Economic Dreams - Economic Nightmares

To the Streets: Occupy Wall Street moves to Main Streets

The "Occupy Wall Street" movement is moving to Main Streets across the globe. It's about time. But I fear that the movement will be captured by the far left, just as the TEA party movement has been captured by the far right. If Occupy Wall Street will evolve to represent the case of the 99% against the 1% we will have a chance for needed social/institutional change here in the US.

'Occupy Wall Street/Main Street' made it to my home base Ogden, UT last weekend. As I've argued here before, it is past time that people protest the growing US-led kleptocracy (a corrupt form of government where governing bodies aid in the transfer of wealth from ordinary citizens to the upper class). I went to the rally, adding one small voice to this important issue.

I found a little 4-minute video (embedded below) that captures the essence of the problem. It is titled "Why Occupy Wall Street? Four Reasons," by D.C. Douglas (hat tip: Sam Glover: The Cycle of Financial Crisis). Below are my four reasons to protest the oligarchic dominance of the American economy and politics. You can boil them down to Supreme Court Justice Louis Brandeis' timeless admonition: "We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can't have both."

My Four Reasons to Occupy Wall Street

• The Robber Barons (Wikipedia) are back, but must NOT be allowed to stay in power! The distribution of wealth in the US is now as skewed toward the top 1% even beyond where it stood in 1929. One percent of this country now owns 40% of the wealth.
• The rich are NOT entitled to take everything, in a democracy underwritten by publicly-financed education, transportation, defense, and much more. A recent Congressional Budget Office report show that "for the 1 percent of the population with the highest income, average real after-tax household income grew by 275 percent between 1979 and 2007." Add this: "In the 1970s, corporate chief executives earned 30 times as much as the average worker. Ten years ago, CEO compensation was 116 times the average. CEOs now earn close to 300 times as much as the average worker."
• The rich are NOT entitled to buy elections. A recent Supreme Court ruling "Citizens United" allows the rich to buy elections. The Koch brothers are rumored to be planning to spend $250000000 (one quarter BILLION) of their personal money on political agendas in 2012. How much influence will that buy?
• Houses of Finance big and small will NOT self-govern in the interest of either their shareholders or in the public interest. Large financial organizations need to be governed by effective regulation—a 21st century "Glass Steagall", among other regulatory apparatus.

I shared Jared Diamond's warnings against kleptocracy some years back. They are worth a relook. One snip:

The difference between a kleptocrat and a wise statesman, between a robber baron and a public benefactor, is merely one of degree: a matter of just how large a percentage of the tribute extracted from producers is retained by the elite, and how much the commoners like the public uses to which the redistributed tribute is put.

Finally here is the Why Occupy Wall Street video, featuring Elizabeth Warren, among others:

The video suggests four resolutions that differ at wee bit from mine:

• Reinstate Glass-Steagall
• Audit the Fed
• Reverse "Citizens United"
• Overhaul the Corporate Tax Code

I'm in favor of better disclosure from the Fed. So is Ben Bernanke. I too support reversing "Citizens United" by Legislative action, most likely by publicly financing all elections. Of course, such financing would not only disallow super-PAC election manipulation, but would also disallow billionaires from manipulation elections with their own money. Finally, like 99.9% of US citizens, I support overhauling the entire US Tax Code, simplifying it, and restructuring it for economic fairness in part by requiring the wealthy few to shoulder more of the tax burden.

Note: I used the term kleptrocacy (Wikipedia) in part to add flair and controversy. Plutocracy (Wikipedia) might have been a better choice. Louis Brandeis favored the term oligarchy (Wikipedia).

 

Fiscal Prudence or Union Busting?

One of my economic dreams, albeit implausible, is that governmental entities could learn to live within their means, and do so without the need for drama and crisis. Like many economists I see little harm in not balancing the budget in any given year, but see little good (and eventually much harm) in ever-increasing budget deficits year-on-year when measured in "real" dollars. This latter possibility I include in the nightmares realm.

Another recurrent economic nightmare is that somehow our politicians and captains of industry will so mess up our system that the United States will become an entrenched plutocracy (Wikipedia), better still kleptocracy (Wikipedia) — assuming that we are not there already. Note: All my chatter about power and corruption here.

Much of the talk this week about the budgetary plight of various states has oddly — likely by political calculation — been intertwined with talk of eliminating collective bargaining by state employee unions. Governor Scott Walker of Wisconsin has been at the epicenter of the debate on the issue, with tens of thousands of protesters surrounding the state capital. Walker's steadfast refusal to budge on "collective bargaining" for pensions and health care — which he wants to deny, although with exceptions for police and firefighters — puts him at odds with organized labor and with liberals generally (NY Times, Steven Greenhouse; Huffington Post, Robert Reich). Notably, police and firefighters too are standing with their fellow state employees in protests.

Alarmingly Interestingly, two Darth Vaders of key players in American plutocracy, the Koch brothers (Wikipedia), showed up in a cameo role. The incident was popularized in a stunt (Huffington Post, Jason Linkins), a fake phone call from David Koch to Governor Walker. For more, and tiny bit less bias than I've used here, see "Who's Afraid of the Brothers Koch" (NY Times, Tobin Harshaw)

Vampire's Lair or Plato's Cave?

I've spend a bunch of time on this blog trying to understand who played what roles in both the run up to, and the meltdown of the recent financial bubble. But I've not, until now covered Matt Taibbi's exposés, or "screeds" as some call them. [Note: I got 179,000 Google hits on "Matt Taibbi"+screed] Taibbi's, The Great American Bubble Machine, Rolling Stone (07/09/2009), libeled Goldman Sachs as a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

Ultimately in the court of public opinion, if not in the legal system, we have to come to grips with who among Wall Street players might have been playing the role of bloodmoney-sucking vampires, aided and/or least cheer-led by politicians, regulators, rating agencies, and the media.

However, since it proves too easy to charge others with crimes (or even moral turpitude), we need to introduce a notion that Gillian Tett talked about in Fool's Gold: that many were blind to realities that others readily saw. Some were blinded by their own institutions and subcultures. Some were simply blinded by greed and venality. All were (some still are) among those dwelling in modern-day versions of Plato's Cave (Wikipedia). To these we have to give a pass — I suppose — although we (and they) have lessons to learn about why we need whistleblowers, and why we all need to take responsibility to speak up when we think things seem not right.

In a recent update to his story, Why Isn't Wall Street in Jail?, Rolling Stone (3/3/2011), Taibbi leaves little doubt that a whole bunch of Wall Street players ought to be in jail for their roles in the meltdown of 2007-2009. See also Taibbi's recent interview with Amy Goodman at Democracy Now.

I don't disagree that many ought to be in jail. But "ought to" is easier than "will be." Too many laws (financial regulation, usury, etc.) were relaxed over the last decade or two, and too many people played too many games on both sides of the political aisle as well as on both sides of the regulatory game to make it easy to sort out bad-enough deeds — vampire deeds — to land very many people in jail.

No matter which court (public opinion or legal) we work with, how are we to decide whether folks were knowingly committing fraud? As noted earlier, the media and politicians too were seldom found on the peoples' side of the issue. Regulators and ratings agencies were either hoodwinked or captured. Those few who dared speak up lost their heads, figuratively speaking. Maybe instead we ought to handsomely reward whistleblowers.

Finally, how are we to determine deeds deemed bad enough to constitute fraud, when we know that both organizations and culture trap people into ideological and methodological traps from which few can escape. People become chained as prisoners, and blinded by circumstance in Plato's Cave, as Gillian Tett notes in the epilogue to Fool's Gold (2009):

[T]he financial world's lack of interest in wider social matters cuts to the very heart of what has gone wrong. What social anthropology teaches its adherents is that nothing in society ever exists in a vacuum or in isolation. Holistic analysis that tries to link different parts of a social structure is crucial, be that in respect to wedding rituals or trading floors. Anthropology also instills a sense of skepticism about official rhetoric. In most societies, elites try to maintain their power not simply by garnering wealth, but also by dominating the mainstream ideologies, in terms of both what is said and what is not discussed. Social "silences" serve to maintain power structures, in ways that participants often barely understand themselves let alone plan.

… In recent years, regulators, bankers, politicians, investors, and journalists have all failed to employ truly holistic thought—to our collective cost. Bankers have treated their mathematical models as if they were an infallible guide to the future, failing to see that they were based on a ridiculously limited set of data. A "silo" mentality has come to rule inside banks, leaving different departments competing for resources, with shockingly little wider vision or oversight. The regulators who were supposed to oversee the banks have mirrored that silo pattern, too, in their own fragmented practices. Most pernicious of all, financiers have come to regard banking as a silo in its own right, detached from the rest of society. They have become like the inhabitants of Plato's cave, who could see shadows of outside reality flickering on the walls but rarely encountered that reality themselves. The chain that linked a synthetic CDO [Collatorized Debt Obligation] of ABS [Asset Backed Securities], say, with a "real" person was so convoluted, it was almost impossible for anybody to fit it into a single cognitive map—be they anthropologist, economist, or credit whiz.

Yet the only thing that is more remarkable than this deadly state of affairs was that it went so unnoticed, for so long. [pp.252-3]

Let's leave final words to John Kenneth Galbraith, The Great Crash 1929:

One of the oldest puzzles in politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves is who is to make wise those who are required to have wisdom.

Some of those in positions of authority wanted the boom to continue. They were making money out of it, and they may have had an intimation of the personal disaster which awaited them when the boom came to an end. But there were also some who saw, however dimly, that a wild speculation was in progress and that something should be done. For these people, however, every proposal to act raised the same intractable problem. The consequences of successful action seemed almost as terrible as the consequences of inaction, and they could be more horrible for those who took the action.

See also: In Plato's Cave, The Economist, 01/22/2009

[Endnote: By their own admission, neither Taibbi nor Tett got their stories perfectly right. But they came close enough. Their main storylines hold true. And if they don't I suspect I'll hear about it soon.]

American Oligarchs and their Minions, take 2

Last Friday, Bill Moyers sat down for an hour with Simon Johnson and James Kwak (authors of The Baseline Scenario and 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.) Watch it in two parts here. The topic of the day was (and will continue to be for the next month or so) financial regulation in the wake of financial meltdown. Among other arguments, Johnson and Kwak make the case for breaking up America's big banks  financial oligarchy. They, with Bill Moyers ever-thoughtful-guidance, help us better understand the the deeds, misdeeds, and too-often blind ideological missteps that brought us to the edge of the abyss, and that keep us in bondage to those who ought have been more concerned with our collective progress than with lining their own pockets with gold.

I continue to be somewhat agnostic on setting up a "size rule" for large financial institutions, but Johnson and Kwak have me leaning in their direction right now.  Here is a snip (from the transcript) arguing for breaking up the big banks:

SIMON JOHNSON: . . . [I say] to all my Republican friends: on Fannie Mae and Freddie Mac, you were right. They became too big to fail. They captured Congress. They were known as some of the most formidable financial lobbyists in the 1990s. They argued for the rights to take on these kinds of risks, okay?

And the Republicans were right. The Republicans called them on this. But now it's the big private banks that have the same incentive structure. That have bulked themselves up so big that you can't let them fail. That's what we saw in September 2008. Hank Paulson looked at his options. And they are all pretty awful. And I'm not a big fan of Hank Paulson, but I think the moment where he looked at it, he was right. That if you let JPMorgan Chase or Goldman Sachs fail, the consequences would have been devastating, because they're so big. It's a Fannie May and Freddie Mac structure come to Wall Street, come to the top guys on Wall Street. And our Republican colleagues and friends should recognize this, they should acknowledge it. And then we can all fix this together.

I also found this commentary on the hedge fund "Magnetar" particularly interesting. It foreshadows what may yet be revealed about many others in the financial industry:

JAMES KWAK: Magnetar is a hedge fund which means that other people gave them money to invest. And their job is to make as much money as possible. And these were the smart guys in the room. They saw that the system was broken. And they found a specific way to exploit it. And they knew that they could go for example, they could go to Wall Street banks and the banks would collaborate in making these extremely toxic securities. Because they knew what the bankers incentives were. They knew that the banker's incentives were to do the deal, to do the transaction, to get the fees up front. And they knew that there was nobody watching out for the investors. There was nobody watching out to make sure that securities they manufactured were actually good securities. But essentially what they were doing is they wanted to short the housing market. And they shorted the market in such a way that they actually made the problem worse, because what they did is they encouraged they tried to create these very toxic securities explicitly so that they could then short those securities. And that's why in a sense, they were they were shorting the American Dream. But what the real story of Magnetar, I think, is that they were exploiting a system that was deeply broken.

So, we like to think that the financial system we have in Wall Street are set up so that as people try to make lots of money they are they are indirectly helping the economy by making sure their capital goes where it's needed most. What the Magnetar story shows us that this is a casino, where you can make money you can make money exploiting the weaknesses in the casino. And it has nothing to do with the American Dream. It has nothing to do with making sure that capital goes to the places where it's needed most.

 Watch the rest of the story. I'll try to update this post as (or if) I see others commenting on on the Moyers, Johnson, Kwak tale.  American Oligarchs and their Minions, "Take One" is here.

Financial Regulatory Reforms: Neither easy nor politically palatable

Months ago I promised to keep tabs on financial regulatory reform measures. Well, I've tried but it is not easy — and I've been distracted (and generally depressed by American US culture and politics).  Today I begin anew, and renew my promise by referring readers via "snips" to two of my favorite bloggers. Steve Randy Waldman explains why financial reform efforts are not going to be easy, and The Epicurean Dealmaker reiterates and expands his proposal for reform. To Waldman, Capital Can't Be Measured (4/3/2010):

Simon Johnson and James Kwak are absolutely right. Sure, "hard" capital and solvency constraints for big banks are better than mealy-mouthed technocratic flexibility. But absent much deeper reforms, totemic leverage restrictions will not meaningfully constrain bank behavior. Bank capital cannot be measured. Think about that until you really get it. Large complex financial institutions report leverage ratios and "tier one" capital and all kinds of aromatic stuff. But those numbers are meaningless. For any "large complex financial institution" levered at the House-proposed limit of 15×, a reasonable confidence interval surrounding its estimate of bank capital would be greater than 100% of the reported value. In English, we cannot distinguish "well capitalized" from insolvent banks, even in good times, and regardless of their formal statements.

Lehman is a case-in-point. On September 10, 2008, Lehman reported 11% "tier one" capital and very conservative "net leverage". On September 25, 2008, Lehman declared bankruptcy. Despite reported shareholder's equity of $28.4B just prior to the bankruptcy, the net worth of the holding company in liquidation is estimated to be anywhere from negative $20B to $130B, implying a swing in value of between $50B and $160B. That is shocking. For an industrial firm, one expects liquidation value to be much less than "going concern" value, because fixed capital intended for a particular production process cannot easily be repurposed and has to be taken apart and sold for scrap. But the assets of a financial holding company are business units and financial positions, which can be sold if they are have value. Yes, liquidation hits intangible "franchise" value and reputation, but those assets are mostly excluded from bank balance sheets, and they are certainly excluded from "tier one" capital calculations. The orderly liquidation of a well-capitalized financial holding company ought to yield something close to tangible net worth, which for Lehman would have been about $24B.

So Lehman misreported its net worth, right? Not according to the law. . . .

So, for large complex financials, capital cannot be measured precisely enough to distinguish conservatively solvent from insolvent banks, and capital positions are always optimistically padded. Given these facts, and I think they are facts, even "hard" capital and leverage restraints are unlikely to prevent misbehavior. Can anything be done about this? Are we doomed to some post-modern quantum mechanical nightmare wherein "Schrodinger's Banks" are simultaneously alive and dead until some politically-shaped "measurement" by a regulator forces a collapse of the superposition of states into hunky-doriness?

Yes, we are doomed, unless and until we simplify the structure of the banks. When I say stuff like "confidence intervals surrounding measures of bank capital are greater than 100%, what does that even mean? Capital does not exist in the world. It is not accessible to the senses. When we claim a bank or any other firm has so much "capital" we are modeling its assets and liabilities and contingent positions and coming up with a number. Unfortunately, there is not one uniquely "true" model of bank capital. Even hewing to GAAP and all regulatory requirements, thousands of estimates and arbitrary choices must be made to compute the capital position of a modern bank. There is a broad, multidimensional "space" of defensible models by which capital might be computed. When we "measure" capital, we select a model and then compute. If we were to randomly select among potential models (even weighted by regulatory acceptability, so that a compliant model is much more likely than an iffy one), we would generate a probability distribution of capital values. That distribution would be very broad, so that for large, complex banks negative values would be moderately probable, as would the highly positive values that actually get reported. If we want to make capital measurable in any practical sense, we have to dramatically narrow the range of models, so that all compliant models produce values tightly clumped around the number we'll call capital. But every customized derivative, nontraded asset, or unusual liability in a bank's capital structure requires modeling. The interaction between a bank holding company and its subsidiaries requires multiple modeling choices, especially when those subsidiaries have crossholdings. A wide variety of contingent liabilities — of holding companies directly, of subsidiaries, of affiliated or spun-off entities like SIVs and securitizations — all require modeling choices. Given the heterogeneity of real-world arrangements, no "one-size-fits-all" model can be legislated or regulated to ensure a consistent capital measure. We cannot have both free-form, "innovative" banks and meaningful measures of regulatory capital. If we want to base a regulatory scheme on formal capital measures, we'll need to circumscribe the structure and composition of banks so that they can only carry positions and relationships for which we have standard regulatory models. "Banks’ internal risk models" or "internal valuations of Level 3 assets" don't cut it. They are gateways to regulatory postmodernism.

Regulation by formal capital has a proud and reasonably successful history, but has been rendered obsolete by the complexity of modern financial institutions. The assets and liabilities of a traditional commercial bank had straightforward, widely acceptable book values. For the corner bank, discretionary modeling mattered only in setting credit loss reserves, and the range of estimates that bank officers, external auditors, and regulators would produce for those reserves was usually pretty narrow (except when all three colluded to fake and forbear in a general crisis). But model complexity overwhelms and destroys regulatory capital as a useful measure for large complex financial institutions. We need either to resimplify banks to make them amenable to the traditional approach, or come up with other approaches more capable of reigning in the brave new world of banking.

So what is to be done? The Epicurean Dealmaker gives us fleeting hope in Poachers Turned Gamekeepers (3/16/2010), but there may be a political flaw in his reasoning. The problem is that the proposed solution requires very highly paid, highly skilled, 'seasoned' regulators. That may not fly in the US where we expect our "civil servants" to be moderately paid as per the usual GS pay-scale or even the moderately higher Senior Executive Service pay-scale. Still, his ideas of general regulatory rules that allow for regulatory discretion (by competent government regulators) seems much better than overly complex government legislative and/or administrative "rules". I wish that the highly debated healthcare reform could have been effected that way.  To the "dealmaker":

. . . [I]nspired by readings among several of the more rational and composed voices in said bloggy peanut gallery, including David Merkel, Mike Konczal, and Felix Salmon. . . .

Like Felix, I agree with David that "dumb regulation"—or, in less pejorative language, simple and relatively inflexible regulation—is far more likely to do the trick than the kind of complex, encyclopedic, tick-all-the-boxes regulation exemplified by the bloated pig currently wending its way through the legislative python in Congress. But I also agree with Felix (and, so it would seem, with David) that simple regulation will only work if it is overseen, enforced, and modified as necessary by extremely intelligent and motivated regulators.

I have argued in these pages before that delivering regulations which are comprehensive, detailed, and complex only encourages the institutions being regulated to immediately try to engineer their way around them. Simple, broad-brush regulations have a much better chance to operate as a set of principles which are well understood by both regulator and regulatee alike. But having such principles-based regulation is not enough. They must be enforced, as financial collapse in the face of a decidedly principles-based regulatory regime in the United Kingdom amply demonstrated. Not only does this mean, in Felix's example, that regulators must have the authority to make up rules, tests, and procedures on the fly on behalf of preserving systemic stability, they must also have the balls to take that phone call from Dick Fuld. And, moreover, to tell him in no uncertain terms to go fuck himself if he doesn't like it. . . .

[R]egulators [should] get hired from Wall Street banks, big law firms, and elsewhere. An effective wholesale financial regulator ¹ should be comprised of forensic accountants, corporate and securities lawyers, investment bankers, derivative structurers, and the like. They should all be paid market rates for their services, which will make their compensation much, much closer to that of the people they regulate. They should be prohibited from accepting positions in private financial industry—and, most especially, at any individual firm they ever directly or indirectly regulated—or firms working for financial firms (law firms, accountancies, etc.) for a minimum of at least three years after they leave government service. Five would be preferable.

While individually expensive, I don't believe you would need to hire many such people to make this kind of regulatory regime work. Given that you really only need high-powered regulators for the very biggest institutions, I am guessing you could get away with fewer than 100 to start. In fact, it might be less, because you really only need these people to direct and train their junior staff, and to interface directly with senior executives of the regulated entities. Fully loaded, I imagine you could fund a financial regulatory SWAT team like this for less than $150 million per year. That's a drop in the bucket compared to the financial losses these supposedly regulated institutions have already inflicted on the American taxpayer, not to mention in comparison with the normal run rate of your average stodgy, inefficient, and ineffective government bureaucracy.² Even better, you could fund such an agency with a levy indexed to the size of each financial institution under its jurisdiction. The larger and more complex a bank, the more fire-breathing, table-throwing, nail-spitting investment bankers and lawyers you could afford to throw at it. Talk about an incentive to shrink your balance sheet.

* * *No plan is without its drawbacks, however, and I knew I could rely on my intelligent and well-meaning interlocutors on Twitter to supply some. Among the more cogent of these, Graeme Hein noted that "Smart regulators can always make more money in [the] private sector." This has always been true, and always will be so, but my plan could be structured to minimize this defect. For one thing, you do not need "the best" investment bankers, traders, or lawyers—whatever that's supposed to mean—on the regulatory case. All you really need is good ones, and there are plenty of those. A certain doggedness, and a commitment to preserve systemic stability and enforce rules and regulations regardless of the wealth, prestige, or lung power of their charges would be necessary as well. Remember, you are not looking for the best traders, or the best M&A advisors, or the best derivatives structurers out there; you are looking for people who can understand what those people do and who can stand up to their counterparts across the negotiating table.³

For another, while pay should be very attractive, and likely many multiples of current front-line regulators' salaries, it does not need to equal that of industry practitioners. It can be paid 100% in cash, which dramatically shrinks the gap with nominally much bigger pay packets stuffed to the gills with unvested, restricted funny money. It can also be far less volatile than industry pay, since it should not depend on the vagaries of market performance the way real investment bankers do. Add to that the psychic compensation from working at a powerful, elite organization which generates fear and respect among its regulatees, and you will have a potent package. You might just be surprised how many top flight industry professionals apply for the job.

Now some people might object to the prospect of a federal agency staffed with lots of employees pulling down half a million dollars or more a year, as loadeddice observed. But the answer here is simple: for socially critical functions, money has never been an object when it comes to government spending. Just look at the military. By the same token, I would find it very easy to argue that the cost of a several dozen government employees earning more than the President of the United States is a very reasonable price to pay for financial and economic security. Unlike the military, however, you don't need to spend millions or billions on hardware to do the job. Instead, you spend millions on the software walking around in wingtips and Gucci loafers.

The most frequent objection among those who deigned to comment, however, was simply that—regardless of the attractiveness of my proposal—such a radical change "would never happen." Perhaps these naysayers are right. It certainly would ruffle a lot of feathers, both in the finance industry itself and in Washington, D.C. But I tend to think that is a good thing, and a reliable indicator of the value and importance of the plan, rather than a defect.

At the end of the day, I do believe most Americans actually prefer their government bureaucrats to be slow, bumbling, and ineffective. It reassures them they can stay one step ahead of City Hall, which, as we all know, you ordinarily should not try to fight. Smart, aggressive, and committed government employees terrify most people, because they have so many natural advantages without such personal qualities. The only solution to this, of course, is constant oversight, which is a sine qua non of my proposal.

¹ "Wholesale" means big commercial, investment, and universal banks, and any other systemically important financial entity. As opposed to retail oriented firms, which should be regulated by the CFPA or whatever bastardized, emasculated entity the political meat grinder decides to come up with. My focus here is on institutions which can bring the system down, not on the ones trying to screw Grandma out of her last $50,000.
² Even less in comparison to the tens of billions of dollars in compensation the systemically important financial institutions pay their own employees. A pittance, I tell you.
³ Sadly, given the revelations coming out of the Lehman examiner's report and other sources, this may actually be a very low bar. Perhaps we need regulators who are better than the "best" investment bankers.

US Oligarchs and their Minions

Simon Johnson, former chief economist for the International Monetary Fund and co-author of The Baseline Scenario takes American oligarchs to task in The Quiet Coup, Atlantic Monthly, May 2009. Johnson believes, going forward, that we should seek smaller, better-regulated banking/finance houses incapable of doing systemic damage, and overseen by a different set of oligarchs (Wiki link). Maybe? Or maybe we'll find a way to regulate bigger entities effectively? Or maybe we'll just set the stage for the next big mess? Who knows?

In any case we certainly need to find something to hope for. Burning existing oligarchs at the stake is likely out. So maybe just replacing them, rewriting regulatory rules, and starting over is the best we can hope for. Somehow I think that is where Team Obama will ultimately attempt to take us. In any case, read Simon's thought provoking, controversial article. Here is a somewhat-lengthy excerpt:

Becoming a Banana Republic
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

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.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a "buck stops somewhere else" sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for "safety and soundness" were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector's profits—such as Brooksley Born's now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.

The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry's ascent. Paul Volcker's monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.

Blame it on Greenspan and Bush

The blame game will go on and on, particularly as the mess world financial crisis deepens. But this, almost a month old from the Financial Times needs to be part of the record. Particularly since the Republican contenders for US President keep blaming it on the GSEs, Fannie Mae and Freddie Mac:

Oxley hits back at ideologues, Greg Farrell, Financial Times, Sept. 9: … Ohio Republican [Mike Oxley] who headed the House financial services committee until his retirement after mid-term elections last year, blames the mess on ideologues within the White House as well as Alan Greenspan, former chairman of the Federal Reserve.

The critics have forgotten that the House passed a GSE reform bill in 2005 that could well have prevented the current crisis, says Mr Oxley, now vice-chairman of Nasdaq.

He fumes about the criticism of his House colleagues. “All the handwringing and bedwetting is going on without remembering how the House stepped up on this,” he says. “What did we get from the White House? We got a one-finger salute.”

The House bill, the 2005 Federal Housing Finance Reform Act, would have created a stronger regulator with new powers to increase capital at Fannie and Freddie, to limit their portfolios and to deal with the possibility of receivership.

Mr Oxley reached out to Barney Frank, then the ranking Democrat on the committee and now its chairman, to secure support on the other side of the aisle. But after winning bipartisan support in the House, where the bill passed by 331 to 90 votes, the legislation lacked a champion in the Senate and faced hostility from the Bush administration.

Adamant that the only solution to the problems posed by Fannie and Freddie was their privatisation, the White House attacked the bill. Mr Greenspan also weighed in, saying that the House legislation was worse than no bill at all. …

HT: Paul Krugman

60 Minutes Does the Shadow Financial System

Last Night 60 Minutes aired an enlightening 12 min. spot on the Shadow Financial System — in which James Grant blames Wall Street investment houses, in the main, for the mess that not only bought the investment banks to the brink of ruin, but also all but wrecked (so far!) the worlds financial systems. It reminds me of an old line from Sci Fi author Robert Heinlein, paraphrasing, "People don't learn from the mistakes of others. They seldom learn from their own mistakes. Never underestimate the power of human stupidity."

As for mistakes, I agree with some of the 60 minutes interviewees that what happened at the top of the investment banks, and among some of their top traders, was likely more the stuff of outright graft and corruption than the stuff of mistakes. The big mistakes were made by the Fed, by the SEC, the so-called rating agencies, and others — in Congress and several Administrations who failed to see not only the bubbles they were blowing (Nasdaq, the housing bubble, and others around the world), but failed to regulate — were indeed actively deregulating — the financial markets. And not all the government players should be left out of the graft and corruption charges. Blame too a distracted American public more interested in watching "Reality" TV, sports and other amusements, than in watching what was happening to their government, to thier retirement funds, and so on.

Watch it:

Watch CBS Videos Online

Wall Street Must Shoulder Much of the Blame

Too often, Wall Street is not held accountable in our current mess. This blog and many others have vilified Alan Greenspan, Congressional mishandling of the GSEs, particularly Freddie Mac and Fannie Mae, and both the George W. Bush Administration and the William Jefferson Clinton Administration. Here is a recent account, squarely placing a big share of the blame on Wall Street:

The Ghost of Bankers Past, Herold Meyerson, The American Prospect, Sept. 25: … [President] Bush spent a good chunk of his speech last night telling the nation his version of how the nation got into this mess, and his account was conspicuous for omitting any reference to Wall Street's causal role in its downfall.

As Bush told the tale, "Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay. Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on."

"In today's mortgage industry," the president continued, "home loans are often packaged together and converted into financial products called mortgage-backed securities. These securities were sold to investors around the world.

"Many investors assumed these securities were trustworthy and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac" -- which provided investors with the illusion of security, Bush said.

And that's it. Borrowers and lenders and investors and Fannie and Freddie are to blame. …

But who cooked up the idea for the securitization of mortgages and reselling them half-a-dozen times in ever-more complicated securities the value of which were essentially indeterminable, but which enriched brokers every time they changed hands? Who came up with credit-default swaps, an utterly unregulated $62 trillion market insuring these bad deals, but with nowhere near the amount of capital needed in case the deals actually went sour? Who created all these new instruments of credit and debt to keep Americans consuming even as their incomes stagnated? Who created a world economy in which Asia produces (Wall Street liked that; the labor was cheap) and America consumes?

Hint: Not homeowners. Not the local mortgage companies. Not Fannie and Freddie. The answer, not that you'd know it from Bush's speech, is Wall Street. But then, had he blamed Wall Street, he might have had to extend the blame to the laissez-faire extremists who, in shaping Republican policy for the past quarter-century, encouraged and enabled Wall Street to run amok. He might have had to blame Ronald Reagan. He might have had to blame himself. Fat chance of that.

Bush's speech, in fact, was about as far as you can get from Franklin Roosevelt's 1933 inaugural address, in which FDR blamed at length "the money changers" who controlled America's financial system for driving the nation into a ditch. Last night, Bush told the nation that we had more to fear than fear itself. Only he didn't correctly identify who'd made it all so goddamn scary.

Remember too, as Barry Ritholtz so aptly explains (Barrons, Sept. 29), Wall Street was helped along for a long time by politicos on both sides of the aisle. Plenty of blame to go around! Now we need to begin the long process of fixing the mess — a process that will, hopefully, take up much time and much thought for the next Administration.

A Trillion Here, A Trillion There

Rumor has it that former US Congressman Everett Dirksen once quipped "… a billion here, a billion there, and pretty soon you are talking about some real money." In the last few years we've upped the ante. Now it's a trillion here, a trillion there — on the Wall Street Bailout, on the Iraq War, for instance. It looks like the NeoCons have at least insured that the government will be squeezed in times to come. Their dark dream of Starving the Beast, however, is not a short-term outcome though. Looks like the US government is getting ever-more-powerful by the day and by the year, in both military and financial arenas. Or maybe that was their real dream after all. Sad but likely true: Too few NeoCons will go to jail. Too many of the rest of us will suffer.

Here is Gretchen Morgenson's take on the latest phase of the mess in today's NY Times, subtitled Fixing Others' Mistakes:

…Treasury Secretary Henry M. Paulson Jr. [Paulson] has called the fund the "troubled asset relief program." I'll just call it TARP for short (you know, the kind of thing they spread over muddy fields so you don’t soil your Guccis). [Iverson note: Yesterday, Willem Buiter called it a TAD: Toxic Asset Dump ].

And depending on how TARP is operated, and how the assets are valued before taxpayers are forced to buy them, it could bloat our final bill for this mess while benefiting the very institutions that got us into it.
Yes, we need a smart plan and a concerted effort to get the frozen credit markets up and running. But we also have to be certain that the types of conflicts of interest that riddle Wall Street aren't visited upon TARP.

Consider: A bank wants to sell the TARPistas (also known as TAXPAYERS) a pile of stinky mortgage securities that it currently values at 60 cents on the dollar. Let’s assume that the most recent actual trade between market participants for similar assets was struck at 30 cents on the dollar.

So what's a fair price that we TARPistas should pay for the assets?

If we bought at 60 cents, a price that the bank would argue is appropriate, we would most likely face a loss. The bank, however, would be much better off than if it had to dump at 30 cents.

Conversely, if the assets were sold at 30 cents, taxpayers could wind up making a profit on the purchase if the assets performed better than expected over time. But the bank would have to write down the value of the assets as a result of the sale, possibly threatening its financial standing yet again.

Do you think, perchance, that financial services lobbyists might be working their Hill contacts right this very
minute to ensure that the TARP valuations are rigged in their favor?

You know the answer to that.

And you also know that we should steel ourselves for heavy losses as the TARP gets pulled over our eyes. Never mind that it was the banks, with their reckless lending and monumental leverage, that drove us into this ditch.

Such is our lot today: They break it. We own it. …

For background, here is yesterday's NY Times look at Hank Paulson and Ben Bernanke's recent takeover of the US financial system: A Professor and a Banker Bury Old Dogma on Markets .

Today Paul Krugman tells us that he isn't sure that the TARP isn't instead just the perverbial 'wool pulled over our eyes':

Thinking the Bailout Through: … Even without panic asset selling, the financial system would be seriously undercapitalized, causing a credit crunch — and this plan does nothing to address that.

Or I should say, the plan does nothing to address the lack of capital unless the Treasury overpays for assets. And if that's the real plan, Congress has every right to balk.

So what should be done? Well, let's think about how, until Paulson hit the panic button, the private sector was supposed to work this out: financial firms were supposed to recapitalize, bringing in outside investors to bulk up their capital base. That is, the private sector was supposed to cut off the problem at stage 2.

It now appears that isn’t happening, and public intervention is needed. But in that case, shouldn't the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside?

Let's not be railroaded into accepting an enormously expensive plan that doesn’t seem to address the real problem.

Yves Smith hates the Paulson/Bernanke plan too, and tries to help us better understand why:

Why You Should Hate the Treasury Bailout Proposal …First, let's focus on the aspect that should get the proposal dinged (or renegotiated) regardless of any possible merit, namely, that it gives the Treasury imperial power with respect to a simply huge amount of funds. $700 billion is comparable to the hard cost of the Iraq war, bigger than the annual Pentagon budget. And mind you, $700 billion is not the maximum that the Treasury may spend, it's the ceiling on the outstandings at any one time. It's a balance sheet number, not an expenditure limit.

But here is the truly offensive section of an overreaching piece of legislation:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

This puts the Treasury's actions beyond the rule of law. This is a financial coup d'etat, with the only limitation the $700 billion balance sheet figure. The measure already gives the Treasury the authority not simply to buy dud mortgage paper but other assets as it deems fit. There is no accountability beyond a report (contents undefined) to Congress three months into the program and semiannually thereafter. The Treasury could via incompetence or venality grossly overpay for assets and advisory services, and fail to exclude consultants with conflicts of interest, and there would be no recourse. Given the truly appalling track record of this Administration in its outsourcing, this is not an idle worry.

But far worse is the precedent it sets. This Administration has worked hard to escape any constraints on its actions, not to pursue noble causes, but to curtail civil liberties: Guantanamo, rendition, torture, warrantless wiretaps. It has used the threat of unseen terrorists and a seemingly perpetual war on radical Muslim to justify gutting the Constitution. The Supreme Court, which has been supine on many fronts, has finally started to push back, but would it challenge a bill that sweeps aside judicial review? …

And Robert Reich said on Thursday that The Bailout of All Bailouts leaves too much room for future Wall Street shenanigans, for future "moral hazard."

… A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street — essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn't get left holding the bag. And there would be no "moral hazard" incentive for future financial wizards to take giant risks with other taxpayers' money.

Today Reich lays out five conditions that ought to be placed on any Bailout:

What Wall Street Should Be Required to Do, to Get A Blank Check From Taxpayers … 1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.

2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?

3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?

4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.

5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. …

I can't wait to see what the next few weeks/months bring. "Interesting Times" indeed! Looks like a good time for me to resume this blog…