Wall Street meltdown « TheCenterLane.com

Compare And Contrast

November 26th, 2009 Posted in Uncategorized

Nov, 26 2009

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November 26, 2009

We have seen and heard so much discussion during the past week concerning the dismal performance of Treasury Secretary “Turbo” Tim Geithner while testifying before the Joint Economic Committee — I won’t repeat it. At this point, there appears to be a consensus that Turbo Tim has to go. The scary part comes when pundits start tossing around names for a possible replacement. One would expect that President Obama might be wise enough to avoid the appointment of another “Wall Street insider” as Treasury Secretary. Rumors are circulating that The Dimon Dog (Jamie Dimon, CEO of JP Morgan Chase) is being considered for the post. This buzz gained more traction when bank analyst, Dick Bove, recently voiced support for Dimon as Treasury Secretary. The handful of Geithner supporters deny that Turbo Tim ever was a “Wall Street insider”. This assertion is contradicted by the fact that Geithner was the President of the New York Federal Reserve at the time of the financial crisis, when he served as architect of the more-than-generous bailouts of those “too big to fail” financial institutions — at taxpayer expense.

These days, the most vilified beneficiary of government largesse resulting from the financial crisis is the widely-despised investment bank, Goldman Sachs — often referred to as the “giant vampire squid” — thanks to Matt Taibbi’s metaphor, describing Goldman as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

For whatever reason, a number of commentators have chosen to help defend Goldman Sachs against what they consider to be unfair criticism. A recent example came to us from James Stewart of The New Yorker. Stewart had previously written a 25-page essay for that magazine, entitled “Eight Days” — a dramatic chronology of the financial crisis as it unfolded during September of 2008. Last week, Stewart seized upon the release of the recent SIGTARP report to defend Goldman with a blog posting which characterized the report as supportive of the argument that Goldman owes the taxpayers nothing as a result of the government bailouts resulting from that near-meltdown. (In case you don’t know, a former Assistant U.S. District Attorney from New York named Neil Barofsky was nominated by President Bush as the Special Investigator General of the TARP program. The acronym for that job title is SIGTARP.) In his blog posting, James Stewart began by characterizing Goldman’s detractors as “conspiracy theorists”. That was a pretty weak start. Stewart went on to imply that the SIGTARP report refutes the claims by critics that, despite Goldman’s repayment of the TARP bailout, it did not repay the government the billions it received as a counterparty to AIG’s collateralized debt obligations. Stewart referred to language in the SIGTARP report to support the spin that because “Goldman was fully hedged on its exposure both to a failure by A.I.G. and to the deterioration of value in its collateralized debt obligations” and that “(i)t repaid its TARP loans with interest, bought back the government’s warrants at a nice profit to the Treasury” Goldman therefore owes the government nothing — other than “a special debt of gratitude”. One important passage from page 22 of the SIGTARP report that Stewart conveniently ignored, concerned the money received by Goldman Sachs as an AIG counterparty by way of Maiden Lane III, at which point those credit default obligations (of questionable value) were purchased at an excessive price by the government. Here’s that passage from the SIGTARP report:

When FRBNY authorized the creation of Maiden Lane III in November 2008, it lent approximately $24.6 billion to the newly formed limited liability company, and AIG provided Maiden Lane III approximately $5 billion in equity. These funds were used to purchase CDOs from AIG counterparties worth an estimated fair value of $29.6 billion at the time of the purchases, which were done in three stages on November 25, 2008, December 18, 2008, and December 22, 2008. AIGFP’s counterparties were paid $27.1 billion, and AIGFP was paid $2.5 billion per an agreement between AIGFP and FRBNY. The $2.5 billion represented the amount of collateral that AIGFP had previously paid to the counterparties that was in excess of the actual decline in the fair value as of October 31, 2008.

FRBNY’s loan to Maiden Lane III is secured by the CDOs as the underlying assets. After the loan has been repaid in full plus interest, and, to the extent that there are sufficient remaining cash proceeds, AIG will be entitled to repayment of the $5 billion that the company contributed in equity, plus accrued interest. After repayment in full of the loan and the equity contribution (each including accrued interest), any remaining proceeds will be split 67 percent to FRBNY and 33 percent to AIG.

On November 21, one of my favorite reporters for The New York Times, Pulitzer Prize winner Gretchen Morgenson, wrote an informative piece concerning the recent SIGTARP Report. Compare and contrast Ms. Morgenson’s discussion of the report’s disclosures, with the spin provided by James Stewart. Here is some of what Ms. Morgenson had to say:

The Fed, under Mr. Geithner’s direction, caved in to A.I.G.’s counterparties, giving them 100 cents on the dollar for positions that would have been worth far less if A.I.G. had defaulted. Goldman Sachs, Merrill Lynch, Societe Generale and other banks were in the group that got full value for their contracts when many others were accepting fire-sale prices.

On the question of whether this payout was what the report describes as a “backdoor bailout” of A.I.G.’s counterparties, Mr. Barofsky concluded: “The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” The report noted that this was money the banks might not otherwise have received had A.I.G. gone belly-up.

*   *   *

Finally, Mr. Barofsky pokes holes in arguments made repeatedly over the past 14 months by Goldman Sachs, A.I.G.’s largest trading partner and recipient of $12.9 billion in taxpayer money in the bailout, that it had faced no material risk in an A.I.G. default — that, in effect, had A.I.G. cratered, Goldman wouldn’t have suffered damage.

*   *   *

Rather than forcing the banks to accept a steep discount, or “haircut,” the Fed gave the banks $27 billion in taxpayer cash and allowed them to keep an additional $35 billion in collateral already posted by A.I.G. That amounted to about $62 billion for the contracts, which the report describes as “far above their market value at the time.”

* *   *

As Goldman prepares to pay out nearly $17 billion in bonuses to its employees in one of its most profitable years ever, it is important that an authoritative, independent voice like Mr. Barofsky’s reminds us how the taxpayer bailout of A.I.G. benefited Goldman.

* *   *

The inspector noted in his report that Goldman made several arguments for why it believed it was not materially at risk in an A.I.G. default, but he is skeptical of the firm’s reasoning.

So is Janet Tavakoli, an expert in derivatives at Tavakoli Structured Finance, a consulting firm.

*   *   *

Ms. Tavakoli argues that Goldman should refund the money it received in the bailout and take back the toxic C.D.O.’s now residing on the Fed’s books — and to do so before it begins showering bonuses on its taxpayer-protected employees.

“A.I.G., a sophisticated investor, foolishly took this risk,” she said. “But the U.S. taxpayer never agreed to be the victim of investments that should undergo a rigorous audit.”

After reading James Stewart’s November 19 blog posting and Gretchen Morgenson’s November 21 article from The New York Times, ask yourself this: Are Gretchen Morgenson and Janet Tavakoli “conspiracy theorists” . . . or is James Stewart just a tool?

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Maria Cantwell In The Spotlight

November 9th, 2009 Posted in Uncategorized

Nov, 09 2009

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November 9, 2009

Meghan McCain’s recent lament in The Daily Beast struck me as rather strange. She really should know better. Ms. McCain expressed her frustration over mainstream media treatment of “two of the most prominent women in politics — Hillary Clinton and Sarah Palin”. Ms. McCain felt the coverage received by those two politicians has been so misogynistic that she has nearly given up on the possibility that she may ever see a woman get elected to the Presidency:

It seems to me the male-dominated media suffers from a Goldilocks Syndrome that keeps women from shattering the glass ceiling. Worse, I fear it will prevent tomorrow’s female leaders from even seeking office.

Of course, if one can see no further than Hillary Clinton or Sarah Palin when seeking female Presidential candidates, then despair is inevitable. In the summer of 2008, after Ms.Clinton faced up to the reality that Barack Obama had won the Democratic nomination, we heard similar doubts expressed by many despondent female supporters of Hillary Clinton — that they would never see a female elected President within their own lifetimes. At that point, I wrote apiece entitled “Women To Watch”, reminding readers that “there are a number of women presently in the Senate, who got there without having been married to a former President (whose surname could be relied upon for recognition purposes).” One of those women, whom I discussed at that time, was Senator Maria Cantwell of Washington. Maria Cantwell has been in the news quite a bit recently and the coverage has been favorable. As I said in June of 2008, those holding out hope for a female Presidential candidate should keep an eye on her.

In our highly-partisan political climate, one rarely hears a national politician break from “party line” rhetoric and talking points while being interviewed by the news media or when writing commentary pieces for news publications and blogs. Nevertheless, Senator Cantwell has taken the bold step of criticizing, not only the administration’s handling of the economic crisis, but the K Street payoff culture enlisting her fellow Democrats as enablers of the status quo.

On October 30, Senator Cantwell wrote a piece for The Huffington Post, decrying the fact that those financial institutions benefiting from the massive bailouts from TARP and the Federal Reserve “have resumed their old habit of using other people’s money to gamble with the same risky unregulated derivatives that led us into this crisis.” The reason for the failure at every level of the federal government to even consider appropriate legislation or regulations to rein-in continuing irresponsible behavior by those institutions was candidly discussed by the Senator:

Look no further than the powerful lobbying arm of the financial services sector, which has spent at least $220 million this year lobbying Congress to stave off new rules to prevent another collapse. That is over $500,000 in lobbying for every member of Congress, which might help explain why, to date, nothing has been fixed in our porous financial regulatory system. Americans want to know when Congress will put an end to the Wall Street’s secret off-book gambling schemes and restore our capitalist system by requiring real transparency and true competition.

Senator Cantwell’s essay is essential reading, coming on the heels of a rebuke, by her fellow Democrats, against efforts at requiring transparency in the trading of credit default swaps:

Imposing full transparency and true competition will require moving derivative trades onto regulated exchanges. That would mean full transparency of trading prices and volumes, reporting requirements for large trader positions, and adequate capital reserves to protect against a default. The government needs full anti-fraud and anti-manipulation authority. Giving regulators this power will ensure a transparent and competitive marketplace and will ensure that violators will go to jail.

On November 2, Senator Cantwell appeared on MSNBC’s Morning Meeting with Dylan Ratigan. At that time, Mr. Ratigan had just written a piece for The Business Insider, expressing his outrage about recent statements by Treasury Secretary “Turbo” Tim Geithner, supporting House bank reform legislation allowing credit default swaps to continue being traded in secret. Since Senator Cantwell had previously discussed that subject with him on October 16, Mr. Ratigan focused on Geithner. Ratigan noted Geithner’s endorsement of the proposed House “banking reform” legislation on the previous day’s broadcast of Meet The Press — despite the bill’s “massive exemptions” allowing opacity in the trading of credit default swaps. Ratigan then asked Senator Cantwell why Tim Geithner still has a job, to which she replied:

I’m not sure because David Gregory had him almost — trying to get a straight answer out of him. What the Treasury Secretary basically said was: yes, banks should take more risks and we should continue the loopholes — and that is really appalling because, right now, we know that lack of transparency has caused this problem with the U.S. economy and Wall Street is continuing, one year later, continuing the same kind of loopholes. And so if the Treasury Secretary doesn’t come down hard against these loopholes and advocate foreclosing them, then we’re going to have a tough time closing them in Congress. So the Treasury Secretary is dodging the issue.

Senator Cantwell sure isn’t dodging any issues. Beyond that, she is demonstrating that she has more cajones than any of her male counterparts in the Senate. So far, all of the publicity concerning her position on financial reform has been favorable. After all, she is boldly standing up to the lobbyists, the Congress they own and a White House that received nearly a million dollars in campaign contributions from Goldman Sachs.

Back in Senator Cantwell’s home state of Washington, The Seattle Times praised her co-sponsorship of Senate Bill 823, the Net Operating Loss Carryback Act, which has already been passed by both houses of Congress. This bill increases the corporate income tax refunds for businesses that were making money during the pre-2008 era but now operate at a loss. As the Seattle Times editorial explained:

The national unemployment rate is still rising. It has just gone double-digit for the first time in 26 years, and is at 10.2 percent.

This is not recovery.

The new law does not have taxpayers underwrite credit default swaps or any of the other alchemic creations of Wall Street investment banks. It is not more aid and comfort for the nationalized and quasi-nationalized corporate giants; it specifically exempts Fannie Mae, Freddie Mac and any company in which the Treasury has recently become an owner.

This law is for the businesses that suffer in the recession, not the ones that caused it. It is one of the few things Congress has done that reaches directly to Main Street America. It is a big deal to many local businesses, including businesses here.

Congratulations, Senator Cantwell!

To Meghan McCain and other women remaining in doubt as to whether they will ever see a female sworn in as President: Just keep watching Maria Cantwell as she continues to earn well-deserved respect.

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Offering Solutions

October 22nd, 2009 Posted in Uncategorized

Oct, 22 2009

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October 22, 2009

Many of us are familiar with the old maxim asserting that “if you’re not part of the solution, you’re part of the problem.” During the past year we’ve been exposed to plenty of hand-wringing by info-tainers from various mainstream media outlets decrying the financial crisis and our current economic predicament. Very few of these people ever seem to offer any significant insight on such interesting topics as: what really caused the meltdown, how to prevent it from happening again, whether any laws were broken that caused this catastrophe, whether any prosecutions might be warranted or how to solve our nation’s continuing economic ills, which seem to be immune to all the attempted cures. The painful thorn in the side of Goldman Sachs, Matt Taibbi, recently raised an important question, reminding people to again scrutinize the vapid media coverage of this pressing crisis:

It’s literally amazing to me that our press corps hasn’t yet managed to draw a distinction between good news on Wall Street for companies like Goldman, and good news in reality.

* * *

In fact the dichotomy between the economic health of ordinary people and the traditional “market indicators” is not merely a non-story, it is a sort of taboo — unmentionable in major news coverage.

That quote inspired Yves Smith of Naked Capitalism to write a superb essay about how “access journalism” has created a controlled press. What follows is just a small nugget of the great analysis in that piece:

So what do we have? A media that predominantly bases its stories on what it is fed because it has to. Ever-leaner staffing, compressed news cycles, and access journalism all conspire to drive reporters to focus on the “must cover” news, which is to a large degree influenced by the parties that initiate the story. And that means they are increasingly in an echo chamber, spending so much time with the influential sources they feel they must cover that they start to be swayed by them.

* * *

The message, quite overly, is: if you are pissed, you are in a minority. The country has moved on. Things are getting better, get with the program. Now I saw the polar opposite today. There is a group of varying sizes, depending on the topic, that e-mails among itself, mainly professional investors, analysts, economists (I’m usually on the periphery but sometimes chime in). I never saw such an angry, active, and large thread about the Goldman BS fest today. Now if people who have not suffered much, and are presumably benefitting from the market recovery are furious, it isn’t hard to imagine that what looks like complacency in the heartlands may simply be contained rage looking for an outlet.

Fortunately, one television news reporter has broken the silence concerning the impact on America’s middle class, caused by Wall Street’s massive Ponzi scam and our government’s response – which he calls “corporate communism”. I’m talking about MSNBC’s Dylan Ratigan. On Wednesday’s edition of his program, Morning Meeting, he decried the fact that the taxpayers have been forced to subsidize the “parlor game” played by Goldman Sachs and other firms involved in proprietary trading on our coin. Mr. Ratigan then proceeded to offer a number of solutions available to ordinary people, who would like to fight back against those pampered institutions considered “too big to fail”. Some of these measures involve: moving accounts from one of those enshrined banks to a local bank or credit union; paying with cash whenever possible and contacting your lawmakers to insist upon financial reform.

My favorite lawmaker in the battle for financial reform is Congressman Alan Grayson, whose district happens to include Disney World. His fantastic interrogation of Federal Reserve general counsel, Scott Alvarez, about whether the Fed tries to manipulate the stock markets, was a great event. Grayson has now co-sponsored a “Financial Autopsy” amendment to the proposed Consumer Financial Protection Agency bill. This amendment is intended to accomplish the following:

– Requires the CFPA conduct a “Financial Autopsy” of each state’s bankruptcies and foreclosures (a scientific sampling), and identify financial products that systematically led to a large number of bankruptcies and foreclosures.
– Requires the CFPA report to Congress annually on the top financial products (the companies and individuals that originated the products) that caused consumer bankruptcies and foreclosures.
– Requires the CFPA take corrective action to eliminate or restrict those deceptive products to prevent future bankruptcies and corrections

– The bottom line is to highlight destructive products based on if they are making people “broke”.

From his website, The Market Ticker, Karl Denninger offered his own contributions to this amendment:

This sort of “feel good” legislative amendment will of course be resisted, but it simply isn’t enough. The basic principle of equity (better said as “fairness under the law”) puts forward the premise that one cannot cheat and be allowed to keep the fruits of one’s outrageous behavior.

So while I like the direction of this amendment, I would put forward the premise that the entirety of the gains “earned” from such toxic products, when found, are clawed back and distributed to the consumers so harmed, and that to the extent this does not fully compensate for that harm such a finding should give rise to a private, civil cause of action for the consumers who are bankrupted or foreclosed.

It’s nice to know that bloggers are no longer the only voices insisting on financial reform. Ed Wallace of Business Week recently warned against the consequences of unchecked speculation on oil futures:

Is today’s stock market divorced from economic reality? Probably. It is a certainty that oil is. We know that because those in the market are still putting out the same tired and incorrect logic that they used successfully last year to push oil to $147 a barrel while demand was plummeting.

Because oil is not carrying a market price that fairly reflects economic conditions and demand inventories, overpriced energy is siphoning off funds that could be used for corporate expansion, increased consumerism and, in time, the recreation of jobs in America.

Did you think that the “Enron Loophole” was closed by the enactment of the 2008 Farm Bill? It wasn’t. The Farm Bill simply gave more authority to the Commodity Futures Trading Commission to regulate futures contracts that had been exempted by the loophole. In case you’re wondering about the person placed in charge of the Commodity Futures Trading Commission by President Obama — his name is Gary Gensler and he used to work for … You guessed it: Goldman Sachs.

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Bait And Switch

October 19th, 2009 Posted in Uncategorized

Oct, 19 2009

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October 19, 2009

On Friday, October 16, Aaron Task interviewed Elizabeth Warren for his online TV show, Tech Ticker. In case you don’t remember, Ms. Warren is the Harvard law professor, appointed to chair the Congressional Oversight Panel which has attempted to trace the money thrown into the infamous slush fund known as TARP — the Troubled Assets Relief Program. Mr. Task questioned Professor Warren as to whether, after all this time, we can expect a full accounting as to where the TARP money went. Professor Warren responded: “No. I think there is no chance that we will get a full accounting of it.” She explained the reason for this is because former Treasury Secretary Hank Paulson never asked for an explanation “on the front end” (when the TARP bailout program began) concerning what the recipients planned to do with this money, nor was any documentation of expenditures requested. As an aside, the folks at The New York Times were kind enough to put together this TARP scorecard, for keeping track of which institutions pay back the money they received. Of course, these amounts do not include all the loans, “backstopping” and other largesse provided to Wall Street by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Treasury. For that information, we can look to this Bailout Tally Report, prepared by Nomi Prins for her book: It Takes a Pillage: Behind the Bailouts, Bonuses,and Backroom Deals from Washington to Wall Street.

During the interview with Aaron Task, Elizabeth Warren expressed particular concern over the fact that former Treasury Secretary Paulson failed to put any restrictions on the use of the TARP bailout funds prior to their dispersal, despite the explanation to the taxpayers that this money would be used to remove the “toxic assets” from the banks’ balance sheets. Worse yet, as she explained: “The toxic assets are still there, by and large” because the TARP money was used by the Wall Street banks to “make bets”. The bait-and-switch tactic used by Secretary Paulson was exposed by Professor Warren when she criticized how the banks used that money:

My biggest complaint would be: That was not how Secretary Paulsen described what was going to happen with American taxpayer dollars. . . . He said we are going to put money into the banks to increase lending — specifically to increase small business lending because that is the engine of our economy . . . I have a real problem when we describe to taxpayers their money will be taken and used one way and in fact it’s used another way.

Professor Warren also noted that nothing had been done to contain “systemic risk” after the financial crisis because those institutions requiring bailouts as they were considered “too big to fail” have grown even larger. This subject was addressed by Rolfe Winkler of Reuters, who questioned whether these institutions, such as Goldman Sachs, are really indispensable:

Many of us didn’t like it — we thought banks like Goldman should have been recapitalized the right way, by wiping out shareholders and forcing subordinated creditors to eat their share of losses. But that ship has sailed. We socialized the risk while privatizing the profit because we were told we had no other choice: The government had to guarantee the biggest banks’ liabilities because they were too unstable to survive bankruptcy or FDIC receivership.

If that’s true, why haven’t we seen any substantial reforms to reduce systemic risk? Congress is kicking around new resolution authority to help resolve failed systemically-important banks. But the goal should be reducing systemic risk to begin with. Yet serious reform of the derivatives market — something that would reduce its size significantly — is nowhere on the radar.

Indeed, Goldman’s trading results suggest that market is coming back with a vengeance. It’s playing in very risky markets with a capital structure that remains vulnerable yet is guaranteed by taxpayers.

* * *

Wall Street and its protectors at the Fed and Treasury tell us the bailout was necessary to protect the financial system, to protect Main Street. That may be. But Main Street still owns much of the risk while Wall Street gets all of the profit.

Elizabeth Warren’s reaction to the issue of what has been done with those profits — the huge, record-breaking bonuses paid to the people at Goldman Sachs and JP Morgan, was to describe the situation as so inappropriate as to leave her “speechless”. Fortunately this sentiment is shared by a number of people who are already taking action in the absence of any responsible government activity. The Gawker website has announced its initiation of what it calls the “Goldman Project” as a way of pushing back against this atrocity:

But what makes it eye-stabbingly, brain-searingly blood-boiling is the fact that Goldman’s employees are personally reaping the benefits of these subsidies to the tune of an average of $700,000 per staffer. Being unjustifiably wealthy in boom times is not enough — when market forces of their own creation brought their company low, they turned to the taxpayers both to rescue the firm and prop up their obscenely acquisitive lifestyles.

* * *

. . . we’re launching the Goldman Project, an ongoing attempt to track and publicize the multi-million second homes, $50,000 cars, $500 bottles of wine, and ostentatious living that we are subsidizing. And we need your help: Are you Facebook friends with a Goldmanite who just posted photos of his lavish bachelor party? Post them to our fancy new tag page, #GoldmanProject, or e-mail them to us. Are you a realtor who just sold a $4 million duplex a Goldman banker? Is your ex-boyfriend Goldman banker planning a year-end trip to Cabo to blow his bonus wad? Shoot us an e-mail. Likewise, if you catch any references to Goldman employees living large in the media, post them to #GoldmanProject to keep a running clipfile.

The folks at Gawker aren’t the only ones taking action. When the American Bankers Association holds its annual meeting in Chicago on October 25-26, it will be confronted with a (hopefully) large protest led by a coalition of labor, community and consumer groups, called the “Showdown in Chicago”. Visit their website and do whatever you can to help make this event a success. The arrogant influence peddlers in Washington need to get the message: Clean things up or get thrown out.

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Simon Johnson In The Spotlight

October 12th, 2009 Posted in Uncategorized

Oct, 12 2009

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October 12, 2009

An ever-increasing number of people are paying close attention to a gentleman named Simon Johnson. Mr. Johnson, a former chief economist at the International Monetary Fund, now works at MIT as Professor of Entrepreneurship at the Sloan School of Management. His Baseline Scenario website is focused on the financial and economic crises. At the Washington Post website, he runs a blog with James Kwak called The Hearing. Last spring, Johnson turned more than a few heads with his article from the May 2009 issue of The Atlantic, “The Quiet Coup”, in which he explained that what happened in America during last year’s financial crisis and what is currently happening with our economic predicament is “shockingly reminiscent” of events experienced during financial crises in emerging market nations (i.e. banana republics and proto-capitalist regimes).

On October 9, Joe Nocera of The New York Times began his column by asking Professor Johnson what he thought the Wall Street banks owed America after receiving trillions of dollars in bailouts. Johnson’s response turned to Wednesday’s upcoming fight before the House Financial Services Committee concerning the financial reforms proposed by the Obama administration:

“They can’t pay what they owe!” he began angrily. Then he paused, collected his thoughts and started over: “Tim Geithner saved them on terms extremely favorable to the banks. They should support all of his proposed reforms.”

Mr. Johnson continued, “What gets me is that the banks have continued to oppose consumer protection. How can they be opposed to consumer protection as defined by a man who is the most favorable Treasury Secretary they have had in a generation? If he has decided that this is what they need, what moral right do they have to oppose it? It is unconscionable.”

This week’s battle over financial reform has been brewing for quite a while. Back on May 31, Gretchen Morgenson and Dan Van Natta wrote a piece for The New York Times entitled, “In Crisis, Banks Dig In for Fight Against Rules”:

Hotly contested legislative wars are traditional fare in Washington, of course, and bills are often shaped by the push and pull of lobbyists — representing a cornucopia of special interests — working with politicians and government agencies.

What makes this fight different, say Wall Street critics and legislative leaders, is that financiers are aggressively seeking to fend off regulation of the very products and practices that directly contributed to the worst economic crisis since the Great Depression. In contrast, after the savings-and-loan debacle of the 1980s, the clout of the financial lobby diminished significantly.

In case you might be looking for a handy scorecard to see which members of Congress are being “lobbied” by the financial industry and to what extent those palms are being greased, The Wall Street Journal was kind enough to provide us with an interactive chart. Just slide the cursor next to the name of any member of the House Financial Services Committee and you will be able to see how much generosity that member received just during the first quarter of 2009 from an entity to be affected by this legislation. The bars next to the committee members’ names are color-coded, with different colors used to identify specific sources, whose names are displayed as you pass over that section of the bar. This thing is a wonderful invention. I call it “The Graft Graph”.

On October 9, Simon Johnson appeared with Representative Marcy Kaptur (D – Ohio) on the PBS program, Bill Moyers Journal. At one point during the interview, Professor Johnson expressed grave doubts about our government’s ability to implement financial reform:

And yet, the opportunity for real reform has already passed. And there is not going to be — not only is there not going to be change, but I’ll go further. I’ll say it’s going to be worse, what comes out of this, in terms of the financial system, its power, and what it can get away with.

* * *

BILL MOYERS: Why have we not had the reform that we all knew was being — was needed and being demanded a year ago?

SIMON JOHNSON: I think the opportunity — the short term opportunity was missed. There was an opportunity that the Obama Administration had. President Obama campaigned on a message of change. I voted for him. I supported him. And I believed in this message. And I thought that the time for change, for the financial sector, was absolutely upon us. This was abundantly apparent by the inauguration in January of this year.

SIMON JOHNSON: And Rahm Emanuel, the President’s Chief of Staff has a saying. He’s widely known for saying, ‘Never let a good crisis go to waste’. Well, the crisis is over, Bill. The crisis in the financial sector, not for people who own homes, but the crisis for the big banks is substantially over. And it was completely wasted. The Administration refused to break the power of the big banks, when they had the opportunity, earlier this year. And the regulatory reforms they are now pursuing will turn out to be, in my opinion, and I do follow this day to day, you know. These reforms will turn out to be essentially meaningless.

Sound familiar? If you change the topic to healthcare reform, you end up with the same bottom line: “These reforms will turn out to be essentially meaningless.” The inevitable watering down of both legislative efforts can be blamed on weak, compromised leadership. It’s one thing to make grand promises on the campaign trail — yet quite another to look a lobbyist in the eye and say: “Thanks, but no thanks.” Toward the end of the televised interview, Bill Moyers had this exchange with Representative Kaptur:

BILL MOYERS: How do we get Congress back? How do we get Congress to do what it’s supposed to do? Oversight. Real reform. Challenge the powers that be.

MARCY KAPTUR: We have to take the money out. We have to get rid of the constant fundraising that happens inside the Congress. Before political parties used to raise money; now individual members are raising money through the DCCC and the RCCC. It is absolutely corrupt.

As we all know, our system of legalized graft goes beyond the halls of Congress. During his Presidential campaign, Barack Obama received nearly $995,000 in contributions from the people at Goldman Sachs. The gang at 85 Broad Street is obviously getting its money’s worth.

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Kill The Whales

October 8th, 2009 Posted in Uncategorized

Oct, 08 2009

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October 8, 2009

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Spread The Word

September 29th, 2009 Posted in Uncategorized

Sep, 29 2009

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September 29, 2009

I’ve seen quite a few articles and broadcasts from “mainstream” news sources during the past few weeks that have actually made me feel encouraged about the public’s response to the financial crisis and our current economic predicament. Six months ago, the dirty picture of what caused last year’s near-meltdown and what has continued to prevent the necessary reforms, was something one could find only by reading a relatively small number of blogs. Michael Panzner wrote a book entitled Financial Armageddon in 2006, predicting what many “experts” later described as unforeseeable. Mr. Panzner now has a blog called Financial Armageddon (as well as another: When Giants Fall). At his Financial Armageddon website, Mr. Panzner has helped ease the pain of the economic catastrophe with a little humor by educating his readers on some novel measurements of our recession level — such as the increased use of hair dye and “The Hot Waitress Index”. (He ran another great posting about the increasing number of disastrous experiences for people who tried to save money by cutting their own hair.) Meanwhile, Matt Taibbi has continued to serve as a gadfly against crony capitalism. Zero Hedge keeps us regularly apprised of the suspicious activities in the equities and futures markets, which are of no apparent concern to regulatory officials. Some bloggers, including Jr Deputy Accountant, have criticized the manic money-printing and other inappropriate activities at the Federal Reserve — which resists all efforts at oversight and transparency. One no longer experiences the stigma of “conspiracy theorist” by accepting the view that our financial and economic problems were caused primarily by regulatory failure.

On September 23, Dan Gerstein wrote a piece for Forbes, about the impressive, 25-page article concerning last year’s financial crisis, written by James Stewart for The New Yorker, entitled: “Eight Days”. At the outset, Mr. Gerstein noted how the New Yorker article provided the reader with some shocking insight on someone we all thought we knew pretty well:

But the biggest eye-opener was that the most incisive and damning questions raised by any of our leaders during this existential crisis came from none other than the era’s top free-market cheerleader in Washington, George W. Bush.

* * *

Paulson and Bernanke alerted Bush that AIG was about to fail, warned of the massive ripple effect AIG going bust would have on the global economy, and explained why the Fed could not intervene with an insurance company to stop this systemic threat. In response, Bush asked “How have we come to the point where we can’t let an institution fail without affecting the whole economy?”

The question raised by President Bush is still tragically apt, since nothing has been accomplished in the past year to break up or downsize those institutions considered “too big to fail”. Mr. Gerstein’s experience from reading the New Yorker article helped reinforce the understanding that our current situation is not only the result of regulatory failure, but it’s also a by-product of something called “regulatory capture” — wherein the regulators are beholden to those whom they are supposed to regulate:

Once disaster was averted and the system stabilized, Paulson, Geithner and Bernanke had no excuse for not laying down the law to Wall Street — figuratively and literally — in the ensuing weeks. By that I mean restructuring the deals we struck with the banks to get far better returns for taxpayers and rewriting the rules governing the financial system to prevent them from ever thinking they could gamble risk-free with our money again.

* * *

There’s no apparent sense of apartness or independence between regulator and regulated. To the contrary, there’s a power imbalance in the wrong direction, with the regulators dependent on and even at the mercy of the regulated. What does it say about the integrity and even the sanity of this system when the doctors have to ask the inmates how to restructure their treatments?

I was particularly impressed by Dan Gerstein’s closing remarks in the Forbes piece. It was encouraging to see another commentary in a mainstream media source, consistent with the ranting I did here, here and here. Mr. Gerstein expressed dismay at the lack of attention given to the unpleasant truth that we live in a plutocracy which won’t be changed until the people demand it:

That’s why I was so disappointed to find Stewart’s epic article buried in the elite pages of the New Yorker. It should have been serialized on the front pages of every newspaper in the country last week, so every American would be reminded in full detail of just how warped and rigged our financial system has been — and why it still is. Maybe then it might sink in that getting mad won’t get us even in the power struggle with the financial elites for control of our economy, and that change won’t happen until taxpayers demand it. You want public accountability for Wall Street? Let’s start with an accountable public.

Each time an article such as Dan Gerstein’s “Too Close For Comfort” gets widespread exposure, we move one step closer to the point where we have an informed, accountable public. It’s unfortunate that his commentary was buried in the elite pages of Forbes. That’s why I have it here. Spread the word.

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Turning Over A Rock

September 24th, 2009 Posted in Uncategorized

Sep, 24 2009

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September 24, 2009

Last year’s financial crisis and our current economic crisis have exposed some pretty ugly things to an unsuspecting public. As news reporters dig and as witnesses are called to testify, these investigations are turning over a very large rock, revealing all the colonies of maggots and fungus infestations, just below ground level, out of our usual view. The voters are learning more about the sleaziness that takes place on Wall Street and in the halls of Congress. Hopefully, they will become motivated to demand some changes.

A recent report by American Public Media’s Steve Henn revealed how the law prohibiting “insider trading” (i.e. acting on confidential corporate information when making a transaction involving that company’s publicly-traded stock) does not apply to members of Congress. Remember how Martha Stewart went to prison? Well, if she had been representing Connecticut in Congress, she might have been able to interpose the defense that she was inspired to sell her ImClone stock based on information she acquired in the exercise of her official duties. Mr. Henn’s report discussed the investment transactions made by some Senators after having been informed by former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, that our financial system was on the verge of a meltdown. After quoting GOP House Minority Leader John Boehner’s public acknowledgement last September that:

We clearly have an unprecedented crisis in our financial system. . . .

On behalf of the American people our job is to put our partisan differences aside and to work together to help solve this crisis.

Mr. Henn proceeded to explain how swift Senatorial action resulted in a bipartisan exercise of greed:

The next day, according to personal financial disclosures, Boehner cashed out of a fund designed to profit from inflation. Since he sold, it’s lost more than half its value.

Sen. Dick Durbin, an Illinois Democrat, who was also at that meeting sold more than $40,000 in mutual funds and reinvested it all with Warren Buffett.

Durbin said like millions of others he was worried about his retirement. Boehner says his stock broker acted alone without even talking to him. Both lawmakers say they didn’t benefit from any special tips.

But over time members of Congress do much better than the rest of us when playing the stock market.

* * *

The value of information that flows from the inner workings of Washington isn’t lost on Wall Street professionals.

Michael Bagley is a former congressional staffer who now runs the OSINT Group. Bagley sells access and research. His clients are hedge funds, and he makes it his business to mine Congress and the rest of Washington for tips.

MICHAEL Bagley: The power center of finance has moved from Wall Street to Washington.

His firm is just one recent entry into Washington’s newest growth industry.

CRAIG HOLMAN: It’s called political intelligence.

Craig Holman is at Public Citizen, a consumer watchdog. Holman believes lobbyists shouldn’t be allowed to sell tips to hedge funds and members of Congress shouldn’t trade on non-public information. But right now it’s legal.

HOLMAN: It’s absolutely incredible, but the Securities and Exchange Act does not apply to members of Congress, congressional staff or even lobbyists.

That law bans corporate insiders, from executives to their bankers and lawyers, from trading on inside information. But it doesn’t apply to political intelligence. That makes this business lucrative. Bagley says firms can charge hedge funds $25,000 a month just to follow a hot issue.

BAGLEY: So information is a commodity in Washington.

Inside information on dozens of issues, from bank capitol requirements to new student loan rules, can move markets. Consumer advocate Craig Holman is backing a bill called the STOCK Act. Introduced in the House, it would force political-intelligence firms to disclose their clients and it would ban lawmakers, staffers, and lobbyists from profiting on non-public knowledge.

Mr. Henn’s report went on to raise concern over the fact that there is nothing to stop members of Congress from acting on such information to the detriment of their constituents in favor of their own portfolios.

In his prepared testimony before the House Financial Services Committee this morning, former Federal Reserve Chair Paul Volcker made this observation:

I understand, and share, concern that the financial crisis has revealed weaknesses in our regulatory and supervisory agencies as well as in the activities of private financial institutions. There has been criticism of the Federal Reserve itself, and even proposals to remove responsibilities other than monetary policy, strictly defined, from the Fed.

Mr. Volcker discussed a number of suggestions for regulatory changes to prevent a repeat of last year’s crisis. He criticized Treasury Secretary “Turbo” Tim Geithner’s approach toward what amounts to simply baby-sitting for those financial institutions considered “too big to fail”. Here is some of Mr. Volcker’s discussion on that point:

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.

Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?

Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?

* * *

What all this amounts to is an unintended and unanticipated extension of the official “safety net”, an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase.

This concern is often discussed as the “moral hazard” issue. William Black, Associate Professor of Economics and Law at the University of Missouri – Kansas City published an excellent paper concerning this issue on September 10. He made some great suggestions as to how to deal with these “Systemically Dangerous Institutions”:

Historically, “too big to fail” was a misnomer – large, insolvent banks and S&Ls were placed in receivership and their “risk capital” (shareholders and subordinated debtholders) received nothing. That treatment is fair, minimizes the costs to the taxpayers, and minimizes “moral hazard.” “Too big to fail” meant only that they were not placed in liquidating receiverships (akin to a Chapter 7 “liquidating” bankruptcy). In this crisis, however, regulators have twisted the term into immunity. Massive insolvent banks are not placed in receivership, their senior managers are left in place, and the taxpayers secretly subsidize their risk capital. This policy is indefensible. It is also unlawful. It violates the Prompt Corrective Action law. If it is continued it will cause future crises and recurrent scandals.

* * *

Under the current regulatory system banks that are too big to fail pose a clear and present danger to the economy. They are not national assets. A bank that is too big to fail is too big to operate safely and too big to regulate. It poses a systemic risk. These banks are not “systemically important”, they are “systemically dangerous.” They are ticking time bombs – except that many of them have already exploded.

Mr. Black then listed twenty areas of reform where these institutions would face additional regulatory compliance and restrictions on their activities, including a ban on “all new speculative investments”. Paul Volcker took that issue a step further with his criticism of “proprietary trading” by these institutions, which often can result in conflicts of interest with customers, since these banks are trading on their own accounts while in a position to act on the confidential investing strategies of their clients.

Paul Volcker made a point of emphasizing the need to clarify the overlapping jurisdictions of the Securities and Exchange Commission and the Commodity Futures Trading Commission (CFTC). On September 18, David Corn wrote a piece about the CFTC, describing it as:

… a somewhat obscure federal agency, but an important one. Its mission is to protect consumers and investors by preventing misconduct in futures trading that could distort the prices of agricultural and energy commodities. In 2000, the CFTC wanted to regulate credit default swaps — complicated and privately traded financial instruments that helped grease the way to the subprime meltdown — but Republican Sen. Phil Gramm, then the chair of the Senate Banking Committee, Fed chair Alan Greenspan and Clinton administration officials (including Lawrence Summers, now President Obama’s top economic adviser) blocked that effort. Had the CFTC been allowed to police swaps, the housing finance crisis that begot the economic crash of last year might not have been as bad. So the CFTC is a critical agency. And under Obama’s proposal for more robust financial regulation — which he talked about during a Wall Street visit on Monday — the CFTC would have greater responsibility to make sure no one was gaming the financial system. Consequently, the composition of the CFTC is more significant than ever.

Mr. Corn expressed his concern over the fact that the Obama administration had nominated Scott O’Malia, a Republican Senate aide, to be a commissioner on the CTFC:

For the past seven years, he’s been a GOP staffer in the Senate. But before that he was a lobbyist for Mirant, an Atlanta-based electricity company. According to House and Senate records, while at Mirant O’Malia was registered to lobby for greater deregulation at a time when his company was exploiting the then-ongoing deregulation of the energy market to bilk consumers. Remember the Enron-driven electricity crisis in California of 2001, when Enron and other companies were manipulating the state’s deregulated electricity markets, causing prices to go sky-high, creating rolling black-outs and triggering a statewide emergency? Mirant was one of those other companies. According to state investigators, Mirant deliberately held back power to force prices up.

After the crisis, Mirant was investigated by various federal and local agencies and became the target of a number of lawsuits. It ultimately agreed to pay California about half a billion dollars to settle claims it had screwed the state’s residents. It also was fined $12.5 million — by the CFTC! — for attempting to manipulate natural gas prices.

Mr. O’Malia had previously been nominated for this position by President George W. Bush. Nevertheless, Washington Senator Maria Cantwell helped block the nomination. As a result, David Corn was understandably shocked when O’Malia was re-nominated for this same position by the Obama administration:

Yet Obama has brought it back. Why would a president who craves change in Washington and who wants the CFTC to be a tougher watchdog do that?

The answer to that question is another question: Does President Obama really want the CFTC to be a tougher watchdog or just another “lap dog” like the SEC?

After all the promises of the needed regulatory “clean-up” to prevent another financial crisis, can we really trust our current leadership to accomplish anything toward that goal?

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The Broken Promise

September 21st, 2009 Posted in Uncategorized

Sep, 21 2009

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September 21, 2009

We expect those politicians aiming for re-election, to make a point of keeping their campaign promises. Many elected officials break those promises and manage to win another term anyway. That fact might explain the reasoning used by so many pols who decide to go the latter route — they believe they can get away with it. Nevertheless, many leaders who break their campaign promises often face crushing defeat on the next Election Day. A good example of this situation arose during the Presidential campaign of George H.W. Bush, who assured America: “Read my lips: No new taxes!” in his acceptance speech (written by Peggy Noonan) at the 1988 Republican National Convention. Although he didn’t enact any new taxes during his sole term in office, he also promised the voters that he would not raise existing taxes after telling everyone to read his lips. When he broke that promise after becoming President, he was confronted with the “read my lips” quote by everyone from Pat Buchanan to Bill Clinton.

Back on July 15, 2008 and throughout the Presidential campaign, Barack Obama promised the voters that if he were elected, there would be “no more trickle-down economics”. Nevertheless, his administration’s continuing bailouts of the banking sector have become the worst examples of trickle-down economics in American history — not just because of their massive size and scope, but because they will probably fail to achieve their intended result. Although the Treasury Department is starting to “come clean” to Congressional Oversight chair Elizabeth Warren, we can’t even be sure about the amount of money infused into the financial sector by one means or another because of the lack of transparency and accountability at the Federal Reserve. (I seem to remember the word “transparency” being used by Candidate Obama.) Although we are all well-aware of the $750 billion TARP slush fund that benefited the banks to some degree, speculation as to the amount given (or “loaned”) to the banks by the Federal Reserve runs from $2 trillion to as high as $6 trillion. So far, the Fed has managed to thwart efforts by some news organizations to learn the ugly truth. As Pat Choate reported for The Huffington Post:

Bloomberg News filed a federal lawsuit in November 2008 in the U.S. District Court, Southern District of New York (Manhattan) challenging that stonewalling and won the case. Chief U.S. District Judge Loretta Preska on August 24 ruled that the Fed had “improperly withheld agency records” giving it a week to disclose daily reports on its loans to banks and other financial institutions.

Three days later, Federal Reserve lawyers asked the courts for a delay so that they could make an expedited appeal of her decision. Several major banks, operating through an organization named “The Clearing House,” filed a supporting brief with the appeals court, claiming that the Federal Reserve had provided its members emergency funds under an agreement not to identify the recipients or the loan terms.

The Clearing House brief described its members as, “[T]he most important participants in the international banking and payments systems and among the world’s largest intermediaries in interbank funds transfers.” They include ABN Amro Bank, N.V. (Dutch), Bank of America, The Bank of New York Mellon, Citibank, Deutsche Bank Trust (Germany), JP MorganChase Bank, UBS (Switzerland), and Wells Fargo.

* * *

Why are the Fed and the banks fighting so hard to keep the loan details secret? Congress and taxpayers cannot know until they have the information the Federal Reserve is keeping from them, but several plausible explanations exist.

One is that the Fed has taken a great deal of worthless collateral and is propping up failed companies and banks. A second is that the information will make the issue of paying out huge Wall Street bonuses in 2009 politically radioactive, particularly if it turns out the payments are dependent on these federal loans.

Finally, the Federal Reserve probably does not want that information to be part of the forthcoming Senate hearings on the re-confirmation of Ben Bernanke, current Chairman of the Federal Reserve.

President Obama’s failure to keep his campaign promise of “no more trickle-down economics” is rooted in his decision to rely on the very same individuals who caused the financial crisis — to somehow cure the nation’s economic ills. These people (Larry Summers, “Turbo” Tim Geithner and Ben Bernanke) have convinced Mr. Obama that “trickle-down economics” (i.e. bailing out the banks, rather than distressed businesses or the taxpayers themselves) would be the best solution.

On Saturday, Australian economist Steve Keen published a fantastic report from his website, explaining how the “money multiplier” myth, fed to Obama by the very people who caused the crisis, was the wrong paradigm to be starting from in attempting to save the economy. Here’s some of what Professor Keen had to say:

While economic outsiders like myself, Michael Hudson, Niall Ferguson and Nassim Taleb argue that the only way to restart the economic engine is to clear it of debt, the government response, has been to attempt to replace the now defunct private debt economic turbocharger with a public one.

In the immediate term, the stupendous size of the stimulus has worked, so that debt in total is still boosting aggregate demand. But what will happen when the government stops turbocharging the economy, and waits anxiously for the private system to once again splutter into life?

I am afraid that all it will do is splutter.

This is especially so since, following the advice of neoclassical economists, Obama has got not a bang but a whimper out of the many bucks he has thrown at the financial system.

In explaining his recovery program in April, PresidentObama noted that:

“there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask”.

He justified giving the money to the lenders, rather than to the debtors, on the basis of “the multiplier effect” from bank lending:

the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth. (page 3 of the speech)

This argument comes straight out of the neoclassical economics textbook. Fortunately, due to the clear manner in which Obama enunciates it, the flaw in this textbook argument is vividly apparent in his speech.

This “multiplier effect” will only work if American families and businesses are willing to take on yet more debt: “a dollar of capital in a bank can actually result in eight or ten dollars of loans”.

So the only way the roughly US$1 trillion of money that the Federal Reserve has injected into the banks will result in additional spending is if American families and businesses take out another US$8-10 trillion in loans.

* *   *

If the money multiplier was going to “ride to the rescue”, private debt would need to rise from its current level of US$41.5 trillion to about US$50 trillion, and this ratio would rise to about 375% — more than twice the level that ushered in the Great Depression.

This is a rescue? It’s a “hair of the dog” cure: having booze for breakfast to overcome the feelings of a hangover from last night’s binge. It is the road to debt alcoholism, not the road to teetotalism and recovery.

Fortunately, it’s a “cure” that is also highly unlikely to work, because the model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

*    *    *

I’ve recently developed a genuinely monetary, credit-driven model of the economy, and one of its first insights is that Obama has been sold a pup on the right way to stimulate the economy: he would have got far more bang for his buck by giving the stimulus to the debtors rather than the creditors.

* * *

The model shows that you get far more “bang for your buck” by giving the money to firms, rather than banks. Unemployment falls in both case below the level that would have applied in the absence of the stimulus, but the reduction in unemployment is far greater when the firms get the stimulus, not the banks: unemployment peaks at over 18 percent without the stimulus, just over 13 percent with the stimulus going to the banks, but under11 percent with the stimulus being given to the firms.

*    * *

So giving the stimulus to the debtors is a more potent way of reducing the impact of a credit crunch — the opposite of the advice given to Obama by his neoclassical advisers.

This could also be one reason that the Australian experience has been better than the USA’s: the stimulus in Australia has emphasized funding the public rather than the banks (and the model shows the same impact from giving money to the workers as from giving it to the firms — and for the same reason, that workers have to spend, so that the money injected into the economy circulates more rapidly.

*    * *

Obama has been sold a pup by neoclassical economics: not only did neoclassical theory help cause the crisis, by championing the growth of private debt and the asset bubbles it financed; it also is undermining efforts to reduce the severity of the crisis.

This is unfortunately the good news: the bad news is that this model only considers an economy undergoing a “credit crunch”, and not also one suffering from a serious debt overhang that only a direct reduction in debt can tackle. That is our actual problem, and while a stimulus will work for awhile, the drag from debt-deleveraging is still present. The economy will therefore lapse back into recession soon after the stimulus is removed.

You can be sure that if we head into a “double-dip” recession as Professor Keen expects, the President will never hear the end of it. If only Mr. Obama had stuck with his campaign promise of “no more trickle-down economics”, we wouldn’t have so many people wishing they lived in Australia.

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The Longest Year

September 14th, 2009 Posted in Uncategorized

Sep, 14 2009

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September 14, 2009

As I write this, President Obama is preparing another fine-sounding, yet empty speech. His subject this time is financial reform. You may recall last week’s lofty address to the joint session of Congress, promoting his latest, somewhat-less-nebulous approach to healthcare reform. He assured the audience that the so-called “public option” (wherein a government-created entity competes with private sector healthcare insurers) would be an integral part of the plan. Within a week, two pieces of political toast from the Democratic Party (Nancy Pelosi and Harry Reid) set about undermining that aspect of the healthcare reform agenda. This is just one reason why, on November 2, 2010, the people who elected Democrats in 2006 and 2008 will be taking a “voters’ holiday”, paving the way for Republican majorities in the Senate and House. The moral lapse involving the public option was documented by David Sirota for Danny Schechter’s NewsDissector blog:

House Speaker Nancy Pelosi for the first time yesterday suggested she may be backing off her support of the public option – the government-run health plan that the private insurance industry is desperately trying to kill. According to CNN, Pelosi and Senate Majority Leader Harry Reid “said they would support any provision that increases competition and accessibility for health insurance – whether or not it is the public option favored by most Democrats.”

This announcement came just hours before Steve Elmendorf, a registered UnitedHealth lobbyist and the head of UnitedHealth’s lobbying firm Elmendorf Strategies, blasted this email invitation throughout Washington, D.C. I just happened to get my hands on a copy of the invitation from a source – check it out:

From: Steve Elmendorf [mailto:steve@elmendorfstrategies.com]
Sent: Friday, September 11, 2009 8:31 AM
Subject: event with Speaker Pelosi at my home
You are cordially invited to a reception with

Speaker of the House
Nancy Pelosi

Thursday, September 24, 2009
6:30pm ~ 8:00pm

At the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.

$5,000 PAC
$2,400 Individual

Again, Elmendorf is a registered lobbyist for UnitedHealth, and his firm’s website brags about its work for UnitedHealth on its website.

The sequencing here is important: Pelosi makes her announcement and then just hours later, the fundraising invitation goes out. Coincidental? I’m guessing no – these things rarely ever are.

I wrote a book a few years ago called Hostile Takeover whose premise was that corruption and legalized bribery has become so widespread that nobody in Washington even tries to hide it. This is about as good an example of that truism as I’ve ever seen.

Whatever President Obama proposes to accomplish in terms of financial reform will surely be met with a similar fate. Worse yet, his appointment of “Turbo” Tim Geithner as Treasury Secretary and his nomination of Ben Bernanke to a second term as Federal Reserve chairman are the best signals of the President’s true intention: Preservation of the status quo, regardless of the cost to the taxpayers.

On this first anniversary of the demise of Lehman Brothers and the acknowledgment of the financial crisis, many commentators have noted the keen observations by Simon Johnson, a former chief economist at the International Monetary Fund, published in the May, 2009 issue of The Atlantic. The theme of Johnson’s article, “The Quiet Coup” was that the current economic and financial crisis in the United States is “shockingly reminiscent” of those experienced in emerging markets (i.e. banana republics and proto-capitalist regimes). The devil behind all the details in setting these systems upright after a financial crisis is the age-old concept of moral hazard or more simply: sleaze. In making the comparison of the United States to the emerging market countries he encountered at the IMF, Mr. Johnson began this way:

But there’s a deeper and more disturbing similarity: elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Here are a few more passages from “The Quiet Coup” that our political leaders would be well-advised to consider:

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.

* * *

The second problem the U.S. faces—the power of the oligarchy— is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

Mr. Johnson pointed out the need to overhaul our current antitrust laws – not because any single institution controls so much market share as to influence prices – but because the failure of any one “to big to fail” bank could collapse the entire financial system.

One of my favorite reporters at The New York Times, Gretchen Morgenson, observed the anniversary of the Lehman Brothers failure with an essay that focused, in large part, on a recent paper by Edward Kane, a finance professor at Boston College, who created the expression: “zombie bank” in 1987. This month, the Networks Financial Institute at Indiana State University published a policy brief by Dr. Kane on the subject of financial regulation. In her article: “But Who Is Watching Regulators?”, Ms. Morgenson summed up Professor Kane’s paper in the following way:

This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things: the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.

Although you may have seen widely-publicized news reports about an “overwhelming number” of academicians opposing the current efforts to require transparency from the Federal Reserve, Professor Kane provides a strong argument in favor of Fed transparency as well as scrutiny of the Treasury and the other government entities enmeshed the complex system of bailouts created within the past year.

At thirty-eight pages, his paper is quite a deep read. Nevertheless, it’s packed with great criticism of the Federal Reserve and the Treasury. We need more of this and when someone of Professor Kane’s stature provides it, there had better be people in high places taking it very seriously. The following are just a few of the many astute observations made by Dr. Kane:

Agency elitism would be evidenced by the extent to which its leaders use crises to establish interpretations and precedents that cover up its mistakes, inflate its powers, expand its discretion, and extend its jurisdiction. According to this standard, Fed efforts to use the crisis as a platform for self-congratulation and for securing enlarged systemic-risk authority sidetracks rather than promotes effective reform.

* * *

A financial institution’s incentive to disobey, circumvent or lobby against a particular rule increases with the opportunity cost of compliance. This means that, to sort out the welfare consequences of any regulatory program, we must assess not only the costs and benefits of compliance, but include the costs and benefits of circumvention as well.

* * *

Realistically, every government-managed program of disaster relief is a strongly lobbied and nontransparent tax-transfer scheme for redistributing wealth and shifting risk away from the disaster’s immediate victims. A financial crisis externalizes – in margin and other collateral calls, in depositor runs, and in bank and borrower pleas for government assistance – a political and economic struggle over when and how losses accumulated in corporate balance sheets and in the portfolios of insolvent financial institutions are to be unwound and reallocated across society. At the same time, insolvent firms and government rescuers share a common interest in mischaracterizing the size and nature of the redistribution so as to minimize taxpayer unrest.

In principle, lenders and investors that voluntarily assume real and financial risks should reap the gains and bear the losses their risk exposures generate. However, in crises, losers pressure government officials to rescue them and to induce other parties to share their pain.

The advocates of crony capitalism and their tools (our politicians and regulatory bureaucrats) need to know that we are on to them. If the current administration is willing to facilitate more of the same, then it’s time for some new candidates to step forward.

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