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).

 

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.]

Reinstate Glass-Steagall: Roubini says yes

I have been keeping an eye on various proposals to "reinstate" Glass-Steagall for quite some time. Sometime I ought to post a more comprehensive list as to who is in favor (and in what sense) and who is opposed. Clearly the folks at New Economic Perspectives (from Kansas City and Beyond) are so inclined. So too Nouriel Roubini, as reported by Tech Ticker, 4/11:

Roubini supports the 'Volcker Rule' which would force banks to stop proprietary trading. "Why should you use taxpayer money to essentially subsidize risky prop trading?," he asks.

Roubini goes even further, saying Congress should reinstate Glass-Steagall which separated commercial banking from investment banking. "If Goldman Sachs wants to be a hedge fund, so be it, but there should be a level playing field," he argues. "Other hedge funds don't borrow at zero rate with the guarantee of the government."

For more on the "Volcker Rule", and financial reform: 5/13 CNN Money video featuring Senator Ted Kaufman, D-Del that is worth a look, and 5/11 link featuring Nouriel Roubini.

Paul Krugman's ideas seem to differ a bit, and seem to be where the Obama Administration is trying to lead Congress. Here's Krugman, Financial Reform 101, 4/1:

It's easy to see where concerns about banks that are "too big to fail" come from. In the face of financial crisis, the U.S. government provided cash and guarantees to financial institutions whose failure, it feared, might bring down the whole system. And the rescue operation was mainly focused on a handful of big players: A.I.G., Citigroup, Bank of America, and so on.

This rescue was necessary, but it put taxpayers on the hook for potentially large losses. And it also established a dangerous precedent: big financial institutions, we now know, will be bailed out in times of crisis. And this, it's argued, will encourage even riskier behavior in the future, since executives at big banks will know that it’s heads they win, tails taxpayers lose.

The solution, say people like Mr. Volcker, is to break big financial institutions into units that aren’t too big to fail, making future bailouts unnecessary and restoring market discipline.

It's a convincing-sounding argument, but I'm one of those people who doesn’t buy it.

Here's how I see it. Breaking up big banks wouldn’t really solve our problems, because it’s perfectly possible to have a financial crisis that mainly takes the form of a run on smaller institutions. In fact, that’s precisely what happened in the 1930s, when most of the banks that collapsed were relatively small — small enough that the Federal Reserve believed that it was O.K. to let them fail. As it turned out, the Fed was dead wrong: the wave of small-bank failures was a catastrophe for the wider economy.

The same would be true today. Breaking up big financial institutions wouldn’t prevent future crises, nor would it eliminate the need for bailouts when those crises happen. The next bailout wouldn’t be concentrated on a few big companies — but it would be a bailout all the same. I don’t have any love for financial giants, but I just don’t believe that breaking them up solves the key problem.

So what's the alternative to breaking up big financial institutions? The answer, I'd argue, is to update and extend old-fashioned bank regulation.

And this is exactly what the Senate is now doing. Sort of. Economics of Contempt (EoC) is generally OK with regulatory reform that doesn't get too bizarre. On the other hand, EoC is particularly against the Sen. Blanche Lincoln's "Section 106" proposal as per derivatives. To EoC, 5/8:

Bloomberg has an excellent story on the origins of Blanche Lincoln's disastrous swaps proposal (the infamous "Section 106") — Bloomberg: How ‘Hard to Fathom’ Derivatives Rule Emerged in U.S. Senate. Short version:

The idea arose from a mix of policy debate, campaign politics and personal relationships -- and little consideration of the business or economic implications, according to interviews with Senate aides, administration officials and industry lobbyists.

Read the whole article. Oh by the way, Paul Volcker has now also come out against Section 106. Sheila Bair penned a letter to Lincoln sharply criticizing Section 106 last week, and the Fed circulated a memo on the Hill a couple weeks ago arguing that Section 106 should be deleted. …

The whole point is that Section 106 doesn't distinguish between prop trading and market-making. It bans banks from doing both. [Robert] Reich clearly has no clue what Lincoln's Section 106 proposal is even about — and yet he's already declared that failing to support it would be "pandering to Wall Street."

Look, this isn't difficult. Swaps are a critical part of modern banking. Just like normal commercial lending requires banks to serve as intermediaries between savers and borrowers, the swaps market also requires intermediaries (known as dealers, or market-makers). These intermediaries borrow short and lend (through swaps) long; they are susceptible to runs; and their disorderly failure can cause severe collateral damage to the real economy. Pretending that swap dealers aren't engaged in an important banking function by refusing to call them "banks" is not just delusional, it's also dangerous. And yet this is what Blanche Lincoln's Section 106 proposal aims to do.

Maybe Section 106 won't last long. According to one source, 5/12 "Reuters was reporting Monday that … Section 106, is going to get excised, perhaps this week."

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.

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.

Financial Regulation – Principles

This morning I am watching CSPAN's coverage of US Treasury Secretary Geithner at a House Committee on Financial Services hearing on financial regulation and systemic risk. Watch Geithner's opening statment here (via Yahoo! News).

Yesterday, over at Mother Jones Kevin Drum laid out some principles to guide new financial regulation. Drum suggested three and asked readers for more:

- Firmer Regulation Over Leverage, wherever and however it occurs. [To increase] capital adequacy ratios, … lead to similar oversight of hedge funds; ̷ overhaul how capital and assets are calculated; [regulate] effective leverage embedded in complex derivatives; [add] rules about off-balance-sheet vehicles; and so forth.

- Stronger Commitment to Act Countercyclically. …to force the Fed to keep an eye on asset inflation as well as goods inflation; a dedication to limiting credit expansion as well as credit destruction; capital adequacy rules that weren't merely stronger, but that tightened during expansions and loosened during contractions; and stronger down payment requirements for mortgage loans.

- A recognition that the global financial system could stand to have a little more sand in its gears. Something to slow it down just a little bit, … like a small transaction tax [Iverson here: e.g. a Tobin Tax (Wiki link) -- that could act in part as an insurance premium to tax payers against the risk that the tax payer will be required to bail them out]; exchange trading for credit derivatives; and stronger transparency rules.

Here is a combined "Eight Regulatory Principles" list, edited slightly:

• Firmer Regulation Over Leverage, (wherever and however it occurs, e.g. higher capital and margin (leverage) requirements that might be even higher for very large firms/entities that pose potential systemic risk)
• Stronger Commitment to Act Countercyclically (to lean against the wind during both "irrational exuberance" and "irrational pessimism", including adding "asset bubbles to diagostic toolkit)
• Better Control of Cross-border Capital Flows
• Better Firewalls Between Financial Businesses
• Holding Credit Rating Agencies and Auditors Accountable for their Judgments
• Making Financial Transactions as Transparent as Possible (like making them exchange traded, or having adequate clearing houses outside exchanges)
• Better Means to Discourage Speculative-runs-to-ruin (on corporations that show signs of relative weakness during market breakdowns)
• Reformed Incentives for Financial Executives, large in-house traders, etc. (e.g. require some bonuses to be paid in restricted stock that can only be liquidated in say 10 years.)
  

One of Drum's reader suggested three tactical moves. I'll add a fourth:

- Reinstate the Glass-Steagall Act in its final form (prior to repeal)
- Repeal the Gramm-Leach-Bliley Act
- Repeal Commodity Futures Modernization Act of 2000, which enabled unregulated market in credit default swaps, among other things
- Develop more flexibility in"Fair Value Accounting", mark-to-market accounting (e.g. to disallow entities to appear ever-more-wounded during bear raids)

From written testimony and verbal responses to questions, it looks to me like Geithner and Co. intend to cover most if not all the bases outlined in the principles above. But intentions must turn to action! We need to keep watch, as well as to add voice to make for better regulation, better action, and better oversight not only of government but of the private entities entrusted with our money.

PS. In March 23 WSJ online, George Soros offers insight into "Means to Discourage Speculative-runs-to-ruin" by regulating Credit Default Swaps.

------------------------
Update, 3/19/2011: Today, in Stop Killing Messengers, I added two more:

• Protecting Rewarding Whistleblowers
• Hiring High-power Talent

Finally, I'll add that I really don't support reinstating Glass-Steagall, but instead creating a modern version of it.

Why I Still Believe in Team Obama

For quite some time I have been giving Ben Bernanke and Tim Geithner passes, every bit as much as I did not give passes to Alan Greenspan. I believe that Team Obama—Larry Summers, Christina Romer, Ben Bernanke, Tim Geithner—see the error of their past ways, AND are savvy enough to guide us, in concert with others, however painfully into the next era of regulated finance.

I am not yet ready to declare capitalism dead. Still, I am very glad to see the gleeful "free market screech-monkey" chatter quieted.

But I just watch this stuff. I'm no expert. I glean advice and seek wisdom from post-Keynesian and other economists, from financial historians, and from those who dabble in complex system theory. I am first to recognize that what I hope to be true will likely not be—In this case trusting my (and your) fate to Team Obama.

If Paul Krugman is right, then I'm wrong to trust in Team Obama. If Jamie Galbraith is right, then I will be most certainly proven wrong if only for this reason:

…The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?

End Note on Free Market Fundamentalism: While looking for a good source on Free Market Fundamentalism, I found this note (5/23/2007) I dropped into Yves Smith's naked capitalism:

[W]e Americans have gravitated to a faith-based society/culture. And a big part of that "faith" transfers directly from religious fundamentalism to free-market fundamentalism (Wiki link): Government sucks, markets do it best/right.

If that thesis is correct, then American politicians (whether pandering to the religious right or themselves "true believers" in free-market fundamentalism) tend to shy away from redistributive policies/practices.

What will shake the faith, I don't know. I've been a believer for quite some time that we've got a hell of a problem here in the US with theological Millennium fever. Free-market fundamentalism is symptomatic of the bigger problem.

See also Market Fundamentalism v. Sustainable Development and my Economic Fundamentalism: Too Many False Prophets.

{Update, 3/24/07}: Better Still, read Steve Keen's recent Neoclassical Economics: Mad, Bad, and Dangerous to Know

Ten Trillion and Counting!

Tuesday, PBS Frontline will investigate what it means to add, in the next five years, 10 trillion dollars more debt to the American banking, political and social systems. See Ten Trillion and Counting. In the meantime we experience each day an ever-weakening US dollar, and ever-shrinking job/income picture for middle-class Americans, and an ever-more-anemic US consumption engine for the world economy.

What are to make of it?  One view, see Brad DeLong for example, paints this as a Keynesian economists dream.  DeLong see this as a chance to flood the world with money just in time to avert a total system collapse.  And then a chance to monitor the situation closely to ward off any hyperinflationary consequences that might accrue from the move. (Or maybe I'm putting words/ideas into DeLong's mouth?)

On the left, Paul Krugman sees the situation more darkly. Krugman believes that the Obama Administration, following the lead from the Fed (Ben Bernanke) and the Treasury (Tim Geithner)  continues to dither

…[I]f you think that the banks really, really have made lousy investments, this won't work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that's the Swedish solution, it's what we eventually did with our own.

On the right, Doug Noland sees this as hopelessly misguided as well:

…Washington fiscal and monetary policies are completely out of control.  Apparently, the overarching objective has evolved to one of rejuvenating the securities and asset markets and inciting quick economic recovery.  I believe the principal objective should be to avoid bankrupting the country … our policymakers and pundits are operating from flawed analytical frameworks … completely oblivious to the risks associated with the current course of policymaking.

There is indeed great hope policymakers will succeed in preserving the current economic structure.  On the back of massive stimulus and monetization, the expectation is that the financial system and asset prices will stabilize.  The economy will be, it is anticipated, not far behind.  And the seductive part of this view is that unprecedented policy measures may actually be able to somewhat rekindle an artificial boom — perhaps enough even to appear to stabilize the system.  But seeming "stabilization" will be in response to massive Washington stimulus and market intervention — and will be dependent upon ongoing massive government stimulus and intervention.  It's called a debt trap.  …Hyman Minsky would view it as the ultimate "Ponzi Finance."

… [O]ur highly inflated and distorted system requires $2.0 TN or so of Credit creation to hold implosion at bay.  It is my belief that this will ONLY be possible with Trillion-plus annual growth in both Treasury debt and Federal Reserves liabilities.  Private sector Credit creation simply will not bounce back sufficiently to play much of a role.  Mortgage, consumer, and business Credit — in this post-Bubble environment — will not re-emerge as much of a force for getting total system Credit near this $2 TN bogey.  In this post-Bubble backdrop, only government finance has a sufficient inflationary bias to get Trillion-plus issuance.  But the day that policymakers try to extract themselves from massive stimulus and monetization will be the day they risk an immediate erosion of confidence and a run on both government and private Credit instruments.  Also as I've written, once the government "printing press" gets revved up it's very difficult to slow it down.  This week currency markets finally took this threat seriously.

I don't know.  For some strange reason, given what I've written here on this blog the last few years, I am still pinning my hopes on Bernanke and Geithner.  I hate the idea of $10 trillion more debt, but I hope that it serves as a systems stabilization mechanism while the longer-term deals are worked out to reset our financial systems (see Ken Rogoff interview noted below.)

For those who want a very good refresher as to why we got into this mess, see Joseph Stiglitz, 'Capitalist Fools', Vanity Fair, Jan 2009  Here is a timeline of events, drawn from Stiglitz that ought to be (hope springs eternal) the subject of an upcoming Congressional hearing:

• 1987 - Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place … "Volcker … understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand. … Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble."
• 1993 – "When I [Stiglitz] was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives [credit-default swaps, and so forth] posed a danger. We didn't put it as memorably as Warren Buffett —who saw derivatives as 'financial weapons of mass destruction'—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with "innovation" in the financial system.
• 1998 - Brooksley Born, head of the Commodity Futures Trading Commission called for derivatives regulation—"a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition."
• 1999 (November) - Congress repealed the Glass-Steagall Act. "Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest."
  … "The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking."
• 2001 (June) - "[W]ith a follow-on installment two years later, [President bush] and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches."
  … "The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement."
• 2002 (July 30) - "[I]n the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. … "[I]n the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are 'incentive pay' in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
  "The incentive structure of the rating agencies also proved perverse. Agencies such as Moody's and Standard & Poor's are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds."
• 2004 (April) - the Securities and Exchange Commission "allowed big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process."
• 2008 (October 3) - The Bush administration's response to the crisis itself. "Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America's banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not. The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, 'cash for trash,' buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
  "The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up."

If such a Congressional hearing were to happen, I'd like to see some name-economists, Administration supporters and detractors from left and right, as well as US government officials past and present, asked at each point along the timeline:What were you thinking? Why were you thinking it? And how would you now rethink it?

For perhaps the best insights as to where this may go, see the Ken Rogoff video interview on PBS NOW, Mar 14 (23 min)

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

Jim Cramer's Rant: 'Fiction in Financials'

Normally I'm not one to recommend financial madman Jim Cramer's rants. But I'll make an exception today for: Cramer Rages on Banks: 'Where's the SEC?!'. The video feed (embedded in the CNBC post) is well-worth a few minutes of your time, even to endure a short ad at the beginning. The CNBC post begins, "Why isn't the Securities and Exchange Commission getting more involved in the whole banking sector writedown situation? Especially since the numbers are likely to get worse, not better? That's what Jim Cramer, CNBC's resident stock guru, wants to know." Then continues:

… "It's all fiction!" [Cramer] declared during a forceful exchange ….

"How can we have these levels of fiction in financials after Sarbanes-Oxley? How do people get away with this? How do they live with themselves?"

Cramer made his comments while reviewing results from Merrill. But his real consternation surrounded the insurers who cover banking investments. Some of those insurers haven't come clean about their liabilities, Cramer speculated. Eventually they will, and then the "fiction" will disappear, he said.

The banking sector and its related industries are all too chummy, Cramer accused. That led the numbers related to mortgage investments -- investments that are currently souring -- to break from reality.

"I think the financial guys all belong to the same club and they got to protect each other," he said.

Worse, those executives behind the current credit crunch are unlikely to get any punishment for their mistakes and disingenuousness about their numbers, Cramer opined.

"I'm fed up with it. The American people should be fed up with it. And the SEC should be fed up with it," Cramer said.

"This is what the SEC is supposed to protect us from," he added. …

P.S. Cramer takes aim too at so-called "mortgage insurers".

Hat Tip: Paul Kedrosky, Infectious Greed.