’s definition of stability and sound management of the dollar, I would hate to see what instability looks like.

Yet that is exactly what we face today and in the near future with a federal government and a Federal Reserve working hand in hand to bail out favored Wall Street firms with sums of money that have quickly reached absurd proportions.

*   *   *

The fact that a single entity, the Federal Reserve, has dominated monetary policy for so long has been detrimental to the economy.  As long as we try to keep up the fictions that the Federal Reserve works to benefit the American people, that attempting to fix interest rates will not distort the economy, and that the Fed can end a recession by injecting liquidity, we will never free ourselves from the boom and bust of the business cycle.

A necessary first step to restoring economic stability in this country is to audit the Fed, to find out the multitude of sectors in which it has involved itself, and, once the audit has been completed, to analyze the results and determine how the Fed should be reined in.

When one sees a former Republican Presidential primary contender enjoy this type of momentum, the inevitable question is whether Ron Paul might make another run for the White House.  Justin Miller had this on his mind last month when he discussed this subject for The Atlantic:

Paul is just as plausible a candidate to run for the Republican nomination as are Mitt Romney, Sarah Palin, or Mike Huckabee who were tested in polls this month.  Like them, Paul’s run for the White House (twice) before and has said he isn’t opposed to doing it again, albeit he said it’s “unlikely.”  What’s more likely, based on the circumstantial evidence, is that the Republican voters would receive Paul better than they did last year.  Feature him in polls from now on and we can test this hypothesis.

As President Obama continues to alienate the liberal base of the Democratic Party, Ron Paul might be just the person the Republicans would want to nominate in 2012.  He’ll be 77 years old at that point — just in time for a single term.

, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More

Fed Up With The Fed

July 20th, 2009 Posted in Uncategorized
Jul, 20 2009
Comments Off on Fed Up With The Fed

July 20, 2009

Last week’s news that Goldman Sachs reported $3.44 billion in earnings for the second quarter of 2009 provoked widespread outrage that was rather hard to avoid.  Even Jon Stewart saw fit to provide his viewers with an informative audio-visual presentation concerning the role of Goldman Sachs in our society.  Allan Sloan pointed out that in addition to the $10 billion Goldman received from the TARP program, (which it repaid) Goldman also received another $12.9 billion as a counterparty to AIG’s bad paper (which it hasn’t repaid). Beyond that, there was the matter of “the Federal Reserve Board moving with lightning speed last fall to allow Goldman to become a bank holding company”.   Sloan lamented that despite this government largesse, Goldman is still fighting with the Treasury Department over how much it should pay taxpayers to buy back the stock purchase warrants it gave the government as part of the TARP deal.  The Federal Reserve did more than put Goldman on the fast track for status as a bank holding company (which it denied to Lehman Brothers, resulting in that company’s bankruptcy).  As Lisa Lerer reported for Politico, Senator Bernie Sanders questioned whether Goldman received even more assistance from the Federal Reserve.  Because the Fed is not subject to transparency, we don’t know the answer to that question.

A commentator writing for the Seeking Alpha website under the pseudonym:  Cynicus Economicus, expressed the opinion that people need to look more at the government and the Federal Reserve as being “at the root of the appearance of the bumper profits and bonuses at Goldman Sachs.”  He went on to explain:

All of this, hidden in opacity, has led to a point at which insolvent banks are now able to make a ‘profit’.  Exactly why has this massive bleeding of resources into insolvent banks been allowed to take place?  Where exactly is the salvation of the real economy, the pot of gold at the end of the rainbow of the financial system?  Like the pot of gold and the rainbow, if we just go a bit further…..we might just find the pot of gold.

In this terrible mess, the point that is forgotten is what a financial system is actually really for.  It only exists to allocate accumulated capital and provision of insurances; the financial system should be a support to the real economy, by efficiently allocating capital.  It is entirely unclear how pouring trillions of dollars into insolvent institutions, capital which will eventually be taken out of the ‘real’ economy, might facilitate this.  The ‘real’ economy is now expensively supporting the financial system, rather than the financial system supporting the real economy.

The opacity of the Federal Reserve has become a focus of populist indignation since the financial crisis hit the meltdown stage last fall.  As I discussed on May 25, Republican Congressman Ron Paul of Texas introduced the Federal Reserve Transparency Act (HR 1207) which would give the Government Accountability Office the authority to audit the Federal Reserve as well as its member components, and require a report to Congress by the end of 2010.  Meanwhile, President Obama has suggested expanding the Fed’s powers to make it the nation’s “systemic risk regulator” overseeing banks such as Goldman Sachs, deemed “too big to fail”.  The suggestion of expanding the Fed’s authority in this way has only added to the cry for more oversight.  On July 17, Willem Buiter wrote a piece for the Financial Times entitled:  “What to do with the Fed”.  He began with this observation:

The desire for stronger Congressional oversight of the Fed is no longer confined to a few libertarian fruitcakes, conspiracy theorists and old lefties.  It is a mainstream view that the Fed has failed to foresee and prevent the crisis, that it has managed it ineffectively since it started, and that it has allowed itself to be used as a quasi-fiscal instrument of the US Treasury, by-passing Congressional control.

Since the introduction of HR 1207, a public debate has ensued over this bill.  This dispute was ratcheted up a notch when a number of economics professors signed a petition, urging Congress and the White House “to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.”  An interesting analysis of this controversy appears at LewRockwell.com, in an article by economist Robert Higgs.  Here’s how Higgs concluded his argument:

All in all, the economists’ petition reflects the astonishing political naivite and historical myopia that now characterize the top echelon of the mainstream economics profession. Everybody now understands that economic central planning is doomed to fail; the problems of cost calculation and producer incentives intrinsic to such planning are common fodder even for economists in upscale institutions.  Yet, somehow, these same economists seem incapable of understanding that the Fed, which is a central planning body working at the very heart of the economy — its monetary order — cannot produce money and set interest rates better than free-market institutions can do so.  It is high time that they extended their education to understand that central planning does not work — indeed, cannot work — any better in the monetary order than it works in the economy as a whole.

It is also high time that the Fed be not only audited and required to reveal its inner machinations to the people who suffer under its misguided actions, but abolished root and branch before it inflicts further centrally planned disaster on the world’s people.

Close down the Federal Reserve?  It’s not a new idea.  Back on September 29, when the Emergency Economic Stabilization Act of 2008 was just a baby, Avery Goodman posted a piece at the Seeking Alpha website arguing for closure of the Fed.  The article made a number of good points, although this was my favorite:

The Fed balance sheet shows that it injected a total of about $262 billion, probably into the stock market, over the last two weeks, pumping up prices on Wall Street.  The practical effect will be to allow people in-the-know to sell their equities at inflated prices to people-who-believe-and-trust, but don’t know.  Sending so much liquidity into the U.S.economy will stoke the fires of hyperinflation, regardless of what they do with interest rates.  In a capitalist society, the stock market should not be subject to such manipulation, by the government or anyone else.  It should rise and fall on its own merits.  If it is meant to fall, let it do so, and fast.  It is better to get the economic downturn over with, using shock therapy, than to continue to bleed the American people slowly to death through a billion tiny pinpricks.

So the battle over the Fed continues.  In the mean time, as The Washington Post reports, Fed Chairman Ben Bernanke takes his show on the road, making four appearances over the next six days.  Tuesday and Wednesday will bring his semiannual testimony on monetary policy before House and Senate committees.  Perhaps he will be accompanied by Goldman Sachs CEO, Lloyd Bankfiend, who could show everyone the nice “green shoots” growing in his IRA at taxpayer expense.

, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Read More
Newer Entries