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Doctor Doom Writes A Prescription

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May 6, 2010

As I discussed on April 26, expectations for serious financial reform are pretty low.  Worse yet, Lloyd Blankfein (CEO of Goldman Sachs) felt confident enough to make this announcement, during a conference call with private wealth management clients:

“We will be among the biggest beneficiaries of reform.”

So how effective could “financial reform” possibly be if Lloyd Bankfiend expects to benefit from it?  Allan Sloan of Fortune suggested following the old Wall Street maxim of “what they promise you isn’t necessarily what you get” when examining the plans to reform Wall Street:

President Obama talks about “a common sense, reasonable, nonideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.”  But what we’ll get from the actual legislation isn’t necessarily what we hear from the Salesman-in-Chief.

Sloan offered an alternative by providing “Six Simple Steps” to help fix the financial system.  He wasn’t alone in providing suggestions overlooked by our legislators.

Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis) has written a new book with Stephen Mihm entitled, Crisis Economics:  A Crash Course in the Future of Finance.  (Mihm is a professor of economic history and a New York Times Magazine writer.)  An excerpt from the book recently appeared in The Telegraph.  The idea of fixing our “sub-prime financial system” was introduced this way:

Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel.  Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

*   *   *

Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis.  Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again.  The crisis was less a function of sub-prime mortgages than of a sub-prime financial system.  Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out.  The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

Roubini and Mihm had nothing favorable to say about CDOs, which they referred to as “Chernobyl Death Obligations”.  Beyond that, the authors called for more transparency in derivatives trading:

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis.  So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted.  Moreover, the regulation of derivatives should be consolidated under a single regulator.

Although derivatives trading reform has been advanced by Senators Maria Cantwell and Blanche Lincoln, inclusion of such a proposal in the financial reform bill faces an uphill battle.  As Ezra Klein of The Washington Post reported:

The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it.

The administration, Treasury and the Fed are also fighting hard against a bipartisan effort to include an amendment in the financial reform bill that would compel a full audit of the Federal Reserve.  I’m intrigued by the possibility that President Obama could veto the financial reform bill if it includes a provision to audit the Fed.

Jordan Fabian of The Hill discussed Congressman Alan Grayson’s theory about why Treasury Secretary Tim Geithner opposes a Fed audit:

But Grayson, who is known for his tough broadsides against opponents, indicated Geithner may have had a role in enacting “secret bailouts and loan guarantees” to large corporations, while New York Fed chairman during the Bush administration.

“It’s one of the biggest conflict of interests I have ever seen,” he said.

With the Senate and the administration resisting various elements of financial reform, the recent tragedy in Nashville provides us with a reminder of how history often repeats itself.  The concluding remarks from the Roubini – Mihm piece in The Telegraph include this timely warning:

If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry.  But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.

The issue of whether our government will take the necessary steps to prevent another financial crisis continues to remain in doubt.



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Fed Up With The Fed

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July 20, 2009

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

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

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

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

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

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

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

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

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

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

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

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