Bagdad, California. Going through the station on the Atchison, Topeka and Santa Fe Railroad between Needles and Barstow
Ilargi: Every now and then I return to a theme I first launched what seems like eons ago, one which only very few people, if any, have so far picked up on. That theme is that we are mired not merely in a financial crisis, but in a full-blown political one. Today is one of those days when it resurfaces, loud and clear.
Lately there have been many questions about Goldman Sachs and its software-orchestrated trading practices, which, necessarily and by its very nature, grossly distorts market trading. There are, as well, unanswered queries concerning Goldman's return of -at least some of- its federal alphabet five-course dinner financial support, a give-back that had president Obama proclaim that Washington has limited say over the firm that was only recently minted as a commercial bank, in a move that evokes images of the present administration dancing on the grave of Glass-Steagall, a law that undoubtedly deserves much more respect regardless of what you might think of its usefulness d.d. July 2009.
My view, by the way, now that you ask, is that the financial system can simply not be kept alive without Glass-Steagall or an updated, but certainly not weakened, modern day version of the 1933 law. Bankers playing black-jack with the lifetime deposits of hard-working Main Street families is one thing that needs to be eradicated more than anything else, though it is certainly by no means the only issue that matters.
There are interesting topics raised by the likes of Max Hyper Keiser, in Should Goldman Sachs be Prosecuted for Human Rights Abuses? , by Representative Alan Grayson, in a downright alienating round of questions with Ben Bernanke concerning $500 billion in dollar swap lines the Fed conducted with foreign banks (Bernanke claims to have no idea where the $half-trillion went), and by former IMF economist Simon Johnson in correspondence with former banker John Talbott. Al want to see profound changes made , in various ways, to the present financial and banking systems.
And then there's the -shifting- government plans aimed at reforming the ways regulation of the system is conducted, plans over which the infighting reaches new heights on a daily basis.
All smart people, all laudable initiatives. And all completely useless.
You cannot reform the existing financial system while leaving the political system intact. They are one and the same, as many of the voices mentioned above would be more than willing to admit. And if Goldman Sachs IS indeed the government, a subject on which there is little contention, then dealing with Goldman alone won't solve the problems. Taking Goldman to court over abusive practices will mean taking the government itself to court.
And that is not going to happen.
Suing people like Tim Geithner, Barney Frank, Barack Obama, Larry Summers, Bob Rubin and the whole rest of the power elite is an option that is so far removed from today's reality, you might as well throw it all out the window right now. And if you don't sue Washington, then suing Goldman has no use either.
Even if it's not clear yet, it increasingly will be as time passes by and matters reach new extremes. Like states which already, in this early stage of the "game", are not able to pay out jobless claims (which leaves people hungry), while a few handful miles away, bankers sue their employers for $100 million bonuses.
This is not a financial crisis. It's a political one.
The Monster of Wall Street Lives
Goldman Sachs and JPMorgan Chase have reported huge profits, the Dow has made it past 9000, and Barack Obama has moved on to health care. The horror show seems to be over. But as in one of those clichéd Hollywood endings, the monster in this story isn't really dead, even if most people think he is. Lost amid all the premature self-congratulation is the fact that the deepest underlying problem that caused the financial disaster is not being solved.
The problem: how to control and keep tabs on the market activities of giant firms that cause such a disruption to the system they can't be allowed to fail. Put simply, six months into the Obama administration there is as yet no coherent proposal for solving this issue, and serious differences remain between Tim Geithner's Treasury and Ben Bernanke's Fed. At hearings this week, Sen. Bob Corker (R-Tenn.) told Bernanke bluntly that he didn't think anyone was up to that immense and vastly complex job. As Corker told me afterward in an interview: "Today there's a whole lot more questions about what systemic risk is and which powers a regulator should have than there are answers. And the last week has brought that to light."
Indeed. On Friday, Geithner reiterated a position he first laid out in June: the administration, he said, wants to hand the job of systemic risk regulator to the Fed. "We propose evolving the Federal Reserve's authority to create a single point of accountability for the consolidated supervision of all large, interconnected firms," he said in testimony. He said again that the administration seeks to create a new Financial Services Oversight Council to monitor systemic risk. B
ut Geithner made clear the council "will not have the responsibility for supervising the largest, most complex, interconnected institutions." Geithner said there's no way such a council would have the "tremendous institutional capacity and organizational accountability" needed for that task, or to respond in a financial emergency. "You cannot convene a committee to put out a fire," Geithner summed things up piquantly in June. "The Federal Reserve is in the best position to play that role."
But Bernanke, in contending testimony this week, shied away from being cast as the über-regulator. Instead, as he saw it, the Fed ought to be restricted to being supervisor of bank holding companies--apparently the same 19 giant firms that went through "stress tests" last spring. "We don't have the resources or the authority" to take "a holistic view of the whole system," he said, "though, of course, in general terms we obviously are watching the economy, but not in that kind of detail."
Bernanke also expressed a lot more enthusiasm than Geithner about the council, urging Congress to debate "what powers it should have." He added: "There may be situations where the council can have authority to harmonize different practices or to identify problems and to take action." When Sen. Mark Warner (D-Va.) pressed Bernanke on this point, he demurred again. Warner asked: "Are you comfortable that the Fed is the de facto systemic-risk overseer at this point; is aggregating enough information upstream from all the day-to-day prudential regulators, not just on the banking side, but from securities, commodities and others--that this aggregation of information is taking place?"
Bernanke responded: "Well, no, we're not being the super-regulator at all." Federal Reserve governor Dan Tarullo, an Obama appointee, emphasized the same point in testimony on Thursday. While a new financial regulatory framework "would involve some expansion of Federal Reserve responsibilities, that expansion would be an incremental and natural extension of the Federal Reserve's existing supervisory and regulatory responsibilities," he said.
Both Bernanke and Geithner argued that other planned measures will ameliorate systemic risk. Under the administration's proposals, big firms will have to "bear the cost of their size through extra capital, liquidity and risk-management requirements," Bernanke said. In other words, there will be an additional cost to bigness that wasn't there before, making M&A enthusiasts think twice. Second, a new resolution authority will be able to take over big firms the way the Federal Depository Insurance Corp. does to banks, raising the prospect "that creditors could lose money if the company fails," Bernanke said. "Both of those things would tend to make being big less attractive." The Fed chief added that under the new regime, "supervisors would choose to tell firms that they needed to limit certain activities if they thought it was a danger to the broad system."
All this helps. But it may be a triumph of hope over experience that Wall Street will decide to get smaller when competing against other global giants, just because of the extra cost of doing business. And it is similarly wishful thinking to believe that the hazy job of systemic-risk regulator that no one seems to want--however it ends up being structured--is going to decide that a future AIG shouldn't get into a certain kind of credit default swap, or that a JPMorgan Chase can't develop some new kind of collateralized debt obligation.
The administration and the Fed have ignored more fundamental calls for change. For example, they have swatted aside a proposal by former Federal Reserve chairman Paul Volcker, the head of Obama's Economic Recovery Board, to bar commercial banks that enjoy federal guarantees from proprietary trading of risky instruments like derivatives. For the most part, the current measures will make it easier to clean up after the next mess. But they won't prevent another mess from happening.
Global deflation pandemic begins to brew
In congressional testimony this week, Federal Reserve Chairman Ben Bernanke gave no indication that he planned to turn off the central bank's liquidity spigots anytime soon. Critics howled that the Fed is risking runaway inflation. More immediately, however, the threat of deflation seems a bigger concern -- not just in the U.S., but also in economies around the world.
Last week, World Bank Chief Economist Justin Lin warned in a speech that a surge in excess capacity world-wide could lead to a global "deflationary downward spiral." The Bank of Japan and the International Monetary Fund are forecasting two years of price declines in Japan, which suffered a serious bout of deflation in the 1990s because of a blowup in its banking sector and collapse in the real-estate market.
Recent data show that prices still are falling in fast-growing economies such as India and China. In the first half of the year, China's consumer-price index was down 1.1% from a year ago, and its producer-price index fell 5.9%, according to China's National Bureau of Statistics from last week. In India, prices have been slipping into negative territory for more than a month. Broadly, prices in Europe are tipping into a deflationary dead zone. In the 16-nation euro region, prices fell 0.1% in June from last year, the first such drop on record. Prices have been flat or down in Finland, Portugal, France, Germany, Ireland, Spain and Switzerland, according to Moody's Economy.com.
There are a few caveats. Recent deflation data in part reflect the comparison with sky-high energy prices last year. And oil prices could spike again. Ironically, that could potentially hurt companies' pricing power by taking spare cash out of struggling consumers' pockets.
But if deflation does take root, it could prove devastating for investors. Deflation can cause stock prices to decline as companies are unable to boost prices; corporate bonds also suffer from rising bankruptcies. Behind a global deflation virus is a collapse of demand in the U.S. Unless the economic engine in the U.S. can get cranking again, deflation could keep spreading.
It's Official: U.S. Trapped in an Extended Deflationary Cycle
Bernanke has just confirmed that the Fed's prediction is for extended deflation.
In an OpEd in the Wall Street Journal, Bernanke writes:My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. ..
As the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures...
There you have it . . . straight from the horse's mouth.
Deflation is the problem "for an extended period". Inflation could only threaten "down the road", if faster growth and easier credit conditions "ultimately" might result in inflationary pressures.
Remember, however, that food, energy and healthcare costs could still skyrocket, even as most other asset classes experience deflation.
And if the U.S. defaults on its debts, the dollar would experience massive devaluation, which would cause hyperinflation for U.S. consumers (because it would take more dollars to buy the same goods or services). If the U.S. defaults, all bets are off.
Jobless Checks for Millions Delayed as States Struggle
Years of state and federal neglect have hobbled the nation’s unemployment system just as a brutal recession has doubled the number of jobless Americans seeking aid. In a program that values timeliness above all else, decisions involving more than a million applicants have been slowed, and hundreds of thousands of needy people have waited months for checks. And with benefit funds at dangerous lows even before the recession began, states are taking on billions in debt, increasing the pressure to raise taxes or cut aid, just as either would inflict maximum pain.
Sixteen states, with exhausted funds, are now paying benefits with borrowed cash, and their number could double by the year’s end. Call centers and Web sites have been overwhelmed, leaving frustrated workers sometimes fighting for days to file an application. While the strained program still makes more than 80 percent of initial payments within three weeks — slightly below the standard set under federal law — cases that require individual review are especially prone to delay. Thirty-eight states are failing to make those decisions within the federal deadline.
For workers who survive a paycheck at a time, even a week’s delay can mean a missed rent payment or foregone meals. Kenneth Kottwitz, a laid-off cabinet maker in Phoenix, waited three months for his benefits to arrive. He exhausted his savings, lost his apartment and moved to a homeless shelter. Luis Coronel, a janitor at a San Francisco hotel, got $6,000 in back benefits after winning an appeal. But in the six months he spent waiting, there were times when he and his pregnant wife could not afford to eat. "I was terrified my wife and daughter would have to live on the street," Mr. Coronel said.
Labor Secretary Hilda Solis said: "Obviously, some of our states were in a pickle. The system wasn’t prepared to deal with the enormity of the calls coming in." The program’s problems, though well known, were brushed aside when unemployment was low. "The unemployment insurance system before the recession was as vulnerable as New Orleans was before Katrina," said Representative Jim McDermott, Democrat of Washington, who is chairman of a House panel with authority over the program.
Now the number of unemployed Americans has doubled since 2007 to 15 million and the program is more than tripling in size. About 9.5 million people are collecting benefits, up from about 2.5 million two years ago. Spending is expected to reach nearly $100 billion this year, about triple what it was two years ago. Given how suddenly the workload has increased, some analysts say the delays might have been even worse.
"Payments are later than they should be, and later than they used to be, but states have been overwhelmed," said Rich Hobbie, director of the National Association of State Workforce Agencies, which represents the program’s administrators. "Considering the significant problems in the program, unemployment is responding well." The recovery act passed in February provided states an additional $500 million for administration. It also suspended interest payments through 2011 for states paying benefits with federal loans.
Unemployment insurance began as a New Deal effort with dual goals: to sustain idled workers and stimulate weak economies. States finance benefits by taxing employers, typically building surpluses in good times to cover payments in bad. In 2007, the average state paid about $290 a week and aided 37 percent of the unemployed. As downturns over the last 20 years proved infrequent and mild, states cut taxes, and the federal government, which pays administrative costs, reduced its support by about 25 percent. The states’ performance sagged.
In a recent report to the Department of Labor, Ohio said its computer problems "kept the system performance at a snail’s pace." Louisiana said its call center was staffed with "temporary workers, with little knowledge" of unemployment insurance. North Carolina said a wave of retirements had left it "unable to maintain pace or volume of work." Virginia wrote "performance continued to be very stagnant" and called the odds of improvement "bleak." By 2007, 11 states were paying benefits so slowly they violated multiple federal rules, up from just two at the start of the decade.
While most eligibility reviews can be done by computer, about a quarter require a caseworker — to ensure, say, the applicant was laid off, rather than quit. In the last year, states processed just 61 percent of these cases within three weeks — well below the federal requirement of 80 percent. More than a half-million cases, 6 percent, took more than eight weeks, and 350,000 took more than 10 weeks. Of the 12.8 million eligibility reviews that have occurred during the recession, 4.6 million took more than three weeks. That is 2.1 million more than federal rules allow.
Appeals take even longer, with 28 states violating timeliness rules, many of them severely. Perhaps no state is as troubled as California, which has not met timeliness standards for nine years. As in most other states, its 30-year-old computer runs on Cobol, a language so obsolete the state must summon retirees to make changes. Yet a major overhaul in California has been delayed for five years, with $66 million in federal funds still waiting to be spent. In part, the shelved project was meant to upgrade the call centers, which were "completely swamped" last winter, a legislative analyst wrote, with "desperate unemployed Californians dialing and redialing for hours."
Deborah Bronow, who runs the state’s unemployment insurance program, said, "The systems were antiquated to begin with," and "we were unprepared." In April, Gov. Arnold Schwarzenegger declared a state of emergency, saying the failure to efficiently process checks posed "extreme peril to the safety of persons and property." California has not met federal standards for adequate reserves since 1990. Still, it cut taxes and raised benefits in the last decade. It is now paying benefits with federal loans, with its debt projected to reach nearly $18 billion next year.
Among those hurt by delays was Mr. Coronel, the San Francisco janitor who lost his hotel job in January. With the phone lines jammed, it took him two days to file an application and a month to learn it had been denied. Then the waiting really began, as Mr. Coronel filed an appeal and heard nothing for three months. Luckless as he applied for new jobs, he borrowed to pay the rent, then moved in with his mother, and joined his pregnant wife in skipping meals. "The worst day was when my daughter was born," he said. "I had no clothes for her, and no car seat."
While federal rules require states to decide 60 percent of appeals cases within a month, in recent years, California has met that deadline for just 5 percent. A report by the state auditor last year found the appeals board rife with nepotism and mismanagement. Mr. Coronel won the appeal, but is soothing a marriage strained by a six-month wait. "It’s extremely stressful when you don’t know how you’re going to support your family," he said.
Nationally, the program is the worst financial shape since the early 1980s, when back-to-back recessions left more than half the states borrowing from the federal government. Tax increases and benefit restraints gradually rebuilt the funds, then states changed course and pushed taxes well below historical levels. From 1960 to 1990, the tax rate averaged about 1.1 percent of overall payroll. Over the last decade, it fell to 0.65 percent. That represents a tax cut of 40 percent. Measured against a decade’s payroll, that saved employers $165 billion. But by 2007, when the recession began, the average state had just six months of recession-level benefits in reserve, half the recommended sum.
"The attitude became, ‘We don’t need a firehouse — we can buy hoses when the fire starts,’ " said Wayne Vroman of the Urban Institute, a Washington research group. Some analysts defend the tax cuts, saying they helped both employers and workers, by spurring the economy and creating jobs. "Lower tax rates make it easier to attract business," said Doug Holmes, president of UWC, a group that advocates on behalf of employers. "We don’t want to spend a whole lot of time beating ourselves up because we didn’t raise taxes enough. Nobody anticipated a recession this size."
A big reason the reserves fell, Mr. Holmes said, is that the jobless now spend more time on the rolls — 15 weeks in recent years, up from 13 weeks several decades ago. Each extra week costs the program about $3 billion a year. The solution, he said, is stronger job placement provisions. But others see an irresponsible past that now promises future pain. "Workers who had nothing to do with the funds becoming insolvent are going to be asked to pay for that with benefit cuts," said Andrew Stettner, an analyst at the National Employment Law Project, a workers’ rights group. "That’s the worst thing states can do — it takes money straight out of the economy."
Among those who say timely benefits are essential is Mr. Kottwitz, the Arizona cabinet maker, who lost his job just before Christmas. He filed a claim and promptly received a debit card, with no money on it. It took him weeks to reach a program clerk, who told him to keep waiting. "They said, ‘We’re behind — be patient,’ " he said. With little savings, no family nearby, and a ninth-grade education, Mr. Kottwitz, 42, had limited options. He got $100 a month in food stamps, collected cans and applied for jobs. When his landlord put him out, he moved to a shelter so overcrowded he spent his first few nights on the ground.
"I felt like I was the scum of the earth," Mr. Kottwitz said. In March, the shelter referred him to Ellen Katz, a lawyer at the William E. Morris Institute for Justice, an advocacy group, who secured his benefits. By the time the money arrived, Mr. Kottwitz had lost nearly 40 pounds. His first stop was an all-you-can-eat buffet. Now back in an apartment, he said he was sharing his story in the hope that someone might read it and offer him a job. "You think that someone would have seen this coming and been more prepared," he said.
Regulators Spar for Turf in Financial Overhaul
The Obama administration scrambled on Friday to defend major elements of its plan to overhaul the nation’s financial regulatory system in the face of significant criticism from lawmakers, the financial services industry, and even senior regulators whose authorities would be eliminated under the proposal.
A turf war among some of the most powerful regulators in Washington, which has played out largely behind the scenes in the last few months, burst into the open at a House hearing. It featured disagreements over two cornerstones of the administration’s financial regulation plan — a new consumer protection agency to take over the functions now performed by the Federal Reserve, and a greater role for the Fed in overseeing large institutions that could pose systemic risks if they become troubled.
Those disagreeing were the Treasury secretary, Timothy F. Geithner; Ben S. Bernanke, the chairman of the Federal Reserve; Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation; and John C. Dugan, the comptroller of the currency. The open display of opposing views, which Mr. Geithner characterized as regulators understandably protecting the prerogatives of their agencies, showed how cumbersome the current financial regulatory system can be. An alphabet soup of agencies oversee the nation’s financial system — sometimes in conflicting ways.
The dispute left some lawmakers baffled and others, who oppose the legislation, entertained. "You all agree that some of the power being proposed for the new agency should reside somewhere else?" Representative John Campbell, Republican of California, asked the panel of senior officials who all nodded affirmatively. The dissent is playing into the hands of industry lobbyists, who are trying to defeat major provisions of the ambitious White House plan — and are skilled in playing regulators and lawmakers against each other.
In the early skirmishes, the lobbyists have notched a few small victories. Earlier this week, senior Democrats in the House conceded that they would not be able to complete work on the proposal to create a consumer protection agency for financial products like credit cards and mortgages before the lawmakers depart for their summer recess at the end of next week.
House Democrats had hoped to complete legislation creating the agency this month. But because of the opposition, Representative Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, said on Friday that the committee would delay its work on the proposal until September. Mr. Frank said that next week the committee, and then the full House, would approve legislation imposing new rules on how companies award executive compensation.
In the Senate, meanwhile, both the chairman and ranking Republican on the banking committee have been skeptical of the administration’s proposal to expand the reach of the Federal Reserve, even though Mr. Bernanke has said that the proposal is only a modest extension of what the central bank is already doing. Barely had Mr. Geithner left the witness chair when a panel of senior regulators challenged many of the details of his plan.
First Mr. Bernanke questioned the proposal to transfer the Fed’s existing job of regulating mortgages and credit cards to a new consumer product agency. Mr. Bernanke said the writing and enforcement of consumer protection rules "are complementary" to the other bank supervisory functions performed by the Fed and those important benefits "would be lost through this change."
Then Ms. Bair, the outspoken chairwoman of the Federal Deposit Insurance Corporation, criticized the proposal to give the new consumer protection agency the authority to enforce new regulations. She also said it would be better to give a council of regulators, which would include her agency, the authority to oversee risk across the industry, rather than vest broad new authority in the Federal Reserve.
"The Oversight Council described in the administration’s proposal currently lacks sufficient authority to effectively address systemic risks," Ms. Bair said. Flatly contesting Mr. Geithner’s recommendation on the new consumer agency, she added, "Federal banking agencies should retain the authority to examine and supervise insured institutions for both consumer protection compliance and safety and soundness."
Mr. Dugan, the comptroller of the currency, which regulates nationally chartered banks, said he also disagreed with the proposal to give the new consumer protection agency the authority to enforce any new regulation. Instead, that should remain with the existing bank regulators, he said. Mr. Geithner urged the lawmakers not to delay or bow to industry pressure, but to move swiftly.
He said that disagreements between the regulators were virtually unavoidable because the plan contemplates shifting a significant amount of power among them. "It’s perfectly reasonable and understandable," he said, that institutions and officials with authority would not want to give it up. Referring to Mr. Bernanke, he added, "With respect to the chairman and the others, they are doing what they should — protecting their prerogatives."
In trying to make the case for the new consumer agency, Mr. Geithner noted that mortgage brokers and large mortgage companies, which played a central role in the financial crisis, were now virtually unregulated by the federal government. And though financial oversight exists in other areas involving consumer protection, companies have been able to select their regulators, a practice that led to "the least restrictive oversight of consumer protection."
And he noted that the banking agencies responsible for enforcing consumer protection had typically had other priorities. Large and small banks and their trade associations in Washington have waged a major lobbying effort to kill the proposal, or at least substantially water it down, so that the new agency would not be able to write new regulations and also enforce them. The banks have maintained that the creation of a new agency would lead to burdensome and duplicative regulation of the banks.
Flexibility Is Signaled on Financial Oversight
Geithner's Comments Suggest Administration Would Be Willing to Compromise on the Plan, Which Has Lost Momentum
Treasury Secretary Timothy Geithner suggested Friday that the Obama administration would agree to revise parts of its plan to overhaul financial-market regulation, moving to protect a key initiative even as the White House wrestled to keep its health-care initiative on track. The effort to revamp financial regulation has lost considerable momentum since it was proposed in June, despite President Barack Obama's call for quick action. It has been hindered by political and industry criticism and overshadowed by a larger political debate over health care. It has also ignited a turf war between federal agencies that stand to gain or lose significant authority.
Mr. Geithner sought to defend the plan at a hearing before the House Financial Services Committee Friday, saying that while it had triggered "heated debate" there "should be no disagreement on the need to act." The sweeping proposal would give the Federal Reserve expanded authority to oversee the country's largest financial firms. It would also create a new regulator for mortgages and credit cards, give the government the power to take over and break up large faltering companies, and toughen oversight of credit derivatives and hedge funds, among other things.
Obama administration officials say flaws in the current regulatory structure put the entire financial sector at risk last year. Mr. Obama has called overhauling financial-market supervision a top priority, one that is critical to rebuilding confidence in the U.S. economy. Mr. Geithner didn't detail specific areas where the administration would be willing to compromise, but the tone of the hearing suggested it was extremely unlikely lawmakers would approve anything without significant changes.
The committee has already delayed a vote on the creation of a financial consumer-protection agency until September, which could make it harder for Congress to vote on the entire package by the end of the year as originally envisioned by the administration. Key policy makers are also divided over how best to revamp the regulatory framework, further complicating the effort. Federal Reserve Chairman Ben Bernanke told the committee on Friday that there should be more "accountability" in bank regulation, essentially supporting the administration's plan to give the Fed power over financial markets.
Federal Deposit Insurance Corp. Chairman Sheila Bair countered that lawmakers should spread oversight by creating a financial-services council with "broad authority and responsibility." Comptroller of the Currency John Dugan said he had "serious concerns" about the proposed financial consumer-protection agency, which would regulate mortgages and credit cards. Mr. Geithner told lawmakers the criticism from regulators should be viewed as efforts to defend their agencies' "traditional prerogatives."
He tried to paint a picture of a regulatory structure in need of repair, saying there was "a lot of dumb regulation in our country" and "a lot of examples of practices that we should not have tolerated." Many lawmakers at the hearing picked apart components of the plan, with many Republicans questioning whether the consumer-protection agency would simply make it harder for people to obtain credit because banks would no longer offer certain products.
Meanwhile, Pennsylvania Democratic Rep. Paul Kanjorski challenged the idea of centralizing too much power in the Fed and said certain powers should instead be focused in a more politically accountable entity such as the Treasury Department. Democrats supportive of the consumer-protection agency hope to rally support for that part of the plan in August by enlisting labor unions and consumer groups to bolster support. Rep. Mel Watt (D., N.C.), was one of the few lawmakers who voiced broad support for the plan and said the fact that most people don't like certain parts of it could mean that the proposal is appropriately balanced.
Representative Alan Grayson on His Questions to Bernanke Over Dollar Swap Lines
From Congressman Alan Grayson, member of the House Financial Services Committee and representative to the 8th Congressional District of Florida:Hi, Alan Grayson here. I just questioned Ben Bernanke in a Financial Services Committee hearing over the Federal Reserveís use of swap lines. You can watch the clip here.
There was some good discussion on the subject, and I enjoy reading the posts and the comments.
I asked the question because I genuinely wanted to know which foreign banks (or others) or else got the $500,000,000,000 in loans, and what they did with the money. Chairman Bernanke said he didn't know. This is puzzling. Yves Smith wondered why Bernanke stonewalled, as did this anonymous economist.For the record, I do not think the currency swaps in question -- half a trillion dollars to foreign central banks -- was what caused the US nominal dollar exchange rate to "appreciate". In the past year, dollar appreciations have been perfectly correlated with declines in the Dow, the seizing up of financial markets, and a diminishing in investor appetite for risk. The Fed's actions were almost certainly in response to this. What happened was, banks all over the world suddenly want to hold either T-bills or dollars, taking as little risk as possible, and not wanting to hold riskier assets such as the Pound or Euro. Everyone wants this at the same time, so to alleviate the demand, the Fed gives other countries half a trill in dollars in return for half a trillion their currencies... This, if anything, should slow the appreciation of the dollar, which is a good thing.
I cannot fathom why Bernanke could not just elucidate this, except to say that perhaps Bernanke is taking his marching orders from someone else and doesn't himself quite understand the rationale.....
This conventional storyline might be correct. Or China might have threatened to sell its Treasury bonds, so the Federal Reserve might have lent this money to friendly banks to backstop the Treasury market. Or you can spin out any number of possibilities here. We don't actually know which one is correct. That's the point. The Constitution grants to Congress power over the currency and power over the public purse strings for a reason - because we are accountable to ordinary citizens through the ballot box. The Federal Open Market Committee isn't.
$500,000,000,000 is ten times the size of the entire State Department budget. Publicly elected lawmakers proposed and debated over 100 amendments to the much-smaller State department budget. That ís how democracy is supposed to work -- not through secret deliberations in which 12 unelected bankers trample on Congressís Constitutional authority to appropriate funds, approve treaties, and coin money.
Should Goldman Sachs be Prosecuted for Human Rights Abuses?
On my show this week ON THE EDGE I ask the question, should Goldman Sachs be prosecuted for human rights violations? I have been in touch with famed human rights attorney Geoffrey Robertson who has agreed to discuss this hypothetical case on my show. My initial thought is that Goldman Sachs was guided in their human rights abuses just like Augusto Pinochet was during the time he was conducting deadly neo-liberal experiments on the population in Chile. The law eventually caught up to the Milton Friedman proselytizing criminal Pinochet and I think the law will eventually catch up with Goldman Sachs, but only if the prosecution venue is moved outside of the U.S.
Here in part 1 of my show ON THE EDGE I discuss the Goldman-Pinochet connection:
Schumer Presses SEC for Ban on 'Unfair' High-Frequency Trades
Charles Schumer, the third-ranking Democrat in the U.S. Senate, asked the Securities and Exchange Commission to ban so-called flash orders for stocks, saying they give high-speed traders an unfair advantage. Schumer’s letter to SEC Chairman Mary Schapiro yesterday raised the stakes in a debate over the practice offered by Nasdaq OMX Group Inc., Bats Global Markets and Direct Edge Holdings LLC, which handle more than two-thirds of the shares traded in the U.S.
With flash orders, exchanges wait up to half a second before they publish bids and offers on competing platforms, giving their own customers an opportunity to gauge demand before other traders. "This kind of unfair access seriously compromises the integrity of our markets and creates a two-tiered system, where a privileged group of insiders receives preferential treatment," Schumer wrote in the letter. Flash orders make up less than 4 percent of U.S. stock trading, according to Direct Edge and Bats.
They have drawn criticism from the Securities Industry and Financial Markets Association, which is Wall Street’s main lobbying group, and Getco LLC, one of the biggest firms that uses high-frequency trading strategies to make markets in stocks and options. NYSE Euronext, owner of the world’s largest exchange by the value of companies it lists, told the SEC in May that the technique results in investors getting worse prices.
Schumer, a member of the Senate Banking Committee, said he will introduce legislation to ban flash orders if the SEC doesn’t act on his request. "This practice has been going on for three years and didn’t get much attention until the New York Stock Exchange" started complaining, said Sang Lee, managing partner at financial- services consultant Aite Group LLC in Boston. "Someone like Chuck Schumer getting involved in the process will create a deeper conversation about where the whole market is headed."
Brian Fallon, a spokesman at Schumer’s office in Washington, confirmed Schumer sent the letter. Erik Hotmire, an SEC spokesman, declined to comment. Nasdaq’s Robert Madden, Randy Williams of Bats and Ray Pellecchia of NYSE Euronext also didn’t respond. Nasdaq and NYSE are based in New York. Bats has its headquarters in Kansas City, Missouri. Direct Edge, based in Jersey City, New Jersey, handles the most flash trades through its three-year-old Enhanced Liquidity Provider program. Chief Executive Officer William O’Brien said in an interview yesterday that it’s available to any brokerage and that investors choose to have their orders held to make it more likely they will be executed.
"Anybody can be part of it," he said. "This is something that warrants a debate, and when you have so many competing interests, we think the SEC is in a better position to fulfill that." The Schumer letter follows concerns expressed by investors and traders that computer-driven strategies executing hundreds of trades a minute make stock prices more volatile and boost costs. NYSE Euronext, operator of the New York Stock Exchange, estimates that about 46 percent of daily volume is executed through high-frequency strategies.
For the past decade, U.S. equity markets have sought to draw more business from high-frequency traders by offering rebates on transaction fees. Exchanges rent space in their data centers to brokerages so they can cut the distance information must travel and reduce transaction times to eke out an edge over the competition. "You have all this activity going on that in one way or another is preferencing one part of the investing group over another," said Michael Panzner, author of "The New Laws of the Stock Market Jungle" and a Wall Street trader for a quarter century. "That’s not good."
More than 75 percent of money managers use computer-driven strategies because they reduce costs, according to a survey this month conducted by Greenwich Associates, a consulting firm in Stamford, Connecticut. For those transactions, they rely on some of Wall Street’s largest brokerages, which account for two- fifths of high-frequency trading, NYSE estimates.
Traders including David Lutz say automated brokerages are helpful because they boost liquidity, increasing the likelihood that buyers and sellers will agree on a price. Competition has driven bids and offers for stocks including Microsoft Corp., Citigroup Inc. and General Electric Co. to 1 cent in the U.S., according to data compiled by Bloomberg. "When high-frequency traders are in the stocks I’m trying to execute, it helps me find the best execution," said Lutz, a managing director of equity trading at Stifel Nicolaus & Co. in Baltimore. "It’s completely benign to me."
The Record of the Federal Reserve
Let’s talk about The Federal Reserve. Consider the following facts:
A) From 1776 to 1912 (136 years), the value of the dollar, relative to the Consumer Price Index, increased by 11%. A dollar could buy 11% more goods in 1912 than in 1776. Thus, if in 1776, you sat on your savings pile of $1,000,000 for 136 years, it would then be worth $1,110,000 in purchasing power (it will have appreciated in value by 11%). A loaf of bread for Thomas Jefferson cost the same as a loaf of bread for Lincoln 50 years later and again the same for J.P. Morgan 50 years after that.
B) The United States Federal Reserve was created in 1913. The stated purpose of the Fed, by its own definition taken from its website, is to "conduct the nation's monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices." Note that "stable prices" is another way of saying "stable dollar," they are two sides of the same coin (couldn’t resist the pun).
C) Then after The Fed’s creation, from 1913 to 2008 (95 years), the value of the dollar, relative to the Consumer Price Index, decreased by 95%. A dollar could buy 95% fewer goods in 2008 than in 1913. Thus, if in 1913, you sat on your savings pile of $1,000,000 for 95 years, it would then be worth only $50,000 in purchasing power (it will have depreciated in value by 95%). One would now need to pay about 20X more than J.P. Morgan for one’s bread. Ask my mother how much the price of milk has increased just in the last ten years alone.
In other words, the value of the dollar remained extremely stable for 150 years, then The Fed was created in order to "stabilize the value of the dollar" and the result has been a 95% devaluation of the dollar in less than 100 years following its creation. Below is a graph of this history, which I’ve marked with the year 1913 so you can see the change. The graph is also marked with the years of decoupling from the gold standard, as no examination of dollar value would be sound without such mention.
While we all take inflation as a "given" – as something that "just happens" in the economy – we would do well to remember that this belief is utterly incorrect. Inflation, which is the loss of value in your saved dollars, is caused by The Federal Reserve through its management of the money supply. Next time you see Ben Bernanke on the television, telling you that they "will take the necessary steps" to help the country, consider their track record so far, and their dismal failure at their stated objective – preserving the value of America’s money.
Outrage doesn’t even begin to describe what Americans should feel in response to this. Yet, Americans aren’t very upset, and indeed the vast majority has no idea about any of this information. I would wager that this is because Americans are educated in Government schools, which barely teach basic accounting, let alone macroeconomic monetary theory. In public school I was forced to memorize the names of every country in
Africa, yet never was there a discussion of the nature of money. Half the nations of Africahave been renamed since, but the economic principles which cause such political turmoil remain the same.
The Federal Reserve System is fraudulent. Whatever its stated purpose, its effective purpose is to create a mechanism of deficit spending by politicians, through the insidious invisible taxation of monetary debasement (aka inflation). With printed money, the Government can buy services for its voters before the effects of inflation are felt. It is then the voters whose money buys less the following year, as the new money has raised prices, and they are none the wiser.
Obama is now mandating that The Fed is to have more oversight, more authority and control over the markets of the United States. If we can learn anything from The Fed, it’s that the best way to succeed as a politician is to stretch one’s failure over a long enough period that people won’t remember it.
Bernanke Says About 25 Financial Firms Systemically Important
Federal Reserve Chairman Ben S. Bernanke said about 25 financial companies may be deemed too big to fail and subjected to additional oversight by the central bank under the Obama administration’s proposed regulatory plan. Twenty-five is a "very rough guess," and "virtually all of those firms" are already subject to umbrella supervision by the central bank, Bernanke said in response to a question from Representative John Campbell, a California Republican, during a House Financial Services Committee hearing today. He didn’t identify any of the companies.
Bernanke separately said the central bank’s emergency lending programs -- such as to the commercial-paper market and to American International Group Inc. -- are declining in size.
"We are currently as you know winding down our 13(3) programs, so I don’t anticipate they will be approaching the previous peaks," the Fed chief said in response to a question. "I can’t anticipate what kinds of situations might arise," he also said.
Bankers Bet Jobs on a Roaring V-Shaped Recovery
The country’s biggest banks are doubling down on a bet that the economy will improve in the latter half of the year. If they’re wrong, and borrowers don’t pull out of a tailspin, bankers and their investors will take a beating. That’s because banks will have to rebuild diminishing reserves that they set aside for soured loans, which results in charges that lower profit.
Signs that big banks are hoping to draw the equivalent of an inside straight on an economic rebound emerged in second- quarter results. Figures from the country’s seven largest commercial banks by assets, including banks like Wells Fargo & Co. and Bank of America Corp., show they went easy on increasing loan-loss reserves in the quarter. That followed a similarly light buildup in the first quarter. Such moves help bolster bank profits. If loan losses slow during the next six months because, say unemployment levels off and housing stabilizes, banks will win big with this bet. They will have pumped up profit today while allocating sufficient reserves for the rest of the year.
At some point in every economic cycle, wagers like these pay off for banks as loan losses peak and provision charges ebb. Timing is everything, though, and there are reasons to worry banks are making their recovery play too early. Economists forecast unemployment to rise higher than 10 percent. While there are growing signs housing may be near a bottom -- yesterday’s announcement of June existing home sales beat expectations -- it is doubtful prices will rebound soon. This means foreclosures will persist.
Plus, commercial real estate loans are a growing threat. U.S. commercial property prices have declined 35 percent since their peak, Moody’s Investors Service said in a recent report, while Federal Reserve Chairman Ben Bernanke warned Congress this week that defaults in this sector may pose a "difficult" challenge for the economy. Meanwhile, banks’ credit losses aren’t showing signs of slowing. At J.P. Morgan Chase & Co., these charge-offs increased to $6 billion in the second quarter from $4.4 billion in the first three months of this year.
Wells Fargo saw charge-offs rise to $4.4 billion from $3.3 billion in the first quarter. Yet as those losses rose, Wells increased its reserve by only $700 million compared with a $1.2 billion buildup in the first quarter. Unless loan losses soon slow, Wells "will have to start materially increasing its provision expense, which will put pressure on earnings and valuations," Paul Miller, a bank analyst at FBR Capital Markets, wrote in a report this week.
Wells isn’t alone in dragging its feet on bulking up reserves. Of the seven biggest banks by total assets, all but Citigroup Inc. saw the growth of nonperforming assets -- mostly loans likely to result in a loss -- grow at a quicker pace than the increase in the bank’s loan-loss reserve, according to my calculations. Additionally, all the banks except Citigroup saw reserves as a percentage of assets fall in the second quarter. Citigroup’s reserves increased to 128 percent of nonperforming assets compared with 119 percent in the first quarter.
Of the other banks, JPMorgan has the highest reserves ratio at 170 percent and SunTrust Banks Inc. had the lowest at 47 percent. Bank of America’s ratio fell to 116 percent from 122 percent, while US Bancorp’s declined to 114 percent. Wells saw its reserve ratio fall the hardest, dropping to 128 percent from 181 percent. While banks don’t have to keep reserves as a percentage of potentially dud loans at a specific level, investors are likely to get antsy if this nears a one-to-one ratio at bigger banks. That makes it more likely the banks will have to add more money to their reserves if the economy doesn’t rebound as planned.
Investors tolerate ratios below 100 percent at smaller banks because they tend to have less debt tied to credit cards and automobile loans that can result in higher losses. That said, SunTrust’s ratio is looking uncomfortably low. And PNC Financial Services Group Inc.’s results released yesterday showed its ratio of reserves fell to 101 percent of nonperforming assets. The dilemma for banks is that keeping reserves at a higher level can wipe out profit. If PNC, for example, had wanted to maintain its reserve at the first-quarter level of 124 percent, it would have had to add about $1 billion to its reserves. Doing so would have wiped out the $207 million net profit it reported in the second quarter.
A move to keep the reserve at an equivalent first-quarter level at SunTrust would have likely doubled what was already a $183 million net loss for the second quarter. For the moment, markets are tolerating the slower reserve buildups, trusting along with banks that an recovery is at hand. After all, lower charge-offs help buoy profits and that lifts share prices. If the economy deals the wrong set of cards in the second half, though, optimistic bankers may find themselves out of jobs while investors face a new round of losses.
The final straw with Citi
"We have and will continue to exit several forms of proprietary risk-taking. Where we continue to take principal risk, we will only do so when we have proven teams and a clear source of advantage." - Citigroup CEO Vikram Pandit on January 16, 2009.
Don’t be fooled by Vikram Pandit’s playing the part of a prudent banker. Instead of scaling back risky hedge fund-style trading, Citi is doing just the opposite. And that raises big questions about why the federal government continues to bail out this basket case of a bank, and why Pandit is allowed to remain at Citi’s helm. Here’s the scoop on this latest bailout outrage: Citi is planning to commit at least an additional $1 billion in capital to a team of stock-focused proprietary traders, say people with knowledge of these strategies — a move seemingly at odds with Pandit’s earlier vow.
These traders buy, sell and short a wide variety of stocks, including telecom, technology, healthcare and consumer financials. And the profits and losses on those trades all go straight to Citi’s bottom line. In all, I’m told that this team of nearly three dozen prop traders and analysts at Citigroup Principal Strategies will get to play with some $2 billion of house money. That’s roughly the same sum of Citi capital the group had under its belt before Lehman Brothers melted down last September. Citi sharply scaled back the operation soon afterward.
By the end of 2008, the Citi Principal Strategies trading group’s committed capital had dwindled to under $800 million. But that was when Citi was fighting for its very survival. Now it appears Pandit has no qualms about ramping up the bank’s prop trading group after getting $350 billion in capital infusions and asset guarantees from U.S. taxpayers. To be sure, $1 billion in capital is chump change compared with the size of the bailout package that Citi has received. And it’s a mere footnote against the $1.8 trillion in assets on Citi’s balance sheet. And maybe it does make business sense for Citi to resume equity prop trading if its main competitors on Wall Street are doing the same.
But it’s the principle here that matters. A bank that’s still a ward of the state has no business running its own internal hedge fund. Actually, Citi Principal Strategies is a collection of seven mini-hedges, each controlling between $250 million and $300 million in Citi — or should we say taxpayer? — money. To me, this is the final straw with Citi and in particular with Pandit. It’s hard to take anything Pandit says seriously after this quiet step-up of proprietary trading. In my book his credibility, which already was wobbly, is shot. Citi, for its part, isn’t commenting on the return of prop trading as a business strategy.
I’m sorry, but a "no comment" just doesn’t cut it. Goldman Sachs might be able to get away with that non-response, but only because it isn’t effectively owned by the federal government. (Yes, Goldman is able to make billions from prop trading because it has the implicit backing of the government behind it, but that’s the subject for a different column). Citi, on the other hand, has an obligation to come clean with its biggest shareholder — the U.S. taxpayer.
Back in April, The Wall Street Journal reported that Citi won the Treasury Department’s permission to pay special bonuses to "many key employees" in order to remain competitive with other Wall Street firms. It’s fair to assume the prop traders might be some of the "key employees" Citi had in mind when it begged Treasury Secretary Tim Geithner for the right to lavish such pay packages on some workers. Before the collapse of Lehman, traders with Citi Principal Strategies used to get to keep a percentage of the profits they made. Is that still the case with these traders — some of whom, a person familiar with the operation tells me, used to work for Pandit’s failed hedge fund Old Lane, which Citi acquired in 2007? We simply don’t know.
In the second quarter, it appears that stock prop trading paid off for Citi. On July 17, Citi reported that "strong results in derivatives, proprietary trading and cash trading" contributed to some $1.1 billion in equity markets revenues.
But trading is risky and there’s always the chance that Citi could lose money on its equity prop trades in future quarters. The bank bailout saved the world financial system from collapse, and that certainly was a good thing. But in keeping sick institutions like Citi afloat, the goal should be getting them well enough to resume lending to businesses and consumers. Until Citi can pay back the government, it has no business going back to the way things used to be. So if a taxpayer-subsidized executive like Pandit wants to get into the hedge fund business he should head for the exit right now and open up his own shop.
Citi in $100 Million Pay Clash
A top Citigroup Inc. trader is pressing the financial giant to honor a 2009 pay package that could total $100 million, setting the stage for a potential showdown between Citi and the government's new pay czar. The trader, Andrew J. Hall, heads Citigroup's energy-trading unit, Phibro LLC -- a secretive operation, run from the site of a former Connecticut dairy farm, that occasionally accounts for a disproportionate chunk of Citigroup income. Mr. Hall's pay package puts Citigroup in a tight spot. Ripping up the contract could trigger Mr. Hall's departure and a potentially messy legal fight. But making any large payouts, even if they're based on previously agreed contracts, could subject Citigroup to political and investor fallout.
Earlier this year, American International Group Inc.'s bonus payments of $165 million to some executives caused an outcry, given the insurer's U.S.-government bailout. Citigroup has received some $45 billion in bailout money. It will be an early test for Kenneth Feinberg, the Treasury Department's pay czar, who was appointed last month to a new position with the power to help set pay for top executives and highly paid employees at seven firms receiving the most government financial aid. Banks and others have a mid-August deadline for submitting pay requests to Mr. Feinberg.
"Companies will need to convince Mr. Feinberg that they have struck the right balance to discourage excessive risk-taking and reward performance for their top executives," a spokesman for Mr. Feinberg said. Mr. Hall is contractually obligated to receive pay based on Phibro's profits, and some observers on Wall Street believe Citigroup has a better chance at repaying the U.S. money with its Phibro unit humming. Critics, however, argue that pay agreements like these need to be redrawn in light of Citigroup's taxpayer-funded bailout. Soon the U.S. government will be a 34% owner of Citigroup.
Citigroup said in a statement: "Retaining and attracting the best talent is very important to the success of Citi and all its stakeholders. Citi continues to examine ways to ensure its employee-compensation practices are competitive in this very challenging market environment." Mr. Hall has long operated with remarkable independence. In late 2007 he shot down Citigroup executives who wanted to merge Phibro with the bank's asset-management arm, which could have clipped his ability to make big investment bets.
A far cry from the buttoned-down Wall Streeter, Mr. Hall leaves the office most afternoons to go rowing or to practice calisthenics with a ballet teacher. Outside the energy markets, Mr. Hall ranks among world's top collectors of contemporary art, favoring often-shocking works that explore subjects including the human toll of the Nazis. Mr. Hall owns a nearly 1,000-year-old castle in Germany where he displays his art collection. For a time, the lawn of his home in Southport, Conn., featured a controversial, 80-foot-long concrete sculpture; he was eventually forced to remove it after a legal battle with the neighbors.
Last year Mr. Hall received pay of more than $100 million, people familiar with the matter say. With this year barely half over, Mr. Hall's specific 2009 pay hasn't yet been set. Citigroup doesn't break out detailed financial reports for Phibro, but traders say the firm is having a good year. Wall Street pay has been a hot-button issue in the wake of the financial crisis. Goldman Sachs Group Inc. and Morgan Stanley recently disclosed that they have set aside a total of more than $17 billion in compensation and benefits for their employees this year. Some big banks that received government bailouts in the U.S. and Britain, including Citigroup, Bank of America Corp. and Royal Bank of Scotland, are offering handsome pay packages to lure stars.
Hanging in the balance in the Hall matter is an important source of profits for Citigroup, which is trying to rebound after a disastrous 2008. Phibro, with a small core group of traders, has generated hundreds of millions of dollars in profit for Citigroup over the years. This spring, after the new pay curbs were unveiled, Mr. Hall and others on his team threatened to leave if their pay was cut by the new compensation rules, people familiar with the matter said.
Citigroup is considering spinning off Phibro as a separate operation, among other options, in hopes of preserving some payoff from Phibro's profits, people familiar with the matter say.
These kinds of pay conflicts represent uncharted territory for the government and Wall Street alike. If the government pressures banks to abrogate pay contracts, traders and bankers could sue to enforce the pacts. That has its own risks: Amid recession and taxpayer-funded bank bailouts, suing over millions of dollars in pay could expose traders to widespread ridicule and political backlash. Meanwhile, J.P. Morgan Chase & Co. told investment-banking employees Thursday that it will raise salaries and reduce bonuses for about half of them. Bonuses can entice some Wall Street traders to take big investment risks.
Mr. Hall's pay contract has multiple parts. He has long had a profit-sharing contract with Citigroup and its predecessor banks entitling him to a large percentage of Phibro's gains. The percentage he and his small team of traders get under the contract terms currently stands below 30%. Mr. Hall's pay and independence from Citigroup's home office reflects a track record of making sizable, successful investment bets. A few years ago, for instance, Mr. Hall, 58 years old, anticipated an important shift in the way the world valued oil, and correctly bet that long-term and short-term energy prices would abandon their historical relationship with each other. In making that investment, Citigroup gave Mr. Hall more leeway to take on risk than it usually gives entire teams, according to traders.
Until this year, Phibro's calendar year ended in September. Now, Phibro's pay will be calculated to a full calendar year, so the pay period for Mr. Hall and others at Phibro ending in December will cover 15 months. Citigroup executives have been meeting periodically with Mr. Feinberg since last month. Lewis Kaden, a Citigroup vice-chairman, has been handling most of the discussions with the pay czar, trying to capitalize on the two men's longtime friendship, according to people familiar with the matter.
Citigroup doesn't report Phibro's detailed financial results, but a footnote in the company's annual report says that $667 million in 2008 revenue from "principal transactions" related to commodities "primarily includes" Phibro's results. The results represented a sliver of Citigroup's $52.8 billion in net revenue last year. But considering that Citigroup reported a 2008 net loss of $27.7 billion, Phibro's contribution was especially important. In 2007, Phibro contributed $686 million to Citigroup, and $487 million in 2006, according to the annual report.
In recent months, Citigroup has told about five former top executives that it won't pay them tens of millions of dollars in promised severance payouts, according to people familiar with the matter. Citigroup already has paid more than half the roughly $100 million it promised to the former executives. But company officials decided not to proceed with the remaining payments to avoid the possibility of a public backlash, people familiar with the situation said. Phibro has one of the most colorful histories on Wall Street. It was founded by the Philipp Brothers nearly a century ago and in 1981 bought Salomon Inc., becoming Phibro-Salomon. (At the time, Phibro had to pay millions of dollars in bonuses to retain Salomon Brothers employees.)
Schwarzenegger Will Sign Budget Deal Closing $26 Billion Gap
California Governor Arnold Schwarzenegger will spend the weekend trimming $1 billion from the state budget, after lawmakers rejected two parts of a plan to erase a $26 billion deficit that threatened the largest U.S. state with insolvency. The governor said he would sign a package of more than two- dozen bills, approved by the Legislature yesterday. The measures divert tax money from municipalities, force companies and individuals to pay income taxes sooner and reduce spending on schools, welfare and public health programs.
"With this budget, California has safely navigated the greatest economic crisis since the Great Depression," Schwarzenegger said during a news conference in Sacramento yesterday. "I think the financial community is going to look at this in a positive way." The package cuts spending by $15 billion, including $6 billion from schools and community colleges, $3 billion from universities and $1.2 billion from prisons. It also raises $4 billion, in part by accelerating personal and corporate income- tax withholding and increasing the amount withheld by 10 percent.
The passage ended a two-month partisan battle over how to eliminate holes that emerged in the $100 billion budget just months after spending cuts and tax increases were enacted in February to bolster the state’s finances. Without a balanced spending plan, California has been forced to pay bills with IOUs to avoid running out of cash. Ratings on $72 billion of bonds were cut close to high-yield, high-risk junk status. "There are a whole host of cuts that pain me," said Senate President Darrell Steinberg, a Sacramento Democrat who was among the leaders who brokered the deal. "Nobody likes this budget because there’s not much to like about it."
The Assembly rejected a measure approved in the Senate allowing new offshore oil drilling along the coast of Santa Barbara, which the state projected would create royalties of about $100 million this year and $1.8 billion over the next 15 years. Assembly Republicans blocked a proposal for the state to take $1 billion of gasoline tax money meant for local governments. The Senate passed the bill. The $1 billion will be made up by line item vetoes from the governor and with reserve funds. Lawmakers will consider how to replenish the fund when they return from vacation next month.
The passage will allow the state to use $2 billion of local property taxes meant for cities and other local jurisdictions and some $1.7 billion earmarked for redevelopment agencies. California cities may sue to block the state from appropriating local revenue, said Chris Mackenzie, executive director of the League of California cities. The deficit plan also shifts $1.5 billion between accounts and moves the last payday for workers this fiscal year to the next 12-month period.
It is the second time this year that the government redrew the budget amid job losses that pushed unemployment to a record 11.6 percent in June and declining incomes that lowered tax collections 15 percent from a year earlier. As the financial strains worsened this year, California bond yields, which move in the opposite direction as price, had jumped compared with top-rated municipal bonds. The difference between a 10-year California bond and a top-rated municipal security reached as much as 1.71 percentage points on July 1, when the California debt yielded 5.21 percent, according to Bloomberg data.
The difference slipped to 1.5 percent today, the lowest since June 19, as investors speculated that prices would rise once a budget deal was struck. Even those who said they recognized the need for the steps said there was little to welcome in its passage. "There is a lot to dislike in this budget," said Republican Senate Leader Dennis Hollingsworth. "We are solving a very big problem and there are no easy solutions to a problem like this."
Why Did Buffett Invest in Moody’s?
by Elizabeth MacDonald
Why did Warren Buffett let Berkshire Hathaway invest in Moody’s Investors Service, given the credit rating agency has a damaged balance sheet and has been running a negative net worth, now at a negative $919 mn? It’s a baffling question for the Oracle of Omaha, renowned for being in the vanguard of the army of Benjamin Graham value investors. Moody’s has reported seven straight quarterly profit declines, it is awash in short-term debt that it’s used for billions of dollars in stock buybacks to shore up its shares, and in the process it has levered up its balance sheet at a time when profits are plunging.
Plus, it has been running for a number of quarters on negative shareholders equity of $919 mn. How does a credit rating agency so submerged in debt, with declining earnings, think it can hand out ratings of banks, investment banks and their debt securities when its own financials are in such disarray? How does a credit rating agency get to operate with a negative book value? Even small broker dealers must have at least $10,000 in net capital to trade. Warren Buffett’s Berkshire Hathaway only just this week cut its stake in Moody’s, Bloomberg reports. Buffett sold the shares over three days beginning July 20 for prices ranging from about $28.73 to $26.59, a separate filing said.
Berkshire still holds about 40 mn shares in Moody’s, about 17% of the outstanding stock, Bloomberg reports. That’s down from just above 20% as of March 31, Bloomberg reports.
Last fall Congress held one of its most heated hearings on the credit crisis, where executives from the credit rating agencies testified. The agencies, which are not government run, wrongfully gave top notch Triple-A ratings to Kryptonite derivatives (many of them subprime-mortgage bonds) just before that market collapsed. Buffett himself has said Moody’s nearly wrecked its brand as its own ratings were proven to be incorrect. The Economist Magazine says: "If the past decade’s financial over-engineering was a crime, rating agencies were the getaway drivers."
Congress at the time released internal memos written by executives at Moody’s and Standard & Poor’s, as well as email exchanges, instant messages, all pointing to how insiders at these companies knew they were botching the job–and did little to stop the worst credit crisis in history from happening. According to one internal message, Moody’s top executive Ray McDaniel wrote that Moody’s "analysts and MDs [managing directors] are continually pitched’ by bankers, issuers, investors" and sometimes "we ‘drink the Kool-aid.’"
The markets have known about this problem for years. The credit rating agencies were painfully slow to warn investors about the problems at Bear Stearns, Enron and WorldCom, just to name a few calamities.
And now this from FT Alphaville, quoting the FT:Credit rating agencies are back in the spotlight, facing a lawsuit from the largest pension fund in the US over what it says are "wildly inaccurate" ratings and heightened scrutiny from regulators. The California Public Employees’ Retirement System (Calpers) is suing the three leading credit rating agencies over potential losses of more than $1bn related to structured investments that were rated triple A but contained risky mortgage debt.
The lawsuit, filed in a California Superior Court, followed the creation by the Securities and Exchange Commission of a group of examiners to oversee rating agencies. Mary Schapiro, the SEC chairman, highlighted, in Congressional testimony this week, that rating agencies are an area that will likely face heightened oversight.
But it’s not just Moody’s tattered balance sheet. Moody’s has several serious vulnerabilities, including its fee arrangements, where it gets paid by issuers to rate bonds or other instruments. Here one of the best stock analysts on Wall Street, who asked to remain anonymous, weighs in:
- The stock price has been held up by company stock buy backs (hence the negative net worth). They have little to no additional firepower to do any more buy backs. In fact, there is a strong argument that they should be going in the opposite direction and deleveraging the company by selling equity in order to retain their license [to operate as a credit ratings agency];
- The analyst goes on to point out the fee model that Moody’s has in place as still being rife with all sorts of distortions and conflicts;
- By moving to this model Moody’s has figured out a way to "double dip" on fees. Take Mass Mutual as an example. It is now charging Mass Mutual a fee to rate certain investments (the first area that they are trying this model is in syndicated bank type loans). And, then it charges Mass Mutual a fee to rate Mass Mutual [itself], so that Mass Mutual can sell insurance and borrow money. Moody’s goes through the portfolio and charges fees for portfolio review as part of the Mass Mutual rating process. So, it charges when Mass Mutual buys and it then charges again when Mass Mutual raises money or sells insurance;
- But, that wasn’t good enough for Moody’s. They are charging each investor a fee for reviewing the investments. So, a loan that used to have a one-time fee paid by the issuer (of say $1,000,000) is now being charged to each individual investor (at a lower rate to the investor but in the aggregate at a much higher aggregate amount). So, if the loan has 10 investors each investors is being charged a fee of $200,000 and, voila, Moody’s has doubled its fees. Needless to say some of the investors are pissed off and starting to make noise with their Congressman. I think that you can call this the "triple dipping fee";
- That wasn’t good enough for Moody’s. Every time the loan is traded Moody’s is charging another fee to the new investor to affirm the rating and they are charging when they evaluate the portfolio of the new investor (like if Mass Mutual trades the loan to Prudential). This is the "quadruple fee" opportunity.
I think it is fair to say that this fee arrangement won’t last and the firming up of income for Moody’s is probably transient.
- The user-based fee system has another flaw (even if they charge fairly). User-based fees were the system that was used in ALL of the deals that were insured by the monolines. The monolines had all of their deals rated by Moody’s and S&P and the monoline paid the fees (not the issuers). Obviously, it was the monolines that crashed first and the ratings of the monolines were all suspect (as were the investments that they made). Investor-paid fees sound like a good idea, but in the economy of 2009 they are worse than issuer-paid fees;
- The securitization revenue stream continues to deteriorate. Recurring fees from securitizations are dropping (as deals amortize off) and aren’t being replaced. Securitization was the golden goose for the rating agencies;
- The entire fee system will likely change a lot and the business will be less profitable. As long as the rating fees are volume-based, there are conflicts of interest that are inconsistent with the mission of rating agencies.
The analyst continued: "And, once they are no longer volume-based, the profitability will plunge. As an aside, the mission of the rating agencies is to be accurate, not do a lot of volume. Guess how I think they should be paid."
For Buffett, Goldman Deal Looks Like a Pot of Gold
Warren E. Buffett's option to buy shares of Goldman Sachs, part of a deal reached at the depths of the credit crisis, has earned a profit on paper of more than $2 billion -- a 44 percent return. Goldman Sachs share price passed $162 on Thursday in trading for the first time since rival Lehman Brothers collapsed in September. It closed Friday at $164.72. Buffett's Omaha-based Berkshire Hathaway holds warrants to buy $5 billion of Goldman common stock for $115 a share anytime in the next four years.
"It must feel good to be Warren Buffett," said Gerald Martin, a finance professor at American University who has studied the billionaire's investing history. "That number just flies in the face of people who like to say he's lost a step." The difference between the strike price and the share value translates into nearly a $2.2 billion paper profit for Berkshire. The U.S. government got a 23 percent annualized return for its investment in the firm after an agreement this week by the bank to pay $1.1 billion to settle warrants remaining after Goldman returned bailout money from the Treasury Department.
Goldman Sachs turned to Buffett in September, agreeing to sell $5 billion in preferred shares paying 10 percent interest, after Lehman's bankruptcy and the emergency takeover of Merrill Lynch by Bank of America. In the midst of crisis, Goldman earned an explicit endorsement from Buffett, celebrated for his investing savvy. Buffett is a director of The Washington Post Co. Berkshire has slipped about 1.3 percent this year as it posted a first-quarter loss on declines in the value of holdings in ConocoPhillips and derivatives tied to corporate bonds.
The Goldman Sachs warrants, Buffett said, were tacked on to give him an incentive to sell some of Berkshire's existing stock holdings to fund the deal. "I wouldn't have done the deal without them throwing in the warrants," Buffett said in March. "That was a time when I talked about an economic Pearl Harbor right at that point. So to part with the funds at that time, I not only wanted a good yield but I wanted a possible kicker."
The 44 percent return is based on the gain if Buffett were to redeem the warrants and sell them at today's price. Berkshire also gets $500 million in interest on the preferred shares annually. Goldman Sachs later accepted $10 billion from the federal government as part of the government's bailout of financial firms -- a deal that also required the bank to grant the Treasury warrants. The Troubled Assets Relief Program charged 5 percent annually and placed restrictions on compensation for some employees. Goldman repaid the $10 billion in June, and last week agreed to the Treasury's request for $1.1 billion to settle the warrants.
Buffett's deal requires the firm to pay Berkshire a 10 percent fee if it repays the preferred shares before 2013. "It makes sense, in a way," said Martin of the Goldman Sachs decision to repay the Treasury funds first. "Who would you rather have breathing down your neck at a shareholder meeting, the government or Warren Buffett? An investment from Buffett reflects well on your company, and taking that government money was always a negative."
Goldman Sachs stock dipped below Buffett's $115 strike price in October, and fell to $52 on Nov. 20. After falling 73 cents, or 0.4 percent, on Friday, the share price stood at $164.72.
The bank said July 14 that second-quarter profit reached $3.44 billion as revenue from trading and stock underwriting set records. Buffett made an investment in General Electric in October, agreeing to buy $3 billion in preferred shares paying 10 percent and taking warrants to buy $3 billion of common stock at a strike price of $22.25. GE dipped below that level the day after the deal was announced and never recovered. The shares gained 8 cents, or 0.7 percent, to close at $12.03 on Friday.
"There's a reasonable chance both kickers will work out, or one kicker works out," Buffett said in March, when the Goldman Sachs warrants were also underwater. "But there's also a reasonable chance neither one does."
New Rule: Not Everything in America Has to Make a Profit
by Bill Maher
How about this for a New Rule: Not everything in America has to make a profit. It used to be that there were some services and institutions so vital to our nation that they were exempt from market pressures. Some things we just didn't do for money. The United States always defined capitalism, but it didn't used to define us. But now it's becoming all that we are.
Did you know, for example, that there was a time when being called a "war profiteer" was a bad thing? But now our war zones are dominated by private contractors and mercenaries who work for corporations. There are more private contractors in Iraq than American troops, and we pay them generous salaries to do jobs the troops used to do for themselves ?-- like laundry. War is not supposed to turn a profit, but our wars have become boondoggles for weapons manufacturers and connected civilian contractors.
Prisons used to be a non-profit business, too. And for good reason --? who the hell wants to own a prison? By definition you're going to have trouble with the tenants. But now prisons are big business. A company called the Corrections Corporation of America is on the New York Stock Exchange, which is convenient since that's where all the real crime is happening anyway. The CCA and similar corporations actually lobby Congress for stiffer sentencing laws so they can lock more people up and make more money. That's why America has the world;s largest prison population ?-- because actually rehabilitating people would have a negative impact on the bottom line.
Television news is another area that used to be roped off from the profit motive. When Walter Cronkite died last week, it was odd to see news anchor after news anchor talking about how much better the news coverage was back in Cronkite's day. I thought, "Gee, if only you were in a position to do something about it."
But maybe they aren't. Because unlike in Cronkite's day, today's news has to make a profit like all the other divisions in a media conglomerate. That's why it wasn't surprising to see the CBS Evening News broadcast live from the Staples Center for two nights this month, just in case Michael Jackson came back to life and sold Iran nuclear weapons. In Uncle Walter's time, the news division was a loss leader. Making money was the job of The Beverly Hillbillies. And now that we have reporters moving to Alaska to hang out with the Palin family, the news is The Beverly Hillbillies.
And finally, there's health care. It wasn't that long ago that when a kid broke his leg playing stickball, his parents took him to the local Catholic hospital, the nun put a thermometer in his mouth, the doctor slapped some plaster on his ankle and you were done. The bill was $1.50, plus you got to keep the thermometer. But like everything else that's good and noble in life, some Wall Street wizard decided that hospitals could be big business, so now they're run by some bean counters in a corporate plaza in Charlotte.
In the U.S. today, three giant for-profit conglomerates own close to 600 hospitals and other health care facilities. They're not hospitals anymore; they're Jiffy Lubes with bedpans. America's largest hospital chain, HCA, was founded by the family of Bill Frist, who perfectly represents the Republican attitude toward health care: it's not a right, it's a racket. The more people who get sick and need medicine, the higher their profit margins. Which is why they're always pushing the Jell-O.
Because medicine is now for-profit we have things like "recision," where insurance companies hire people to figure out ways to deny you coverage when you get sick, even though you've been paying into your plan for years. When did the profit motive become the only reason to do anything? When did that become the new patriotism? Ask not what you could do for your country, ask what's in it for Blue Cross/Blue Shield. If conservatives get to call universal health care "socialized medicine," I get to call private health care "soulless vampires making money off human pain." The problem with President Obama's health care plan isn't socialism, it's capitalism.
And if medicine is for profit, and war, and the news, and the penal system, my question is: what's wrong with firemen? Why don't they charge? They must be commies.
Oh my God! That explains the red trucks!
OPEC braces for sharp drop in oil prices
Why is OPEC expecting a sharp drop in oil prices? First, much of the rise in oil prices has followed the rally on Wall Street. Investors reasoned that higher stock prices means that business is doing better and hence a need for more oil, and prices rise. Not so fast. Business demand for oil is weak, and the consumer got clobbered by the recession and is holding back spending money. So the classic relationship between the stock market and oil that investors follow is not there this year.
The Wall Street Journal is reporting that stockpiles are at a 24-year high. Distillate demand for gasoline and diesel fuel dropped by 15%. Refiners have cut back production to 85.8%, from 87.9% the previous week. Distillate stocks surged to 160.5 million barrels, the highest level since 1985. The price of September crude closed at $68.05 per barrel on Friday, up 89 cents. The futures contracts for crude in are a contango.
What is a contango? It is a futures market where the prices for distant contracts are higher that those for nearby delivery. For example, the September futures contract closed at $68.05 per barrel while the December contract closed at $72.52 per barrel. This sets up a huge profit margin for oil traders. They simply buy the cash crude oil and sell distant futures contracts against them. The profit spread between September and December is $4.47 per barrel. Figure that profit on say 1,000,000 barrels.
The effect of these factors are that the buyers of nearby oil have no more room to store it. They are using tankers and barges and running out of room. So now we have a glut of oil. OPEC sees this and is bracing for a sharp drop in prices. This is also how banks are racking up huge profits. They are borrowing money at 0.25% from the Fed and lending it out longer term at much higher rates to businesses and consumers. Would you sell oil contracts at these levels?
Canada Had C$7.53 Billion Deficit in April-May
Canada reported a C$7.53 billion ($6.96 billion) budget deficit in the first two months of the fiscal year that began April 1 amid declining tax revenue and higher spending, including benefits to unemployed workers and government aid for car companies. The country’s deficit in April and May was more than eight times larger than the deficit recorded during the same period last year, the Finance Department said today from Ottawa. Revenue fell 6.9 percent to C$34.5 billion in April and May, the ministry said in today’s report, including a 38 percent drop in goods and services tax revenue to C$2.29 billion. Corporate income tax receipts plunged 24 percent from the year- ago period to C$4.36 billion, the report said.
Program spending rose 13 percent from the year-earlier period to C$36.9 billion, which includes aid the government provided to Chrysler LLC and General Motors Corp. Transfers to people, including jobless benefits, rose 16 percent. For the month of April, the deficit widened to C$3.98 billion from C$1.08 billion in the year-earlier month, the finance department said. The deficit was C$3.54 billion in May, compared with a surplus of C$200 million last year.
BoCom’s Zhang Says Yuan Won’t Oust Dollar in at Least a Decade
The yuan won’t replace the U.S. dollar as China’s leading international trade currency for at least a decade because of limits on investment flows, according to an executive at Bank of Communications Co. A pilot program allowing Chinese companies to settle trade in their local currency has produced a "small" amount of business in the first three weeks, said Zhang Xiaoming, general manager at the international banking department of the nation’s fifth-largest bank by assets. China should expand channels for companies to invest yuan to preserve the value of their assets or make a profit, he said.
"We can’t force our clients to use a certain currency for trade settlement," Zhang, whose Shanghai-based bank is one of the two lenders permitted to offer transaction services for the city’s program, said in a July 22 interview. "More should be done to push forward capital-account reform and increase ways of yuan use outside China." The government allowed companies in Shanghai and four other cities in the southern province of Guangdong to take part in the settlement trial on July 2, seeking to reduce reliance on the U.S. dollar and curb growth in the nation’s more than $2 trillion in foreign-exchange reserves. As much as 50 percent of China’s trade will be settled in yuan in three years as a weaker dollar makes it more attractive to hold China’s currency, according to Qu Hongbin, chief China economist at HSBC Holdings Plc, Europe’s biggest bank.
"The U.S. dollar will remain as the world’s major reserve and trade currency for a long time," said Zhang. "It would be quite good if yuan trade can account for 20 percent of the total foreign trade of China in the imaginable future." Three Shanghai companies agreed to settle import and export contracts in yuan for the first time on July 6. Shanghai Silk Group, Shanghai Electric Group Co. and Shanghai Huanyu Import & Export Co. signed contracts worth 14 million yuan ($2 million) with customers in Hong Kong and Indonesia. The settlement is initially limited to trade with Hong Kong, Macau and Association of Southeast Asian Nations.
A stable exchange rate and a creditworthy issuer are the other two prerequisites for making the currency more popular in cross-border trade, according to Zhang. The yuan was little changed at 6.8316 per dollar as of 12:01 p.m. in Shanghai, according to the China Foreign Exchange Trade System. The currency will end this year at 6.8 and reach 6.5 in 2010, based on the median estimates of analysts surveyed by Bloomberg. Investors outside mainland China can only park yuan capital in deposits and bonds in Hong Kong. Chinese regulators have approved 85 qualified foreign institutional investors to buy local stocks and bonds and pledged to expand the total quotas under the QFII program to $30 billion.
"The government’s policy of easing capital controls is key in determining how fast the yuan can be accepted in trade," said Fang Ming, an analyst in Beijing at Bank of China Ltd., the nation’s third-largest lender. "The next step should be to allow more investments from Hong Kong, Macau and Asean nations into yuan assets inside mainland China." Fang said yuan trade may account for as much as 40 percent of China’s total cross-border trade within a decade. Bank of China is the other lender that, like Bank of Communications, won approval to take part in Shanghai’s yuan settlement program.
Chinese regulators have approved about 100 companies in Shanghai and 300 firms in Guangdong to settle trade in the local currency, said Zhang, who declined to give detailed settlement figures. The government may expand the trial to the southern provinces of Yunnan and Guangxi, he said. The nation’s foreign trade climbed 18 percent to $2.56 trillion in 2008. Most of the country’s international trade is settled in the U.S. currency. HSBC holds a 19 percent stake in Bank of Communications.
Britain’s 'gunboat' diplomacy still angers Iceland
Iceland's new finance minister Steingrímur Sigfússon is not looking for a fight with Britain. But like every citizen of this rocky outpost, he thinks the British government's draconian sanctions against his country at the height of the financial crisis last year were grotesque and have made it much harder to clinch a deal to refund IceSave depositors in the UK. "To apply anti-terrorist laws to freeze Icelandic assets is a long way beyond what is acceptable and it has left a lot of bad feelings," he told The Daily Telegraph. Almost nobody on this island nation can fathom what made Britain think it proportional to list Iceland's central bank alongside al-Qaeda as a terrorist organisation.
"Somehow we have to solve this problem in a civilised manner, but the IceSave agreement is very unpopular. People feel that this imposes a terrible burden," he said. Indeed, he himself has to walk a daily gauntlet, passing youths wearing "IceSlave" T-shirts on the Hverfisgata drag. Mr Sigfússon, a Left-Green radical, said his moral mission is to slam the door on the Iceland's 20-year foray into free-market adventurism, an era that saw the big three banks evolve from sleepy state lenders into global-macro hedge funds with liabilities equal to 11 times GDP. The trio of Landsbanki (mother of IceSave), Glitnir, and Kaupthing collapsed in October with $60bn (£36bn) in foreign debts, a colossal sum for a nation of just 300,000 people.
"We're going to move away completely from these catastrophic policies. We will bring the country back to its course as a Nordic welfare society, with a strong public sector, and a redistribution of wealth," he said. Einars Már
Gudmundsson, Iceland's top novelist, said Britain's conduct had been deeply wounding. "We have always been a good ally. We lost more fishermen shipping cod to England during the war than you lost on the battlefield, proportionally," he said. "This proves what socialists have always said, that in a capitalist world, nobody is your friend. I have sympathy for British people foolish enough to believe Landsbanki, but I had never heard of IceSave till this happened. We were told that what these banks did abroad was nothing to do with us, but when it all went wrong the responsibility fell back on us. It is why we feel a great sense of injustice," he said.
Officials are angry that Britain used its influence to block a deal with the International Monetary Fund and Nordic states at the worst moment of the crisis last November. (Britain said Iceland had violated its European Economic Area duties by shuffling assets in favour of domestic interests) But what rankles reformers is that Labour has continued to mete out the much same treatment to the Socialist-Green coalition brought to power in February by the so-called "Saucepan Revolution". "There has not been any real change in Britain's approach. It has been 18th century gunboat diplomacy at every stage," said one official.
Under the proposed IceSave deal, the Icelandic state will cover $5.5bn in deposits for some 200,000 British and 120,000 Dutch savers drawn into Landsbanki's snare at the height of the credit bubble. Britain and the Netherlands will provide a loan at 5.55pc interest. It must be repaid within 15 years, with seven-year grace period. Central bank estimates suggest that the terms will increase Iceland's public debt by 20pc of GDP. The repayments will be around 2.5pc of GDP annual from 2016 onwards. Iceland's government is stoically backing the deal, deeming it the only way to re-enter polite society, keep IMF loans flowing, and clear the way for Iceland's EU accession. In case there was any doubt, Dutch foreign minister Maxime Verhagen said this week that a deal is "absolutely necessary" to clear the way for Iceland's EU bid.
Whether the IceSave deal will clear Iceland's Althingi – the world's oldest parliament, dating to 930 AD – is another matter. All opposition parties intend to block it, and MPs for the ruling coalition are torn. "It is very dangerous for the state to take on this sort of debt responsibility," said Sigmundur David Gunnlaugsson, chair of the Progressive Party. The No camp is circulating an internal memo from Sweden's Riksbank that pins much of the responsibility for the IceSave debacle on Britain and the EU. It said "absurd" EU rules – which cover Iceland through the EEA – have created a regulatory dog's dinner. "While Icelandic politicians and regulators are responsible for allowing highly leveraged expansion, they are not the only ones to blame," it said.
The EU directive was muddled, stipulating only that states must set up a "guarantee scheme" for banks, not that they are liable for all losses. It was well-known that these schemes are often private foundations with tiny resources, yet the UK "hardly bothered" to inform savers of this fact. It let IceSave state on its website that savers enjoyed protection equal to the UK's own scheme. "The conclusion is clear: the EU host countries (UK and Holland) are also to blame for Iceland's disaster. Consequently, it would be reasonable that they carry some of the burden. It takes two to tango," said the report acidly. For Britain, an irksome precedent has been set. Allies can expect no quarter if they spiral into a deep financial crisis. This could come back to haunt.
More Than Half Swedbank Mortgages in Latvia Exceed Collateral
More than half the Latvian mortgages issued by Swedbank AB, the largest bank in the Baltics, exceed the value of their collateral after property prices plunged. The loan-to-value ratio exceeded 100 percent in 54 percent of home loans issued in Latvia by the end of June, said Jenny Clevstrom, a spokeswoman with Swedbank in Stockholm, in an e- mail yesterday. The share was 37 percent for Lithuanian mortgages and 24 percent for loans granted in Estonia, she said.
Worsening credit quality highlights risks for Swedbank from falling property prices in the Baltic countries, which are going through their worst recessions since gaining independence from the Soviet Union in 1991. "The decline in collateral prices is due to the present situation of the property market: according to Swedbank analysts the prices of apartments in Tallinn have declined by 53 percent from peaks in the summer of 2007," said Mart Siilivask, Swedbank’s spokesman in Estonia, in an e-mail. "The price decline in the Latvian capital. Riga. has been 68 percent and in the Lithuanian capital, Vilnius, 28 percent."
Swedbank on July 17 reported a second consecutive quarterly net loss as bad loans in the Baltic region soared and said it will shed 3,600 jobs by the end of the second quarter next year mainly in Estonia, Latvia and Lithuania and in Ukraine. A fall in the value of the collateral below the outstanding loan allows the bank to seek additional guarantees from clients. Swedbank is not planning to do that for any mortgages that are not in arrears, said Priit Perens, chief executive of Swedbank’s Estonian unit, according to newspaper Eesti Ekspress today.
Who caused the economic crisis?
by Simon Johnson and John Talbott
John R. Talbott is a former investment banker with Goldman Sachs and the author of "The 86 Biggest Lies on Wall Street," "Contagion," "Obamanomics," and "The Coming Crash in the Housing Market." His books predicted the housing market crash, the financial crisis and the election of Barack Obama when Obama was still a little-known underdog. Talbott is currently engaged in trying to build what he calls "a grass-roots movement of ordinary Americans who want to take back the government from lobbyists and corporate interests." Anyone interested in learning more can e-mail him at johntalbs (at) hotmail (dot) com.
Simon Johnson, the former chief economist of the International Monetary Fund (IMF), is the cofounder of BaselineScenario.com, a Web site tracking the ongoing financial crisis. He is also the Ronald A. Kurtz professor of entrepreneurship at the MIT Sloan School of Management, a member of the Congressional Budget Office's Council of Economic Advisers and a senior fellow at the Peterson Institute for International Economics in Washington, D.C. He is one of the most visible public commentators on the ongoing financial crisis and its causes and on what role the government and regulatory policy will play in moving the economy forward.
From June to July of 2009, Talbott and Johnson held an e-mail conversation on the following topic: "The economic crisis: Who caused it? Was it preventable? Was criminal activity involved in bringing it about? And is it over?" The exchange below is the first of three sets of e-mails.
From: John Talbott
To: Simon Johnson
Subject: A Vast Criminal Enterprise
I believe economists are doing a very poor job of explaining to the American people who and what caused the current economic crisis. I think the reasons for this are threefold.
One: Economists and media pundits -- themselves mostly gentlemanly elites anxious to please corporate America -- are slow to make the accusation that what happened here was truly criminal, and so miss the real story. The American people understand that when a group of bankers shuffle some paper unproductively and get away with hundreds of billions of dollars in bonuses, yet cause a loss of $40 trillion in global wealth and cause approximately 100 million people to become unemployed worldwide, there is only one word to describe it: criminal. We don't have to argue about whether their actions were technically illegal or violated existing statutes, as in this conspiracy the crooks were writing their own regulations and legislation through their control of the government through lobbying.
Two: There has been no criminal investigation to date, so evidence supporting criminality has not been uncovered -- no one is looking for it. Liberals hate to think that Obama, led by Geithner and Summers, is part of a grand cover-up scheme, but that is exactly what is going on. How else can you explain the lack of criminal investigations? Why isn't the FBI breaking down the doors of the commercial and investment banks and grabbing computers so as to preserve incendiary e-mails that will most definitely implicate executives? Why are managements that caused this still in their jobs and still receiving bonuses? Are the bonuses paid to the folks at AIG that caused its collapse nothing more than hush money? How can the rating agencies still be in business? Why don't we make one arrest and lean on the bankster to see if he will fold like the cheap suit that he is and name other conspirators? The FBI spends more time investigating $2,000 drug buys than they have to date investigating the biggest heist in the history of the world: $40 trillion, that's trillion with a T, that's 40 million bags each containing $1 million.
The third reason that we have not had an easy-to-understand explanation from economists as to the cause of this mess: I think we're all trying to fit the facts as we know them into one simple story of causation. I believe there are actually three different storylines occurring contemporaneously, and all of them criminal. It is similar to what Winston Churchill said about trying to forecast Russia's next moves in 1939: "It is a riddle, wrapped in a mystery, inside an enigma."
So what are these three criminal storylines? The first, and the smallest (if you can believe it) at approximately $10 trillion, is the housing crash and the mortgage meltdown. Totally criminal, as its primary cause was banksters stuffing worthless mortgage paper into CDOs [securities known as collateralized debt obligations] and calling them AAA. Criminal at every level, as real estate agents were convincing their buyers to pay more, not less, to "earn" their fees through a winning bid, appraisers were offering non-independent and completely tainted appraisals, mortgage brokers were altering loan documents and changing income data to qualify buyers, bankers were paying rating agencies to call junk paper AAA, and principal investors like pension funds, insurance companies, and sovereign governments failed to perform even the minimum levels of due diligence demanded by their fiduciary duties.
But the second story is even bigger and extends far beyond mortgages to the entire banking system. The banks had found a way to avoid the regulation that everyone knew they needed ever since they were given federally backed depositor insurance to prevent bank runs back in the '30s. They became one of the biggest lobbyists and campaign contributors to your Congress and your presidents. Then, amazingly, they just asked that all limitations on their activities be removed -- and they were. If I paid you $2 for your vote, it would be illegal, but somehow these banks could pay hundreds of millions to our congressmen and presidents for their votes and it was all perfectly legal. Completely nuts!
So what did banks do that was criminal? Well, first they paid your government to eliminate bank restrictions, then they overleveraged, knowing they could not honor contracts with such leverage, then they lied to their shareholders about the risks and magnitudes of their positions, hid their positions illegally off balance sheet, and through the use of derivatives managed to violate minimum capital requirements on an almost daily basis. They took bank debt leverage from 8:1 to over 30:1, thus assuring that the banking system could not survive even a modest credit tightening or recession. They made crazy bets in the credit default swap market that they could never honor in a downturn. They loaned money to anyone who could fog a knife because they knew they were going to stuff it to others through securitization and CDOs. If we had a criminal investigation, we would have access to the incriminating phone calls and e-mails in which the banksters disclosed what they really thought of the assets they were pawning off on others. To see how traders incriminate themselves, watch "The Smartest Guys in the Room," about Enron's collapse.
The final storyline of criminality is the biggest of all. It is bigger than the current financial crisis. It is corporate America's complete control of our nation's elected officials, especially our Congress, through lobbying and campaign donations. Yes, the banks played this game, but the game was much bigger than just the financial industry. Coal-fired utilities have so watered down impending legislation concerning global warming that they have now come out in favor of it in the House vote. TARP money went to banking friends of Hank Paulson, although 97 percent of congressional correspondence from the American people was against it. The credit card industry took a minor slap on the wrist, but faces no limitation on the egregious interest rates it can charge its customers. Pharmaceutical and hospital corporations are fighting hard to keep Americans from having a public alternative to their healthcare, and right now are winning that fight. The transportation industry is at the government trough trying to pass a $500 billion windfall. The AARP prevents any meaningful reform of Social Security; the teachers' union does the same for education reform. Is it crazy to think that defense companies like Dick Cheney's Halliburton (which saw its stock price increase 700 percent during the Iraq war, thanks to no-bid contracts) may be promoting U.S. aggression around the world?
The American people understand that their government is corrupt; that is why they don't want to rely solely on more government regulation to solve this crisis. No, if we are to ever to see positive growth again in this country, we need to make the fundamental reforms that are necessary without relying on regulation which is so often co-opted or captured by those we are trying to regulate. This suggests we need to find a way to get corporations out of our government and ensure they never become either too big to fail or so big that they improperly influence markets and our government.
From: Simon Johnson
To: John Talbott
Subject: Re: A Vast Criminal Conspiracy
You make many good points, but I think the situation may actually be worse.
You stress that criminal acts must have been committed, and I'm sure this is right at the level of individual lenders or investment banks that packaged and resold dubious mortgages, for example. As you point out, when and if prosecutors get their hands on the right e-mails, we'll see evidence for a great deal of intentional deception (of consumers, investors, regulators and everyone else).
Given that we have a relatively decentralized criminal justice system, within which prosecutors have an incentive to build a tough reputation, and given that it takes time to build these kinds of cases, I suspect we will see more such prosecutions in the near future. Also, civil cases now under way may well uncover evidence of criminal wrongdoing -- and this will presumably be referred to prosecutors.
The bigger problem, however, is that much of what has severely damaged our economy and still jeopardizes our future is completely legal. Take, for example, campaign contributions. You rightly rail against these and the power that they confer on big donors -- primarily lobbies of various kinds. And we're all against direct favor buying that is presumably illegal. But much of what was done -- for example, in terms of financial market deregulation since the early 1990s -- was surely completely legal, but a very bad idea.
Bad ideas in public policy, of course, are always with us. What worries me most about our situation at this moment is that while our current leadership on economic strategy issues now talks about the mistakes of their (and our) past, their policies are pointing us back in the same direction. The latest evidence in this regard is the regulatory plan released by the Treasury this June.
This plan is a long list of technocratic tweaks. But when you dig through all the details, it is hard to find anything that will really make a difference to the functioning of our financial system. Most importantly, we will still have banks that are perceived as "too big to fail," and these institutions will have access to government bailouts under vague and completely open-ended terms. In what way will this encourage responsible lending in the future?
The administration does propose to add an agency protecting consumers against financial products -- and this is an implicit recognition that you are right, that the finance industry has long been ripping off consumers in various ways. But beyond that, there is nothing currently on the table that would make our banking system and -- by implication -- the world's financial system better run.
What happened? The finance industry has captured, intellectually, both public policy and a wide range of public intellectuals. People really believe that we need something like today's financial sector in order to resume reasonable growth in this country. This is despite the fact that financial innovation has added little to productivity in the past two decades, and it flies in the face of the obvious damage done recently by overborrowing at various levels.
You point out specifically that economists have not done a good job in terms of explaining the deeper causes of the crisis, and I would agree with that. But again I think this is due to the wrong mental model more than anything else. Most economists think that if we're talking about Indonesia or Korea or Russia, considerations of political economy -- i.e., who has power, what they are trying to do, etc. -- are first order. But as soon as we start to talk about the United States, many reasonable people think that the same special interest politics are second order and that the real action comes from more technical considerations, such as the "business cycle" (whatever that really means).
Implicitly, many economists see the U.S. as quite different from those middle-income countries often called "emerging markets." If these economists allow politics into their view of the world, they consider how altruistic policymakers try to balance conflicting objectives. The U.S., supposedly, is not about the competition for power and influence between strong interest groups.
My own view is that we should be dubious whenever someone says or assumes that "the U.S. is different." Most countries have powerful groups -- almost always including the financial sector, and big banks in particular -- and they are always trying to slant things their way. The U.S. may in fact have a worse problem, as our financial sector made a great deal of money in the early deregulation years of the 1980s and plowed that back into further financial influence.
Big finance, of course, was helped by two major waves of innovation: lower communication costs meant that global investing became cheaper, and lower computing costs meant that more complicated trading strategies (i.e., involving derivatives) became more profitable. Of course, to really take advantage of these changes the finance industry needed new rules: lower barriers to capital flows across borders and no regulation for derivatives trading. When they got both, by the mid-1990s, it was off to the races -- the unsustainable rise of the financial sector since that time is what has really pulled us into our current predicament.
And the way in which the Obama administration is attempting to extricate us from the crisis -- with unconditional support for big banks, regardless of costs -- is not addressing the fundamental imbalance of power that favors the financial sector. If anything, the big banks that survive in this sector have now become more powerful -- the political market share of JP Morgan Chase or Goldman Sachs has increased because Lehman and Bear Stearns are out of business.
Private equity and hedge funds, which could have been brought on board with a more reformist agenda (as they have no great love for supersized big banks), instead are lining up with everyone else for government subsidies of various kinds (e.g., through the toxic asset purchase programs organized by the Treasury). And small banks -- who have considerable potential clout through their access to the Senate -- devote most of their time to shooting down sensible changes to more general financial rules (e.g., about whether mortgages can be modified in personal bankruptcy), rather than helping to rein in big banks.
In some sense, the administration's political strategy in this area is not going at all well. But in another more profound sense, the political strategy of Big Finance is proving incredibly effective. They survived the crisis essentially intact, they will keep the rules that have served them (but not us) well, and their day-to-day influence in the corridors of Washington power has never been higher.
There will be a continuing struggle for reform -- after all, we've seen overbearing financial power reined in before in this country (e.g., by FDR and Congress, following the Pecora Hearings in the early 1930s). But it's going to be a long struggle. There is nothing on the immediate horizon that will address our fundamental problems; in fact, the economic recovery will further strengthen the hand of the largest banks, as they will argue that we should now "move on."
But as long as people like you keep writing about the deeper issues at stake, and -- by all means -- pushing everyone to look for and expose criminal wrongdoing, we will eventually move in the right direction. The battle to control finance is really an argument about ideas. What is the right way to organize the economy? How should big banks be effectively brought under control? How do we prevent anyone from exercising disproportionate influence in our open political system?
Keep at it.
"I would shut down the hedge fund industry"
by Simon Johnson and John Talbott
From: John Talbott
To: Simon Johnson
Subject: Complexity With No Purpose
You make some very good points [in your first e-mail]. Let me try to address some of them, and in so doing extend this e-mail exchange into a conversation about the real reforms needed.
Don't worry, this isn't over yet. We haven't missed our chance to enact real reform. There isn't going to be any big recovery until we address these fundamental issues. Given the debt overhang, the banks' general unwillingness to lend, the lack of transparency and trust in the markets, the possible change in people's desire for increased status-seeking through crazy borrowing and crazy consumption, a substantial decline in immigration and population growth, and the fast approaching retirement of the baby boomers, I don't see the American economy growing in real terms for years, if not decades, into the future. The real risk is that the economy will continue to suffer, unemployment will increase, and discontent will grow to the point that the Republicans stage a comeback. It may sound far-fetched now, but I can tell you: There is enormous anger out there about government spending, the increased debt, the bailouts and the fact that Washington is still taking orders from special interests. This is not the change people signed on for.
You are right -- this is much bigger than Bernie Madoff and his friends stealing billions from investors. Because the banks lobbied to change the law before they acted, their actions are technically legal. But paying elected representatives money to change laws so that you can violate them seems to me to be at the heart of what criminal activity is all about. But you are right, because the laws were changed, criminal prosecutors in the states are not going to be very effective in bringing effective prosecutions, especially given that federal enforcement agencies like the FBI and the SEC [Securities and Exchange Commission] are collecting so little useful evidence and pursuing so few leads.
It is a real question how a country can stop corruption once corruption reaches its legislature, since the legislature is the place where we would expect reform legislation to be enacted. I believe this is one of the reasons why the poorest countries of the world have remained poor for centuries. As we have seen here in the U.S., once you lose control of your legislature, accomplishing real reform is a much bigger problem. Prosecuting attorneys are not going to be much help, judges and the court system have their hands tied by corrupt legislation, and well-meaning presidents face ostracism inside the Beltway if they openly oppose Congress, lobbyists and corporate special interests.
I believe pressure for reform has to come directly from the people. And I believe that Washington is so corrupt that attempts to bring reform through the vote will be ineffectual. The two parties have too much of a lock on power while incumbents have too much money (and they have gerrymandered their districts to the point that their losing is near impossible). Congress' approval rating of 14 percent and congressional incumbents' 98.4 percent success rate at re-election fully describes the problem of attempting reform through the vote.
That is why I am starting an effort to organize Americans who are angry with the power of corporate special interests to take back their country by putting pressure not on the corrupt Congress, but on the source of their funding: our biggest banks and corporations. Follow the money. [Anyone interested in further information can contact Talbott at johntalbs (at) hotmail (dot) com.] The task is getting Americans organized, because once organized we hold the ultimate trump card. It is we Americans who make these corporations what they are today by buying their products and services. Any threat to not buy the products of big government lobbyists would certainly get their attention. I honestly believe it is also in the interest of our biggest corporations to stop influencing our government, because until they do, so our country is not going to be seeing any real economic growth. Banksters, greedy healthcare companies, a weak education system, unnecessary wars and a bankrupt government trying to fund its retirees' costs are not conducive to economic growth, and the corporations should come to realize this. This is a classic collective-action problem where each corporation cheats and steals a little, but the overall effect is to strangle the economy and prevent a truly prosperous future.
Of course, the real reforms that need to be accomplished, once we get corporations out of Washington and politics, include limiting the leverage of banks and prohibiting them from risky activities -- principal trading for their own account, derivatives trading, and many other investment banking activities -- and assuring complete transparency of all of their positions. We also need to strengthen the board supervision of management by getting managers, including the CEO and his cronies, out of the boardroom and replacing them with real shareholder representatives. We don't need to limit compensation, but we need to make sure that it is structured so that toxic waste cannot be left behind by a poorly thought-out bonus system.
But there are bigger reforms that are also needed. We need to downsize all corporations, especially the banks. We need to make sure they are not too big to fail. This downsizing will not hurt investors, as they will get two new smaller company shares of equal worth for every big old company share they held.
We need to shut down the credit default swap (CDS) market, because extensive trading of default risk makes everyone too interconnected to fail. I know the CDS market was created to limit risk through hedging, but it has done just the opposite. It has made all firms so interconnected that one cannot fail without bringing them all down. This violates the first rule of capitalism -- that firms must be allowed to fail -- and therefore it needs to be stopped completely. The only analogy I can think of to demonstrate how crazy this market has become is to go back in history to the early days of risk sharing when well-capitalized institutions on shore offered insurance against the loss of a ship at sea. The CDS market, if it were operating back then, would have allowed ships at sea themselves to guarantee the fate of other ships at sea, with very small boats such as hedge funds somehow insuring the return of very large merchant ships. The whole mess would have become so interconnected that one ship's sinking would have bankrupted everybody.
People today seem to think that just because two people want to trade something, it must be good. Because the CDS market is big, it must be useful, goes the argument. It gets at the belief system that you suggested people have adopted: that markets are inherently good. Maybe always efficient, but not always good. There are some things like company default risk that shouldn't be traded. In the past people wanted to buy and sell slaves, child pornography, women's bodies, or weapons of mass destruction, or to offer payments to elected government representatives and bribes to international governments and competitors. Just because a market can develop does not mean the functioning of that market is good for society. Markets cannot self-reflect. That is what humans do. Only we can decide if a particular market is doing more harm than good.
I would extend my reforms to include shutting down most derivatives trading. If used properly, it can be an effective hedging tool, but since its introduction it has made investment analysis moot, as no one actually knows what risks you are buying when you buy the stock of a company or bank actively engaged in derivatives. You may be bullish on gold prices, so you buy a gold mining stock -- only to find out that the company has in fact hedged its gold exposure so effectively through derivatives that it makes money only if gold prices decline, not increase.
Similarly, I would shut down the hedge fund industry. They are nothing more than enablers for these banks and companies like AIG to concoct schemes to avoid regulation or increase risk. Basic investment theory says you can't beat the markets, so I will bet that the hedge funds that are claiming to do so are doing it illegally through insider trading and market manipulation of individual stocks and asset prices. Don't take my word for it. Let's have the government tap the phones and check the e-mails of the hedge funds for a six-month period on a confidential basis and see what happens to their reported outsized profitability and trading brilliance.
From: Simon Johnson
To: John Talbott
Subject: Re: Complexity With No Purpose
Thanks for your follow-up note.
I take your point that there should be a great deal of popular anger -- there is certainly plenty of reason for ordinary voters to be upset. But I'm not so sure this will be manifested anytime soon; for most people, what has happened is a bit abstract and rather too confusing.
On top of this, the big banks have done a great job of muddying the waters. Their message gets through to many: Everyone is to blame and no one is responsible for the crisis, so let's go back to some version of business as usual.
I actually agree there will be change, but I would suggest three other ways in which this will be manifested.
First, the financial sector has become so bloated that going back to any version of "business as usual" is inherently difficult. Even ardent supporters of the financial sector think that much of its supposed growth since the mid-1990s is likely to evaporate. And there is no one who thinks that finance can continue to expand its already high share of our national economy.
In our bubble/boom, we overbuilt, just like Japan overbuilt in the 1980s. Japan added excessive commercial real estate and too much manufacturing capacity; it took more than a decade to work off that overhang and the associated corporate debt. We overbuilt residential real estate to some degree, but mostly we overbuilt financial services. That overhang could disappear fast -- buildings decay over time, but financial services are just people sitting in front of computers. Turn off the perceived business model and there's nothing left -- except perhaps too much office space in former financial centers.
Of course, it is possible that this aggregate contraction will come in terms of exits by smaller players in the financial markets, rather than downsizing the biggest banks. This would be ironic and also dangerous -- the real problem we face is from the banks and other financial firms that are "too big to fail" because they are so large relative to the financial system. If the biggest banks end up increasing their political and economic market share, this would not be good.
In this context, my second potential mechanism will be important. As you suggest, much of what passes for "financial innovation" is actually various ways to rip off customers. The biggest, most "sophisticated" banks have become very good at getting people to overpay.
Resistance to this kind of overpayment is growing. The existing level of fees, implicit and explicit, for all kinds of financial services has moved from irksome to completely unacceptable. Disappointed customers and rising competitive pressures are forcing these fees down. All of finance will be affected, but the biggest hit should be on the banks that are more about "rent extraction" than actually intermediating money from savers to borrowers.
The big banks are definitely in this line of fire. You're going to see some aggressive new entrants, undermining all manner of previously effective cartels, at the same time as fewer transactions and lower fees.
Third, there is great frustration and mounting anger among other members of our business elite. What the big banks have gotten away with is absolutely not in the interest of "real economy" entrepreneurs and the venture capital that backs them financially. It's also not in the interest of small and medium-sized banks who find themselves under increasing pressure -- particularly as commercial real estate goes bad -- but who are small enough and politically unconnected enough to fail. And the executives who run large nonfinancial corporations are beginning to figure out how badly they got clobbered and by whom.
They are worried about the budget deficit, about the issue of money, and -- most of all -- about their future taxes. All of these worries are completely appropriate. And they understand very clearly who is responsible: the biggest of the big banks.
Why does this matter? These business elites wield great influence, partly behind the scenes. They are increasingly articulating to their contacts in the administration and on Capitol Hill that "too big to fail" is no longer acceptable.
I hear more and more, including from influential people in the financial sector, that there needs to be some sort of "tax" (speaking loosely) on size in finance. There is a growing consensus that if you are big enough to jeopardize the financial system and to require a future bailout, you should pay for that privilege.
The payment can be in terms of higher capital requirements or something else. There are many ways to make this work -- as Deng Xiaoping said, "It doesn't matter if the cat is black or white, as long as it catches mice." The cult of size within the financial sector is over.
Overall, I may be more optimistic than you about change for Big Finance being on the way. But I'm probably less positive about where this ends up more broadly for society. You have a long list of reforms throughout society, and while we can argue the details, I'm broadly sympathetic to many of your points.
These mechanisms for imposing change on Big Finance, however, would do little to move things forward on a broader front.
That needs a more comprehensive national leadership push. Personally, I have not given up on President Obama -- I think much of his strategic agenda makes sense and many of his tactics are sensible, but the banking crisis is still an Achilles' heel. If he can get past that, and put the big banks back in their (smaller) boxes, I'm optimistic that he will have the opportunity to push over time for more extensive reforms.
And if not him, who?
Fix the economy? Curb corporate America
by Simon Johnson and John Talbott
From: John Talbott
To: Simon Johnson
Subject: Taking Back the Country
I think you and I and most economists suffer from an antiquated belief that if we can just figure out exactly what went wrong, policymakers will beat a path to our door to ask our help in enacting necessary reforms. Unfortunately, the world no longer works that way. Our corrupted government, our criminal businesses and banking institutions, lobbyists, special interests, and the corporate controlled media are not interested in fixing this problem. They are making trillions of dollars through a vast scheme that transfers wealth from ordinary American taxpayers and consumers to their corrupt coffers. You are right that if big business thought about it, they should support efforts at restricting lobbying so that growth-oriented government policies could be implemented without the influence of corrupting special interests. But each lobbying corporation is also its own special interest, and so such internal reform is impossible.
The million-dollar question is: Why haven't ordinary Americans reacted more passionately and angrily in taking real action to end this systemic abuse? A decade ago, I wrote my first book on the corrupting influence of big business lobbying on our government and concluded at the time that average Americans would not focus on the issue until they had suffered real pain. I concluded that you can't defuse a bomb in America until after it has gone off.
But now the bomb has exploded. Forty million Americans are unemployed, millions have lost their homes, and most have taken a very substantial hit to their incomes, retirement savings and wealth. Why aren't Americans in the streets protesting this corrupt, enormously damaging criminal enterprise? I have traveled enough around America to realize that even though the current situation is enormously complex and not all Americans can describe exactly how the CDO market works, almost without exception every American can relate to you his frustration with how corrupt this government is and how unjust corporate lobbying and special influence in Washington has become. They get it. As a matter of fact, some of my high school-educated friends from my home state of Kentucky understand it a lot better than my Harvard-educated friends from Wall Street.
So I don't think the current challenge is figuring out exactly what caused the crisis. Focusing on what caused this episode will lead to narrow regulatory reform that reminds me that we all now take off our shoes at airports because one crazy fellow had the idea of putting a bomb in his heel. So while reform is needed in subprime mortgages, securitization, derivatives, and even in the magnitude of our financial institutions, none of these get at the fundamental problem: The people of this country are no longer making the rules by which they wish to live. If subprime mortgages hadn't blown up, some other area of highly leveraged bank lending would have eventually imploded. Even if the banking industry hadn't crashed, some other sector of the corrupt business/government criminal enterprise would have. Maybe the ice shelf of Greenland would have collapsed into the North Atlantic, maybe we would have run out of oil, maybe Microsoft's monopoly position in operating systems would have led to a worldwide computer virus shutdown, maybe poor consumer safety standards with China would have led to a global disease epidemic. The point is that when corporations make the rules, the results are not always good for the inhabitants of the planet.
So we don't have to decide today exactly what the reforms will be -- we just need to get corporate America out of our government so that the people can deliberate and make these reform decisions themselves without undue influence from bankers and corporations.
But there are two huge impediments to accomplishing this. This is not a traditional economics problem, it is an organizing problem or a collective action problem. People know the system is rigged and broken and unjust, but they feel as if there is very little that any one of them can do to effect much change. The organizing task is further complicated by the fact that our media, including television networks, cable TV, radio, newspapers, and magazine and book publishing, are almost all sponsored, owned and controlled by big corporations. The only hope is the Internet, over which big business has tried but to date failed to successfully exert its dominance. The Internet will prove to be both a source of unbiased news and information as well as the communication tool concerned citizens can utilize to fight back against big government, big business and big media.
What has to happen to get this movement started? First, I think people need to see that there is a channel being constructed that has the potential to be effective in directing their anger into real positive reform and change. I am in the process of beginning just such an organization and encourage people who are interested in fighting back against the system and against corporate lobbyists and special interests to contact me at my e-mail address, johntalbs (at) hotmail (dot) com.
Next, people have to believe that if they invest their time in such an effort they have the potential of winning. In this case, this is rather straightforward and easy to explain. If we are successful in organizing 5 million to 10 million Americans who want to see real change about how business is conducted in Washington, then by definition, we will have not only substantial political and voting power, but more important, the beginnings of a real consumer movement that could easily boycott the products and services of the worst corporate lobbyers in our government.
And this is where the magic of the Internet comes in. No one person could organize a 10 million person database in his lifetime. But Obama was able to accomplish it in less than two years. How? We don't have his money. Instead, we create our own Ponzi scheme. We create the ultimate chain letter. I e-mail 30 of my friends who each e-mail 30 of their friends and so on and so on. If only four cycles of people pass on the info we end up contacting 25 million Americans. We ask people to give us their e-mails and then contact them when we want to boycott a new offender.
It is time for Americans to realize that things are not going to improve until they get involved. It will take time. But the economy is not going to improve until we straighten out our corrupt system. Do you have anything more important that you are working on than this? The survival of liberal democratic society in the world.
Thanks for a great exchange of ideas. And best of luck in your future research and work.
From: Simon Johnson
To: John Talbott
Subject: Re: Taking Back the Country
I admire your energy and focus in trying to mobilize a broader cross section of people against the big banks in particular and the way our political-financial system operates in general. I'm sure this is worthwhile and not at all a waste of time. Any efforts you or others put into educating people -- or enabling people to better educate themselves -- will surely pay off over time.
However, my sense of the political cycle around these issues is perhaps a bit different from yours. On the first round -- the crisis, immediate policy response and first-round "reform" efforts -- the big bankers have definitely won.
You were right when you argued way back that it would take a crisis before anyone really understood that we have a problem. But even so, most people still do not fully understand what has happened to them over the past 12 months -- and why their future taxes will be so much higher. I spend quite a lot of time talking to relatively well-informed people. After an hour or so of intense discussion and argument, I would say that most people see much more clearly just what the big banks got away with, although they do not necessarily agree with the idea of stricter regulatory controls on those banks. Left to their own devices, or just relying on the usual sources, I'm not sure how clear any of this is to most people.
And I worry that e-mailing friends doesn't necessarily engage people at the necessary level. You need repeated reinforcement of the key themes -- and a lot of back and forth with people you trust -- to really change minds on something this big. Or, as you say, you need to see it again and again, and perhaps you need to worry about the consequences for your own well-being.
If the big banks could just lie low for a while, I honestly think they would get away with everything -- the backlash would fade, and we'd be setting ourselves up for another massive crisis down the road.
Fortunately (in a sense), the banks cannot back off from their most egregious behavior. Perhaps this is in their DNA; definitely it is in their organizational culture and how they see the world -- the people who run the biggest financial institutions really think they are the masters of the universe and are proceeding on that basis.
Their profits, their wages, their bonuses, and their behavior have begun to antagonize people greatly. Already, some of my contacts who are close to the administration wince at the latest news from the financial sector, be it the bonuses that were paid last year to senior people who oversaw major mistakes (some of whom are now rewarded with senior policy roles!) or the blatant bragging about political influence that some CEOs are now making public.
And even if some sensible people at these banks would like to rein in employee compensation to more moderate and reasonable levels, they have a problem. If you lower the wages for your people, another bank -- perhaps one based in Europe -- will hire them away with a crazy package. The rat race, across companies and between people, means that this can only be curtailed through regulation. But the survivor banks are so strong politically that they will defeat all meaningful regulation for compensation.
This very success makes them more vulnerable to further criticism and backlash.
I'm not saying that the banks will simply commit political suicide. Nothing is ever so simple. But they will likely undermine themselves with Congress and eventually even with the administration. The midterm elections in 2010 and the presidential election in 2012 could well be very much about restricting the power of the big banks.
American democracy does not get on well with overweening unelected individuals who pretend to great power. Andrew Jackson saw off Nicolas Biddle in the 1830s. Teddy Roosevelt stood up to -- and eventually towered over -- even J.P. Morgan at the beginning of the 20th century. And FDR remade everything in the 1930s.
As I said before, I'm optimistic that President Obama can do the same. The challenge to democracy is palpable and growing. The fact that two -- and only two -- big banks came through the crisis unscathed is a perfect symbol of the problem. In the past, part of the myth of Wall Street was that it was competitive, that many could enter the industry, and that its political power was not too concentrated. This myth, among many, has now exploded.
We see the power for what it is. Mainstream media increasingly picks up the story line. And still the big banks cannot step back and curtail their most troubling activities.
Keep explaining and let the big banks provide the supportive evidence you need.
Who Regulates Banks Best? Bozo the Clown or Barney Frank
by Michael David White
Bozo the Clown or Barney Frank. Day 1.
Savings, Leverage, Equity. Folly’s Eternal Recurrence.
Bozo: “Listen Barney, let’s start at the beginning. Borrowers and lenders define themselves first by their savings account. Requiring the right ratio of savings to lending and borrowing — the ratio of leverage — is the key to managing banking, insurance, derivatives, hedge funds — the entire world of finance.
“The right leverage tops the commandments for the regulation of lending. It may represent as much as 90% of the job of regulating banks. Our next credit bubble will begin when the limits are widely circumvented. What we are experiencing today is insane and perfectly normal. It happens every 30 or 50 or 100 years.
“Financial bubbles are as common as earthquakes. You don’t really believe they happen, but they do. Enough about me Barney. What is the best wise gay thinking on leverage and bank regulation?”
Barney: “You know what Bozo, that red-hair dye is hitting your brain, and the results are not good for your thinking. The truth is we can never allow this insanity to happen again, and new regulation regulation regulation must pave the way.
“Do you want me to spell it out for you? This is a Republican crisis. It is even criminal in many respects. They will and they must be stopped so this can never ever happen again.
“By the way, do you think there has ever been such a thing as a wise clown? Good luck on that one. Talk it over with your friends in the big-red-hair club.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 2.
Income. Real & Imagined.
Bozo: “Call me a clown Barney, but, in my opinion, a borrower has income which makes repayment likely. The amount of income and the amount of the loan walk hand-in-hand together. Think of it like you and Liberace at the beach.”
Barney: “Wow Mr. Clown, you have discovered your inner Bozo. It’s red-hair-dye in-Bozo’s-brain all over again. Better yet, loosen up those shoes because you are thinking with your dogs.
“I am confident non-traditional sources of income should always be considered — even when they cannot be verified by pieces of paper. The only thing that paper is is paper.
“Do you really want the world to live and die for paper? Are you telling me there is no such thing as a cash economy? My mandate and mission is to end the racist underwriting practices, and a little “stated” income goes a long way.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 3.
Asset-based lending. Appraisals. Liquidation.
Bozo: “It’s weird Barney, but true. A borrower who does not have income may, in some circumstances, reasonably borrow based upon the value of an asset. It’s especially true for the self-employed.
“If you don’t get my drift on that, study the C.P.A. handbook at Geithner & Daschle. Then ask the practitioners there to explain the propensity of self-employed persons to pay income taxes.
“If we are going to take part in asset-based lending, the value of the asset must be appraised — by the lender; not the borrower or the borrower’s broker. A conservative banker will use a low-ball appraiser. And he will lend less than the liquidation value of the asset. And he will charge a higher rate for lending on an asset without income to back up repayment.
“Hold off on the “stated” income thing Barney. Just keep that income line blank on the loan application.
“Cookie will tell you about the dangers of encouraging misrepresentation. Once the fraud begins, you will find it is easy for people to adapt the practice to new uses. Check the bible on this.”
Barney: “Remember this clown face: Our mortgage market is the 7th wonder of the world. Look at all the beautiful things we have done. Globally, everybody knows I am the driving force and leading provider of affordable housing.
“Just look at the supply we have today. It’s unbelievable. That’s me and what I did. Am I right? Look at the vacancies. Look at the fire-sale prices. Look at the subsidized interest rates. Everything is working out perfectly.
“Nobody can say I’m not a major collateral generator. And remember, all this new collateral coming on to the market, that’s new opportunity for the banks. We have a great new opportunity for credit expansion to get the banks healthy again.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 4.Inflated Bubbles. Leveraged Distortions. Alice Plays Wonderland.
Bozo: “It’s true Barney that the safest loan is to a borrower who has income to repay the loan, and, should the income disappear, an asset to repay the loan. Remain vigilant. This is a false statement when liberal leverage has created an Alice in Wonderland world.
“When Alice rules, the conservative loan becomes the worst loan because the income and asset value are lies. Bankers throw money all around. A lot of it will be lost. Wake up and look around you Barney. You live in this place.
“It is neither Republican nor Democrat. It is human. Or go ask Alice if that helps. She is one trippy babe and does not follow guidelines — unless she is under the influence of Lysergic Acid Diethylamide. She’s a very colorful girl.”
Barney: “Here’s what I know Bozo. Fannie and Freddie are doing a great job. There are so many things I love about them. And none of this can be denied.
“I support their affordable-housing mission, their towering subprime mortgage portfolio, their derivatives holdings of unknown risk and dimension (so mysterious and sexy), their unique accounting principles, their world-record-breaking leverage, far greater than infinity ever was, their unrivaled political contributions, their job factory for my friends, my family, and my party.
“It’s so crazy over there I think I could even get a total clown like you a job. Just check that box on the race question as “other”. It’s very good for admissions into the club. Most of all Bozo, what I love is the beautiful power of a $5 trillion mortgage machine which will buy anything I say it will.
“What a marvelous massive money empire I have built. Did you know that this has never been seen before in the history of the world? And look at this: Fannie and Freddie are not bankrupt and never will be. I can say, without equivocation, that their capital enhancements will never exceed $1 to $2 trillion dollars. Or at most $3 trillion if the waters get a little choppy.
“We all agree that capital and leverage are necessary components of lending. We all agree that capital should be increased. Am I right Bozo? Let me be the first to say we do not need a repeat of excess lending.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 5.
Law & Punishment
Bozo: “Enforcing the law enforces the law. Enforce the law you Kumquat.”
Barney: “To be honest, I have never eaten a Kumquat, or even experimented with one during sex.
“I tell you what I did do. I called up Chris Dodd the other day. I am just dying to be a friend of Angelo, and I had to get his phone number. Mixing politics and business is so exciting Bozo. And wowee, isn’t Angelo a sexy beast?
“I wonder if he will charge me points on my mortgage? If he does, I have a very fun proposal for Mr. CEO, my pretty Angelo: “I know just the thing Angelo to make those closing costs go away.” Tell me the truth Bozo: Am I sexy?”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 6.
Transparency. Simplicity. Busy Bodies.
Bozo: “Transparency simplifies understanding. Simplicity encourages compliance. Frauds and enterprise destruction depend upon confusion and rule-making and irrational checks and balances.
“Mark my words Barney. Transparency and simplicity are the golden rules of wise regulation. We need to radically simplify regulation to aid compliance and enforcement.
“The wildest and craziest lie, now accepted and promoted as gospel by the clowns on your side, is that we lack regulation. We have a thousand times more regulation now than is needed.
“What we lack is regulation which is simple and intelligent and tough and strictly enforced. Once again Barney, the world wants to know the wise gay position on this? I’m not referring to backwards or upside down.”
Barney: “I can’t think about that now. I just got a call Bozo, and the caller said I was demented. Why do they keep on saying that about me? Do I look demented to you?
“I think you know I am chairman of the House Financial Services Committee. I understand economics. I understand business. I even support accounting at the government-sponsored enterprises. That’s transparency.
“Look at the progress we are making Bozo. Look at the foreclosures. Look at all the houses we have for sale. Housing is affordable again. Everyone knows that.
“The GSE’s will soon own more homes than anybody ever has ever in the history of the world. And because of my determined oversight, I know each and every one of those homes will be carried on the books. Everything’s up front and out in the open. Capisce?”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 7.
Monopoly. Anti-Trust. Printing All The News That’s Fit to Barney.
Bozo: “You know Barney, economic theory looks down on monopolies. This is one theory which we should not ignore.
“I say limit any financial company to a 15% market share in any business line. For now what we need is to slice and dice the money-center banks. Divide. Sell. Cut them up. Break them down until their failure is irrelevant.
“And Fannie and Freddie? I’m sorry to say this Boy Wonder, but they should get crushed into a million little pieces. We have to burn the pieces too.
“You can reasonably grant monopolies in limited areas — as in granting the federal government the capacity to conduct war and field a standing army. Is a mortgage lender the same as a standing army?
“Let me give you Lending 101, Mr. Chairman. A mortgage loan is the easiest loan to make in the world. What is so scary, what should frighten you more than anything, is that mortgage lenders never needed any monopolistic powers. Did you know that? Does it matter to you? Why is it this central issue will score no air time? The public option for medical coverage is a repeat of Fannie & Freddie in the mortgage world, but how many voters know?
“Why have I never heard or seen one news report on monopolies, GSE’s, and mortgage loans? Where’s the conspirator hiding this news? Do you argue that a $5 trillion mega-force Hoover suction device in a $12 trillion market had no influence? Are you Kookoo for Cocoa Puffs?
“Better wake yourself from that Stalinist dream fat boy. Take off the Mao jacket. Break up your little GSE’s Barney and go home. You can play dress up there if you want too.”
Barney: “Interesting points Red. I agree. The MSM boys are so whorish that it makes me scream with joy. God is great.
“I don’t even have to explain anything to them. I’m so very glad all of us are close friends after work too. Look at the way they handle Fannie and Freddie.
“This is what we say back in my office on the Hill. ‘Whatever the big monsters lose, they can’t make the news, because it’s just a big goddamn GSE snooze.’
“And my cute little MSM’s are falling all over each other to get something dirty on AIG!!!! Derivatives: Bad. Bad. Bad. GSE’s: Good. Isn’t it fun?
“The way I see it, I am the author of every newspaper in the world. Even Mom never said I could do that. Can I tell you what’s next?
“I’m going to bring them back in on Greenspan again. They didn’t hit him hard enough the first time out, and I’m going to lead them back in to the Coliseum.
“That super freak midget wanted to cut off Fannie and Freddie. I will not stop until that phony is in jail.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 8.
Accounting – Gay & Straight
Bozo: “Assets are carried on a balance sheet. Liabilities are carried on a balance sheet. That’s the whole game Barney. Just prohibit assets and liabilities carried off of a balance sheet.
“You gotta play this one straight your highness. Sorry. Some times it just doesn’t work out the way you hope it will.”
Who Regulates Banks Best?
Bozo the Clown or Barney Frank. Day 9.
Loss Recognition. Marking to Market. Going Both Ways.
Bozo: “When should losses be recognized on long-term assets? Good question Barney. I say marking to market prior to a sale event or a write off is ridiculous. Yet it’s best too if market prices are always disclosed.
“If you disclose both numbers, then the investor makes their own judgment. There is a difference between 3 months (a quarter) and 10 years. Marking-to-market makes them the same. They aren’t the same.
“Mark-to-market gives a 10-year asset 40 reporting periods and 10 tax events. It should only have one tax event.
“Mark-to-market is as dumb as an ox; as is failing to disclose the market value of all assets in every reporting period.
“I think that’s about it Barney. We are at the end of our allotted time.
“In special recognition of your contributions, I am announcing today that you, Representative Barney Frank, are the first winner of the Bernard Madoff Award for Excellence in Banking Regulation & Solvency.
“The award recognizes your outstanding contributions to the mortgage and housing crisis. You are, with little question, the most influential individual in creating the financial catastrophe.
“You have destroyed a lifetime of work and savings for millions. You have destroyed millions of jobs. You have ruined millions of lives. How can one guess at the divorce, homelessness, and suicide which the crisis has encouraged?
“The global economy is moving backward. Of millions who were starving before, their numbers have now multipied. Fifty million people are expected to lose their job from the fallout of the crisis.
“You are an instrument of death and destruction. You rival in violent and malicious influence the great criminals of world history. I would suggest you pray to God for forgiveness. Please exit the stage. You have left the world a lot of work to do.”
Barney: “I don’t like that language for a minute Mr. Bozo the Clown.
“I have always been held accountable for my actions. I conduct myself by the highest standards.
“I have always believed in public service. I have a long history of sacrificing for the good of my country.
“Just look around you. There’s affordable housing everywhere for one thing. And every day it gets cheaper and cheaper. And not just here, but all over the world. In Ireland. In Spain. Affordability has gone totally global. And I created it.
“And I would also tell you this: Recognition for the enormous gains I have brought to the world of housing and banking has only just begun. My recognition has only just begun to be known all over the world.
“And believe me, when I say that, that’s not some kind of clown talking. I’m no clown Bozo.”