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I Knew This Would Happen

May 27th, 2010 Posted in Uncategorized
May, 27 2010
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May 27, 2010

It was almost a year ago when I predicted that President Obama would eventually announce the need for a “second stimulus”.  Once the decision was made to drink the Keynesian Kool-Aid with the implementation of last year’s economic stimulus package, we were faced with the question of how much to drink.  As I expected, our President took the half-assed, yet “moderate” approach of limiting the stimulus effort to less than what was admitted as the cost of the TARP program, as well as approving  the waste of stimulus funds on “pork” projects, ill-suited to stimulate economic recovery.  In that July 9, 2009 piece, I discussed the fact that liberal economist, Paul Krugman, was not alone in claiming that $787 billion would not be an adequate amount to jump-start the economy back to firing on all cylinders.  I pointed out that a survey of economists conducted by Bloomberg News in February of 2009 revealed a consensus opinion that an $800 billion stimulus would prove to be inadequate.  The February 12, 2009 Bloomberg article by Timothy Homan and Alex Tanzi revealed that:

Even as Obama aims to create 3.5 million jobs with a stimulus plan, economists foresee an unemployment rate exceeding 8 percent through next year.

As we now reach the mid-point of that “next year”, the unemployment rate is at 9.9 percent.  Those economists were right.  Beyond that, some highly-respected economists, including Robert Shiller, are discussing the risk of our experiencing a “double-dip” recession.  As a result, Larry Summers, Director of the President’s National Economic Council, is advocating the passage of a new set of spending measures, referred to as the “second stimulus”.  To help offset the expense, the President has asked Congress to grant him powers to cut unnecessary spending, as would be accomplished with a “line item veto”.  The Financial Times described the situation this way :

The combined announcements were made amid rising concern that centrist Democrats, or those representing marginal districts, might vote against the spending measures, which include more loans for small businesses, an extension of unemployment insurance and aid to states to prevent hundreds of thousands more teachers from being laid off.

*   *   *

Taken together, Mr Summers’s speech and Mr Obama’s announcement show an administration walking a fine line between the need to signal strong medium-term fiscal discipline and not jeopardising what they fear may be a fragile recovery.

Because they couldn’t get it right the first time, the President and his administration have placed themselves in the position of seeking piecemeal stimulus measures.  If they had done it right, we would probably be enjoying economic recovery and a boost in the ranks of the employed at this point.  As a result, this half-assed, piecemeal approach will likely prove more costly than doing it right on the first try.  With mid-term elections approaching, deficit hawks have their knives sharpened for anything that can be described as an “entitlement” (unless that entitlement inures to the benefit of a favored Wall Street institution).  Harold Meyerson of The Washington Post challenged the logic of the deficit hawks with this argument:

Those who oppose the jobs bills in the House and Senate this week should be compelled to answer some questions, starting with:  Absent more stimulus, what do they see as the plausible engine of economic recovery?  What effect will laying off as many as 300,000 teachers have on the education of American children?  And, more elementally, don’t they know there’s a recession on?

Marshall Auerback of the Roosevelt Institute picked up where Harold Meyerson left off, as this recent posting at the New Deal 2.0 website demonstrates:

In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt.  That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.

Fiscal austerity, by contrast, won’t cut it.  Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse.  Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of  Defense, where we always seem to be able to appropriate a few billion, whenever necessary.  “Affordability” principles never extend to the Pentagon, it appears.

The fact that we are still in the midst of a severe recession (rather than a robust economic recovery as is often claimed) accounts for the rationale asserted by Larry Summers in advocating a second stimulus amounting to approximately $200 billion in spending measures.  Here’s how Summers explained the proposal in a May 24 speech at the Johns Hopkins School of Advanced International Studies:

It has in recent years been essential for the federal deficit to increase as the economy has gone into recession and has been severely constrained by demand.

And I cannot agree with those who suggest that it somehow threatens the future to provide truly temporary, high-bang-for-the-buck jobs and growth measures.

Rather, assuring as rapid a recovery as possible strengthens our future economy, our future prosperity, with many benefits, including a greater ability to manage our debts.

On the other hand, those who recognize the fiscal and growth benefits of strong expansionary policies must also recognize that it is simultaneously desirable to provide confidence that deficits will come down to sustainable levels as recovery is achieved.  Such confidence both spurs recovery by reducing capital costs and reduces the risk of financial accidents.

To put the point differently:  It is not possible to imagine sound budgets in the absence of economic growth and solid economic performance.

*   *   *

It is important to recognize that the ultimate consequences of stimulus for indebtedness depend critically on the macroeconomic conditions.  When the economy is demand constrained, the impact of a dollar of tax cuts or expansionary investment will be at its highest and the impact on deficits at its lowest.
*   *   *

In areas where the government has a significant opportunity for impact, it would be pennywise and pound foolish not to take advantage of our capacity to encourage near-term job creation.   This explains the logic of the Recovery Act’s success and the rationale for taking additional targeted actions to increase confidence in our economic recovery.

Consider the package currently under consideration in Congress to extend unemployment and health benefits to those out of work and support to states to avoid budget cuts as a case in point.

It would be an act of fiscal shortsightedness to break from the longstanding practice of extending these provisions at a moment when sustained economic recovery is so crucial to our medium-term fiscal prospects.

So, here we are at the introduction of the second stimulus plan.  Despite the denial by President Obama that he would seek a second stimulus, he has Larry Summers doing just that.  Last year, the public and the Congress had the will – not to mention the sense of urgency – to approve such measures.  This time around, it might not happen and that would be due to the leadership flaw I observed last year:

President Obama should have done it right the first time.  His penchant for compromise — simply for the sake of compromise itself — is bound to bite him in the ass on this issue, as it surely will on health care reform — should he abandon the “public option”.  The new President made the mistake of assuming that if he established a reputation for being flexible, his opposition would be flexible in return.  The voting public will perceive this as weak leadership.  As a result, President Obama will need to re-invent this aspect of his public image before he can even consider presenting a second economic stimulus proposal.

At this point, Obama’s “flexibility” is often viewed by the voting public as a lack of existential authenticity, sincerity or — worse yet —  credibility.  As a result, I would expect to see more articles like the recent piece by Carol Lee at Politico, entitled, “Obama:  Day for ‘partnership’ passed”.

Here comes the makeover!






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Too Cute By Half

April 29th, 2010 Posted in Uncategorized
Apr, 29 2010
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April 29, 2010

On April 15, I discussed the disappointing performance of the Financial Crisis Inquiry Commission (FCIC).  The vapid FCIC hearings have featured softball questions with no follow-up to the self-serving answers provided by the CEOs of those too-big–to-fail financial institutions.

In stark contrast to the FCIC hearings, Tuesday brought us the bipartisan assault on Goldman Sachs by the Senate Permanent Subcommittee on Investigations.  Goldman’s most memorable representatives from that event were the four men described by Steven Pearlstein of The Washington Post as “The Fab Four”, apparently because the group’s most notorious member, Fabrice “Fabulous Fab” Tourre, has become the central focus of the SEC’s fraud suit against Goldman.   Tourre’s fellow panel members were Daniel Sparks (former partner in charge of the mortgage department), Joshua Birnbaum (former managing director of Structured Products Group trading) and Michael Swenson (current managing director of Structured Products Group trading).  The panel members were obviously over-prepared by their attorneys.  Their obvious efforts at obfuscation turned the hearing into a public relations disaster for Goldman, destined to become a Saturday Night Live sketch.  Although these guys were proud of their evasiveness, most commentators considered them too cute by half.  The viewing public could not have been favorably impressed.  Both The Washington Post’s Steven Pearlstein as well as Tunku Varadarajan of The Daily Beast provided negative critiques of the group’s testimony.  On the other hand, it was a pleasure to see the Senators on the Subcommittee doing their job so well, cross-examining the hell out of those guys and not letting them get away with their rehearsed non-answers.

A frequently-repeated theme from all the Goldman witnesses who testified on Tuesday (including CEO Lloyd Bankfiend and CFO David Viniar) was that Goldman had been acting only as a “market maker” and therefore had no duty to inform its customers that Goldman had short positions on its own products, such as the Abacus-2007AC1 CDO.  This assertion is completely disingenuous.  When Goldman creates a product and sells it to its own customers, its role is not limited to that of  “market-maker”.  The “market-maker defense” was apparently created last summer, when Goldman was defending its “high-frequency trading” (HFT) activities on stock exchanges.  In those situations, Goldman would be paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves to buy and sell stocks.  The purpose of paying Goldman to make such trades (often selling a stock for the same price they paid for it) was to provide liquidity for the markets.  As a result, retail (Ma and Pa) investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock.  That type of market-making bears no resemblance to the situations which were the focus of Tuesday’s hearing.

Coincidentally, Goldman’s involvement in high-frequency trading resulted in allegations that the firm was “front-running” its own customers.   It was claimed that when a Goldman customer would send out a limit order, Goldman’s proprietary trading desk would buy the stock first, then resell it to the client at the high limit of the order.  (Of course, Goldman denied front-running its clients.)  The Zero Hedge website focused on the language of the disclaimer Goldman posted on its “GS360” portal.  Zero Hedge found some language in the GS360 disclaimer which could arguably have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders.

At Tuesday’s hearing, the Goldman witnesses were repeatedly questioned as to what, if any, duty the firm owed its clients who bought synthetic CDOs, such as Abacus.  Alistair Barr of MarketWatch contended that the contradictory answers provided by the witnesses on that issue exposed internal disagreement at Goldman as to what duty the firm owed its customers.  Kurt Brouwer of MarketWatch looked at the problem this way :

This distinction is of fundamental importance to anyone who is a client of a Wall Street firm.  These are often very large and diverse financial services firms that have — wittingly or unwittingly — blurred the distinction between the standard of responsibility a firm has as a broker versus the requirements of an investment advisor.  These firms like to tout their brilliant and objective advisory capabilities in marketing brochures, but when pressed in a hearing, they tend to fall back on the much looser standards required of a brokerage firm, which could be expressed like this:

Well, the firm made money and the traders made money.  Two out of three ain’t bad, right?

The third party referred to indirectly would be the clients who, all too frequently, are left out of the equation.

A more useful approach could involve looking at the language of the brokerage agreements in effect between Goldman and its clients.  How did those contracts define Goldman’s duty to its own customers who purchased the synthetic CDOs that Goldman itself created?  The answer to that question could reveal that Goldman Sachs might have more lawsuits to fear than the one brought by the SEC.



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Failed Financial Reform And Failed Justice

April 26th, 2010 Posted in Uncategorized
Apr, 26 2010
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April 26, 2010

As the long-awaited financial reform legislation finally seems to be headed toward enactment, the groans of disappointment are loud and clear.  My favorite reporter at The New York Times, Gretchen Morgenson, did a fine job of exposing the shortcomings destined for inclusion in this lame bill:

Unfortunately, the leading proposals would do little to cure the epidemic unleashed on American taxpayers by the lords of finance and their bailout partners.  The central problem is that neither the Senate nor House bills would chop down big banks to a more manageable and less threatening size.  The bills also don’t eliminate the prospect of future bailouts of interconnected and powerful companies.

Too big to fail is alive and well, alas.  Indeed, several aspects of the legislative proposals sanction and codify the special status conferred on institutions that are seen as systemically important.  Instead of reducing the number of behemoth firms assigned this special status, the bills would encourage smaller companies to grow large and dangerous so that they, too, could have a seat at the bailout buffet.

*   *   *

It is disappointing that none of the current proposals call for breaking up institutions that are now too big or on their way there.  Such is the view of Richard W. Fisher, president of the Federal Reserve Bank of Dallas.

“The social costs associated with these big financial institutions are much greater than any benefits they may provide,” Mr. Fisher said in an interview last week.  “We need to find some international convention to limit their size.”

*   *   *

Edward Kane, a finance professor at Boston College and an authority on financial institutions and regulators, said that it was not surprising that substantive changes for both groups are not on the table.  After all, powerful banks want to maintain their ability to privatize gains and socialize losses.

“To understand why defects in in solvency detection and resolution persist, analysts must acknowledge that large financial institutions invest in building and exercising political clout,” Mr.Kane writes in an article, titled “Defining and Controlling Systemic Risk,” that he is scheduled to present next month at a Federal Reserve conference.

But regulators, eager to avoid being blamed for missteps in oversight, also have an interest in the status quo, Mr. Kane argues.  “As in a long-running poker game in which one player (here, the taxpayer) is a perennial and relatively clueless loser,” he writes, “other players see little reason to disturb the equilibrium.”

At Forbes, Robert Lenzner focused on the human failings responsible for the bad behavior of the big banks with his emphasis on the notion that “a fish stinks from the head”:

No well-intentioned reform bill that will pass Congress can prevent the mind-blowing stupidity, hubris and denial utilized by the big fish of Wall Street from stinking from the head.

*   *   *

Transparency won’t help if the Obama plan does not absolutely require all derivatives to be registered at the Securities and Exchange Commission.  It’s an invitation for abuse as five major market making banks like JPMorgan Chase account for 95% of all derivatives transactions and a very large share of their profits.  We haven’t seen evidence that they police themselves satisfactorily.

Derivatives expert Janet Tavakoli recently expressed her disgust over the disingenuousness of the current version of this legislation:

Our proposed “financial reform” bill is a sham, and the health of our society and our economy is at stake.

Ms. Tavakoli referred to the recent Huffington Post article by Dan Froomkin, which highlighted the criticism of the financial reform legislation provided by Professor William Black (the former prosecutor from the Savings and Loan crisis, whose execution was called for by Charles Keating).  Froomkin embraced the logic of economist James Galbraith, who emphasized that rather than relying on the expertise of economists to shape financial reform, we should be looking to the assistance of criminologists.  William Black reinforced this idea:

Criminologists, Black said, are trained to identify the environments that produce epidemics of fraud — and in the case of the financial crisis, the culprit is obvious.

“We’re looking at incentive structures,” he told HuffPost.  “Not people suddenly becoming evil.  Not people suddenly becoming crazy.  But people reacting to perverse incentive structures.”

CEOs can’t send out a memo telling their front-line professionals to commit fraud, “but you can send the same message with your compensations system, and you can do it without going to jail,” Black said.

Criminologists ask “fundamentally different types of question” than the ones being asked.

Back at The New York Times, Frank Rich provided us with a rare example of mainstream media outrage over the lack of interest in prosecuting the fraudsters responsible for the financial disaster that put eight million people out of work:

That no one at Lehman Brothers has yet been held liable for its Enronesque bookkeeping deceit is appalling.  That we still haven’t seen the e-mail and documents that would illuminate A.I.G.’s machinations with Goldman and the rest of its counterparties amounts to a cover-up.  That investigative journalists have consistently been way ahead of the authorities, the S.E.C. included, in uncovering Wall Street’s foul play is a scandal.  If this culture remains in place, the whole crisis will have gone to waste.

Unfortunately, the likelihood that any significant financial reform will be enacted as a result of the financial crisis is about the same as the likelihood that we will see anyone doing a “perp walk” for the fraudulent behavior that caused the meltdown.  Don’t expect serious reform and don’t expect justice.



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Unrealistic Expectations

April 22nd, 2010 Posted in Uncategorized
Apr, 22 2010
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April 22, 2010

Newsweek’s Daniel Gross is back at it again.  His cover story for Newsweek’s April 9 issue is another attempt to make a preemptive strike at writing history.  You may remember his cover story for the magazine’s July 25 issue, entitled:  “The Recession Is Over”.  During the eight months since the publication of that article, the sober-minded National Bureau of Economic Research, or NBER —  which is charged with making the determination that a recession has ended – has yet to make such a proclamation.

The most recent cover story by Daniel Gross, “The Comeback Country” has drawn plenty of criticism.  (The magazine cover used the headline “America’s Back” to introduce the piece.)  At The Huffington Post, Dan Dorfman discussed the article with Olivier Garret, the CEO of Casey Research, an economic and investment consulting firm.  Garret described the Newsweek cover story as “fantasy journalism” and he shared a number of observations with Dan Dorfman:

“You know when a magazine like Newsweek touts a bullish economic recovery on its cover, just the opposite is likely to be the case,” he says.  “It sees superficial signs of improvement, but it’s ignoring the big picture.”

*   *   *

Meanwhile, Garret sees additional signs of economic anguish.  Among them:  More foreclosures and delinquencies of real estate properties will plague construction spending; banks haven’t yet cleaned up their balance sheets; private debt is no longer going down as it did in 2009; both short and long term rates should be headed higher, and many companies, he says, tell him they’re reluctant to invest and hire.

He also sees some major corporate bankruptcies, worries about the country’s ability to repay its debt, looks for rising cost of capital, which should further slow the economy, and expects a spreading sovereign debt crisis.

*  *  *

Many economists are projecting GDP growth in the range of 3% to 4% in the first quarter and similar growth for the entire year.  Much too optimistic, Garret tells me.  His outlook (which would clobber the stock market if he’s right):  up 0.4%-0.5% in the first quarter after revisions and between 0% and 1% for all of 2010.

“Fantasy economies only work in the mind, not in real life,” he says.

Given his bleak economic outlook, Garret expects a major market adjustment, say about a 10% to 20% decline in stock prices over the next six months.  He figures it could be triggered by one event, such as as an extension of the sovereign debt crisis.

David Cottle of The Wall Street Journal had this reaction to the Newsweek article:

Therefore, when you see a cover such as Newsweek’s recent effort, yelling “America’s Back” in no uncertain terms, it’s quite tempting to stock up on bonds, cash, tinned goods and ammunition.

Now, in fairness to the author, Daniel Goss, he makes the good point that the U.S. economy is growing at a clip that has consistently surprised gloomy forecasters.  It is.  The turnaround we’ve seen since Lehman Brothers imploded has been remarkable, if not entirely satisfying, he says, and he is quite right.  At the very least, U.S. growth is all-too-predictably leaving the European version in the dust.  Goss is also pretty upfront about the corners of the U.S. economy that have so far failed to keep up:  job creation and the housing market being the most obvious.

However, the problem with all these ‘back to normal’ pieces, and Goss’s is only one of many creeping out as the sky resolutely fails to fall in, is that the ‘normal’ they want to go back to was, in reality, anything but.

The financial sector remains unreformed, the global economy remains dangerously unbalanced.  The perilous highways that brought us to 2007 have not been sealed off in favor of straighter, if slower, roads.  Of course it would be great for us all if America were ‘back’ and so we must hope Newsweek’s cover doesn’t join the ranks of those which cruel history renders unintentionally hilarious .

But back where?  That’s the real question.

Meanwhile, the Pew Research Center has turned to Americans themselves to find out just how “back” America really is.  This report from April 20 didn’t seem to resonate so well with the rosy picture painted by Daniel Gross:

Americans are united in the belief that the economy is in bad shape (92% give it a negative rating), and for many the repercussions are hitting close to home.  Fully 70% of Americans say they have faced one or more job or financial-related problems in the past year, up from 59% in February 2009.  Jobs have become difficult to find in local communities for 85% of Americans.  A majority now says that someone in their household has been without a job or looking for work (54%); just 39% said this in February 2009. Only a quarter reports receiving a pay raise or a better job in the past year (24%), while almost an equal number say they have been laid off or lost a job (21%).

As economic conditions continue to deteriorate for middle-class Americans, the first few months of 2009 are already looking like “the good old days”.   The “comeback” isn’t looking too good.



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The Goldman Fallout

April 19th, 2010 Posted in Uncategorized
Apr, 19 2010
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April 19, 2010

In the aftermath of the disclosure concerning the Securities and Exchange Commission’s fraud suit against Goldman Sachs, we have heard more than a little reverberation of Matt Taibbi’s “vampire squid” metaphor, along with plenty of concern about which other firms might find themselves in the SEC’s  crosshairs.

As Jonathan Weil explained for Bloomberg News :

As Wall Street bombshells go, the lawsuit that the Securities and Exchange Commission filed against Goldman Sachs Group Inc. is about as big as it gets.

At The Economist, there was a detectable scent of schadenfreude in the discussion, which reminded readers that despite Lloyd Blankfein’s boast of having repaid Goldman’s share of the TARP bailout, not everyone has overlooked Maiden Lane III:

IS THE most powerful and controversial firm on Wall Street about to get the comeuppance that so many think it deserves?

*   *   *

The charges could hardly come at a worse time for Goldman.  The firm has been under fire on a number of fronts, including over the handsome payout it secured from the New York Fed as a derivatives counterparty of American International Group, an insurer that almost failed in 2008.  In a string of negative articles over the past year, Goldman has been accused of everything from double-dealing for its own advantage to planting its own people in the Treasury and other agencies to ensure that its interests were looked after.

At this point, those who criticized Matt Taibbi for his tour de force against Goldman (such as Megan McArdle) must be experiencing a bit of remorse.  Meanwhile, those of us who wrote items appearing at GoldmanSachs666.com are exercising our bragging rights.

The complaint filed against Goldman by the SEC finally put to rest the tired old lie that nobody saw the financial crisis coming.  The e-mails from Goldman VP, Fabrice Tourre, made it perfectly clear that in addition to being aware of the imminent collapse, some Wall Street insiders were actually counting on it.  Jonathan Weil’s Bloomberg article provided us with the translated missives from Mr. Tourre:

“More and more leverage in the system.  The whole building is about to collapse anytime now,” Fabrice Tourre, the Goldman Sachs vice president who was sued for his role in putting together the deal, wrote on Jan. 23, 2007.

“Only potential survivor, the fabulous Fab …  standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

A few weeks later, Tourre, now 31, e-mailed a top Goldman trader:  “the cdo biz is dead we don’t have a lot of time left.”  Goldman closed the Abacus offering in April 2007.

Michael Shedlock (a/k/a Mish) has quoted a number of sources reporting that Goldman may soon find itself defending similar suits in Germany and the UK.

Not surprisingly, there is mounting concern over the possibility that other investment firms could find themselves defending similar actions by the SEC.  As Anusha Shrivastava reported for The Wall Street Journal, the action in the credit markets on Friday revealed widespread apprehension that other firms could face similar exposure:

Credit markets were shaken Friday by the news as investors tried to figure out whether other firms or other structured finance products will be affected.

Investors are concerned that the SEC’s action may create a domino effect affecting other firms and other structured finance products.  There’s also the worry that this regulatory move may rattle the recovery and bring uncertainty back to the market.

“Credit markets are seeing a sizeable impact from the Goldman news,” said Bill Larkin, a portfolio manager at Cabot Money Management, in Salem, Mass.  “The question is, has the S.E.C. discovered what may have been a common practice across the industry?  Is this the tip of the iceberg?”

*  *  *

The SEC’s move marks “an escalation in the battle to expose conflicts of interest on Wall Street,” said Chris Whalen of Institutional Risk Analytics in a note to clients.  “Once upon a time, Wall Street firms protected clients and observed suitability …  This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another.”

The timing of this suit could not have been better – with the Senate about to consider what (if anything) it will do with financial reform legislation.  Bill Black expects that this scandal will provide the necessary boost to get financial reform enacted into law.  I hope he’s right.



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Financial Crisis Inquiry Disappointment

April 15th, 2010 Posted in Uncategorized
Apr, 15 2010
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April 15, 2010

The Financial Crisis Inquiry Commission (FCIC) has been widely criticized for its lame efforts at investigating the causes of the financial crisis.  As I pointed out on January 11, a number of commentators had been expressing doubt concerning what the FCIC could accomplish before the commission held its first hearing.  At this point — just three months later — we are already hearing the question of whether it might be “time to pull the plug on the FCIC”.   Writing for the Center for Media and Democracy’s PRWatch.org website, Mary Bottari posed that question as the title to her critical piece, documenting the commission’s “lackluster performance”:

The FCIC is a 10-person panel assembled to report on the meltdown to President Obama later this year.  The New York Times reported last week what was becoming increasingly obvious: the commission was in shambles.  The commission waited eight months before having its first hearing.  A top investigator resigned due to delays in hiring staff, no subpoenas have been issued and partisan infighting means few new documents have been released that would aid reporters in piecing together the crime scene, even if  FCIC investigators are not up to the task.  Worse, it seems like the majority of staff  have been borrowed from the complicit Federal Reserve.

These problems were on full display in last week’s hearings.  The three days of hearings were marked by some heat, but little light.

The FCIC’s failure to issue any subpoenas became a major point of criticism by Eliot Spitzer, who had this to say in a recent posting for Slate :

The Financial Crisis Inquiry Commission has so far been a waste.  Some momentary theater has been provided by the witnesses who have tried to excuse, explain, or occasionally admit their role in the cataclysm of the past two years.  While this has ginned up some additional public outrage, it hasn’t deepened our knowledge about what critical players knew or did.  There is a simple reason for this:  The commission has not issued a single subpoena.  Any investigator will tell you that you must get the documentary evidence before you examine the witnesses.  The evidence is waiting to be seized from the Fed, AIG, Goldman Sachs, and on down the line.  Yet not one subpoena.

Rather than accept Robert Rubin’s simple disclaimers about Citigroup, why hasn’t the FCIC combed through the actual communications among the board, the executive committee, the audit committee, and the risk-management committee?  Why hasn’t the FCIC collected AIG’s e-mails with the Fed and Goldman Sachs?  Unless the subpoenas are issued, we will lose the chance to make the record.

As Binyamin Appelbaum pointed out in The Washington Post back on January 8, if a financial reform bill is eventually passed, it will likely be signed into law before the mid-term elections in November – one month before the FCIC is required to publish its findings.  As a result, there is a serious question as to whether the commission’s efforts will contribute anything to financial reform legislation.  Given the FCIC’s unwillingness to exercise its subpoena power, we are faced with the question of why the commission should even bother wasting its time and the taxpayers’ money on an irrelevant, ineffective exercise.

Although Mary Bottari’s essay discussed the possibility that the FCIC might still “get its act together”, the cynicism expressed by Eliot Spitzer provided a much more realistic assessment of the situation:

Americans have been betrayed by Washington over financial reform.  Our leaders have failed to get the evidence, failed to push back when clearly inadequate explanations were provided, and failed to explore the structural reforms that will work.  Pretend tears will drip from bankers’ eyes after the consumer protection agency is created.  Then their wolfish teeth will slowly break into a grin, the pure delight that Washington has failed to do anything meaningful to restructure the banking sector.

Just when it was beginning to appear as though we might actually see some meaningful financial reform find its way into law, we have been reminded that Washington has its own ways – which benefit the American public only by rare coincidence.




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Financial Reform Might Actually Happen

April 12th, 2010 Posted in Uncategorized
Apr, 12 2010
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April 12, 2010

The long-overdue need for financial reform is finally getting some serious attention in Washington.  As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.

On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”.  At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:

What happens if we do nothing?

What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen?  It will be a body blow to many banks, especially in Europe.  Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk.  In the next crisis, we will not have the tools available to stem the tide that we did the last time.  Rates are already low.  Do you think we could pass another TARP?  The Fed’s balance sheet is already bloated.  It could get much worse unless we get financial reforms that have some bite.

All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time.  Fix the big things. Credit default swaps. Too big to fail.  Leverage. Then worry about the details.

Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized.  Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:

Let me be clear.  There are a lot of things not to like about the Federal Reserve System.  I think it was Milton Friedman who said we would be better off with a computer determining monetary policy.  A quote from an interview with him is instructive.  When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:

“Yes.  Of course it depends very much on how the computer is programmed.  I am not saying that any computer program would do.  In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year.  There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions.  One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge.  We have seen that in the history of our own Federal Reserve System.

Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s.  He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”.  Nevertheless, the solution he embraced was simple:

The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach:  Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds.  Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.

“Bankers would hate it.  It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square.  If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.

His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.

Bankers would scream about the need to protect their proprietary-trading information.  And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2.  To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.

Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one.  The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk.  They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system.  In fact, COR is the core of the whole scheme.

The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary.  Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:

Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)?  Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?

Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.

Regardless of what the final product will include – one thing is becoming increasingly likely:  Some semblance of financial reform legislation will eventually become enacted.  It won’t be perfect but anything will be better than what we have now.  (Well, almost anything  .  .  .)



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Building A Consensus For Survival

March 29th, 2010 Posted in Uncategorized
Mar, 29 2010
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March 29, 2010

In my last posting, I focused on the fantastic discourse in favor of financial reform presented by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, in a speech before the U.S. Chamber of Commerce.  In addition to Hoenig’s speech, last week brought us a number of excellent arguments for the cause that is so bitterly opposed by Wall Street lobbyists.  On the same day that Thomas Hoenig delivered his great speech to the U.S. Chamber of Commerce, Deputy Treasury Secretary Neal Wolin also addressed that institution to argue in favor of financial reform.  I enjoyed the fact that he rubbed this in their faces:

That is why it is so puzzling that, despite the urgent and undeniable need for reform, the Chamber of Commerce has launched a $3 million advertising campaign against it.  That campaign is not designed to improve the House and Senate bills.  It is designed to defeat them.  It is designed to delay reform until the memory of the crisis fades and the political will for change dies out.

The Chamber’s campaign comes on top of the $1.4 million per day already being spent on lobbying and campaign contributions by big banks and Wall Street financial firms.  There are four financial lobbyists for every member of Congress.

Wolin’s presentation was yet another signal from the Treasury Department that inspired economist Simon Johnson to begin feeling optimistic about the possibility that some meaningful degree of financial reform might actually take place:

Against all the odds, a glimmer of hope for real financial reform begins to shine through.  It’s not that anything definite has happened — in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on — at least on the issue of consumer protection.  Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble             financial innovation and sophisticated risk management.”

Yep.  That was our old pal and former New York Fed President, “Turbo” Tim Geithner, making the case for financial reform before the American Enterprise Institute.  (You remember them — the outfit that fired David Frum for speaking out against Fox News and the rest of the “conservative entertainment industry”.)  Treasury Secretary Geithner made his pitch for reform by reminding his conservative audience that longstanding advocates of the “efficient market hypothesis” had come on board in favor of financial reform:

Now, the recognition that markets failed and that the necessary solution involves reform; that it requires rules enforced by government is not a partisan or political judgment.  It is a conclusion reached by liberals and by conservative skeptics of regulation.

Judge Richard Posner, a leader in the conservative Chicago School of economics, wrote last year, that “we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

And consider Alan Greenspan, a skeptic of the benefits of regulation, who recently said, “inhibiting irrational behavior when it can be identified, through regulation,   . . .   could be stabilizing.”

No wonder Simon Johnson is feeling so upbeat!  The administration is actually making a serious attempt at doing what needs to be done to get this accomplished.

Meanwhile, The New York Times had run a superb article by David Leonhardt just as Geithner was about to address the AEI.  Leonhardt’s essay, “Heading Off the Next Financial Crisis” is a thorough analysis, providing historical background and covering every angle on what needs to be done to clean up the mess that got us where we are today — and to prevent it from happening again.  Here are some snippets from the first page that had me hooked right away:

It was a maddening story line:  the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times.  Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.

*   *   *

In a way, this issue is more about human nature than about politics.  By definition, the next period of financial excess will appear to have recent history on its side.

*   *   *

One way to deal with regulator fallibility is to implement clear, sweeping rules that limit people’s ability to persuade themselves that the next bubble is different — upfront capital requirements, for example, that banks cannot alter.  Thus far, the White House, the Fed and Congress have mostly steered clear of such rules.

Congratulations to David Leonhardt for putting that great piece together.  As more commentators continue to advance such astute, sensible appeals to plug the leaks in our sinking financial system, there is a greater likelihood that our lawmakers will realize that the economic risk of doing nothing far exceeds the amounts of money in those envelopes from the lobbyists.



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Dumping On Alan Greenspan

March 22nd, 2010 Posted in Uncategorized
Mar, 22 2010
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March 22, 2010

On Friday, March 19, former Federal Reserve chair, Alan Greenspan appeared before the Brookings Institution to present his 48-page paper entitled, “The Crisis”.  The obvious subject of the paper concerned the causes of the 2008 financial crisis.  With this document, Greenspan attempted to add his own spin to history, for the sake of restoring his tattered public image.  The man once known as “The Maestro” had fallen into the orchestra pit and was struggling to preserve his prestige.  After the release of his paper on Friday, there has been no shortage of criticism, despite Greenspan’s “enlightened” change of attitude concerning bank regulation.  Greenspan’s refusal to admit the Federal Reserve’s monetary policy had anything to do with causing the crisis has placed him directly in the crosshairs of more than a few critics.

Sewell Chan of The New York Times provided this summary of Greenspan’s paper:

Mr. Greenspan, who has long argued that the market is often a more effective regulator than the government, has now adopted a more expansive view of the proper role of the state.

He argues that regulators should enforce collateral and capital requirements, limit or ban certain kinds of concentrated bank lending, and even compel financial companies to develop “living wills” that specify how they are to be liquidated in an orderly way.

*   *   *

. . . Mr. Greenspan warned that “megabanks” formed through mergers created the potential for “unusually large systemic risks” should they fail.

Mr. Greenspan added:  “Regrettably, we did little to address the problem.”

That is as close as Greenspan came to admitting that the Federal Reserve had a role in helping to cause the financial crisis.  Nevertheless, these magic words from page 39 of “The Crisis” are what got everybody jumping:

To my knowledge, that lowering of the federal funds rate nearly a decade ago was not considered a key factor in the housing bubble.

The best retort to this denial of reality came from Barry Ritholtz, author of Bailout Nation.  His essay entitled, “Explaining the Impact of Ultra-Low Rates to Greenspan” is a must read.  Here’s how Ritholtz concluded the piece:

The lack of regulatory enforcement was a huge factor in allowing the credit bubble to inflate, and set the stage for the entire credit crisis.  But it was intricately interwoven with the ultra low rates Alan Greenspan set as Fed Chair.

So while he is correct in pointing out that his own failures as a bank regulator are in part to blame, he needs to also recognize that his failures in setting monetary policy was also a major factor.

In other words, his incompetence as a regulator made his incompetence as a central banker even worse.

Paul La Monica wrote an interesting post for CNN Money’s The Buzz blog entitled, “Greenspan and Bernanke still don’t get it”.  He was similarly unimpressed with Greenspan’s denial that Fed monetary policy helped cause the crisis:

This argument is getting tiresome.  Keeping rates so low helped inflate the bubble.

*   *   *

“The Fed wasn’t the sole culprit.  But if not for an artificially steep yield curve, we probably would not have had a global financial crisis,” said John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala.

“Greenspan and Bernanke are missing the point.  It all stems from monetary policy,” Norris added.  “If you give bankers an inducement to lend more than they ordinarily would they are going to do so.”

From across the pond, Stephen Foley wrote a great article for The Independent entitled, “For the wrong answers, turn to Greenspan”.  He began the piece this way:

The former US Federal Reserve chairman, the wizened wiseman of laissez-faire economics, shocked us all — and probably himself — when he told a congressional panel in 2008 that he had found “a flaw in the model I perceived is the critical functioning structure that defines how the world works, so to speak”.  He meant that he had realised banks cannot be trusted to manage their own risks, and that markets do not smoothly self-correct.

But instead of taking that revelation and helping to point the way to a new, post-crisis financial world, he has shuddered to an intellectual halt.  It is the same intellectual stop sign that Wall Street’s bankers are at.  The failure to move forward is regrettable, dangerous and more than a little self-serving.

These reactions to Greenspan’s paper are surely just the beginning of an overwhelming backlash.  The Economist has already weighed in and before too long, we might even see a movie documenting the Fed’s responsibility for helping to cause The Great Recession.



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Everyone Knew About Lehman Brothers

March 19th, 2010 Posted in Uncategorized
Mar, 19 2010
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March 19, 2010

A March 18 report by Henny Sender at the Financial Times revealed that former officials from Merrill Lynch had contacted the Securities and Exchange Commission as well as the Federal Reserve of New York to complain that Lehman Brothers had been incorrectly calculating a key measure of its financial health.  The regulators received this warning several months before Lehman filed for bankruptcy in September of 2008.  Apparently Lehman’s reports of robust financial health were making Merrill look bad:

Former Merrill Lynch officials said they contacted regulators about the way Lehman measured its liquidity position for competitive reasons.  The Merrill officials said they were coming under pressure from their trading partners and investors, who feared that Merrill was less liquid than Lehman.

*   *   *

In the account given by the Merrill officials, the SEC, the lead regulator, and the New York Federal Reserve were given warnings about Lehman’s balance sheet calculations as far back as March 2008.

*   *   *

The former Merrill officials said they contacted the regulators after Lehman released an estimate of its liquidity position in the first quarter of 2008.  Lehman touted its results to its counterparties and its investors as proof that it was sounder than some of its rivals, including Merrill, these people said.

*   *   *

“We started getting calls from our counterparties and investors in our debt.  Since we didn’t believe the Lehman numbers and thought their calculations were aggressive, we called the regulators,” says one former Merrill banker, now at another big bank.

Could the people at Merrill Lynch have expected the New York Fed to intervene and prevent the accounting chicanery at Lehman?  After all, Lehman’s CEO, Richard Fuld, was also a class B director of the New York Fed.  Would any FRBNY investigator really want to make trouble for one of the directors of his or her employer?  This type of conflict of interest is endemic to the self-regulatory milieu presided over by the Federal Reserve.  When people talk about protecting “Fed independence”, I guess this is what they mean.

The Financial Times report inspired Yves Smith of Naked Capitalism to emphasize that the New York Fed’s failure to do its job, having been given this additional information from Merrill officials, underscores the ineptitude of the New York Fed’s president at the time — Tim Geithner:

The fact that Merrill, with a little digging, could see that Lehman’s assertions about its financial health were bogus says other firms were likely to figure it out sooner rather than later.  That in turn meant that the Lehman was extremely vulnerable to a run.  Bear was brought down in a mere ten days.  Having just been through the Bear implosion, the warning should have put the authorities in emergency preparedness overdrive.  Instead, they went into “Mission Accomplished” mode.

This Financial Times story provides yet more confirmation that Geithner is not fit to serve as a regulator and should resign as Treasury Secretary.  But it may take Congress forcing a release of the Lehman-related e-mails and other correspondence by the New York Fed to bring about that outcome.

Those “Lehman-related e-mails” should be really interesting.  If Richard Fuld was a party to any of those, it will be interesting to note whether his e-mail address was “@LehmanBros”, “@FRBNY” or both.

The Lehman scandal has come to light at precisely the time when Ben Bernanke is struggling to maintain as much power for the Federal Reserve as he can — in addition to getting control over the proposed Consumer Financial Protection Agency.  One would think that Bernanke is pursuing a lost cause, given the circumstances and the timing.  Nevertheless, as Jesse of Jesse’s Cafe Americain points out — Bernanke may win this fight:

The Fed is the last place that should receive additional power over the banking system, showing itself to be a bureaucracy incapable of exercising the kind of occasionally stern judgment, the tough love, that wayward bankers require.  And the mere thought of putting Consumer Protection under their purview makes one’s skin crawl with fear and the gall of injustice.

They may get it, this more power, not because it is deserved, but because politicians themselves wish to have more power and money, and this is one way to obtain it.

The next time the financial system crashes, the torches and pitchforks will come out of the barns and there will be a serious reform, and some tar and feathering in congressional committees, and a few virtual lynchings.  The damage to the people of the middle class will be an American tragedy.  But this too shall pass.

It’s beginning to appear as though it really will require another financial crisis before our graft-hungry politicians will make any serious effort at financial reform.  If economist Randall Wray is correct, that day may be coming sooner than most people expect:

Another financial crisis is nearly certain to hit in coming months — probably before summer.  The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking.

Although that may sound a bit scary, we have to look at the bright side:  at least we will finally be on a path toward serious financial reform.



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