Hot dogs for fans waiting for gates to open for Game Two of World Series between Cleveland Indians and Brooklyn Robins (later Dodgers) at Ebbets Field, New York City
Ilargi: In the days leading up to President Obama's inauguration, Christina Romer, since then appointed as chairwoman of the White House Council of Economic Advisers, told the media that the new administration was in uncharted waters, since a situation such as the one they inherited had never before taken place. In a 1994 paper for which she studied 50 past recessions, Romer stated that stimulus plans historically don't seem to be effective.
Today, she has changed her views, and not a little bit. She's fully behind all of Obama's stimulus plans, of which she told FOXNews this morning: "We absolutely think that they are going to do the job for the American economy”, adding she feels "incredibly confident" that they will. On another show, CNN’s State of the Union, Mrs. Romer went one step further, claiming she has "every expectation, as do private forecasters, that we will bottom out this year and actually be growing again by the end of the year."
It was Romer's second consecutive Sunday on the talk show circuit (last week's gem was "It is an economic war. We haven’t won yet. We have staged a wonderful battle."), and it's hard not to get the impression that she's being pushed into the public eye because she's one of the few faces in Obama's economic team who's not yet perceived as 'damaged goods'. Still, if and when someone on that team changes her ideas so fast and so drastic, that may not last long.
I have no idea why Romer, perhaps coached by the spin crew, deems it appropriate to now claim economic growth in the US by the end of 2009. It looks to me like a bet you can only lose, and, what's more, one you have no need to make. It would be perfectly understandable for everyone if she had said it won't be before 2010, no-one would reproach her for that. Perhaps it just smells of the increasing despair in the administration, but then again, that maybe should be reason to be careful with what is said by those whose reputations haven't yet been tainted, like those of for example Summers and Geithner have.
Presumably the growth factor religion is so strong among decision makers in Washington that they can't help themselves from uttering the word "growth" from time to time, almost like Tourette patients. Perhaps that's why they seem willing to ignore the notion that mentioning the word gets riskier all the time. If you keep talking about it, people will want to see the real thing one day. And there lies the main problem to date of the Obama administration: a lot of words, and preciously few tangible results.
The waters haven't gotten one inch more familiar or less uncharted since Christina Romer talked about them 10 weeks ago; on the contrary, things have demonstrably gotten much worse, and still she all of a sudden tries to look convinced that the course the ship has taken is the right one. Pure and abstract faith takes the day once more. Either that or the chairwoman is lying to our faces.
In the light of the coming week, in which Timothy Geithner will present his already heavily disputed $1 trillion+ toxic assets plan, and in which the president is set to present his $3.6 trillion+ budget on Capitol Hill, the reasoning behind Mrs. Romer's words is hard to fathom. She may fool ordinary people, but nary a soul in the Capital will take her seriously, perhaps ever again. It feels a little like a scorched earth strategy.
The administration, in the surprisingly small window of 8 weeks and five days, has only one surefire asset left -that is, at least for now-, and that is of course Obama's popularity and the belief and confidence Americans have in him personally. It looks more and more obvious that there is one thing only that can preserve that faith, and that is transparency, honesty, telling people how things truly stand in the country. Christina Romer's words are one more sign in a long line that we shouldn't be holding our breath waiting for it.
The Escalator of Life Is Going Down
We're riding on the escalator of life
We're shopping in the human mall
We're dancing on the escalator of life
Won't be happy 'til we have it all
We want it all
Escalator of life - up and down
Escalator of life - round and round
There's 111 choices
Don't listen to those little voices
I don't let the guilty feeling shake me
You can have your cake and eat it baby--Robert Hazard – Escalator of Life
Americans have been on the escalator of life for the last 30 years. The escalator has been going up for the vast majority of that time. Since Ronald Reagan was President, the escalator has been moving upwards with only a few momentary breakdowns. We wanted it all. We believed it was our right to have it all. Americans did whatever it took to have it all. That meant an explosion of household debt promoted by bankers, the Federal Reserve, politicians, the media, and Presidents. We were dancing on the escalator of life for decades but our shoelace got caught in the escalator last year and severed our foot. We are bleeding to death as the escalator heads relentlessly downward. There are millions of Americans who have a guilty feeling about how they have lived their lives. They had their cake and tried to eat it too. Americans are now repenting by dramatically reducing their spending. The U.S, government is desperately attempting to convince Americans to get back on the escalator.
The financial system has stopped functioning because no one trusts anyone else. The rules are changed by the Treasury and Federal Reserve on a daily basis. It seems like every company in America has converted into a bank so it can acquire a slice of the taxpayer funded pie called TARP. The government has been using all the tools at their disposal to dig the country out of this hole. If they dig too far, the stimulus could blow up in a torrent of inflation.
Which Assets Are Toxic?
In the last nine years U.S. financial institutions became extremely creative with their financial “products”. They were encouraged by Federal Reserve Chairman Alan Greenspan who was sure that any regulation other than self-regulation would be counterproductive. In the bully pulpit was our first Harvard MBA President George Bush, proclaiming the benefits of free market capitalism while not being able to pronounce or spell derivative, let alone understand them.
Watching over the creative bankers was the eagle eyed SEC, which had just received accolades for the Enron and WorldCom scandals. This trusting bunch of morons, hoping to one day get cushy jobs on Wall Street, decided that the investment bankers should be allowed to leverage their assets 30 to 1, rather than the overly restrictive 12 to 1 that had been in place for decades. Their models, created by overly confident MBAs, assured them that nothing could go wrong.
The final piece of the puzzle was obtaining a AAA rating for these new “products” from the staid old rating agencies Moody’s and S&P. These two companies had a very predictable boring revenue stream. Their CEOs wanted a little excitement in their lives, and maybe, just maybe, big bonuses and stock options. They decided to jump head first into rating the new indecipherable products. They also had their cock sure MBAs creating models which assured them that all was well. Surprisingly, after being paid billions in fees, the rating agencies provided AAA ratings across the board to all of the new investment products.
The Wall Street geniuses peddled MBSs, CDSs, and CDOs, to pension plans, cities, states, foreign banks, foreign villages, and anyone else who wanted to get in on the easy money. With AAA ratings, no one bothered to conduct due diligence and understand what could go wrong. The amount of derivatives outstanding rocketed from $40 trillion in 2000 to $684 trillion in 2008. It has been reported that 80% of all Credit Default Swaps outstanding in 2008 were speculative. There was no hedging going on. Wall Street had become a Las Vegas casino. Credit default swaps totaling $440 billion were written by AIG. These were pure speculative bets and the American taxpayer is still paying off. The bill is up to $160 billion so far. The executives at AIG must have exceeded their loss goals, because the American taxpayer is paying $165 million in retention bonuses to executives of the unit that nearly collapsed the worldwide financial system. Why would anyone want to retain these executives? If these people were asked, “How do you sleep at night?” they would respond, “On a big pile of cash”.
The economy, juiced by low interest rates, mortgage brokers handing out loans like candy, investment banks packaging thousands of worthless subprime loans into AAA products, auto companies putting deadbeats in Cadillac Escalades with no money down, and consumers sucking $3 trillion of equity from their ever increasing home values, appeared unstoppable. Home values doubled in five years. The Dow Jones reached 14,000 in October 2007, Treasury Secretary Hank Paulson was touting the fundamentally sound American economy, and Federal Reserve Chairman Ben Bernanke said there might be a minor blip from slight weakness in the housing market. As the economy was sailing along at seventy miles per hour, it hit something in the middle of the road. A Bear Stearns hedge fund blew up. The Wall Street gurus and government bureaucrats assured the public that all was well.
Congress, the Treasury, the Federal Reserve, and two Presidents have tried to convince Americans that the financial system is no longer infected with toxic germs. They have committed $11.6 trillion of your tax dollars to try and make the system kissable again. It hasn’t worked. They can pour another $11 trillion into the system, and probably will, but the trust in gone. The American public will no longer trust anything they are told by Wall Street, the Treasury, the Federal Reserve or Congress. We’ve been lied to, fleeced of our retirement savings, and now told to foot the bill for the criminals on Wall Street – for the good of the country. Enough is enough. The ruling elite from government and big business urgently want Americans to regain confidence and return to borrowing and spending. They again missed the train. Saving, frugality and living within your means are back. This will destroy entire industries built upon a foundation of overspending and debt. Too bad. Good old fashioned American individuality and love of liberty will revive the country, not TARP, TALF and whatever other programs the government tries to peddle.Source: Barry Ritholtz
We know what has happened in the last eighteen months. We still don’t know what toxic assets still remain in the system we don’t know about. The banks’ balance sheets are a black box, they have billions in off-balance sheet “assets”, and the commercial real estate market is just starting to collapse. The ever optimistic cheerleaders on CNBC would rather extrapolate four up days in a row into a new bull market, than examine the facts staring them in the face. No wonder Jon Stewart had such an easy time obliterating Jim Cramer and the whole network. Banks were handing out construction and land development loans between 2004 and 2007 at twice the rate of residential mortgage loans. With Americans losing jobs at a record pace, corporate bankruptcies soaring, and retailers bearing the brunt of consumer deleveraging, commercial real estate loans will begin to go bad late in 2009 and through 2010.
Bad mortgage loans have been the primary driver of the financial crisis so far. The nice little pie chart that follows shows that residential mortgages make up only 26 percent of bank loan portfolios. Commercial, non-residential real estate and construction loans total 40 percent of bank loan portfolios. These loans will provide the next leg down in this death spiral. Anyone who can’t see this coming is just not looking.
The credit card losses are confined to a few major players. Citicorp, Bank of America , American Express and Capital One will face the music when the credit card debt bubble bursts all over their faces. U.S. credit card defaults rose in February to their highest level in at least 20 years. AmEx, the largest U.S. charge card operator by sales volume, said its net charge-off rate, debts companies believe they will never be able to collect -- rose to 8.70 percent in February from 8.30 percent in January. Citigroup’s default rate soared to 9.33 percent in February, from 6.95 percent a month earlier. Analysts estimate credit card charge-offs could climb to between 9 and 10 percent this year from 6 to 7 percent at the end of 2008. In that scenario, such losses could total $70 billion to $75 billion in 2009. Meredith Whitney estimates that Americans' credit card lines will be cut by $2.7 trillion, or 50 percent, by the end of 2010. The pain has only just begun. Prepare to bailout more banks with your tax dollars.
Even though we know that adjustable rate mortgages were a major cause of the financial crisis, the storm has not passed. Just because the problem is obvious, doesn’t mean it is not a problem. The chart from T2 Partners produced about one year ago shows that we are now in a lull for adjustable rate mortgage resets. There will be another crescendo of resets in 2010 and 2011. When banks ask for more taxpayer money to sure up their balance sheets in 2010, Timmy Geithner will be wearing his best “shoulda guessed” face when he gets the call from Citicorp.
After a year of frantic juvenile attempts to revitalize our financial system with your tax dollars, the government has accomplished nothing but driving our National Debt to obscene levels exceeding $11 trillion, on its way to $15 trillion by the end of Obama’s 1st term. All of the stimulus, TALFs, TARPs, TAFs, nationalizations, guarantees and printing of dollars will eventually explode in the faces of our leaders in one toxic geyser. The events of the last week show how warped the world gets when government owns private businesses. The U.S. owns AIG. The CEO, placed there by the U.S., pays out $165 million in bonuses to executives who nearly brought down the worldwide financial system. Government officials are outraged and appalled going on every TV show they can find to register their disgust. They are so used to sitting on the sidelines and criticizing the coach, they don’t even realize they are the coach.
Last week, another government owned company, Freddie Mac, reported a quarterly loss of $24 billion and demanded another $30 billion of taxpayer money. I didn’t hear Barney Frank on CNBC outraged at those results. As the government socializes the losses of corporations and Ben Bernanke attempts to create inflation, the deterioration and ultimate collapse of our economic system is pretty much a lock. Only the timing is uncertain.
Americans, from the country’s founding, have always cherished liberty over dependency. Personal responsibility and self reliance had forever been the hallmarks of the American population. Since 1913 when the Federal Reserve was created and the Federal income tax was implemented, Americans have been slowly and insidiously made dependent upon the government and criminal bankers running this country. Government has taxed and borrowed to implement policies and programs that make people more dependent on them and increased government’s control over our lives. Bankers have marketed debt as the way for Americans to live the good life. Americans have become serfs, ever indebted to the lords of the manor in Washington DC and on Wall Street. Until Americans decide to choose liberty and freedom over relying on government to solve all our problems, the country will continue on its path to socialism and bankruptcy.
Since the start of this financial crisis, government bureaucrats, Congressmen, Federal Reserve chairmen and have tried to hide the debris of our economic system in the woods. Nothing has worked. Bad mortgage loans, bad car loans, bad commercial loans, and bad credit card debt cannot be hidden. They must be written off. Letting banks pretend it isn’t bad debt has just led to more uncertainty in the markets. The smoke and mirrors that Treasury and the Federal Reserve have used to fool the public into trusting the banking system have not worked. Now they want to change the rules of the road.
All attempts to change the rules have backfired. The SEC outlawed short selling to stop the stock market from going down. The market accelerated downward, with no possibility for short covering to stop the fall. Hank Paulson forced banks to take billions of taxpayer dollars whether they wanted it or not. This was supposed to bring confidence in the system back. It didn’t. The government took over AIG, Fannie Mae, and Freddie Mac, deciding they could run them better than the existing horrible managements. These moves have already cost the American taxpayer a quarter trillion dollars. With many more billions to be poured down these rat holes.
The financial system is gridlocked. Four lanes have suddenly converged into two lanes and the drivers are angry. The AIGs of the world went from selling plain vanilla insurance to making bets with every major bank in the world along with guaranteeing risky bets by these same banks. Fannie Mae and Freddie Mac went from providing liquidity to the mortgage markets so that average Americans could buy a house to a Democratic Party tool used to provide mortgage loans to poor Democratic constituents so they could win more votes in the next election. Investment banks went from investing in productive business ventures to creating fake credit instruments designed solely to generate monstrous fees and bonuses for executives.
The rating agencies Moody’s and S&P went from the boring business of rating corporate bonds and generating 10 percent annual growth to giving AAA ratings to indecipherable derivative products that were then sold to pension plans and schools. Mortgage brokers went from helping match worthy borrowers with the best mortgage to criminals pushing no doc stated income adjustable rate mortgages on people who could never possibly afford a home. Consumers went from utilizing credit for just home purchases with 20% down to utilizing credit for multiple home purchases with nothing down, utilizing credit for car purchases with nothing down, and utilizing credit to buy every electronic gadget, kitchen appliance, and other toys flaunted by neighbors. The rules of the road were changed during rush hour causing chaos and confusion. Until honesty, integrity, and morality are again restored to our financial and governmental systems, gridlock and distrust will reign.
Where’s My Net Worth, Dude?
Americans are wondering where their net worth went. They can’t find it anywhere. It dissipated into thin air. It never really existed. Does that make you feel better? American households lost $11.2 trillion of net worth in 2008, and net worth is now below 2004 levels. The 17.9% drop in net worth during 2008 is mind boggling and will have a drastic impact on the future trajectory of household consumption and saving. Nearly 25% of the loss in net worth was from real estate, and equities and mutual fund shares made up 50% of the loss.
The dramatic rise in net worth coincided with the biggest debt bubble in history. Home ownership reached an all-time high of 68% in 2005. Stock ownership is still in the 50% range, so the downturn in housing values is affecting many more people than the 2000-2001 dot.com collapse. As you can see, home values fall but the debt remains the same. With at least another year of falling home prices, the number of people underwater on their home mortgages will reach 25 million, or one-third of all the houses in the United States. You won’t hear Mustard Seed Kudlow or Mad Money Cramer telling you this.
President Obama and Democrats in Congress passed a $787 billion pork filled calamity that will contribute to an explosion of our financial system. Very little of this socialist’s dream will help the U.S. economy in 2009. Vast sums will be allocated to unnecessary make work projects throughout the country. Picture thousands of Ralphs taking their time on construction projects while six guys stand around watching one guy using a jackhammer. Every construction project in the country will be a union job. This means 40% more expensive and a 40% longer timeline. When the majority of this stimulus hits in 2010 and 2011, along with Bernanke’s humongous printing of dollars we will hear a rumble before inflation erupts across the globe.Oh The Humanity!
The American economy hit debris in the road years ago. Instead of pulling over and taking care of the problems before they became a crisis, our leaders ignored the problems. Government overspending, ignoring $56 trillion of unfunded liabilities, funding over-expenditures with money borrowed from foreigners, not addressing crumbling infrastructure, not creating a cohesive energy policy, and over-reaching in empire building were the fuel that led to our economy bursting into flames before our very eyes. President Obama and his minions in Congress scream, “Oh the humanity”, and take your hard earned money and redistribute it to the fools who created the tragedy.
It’s My Life
Tomorrow's getting harder make no mistake
Luck ain't even lucky
Got to make your own breaks
It's my life
And it's now or never
I ain't gonna live forever
I just want to live while I'm alive
(It's my life)
My heart is like an open highway
Like Frankie said
I did it my way
I just want to live while I'm alive
'Cause it's my life
Better stand tall when they're calling you out
Don't bend, don't break, baby, don't back down
--It’s My Life – Bon Jovi
The American people are at a crossroads. It’s our lives, not the governments. The country is headed on a path toward government running everything in our lives. Now is the time to stand tall. Barack Obama, Ben Bernanke, and Nancy Pelosi can not make us spend money we don’t have. We can force the painful restructuring of our economy on our politician leaders. They can stimulate, print, and urge you to spend, but we don’t have to listen. We can throw them out of office in 2012. If the new set of clueless morons doesn’t do what is right, we can throw them out too. We must heed the warning of Founding Father Thomas Jefferson.
A government big enough to give you everything you want, is strong enough to take everything you have.
Christina Romer: US economy will be growing again by the end of the year
President Obama’s lead economist predicted Sunday that the nation’s struggling, recessionary economy will be growing by the end of the year. "I have every expectation, as do private forecasters, that we will bottom out this year," Christina Romer, chair of the White House Council of Economic Advisers, said on CNN’s State of the Union. "And, [we’ll] actually be growing again by the end of the year." Romer’s comments came in a wide-ranging interview with Chief National Correspondent John King where she defended the new administration’s economic policies in the face of growing criticism by Republicans – particularly over how Treasury Secretary Timothy Geithner handled payment of $165 million in bonuses to AIG employees and how Geithner has been slow to roll out the specifics of his plan to stabilize some of the nation’s largest banks.
"I think it is important to realize this is just one piece of what we're doing," Romer said of the detailed Geithner bank rescue plan expected any day now. Romer pointed out that in the roughly nine weeks since Obama’s inauguration, the White House has rolled out a housing plan, a small-business plan, and a consumer and business lending initiative. "This is just one more of those pieces, and I don't think Wall Street is expecting the silver bullet . . . there’ll be more to come." Romer also left open the possibility that the White House could take more drastic action to stabilize the nation’s mortgage market through its control over mortgage giants Fannie Mae and Freddie Mac. She suggested the two massive financial entities could be broken up in order to make them more manageable and possibly avert another financial and mortgage crisis.
"I think that’s certainly going to be an issue going forward," Romer told King when asked whether the two companies needed to be broken up. "I think it should be part of the overall financial regulatory reform." "If you are going to be too big to fail, we’ve got to have an eye on you and make sure that you’re taking prudent practices," Roemer also said of large entities like Fannie, Freddie, and AIG which have posed systemic risks to the nation’s financial system in the past six months. Romer also said she wasn’t sure "it was useful" to get to the bottom of exactly how the recent stimulus bill came to include language protecting $165 million in bonus payments recently paid to the same AIG employees who brought the financial behemoth to the verge of collapse. "The President, again, is very aware of just how outrageous these things are," she said when asked about the AIG bonuses.
Romer: Firms Will Buy Toxic Assets Because 'We Need Them to Do This'
AIG outrage is genuine, but be careful about the fallout, said the head of the president's Council of Economic Advisers, noting that private investors are "kind of doing us a favor" in buying toxic assets and should be recognized for their contribution. Adviser Cristina Romer told "FOX News Sunday" that private firms not getting federal bailout money should not be intimidated by Congress' decision to tax executive bonuses by 90 percent because they understand that this is a new culture of doing business. "We've got banks with a lot of toxic assets, what 'toxic' means is they are highly uncertain ... so that is certainly the big picture, and that is going to be the main reason for doing this ... We simply -- we simply need them. We need them -- you know, we've got a limited amount of money that the government has to go in here, so we need to partner, not just with private firms, but with the FDIC, with the Fed, to leverage the money that we have," she said.
Treasury Sec. Tim Geithner has long stated the U.S. needs a public-private partnership to deal with toxic assets. The new plan is expected to be announced Monday -- in advance of President Obama's prime time press conference. The Wall Street Journal reported over the weekend that the administration plans to create an entity backed by the Federal Deposit Insurance Corp. to buy and hold loans, and it will expand the Federal Reserve's ability to hold older, "legacy" assets. The newspaper added that the public-private partnership would be managed by private investors but financed with a combination of private money and capital from the government, which would share in any profit or loss. The price for the mortgages and other securities has not been determined yet.
Meanwhile, the Obama administration is in the midst of developing a plan that would increase oversight on executive pay at all banks and financial firms, and possibly other companies, The New York Times reported Sunday. The paper reported that the plan would cover publicly traded companies, including ones not getting federal bailout money. Already many of those firms have to report some of their pay practices to the Securities and Exchange Commission, but this would evidently go further. The administration has not indicated yet what "oversight" means, and whether it is merely reporting pay levels, or possibly limiting them. "We have to level the playing field," Rep. Charles Rangel, D-N.Y., chairman of the House Ways and Means Committee, told "FOX News Sunday," about the decision to tax executive bonuses at 90 percent at firms getting federal bailout funds.
An administration official told FOX News on Sunday that it's "inaccurate" to say the administration's plan includes "sweeping" measures to address excessive bonuses. The aide said the administration "recognized these incentives to take risky bets to get a quick return contributed to risky behavior in the financial system that led to this crisis. ... Our regulatory reform efforts are focused on the big picture, rules of road because we cannot ever allow this to happen again." Deputy White House Press Secretary Jen Psaki added that the administration will work with congress in the coming weeks to "unveil financial regulatory reform to make our system stronger and smart, and to ensure we never find ourselves in a situation like this again." She said the administration is focused this week on addressing "the systemic risk built into our regulatory structure, including updating regulations and establishing new resolution authority to deal with companies that pose risks to our broader financial system."
Romer said that many of the investors helping out in the toxic asset purchases understand that President Obama realizes they are in a different category from American Insurance Group and other bailed-out companies. "We ought to be careful for a minute ... we have to acknowledge that outrage is genuine and something we all feel," she said. "I think we're going to have sensible strategy going forward. The president understands the distinction between" placing restrictions on companies that contributed to the financial mess and those that are trying to help. They are firms that are being the good guys here, are coming into a market that hasn't existed to try to help us get these toxic assets off banks' balance sheets," Romer said.
Shelby Says Geithner May Not ‘Last Long’ at Treasury
Senator Richard Shelby, the leading Republican on the Senate Banking Committee, said that confidence is ebbing in U.S. Treasury Secretary Timothy Geithner after his handling of bonuses at American International Group Inc. Speaking today on "Fox News Sunday," Shelby said Geithner is on "shaky ground" with Congress and many other Americans. "My confidence is waning every day," Shelby said when asked about the Treasury chief whose nomination he voted to confirm in January. "If he keeps going down this road, I think that he won’t last long." The Alabama senator’s comments came as the Treasury secretary prepares to lay out detailed plans to remove so-called toxic assets from banks’ balance sheets in an effort to spur lending during the recession.
Shelby criticized the Treasury last week for not stopping $165 million in bonuses being paid out to employees of AIG, the global insurer rescued by the government. President Barack Obama said he would refuse a resignation offer from Geithner, joking in a March 20 interview with the CBS News program "60 Minutes" that he would tell the Cabinet member: "Sorry, buddy, you’ve still got the job." House Majority Leader Steny Hoyer said Geithner should have taken a tougher line with AIG. "I think he is of the opinion that he should have acted more forcefully with the institutions, AIG in particular," Hoyer said in an interview with C-Span aired today. "I think Congress shares that view." Hoyer, a Maryland Democrat, added that Geithner should keep his job. "As long as he has the president’s confidence, he ought to stay," Hoyer said.
Christina Romer, the chairwoman of the President’s Council of Economic Advisers, said on the Fox program that Geithner was doing a good job and had been dealt an "unbelievably difficult hand." New York Mayor Michael Bloomberg, speaking on NBC’s "Meet the Press" program today, also defended Geithner. "I think Tim Geithner is exactly the guy that I would want there," he said. Bloomberg, an independent, is founder and majority owner of Bloomberg News parent Bloomberg LP. House Financial Services Committee Chairman Barney Frank and Senator Charles Grassley of Iowa, the top Republican on the Finance Committee, rejected suggestions Geithner should quit.
"I don’t think anybody after two months has been tested enough that I would say he should resign," Grassley said on CBS’s "Face the Nation" program. Still, Grassley said Geithner "screwed up twice" with New York-based AIG: as president of the Federal Reserve Bank of New York and as Treasury secretary. "I think it raises questions about whether he’s got his eye on the ball or not," Grassley said. The troubles at AIG are "a Bush administration creation" and Geithner inherited "a difficult situation," said Frank, a Massachusetts Democrat. He said the government, which is now the majority shareholder of AIG, should sue to recover the disputed bonuses paid to employees of the global insurer.
The issue of compensation at financial firms may weigh on an emerging government effort to attract private money to ease lending by banks. Romer said investors who buy up troubled bank assets in partnership with the government are "doing us a favor" and would be treated differently than bailed-out companies whose bonuses are targets of taxes proposed by angry lawmakers. Shelby said that it was possible that congressional plans to tax bonuses could scare away those investors. Romer dismissed a forecast by the nonpartisan Congressional Budget Office that the budget deficit will total $9.27 trillion between 2010 and 2019. Romer said the projection was based on expectations for economic growth that were "too pessimistic."
G.O.P. Wary of White House Optimism on Economy
A top economic advisor to President Obama said on Sunday that she was confident that the economy would begin to rebound this year, a message starkly contradicted by Republican leaders who expressed doubts about the growing deficit. "I think we are absolutely taking the right policies," said Christina D. Romer, chairwoman of the White House Council of Economic Advisers, during an appearance on CNN’s "State of the Union," one of two stops she made on the talk-show circuit. "I have every expectation, as do private forecasters, that we will bottom out this year and actually be growing again by next year." Asked on "Fox News Sunday" how confident she is that a year from now Obama administration policies would be succeeding, she replied: "Incredibly confident." "We absolutely think that they are going to do the job for the American economy," Ms. Romer added.
That optimism was not met by Senator Judd Gregg of New Hampshire, the senior Republican on the Senate Budget Committee, and Senator Richard Shelby of Alabama, top Republican on the Senate Banking Committee. They cited new estimates released Friday by the Congressional Budget Office that calculated that the White House’s tax and spending plans would create deficits totaling $2.3 trillion more than the president’s budget projected for the next decade. "The practical implications of this is bankruptcy for the United States," said Mr. Gregg, who also appeared on CNN. "There’s no other way around it. If we maintain the proposals which are in this budget over the 10-year period the budget covers, this country will go bankrupt. People will not buy our debt; our dollar will become devalued. "It is a very severe situation. And I find it almost unconscionable that this administration is essentially saying, well, we’re just going to blithely go along on this course of action after they’re getting these numbers."
Mr. Shelby, speaking on "Fox News Sunday," said Mr. Obama was going to have to scale back his budget in light of the new estimates: "He’s going to have to. We’re on a — on the fast road to financial destruction, and I see a 20 billion — a $20 trillion deficit in the few years to come," he said. Maine Senator Susan Collins, one of the few Republicans to support President Obama’s stimulus package, said she could not back his budget plan, which she said would bring debt to an unprecedented level. "It poses a threat to the basic health of our economy," she said on ABC’s "This Week." Ms. Romer challenged the estimates, calling the figures unrealistically pessimistic. "There is a question whether the C.B.O. is right," Ms. Romer said. "So we know that forecasts, both of what the economy is going to do and of what the budget deficit are going to do, are highly uncertain. And especially when you get further out in the C.B.O. numbers, we think they really are too pessimistic in thinking about how fast the U.S. economy can grow."
Kent Conrad, chairman of the Senate Budget Committee, said the different estimates could be explained. "In fairness to this administration, they locked down their forecasts three months ago," said Mr. Conrad, a Democrat of North Dakota. "There’s been a lot of bad news since." But he added: "We have got to get back to a more sustainable fiscal circumstance. We cannot have debt pile on top of debt. We cannot run budget deficits in the out-years of over $1 trillion a year. "I will present a budget that I think begins to move in that direction," Mr. Conrad said. "It acknowledges in the short term, yes, we have got to have added deficits and debt to give lift to this economy, but longer term, we have got to pivot."
The state of the economy once again dominated the talk shows on Sunday, the day before the administration plans to unveil its toxic-asset plan. The plan, which will likely offer generous subsidies to coax investors to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, is core to President Obama’s effort to rescue the nation’s banking system. Industry analysts estimate that the nation’s banks are holding at least $2 trillion in so-called "toxic assets," mostly residential and commercial mortgages that are weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession.
Ms. Romer stressed that the private investors entering a partnership with the government to buy assets of trouble companies would not be subject to the same scrutiny now being leveled at American International Group. In response to the $165 million in bonuses that A.I.G. dispensed to the business unit that caused its near-collapse, the House moved to impose a 90 percent tax on bonuses given out at companies receiving more than $5 billion in bailout money.
"What we’re talking about now are private firms that are kind of doing us a favor," Ms. Romer said on Fox, "right, coming into this market to help us buy these toxic assets off banks’ balance sheets. And I think they understand that the president realizes they’re in a different category, and I think they are going to have confidence that they’re going to be able to come into this — into this program." The job security of Treasury Secretary Timothy F. Geithner was another topic of conversation on Sunday, with both Democrats and Republicans saying that they favored giving him more time. "In the area of trying to stabilize the financial sector of our economy, they’re doing the right things," Mr. Gregg said. "They haven’t done it as definitively as they should have, clearly. We would have liked a plan that was more definitive earlier, but they are moving in the right direction, and the Fed is moving in the right direction," he said.
"I don’t think anybody after two months has been tested enough that I would say he should resign," Senator Charles E. Grassley, Republican of Iowa, said on CBS’s "Face the Nation." Other leaders backing Mr. Geithner included New York Mayor Mayor Michael R. Bloomberg and California Gov. Arnold Schwarzenegger. President Obama reiterated his support for Mr. Geithner during an interview with "60 Minutes" to air Sunday evening. One exception was Mr. Shelby, who said his confidence is waning daily. "I think he’s probably on shaky grounds now, at least with the Congress and a lot of the American people," he added. Ms. Romer dismissed talk of a resignation as "really silly." "Tim Geithner is an excellent secretary of the treasury," she said.
Six months after the AIG bailout: Where is the money?
Under public and media pressure caused by the news that AIG used the bailout money to distribute generous bonuses, the group decided last week to publish stats on spending. I worked with Damiko Morris in DC to finding the best way to translate the six-page document into a comprehensive information graphic.
click to enlarge
G20 warned unrest will sweep globe
A wave of social and political unrest could sweep through the world's poorest countries if G20 leaders fail to come to their aid, the World Bank warns today, as new research says the credit crunch will cost developing countries $750bn (£520bn) in lost output and drive millions more into poverty. Ngozi Okonjo-Iweala, managing director of the World Bank, is urging G20 leaders to use the London summit in less than a fortnight's time to help protect the developing world against the worst effects of the financial crisis. "We have to look at the impact of this on low income countries. Otherwise, without wanting to sound alarmist, social unrest and political crisis could be the result. It's in the self-interest of everyone to prevent that," she told the Observer
Her stark warning came as a new report from the Overseas Development Institute (ODI) said the collapse of the global economy would cost 90 million lives, lead to an increase to nearly a billion in the number of people going hungry and cost developing countries $750bn in lost growth. "Tens of millions of people will be forced back below the poverty line. There will be irreversible effects on the very poorest," said Simon Maxwell, the ODI's director. The ODI is calling for an extra $50bn in aid for Africa, and urging G20 countries to set aside a "significant proportion" of the cash they are spending on fiscal packages, to help build up the infrastructure in poor countries, and lift people above the breadline.
"When they sit down around the table at the G20, there will be plenty for the leaders to disagree about. This should not be one of those things, but it might well be," Maxwell said. The ODI also said the G20 should not set unrealistic expectations about resuscitating the stalled Doha round of international trade talks, and should instead make a firm promise to avoid tit-for-tat protectionism. Okonjo-Iweala said hundreds of thousands of workers were losing their jobs across the developing world, where social safety nets are almost non-existent, and called for more resources for the World Bank's "vulnerability fund," which helps cash-strapped governments to make direct welfare payments. "There is a credit crunch in many of these countries: foreign direct investment has dried up," she said.
Gordon Brown will fly to Brazil this week to try and win the support of President Lula for his agenda of co-ordinated fiscal stimulus, free trade, and a boost to overseas aid budgets. Downing Street wants to secure a doubling in the resources of the International Monetary Fund, so it can bail out the worst-affected countries; and a promise of new loans to help facilitate cross-border trade. With budgets tight at home, and noisy demands for help from domestic constituencies, however, Brown is concerned many countries are failing even to live up to the promises on aid they made at the Gleneagles G8 meeting in 2005. In Italy, Silvio Berlusconi has slashed aid spending in the face of a fiscal crisis.
Hopes fading for salvation at the summit
For more than a decade, London's Docklands, with its glass and steel skyscrapers, was the pulsating heart of global financial capitalism, the East End postcode with a Wild West atmosphere, where interfering politicians feared to tread. In 11 days' time, 20 of the world's most important leaders will gather here, at the ExCeL Centre, with a mandate to clear up the chaos unleashed by the crunch - and rein in the might of the financiers. Gordon Brown has trumpeted the London summit as nothing less than a New Deal for the world's crisis-hit economy; one day that will rewrite the rules of financial markets, fix the broken banking system and pull the world back from a new Great Depression.
Last week, the International Monetary Fund warned the stakes could not be higher: for the first time since 1945, the global economy as a whole will contract in 2009. "Turning around global growth will depend critically on more concerted policy actions to stabilise financial conditions, as well as sustained strong policy support to bolster demand," the IMF said. The fund sees the current crisis as the most serious since the 1930s, when the US economy contracted by 25% in four years and six million unemployed in Germany led to the rise of Hitler. The devastation of the Great Depression and the ravages of the second world war led to the most radical shake-up of the world's economic system since the industrial revolution. In 1944, the historic Bretton Woods summit created the system of fixed exchange rates that lasted until the 1970s, and the IMF and World Bank, which remain guardians of the global economy today.
In the autumn, the government was hailing the London summit as a 21st-century Bretton Woods, yet Downing Street has already begun rowing back from the early fanfare about rebuilding capitalism - and judging by the communiqué from G20 finance ministers after their summit in Horsham, West Sussex on 14 March, ambitions are now relatively modest. "They're just not tackling the problem of how much of the casino needs to be shut down," says Heiner Flassbeck of Unctad, the UN's trade and development arm, which published a scathing report last week calling for G20 ministers to overturn two decades of "market fundamentalist laissez-faire". Flassbeck said the sub-prime mortgages that triggered the crisis were only one symptom of an out-of-control financial sector; there had also been rampant speculation in markets for commodities, currencies and other assets, which must now be re-regulated.
"Because all these pyramids have collapsed in a very short time, that's why we have seen such a global impact." An early warning that next month's meeting might not meet Brown's grand expectations came when he clashed with other G8 countries, including Italy, about whether it should be called a "G20 summit" at all - hence its official title of the London summit. (This despite unfortunate associations with the ill-fated 1933 London summit of world leaders, which was torpedoed by Franklin Roosevelt, a Democrat president newly arrived in the White House with a mandate to revive a US economy deep in slump.)
Signs of potential conflict abound: Barack Obama wants the summit to focus on measures that can be taken now to revive growth and create jobs, and will be armed by the latest emergency steps taken by the Federal Reserve to pump trillions of dollars into the US economy. The Europeans worry that policymakers are doing too much in the short term to boost demand and too little in the long term to ensure there is no return to the bubble conditions that created the current crisis. But calls from Nicolas Sarkozy and Angela Merkel for curbs on hedge funds and private equity companies, together with tougher regulations on "toxic" derivative products may be greeted coolly by the Americans.
Alistair Darling tried valiantly to paper over the cracks at last weekend's meeting in Horsham. Policymakers pledged to do "whatever it takes", for as long as it takes, to lift the world economy out of recession, while acknowledging that many governments have already taken steps; but back in London, Merkel was reminding Brown that any decisions Germany might take to launch a further fiscal stimulus would be a matter for its parliament in Berlin, not for an international summit. "Leaders talk global, think national," says Gerard Lyons, chief economist at Standard Chartered, though he adds that the lack of substantive proposals after the finance ministers' meeting could mean they are saving the goodies for their bosses.
The chemistry between the G20 leaders is hardly warm. Brown spent a decade as chancellor lecturing his continental counterparts about Britain's deregulated financial markets and flexible labour market, and they are determined not to let the prime minister claim credit for saving the world, especially when Britain is going to have one of the deepest recessions. Forecasts presented to G20 governments by the IMF last week showed UK GDP declining by 3.8% this year and a further 0.2% in 2010.
In the US, meanwhile, Obama is struggling to complete his financial team, with Treasury secretary Tim Geithner the only major post at the department confirmed. Geithner, who scraped through his confirmation on Capitol Hill after admitting failing to pay $34,000 in taxes, has since been battered by the political storm over bonuses paid to executives at AIG, and Wall Street's initial lack of confidence in his rescue package. Expectations for what the leaders should achieve are still running high. A mass rally, involving a coalition of more than 100 groups, from churches to trades unions, is planned for next Saturday. Under the banner of "Jobs, Justice and Climate", thousands will march through central London to a rally in Hyde Park, calling for Brown and his fellow leaders to reform international markets, protect vulnerable jobs and support the world's poor through the credit crunch.
On 2 April though, a security lockdown will be in place. Police are on high alert lest the first summit of world leaders to be held in London since John Major hosted the G7 in 1991 become a pitched battle between the security forces and anti-globalisation protesters. With the leaders of rich countries facing intense pressure at home to combat mass unemployment and shore up their embattled financial systems, campaigners are nervous that there will be little will for fresh efforts to help the poor. Ngozi Okonjo-Iweala, managing director of the World Bank and a former Nigerian finance minister, says more than 50 million people are likely to be plunged into poverty by the credit crunch, as developing countries are starved of resources and volatile commodity prices wreak havoc on exporting countries' public finances. "The story that needs emphasising is how the emerging countries have been impacted by the second and third rounds of the crisis," she says. "The fact is that developing countries should be part of the solution: they did not cause the problem."
Simon Maxwell, director of the Overseas Development Institute, says: "If Gordon Brown had his way, extra money would be found. He has provided extraordinary leadership in keeping development high on the agenda. Other countries are much less willing to take development seriously. Some are saying, 'Don't ask us, because we don't want to embarrass you by saying no'." However, the fact that the G20, rather than the G8, is the forum for these discussions is a recognition of the changing global economy. For decades after the second world war, the leading capitalist economies of western Europe, North America and Japan dominated the scene. They accounted for the lion's share of global output and trade and controlled the IMF and World Bank, promulgating a controversial set of free market policies known as the "Washington consensus".
When modern summitry began in the mid-1970s, it involved only six countries - the US, West Germany, Italy, Japan, France and Britain - but the G6 quickly became a G7 with the arrival of Canada. Boris Yeltsin was rewarded for his role in turning Russia into a market economy when he was given a seat in the 1990s, but in recent years the limitations of the G8 have been exposed. Attempts to discuss currencies and the global economic imbalances have been rendered futile by the absence of China and the oil exporters; the input of China and India have been deemed vital if there is to be progress on climate change; China, India, Brazil and South Africa are all key players in the long-running Doha round of trade talks.
Reluctant to cede power and influence, the G8 first came up with an uneasy compromise. It invited five leading developing countries - China, India, Brazil, South Africa and Mexico - to some sessions of the annual summer summit. This G8-plus-5 format, predictably, ruffled feathers in Beijing and New Delhi, and matters came to a head in Japan last year when the top-level Chinese delegation took great offence at being kept waiting for an hour in Hokkaido while the G8 wrapped up private business. So, when George Bush called a crisis meeting after last autumn's financial meltdown, it was clear that the format had to be wider than the G8. It included all five big developing countries together with Indonesia, the world's fourth most populous country, Saudi Arabia, the biggest oil producer, Argentina, Turkey, Korea and Australia - and the EU took the 20th seat around the table.
While broader and more representative than the G8, the G20 has its critics. Some doubt if a body so diverse can come to any agreement, pointing out that it was hard enough to reach consensus at the G8. Others argue it still excludes the very poorest countries of sub-Saharan Africa - though Downing Street has invited Ethiopia, representing Nepad, the African development coalition, Gabon's foreign minister Jean Ping from the African Union, and Donald Kaberuka, president of the African Development Bank. Leaders are expected to promise measures to tackle the immediate crisis, including more resources for the IMF to lend to struggling economies, and help for poor countries unable to finance international trade because of the credit crunch. Amar Bhattacharya of the G24 Secretariat, which represents low-income countries, says he is encouraged by the progress already made, but it will be crucial to ensure that any promises - on new fiscal stimulus, for example - are carefully monitored: "I think the best way to proceed is to have a very effective monitoring system, so that we can ensure that those locomotives with the most steam are doing the most work."
The G20 leaders will also discuss how to regulate international financial markets more effectively, to prevent a crisis on the extraordinary scale of the past two years from happening again. Hedge funds are likely to find themselves facing a stricter regime after 2 April, though details remain sketchy - the finance ministers merely called on them to be more transparent in reporting their positions. Complex assets such as derivatives, and the off-balance-sheet vehicles used by many credit-crunched banks, are also expected to come under closer scrutiny. All G20 leaders also agree something may be needed to rein in the activities of tax havens, not just to stop government revenues being lost, but to throw open the complex and secretive dealings of multinational financial institutions that have used offshore locations to conceal parts of their business from regulators.
However, with several of the most notorious tax havens, including Liechtenstein and Jersey, making grand declarations about their new commitment to openness, there are fears that the will to take tougher action may be absent. Claire Melamed, director of policy at Action Aid, says: "It would be a major missed opportunity if they don't follow through. At the moment, there are quite worrying signs they're not going to." For Brown, much more is at stake than creating international common purpose in the face of economic disaster. The London summit is one of two meticulously planned political moments for Labour to show that, despite Britain's role as home of some of the worst-regulated and hardest-hit financial institutions, the government is part of the solution, not the author of the crisis.
Little more than a fortnight after the summit, Darling hopes to use his budget as a new assault on the worsening recession and lengthening dole queues. In October, when Britain's bank recapitalisation plan looked firmer and more decisive than US treasury secretary Hank Paulson's flailing response to the woes of Wall Street, Brown saw his popularity bounce, as he bestrode the world scene. But with 2 million now unemployed at home, it may take more than even the most successful summit to restore his electoral fortunes. So determined is the government to win the favour of the leaders flying into Docklands that it has passed special legislation to suspend the smoking ban in the vicinity of the ExCeL centre for the duration. But it may take more than a grand international bargain struck in the nostalgic surroundings of a smoke-filled room to save the world economy - or resuscitate the Brown premiership.
Nearly 500 years of key political gatherings
The field of the cloth of gold
The first summit the modern age would recognise as such took place in the summer of 1520 just outside Calais, when Henry VIII crossed the Channel for talks with Francis I. Although it lacked TV cameras and spin doctors, the Cloth of Gold had all the classic features of summitry; it was orchestrated by top officials; it involved more pageantry and feasting than substance; and the show of amity did little to paper over the cracks in the fragile relationship between the two countries.
The treaty of Versailles
Two months after the end of the first world war, the Allied Powers gathered at Versailles in January 1919. A mixture of the idealistic plans for a League of Nations and the self-determination of peoples proposed by the US President Woodrow Wilson and the desire for recompense for the damage to France from the devastation on the western front, the conference saddled a dismembered Germany with a massive reparations bill. John Maynard Keynes, part of the UK delegation, warned in his Economic Consequences of the Peace that Versailles was storing up problems for the future.
A quarter of a century later an ailing Keynes had the opportunity to do better, second time round. Two-and-a-half years in the planning, the three weeks of talks at the Mount Washington hotel in New Hampshire in July 1944 were dominated by Keynes, but the real decisions were taken by his American counterpart, Harry Dexter White. Bretton Woods created the International Monetary Fund to oversee a post-second world war system of fixed exchange rates, and the World Bank to help to rebuild the economies of western Europe, but plans for a World Trade Organisation were put on ice for half a century following opposition from the US Congress.
Three decades of prosperity came to an end with the oil shock of 1973-74. The combination of rising unemployment and inflation - stagflation - prompted the French President Giscard D'Estaing to invite five other world leaders for a "fireside chat" at a château just outside Paris. Although modest by later standards, this was the first of the gatherings of world leaders which now take place on a rotating basis each year. Rambouillet had no easy answers to the first recession in the west since the 1930s, but its main themes - avoiding protectionism, energy dependency and boosting growth - will be on the agenda next week.
The last big summit of world leaders to be held on British soil, the meeting at the Scottish luxury hotel in July 2005 coincided with - and to an extent was overshadowed by - the 7/7 terrorist bombings in London. Tony Blair shuttled between the summit and Downing Street and, after much arm-twisting, persuaded the G8 to sign up to a package for developing countries that involved debt relief, a £50bn increase in aid and easier access to western markets. Although Gleneagles was one of only a handful of summits to result in more than a bland communiqué, the G8 has yet to deliver on its promises.
China to Develop Derivatives, Introduce New Products, PBOC Says
China will develop its derivatives market and introduce interest-rate options even though problems in that market triggered the global financial crisis, said Liu Shiyu, deputy governor of the People’s Bank of China. "If we don’t develop our over-the-counter market for derivatives as early as possible, we may find ourselves lagging behind once the global financial crisis bottoms out," Liu told a forum in Beijing today. "We should shift from a government- led to a more market-oriented mechanism to encourage financial products innovation."
The nation will introduce interest-rate options on the interbank market, he said, without giving a time frame. The platform accounts for more than 95 percent of the bonds traded, compared with the stock-exchange based facility. The government currently allows trading in bond forwards, interest-rate swaps and forwards, yuan forwards and swaps. China’s regulators have pledged repeatedly the nation won’t reverse the course of financial innovation since the onset of subprime crisis in 2007, while stressing on improved monitoring. The government will "steadily push forward" development of fixed-income products and related financial innovations, the State Council, China’s cabinet, said in a financial sector guideline in December.
China’s over-the-counter trading of derivatives rose 35 percent last year to 4 trillion yuan ($585 billion), compared with 130 trillion yuan of all transactions in the market, Zhang Shengju, a researcher at the National Interbank Funding Center told the forum. Li Bo, the department head of laws and regulations at the central bank, proposed at the forum to establish "as early as possible" a central clearing house for over-the-counter trading, which will help reduce risks in derivatives such as credit-default swaps. Options are the right, without the obligation, to buy or sell an asset by a set date. Credit-default swaps are used to speculate on the ability of companies and sovereigns to repay their debt. They pay buyers the face value of debt protected if the borrower fails to meet payments.
Has a ‘Katrina Moment’ Arrived?
A charming visit with Jay Leno won’t fix it. A 90 percent tax on bankers’ bonuses won’t fix it. Firing Timothy Geithner won’t fix it. Unless and until Barack Obama addresses the full depth of Americans’ anger with his full arsenal of policy smarts and political gifts, his presidency and, worse, our economy will be paralyzed. It would be foolish to dismiss as hyperbole the stark warning delivered by Paulette Altmaier of Cupertino, Calif., in a letter to the editor published by The Times last week: "President Obama may not realize it yet, but his Katrina moment has arrived."
Six weeks ago I wrote in this space that the country’s surge of populist rage could devour the president’s best-laid plans, including the essential Act II of the bank rescue, if he didn’t get in front of it. The occasion then was the Tom Daschle firestorm. The White House seemed utterly blindsided by the public’s revulsion at the moneyed insiders’ culture illuminated by Daschle’s post-Senate career. Yet last week’s events suggest that the administration learned nothing from that brush with disaster. Otherwise it never would have used Lawrence Summers, the chief economic adviser, as a messenger just as the A.I.G. rage was reaching a full boil last weekend. Summers is so tone-deaf that he makes Geithner seem like Bobby Kennedy.
Bob Schieffer of CBS asked Summers the simple question that has haunted the American public since the bailouts began last fall: "Do you know, Dr. Summers, what the banks have done with all of this money that has been funneled to them through these bailouts?" What followed was a monologue of evasion that, translated into English, amounted to: Not really, but you little folk needn’t worry about it. Yet even as Summers spoke, A.I.G. was belatedly confirming what he would not. It has, in essence, been laundering its $170 billion in taxpayers’ money by paying off its reckless partners in gambling and greed, from Goldman Sachs and Citigroup on Wall Street to Société Générale and Deutsche Bank abroad.
Summers was even more highhanded in addressing the "retention bonuses" handed to the very employees who brokered all those bad bets. After reciting the requisite outrage talking point, he delivered a patronizing lecture to viewers of ABC’s "This Week" on how our "tradition of upholding law" made it impossible to abrogate the bonus agreements. It never occurred to Summers that Americans might know that contracts are renegotiated all the time — most conspicuously of late by the United Automobile Workers, which consented to givebacks as its contribution to the Detroit bailout plan. Nor did he note, for all his supposed reverence for the law, that the A.I.G. unit being rewarded with these bonuses is now under legal investigation by British and American authorities.
Within 24 hours, Summers’s stand was discarded by Obama, who tardily (and impotently) vowed to "pursue every single legal avenue" to block the bonuses. The question is not just why the White House was the last to learn about bonuses that Democratic congressmen had sought hearings about back in December, but why it was so slow to realize that the public’s anger couldn’t be sated by Summers’s legalese or by constant reiteration of the word outrage. By the time Obama acted, even the G.O.P. leader Mitch McConnell was ahead of him in full (if hypocritical) fulmination. David Axelrod tried to rationalize the lagging response when he told The Washington Post last week that "people are not sitting around their kitchen tables thinking about A.I.G.," but are instead "thinking about their own jobs." While that’s technically true, it misses the point.
Of course most Americans don’t know how A.I.G. brought the world’s financial system to near-ruin or what credit-default swaps are. They may not even know what A.I.G. stands for. But Americans do make the connection between their fears about their own jobs and their broad understanding of the A.I.G. debacle. They know that the corporate bosses who may yet lay them off have sometimes been as obscenely overcompensated for failure as Wall Street’s bonus babies. As The Wall Street Journal reported last week, chief executives at businesses as diverse as Texas Instruments and the home builder Hovnanian Enterprises have received millions in bonuses even as their companies’ shares have lost more than half their value.
Since Americans get the big picture of this inequitable system, that grotesque reality dwarfs any fine print. That’s why it doesn’t matter that the disputed bonuses at A.I.G. amount to less than one-tenth of one percent of its bailout. Or that CNBC — with 300,000 viewers on a typical day by Nielsen’s measure — is a relatively minor player in the crash. Or that Edward Liddy had nothing to do with A.I.G.’s collapse, or that John Thain, of the celebrated trash can, arrived after, not before, others wrecked Merrill Lynch. These prominent players are just the handiest camera-ready triggers for the larger rage. Passions are now so hot that even Bernie Madoff’s crimes began to pale as we turned our attention to A.I.G.’s misdeeds, just as A.I.G. will fade when the next malefactor surfaces.
What made Jon Stewart’s takedown of Jim Cramer resonate was less his specific brief against CNBC’s cheerleading for bad stocks than his larger indictment of the gaping economic inequality that defined the bubble. As Stewart said, there were "two markets" — the long-term market that Americans earnestly thought would sustain their 401(k)’s, and the fast-moving, short-term "real market" in the back room where high-rolling insiders wagered "giant piles of money" and brought down everyone with them.
No one is more commanding on this subject than our president. In his town-hall meeting in Costa Mesa, Calif., on Wednesday, he described the A.I.G. bonuses as merely a symptom of "a culture where people made enormous sums of money taking irresponsible risks that have now put the entire economy at risk." But rhetoric won’t tamp down the anger out there, and neither will calculated displays of presidential "outrage." We must have governance to match the message. To get ahead of the anger, Obama must do what he has repeatedly promised but not always done: make everything about his economic policies transparent and hold every player accountable. His administration must start actually answering the questions that officials like Geithner and Summers routinely duck.
Inquiring Americans have the right to know why it took six months for us to learn (some of) what A.I.G. did with our money. We need to understand why some of that money was used to bail out foreign banks. And why Goldman, which declared that its potential losses with A.I.G. were "immaterial," nonetheless got the largest-known A.I.G. handout of taxpayers’ cash ($12.9 billion) while also receiving a TARP bailout. We need to be told why retention bonuses went to some 50 bankers who not only were in the toxic A.I.G. unit but who left despite the "retention" jackpots. We must be told why taxpayers have so little control of the bailed-out financial institutions that we now own some or most of. And where are the M.R.I.’s from those "stress tests" the Treasury Department is giving those banks?
That’s just a short list. In general, it’s hard to imagine taxpayers shelling out billions for a second bank bailout unless there’s a full accounting of every dime of the first, and true transparency for the new plan whose rollout is becoming the most attenuated striptease since the heyday of Gypsy Rose Lee. Another compelling question connects all of the above: why has there been so little transparency and so much evasiveness so far? The answer, I fear, is that too many of the administration’s officials are too marinated in the insiders’ culture to police it, reform it or own up to their own past complicity with it.
The "dirty little secret," Obama told Leno on Thursday, is that "most of the stuff that got us into trouble was perfectly legal." An even dirtier secret is that a prime mover in keeping that stuff legal was Summers, who helped torpedo the regulation of derivatives while in the Clinton administration. His mentor Robert Rubin, no less, wrote in his 2003 memoir that Summers underestimated how the risk of derivatives might multiply "under extraordinary circumstances."
Given that Summers worked for a secretive hedge fund, D. E. Shaw, after he was pushed out of Harvard’s presidency at the bubble’s height, you have to wonder how he can now sell the administration’s plan for buying up toxic assets with the help of hedge funds. It will look like another giveaway to his own insiders’ club. As for Geithner, people might take him more seriously if he gave a credible account of why, while at the New York Fed, he and the Goldman alumnus Hank Paulson let Lehman Brothers fail but saved the Goldman-trading ally A.I.G.
As the nation’s anger rose last week, the president took responsibility for what’s happening on his watch — more than he needed to, given the disaster he inherited. But in the credit mess, action must match words. To fall short would be to deliver us into the catastrophic hands of a Republican opposition whose only known economic program is to reject job-creating stimulus spending and root for Obama and, by extension, the country to fail. With all due deference to Ponzi schemers from Madoff to A.I.G., this would be the biggest outrage of them all.
Obama's Big Week
The Obama administration is going on the offensive following a week of stinging rebukes for overspending and failing to curb executive bonuses for bailed out firms. Tuesday evening, President Obama will attempt to defuse Americans' ire in a nationally televised press conference at 8 p.m. ET. He'll also make the case for the Treasury Department's risky gambit to partner with the private sector to remove toxic assets from banks' balance sheets. It's a crucial week for this young administration, still fighting to brand itself as a guardian of the middle class without alienating business, swept up in a class drama over $165 million in bonuses doled out by American International Group.
Voters who put Obama in the White House want to know what he's doing about it. Impatience is also growing over his hydra-headed spending plans, which the Congressional Budget Office said underestimated the deficit damage by $2.3 trillion. The public wants the economy back on track and stock markets to rise. Inherited or not, the mess is Obama's now. Treasury's plan to remove bad assets from bank balance sheets could help. The New York Times reported Saturday that it will have three basic parts. The Federal Deposit Insurance Corp. will lend investors about 85% of the money needed to buy toxic securities from banks that want to remove them from their balance sheets, the paper reported.
In addition, the government is expected to pay several investment management firms to match private-sector money and expand a new Treasury-Federal Reserve program designed to boost consumer lending. The troubled assets reportedly will be priced via an auction mechanism, according to reports. Treasury officials did not respond to a request for comment. If successful, the plan will show critics that the administration is not just in favor of increased government spending to lift the country out of its malaise but that private sector involvement is important as well.
To work, it must be specific enough to restore confidence among investors that the White House knows what it is doing. Lack of detail left markets nonplussed when Treasury Secretary Timothy Geithner first mentioned the so-called Public-Private Investment Fund last month. It will also need to be the government's "final answer"--or something close to it--in devising a program to rid banks of rotten securities. Former Treasury Secretary Henry Paulson head-faked markets last fall by announcing that the government would buy the assets with bailout money but then used it to keep banks afloat. This time, investors need assurance the government will do what it says.
Democrats threaten the banking plan, as well as the nation's broader agenda, by stoking public anger at AIG and other Wall Street firms. Hot to send Obama legislation aimed at heavily taxing executive pay, they risk rigging a booby trap for the new president. If he opposes the legislation, he could look insensitive to Main Street. If he favors it, he may alienate the business community, potentially prolonging the banking crisis. It's all a troubling distraction from more crucial debates on financial services regulation, fixing U.S. health care and righting the education system. Can the president get America beyond bonuses in the week ahead? Here's hoping.
Congress loathe to more bailouts after AIG
Forget about any more bailouts anytime soon.Any Obama administration bid to seek more taxpayer money for failing banks will face stiff resistance in Congress, where Treasury Department credibility is ebbing fast and lawmakers are bowing before a constituent revolt. Treasury Secretary Timothy Geithner is expected to roll out the details of his next financial rescue plan any day. But the administration faces resistance on several fronts: Its credibility has been badly damaged, with Geithner under withering scrutiny in Congress, even as lawmakers’ constituents are boiling mad and Republicans are increasingly united in opposing more bailouts.
News that executives at American International Group got $165 million in bonuses after taxpayers bailed AIG out to the tune of $170 billion triggered a political firestorm last week that’s likely to burn for some time. It crystallized public revulsion at bailing out big banks. "AIG has become the straw that broke the camel’s back. It pushed people off the edge," said Sen. Mary Landrieu, D-La. "Blanket bailouts have been taken off the table," added Sen. Ben Nelson, D-Neb. Obama’s fiscal 2010 budget outline listed another $250 billion as a "contingent reserve for further efforts to stabilize the financial system," and his aides said that amount could be leveraged to spend as much as $750 billion more buying bad assets from imperiled banks. Congress expects to vote on that budget blueprint next week.
Sen. Christopher Dodd, D-Conn., is a daily reminder of the bailout credibility problem. As the Senate Banking Committee chairman and a 28-year Senate veteran, colleagues have long looked to him for guidance on complex financial issues. Now, though, he’s become a convenient target for bailout critics. Here’s why: First he said last week that he wasn’t involved in a last-minute change to last month’s economic stimulus bill that allowed AIG to pay the bonuses. The next day, Dodd reversed himself. He said his comments had been misinterpreted, that he’d "agreed reluctantly" to include the language permitting the bonuses, but "did so at the request of administration officials."
Republicans pounced and Democrats winced. Geithner confirmed on CNN that Treasury had asked Dodd to insert the language, but denied that he’d done it himself, placing responsibility on some unidentified Treasury staffer. That didn’t help his credibility. Many Democrats already had reservations about Geithner because of his lapses in paying income taxes; the latest news intensified their skepticism. "This matter has been misjudged by the administration," said Landrieu, a moderate Democrat who’s one of a handful of swing votes in the Senate.
Sen. Ron Wyden, D-Ore., emphatically agreed. He and Sen. Olympia Snowe, R-Maine, had won overwhelming Senate approval of a plan to sharply restrict and tax big bonuses at firms receiving government bailout money, only to see their provision dropped during last-minute negotiations with the House. A miffed Wyden said "the Obama economic team" engineered the elimination of his terms. He said he wasn’t sure if Geithner himself was behind it; still, suspicions focus most on him. Helping to stoke the surliness on Capitol Hill are the lawmakers’ constituents, who have never embraced bailouts since they started last year, as polls have made clear.
The AIG bonus mess is both a lawmaker’s dream and nightmare. It’s a dream because people understand the issue, so members of Congress can use it to show that they’re in tune with their constituents’ struggles. Hence the speed with which the House voted Thursday to tax back 90% of the bonuses. Listen to Sen. Carl Levin, D-Mich. He noted that autoworkers recently "agreed to significant reductions in their pay and benefits. They are doing what they can to help their companies survive and help get our nation out of this economic ditch. ... Contrast those autoworkers with AIG executives."
There’s a political dark side, however: Lawmakers also are open to charges that they should have known what they were doing in passing the stimulus bill with language permitting the AIG bonuses. "It sounds to me like these guys were trying to cover their tracks," said Sen. Jon Kyl of Arizona, the assistant Republican Senate leader, referring to efforts to tax back the bonus money. The biggest nightmare for lawmakers will come if they’re asked for more bailout funds by a president who insists that they’re critical to rescuing the economy. "We’re not out of the woods with these financial institutions," noted Sen. Bob Corker, R-Tenn., a Banking Committee member. Nelson said that any new proposals almost certainly will have to be targeted and include specific conditions. Sen. John Ensign of Nevada, the Senate Republican Policy Committee chairman, said that any new plan would be considered only after "we get to the bottom of this to make sure it doesn’t happen again."
Rep. Barney Frank, D-Mass., the House Financial Services Committee chairman, said the furor could cool if Congress begins tackling financial industry regulatory measures. "If you show people you’re going to do a more balanced set of things, that there’s a conscious strategy to make the entire system better, you may be able to get more done," he said. Frank and Geithner last week discussed potential changes, and Geithner and Federal Reserve Chairman Ben Bernanke are to testify before Frank’s committee on Tuesday. Their appearance could be the start of a long, hard slog. Getting the $700-billion bank bailout money approved last fall "was like pulling teeth," said Sen. Richard Durbin of Illinois, the Senate assistant majority leader. So would the next time seem like a root canal? "I think it would," he said.
At AIG, we're all about people
As a member of the board of directors of the American International Group, I am pained by the hailstorm of fecal matter raining on our company for the $450 million in bonuses we are paying out to the traders in credit derivatives after receiving billions from the U.S. Treasury to rescue us from going over the cliff that the derivative traders were driving us toward. I was in Greece when the storm hit and got a call from Marie, my assistant, saying, "We're sending the jet," and came home to find a stack of anonymous letters in the solarium, saying, "Bonuses? To the jerks who totaled a corporation? Where did this idea of rewarding failure come from? Are you living in a fairy tale in which wealth is generated by following owls into underground caverns?"
Many of these missives were written with black felt-tip pens in big block letters and words snipped out of magazines, words such as "fraud" and "skunks," "San Quentin," "die in hell" and "eat glass shards," and a picture of a naked man chained to a rock and a bird pecking out his liver. To cancel bonuses because of a bad year is like refusing to water the greens just because a golfer has hit into the rough. It would be counterproductive. And in the end, AIG is not about credit default swaps or derivatives. It is about people. People like Megan, who suffered a painful case of shingles after a $4 billion default swap dropped to $234.15 and whose mission is to save the endangered grommet. That's where her bonus is going, to create a grommet habitat in Vermont.
I wish that the politicians lining up to drop cherry bombs in our toilets could meet the AIG family, including its wonderful board of directors: Peter Lorre, Louie Louie, Larry King, the Duke of Earl, Erle Stanley Gardner, Ralph Stanley, Morgan Stanley, Stan and Ollie, Alley Oop, Rupert Murdoch, Dr. John, John Roberts, Judge Judy, Rudy Giuliani, Sweet Leilani, Sleeping Beauty, Buddy Guy, Si Newhouse, Rufus Wainwright, Wayne Newton, Newt Gingrich, Richard Cory, Lorrie Moore, and did I mention Peter Lorre? He's there too. Their friendship is all the reward I need for my service, although I will receive a bonus myself for having a perfect record of attendance for three years running. Last weekend, we held an emergency meeting in Antigua at one of those resorts where men can walk around freely and not be accosted by embittered stockholders or their lawyers. We agreed that the first priority is to reestablish confidence.
These are difficult times and we will need to think positively to work our way through them and reach the other side. Recrimination will get us nowhere. It's just like in sailing a yacht. If your crew neglects to secure the lanyard and the yardarm swings loose and knocks the martinis off your tray and spills a thousand dollars worth of beluga caviar on the deck, do you curse the silly buggers and perhaps distract them so that the Windermere lands on the reef and is reduced to splinters in waters populated by hammerhead sharks? No, and neither do we at AIG. It's easy to look back and say what should have been done, but that is not our style. I have never heard an iota of acrimony in a board meeting. The level of civility has never wavered. My bonus was approved unanimously, and when I announced my resignation, people came around to give me hugs.
They cried, "If you're leaving, then we'll leave too," and so they will, and as of Monday we'll be replaced by Dick Cheney, Lil Wayne, Jane Smiley, Miley Cyrus, Don Imus, Iris Murdoch, Dr. Phil, Lil' Kim, Jimmy Kimmel, Homer Simpson, Lil Simon, Simon Cowell, Carl Kasell, Russell Banks, Ben Bernanke, Frankie Avalon, Lon Chaney, and did I mention Dick Cheney? He's there too. It's painful for me to leave AIG, but I am not comfortable with the government owning 80 percent of our company. Call me old-fashioned, but that is just plain socialism to me, and this latest frenzy of plain old class warfare fomented by an anti-business administration has convinced me that it's time to move on. And so I am leaving for Costa Rica and a settlement on its Pacific shore where one can enjoy the ocean breeze far away from discord and bitterness. It is a new residential development called Tierra de Gracias and homesite sales are limited to persons who are profoundly thankful.
The Next Bubble: Obama's Budget Deficit
The U.S. could be in the hole $2.3 trillion more than expected--and that's if the economy performs well.
As President Obama prepares to send his budget to Congress next week, he's run into a bit of a stumbling block. The Congressional Budget Office said Friday that the national debt under the president's budget will be $2.3 trillion deeper than the White House estimates. Now for the real bad news: Both estimates are optimistic. If the economy continues to deteriorate faster than economists project, those numbers will balloon further. Over the next decade, the CBO projects that the White House budget will run $9.3 trillion in deficits. The White House projection had been $7 trillion. The problem for Obama, as his budget moves to Congress: Lawmakers tend to trust CBO figures over all others. "CBO's word is the gospel," Sen. Chuck Grassley, R-Iowa, the ranking member of the Senate Budget Committee, said in a statement.
When the White House released its budget in February, its economic forecast was in the same ballpark as other estimates, but decidedly on the sunny side. One assumption, for example, was that the average unemployment for 2009 would be 8.1%. That assumption was quickly blown to pieces when the Bureau of Labor Statistics announced two weeks later that unemployment had already reached that level by January. The CBO projects 2009 unemployment will instead be 8.8% before peaking in 2010. The key metric, when determining if a deficit is controllable, is looking at the ratio of the debt to the country's GDP. If this ratio is shrinking, then the debt is manageable. The White House said this would happen by 2013. The CBO says this will not happen, even by 2019. This difference between White House and CBO estimates is driven primarily by assumptions about the overall direction of the country's economy.
That economic reality could be even worse than what the CBO projects. After a 1.5% loss in 2009, the CBO says real GDP will grow by 4.1% in 2010 and 2011, hopeful assumptions shared by Obama's team. "As you emerge from a recession, economic growth rates can temporarily be quite high because you're starting from such a low base," promises Peter Orszag, director of the White House Office of Management and Budget. This is indeed the case with some recessions. But growth can also be quite slow for years coming out of a recession, leaving tax revenues much lower--and deficits higher--than either the CBO or White House projections. The White House estimates are "incredibly high by recent historical standards," says Martin Regalia, chief economist for the U.S. Chamber of Commerce. The Chamber, quick to point out that it supported both the $700 billion bank bailout and the stimulus package, is opposed to Obama's budget.
If spending stays elevated without a robust recovery, an increase in taxes is one of the only ways to close the deficit. Orszag says new numbers from the Congressional Budget Office are an expected part of the process, and the White House will stick to its goal of cutting the deficit in half, using CBO numbers not its own numbers. Speaker of the House Nancy Pelosi released a statement saying she believes the House can pass a budget reflecting the president's priorities in two weeks. The Senate was less sanguine. "The reality is we are going to have to make adjustments to the president's budget if we want to keep the deficit on a downward trajectory," says Sen. Kent Conrad, D-N.D., the chairman of the Senate Budget Committee. If the economy doesn't pick up soon, that'll be the understatement of the decade.
In the Capital, a Glut of Outrage
History will record the third week of March 2009 as Outrage Week in Washington. The initial outrage outbreak followed revelations of million-dollar bonuses at bailout beneficiary American International Group. Like a spring fever, outrage spread across party lines, and 85 House Republicans joined the Democratic majority in passing a punitive 90 percent tax on the bonuses. Then came the backlash to the outrage. The sages of Washington warned of mob rule, chaos in the streets. But then some people hollered that not being outraged was itself an outrage. At the core of all this populist outrage and elite counter-outrage is a mystery: Why now, exactly? Why did the AIG case -- $165 million in bonuses, contractually agreed upon last year -- roil the capital so feverishly after months of the government shoveling tens of billions, hundreds of billions, make that trillions of dollars, to private companies?
It may simply be that, after months of dismaying reports of executives getting fat bonuses, the AIG case was the final tumbler in the lock. This one clicked. And bonuses aren't abstractions: AIG might be a faceless corporation (what does it stand for, again?), but its executives can easily be pictured as they pocket their one, two, four, six million dollars in bonuses -- each. "Why do they deserve that bonus?" asked David Donaldson, a District sanitation worker, as he emptied garbage cans near the White House on Saturday afternoon. "We're doing labor," his co-worker Ricardo Brandon said. "We get a bonus, we get, like, 50 cents. Dealing with hazardous materials. Having to fight off rats." Most people know exactly how much money they get paid, and they know that under no circumstance are they likely to make Wall Street kind of money.
And so, from where Daisy Montague's standing, making espresso drinks for $12 an hour at the Baked & Wired coffee shop in Georgetown, the AIG executives should give back not 90 percent but 100 percent. "What is it they do that's so valuable? And why are we rewarding the people who put us in this crisis we're in now?" the 25-year-old, who has a college degree in theater education, said Saturday morning. "I think those folks are basically stealing from taxpayers such as myself." Neil Pfortsch, 51, a concrete pump operator working Saturday at a site in downtown Washington, said of the AIG executives, "They ought to put 'em in jail." He said he has seen the value of his 401(k) drop 40 percent over the past year. He wishes he'd gotten out of the stock market a year ago. The AIG executives will take their money, he guesses, "and hide it. Know where to without losing. That's why they're executives."
It was the president himself who began the percussive backbeat of "outrage" last Monday when, after learning of the AIG bonuses, he asked, "How do they justify this outrage?" But the president is not a natural at the language of outrage, and he took heat for not sounding more like Clint Eastwood. The Obama administration is now in the awkward position of trying to figure out how populist it wants to be. By week's end, it was no longer clear whether the administration and its allies in Congress wanted to partner with troubled financial institutions in an attempt to stabilize them or simply blow them up. The financial companies need the federal government but increasingly view it as untrustworthy. Headhunters prowl the headquarters of Fannie Mae, which is effectively owned by taxpayers and where top executives infuriated by the clawback tax are ready to bolt.
By Thursday night, when President Obama appeared on NBC's "The Tonight Show," he seemed to have moderated his rhetoric slightly and did not offer a full-throated endorsement of the House vote on the 90 percent tax, which host Jay Leno described as a bit scary. "I understand Congress's frustrations, and they're responding to, I think, everybody's anger," Obama said. "But I think that the best way to handle this is to make sure that you've closed the door before the horse gets out of the barn. . . . The important thing over the next several months is making sure that we don't lurch from thing to thing, but we try to make steady progress." Susan Hayden, a meeting planner in the District, offered her theory Saturday for why this scandal cut to the bone so much more than others: The economy has gotten worse and worse. People really feel it now, and when they ponder financial executives getting million-dollar bonuses, of course they're outraged.
"These guys aren't worth it," she said. "It's kind of like the old-boy network. It's kind of exploded." Polls would suggest that umpteen-billion-dollar bailouts to financial institutions do not enrage the public as much as mere millions going to unsavory individuals. In September, for example, a bare majority, 51 percent, of respondents to a Washington Post-ABC News poll said they opposed the initial $700 billion bailout of the financial sector, and only 29 percent of those said they "strongly" opposed it. But in a Gallup poll Wednesday, 70 percent of Democrats and 56 percent of Republicans said they were "outraged" by the AIG bonuses, with most of the rest putting themselves down as "bothered."
In Washington, outrage is a prized political commodity. It can be a fundraising accelerant. Interest groups and partisans scurry to channel it toward their particular agenda. The liberal activist organization MoveOn.org has started an e-mail campaign that invites recipients to throw a "virtual tomato" at an image of an AIG corporate office. Meanwhile, the conservative advocacy group Americans for Prosperity, which favors limited government and free trade, has sent out its own Action Alert, decrying the "outrage" of the AIG bonuses and, for good measure, asking members to lobby Congress to block a "cap and trade" system to limit carbon emissions linked to global warming.
"We think the outrage is an important step to demanding action. In the past, we've had a problem with silence," said Stephen Lerner, special assistant to the president of the Service Employees International Union, which has staged protests against the bonuses. "It's not just the bonuses. It's the way these guys have gamed the entire system to enrich themselves and then have asked us to bail them out from problems that they created," Lerner said. There's certainly more outrage than consensus in Washington. "Something's gotta change, and something's gotta change quick," Tyler Gilbert, 33, a father of five and real estate consultant, said Saturday as he prepared for a presentation at the Georgetown waterfront. Is he "outraged" by the AIG bonuses? He preferred a word that's not printable. Finally, he rephrased it: "I'm perturbed."
Obama Told Us To Speak Out, But Is He Listening?
The president is getting what he asked for, but perhaps not what he had in mind. During the campaign, Barack Obama beckoned Americans to put aside their cynicism about politics and re-engage as active citizens. They are now doing so with red-hot anger. They are outraged by events and forcing their way into congressional affairs and behind closed doors where policy wonks discuss issues with cerebral civility. The president is now trapped between these two realms -- the governing elites who decide things and the people who are governed. Which side is he on? If he does not choose wisely, the anger could devour his presidency. The immediate impetus is the latest outrage from the financial sector. AIG, the failed insurance giant on government life support, proceeded to hand out $165 million in employee bonuses. Because Washington has pumped $170 billion into this zombie corporation, people quickly grasped that AIG was redistributing their tax money.
On March 13, the White House sent out Larry Summers, the president's economic adviser, to explain things. Government has no choice, Summers said, because this is a government of laws and we must honor contracts. On Monday, the president scrapped that line, hoping to dodge the outrage. Something fundamental has been altered in American politics. Encouraged by Obama's message of hope, agitated by darkening economic prospects, many people have thrown off sullen passivity and are trying to reclaim their role as citizens. This disturbs the routines of Washington but has great potential for restoring a functioning democracy. Timely intervention by the people could save the country from some truly bad ideas now circulating in Washington and on Wall Street. Ideas that could lead to the creation of a corporate state, legitimized by government and financed by everyone else. Once people understand the concept, expect a lot more outrage.
Public anger is likely to be a recurring episode, because the president has budgeted another $750 billion to rescue the financial system from its troubles. If Congress gives him the money, people will be watching where it goes. Obama is vulnerable to the blowback. In his address to Congress last month, he promised, "This is not about helping banks, it's about helping people." The first half of his statement is demonstrably not true, as people see for themselves and as bankers parade their arrogant excess. The second half is merely wishful. "Populist anger" is a condescending label pundits use to suggest an irrational, unruly temperament. But what's really going on is deeper and potentially more forceful. It will not be contained with good rhetoric or symbolic gestures.
Populism was the highly creative, self-made movement formed by desperate farmers in the late 19th century. It is disparaged in elite circles, but it generated vital ideas that ultimately reshaped government and democracy. We are not there yet, not even close. But the impulse for small-d democracy could be very healthy -- if the political system learns to listen and respond. At the center of this story is Obama, who inherited the Democratic Party's awkward straddle between monied interests and working people. I voted for him joyfully and sympathize. His message to the nation last week reflected his dilemma. "I don't want to quell anger. People are right to be angry. I'm angry," he told reporters on Wednesday. Then he pivoted: "What I want us to do is channel our anger in a constructive way."
What's changed the president's situation? During the past nine months, gigantic financial bailouts amid collapsing economic life made visible the crippling divide between governing elites and citizens at large. People everywhere learned a blunt lesson about power, who has it and who doesn't. They watched Washington rush to rescue the very financial interests that caused the catastrophe. They learned that government has plenty of money to spend when the right people want it. "Where's my bailout," became the rueful punch line at lunch counters and construction sites nationwide. Then to deepen the insult, people watched as establishment forces re-launched their campaign for "entitlement reform" -- a euphemism for whacking Social Security benefits, Medicare and Medicaid.
Of course, popular alienation has been around a long time. But the stakes for the country are now far more grave. My new book -- "Come Home, America: The Rise and Fall (and Redeeming Promise) of Our Country" -- asserts that we're at the end of the long and mostly triumphant era that started with victory in World War II. We are going to change as a country, for better or worse, like it or not. If people and the president do not stand up for just solutions, politics as usual will prevail. Congressional leaders are once again rushing to enact hasty "reforms" that might get the financial monkey off their back, but will permanently damage our democracy. Elite opinion wants to empower the Federal Reserve to act as the "super-cop" protecting the financial system against systemic risk in the future. This idea is another instance of rewarding failure.
The Fed was blind to the systemic risk accumulating during the past two decades and it failed utterly to head off the excesses -- the explosion of debt and Wall Street's fraudulent valuations. The central bank, in fact, with its erratic monetary policy, was a central source of what destabilized the economy. Why would politicians make this cloistered and unaccountable institution more powerful, when the Fed has been derelict in its historical obligation to protect the "safety and soundness" of the system? Reforms ought to head the opposite way -- forcing the Fed into daylight and the same regular order required of government agencies. A few weeks ago, a freshman congressman, Rep. Alan Grayson (D-Fla.), became an Internet celebrity with the video of him grilling the Federal Reserve vice chairman at a House hearing. The Fed is in the process of handing out almost $3 trillion. Can you tell us which firms and banks are getting money? Grayson asked.
Donald Kohn said that would be inappropriate. It might discourage some banks from taking the public's money. More outrage ensued and last week, after a good pounding from citizens, the Fed folded and named some names. A new regulatory regime that puts the secretive central bank in charge of everything would sanctify the policy of "too big to fail" that Fed officials have long followed but never honestly acknowledged. It would also revive the Wall Street club, albeit smaller than before, with which the Fed has been so cozy. If the largest bank holding companies are given privileged proximity to the source of government protection, then everyone in finance and commerce will want to become a bank holding company, too. We are already seeing this happening as former investment houses like Goldman Sachs and non-bank financial firms decide to join the system.
Why not General Electric and Microsoft? Where does this end? What does it mean for smaller enterprises that lack the scale and influence? Whatever the intentions, this "reform" would effectively legitimize the existence of a corporate state. This concentrated power would be neither socialism nor capitalism, but a grotesque hybrid that combines the worst qualities of both systems. Government and politics would become even more responsive to big money, but also able to tamper intimately with private enterprise, picking winners and losers based on political loyalties, not on performance. Capitalism with its inherent tendency toward monopoly would have the means to monopolize democracy. Barack Obama can resist all this, if he chooses, but he seems conflicted. Obama's approach so far is devoted to restoring Wall Street's famous names, and his economic advisers tell him this is the "responsible" imperative, no matter that it might offend the unwashed public.
Obama evidently agrees. He does not seem to grasp that the tone-deaf technocrats are leading him into a dead-end. The president needs to hear a second opinion -- millions of them. People are angry, but they want this president to succeed. Mobilized citizens can help him to prevail. If he goes with the other side, they will bring him down.
Small Banks Could Drive Recovery, Bernanke Says
Small banks could play a key role in spurring the nation's economic recovery, Federal Reserve Chairman Ben S. Bernanke said yesterday, as many appear strong enough to make new loans while bigger institutions have pulled back. Bernanke urged community bankers "not to let fear drive" their decisions and to make sound loans. In a speech, he told the Independent Community Bankers of America that the Fed has instructed bank examiners to encourage such institutions to make loans so long as they are "economically viable." The Fed chairman is working on multiple fronts to try to restart lending, and his words of encouragement yesterday were part of that broader effort. The central bank has already supported government injections of cash into big financial institutions and, this week, launched a new program to fund $200 billion in consumer loans.
Smaller banks have, generally, held up better through the recession than the biggest financial institutions. While 20 banks have failed so far this year, that pace is far slower than in the early 1990s, when hundreds failed annually. Small banks have tended to make straightforward loans to individuals and businesses, rather than exposing themselves to the complicated securities that dragged down their larger competitors. "If community banks are prudent but opportunistic in extending credit to strong borrowers, they will help the economy recover while benefiting from that recovery themselves," Bernanke said. He also said that "in some instances, community banks are able to step in at crucial moments when local businesses or consumers have been unable to find credit elsewhere."
But there are some limits to how much small banks can boost the broader economy. One is scale. The 7,800 smallest U.S. banks had total deposits of only about $1.2 trillion last year, about the size of Bank of America and J.P. Morgan Chase put together. Even though some community banks have seen their deposits rise by up to 8 percent this year, according to Cam Fine, chief executive of the independent bankers group, they would have to grow improbably fast to make up for the total decrease in lending last year. Moreover, while most community banks have held up relatively well through the recession so far, major losses could still lie ahead. Small banks tend to lend heavily for office buildings, retail centers and other real estate projects in their communities. Losses on those loans are likely to rise in the coming months, analysts have said, as stores and office tenants default and newly developed homes sell for less than had been anticipated.
There are indeed large parts of the country, such as the Southwest, Florida and the industrial Midwest, where commercial real estate is "very, very weak," Fine said. He argued, though, that small banks, burned by the real estate crash of the early 1990s, made loans on sufficiently conservative terms that most should be able to weather the problems. Banks as a whole still face major challenges. The Federal Deposit Insurance Corp. said yesterday that the industry lost $32.1 billion in the final three months of 2008, more than the $26.2 billion first reported last month.
Fed’s Expanded Regulatory Role in Doubt as Frank Backs Away
A proposal to put the Federal Reserve in charge of market oversight is losing congressional support after its main backer, Barney Frank, said criticism over American International Group Inc. "undercuts" his proposal. "There’s still a need for a systemic-risk regulator," Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, said yesterday. "The argument for the Fed alone has lost a lot of political support. I think that’s now got to be re-looked at." Senate Banking Committee Chairman Christopher Dodd and Richard Shelby, the panel’s top Republican, said March 19 they are reluctant to expand the Fed’s role, faulting the central bank for lapses leading to the financial crisis.
Congress is overhauling U.S. financial regulations and agencies that lawmakers have faulted for lax oversight. Frank, who is playing a lead role in the redesign, has been pushing to expand the Fed’s authority. Lawmakers are considering setting up a regulator or giving power to an existing agency to monitor risk and detect problems across an array of financial-services firms to prevent shocks to the economy such as the one caused by the collapse of Lehman Brothers Holdings Inc. in September. Congress chastised AIG Chief Executive Officer Edward Liddy over $165 million in retention pay after the New York-based insurer received $173 billion in taxpayer funds. Lawmakers advanced legislation that would tax bonuses at AIG and other companies that are getting federal aid.
The bonus controversy "throws open the question about how you do it," Frank said. "It’s something we’re now all thinking about." Dodd and Shelby endorsed the idea of creating a systemic- risk regulator. "Whether or not those vast powers will reside at the Fed remains an open question," Dodd said at a March 19 hearing on the issue. "I think we’re going to have to create a systemic-risk regulator," Shelby of Alabama told reporters on March 19, adding he’s still weighing whether an existing or a new agency should get those powers. The Federal Reserve Bank of New York has been in the lead in overseeing AIG since the company’s initial bailout in September. The Fed gave AIG "a massive infusion of cash" in September "and the many funds since then without any requirements or conditions," House Speaker Nancy Pelosi said on March 19.
"I’m not enamored with some of the Fed’s actions regarding oversight," Shelby said about the idea of giving the authority to the Fed. "Some of the biggest failures in the world occurred under their watch." Dodd, a Connecticut Democrat, raised the idea of giving the systemic-risk authority to the Federal Deposit Insurance Corp., the bank regulator that insures deposits. "I’m not rejecting the Fed as an alternative," Dodd told reporters. Still, he expressed doubts about housing the authority at the Fed, citing "the obvious mistakes the Fed made in the run-up to the current crisis." Dodd has repeatedly chided the Fed for not using its authority under a 1994 law to approve new rules to strengthen consumer protections in mortgage lending. The Fed adopted tougher mortgage rules in July 2008.
Questions about the Fed’s performance on consumer protection issues are "going to come up," said Kevin Barnard, co-head of the financial institutions practice at law firm Arnold & Porter LLP in New York. "Did the Fed perform as well as some might have liked? What does that tell us about their ability to be the systemic-risk regulator?" The Fed’s role as a regulator has not been without setbacks, Chairman Ben S. Bernanke admits. "We probably could have done more," Bernanke told CBS Corp.’s "60 Minutes" program March 15. The Fed chief has said he supports creating a systemic-risk regulator, without saying whether the principal authority should go to the Fed. "Effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role," Bernanke said in a March 10 speech.
Treasury Secretary Timothy Geithner is scheduled to testify on the issue in Frank’s committee on March 26. "It was a dangerous idea to give that power to the Fed," said Peter Wallison, a financial policy fellow at the American Enterprise Institute, who testified on the issue in Frank’s committee on March 17. "It would have compromised them and threatened their credibility as a monetary authority." He suggested giving the authority to the President’s Working Group on Financial Markets, which includes the leaders of the Fed, the Treasury Department, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The American Bankers Association "can tolerate it going to the Fed if we can make sure it doesn’t compromise the Fed’s monetary-policy role, which is their number-one priority," said Wayne Abernathy, the Washington-based industry group’s executive vice president of financial institutions policy.
US working families struggle to make ends meet
As thousands of jobs are shed on a daily basis and consumer credit tightens, the economic crisis is driving working families and individuals to make difficult decisions on how to spend their dwindling resources—many with serious ramifications for their current and future well-being. Because real wages have stagnated since the early 1970s, families have attempted in recent years to make ends meet by working longer hours, taking on second jobs, or by adding more family members to the labor force. Such options have now become few and far between as more and more workers search for work and many are forced to work reduced hours.
The most recent Federal Reserve flow of funds report indicates that at $13.9 trillion, American household debt more than doubled over the last decade. Or, as Time magazine put it, "Household debt in the US—the money we owe as individuals—zoomed to more than 130% of income in 2007, up from about 60% in 1980." However, with the collapse of the housing market has come a drying up of credit. Decreased home values mean decreased home equity that can be realized either through sale or borrowing. Some banks are even offering customers hundreds of dollars to cancel their unused home equity lines of credit. Likewise, credit card companies are decreasing credit limits, raising rates, canceling cards, or offering small financial incentives to cancel them.
Reuters quoted banking analyst Meredith Whitney, who warned that "credit cards are the next credit crunch." Available lines of credit were reduced by nearly $500 billion in the fourth quarter of 2008 alone, she said, estimating that over $2 trillion of credit card lines will be cut in 2009. In response to these pressures, people—and businesses—have cut back on spending. According to a Commerce Department report released February 27, consumer spending—which accounts for about two-thirds of the US economy—decreased in the fourth quarter of 2008 at a 4.3 percent pace, the most in 28 years. Spending on health care is one area where people are cutting back, often endangering their health, their lives. According to the February 25 news release for a Kaiser Family Foundation survey, in the past 12 months more than half (53 percent) of American households say they have cut back on health care due to cost concerns.
The survey showed: "The most common actions reported are relying on home remedies and over-the-counter drugs rather than visiting a doctor (35%) or skipping dental care (34%). Roughly one in four report putting off health care they needed (27%), one in five say they have not filled a prescription (21%), and one in six (15%) say they cut pills in half or skipped doses to make their prescription last longer." When medical care cannot be postponed, however, the consequences of health care outlays can be devastating. Nineteen percent of people reported "serious financial problems recently due to family medical bills." Spending for health care means other bills are put off, and families must cut back on basic necessities like food, housing and utilities. "Specifically, 13 percent say they have used up all or most of their savings trying to pay off high medical bills in the past 12 months," according to the Kaiser study.
A recent Bank of America Retirement Savings Survey also found that economic conditions have caused 18 percent of respondents to withdraw money from their qualified retirement accounts prematurely. In spite of having to pay income tax and, in most cases, a 10 percent early withdrawal penalty on this money, 25 percent of respondents withdrew the funds because they needed it to make credit card payments, 22 percent needed it to make mortgage payments, and 22 percent because they had lost a job. Reports indicate pawnshop business is booming in the US, Canada and Britain. In addition to an influx of new customers, many of those who used to shop in pawnshops are now going there to sell items to get cash to pay bills.
Reports also indicate a marked increase in the number of people donating their blood, semen, hair, and eggs. Donations of blood can earn $20 to $35, semen can earn up to about $200, a yard of hair up to about $2,500, and eggs up to $10,000. "The Center for Egg Options in Illinois has seen a 40 percent increase in egg donor inquiries since the start of 2008," according to Reuters. A recent survey by Feeding America, formerly America's Second Harvest, finds a 30 percent average increase in people seeking help at food banks across the nation, twice the increase seen six months ago. More than 70 percent of food banks are unable to meet the demand and are being forced to cut back on the food they provide to soup kitchens, food pantries and emergency shelters.
After a request for $300 million in emergency assistance was left out of the recent economic recovery package, Vicki Escarra, president and CEO of Feeding America, said, "It is tragic that this legislation ignores the emergency food needs of millions of people affected by the faltering economy."
"Many of the people we see are recently unemployed and do not currently qualify for food stamps, or are waiting for benefits to be approved," she said. "Our food banks are seeing unprecedented numbers of people coming to food pantries across the country, and their shelves are becoming emptier by the day. Escarra added, "We cannot continue to feed millions of additional men, women and children who are turning to us, often for the first time, without more support from the federal government. Americans are going hungry, and we are in a crisis."
More and more people are also looking to payday lending companies for needed cash. In some states, these legalized loan-shark operations can charge over 400 percent interest annually on loans. While several states have passed laws putting a cap on the interest rates these companies can charge at far lower levels, 35 states have not. Even in those states where interest rates have been capped, payday lenders are finding ways around usury laws. Ohioans voted in the last election to cap payday lending rates at 28 percent, to limit the amount a person can borrow from such firms to $500, and to allow a consumer to take out no more than four loans per year. To get around the law, when payday lenders give a customer a $500 check, they then charge the customer $75 to cash it.
Lower credit-card limits trimming credit scores
Wayne Brown has a dilemma. He said if he reduces his credit-card balance, American Express will cut his credit limit to the amount of the new balance. If he doesn't make a big payment, his interest rate may skyrocket. The credit limits on Brown's cards have been lowered, which has raised his debt relative to his available credit. This so-called utilization rate is a key factor in determining credit scores Brown, a 58-year-old construction-company owner in San Diego, has seen his score drop to 650 from 760 the past 13 months. "Interest rates on all of my cards are going up now, and my minimum payments are almost doubling because it looks like I've maxed out my cards," said Brown, who uses credit cards to fund his home-building company. "It's a Catch-22."
About 45 percent of U.S. banks reduced credit limits for new or existing credit-card customers in the fourth quarter of 2008, according to a Federal Reserve January survey of senior loan officers. Financial institutions may slash $2 trillion in credit-card lines in the next 18 months, Meredith Whitney, a former Oppenheimer analyst, wrote in a Nov. 30 report. "You're no longer immune if you have good credit," said Curtis Arnold, the founder of CardRatings.com, a Web site that reviews credit cards. "The issuers hold the cards, literally." Credit-card issuers such as American Express, Citigroup and JPMorgan Chase have cut credit limits to guard against risk and prevent delinquency and charge-off rates from increasing, said Arnold.
The average charge-off rate, reflecting loans the banks don't expect to be repaid, was 7.1 percent in January, compared with 4.6 percent a year earlier, according to data compiled by Bloomberg. If credit-card limits are decreased, consumers should pay off balances as quickly as possible, consider making online payments before the monthly statement arrives to reduce debt, and weigh transferring balances to a card with a lower rate, said Jeff Blyskal, a senior editor of Consumer Reports. He said consumers should beware of teaser rates and high fees when transferring balances. Cardholders will damage their credit history if they cancel an older account and lose the available credit on that card, said Emily Peters, personal-finance expert at consumer Web site credit.com. Credit-score companies look at the total amount of debt relative to credit limits on all credit cards when evaluating scores.
American Express, the largest U.S. credit-card company by purchases, is offering $300 to some customers if they pay their balances in full by April 30 to reduce the risk of defaults. Chase increased the minimum payment to 5 percent from 2 percent for certain borrowers with large balances, and Capital One Financial increased the rates for new customers on 15 cards, according to Bill Hardekopf, chief executive of LowCards.com, a Web site that compares the rates of almost 1,100 credit cards. Desiree Fish, a spokeswoman for American Express, said consumers' overall debt levels relative to their financial resources is the primary factor for any credit-limit reduction. She declined to comment on the specifics of Brown's case. Citigroup is lowering credit limits because of the market environment and deterioration of consumer credit, said spokesman Samuel Wang. In 2008, Chase decreased credit lines or closed accounts totaling $129 billion, Gordon Smith, JPMorgan's chief executive of card services, said last month. Credit lines to new and existing customers were increased by $107 billion, Smith said.
Critz George, a retired nuclear engineer and physicist in Albuquerque, N.M., said he had three Chase cards and one Citibank card closed because of inactivity, without advance notice. George, 71, said he fears having four lines of credit closed will lower his credit score. "I feel like it was an arbitrary and capricious decision because I have paid in full and on-time for the last 20 years," he said. Brown, who is also a mortgage broker, said he was always careful to keep his balance at one-third of the limit. He said the reduced credit limits on his American Express and Bank of America cards have made that impossible. "I'm angry because I've always been proud of my credit history and now it's gone to hell, not because of something I've done."
Dollar Declines Most Since 1985 Plaza Accord on Fed Bond Buying
The dollar dropped the most against the currencies of six major U.S. trading partners since the Plaza Accord almost a quarter-century ago as the Federal Reserve’s plan to purchase Treasuries spurred speculation that it’s debasing the greenback. "What it introduces is the problem of the currency to the extent that the Fed is buying what isn’t desired by foreign holders," said Bill Gross, co-chief investment officer of Pacific Investment Management Co., in an interview on Bloomberg Television on March 19. "The Fed can keep interest rates where they want to keep them, at least for a 6- to 12- to 18-month period of time, but it will have consequences down the road." The U.S. currency weakened beyond $1.37 per euro this week for the first time since January as the central bank’s decision to increase its balance sheet by $1.15 trillion lowered yields, making American assets less attractive. The Norwegian krone and the New Zealand dollar rallied as the Fed’s move spurred advances in commodities.
The dollar depreciated 4.8 percent to $1.3582 per euro yesterday, from $1.2928 on March 13. The U.S. currency touched $1.3738 on March 19, the weakest level since Jan. 9. The dollar also fell 2.1 percent to 95.94 yen from 97.95. The euro increased for a fifth week versus the yen, gaining 2.9 percent to 130.29 after touching 130.49 yesterday, the highest level since Dec. 18. The ICE’s trade-weighted Dollar Index dropped 4.1 percent this week to 83.84, the biggest decrease since the week in September 1985 when the U.S., U.K., France, Japan and West Germany agreed at New York’s Plaza Hotel to coordinate the devaluation of the dollar against the yen and deutsche mark. The U.S. currency tumbled 3.4 percent versus the euro on March 18, the biggest drop since the 16-nation currency’s 1999 debut, when the Fed unexpectedly announced at the end of its two-day policy meeting that it will buy up to $300 billion of Treasuries and increase its purchase of agency mortgage-backed securities, a policy known as quantitative easing.
"The dollar’s decline this week has more or less priced in the policy response," said David Woo, global head of foreign- exchange strategy at Barclays Capital in London, in an interview on Bloomberg Television. "Over the next three months, I don’t see much downside for the dollar to the extent other central banks will be under pressure to follow the Fed’s lead and essentially go down the route of quantitative easing." Stocks advanced this week, while crude oil had a fifth week of gains, the longest winning streak in 11 months. The Standard & Poor’s 500 Index increased 1.6 percent. Crude oil rose above $50 a barrel. Norway’s krone was the best performer versus the dollar among the major currencies, increasing 7 percent this week to 6.377, the biggest advance since 1973. The Australian dollar gained 4.4 percent to 68.69 U.S. cents, extending its advance in March to 7.5 percent. Crude oil is Norway’s largest export, while raw materials account for 60 percent of Australia’s overseas sales.
Colombia’s peso increased 3.6 percent to 2,359 per dollar, while the South Korean won appreciated 5 percent to 1,412.25 on demand for emerging-market assets. "The rise in risk appetite may be sustained in the near term, which would make the dollar weaker still," a team led by Vincent Chaigneau, head of fixed-income and currency strategy at Societe Generale SA in London, wrote in a research note yesterday. "We remain skeptical about the durability of that run, but still believe that the newly found dollar weakness could last." The yield on the benchmark 10-year Treasury note dropped the most since January 1962 on the day of the Fed’s announcement and fell 0.26 percentage point this week in its biggest decrease since December. At 2.63 percent, the yield was 0.34 percentage point lower than that of the comparable-maturity German bund. The gap widened 0.16 percentage point from a week earlier, making U.S. assets less attractive.
"We would by no means assume that the reaction to the Fed’s quantitative-easing announcement has run its course," Credit Suisse Group AG currency strategists led by London-based Ray Farris wrote in a research note yesterday. "Fed purchases of Treasuries are likely to be quite problematic for the U.S. dollar, particularly given large foreign holdings of Treasuries and the loss of yield support for the dollar that Fed purchases have caused." Foreigners hold about half of the marketable Treasury debts that are outstanding. China, the biggest foreign holder, with $740 billion, is "worried" about its holdings of Treasuries and wants assurances that the investment is safe, Premier Wen Jiabao said at a press briefing in Beijing two weeks ago.
Goldman Sachs Group Inc. raised on March 19 the target on its bet against the dollar to $1.40 per euro, and Citigroup Inc. recommended on the same day that its clients buy the euro versus the dollar. The yen fell to a three-month low against the euro as the Bank of Japan bought government notes and made subordinated loans to banks to spur the economy. The stretch of weekly declines was the longest since July.
California Tries New York's Airwaves to Sell $4 Billion in Bonds
California is running radio advertisements in New York for the first time to promote the sale of its bonds, seeking to drum up interest in a $4 billion issue it plans next week. The sale is California’s first since June and comes a month after the end of a political tussle over a record $42 billion budget shortfall that threatened to leave the state without enough money to pay its bills. The three major credit-rating companies lowered the state’s grade to the lowest among U.S. states within the past two months. California Treasurer Bill Lockyer has boosted his campaign to sell more of the state’s bonds to small investors as the large banks, insurance companies and hedge funds that once dominated the municipal bond market hold on to cash. Lockyer is running radio advertisements on New York radio stations though March 23, when officials begin taking orders from individual buyers, said Joe DeAnda, a spokesman for the treasurer.
"It’s to increase our exposure and attract as many investors as possible," said DeAnda. The debt comes to market after State Legislative Analyst Mac Taylor said on March 13 that California will have $8 billion less than it will need over the next 16 months even after legislative agreement on a deficit reduction plan last month. The chronic budget woes have weighed on the price of California bonds, pushing up borrowing costs relative to other states. A California general obligation bond maturing in 2035 sold today for 83.18 cents on the dollar, yielding 6.04 percent, according to Municipal Securities Rulemaking Board data. That is 0.79 percentage point more than top rated general obligation bonds, according to Municipal Market Advisors indexes.
Such yields may attract individual investors looking to shelter income from federal taxes. For someone in the top 35 percent U.S. tax bracket, the California yield is equivalent to earning 9.29 percent on a taxable investment, according to Bloomberg data. California bonds are at little risk of default because the state constitution makes paying investors a top priority. Robert Amodeo, a portfolio manager with Western Asset Management Co., said new municipal bonds are offering "compelling" returns compared with other securities. "They’re pricing these deals to go," Amodeo said. "These are historic prices."
The state’s radio pitch depicts California as a place that has "captured America’s imagination and spirit. It’s the state that gave us personal computers, recycling and blue jeans." An announcer refers to California as "a state that offers solutions and opportunity. And now, California is offering one of the few opportunities to make an attractive investment in these tough times." The state’s radio commercials are part of a $495,000 campaign that also includes advertisements in the Wall Street Journal and online, DeAnda said.
Chips down for casino banks
It doesn't take the biggest brain on the planet to divine that casinos and savings banks are very different beasts. That is why there is a growing clamour from luminaries including Bank of England governor Mervyn King and former chancellor Nigel Lawson to look at introducing Glass-Steagall style rules. Glass-Steagall was the 1930s regulation in the US that separated banks' function as utilities from their gambling activities; it came out of the belief that banks' speculation on the stock markets with their savers' money helped cause the crash of 1929 and the Great Depression.
Its repeal in 1999 by the Clinton administration was driven by powerful banking interests, a textbook case of politicians bowing to the finance industry, which had conducted a $300m lobbying assault. It worked to the immediate benefit of ambitious bank bosses in general, and Sandy Weill in particular. Weill, the former head of Citigroup, in 1998 had announced a $70bn deal with insurance company Travelers, to create a huge, multi-purpose financial institution of precisely the sort Glass-Steagall sought to prevent. Robert Rubin, Clinton's treasury secretary, accepted a job as Weill's lieutenant soon after.
We never had Glass-Steagall, but until the Big Bang in 1986 our staid old banks and building societies operated in a distinct sphere from the gentlemanly merchant bankers of the Square Mile. Since liberalisation, however, the high-street counters of Barclays, NatWest and the Midland (now HSBC) have been reduced to unexciting outposts of their parent companies' global empires. Adair Turner, chairman of the Financial Services Authority and a former Merrill Lynch man, is cooler than King on the Glass-Steagall idea because of the practical difficulties of severing casino banking so totally from its distant high-street cousin. Northern Rock, he points out, was a narrow utility bank, while Bear Stearns and Lehman were pure casino banks but still systemically important.
True, but that does not demolish the case for cordoning off the casinos; it needs to happen along with other reforms. The repeal of Glass-Steagall may not be the prime cause of the crunch, but there is correlation. Weill's triumph added to the bankers' sense of their own rightness and invincibility; it showed that fraternisation between financiers and policymakers was now the norm. One powerful reason for bringing back some variant of the act is that without it, the casino culture infects the utility banks and the wider society. At the root of the crunch was a toxic cocktail: the mis-selling of sub-prime mortgages on Main Street and the packaging of them into securitisations on Wall Street. Bear and Lehman were not utility banks, but arguably, they would not have run into such trouble without the fall in consumer lending standards that accompanied repeal.
Professor Richard Portes at the London Business School argues that the banks need to be broken up because they are too big both from the point of view of consumer competition and in terms of their lobbying power: I agree. Mega-banks have exerted a pernicious influence. They became not just too big to fail, but too big for the system to handle. Bank balance sheets cannot, in a sane world, be bigger than that of the government of their main host country. Other measures are needed: utility banks, which would have taxpayer protection for deposits, should be subjected to curbs on their wholesale funding and securitisations. The idea of caps on "extreme mortgages" of six times salary or more than 100 per cent of a property value was kicked into the long grass by Adair Turner in his report on financial regulation last week, but it is a sensible one.
We also need to bring in counter-cyclical capital requirements, so that banks build up their reserves when times are good. Note to G Brown and A Darling: it might have been an idea for you to have done that, too. Bringing in a modern version of Glass-Steagall will not be easy. As Turner points out, it would be tough for one country to introduce on its own, which is why it should be on the agenda at the G20. It will definitely be deeply unpopular with bankers. But to allow, as we have done, a situation where the casinos can make the sky fall in on our banking halls is madness.
Gordon Brown's G20 summit agenda is already unravelling
It is depressingly obvious that Gordon Brown is now feeling what Tony Blair used to call the "hand of history". In 11 days, the Prime Minister will host the G20 Summit at the ExCel exhibition and conference centre in east London, a gathering choreographed to parade his capacity to save the world from financial ruin, his stature on the global stage and his personal alliance with President Obama. It is hard to exaggerate the extent to which Mr Brown has invested in this diplomatic jamboree. The model, explicitly, is the Bretton Woods conference of July 1944, in which delegates from 44 countries met in New Hampshire, at the same time as the Normandy landings, in order to design what would become the world's post-war international financial system. The fruits of their work were the International Monetary Fund and what became the World Bank (as well as a still-born idea for a global currency called the "bancor").
It is not hard to see why the Bretton Woods meeting should have inspired Brown. Doubtless he regards himself as Churchill to Obama's FDR, the two statesmen whose determination to ensure post-war prosperity was the driving force behind this gathering of 730 delegates. The presiding intellect at the conference was John Maynard Keynes, whose wife Lydia wrote that the event was a "madhouse… with most people working more than humanly possible": again, this would appeal to Gordon the Stakhanovite. Keynes doubted whether he had "ever worked so continuously hard in his life". On the last night, there was a grand banquet at which the great economist was hailed as the all-conquering hero. "The whole meeting spontaneously stood up and waited, silent, until he had taken his place," recorded the Treasury official, Sir Wilfrid Eady. "Someone of more than ordinary stature had entered the room."
None of these details will have been lost on a politician as historically literate as Brown. It is the significance, rather than the specifics, that he longs to replicate. Yet, even before the first photo-op, the G20 summit's agenda is unravelling. Last week, Angela Merkel made it unambiguously clear that she disagrees with British and American demands for yet more fiscal stimulus. "It is not time to look at more growth measures," the German Chancellor said. "I disagree with this idea completely. The existing measures must work, they must be allowed to develop." China is reported to be implacably opposed to British plans for financial market regulation – although Mr Brown disputes this. As important as the agenda, however, is the psychology that underpins the conference. Although he never thought much of EU summits, the Prime Minister is a strong believer in global oligarchy: he has a faith that borders upon hubris, a faith that tends to be especially strong among left-of-centre heads of government, in the ability of Great Men to tackle the great problems of our time, to bang heads together where necessary, and still have time to go for a walk before tea.
And yet the success or failure of negotiation is often much more arbitrary than politicians care to admit at the time. Reading Jonathan Powell's account of the Northern Ireland peace process, Great Hatred, Little Room, Tony Blair conceded privately that the whole thing was the product of a series of historic accidents and lucky breaks. I am not sure Gordon is ready to admit that success or failure is ever beyond his control. Blair achieved his diplomatic breakthrough in Ulster in April 1998, less than a year after he had become prime minister. Usually, it is towards the end of a politician's life cycle that he or she gets truly afflicted by the itch to solve a great international problem, bring peace to an ancestral conflict, coax order out of planetary chaos, or otherwise bring humanity one answer closer to completing the global crossword. The most obvious recent example of this syndrome was Bill Clinton's doomed Camp David summit with Ehud Barak and Yasser Arafat. Its failure was a devastating personal blow to the President in his sunset months. Arafat saluted him as a great man. "Mr Chairman," Clinton replied bitterly (according to his memoirs). "I am not a great man. I am a failure and you have made me one."
I am told that one or two members of the Number 10 team have been very discreetly deputed to look at "legacy" issues: in translation, this means that, since Gordon will not be PM for much more than a year, all his remaining efforts should be seen with an eye to the likely verdict of posterity. Of three things I am sure: nobody in Number 10 will confirm that there is such a sub-sub-committee offering PG Tips (Post-Gordon Advice, that is); that the word legacy is never, ever, given an uppercase "L"; and, third, that I most definitely wouldn't like to be the world leader who, by some act of obstruction, is reckoned by Brown to have prevented the G20 summit from being a historic success and thus, adapting Clinton's self-pitying phrase, to have "made Gordon a failure rather than a great man." That, I imagine, would be an interesting and quite animated conversation upon which to eavesdrop in the dreary corridors of the ExCel centre. Brown: "That was a very unfortunate intervention this morning, Grigori. Very". Other World Leader: "Yes? You like, Mr Gordins? Is good talkings! We are having big funs, Mr Gordins…. We play table tennising later, yes?" – Cut to sound of shiny-suited PM of Absurdistan having his head hit repeatedly by a big cardboard sign bearing the slogan: "Be Heard at the G20!"
I find it hard, in any case, to imagine that gatherings of the global oligarchy can solve this crisis. New, bottom-up methods will be needed. The polar opposite of the G20 geopolitical extravaganza is open-source technology, to which everyone, anywhere, can contribute, in real time. (On which note, may I cordially invite all Sunday Telegraph readers to visit and join in The Spectator's online inquiry into the recession, set up by my colleague Fraser Nelson. Mr Brown is a politician at one end of a prime minister's life cycle. David Cameron is, the Tory leader hopes, at the other. Last week I wrote about the Tory leader's ambitions to position himself as Keith Joseph and Margaret Thatcher did in the late Seventies, as the enemy (in Cameron's words) of "cosy economic consensus".
On Thursday, he began to put flesh on the bones of his critique, officially dropping the long-redundant promise to "share the proceeds of growth" between tax cuts and public services. Debt reduction will be the absolute heart of Conservative economic policy. But Mr Cameron still has a long way to go to prove that his taxation of the affluent will be "fair" in the true meaning of that word, rather than the crudely populist, fleece-the-rich sense; and that he really will get a grip on public spending. One Prime Minister, nearing the end, believes that he feels "the hand of history" on his shoulder. His opponent, approaching (he hopes) the beginning of his years in Number 10, starts to feels the vice-like handshake of economic reality. Soon, that hand may curl into something more like a savage punch to the solar plexus. In 11 days, the G20 will launch a general election campaign. That campaign will be long, brutal – and utterly mesmerising.
UK to remain in deflation trap until 2012, economists warn
The forecast, by a team at BNP Paribas, states that prices in Britain will keep falling for at least another two-and-a-half years, as Britain suffers an apparently intractable bout of debt deflation. The warning comes only days before official figures confirm this Tuesday that the Retail Price Index has dipped into negative territory for the first time in almost half a century. It also follows a warning from the Bank itself that the UK is now exhibiting early signs of becoming stuck in debt deflation ? the combination of falling prices and rising debt burdens that afflicted the US during the Great Depression.
But while many assume the combination of near-zero interest rates and a heavily-devalued pound will help prevent falling prices from becoming entrenched, and may stoke inflation, the BNP Paribas economists said they expected deflation to persist all the way until 2012. Furthermore, the fall in prices would be broad-based across the economy, pushing into the red not only the RPI but also the Consumer Price Index, which the Bank's Monetary Policy Committee targets. Alan Clarke, UK economist at BNP Paribas, said: "Our revised economic forecasts for the UK are the most pessimistic in the market. We expect GDP to contract by more than 4pc this year and by a further 1pc in 2010. We expect deflation to set in during 2011, even earlier were it not for the VAT hike [which will follow the temporary cut in the tax this year]."
"Over the medium term, we expect the unemployment rate to surge to above 10pc ? well above neutral. This will exert significant downward pressure on inflation, turning negative in 2011." The forecast is based largely on the bank's prediction that the unemployment rate will soar to 10.4pc of the workforce by 2011, depressing the wider economy and underlines the disparity between economists' expectations for the coming years. The Office for National Statistics will on Tuesday announce that the annual rate of change in the RPI has dropped beneath zero for the first time since February 1960, most likely falling to -0.6pc. It is also likely to say that CPI inflation has fallen to around 2.5pc. The CPI does not include the effects of either house prices or mortgage interest payments,
Britain heads for year-long battle with deflation
Britain faces a year of deflation – falling prices – that will add to the pressures on the already deteriorating public finances, analysts say. Figures on Tuesday are set to show the retail prices index (RPI) down by about 0.8% on a year ago, projections by City economists show. This will mark the start of the first period of price deflation for nearly half a century. Inflation on the RPI measure was last negative in March 1960, having been below zero for the first three months of that year and in May and June of 1959. This time the deflationary episode will be longer and is expected to last until spring of next year, reflecting the effect of low mortgage rates and falling house prices on the RPI but also a drop in underlying inflationary pressures as a result of the recession.
"The RPI looks set to grab the headlines and we think this measure will continue in negative territory until 2010," said Philip Shaw of Investec. Malcolm Barr, an economist with JP Morgan, predicted that RPI deflation would reach its maximum in September, with prices down 4% on a year ago. One factor that would push inflation back up next year, he said, would be the reimposition of a 17.5% Vat rate. The government’s target inflation measure, the consumer prices index, will not drop into negative territory this week. It is expected to show that inflation dropped to 2.6% last month, from 3% in January. However, analysts also expect a short period of deflation, even on this measure, in late summer and early autumn, as last year’s big energy and food price rises drop out of the annual comparison.
The juxtaposition of impending deflation, rising unemployment and the financial crisis is already having a decisive effect on earnings growth, which is hitting the government’s tax take hard. Figures last week showed that private-sector earnings in January, including bonuses, were down by 1.1% on a year earlier. "The negative contribution from bonuses, at -4.4 percentage points, is almost twice the previous record and is consistent with a drop in bonuses of about a third," said Ben Broadbent, an economist with Goldman Sachs. "We can expect an even bigger negative in the data for February, the peak month for bonus payments." Deflation makes it even harder for the government to control the public finances. Many components of government spending are "sticky" and will prove difficult to cut even in a period of falling prices. State pensions will rise by 2.5% in April 2010 but, if they were based strictly on next September’s RPI figure as is usually the case, they would be cut.
In contrast, deflation will eat directly into corporate and personal tax revenues, particularly income tax and Vat. This weekend the Ernst & Young Item Club, which uses the Treasury’s economic model, warns that government borrowing will hit £180 billion in 2009-10, a record 12.6% of gross domestic product. Alistair Darling’s budget is due on April 22. David Kern, British Chambers of Commerce chief economist, said the government was confronted with a "terrible" situation. "The inflation story is complicated," he said. "We face short-term deflation but the fear of inflation two or three years ahead. The best way to cut the budget deficit is to get out of recession, but there also has to be a credible plan to cut it. In the meantime, the only thing they can do for business is to have a bonfire of regulations."
RBS faces probe over 'threats' to directors
The scandal engulfing the Royal Bank of Scotland reaches new heights today with serious allegations from a senior Labour politician that at least three of its former non-executive directors may have been intimidated and threatened with the sack for asking searching questions about its financial affairs. The Observer can reveal that a former government minister, Lord Foulkes of Cumnock, who has been extensively briefed by former bank insiders, has written to the Financial Services Authority, the City watchdog, asking it to pursue the claims which, if true, could trigger a criminal investigation.
The intervention by Foulkes, who is also a member of the Scottish parliament and sits on the Commons security and intelligence committee, comes amid fears that the bank will be exposed as the UK's equivalent of Enron - the US trader that collapsed amid systemic fraud. Last night Foulkes said there was "widespread public anger among the public and Parliament that bankers in the midst of this financial crisis appear to be profiting and no action is being taken in relation to action which could constitute criminal offences". In relation to claims of intimidation, Foulkes said: "If it were to transpire that executives were pressured in such a way, then that is a most serious matter indeed that needs urgent action."
He is also understood to have been disturbed by claims that the bank misled investors over its exposure to bad debts. Yesterday it was reported that more than £30bn of "toxic" sub-prime mortgages were bought for RBS by traders in 2007 without the board being informed - a claim denied by the bank. Foulkes's letter to the FSA chairman, Lord Turner, states: "You will be aware that there is widespread disquiet that, unlike in the USA, there appears to be no action being taken against any of the UK bankers who may have been culpable of one or more offences in their dealings."
He asks Turner to address "whether any knowingly false statements were made or prospectuses issued that could have led potential investors or depositors to believe the position was more favourable than the board knew it to be and whether there was any intimidation of non-executive directors who had been asking probing questions which led them to believe they would not be reappointed if they continued to pursue such searching questions". Matthew Oakeshott, the Liberal Democrat treasury spokesman in the Lords, said: "I have never come across such damaging claims of megalomania, cover-up and intimidation ... Never mind Northern Rock. I am really afraid that RBS will turn out to have been another Enron."
Foulkes's letter will be seen as the latest attempt by the establishment to up the ante on Sir Fred Goodwin, the bank's former chief executive, who has been blamed for its demise. Last month, Gordon Brown made a personal demand for Goodwin to hand back some of his £16m pension and pledged to take "all the legal action necessary" if he did not comply. The bank's financial reports reveal that the former non-execs, who included Peter Sutherland, chairman of BP, Jim Currie, the former head of Customs and Excise and Steve Robson, a former adviser to the Treasury, were paid a basic fee of £72,500 a year. According to RBS, they were meant to "satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible".
Concerns that the bank's non-executives failed to hold the board to account are bound to throw up further questions about how RBS was being run as it transformed itself from a relatively small outfit into one of the world's largest financial institutions. RBS said the bank had not seen Foulkes's letter and could not comment. However, a source close to the bank said allegations that the non-executive directors were pressurised may have some foundation. "Bullied is too strong a word, but, like many companies, somebody is clearly the leader and they may throw their weight around," the source said.
Last month RBS recorded a loss of £28bn - the largest in UK corporate history. Its catastrophic collapse has forced the government to take a 75% stake in the bank. UK taxpayers are also having to underwrite billions of pounds of its toxic loans bought by subsidiaries in the US. When contacted about Foulkes's letter, a spokesman for the FSA said: "We don't comment on whether or not we are going to pursue individual companies unless it is decided it is a matter of interest to the public."
Key repossession ruling opens door to mortgage mis-selling complaints
A remarkable ombudsman victory for a householder who had his home repossessed after being mis-sold a hefty mortgage could set a precedent, preventing others from losing their properties as the recession bites, lawyers say. This year an estimated 75,000 families - against 40,000 last year - will lose their homes, according to the Council of Mortgage Lenders (CML). But many who face handing back the keys could be helped by rules covering "suitable advice" for borrowers, buried in the handbook of the Financial Services Authority (FSA), the City regulator.
Andrew Brown (not his real name) struggled to repay his mortgage but subsequently took his mis-selling case to the Financial Ombudsman Service, and has now won. Despite turning to the FOS late on and being repossessed, he will receive compensation - while other borrowers who begin cases at an earlier stage than he did might well be able to save their homes too. A housing association tenant, Brown had the valuable promise of a rent fixed for life. However, a mortgage adviser persuaded him to buy the property and failed to consider "what would happen when the attractive discounted rate [set up on that mortgage] ended", according to an FOS spokeswoman.
Brown was repossessed and had to move; he then lodged a complaint with his mortgage adviser and ultimately brought the case to the FOS. Industry specialists believe more claims of this kind are now likely to emerge. The main source of optimism for those in a similar position lies deep within the FSA's rulebook for mortgage advisers, Mortgage and Home Finance: Conduct of Business (MCOB). This states mortgage advice must be "suitable for that customer" and that advisers "must make and retain a record" of it being suitable; this is known, crucially (and rather technically), as complying with section 4.7. Breaches of the MCOB rules are "actionable at the suit of a private person who suffers loss as a result", under section 150 of the Financial Services and Markets Act 2000.
"Undoubtedly, such cases would succeed," says professional negligence barrister John Virgo of Guildhall Chambers in Bristol. "There is a fundamental obligation under MCOB [rules] and I'm sure there will be a pretty big increase in this sort of litigation." Philip Ryley, head of financial services and markets at solicitor Michelmores, is more cautious. He says: "It really depends on each individual case as to whether they have received a service which would breach MCOB rules. It is an issue that may be raised before district judges [deciding repossession cases]. "If it develops wholesale, it devalues the meritous cases that exist. The courts will soon become familiar with these arguments and will then require the borrowers to produce evidence at an early stage. to root out frivolous or unsubstantiated allegations."
Though there may be concern some borrowers might try to exploit the MCOB rule without good cause, there appear to be many cases of people being mis-sold mortgages they could not afford. A Citizens Advice report entitled Set Up to Fail, on the sub-prime lending market in 2007, found the charity's repossession clients had often found themselves with "inappropriate and unaffordable" mortgages and secured loans, and that people buying council houses received "particularly poor advice". One case it highlighted concerned a couple with a disabled child in south-east Wales who were persuaded to take a second mortgage on their home. The loan wiped out their equity and meant £1,300 - 87% - of their £1,500 monthly income went on mortgage repayments.
The CML accepts the rulebook can be invoked by consumers. "The MCOB rules are there for a reason: to protect consumers," says spokeswoman Sue Anderson. "Consumers have 'the ability and right' to rely on these regulations if they believe they have not been dealt with correctly," she says. In 2007, Cash highlighted how cold-callers were using dodgy selling tactics to convince social housing tenants to exercise their "right to buy" and saddle these low-income homes with inappropriate mortgages. Although the ombudsman found in Brown's favour, the issue remains complicated.
The FOS is charged with restoring people, as far as possible, to the situation they would otherwise have been in - and that is not straightforward in circumstances such as these. "Historically, you may not have been worse off," says the FOS spokeswoman, referring to the fact that when house prices were rising - until 2007 - people who had been mis-sold an unsuitable mortgage might not have lost out if the price of their house was rising. They would not have won compensation. Now, the ombudsman is having to work out how to compensate someone who has not been protected by the rise in property values.
Brilliant financial reporting recounts how the 'House' came tumbling down
It seems almost achingly quaint to recall those warm and hazy days when "banker" was a synonym for sobriety and propriety — a time when those who worked in finance, as well as those who reported on it, believed that a pinstriped suit connoted one thing and a chalk stripe something else entirely. Anyone who still retains such antique illusions will lose them in fewer than 10 pages into "House of Cards," William D. Cohan's masterfully reported account of the collapse of Bear Stearns, the investment banking house whose implosion a year ago signaled the beginning of the worst global financial crisis since the Great Depression.
Cohan, a former senior investment banker who has turned into one of our most able financial journalists, is the author of 2007's "The Last Tycoons," a highly regarded history of Lazard Freres & Co., Wall Street's most storied investment bank. In this new book, he deploys not only his hands-on experience of this exotic corner of the financial industry, but also a remarkable gift for plain-spoken explanation. That's essential, because it may be only quantum physics that defies the descriptive powers of ordinary language quite so completely as the derivatives markets whose meltdowns have devastated Wall Street.
The other great strength of this important book is the breadth and skill of the author's interviews. Essentially, with pauses for needed explanation, he has used them to construct a staccato narrative of the frantic 10 days in March 2008 that began with the first doubts about Bear Stearns' liquidity and ended when the Federal Reserve and U.S. Treasury forced the company to sell itself at a fire-sale price to JP Morgan Chase. That and the subsequent bankruptcy of Lehman Brothers, the sale of Merrill Lynch, the collapse of insurance giant AIG and the virtual incapacitation of much of the banking sector, including behemoths Bank of America and Citibank, marked the end of Wall Street's second Gilded Age and the onset of the current global financial crisis.
At the time of its collapse, Bear Stearns was one of the world's largest and most aggressive investment banks, securities traders and brokerage companies. It employed more than 15,000 people around the world and, just a year earlier, Fortune had recognized it as "America's most admired securities firm." It also was the company most heavily invested in various forms of mortgage-backed securities, the novel financial instruments that subsequently sucked the world financial system down into a whirlpool of illiquidity, as American real estate inflation slowed and, then, declined.
Dirty little secret
That was Bear Stearns' undoing because, as Cohan explains, "Unlike a bank, which is able to use the cash from its depositors to fund most of its operations ... pure investment banks such as Lehman Brothers and Bear Stearns had no depositors' money to use. Instead they funded their operations in a few ways: either by occasionally issuing long-term securities, such as debt or preferred stock, or most often by obtaining short-term, borrowings in the unsecured commercial paper market or in the overnight 'repo' market, where the borrowings are secured by the various securities and other assets on their balance sheets. These routine borrowings have been repeated day after day for some 30 years and worked splendidly — until there was perceived to be a problem with either the securities or the institutions backing them up, and then the funding evaporated. The dirty little secret of the Wall Street securities firms — Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns — was that every one of them funded their business in this way to varying degrees, and every one of them was always just 24 hours away from a funding crisis."
That crisis came to Bear Stearns when Wall Street players began to raise questions about the liquidity implications of the huge positions in mortgage-backed securities — particularly subprime mortgages — that it was carrying on its books. Cohan points out that numerous analysts, including respected Meredith Whitney, had for some years warned that the trade in credit default swaps and various mortgage-backed instruments was setting the stage for "a credit implosion" that "could begin a domino effect of corporate insolvencies." Welcome to our pain, circa 2009.
Profiling the greedy
Cohan does a brilliant job of sketching in the eccentric, vulgar, greedy, profane and coarse individuals who ignored all these warnings to their own profit and the ruin of so many others. It's impossible to do justice to his reportorial detail in a review, but suffice to say it's slightly horrifying to learn the importance bridge played in Bear Stearns' internal culture. The company's last chief executive, Alan Schwartz, is philosophical about the collapse of his company. He can afford to be; he was paid $35,734,220 in cash less than a year before Bear Stearns' sale. As he sees it, he could have done a better job of running his business, but — in the end — "it was a team effort. We all (messed) up. Government. Rating agencies. Wall Street. Commercial banks. Regulators. Investors. Everybody."
In the midst of all this heedlessness and wanton venality we confront the mentality of looters rather than financiers, let alone captains of industry. Schwartz's airy dispersal of responsibility into the rhetorical ether notwithstanding, it's hard not to feel nostalgic for those sober old guys in the pinstripes and to hunger for their advice on where to go from here. Former Federal Reserve Chairman Paul Volcker, now 81 and an adviser to President Barack Obama, certainly is one of those. Recently, he admitted to a gathering of Nobel laureates and high-level investors that "even the experts don't quite know what's going on" in the global economy. The financial meltdown that began on Wall Street, he said, spread through the rest of the world with "shocking" speed, adding, "I don't remember any time, maybe even the Great Depression, when things went down quite so fast."
While the precise structural causes of the current catastrophe still may be obscure, Volcker said he was confident we won't "revert to the kind of financial system we had before the crisis." The future, he predicted, will hold not only more stringent regulation of the entire banking system — particularly with regard to risk management — but also of hedge and equity funds. To the remaining Wall Street smart guys who argue that reregulation will stifle the "creativity" of the American financial sector, Volcker had a dismissive rejoinder: The most heralded of these financial "innovations" — like credit default swaps and asset-backed securities of the sort that brought so many down — have created little but fees for their originators. The only banking "innovation" that has been of real importance to the vast majority of people in the last three decades, Volcker pointed out, is the automated teller machine. As Cohan's remarkable new work of financial journalism shows, the current mess began when the investment bankers began to treat everyone else's finances like their private ATMs.
TITLE: "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street"
AUTHOR: William D. Cohan
The Great American Banking Experiment
One of the most common questions that folks who are becoming newly acquainted with terms like ‘fiat money’ and ‘fractional reserve banking’ are asking is “How did we get here?” For sure, the recent publicity of 21st Century Tea Parties along with the occurrence of the worst financial crisis in recorded history has people asking questions. In terms of the American obsession with central banking and fiat currency, 1913 is generally identified as the point where the country went wrong. In truth, however, our obsession with funny money has transcended all; including even, the birth of the nation. And on a global scale, the eternal ponzi scheme of fractional reserve banking has been going on for a few thousand years now. It is a scheme that has been so perfectly atrocious over the centuries that it makes ponzicons Stanford and Madoff look like petty thieves. In this week’s piece we’ll take a look at some of the more noteworthy landmarks in America’s great experiment with paper money.
Gresham’s Law deals with a situation when there are two (or more) competing currencies and one is ‘pegged’ against the other. More specifically, the law deals with bimetallic currency systems where both Gold and Silver are used in an economy and the ratio of the two is fixed. A good historical reference would be the post Bank of North America United States in the early 1800s. The US Constitution in Article 1, Section 8 gave Congress the power to coin money and determine the value thereof. A Constitutional Dollar was determined to be a coin containing 371.25 grains of pure silver. In order to encourage the use of gold as well as Silver, the ratio was set at 15:1 – therefore a Constitutional Dollar could also be a Gold coin containing 24.75 grains of pure Gold. For anyone who knows Gold, 24.75 grains is not a very large coin so coins that contained 247.5 grains of Gold were used and were valued at 10 Dollars. So far, so good, right?
The only problem here is that the exchange ratio of any two goods will vary over time. When the 15:1 value was set, that was the going market rate. Alexander Hamilton, who was a big proponent of the bimetallic system, gets an “A” for effort, but failed to recognize and/or provide for the constant fluctuation. In the case of the Gold-Silver ratio, the supply of Silver grew disproportionately to that of Gold due in large part to mining in the Caribbean. The silver made it to our shores thanks to a vibrant trading relationship between America and that region of the world.
This is where Gresham’s Law comes into play. The law states that any time one money is compulsorily undervalued while another is overvalued, the undervalued money will be driven out of the economy or hoarded while the overvalued money will explode into circulation. In following Gresham’s Law, Gold all but disappeared from circulation in early 19th century America. With the obvious consequences of Gresham’s Law, it is easy to ask why any government would forcibly attempt to impose a bimetallic standard on an economy? Hint: It must be remembered that in absence of paper money, the supply of money in the economy was determined by the quantity of specie (Gold and/or Silver).
The monetary ‘authorities’ at the time were attempting to make sure that the economy had enough money to function properly, which was certainly a good intention. Where they went wrong in their approach is that the economy could have easily functioned on silver alone since it was in good supply. Market prices for other goods would have adjusted themselves through the laws of marginal utility and supply/demand according to the supply of both specie and the other goods. Gresham’s Law is easily observed today in our own currency system with a slight variation. While the Dollar and Gold are allowed to adjust to a certain extent in terms of each other, it is easy to see how the undervalued money (Gold) has gone into hiding while the overvalued ‘money’ (Federal Reserve Notes) have flooded into circulation.
Early American Attempts at Fiat Paper Money
Perhaps ironically, America’s first attempts at fiat money began before Lexington and Concord. Before the French and Indian War. And even before the 18th century had seen the light of day. The first government issue of paper money came in 1690 in the colony of Massachusetts. It had become a custom there to embark on plundering missions into Quebec and then use the proceeds of the missions to pay off the soldiers upon return to the colony. In 1690, however, one such mission was unsuccessful so there were no spoils to distribute. In order to placate the soldiers, the colonial government attempted to borrow the required money from local merchants. However, these merchants had a rather dim view of the creditworthiness of the government and refused. In an ill-fated decision, the government of the Massachusetts colony then decided to issue paper notes with the promise of both redeemability and that the issuance was a one-time affair. They ended up being wrong on both counts.
These endeavors continued almost constantly up to and through the American Revolution with two predictable results: the notes issued always depreciated versus the competing specie money and the amount of paper notes issued got larger with each subsequent attempt. These comparisons are important to make when connecting early monetary ventures to what is going on today.
Early in the American Revolution, the Continental Congress ran into the serious issue of funding and opted to look towards fiat money for the solution to the problem. Unlike some of the previous redeemable fiat ventures, the ‘Continental’ as it became known was not to be redeemable at all, but would rather be dismantled after the war ended by using taxes paid by the colonies. While this was a temporary solution, it carried the double whammy of inflation and taxation for the colonies. Certainly, sacrifices had to be made, but what is most interesting is what happened next. From 1775 through 1779, the supply of Continentals exploded by over 1800%. Predictably, the value of the Continental in specie (silver) had fallen to 42:1 from a beginning value of 1-1.25:1. By 1781, with the war still raging, the value of the Continental had fallen to a negligible 168:1. Comparatively speaking, today’s fiat dollar which traded with specie (gold) before the Great Depression at a rate of 20:1 now trades around 950:1 - a similar hyperinflation although over a much longer period of time.
The next step taken by the colonial government was to impose price controls and attempt to dictate the market value of the failing currency. These efforts flouted several of the laws of economics, the first of which is that you cannot run an effective paper money system without confidence. The second is that price controls create shortages by artificially setting the market price below that of the equilibrium price as is illustrated in the chart below:
With the impending failure of the Continental in 1779, the Congress resigned itself to allow the Continental to depreciate unredeemed into worthlessness. However, and tragically, the Congress then resorted to issuing loan certificates for the purchase of goods and services from Colonial merchants and refusing to pay anything in else. Soon enough the certificates became used as a currency and, much like their brother the Continental, began to depreciate. Here’s the important part though. Instead of allowing the certificates to be redeemed at a depreciated value, they were carried into perpetuity and the permanent Federal debt was born. This unpaid bill is better known today as the National Debt.
The Bank of North America and Robert Morris
In 1781, Robert Morris introduced a bill that created both the first commercial bank and the first central bank. The resulting catastrophe, headed by Morris himself, opened in 1782 and quickly ran into problems. The first of these problems was our old friend confidence. Americans, already weary of paper notes due to decades of failures, inflation, and broken promises just couldn’t shake the perception that the new bank’s notes were being inflated compared to the still-existing specie. The bank, in an extraordinary move at the time actually went as far as to hire people to promote the new bank and its notes and to insist on redemption for specie. Obviously the idea here was to gain the confidence of the public by demonstrating that the notes were in fact worth something. Paradoxically, today’s Fed doesn’t even try to maintain an illusion of backing or intrinsic worth.
The First Bank of the US - 1791
This first experiment into central banking lasted barely a year as in early 1783 Morris moved to end the institution’s authority as a central bank and shifted its focus to commercial activities with a Pennsylvania charter. Although short, it was one of many important steps in the establishment of a central banking authority. Perhaps most importantly, the population grew more accustomed to using paper money. By the 20th century, specie was removed from circulation in totality while the ability to redeem still existed. Eventually, redeemability was suspended as well, leaving us with a paper currency with only implicit worth. In 1971, in a final blow to sound money, settlement of foreign debt in specie was suspended as well. What has transpired since has been a slower, but eerily similar version of the demise of the Continental.
In conclusion, there is absolutely nothing wrong with paper money in and of itself. It can actually serve a valuable purpose in that it is more portable, easily divisible, and in the case of the grain banks thousands of years ago, was much easier than moving bushels of wheat. However, the predilection of those charged with running these types of operations has been to coerce and conspire to rob the people of wealth through stealth. Whereas it would have been exceedingly problematic to confiscate a farmer’s grain without incurring his wrath, it was magnificently simple to inflate his wealth away through the over issuance of grain receipts. The parallels between these early experiments and what goes on today are astounding. We as a people still haven’t gotten our heads around the idea of inflation - the over issuance of fiat paper money - and the confiscation of wealth it represents. What could never be done through direct taxation has been done under another name, right under our very noses, and in plain sight.