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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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Geithner Watch

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August 19, 2010

It’s that time once again.  The Treasury Department has launched another “charm offensive” – and not a moment too soon.  “Turbo” Tim Geithner got some really bad publicity at the Daily Beast website by way of a piece by Philip Shenon.  The story concerned the fact that a man named Daniel Zelikow — while in between revolving door spins at JP Morgan Chase — let Geithner live rent-free in Zelikow’s $3.5 million Washington townhouse, during Geithner’s first eight months as Treasury Secretary.  Zelikow (who had previously worked for JP Morgan Chase from 1999 until 2007) was working at the Inter-American Development Bank at the time.  The Daily Beast described the situation this way:

At that time, Geithner was overseeing the bailout of several huge Wall Street banks, including JPMorgan, which received $25 billion in federal rescue funds from the TARP program.

Zelikow, a friend of Geithner’s since they were classmates at Dartmouth College in the early 1980s, begins work this month running JPMorgan’s new 12-member International Public Sector Group, which will develop foreign governments as clients.

*   *   *

Stephen Gillers, a law professor at New York University who is a specialist in government ethics and author of a leading textbook on legal ethics, described Geithner’s original decision to move in with Zelikow last year as “just awful” —  given the conflict-of-interest problems it seemed to create.

He tells The Daily Beast that Geithner now needs to avoid even the appearance of assisting JPMorgan in any way that suggested a “thank-you note” to Zelikow in exchange for last year’s free rent.

“He needs to be purer than Caesar’s wife — purer than Caesar’s whole family,” Gillers said of the Treasury secretary.

The Daily Beast story came right on the heels of Matt Taibbi’s superlative article in Rolling Stone, exposing the skullduggery involved in removing all the teeth from the financial “reform” bill.  Taibbi did not speak kindly of Geithner:

If Obama’s team had had their way, last month’s debate over the Volcker rule would never have happened.  When the original version of the finance-­reform bill passed the House last fall  – heavily influenced by treasury secretary and noted pencil-necked Wall Street stooge Timothy Geithner – it contained no attempt to ban banks with federally insured deposits from engaging in prop trading.

Just when it became clear that Geithner needed to make some new friends in the blogosphere, another conclave with financial bloggers took place on Monday, August 16.  The first such event took place last November.  I reviewed several accounts of the November meeting in a piece entitled “Avoiding The Kool -Aid”.  Since that time, Treasury has decided to conduct such meetings 4 – 6 times per year.  The conferences follow an “open discussion” format, led by individual senior Treasury officials (including Turbo Tim himself) with three presenters, each leading a 45-minute session.  A small number of financial bloggers are invited to attend.  Some of the bloggers who were unable to attend last November’s session were sorry they missed it.  The August 16 meeting was the first one I’d heard about since the November event.  The following bloggers attended the August 16 session:  Phil Davis of Phil’s Stock World, Yves Smith of Naked Capitalism, John Lounsbury for Ed Harrison’s Credit Writedowns, Michael Konczal of Rortybomb, Steve Waldman of Interfluidity, as well as Tyler Cowen and Alex Tabarrok of Marginal Revolution.  As of this writing, Alex Tabarrok and John Lounsbury were the only attendees to have written about the event.  You can expect to see something soon from Yves Smith of Naked Capitalism.

At this juncture, the effort appears to have worked to Geithner’s advantage, since he made a favorable impression on Alex Tabarrok, just as he had done last November with Tabarrok’s partner at Marginal Revolution, Tyler Cowen:

As Tyler said after an earlier visit, Geithner is smart and deep.  Geithner took questions on any topic.  Bear in mind that taking questions from people like Mike Konczal, Tyler, or Interfluidity is not like taking questions from the press.  Geithner quickly identified the heart of every question and responded in a way that showed a command of both theory and fact.  We went way over scheduled time.  He seemed to be having fun.

It will be interesting to see whether the upcoming accounts of the meeting continue to provide Geithner with the image makeover he so desperately needs.


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Another Troubling Appointment By Obama

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February 5, 2009

It all started with Bill Richardson.  On January 4, New Mexico Governor Bill Richardson announced that he was withdrawing as nominee for the position of Commerce Secretary, due to an investigation into allegations of influence peddling.

Then there was a brief moment of concern over the fact that Treasury Secretary nominee, Timothy Geithner, was a little late with some self-employment tax payments.  Since his new position would put him in charge of the Internal Revenue Service, many people found this shocking.  Even more shocking was his admission that he prepared his income taxes using the TurboTax software program.  That entire controversy was overlooked because Geithner has been regarded as the only person in Washington who fully understands the TARP bailout bill (as Newsweek‘s Jonathan Alter once said).

On February 3, two more Obama appointees had to step aside.  The first was Nancy Killefer, who had been selected to become “Chief Performance Officer”, in which role she would have been tasked with cleaning up waste in government programs.  Her situation didn’t sound all that scandalous.  The Wall Street Journal explained that she “… had a $946.69 tax lien imposed on her home by the District of Columbia for unpaid taxes on household help, a debt she had satisfied long ago.”  Later that day, Tom Daschle had to withdraw his nomination to become Secretary of Health and Human Services.  It seemed that his failure to timely pay over $100,000 in taxes was just part of the problem.  As the previously-mentioned Wall Street Journal article pointed out, the Daschle nomination provided additional embarrassment for President Obama:

Beyond the tax issue, Mr. Daschle was increasingly being portrayed as a Washington insider who made a fortune by trading on his Beltway connections — an example of the kind of culture Mr. Obama had pledged to change.

Meanwhile, many Democrats were expressing dismay over the February 2 announcement that Republican Senator Judd Gregg had been tapped to become Commerce Secretary.  Back in 1995, as United States Senator representing New Hampshire, he voted in favor of a budget measure that would have abolished the Commerce Department.  To many, this seemed too much like the George W. Bush tactic of putting a saboteur in charge of an administrative agency.  Nevertheless, Senator Gregg was ready to address those concerns.  As Liz Sidoti reported for the Associated Press:

In a conference call with reporters, Gregg dismissed questions about the vote.

“I say those were my wild and crazy days,” he said.  “My record on supporting Commerce far exceeds any one vote that was cast early on in the context of an overall budget.”

Gregg said he’s strongly supported the agency, particularly its scientific initiatives, including at the agency’s largest department, the National Oceanic and Atmospheric Administration.

Finally, on Wednesday February 5, those who concurred with President Obama’s appointment of Mary Schapiro as Chair of the Securities and Exchange Commission (SEC) had good reason to feel anxious.  That day brought us the long-awaited testimony of independent financial fraud investigator, Harry Markopolos, before the House Financial Services Committee.  Back in May of 2000, Mr. Markopolos tried to alert the SEC to the fact that Bernie Madoff’s hedge fund was a multi-billion-dollar Ponzi scheme.  As Markopolos explained in his testimony, he repeatedly attempted to get the SEC to investigate this scam, only to be rebuffed on every occasion.  Although his testimony included some good advice directed to Ms. Schapiro about “cleaning up” the SEC, this portion of his testimony, as discussed by Marcy Gordon of the Associated Press, deserves some serious attention:

While the SEC is incompetent, the securities industry’s self-policing organization, the Financial Industry Regulatory Authority, is “very corrupt,” Markopolos charged.  That organization was headed until December by Schapiro, who has said Madoff carried out the scheme through his investment business and FINRA was empowered to inspect only the brokerage operation.

So Schapiro’s defense is that FINRA was empowered to inspect only brokerages and Madoff Investments was not a brokerage.  This doesn’t address Markopolos’ testimony that FINRA is “very corrupt”.  Mary Schapiro was the Chair and CEO of that “very corrupt” entity from 2006 until December of 2008.  Let’s not forget that during her tenure in that position she appointed Bernie Madoff’s son, Mark Madoff, to the board of the National Adjudicatory Council.  The Mark Madoff appointment was discussed back on December 18 by Randall Smith and Kara Scannell, in The Wall Street Journal.  At that time, they provided an informative analysis of the SEC nominee’s track record, which should have discouraged the new President from appointing her as he did on his second day in office:

She was credited with beefing up enforcement while at the National Association of Securities Dealers and guiding the creation of the Financial Industry Regulatory Authority, which she now leads.  But some in the industry questioned whether she would be strong enough to get the SEC back on track.

*   *   *

Robert Banks, a director of the Public Investors Arbitration Bar Association, an industry group for plaintiff lawyers  . . .  said that under Ms. Schapiro, “Finra has not put much of a dent in fraud,” and the entire system needs an overhaul.  “The government needs to treat regulation seriously, and for the past eight years we have not had real securities regulation in this country,” Mr. Banks said.

Since Ms. Schapiro took over Finra in 2006, the number of enforcement cases has dropped, in part because actions stemming from the tech-bubble collapse ebbed and the markets rebounded from 2002 to 2007.  The agency has been on the fringe of the major Wall Street blowups, and opted to focus on more bread-and-butter issues such as fraud aimed at senior citizens.

Out of the gate, Ms. Schapiro faces potential controversy.  In 2001 she appointed Mark Madoff, son of disgraced financier Bernard Madoff, to the board of the National Adjudicatory Council, the national committee that reviews initial decisions rendered in Finra disciplinary and membership proceedings.  Both sons of Mr. Madoff have denied any involvement in the massive Ponzi scheme their father has been accused of running.

I would be much more comfortable with a small-time tax cheat in charge of the SEC, than I am with Mary Schapiro in that position.  As his testimony demonstrates, Harry Markopolos is the person who should be running the SEC.

The “Bad Bank” Debate

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January 29, 2009

The $700 billion Troubled Assets Relief Program (TARP) doesn’t seem to have accomplished much in the way of relieving banks from the ownership of “troubled assets”.  In fact, nobody seems to know exactly what was done with the first $350 billion in TARP funds, and those who do know are not talking.  Meanwhile, the nation’s banks have continued to flounder.  As David Cho reported in The Washington Post on Wednesday, January 28:

The health of many banks is getting worse, not better, as the downturn makes it difficult for all kinds of consumers and businesses to pay back money they borrowed from these financial firms.  Conservative estimates put bank losses yet to be declared at $1 trillion.

The continuing need for banks to unload their toxic assets has brought attention to the idea of creating a “bad bank” to buy mortgage-backed securities and other toxic assets, thus freeing-up banks to get back into the lending business.  Bloomberg News and other sources reported on Wednesday that FDIC chair, Sheila Bair, is pushing for her agency to run such a “bad bank”.  Our new Treasury Secretary, Tim Geithner, has also discussed the idea of such a bank (often referred to as an “aggregator bank”) as reported on Wednesday by Reuters:

Geithner said last week the administration was reviewing the option of setting up a bad bank, but that it is “enormously complicated to get right.”

The idea of creating such a bank has drawn quite a bit of criticism.  Back on January 18, Paul Krugman (recipient of the Nobel Prize in Economics) characterized this approach, without first “nationalizing” the banks on a temporary basis, as “Wall Street Voodoo”:

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s:  it seized the defunct banks, cleaning out the shareholders.  Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches.  Instead, they’re reportedly gravitating toward a compromise approach:  moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Krugman scrutinized Sheila Bair’s earlier explanation that the aggregator bank would buy the toxic assets at “fair value”, by questioning how we define what “fair value” really means.  He concluded that this entire endeavor (as it is currently being discussed) is a bad idea for all concerned:

Unfortunately, the price of this retreat into superstition may be high.  I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

Krugman is not alone in his skepticism concerning this plan.  As Annelena Lobb and Rob Curran  reported in Wednesday’s Wall Street Journal, this idea is facing some criticism from those in the financial planning business:

“I don’t see how this increases liquidity,” says Paul Sutherland, chief investment officer at FIM Group in Traverse City, Mich.  “This idea that we should burn million-dollar bills from taxpayers to take bad assets isn’t the best path.”

Billionaire financier Geroge Soros told CNBC that he disagrees with the “bad bank” strategy, explaining that the proposal “will help relieve the situation, but it will not be sufficient to turn it around”.  He then took advantage of the opportunity to criticize the execution of the first stage of the TARP bailout:

As to Paulson’s handling of the first half of the $700 billion Wall Street bailout fund known as TARP, Soros said the money was used “capriciously and haphazardly.”  He said half of it has now been wasted, and the rest will need to be used to plug holes.

Former Secretary of Labor, Robert Reich, anticipates that a “big chunk” of the remaining TARP funds will be used to create this aggregator bank.  Accordingly, he has suggested application of the type of standards that were absent during the first TARP phase:

Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market, private-sector banks that benefit from this form of taxpayer relief must (1) refrain from issuing dividends, purchasing other companies, or paying off creditors; (2) compensate their executives, traders, or directors no more than 10 percent of what they received in 2007; (3) be reimbursed by their executives, traders, and directors 50 percent of whatever amounts they were compensated in 2005, 2006, 2007, and 2008 — compensation which was, after all, based on false premises and fraudulent assertions, and on balance sheets that hid the true extent of these banks’ risks and liabilities; and (4) commit at least 90 percent of their remaining capital to new bank loans.

However, Reich’s precondition:  “Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market” is exactly what makes his approach unworkable.  The cost of purchasing the toxic assets from banks will never be recouped by selling them in the open market.  This point was emphasized by none other than “Doctor Doom” himself (Dr. Nouriel Roubini) during an interview with CNBC at the World Economic Forum in Davos, Switzerland.  Dr. Roubini pointed out:

At which price do you buy the assets?  If you buy them at a high price, you are having a huge fiscal cost.  If you buy them at the right market price, the banks are insolvent and you have to take them over.  So I think it’s a bad idea.  It’s another form of moral hazard and putting on the taxpayers, the cost of the bailout of the financial system.

What is Dr. Roubini’s solution?  Face up to the reality that the banks are insolvent and “do what Sweden did”:  take over the banks, clean them up by selling off the bad assets and sell them back to the private sector.

Nevertheless, you can’t always count on the federal government to do the right thing.  In this case, I doubt that they will.  As David Cho pointed out at the end of his Washington Post article:

The bailout program “is a public relations nightmare,” one government official said.  He added that Obama officials are sure to face criticism for whatever course they take.