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There WILL Be Another Financial Crisis

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The latest Quarterly Report from SIGTARP – the Special Inspector General for the Troubled Asset Relief Program (Neil Barofsky) – was released on January 26, 2011.  The report brought a mix of good and bad news.  Among the good news was this tidbit:

Where fraud has managed to slip in, SIGTARP’s Investigations Division has already produced outstanding results in bringing to justice those who have sought to profit criminally from TARP, with 45 individuals charged civilly or criminally with fraud, of whom 13 have been criminally convicted. SIGTARP’s investigative efforts have helped prevent $555.2 million in taxpayer funds from being lost to fraud.  And with 142 ongoing investigations (including 64 into executives at financial institutions that applied for and/or received TARP funding through TARP’s Capital Purchase Program [“CPP”]), much more remains to be done.

Much of the bad news from SIGTARP stems from the never-ending problem of “moral hazard” resulting from the perpetually-increasing growth of those financial institutions, which have been “too big to fail” for too long:

In short, the continued existence of institutions that are “too big to fail” — an undeniable byproduct of former Secretary Paulson and Secretary Geithner’s use of TARP to assure the markets that during a time of crisis that they would not let such institutions fail — is a recipe for disaster.  These institutions and their leaders are incentivized to engage in precisely the sort of behavior that could trigger the next financial crisis, thus perpetuating a doomsday cycle of booms, busts, and bailouts.

Worse yet, as Mr. Barofsky pointed out in a January 25 interview with the Center for Public Integrity, the system has been rigged to provide additional advantages to the TBTF banks, making it impossible for smaller institutions to compete with them:

Noting that the major financial institutions are 20 percent larger than they were before the financial crisis, Barofsky said that the financial markets simply don’t believe that the government will allow one of these biggest banks to collapse, regardless of what they say will happen.  Those big banks enjoy access to cheaper credit than smaller institutions, based on that implicit government guarantee, he said.

As evidence, he cited the ratings agency Standard & Poor’s, which recently announced its intention to add the prospect of government support into its calculation when determining a bank’s credit rating.

At 1:35 into the video clip of the Center for Public Integrity’s interview with Mr. Barofsky, he explained:

There’s going to be another financial crisis.  Of course, there is.

He went on to point out that once the next crisis begins, we will have the option of implementing the mechanisms established by the Dodd-Frank bill for breaking up insolvent banks.  The question then becomes:  Will be break up those banks or bail them out?  Barofsky suspects that the market is anticipating another round of bailouts.  He noted that “there’s a question of whether there will be the political will as well as the regulatory will to do that”.  As he pointed out on page 11 of the latest SIGTARP Quarterly Report:

As long as the relevant actors (executives, ratings agencies, creditors and counterparties) believe there will be a bailout, the problems of “too big to fail” will almost certainly persist.

Let’s not forget that most dangerous among those problems is the encouraged and facilitated “risky behavior” by those institutions, which will bring about the next financial crisis.  This is the “Doomsday Cycle” problem discussed by Mr. Barofsky.  “The Doomsday Cycle” was the subject of a paper, written last year by economists Simon Johnson and Peter Boone.

The SIGTARP Report then focused on what has been discussed as TARP’s biggest failure:

As SIGTARP discussed in its October 2010 Quarterly Report, after two years, TARP’s Main Street goals of “increas[ing] lending,” and “promot[ing] jobs and economic growth” had been largely unmet, but it is TARP’s failure to realize its most specific Main Street goal, “preserving homeownership,” that has had perhaps the most devastating consequences.  Treasury’s central foreclosure prevention effort designed to address that goal — the Home Affordable Modification Program (“HAMP”) — has been beset by problems from the outset and, despite frequent retooling, continues to fall dramatically short of any meaningful standard of success.  Indeed, even the “good news” of falling estimates for TARP’s cost is driven in part by the ineffectiveness of HAMP and related programs, which provide for TARP-funded grants and incentives.

As we begin fighting over the Final Report of the Financial Crisis Inquiry Commission (FCIC) — which investigated the causes of the financial crisis — it is important to be mindful of Neil Barofsky’s admonition that there will be another financial crisis.  If our government fails to prosecute the malfeasance that caused the crisis itself, that neglect — combined with the enhanced size of those “too big to fail” banks — could create a disaster we would have to characterize as “TBFAB” – Too Big For A Bailout.  What will happen at that point?


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Head For The Hills

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March 12, 2010

When a stranger in a tinfoil hat tells me that the sky is falling, I don’t pay attention to him.  On the other hand, when credible sources warn of an upcoming economic collapse as a result of our government’s financial ignorance — I listen.

Simon Johnson is a professor of Entrepreneurship at MIT’s Sloan School of Management.  From 2007-2008, he was chief economist at the International Monetary Fund.  He recently co-authored an article for CenterPiece with Peter Boone entitled, “The Doomsday Cycle”.  Their essay began with this observation:

Each time the system runs into problems, the Federal Reserve quickly lowers interest rates to revive it.  These crises appear to be getting worse and worse — and their impact is increasingly global.  Not only are interest rates near zero around the world, but many countries are on fiscal trajectories that require major changes to avoid eventual financial collapse.

What will happen when the next shock hits?  We believe we may be nearing the stage where the answer will be — just as it was in the Great Depression — a calamitous global collapse.  The root problem is that we have let a “doomsday cycle” infiltrate our economic system  . . .

The essay contains a number of proposals for correcting this problem.  One of them involves tripling the requirement for core capital at major banks to 15-20% of assets.  They concluded with this warning:

Last year, we came remarkably close to collapse.  Next time, it may be worse.  The threat of the doomsday cycle remains strong and growing.

Of course, the fact that scares me is that our government doesn’t give a damn.  We aren’t likely to see any changes in capital requirements or anything else that was suggested in that article.

Niall Ferguson is a professor of economic history at Harvard.  He recently wrote an article entitled, “Complexity and Collapse — Empires on the Edge of Chaos”.  It was published in the March/April 2010 issue of Foreign Affairs magazine.  The piece began with this summary:

Imperial collapse may come much more suddenly than many historians imagine.  A combination of fiscal deficits and military overstretch suggests that the United States may be the next empire on the precipice.

Niall Ferguson’s essay inspired Paul Farrell of MarketWatch to write a commentary on Ferguson’s piece, summarizing the highlights, while driving home this message:

Dismiss his warning at your peril.  Everything you learned, everything you believe and everything driving our political leaders is based on a misleading, outdated theory of history.  The American Empire is at the edge of a dangerous precipice, at risk of a sudden, rapid collapse.

*   *   *

His message negates all the happy talk you’re hearing in today’s news — about economic recovery and new bull markets, about “hope,” about a return to “American greatness” — from Washington politicians and Wall Street bankers.

*   *   *

“The Consummation of Empire” focuses us on Ferguson’s core message:  At the very peak of their power, affluence and glory, leaders arise, run amok with imperial visions and sabotage themselves, their people and their nation.  They have it all.

Fortunately, Mr. Farrell included some advice for those of us who are wondering about how to survive an economic collapse:  Head for the hills.  Here’s what he had to say:

At this point, investors are asking themselves:  How can I prepare for the destruction and collapse of the American Empire?  There is no solution in the Cole-Ferguson scenario, only an acceptance of fate, of destiny, of history’s inevitable cycles.

But there is one in “Wealth, War and Wisdom” by hedge fund manager Barton Biggs, Morgan Stanley’s former chief global strategist who warns us of the “possibility of a breakdown of the civilized infrastructure,” advising us to buy a farm in the mountains.

“Your safe haven must be self-sufficient and capable of growing some kind of food … well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc.  Think Swiss Family Robinson.”  And when they come looting, fire “a few rounds over the approaching brigands’ heads.”

A reading of Paul Farrell’s article about Barton Biggs from July of 2009, reveals a more comfortable assessment of a crisis which may be 40 or 50 years in the future.  Professor Ferguson’s essay has apparently given Mr. Farrell a greater sense of urgency about the disaster ahead.  Here’s the assessment Mr. Farrell gave last summer:

But how to invest for the “End of Civilization” coming around 2050?  The next 40 years will be confusing: Accelerating struggles between aging populations and disenchanted youth, soaring commodity prices, global warming, peak oil, food shortages, famine, blackouts, rationing, civil disorder, increasing crime, worldwide jihads, riots, anarchy and other dark scenarios of a tomorrow with “warfare defining human life.”

Compare and contrast that view with the concluding remark from Mr. Farrell’s recent piece:

You are forewarned:  If the peak of America’s glory was the leadership handoff from Clinton to Bush, then we have already triggered the countdown to collapse, the decade from 2010 until 2020 … tick … tick … tick …

You have just read the views of some intelligent men who are warning us that a huge disaster may lie just around the corner.  Yikes!



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Three New Books For March

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February 24, 2010

The month of March brings us three new books about the financial crisis.  The authors are not out to make apologies for anyone.  To the contrary, they point directly at the villains and expose the systemic flaws that were exploited by those who still may yet destroy the world economy.  All three of these books are available at the Amazon widget on the sidebar at the left side of this page.

Regular fans of the Naked Capitalism blog have been following the progress of Yves Smith on her new book, ECONned:  How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.  It will be released on March 2.  Here is some information about the book from the product description at the Amazon website:

ECONned is the first book to examine the unquestioned role of economists as policy-makers, and how they helped create an unmitigated economic disaster.

Here, Yves Smith looks at how economists in key policy positions put doctrine before hard evidence, ignoring the deteriorating conditions and rising dangers that eventually led them, and us, off the cliff and into financial meltdown.  Intelligently written for the layman, Smith takes us on a terrifying investigation of the financial realm over the last twenty-five years of misrepresentations, naive interpretations of economic conditions, rationalizations of bad outcomes, and rejection of clear signs of growing instability.

In eConned (sic), author Yves Smith reveals:

–why the measures taken by the Obama Administration are mere palliatives and are unlikely to pave the way for a solid recovery

–how economists have come to play a profoundly anti-democratic role in policy

–how financial models and concepts that were discredited more than thirty years ago are still widely used by banks, regulators, and investors

–how management and employees of major financial firms looted them, enriching themselves and leaving the mess to taxpayers

–how financial regulation enabled predatory behavior by Wall Street towards investors

–how economics has no theory of financial systems, yet economists fearlessly prescribe how to manage them

Michael Lewis is the author of the wildly-popular book, Liar’s Poker, based on his experience as a bond trader for Solomon Brothers in the mid-80s.  His new book, The BigShort: Inside the Doomsday Machine, will be released on March 15.  Here is some of what Amazon’s product description says about it:

A brilliant account — character-rich and darkly humorous — of how the U.S. economy was driven over the cliff.

*   *   *

Michael Lewis’s splendid cast of characters includes villains, a few heroes, and a lot of people who look very, very foolish:  high government officials, including the watchdogs; heads of major investment banks (some overlap here with previous category); perhaps even the face in your mirror.  In this trenchant, raucous, irresistible narrative, Lewis writes of the goats and of the few who saw what the emperor was wearing, and gives them, most memorably, what they deserve.  He proves yet again that he is the finest and funniest chronicler of our times.

Our third author, Simon Johnson, recently co-authored an article for CenterPiece with Peter Boone entitled, “The Doomsday Cycle” which explains how “we have let a ‘doomsday cycle’ infiltrate our economic system”.  The essay contains a number of proposals for correcting this problem.  Here is one of them:

We believe that the best route to creating a safer system is to have very large and robust capital requirements, which are legislated and difficult to circumvent or revise.  If we triple core capital at major banks to15-25% of assets, and err on the side of requiring too much capital for derivatives and other complicated financial structures, we will create a much safer system with less scope for “gaming” the rules.

Simon Johnson is a professor of Entrepreneurship at MIT’s Sloan School of Management.  From 2007-2008, he was chief economist at the International Monetary Fund.  With James Kwak, he is the co-publisher of The Baseline Scenario website.  Johnson and Kwak have written a new book entitled, 13 Bankers:  The Wall Street Takeover and the Next Financial Meltdown.  Although this book won’t be released until March 30, the Amazon website has already quoted from reviews by the following people:  Bill Bradley, Robert Reich, Arianna Huffington, Bill Moyers, Alan Grayson, Brad Miller, Elizabeth Warren and others.  Professor Warren must be a Democrat, based on the affiliation of nearly everyone else who reviewed the book.

Here is some of what can be found in Amazon’s product description:

.  .  .  a wide-ranging, meticulous, and bracing account of recent U.S. financial history within the context of previous showdowns between American democracy and Big Finance: from Thomas Jefferson to Andrew Jackson, from Theodore Roosevelt to Franklin Delano Roosevelt.  They convincingly show why our future is imperiled by the ideology of finance (finance is good, unregulated finance is better, unfettered finance run amok is best) and by Wall Street’s political control of government policy pertaining to it.

As these authors make the talk show circuit to promote their books during the coming weeks, the American public will hearing repeated pleas to demand that our elected officials take action to stop the mercenary financial behemoths from destroying the world.  Perhaps the message will finally hit home.

If you are interested in any of these three books, they’re available on the right side of this page.



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