Saturday, November 7, 2009
Government put $4.3 Trillion of Taxpayer Money Into Bank Guarantees
I have repeatedly pointed out that the government's rescue of the too big to fails didn't just include $700 billion or so in Tarp, but also massive guarantees.
Elizabeth Warren and the Tarp oversight panel now say taxpayer money guaranteed assets worth $4.3 trillion at the height of the financial crisis, in a bid to help banks ride out the panic.
In addition, the Oversight panel's report notes that the guarantees are still providing invisible government subsidies even to healthy banks, even though many of the programs have now expired.
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Friday, November 6, 2009
“The [Head of One of the Biggest Dark Pools Said] the Amount of Money Devoted to High-frequency Trading Could ‘QUINTUPLE Between this Year and Next’"
In a must-read essay, Senator Ted Kaufman reveals that - despite all of the talk coming out of Washington - high-frequency trading is set to explode:
We've gone from an era dominated by a duopoly of the New York Stock Exchange and Nasdaq to a highly fragmented market of more than 60 trading centers. Dark pools, which allow confidential trading away from the public eye, have flourished, growing from 1.5 percent to 12 percent of market trades in under five years.
Competition for orders is intense and increasingly problematic. Flash orders, liquidity rebates, direct access granted to hedge funds by the exchanges, dark pools, indications of interest, and payment for order flow are each a consequence of these 60 centers all competing for market share.
Moreover, in just a few short years, high frequency trading - which feeds everywhere on small price differences in the many fragmented trading venues - has skyrocketed from 30 to 70 percent of the daily volume.
Indeed, the chief executive of one of the country's biggest block trading dark pools was quoted two weeks ago as saying that the amount of money devoted to high-frequency trading could "quintuple between this year and next."
Mr. President, we have no effective regulation in these markets.
Last week, Rick Ketchum, the Chairman & CEO of the Financial Industry Regulatory Authority - the self-regulatory body governing broker-dealers - gave a very thoughtful and candid speech, which I applaud. In it, Mr. Ketchum admitted that we have inadequate regulatory market surveillance.
His candor was refreshing but also ominous: "There is much more to be done in the areas of front-running, manipulation, abusive short selling, and just having a better understanding of who is moving the markets and why."
Mr. Ketchum went on to say:[T]here are impediments to regulatory effectiveness that are not terribly well understood and potentially damaging to the integrity of the markets...The decline of the primary market concept, where there was a single price discovery market whose on-site regulator saw 90-plus percent of the trading activity, has obviously become a reality. In its place are now two or three or maybe four regulators all looking at an incomplete picture of the market and knowing full well that this fractured approach does not work.Mr. President, at the same time that we have no effective regulatory surveillance, we have also learned about potential manipulation by high frequency traders.
Last week, the Senate Banking Subcommittee for Securities, Insurance, and Investment held a hearing on a wide range of important market structure issues.
At the hearing, Mr. James Brigagliano, Co-Acting Director of the Division of Trading and Markets, testified that the Commission intends to take a "deep dive" into high frequency trading issues, due to concerns that some high frequency programs may enable possible front-running and manipulation.
Mr. Brigagliano's testimony about his concerns were troubling:[I]f there are traders taking positions and then generating momentum through high frequency trading that would benefit those positions, that could be manipulation, which would concern us. If there was momentum trading designed - or that actually exacerbated intra-day volatility - that might concern us because it could cause investors to get a worse price. And the other item I mentioned was if there were liquidity detection strategies that enabled high-frequency traders to front-run pension funds and mutual funds that would also concern us.Reinforcing the case for quick action, several panelists acknowledged that it is a daily occurrence for dark pools to exclude certain possible high frequency manipulators.
For example, Robert Gasser, President and CEO of Investment Technology Group, asserted that surveillance is a "big challenge" and that improving market surveillance must be a regulatory priority:
"I can tell you that there are some frictional trades going on out there that clearly look as if they are testing the boundaries of liquidity provision versus market manipulation."
But none of the panelists, when asked, felt a responsibility to report any of their suspicions of manipulative activity to the SEC. That is up to the regulators and their surveillance to stop, they apparently believe.
Finally, at the end of the hearing, Subcommittee Chairman Reed asked about the reported arrest of a Goldman Sachs employee who had allegedly stolen code from Goldman used for their high frequency trading programs.
A Federal prosecutor, arguing that the judge should set a high bail, said he had been told that with this software there was the danger that a knowledgeable person could manipulate the markets in unfair ways.
The SEC has said it intends to issue a concept release to launch a study of high frequency trading. According to news reports, this will happen next year. Mr. President, I don't believe next year is soon enough. We need the SEC to being its study immediately. Where is the sense of urgency?
Mr. President, our stock markets are also opaque. Again, I refer to Chairman Ketchum's speech: "There are impediments to regulatory effectiveness that are not terribly well understood and potentially damaging to the integrity of the markets."
He went on to say:We need more information on the entities that move markets - the high frequency traders and hedge funds that are not registered. Right now, we are looking through a translucent veil, and only seeing the registered firms, and that gives us an incomplete - if not inaccurate - picture of the markets.Senator Schumer echoed this theme at last week's hearing:Market surveillance should be consolidated across all trading venues to eliminate the information gaps and coordination problems that make surveillance across all the markets virtually impossible today.Let me repeat: market surveillance across all the markets is "virtually impossible today." And none of the industry witnesses disagreed with Senator Schumer. That is why the SEC must not let months go by without taking meaningful action. We need the Commission to report now on what it should be doing sooner to discover and stop any such high frequency manipulation. Mr. President, where is the sense of urgency? Mr. President, we must also act urgently because high frequency trading poses a systemic risk. Both industry experts and SEC Commissioners have recognized this threat. One industry expert has warned about high-frequency malfunctions:The next Long Term Capital meltdown would happen in a five-minute time period. ... At 1,000 shares per order and an average price of $20 per share, $2.4 billion of improper trades could be executed in [a] short time frame.This is a real problem, Mr. President. We have unregulated entities - hedge funds - using high frequency trading programs interacting directly with the exchanges. As Chairman Reed said at last week's hearing, nothing requires that these people even be located within the United States. Known as "sponsored access," hedge funds use the name of a broker-dealer to gain direct trading access to the exchange - but do not have to comply with any of the broker-dealer rules or risk checks. SEC Commissioner Elisse Walter has recognized this threat:[Sponsored access] presents a variety of unique risks and concerns, particularly when trading firms have unfiltered access to the markets. These risks could affect several market participants and potentially threaten the stability of the markets.Let me repeat that: "These risks could affect several market participants and potentially threaten the stability of the markets."
Even those on Wall Street responsible for overseeing their firms' high frequency programs are not up to speed on the risks involved, according to a recent study conducted by 7city Learning. In a survey of quantitative analysts, who design and implement high frequency trading algorithms, two-thirds asserted their supervisors "do not understand the work they do."
And though quants and risk managers played a central role exacerbating last year's financial crisis, 86% of those surveyed indicated their supervisors' "level of understanding of the job of a quant is the same or worse than it was a year ago," and 70% said the same about their institutions as a whole.
Senator Sanders Introduces Bill to Break Up the Too Big to Fails
As Reuters notes:
An independent U.S. senator on Friday introduced a bill that would give the government the power to identify and break up financial firms that are "too big to fail," an idea that is catching on.
"If an institution is too big to fail, it is too big to exist," said Senator Bernie Sanders in a statement.
"We should break them up so they are no longer in a position to bring down the entire economy," he said.
Sanders is an independent outside the U.S. political mainstream. But he is not the only one looking at break-ups.
Representative Paul Kanjorski, the Democratic chairman of the capital markets subcommittee in the U.S. House of Representatives, is working on a break-up power amendment.
It would give a new government systemic risk council break-up power, with clearance from the president.
"It's the natural action of capital to grow and exceed. Now we're going to contain it," Kanjorski told CNBC television.
For background on the too big to fail issue, see this, this and this.
Sanders' legislation would give the Secretary of the Treasury ultimate decision-making power:
Sanders' legislation would give Treasury Secretary Timothy Geithner 90 days to list commercial banks, investment banks, hedge funds and insurers that he deems too big to fail.That wouldn't be so bad if Obama fires Geithner and replaces him with someone independent of Wall Street.
Investor Psychology: Fear Turns People Into Sheep
Investors are basically rational, right?
In fact, as many studies have demonstrated, the answer is no.
But instead of wading through all of the investment psychology research, let's look at research into people's basic reasoning abilities. Bear with me for a minute. A study in an area unrelated to investing sheds light on people's basic thinking processes.
Sociologists from four major research institutions investigated why so many Americans believed that Saddam Hussein was behind 9/11, years after it became obvious that Iraq had nothing to do with 9/11.
The researchers found, as described in an article in the journal Sociological Inquiry (and re-printed by Newsweek):
- Many Americans felt an urgent need to seek justification for a war already in progress
- Rather than search rationally for information that either confirms or disconfirms a particular belief, people actually seek out information that confirms what they already believe.
- "For the most part people completely ignore contrary information."
- "The study demonstrates voters' ability to develop elaborate rationalizations based on faulty information"
- People get deeply attached to their beliefs, and form emotional attachments that get wrapped up in their personal identity and sense of morality, irrespective of the facts of the matter.
- "We refer to this as 'inferred justification, because for these voters, the sheer fact that we were engaged in war led to a post-hoc search for a justification for that war.
- "People were basically making up justifications for the fact that we were at war"
- "They wanted to believe in the link [between 9/11 and Iraq] because it helped them make sense of a current reality. So voters' ability to develop elaborate rationalizations based on faulty information, whether we think that is good or bad for democratic practice, does at least demonstrate an impressive form of creativity.
Subjects were presented during one-on-one interviews with a newspaper clip of this Bush quote: "This administration never said that the 9/11 attacks were orchestrated between Saddam and al-Qaeda."The Sept. 11 Commission, too, found no such link, the subjects were told.
"Well, I bet they say that the commission didn't have any proof of it," one subject responded, "but I guess we still can have our opinions and feel that way even though they say that."
Reasoned another: "Saddam, I can't judge if he did what he's being accused of, but if Bush thinks he did it, then he did it."
Others declined to engage the information at all. Most curious to the researchers were the respondents who reasoned that Saddam must have been connected to Sept. 11, because why else would the Bush Administration have gone to war in Iraq?
The desire to believe this was more powerful, according to the researchers, than any active campaign to plant the idea.
Such a campaign did exist in the run-up to the war...
He won't credit [politicians spouting misinformation] alone for the phenomenon, though.
"That kind of puts the idea out there, but what people then do with the idea ... " he said. "Our argument is that people aren't just empty vessels. You don't just sort of open up their brains and dump false information in and they regurgitate it. They're actually active processing cognitive agents"...
The alternate explanation raises queasy questions for the rest of society.
"I think we'd all like to believe that when people come across disconfirming evidence, what they tend to do is to update their opinions," said Andrew Perrin, an associate professor at UNC and another author of the study...
"The implications for how democracy works are quite profound, there's no question in my mind about that," Perrin said. "What it means is that we have to think about the emotional states in which citizens find themselves that then lead them to reason and deliberate in particular ways."
Evidence suggests people are more likely to pay attention to facts within certain emotional states and social situations. Some may never change their minds. For others, policy-makers could better identify those states, for example minimizing the fear that often clouds a person's ability to assess facts ...
The Alternet article links to a must-read interview with psychology professor Sheldon Solomon, who explains:
A large body of evidence shows that momentarily [raising fear of death], typically by asking people to think about themselves dying, intensifies people's strivings to protect and bolster aspects of their worldviews, and to bolster their self-esteem. The most common finding is that [fear of death] increases positive reactions to those who share cherished aspects of one's cultural worldview, and negative reactions toward those who violate cherished cultural values or are merely different.
Fear in the Economic and Financial Arenas
Has something similar happened in the economic/financial arenas?
Congressmen Brad Sherman and Paul Kanjorski and Senator James Inhofe all say that the government warned of martial law if Tarp wasn't passed. And Rahm Emanuel famously said:
Never let a serious crisis go to waste. What I mean by that is it's an opportunity to do things you couldn't do before.
Last year:
- Senator Leahy said "If we learned anything from 9/11, the biggest mistake is to pass anything they ask for just because it's an emergency"
- The New York Times wrote:
"The rescue is being sold as a must-have emergency measure by an administration with a controversial record when it comes to asking Congress for special authority in time of duress."
***
Mr. Paulson has argued that the powers he seeks are necessary to chase away the wolf howling at the door: a potentially swift shredding of the American financial system. That would be catastrophic for everyone, he argues, not only banks, but also ordinary Americans who depend on their finances to buy homes and cars, and to pay for college.
Some are suspicious of Mr. Paulson’s characterizations, finding in his warnings and demands for extraordinary powers a parallel with the way the Bush administration gained authority for the war in Iraq. Then, the White House suggested that mushroom clouds could accompany Congress’s failure to act. This time, it is financial Armageddon supposedly on the doorstep.
“This is scare tactics to try to do something that’s in the private but not the public interest,” said Allan Meltzer, a former economic adviser to President Reagan, and an expert on monetary policy at the Carnegie Mellon Tepper School of Business. “It’s terrible.”
Not Just Government
But it's not just government . . .
If the too big to fails say that the world economy will crash and there will be martial law unless they are bailed out, politicians - most of whom don't understand finance or economics - will believe them, and sound the alarm themselves.
As Karl Denninger wrote yesterday:
[AIG's CEO] left Geithner with two documents. One was a fact sheet that listed all the attributes of AIG FP [the division run by Joe Cassano that blew the company up] and argued why it should be given status as a primary dealer. The other–a bombshell that Willumstad was confident would draw Geithner’s attention–was a report on AIG’s counterparty exposure around the world, which included “2.7 trillion of notional derivative exposures, with 12,000 individual contracts.” About halfway down the page, in bold, was the detail that Willumstad hoped would strike Geithner as startling: “$1 trillion of exposures concentrated with 12 major financial institutions.”
Was that a threat?
And isn't threatening the United States (whether directly or otherwise) something you're not supposed to do?
Sounds like "Bail me out or I will crash everything."
Isn't that analagous to walking into a bank, opening one's coat to reveal an explosives-laced belt, and saying "gimme all the money or everyone dies!"
Yves Smith has previously used a similar analogy.
Fear Among Individual Investors
Investors - as with politicians or Americans in general - believe that "when [they] come across disconfirming evidence . . . . they tend to ... update their opinions", but in reality, they cling to the beliefs they formed during certain heightened emotional states, such as fear.
Fear turns people into sheep. Once they are sheep, they will strive mightily to justify the actions of their "leaders" - whether those leaders gave trillions of dollars in bailouts or got us into war, and even if the leaders' justifications were false.
I believe this dynamic is also playing out in the fact that many Americans assume that the government has a real plan for fixing the economy, is working as hard as it can to do so, and that - eventually - things will improve.
Just as most Americans believe "since we're at war in Iraq, and since the government previously claimed that Saddam was behind 9/11, he must have been", they are probably thinking "since the government gave trillions to the giant banks and said that economists have figure out how to fix things, they must have done what was needed, and things will turn around in a v-shape recovery".
The lengths people go to rationalize a false link between Saddam and 9/11 is a great example, because it may reveal by analogy how far people will go to justify their trust in our economic leaders and in their own investment decisions.Of course, the yearning for high returns is the other half of what drives investor psychology. But this essay focuses on fear.
Thursday, November 5, 2009
The Government is Patching the Barn Door Instead of Catching the Escaped Horses
If all of the horses are already out of the barn, fussing about how to patch the door to fill in a few cracks isn't really very helpful.
You have to go out and round up the escaped horses. Then - once you catch them - you can think about how to improve the barn.
The same is true with the economy.
The too big to fails are - by their very size and the moral hazard created by the government's actions - drawing the American economy down into a black hole.
The TBTFs - by their very size - are so powerful that they are making the playing field uneven and warping democracy.
By allowing the TBTFs - even after all of their fraud and recklessness - to profit through taxpayer bailouts, various guarantees, incentives and other perks, the government is encouraging them to loot the economy again in the future.
Letting them get so big and powerful was letting the horse out of the barn. Allowing them to stay gigantic is letting the escaped horses go free while arguing over small cracks in the barn.
Similarly, failing to claw back the secret bailouts through AIG and other channels to American and foreign banks - see this, this, this, this, this and this - is also letting the runaway horses get away.
Indeed, as derivatives and other financial experts will tell you, the government's proposals do not even effectively fix the cracks, let alone close the barn door, let alone catch the escaped horses.
For a short example of the patching-the-barn-door-approach, read this short report from McClatchy on Barney Frank's overall game plan.
“By All Relevant Debt Indicators, the US Fiscal Scenario Will Soon Approximate [that of] Countries on the Verge of a Sovereign Debt Default”
Josh Lipton points out:
The American Enterprise Institute for Public Policy Research (AEI) published a paper indicating that “by all relevant debt indicators, the US fiscal scenario will soon approximate the economic scenario for countries on the verge of a sovereign debt default.”
Well, the U.S. is acting like a banana republic.
Lipton also quotes Einhorn and Rosenberg to argue that America's overheated printing presses and huge debts are helping to drive gold higher:
David Einhorn of Greenlight Capital, recently speaking of why he’s become a fan of gold, had this to say:
Einhorn added, “Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.”I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.
David Rosenberg, chief economist and strategist at Gluskin Sheff, also continues to favor gold. The fact that the yellow metal continues to surge higher -- even with ongoing deflationary developments -- suggests that other factors are driving bullion to new bullish heights, he says.
“It’s called scarcity of supply relative to fiat currency,” Rosenberg argues.
Wednesday, November 4, 2009
Wall Street Journal Admits Economists Were Wrong, But Fails to Discuss their INCENTIVE for Being Wrong
The Wall Street Journal admits this week that economists blew it:
The pain of the financial crisis has economists striving to understand precisely why it happened and how to prevent a repeat...I have repeatedly pointed out the flaws in mainstream economics. See this, this, this, this and this.
The crisis exposed the inadequacy of economists' traditional tool kit, forcing them to revisit questions many had long thought answered, such as how to tame disruptive boom-and-bust cycles..."We could be looking at a paradigm shift," says Frederic Mishkin, a former Federal Reserve governor now at Columbia University.
That shift could change the way central bankers do their job, possibly leading them to wade more deeply into markets. They could, for example, place greater emphasis on the amount of borrowing in the economy, rather than just the interest rates at which borrowing is done. In boom times, that could lead them to restrict how much money various players, ranging from hedge funds to home buyers, can borrow
But the Journal makes it sound like the policy-makers and economists who deployed faulty models were innocently ignorant of any larger truths:
The models "were not able to draw up the red flags," says Tim Besley, a professor at the London School of Economics who served on the Bank of England's policy-making committee until recently.Barry Ritholtz has an excellent criticism of the article, pointing out:
There are many areas I would have liked to see the [journal's] article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics...
Let’s start with the basics. Hard “science” — Physics, Biology, Chemistry, and all variants thereto — begins humbly. They try to describe the universe around us by creating theories, and then testing them. These theorems are always preliminary. Even when testing validates them, Science is always prepared — even eager — to replace them with newer theories that are proven to be even more valid.
The humility of science begins with an admission: We know nothing. We seek to learn through experiment and logic, and constantly evolve more and more accurate explanations. Scientific belief evolves gradually over time. Nothing is assumed, presumed, or hypothesized as true. Indeed, research is a presumption that current theories are inadequate or incomplete. The practice of science is a an ongoing search for better explanations, more proof, further verification — for Truth.
Science is the ultimate “show me” state.
Economics has a somewhat, shall we call it, less rigorous approach. Indeed, the arrogance of economics is that it is the polar opposite of Science. It begins with a few basic assumptions, many of which are obviously untrue; some are demonstrably false.
No, Mankind is not a rational, profit maximizing actor. No, markets are not perfectly, or even nearly, efficient. No, prices do not reflect the sum total of all that is known about a given market, sector or stock. Those of you who pretend otherwise are fools who deserve to have your 401ks cut in half. That is called just desserts. The problem is that your foolishness helped cut nearly everyone else’s 401ks in half. That is called criminal incompetence.
Where was I? Ahhh, our sad tale of the practitioners of the dismal arts.
Starting from a false premise that fails to understand the most basic behaviors of the Human animal, economics proceeds to build an edifice of cards on a foundation of sand. (How could that possibly go astray?) Like a moonshot off by a few inches at launch, by the time the we reach further into time and space, the trajectory is off by millions of miles . . .
Economics ... creates an illusion of precision where none exists. The belief in their models led to all manner of mischief, from subprime to derivatives to risk management...
The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.
But I would go further in my criticism of the economic profession by arguing that the decisions to use faulty models was an economic and political choice, because it benefited the economists and those who hired them.
For example, the elites get wealthy during booms and they get wealthy during busts. Therefore, the boom-and-bust cycle benefits them enormously, as they can trade both ways.
Specifically, as Simon Johnson, William K. Black and others point out, the big boys make bucketloads of money during the booms using fraudulent schemes and knowing that many borrowers will default. Then, during the bust, they know the government will bail them out, and they will be able to buy up competitors for cheap and consolidate power. They may also bet against the same products they are selling during the boom (more here), knowing that they'll make a killing when it busts.
But economists have pretended there is no such thing as a bubble. Indeed, BIS slammed the Fed and other central banks for blowing bubbles and then using "gimmicks and palliatives" afterwards.
It is not like economists weren't warning about booms and busts. Nobel prize winner Hayek and others were, but were ignored because it was "inconvenient" to discuss this "impolite" issue.
Likewise, the entire Federal Reserve model is faulty, benefiting the banks themselves but not the public.
However, as Huffington Post notes:
The problems of a massive debt overhang were also thoroughly documented by Minsky, but mainstream economists pretended that debt doesn't matter.The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.
This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.
"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."
And - even now - mainstream economists are STILL willfully ignoring things like massive leverage, hoping that the economy can be pumped back up to super-leveraged house-of-cards levels.
As the Wall Street Journal article notes:
As they did in the two revolutions in economic thought of the past century, economists are rediscovering relevant work.It is only "rediscovered" because it was out of favor, and it was only out of favor because it was seen as unnecessarily crimping profits by, for example, arguing for more moderation during boom times.
The powers-that-be do not like economists who say "Boys, if you don't slow down, that bubble is going to get too big and pop right in your face". They don't want to hear that they can't make endless money using crazy levels of leverage and 30-to-1 levels of fractional reserve banking, and credit derivatives. And of course, they don't want to hear that the Federal Reserve is a big part of the problem.
Indeed, the Journal and the economists it quotes seem to be in no hurry whatsoever to change things:
The quest is bringing financial economists -- long viewed by some as a curiosity mostly relevant to Wall Street -- together with macroeconomists. Some believe a viable solution will emerge within a couple of years; others say it could take decades.Note: I am not necessarily saying that mainstream economists were intentionally wrong, or that they lied because it led to promotions or pleased their Wall Street, Fed or academic bosses.
But it is harder to fight the current and swim upstream then to go with the flow, and with so many rewards for doing so, there is a strong unconscious bias towards believing the prevailing myths. Just like regulators who are too close to their wards often come to adopt their views, many economists suffered "intellectual capture" by being too closely allied with Wall Street and the Fed.
As Upton Sinclair said:
It is difficult to get a man to understand something, when his salary depends upon his not understanding it.
Will the Democrats Lose in 2010 (or 2012) Because They Won't Pass Real Financial Reforms?
Yesterday, Elliot Spitzer said that the White House's defense of the financial status quo will give Republicans powerful ammunition in the 2010 elections.
Democratic cheerleader Markos Moulitsas (the "Kos" behind Daily Kos) wrote the following about the Democratic losses in several state elections:
Democratic turnout collapsed. This is a base problem, and this is what Democrats better take from tonight:
... If you water down reform in favor of Blue Dogs and their corporate benefactors, you will lose votes...
If you forget why you were elected -- ... financial services ... reform -- you will lose votes.
Tonight proved conclusively that we're not going to turn out just because you have a (D) next to your name, or because Obama tells us to. We'll turn out if we feel it's worth our time and effort to vote, and we'll work hard to make sure others turn out if you inspire us with bold and decisive action.
The choice is yours. Give us a reason to vote for you, or we sit home.
People elected Obama in the hope that he would be different from Bush. But in the most important ways, he is just continuing Bush and Clinton's (think repeal of Glass-Steagall) worst policies.
Both the Republican and Democratic party leadership have become lapdops for the big banks and the status quo. Neither are open to real reform or change.
The Democrats haven't broken up the too big to fails. They haven't restored Glass-Steagall. They haven't really reined in credit default swaps. They haven't pushed for honest accounting or forced the giants to put their toxic SIV-hidden assets back on their books.
People are sick and tired of both parties' catering to the big boys. Indeed, given last night's election results and the Dems' utter failure to institute any real financial reform, trend forecaster Gerald Calente's prediction that a third party candidate will win the 2012 presidential election is sounding a little less crazy.
Tuesday, November 3, 2009
Take the Power to Create Credit Away from the Giant Banks and Give It Back to the People
Many people - including former analyst for the U.S. Treasury Richard Cook - argue that credit is too important a function to be left to the private banks.
Indeed, even after taxpayers have given trillions in bailouts, backstops, guarantees, and other gifts, the giant banks are still not lending out much credit to individuals or small businesses.
The talking heads say that real reform of this nature is not "politically feasible". But not politically feasible doesn't actually mean anything except that the powers-that-be don't want it.
We have been throwing ourselves against a brick wall trying to force the giant banks into doing the right thing, but as Buckminster Fuller said:
You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.
A Better Model
Gold advocates argue for a return to a gold-backed standard. This would, in fact, be a vast improvement over the fiat currency system we have now, as it would help to stabilize the currency, add discipline and consistency, and reign in the funding of unnecessary wars and other imperial mischief which are funded by the unlimited printing of new fiat dollars.
But Ellen Brown argues that a gold standard restricts credit for the little guy, not just Uncle Sam. If Brown is right - and given that the too big to fails are refusing to lend to most little guys - public banking might be the only way to restore a healthy economy and ease the pain for the average American. (Brown also argues that it was actually the bankers - and not the populists - who forced the adoption of a gold standard in the 1890s, and that the true meaning of the "Cross of Gold" speech has been forgotten).
But as discussed below, it may not be necessary to choose between a gold standard and other options.
National Public Bank
AFL-CIO president Richard Trumka told Congress last week:
If the Federal Reserve were made a fully public body, it would be an acceptable alternative.The American Monetary Institute proposes the following alternative:
Incorporate the Federal Reserve System into the U.S. Treasury where all new money would be created by government as money, not interest-bearing debt; and be spent into circulation to promote the general welfare. The monetary system would be monitored to be neither inflationary nor deflationary.Bloomberg News columnist Matthew Lynn writes:
Second, halt the bank’s privilege to create money by ending the fractional reserve system in a gentle and elegant way.
All the past monetized private credit would be converted into U.S. government money. Banks would then act as intermediaries accepting savings deposits and loaning them out to borrowers. They would do what people think they do now. This Act nationalizes the money system, not the banking system.
The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people...Sovereign nations such as the U.S. and England have the power to create credit and money (and see this, this and this). Taking the credit-creation power away from the banks and giving it back to the nation would ensure that credit is freed up for people's use, and the stranglehold over the economy is taken away from the too big to fails.
Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues...
State Public Banks
Many people argue that - given its actions - people don't trust the federal government to create money.
Fair enough. Why not let the states do it?
Michael Moore recommends that the American people demand:
Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies -- and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies -- you name it. If a company's primary motive to exist is to make a profit, then it needs a set of stringent rules to live by -- and the first rule is "Do no harm." The second rule: The question must always be asked -- "Is this for the common good?" (Click here for some info about the state-owned Bank of North Dakota.)As Moore notes, the state of North Dakota already has such a bank, and - because of that - North Dakota is just about the only state which is not running a huge deficit.
PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks.
See this for details.
Local Public Banks
An alternative to federal or state public banking is local public banks, as proposed by Edward Kellogg and others.
As summarized by Adrian Kuzminski:
During this time of financial and economic crisis, it is worth recalling that credible alternatives to our current financial system exist, if largely unrecognized, and deserve serious consideration...What's the Best Option?
The now-neglected 19th-century American proto-populist, Edward Kellogg ... was a kind of godfather to the later populist movement on monetary issues. Perhaps the most profound of American writers on monetary issues, Kellogg advocated a decentralized but nationally regulated monetary system based on non-usurious, low-interest public loans to individuals. His vision inspired 19th-century century mutualists, greenbackers, populists, and others who sought to restructure the monetary system to redistribute wealth.
In our own day, when usurious credit in the form of private finance capital remains the dominant force in economic life, and is largely taken for granted even by educated people, the alternative Kellogg offers is more important than ever. Indeed, I suggest that Kellogg's theory of money is the best monetary alternative we have to the baleful system under which we suffer...
Edward Kellogg (1790-1858) was a New York City businessman whose losses in the crash of 1837 led him to examine the business cycle, monetary policy, and debt. In a series of writings, Kellogg developed the idea of ... having the government provide very-low-interest loans to the general public. These loans would have a uniform, fixed interest rate, established by law. They would be issued locally through a system of public credit banks he called the Safety Fund. Once issued, these low-interest loan notes would circulate as currency, replacing the privately issued banking notes of his day (which today take the form of Federal Reserve Notes)...
In his day Kellogg seems to have influenced even Abraham Lincoln who, according to historian Mark A. Lause, " . . . had his own copy of Kellogg's book, Labor and Capital [sic] advocating the government issuance of paper currency as a just means of redistributing wealth, and he corresponded with the author's son-in-law." Kellogg's public currency was intended to end the monopoly over the discretionary issuance of money at interest, which was held then (and now) by the private banking and investment system...
Kellogg proposed to establish local public credit banks, and we might imagine one in each community. These local public credit banks would be part of the Safety Fund. Instead of money being issued (as it is now) through a privatized and centralized money-management system on a top-down basis, primarily as loans at increasing rates of interest from a central bank to major commercial banks, and then to regional and local banks, and then to the public, money in his system would be issued by local federal banks as loans directly to citizens at nominal interest on the basis of their economic prospects. Once lent out, Kellogg's public credit notes would flow into circulation, providing the basis for a new currency backed by the assets of individual borrowers...
A centralized national currency would be replaced, in Kellogg's system, by a locally issued currency. But that currency would everywhere be subject to common national standards, ensuring that each local public credit bank reliably issued equivalent units of currency. A dollar issued by one local public credit bank of the Safety Fund, Kellogg intended, would be worth the same as, and be freely interchangeable with, one issued by any other. The independence of local branches would be guaranteed by the discretionary power reserved to them as a local monopoly actually to loan money; the compatibility of their monies would be ensured under federal law by fixing the value of the dollar by law at 1.1 percent/year – that is, by lending money everywhere to citizens at that rate...
The goal is to establish and preserve economic decentralization. Amounts of money lent in Kellogg's system would vary considerably from place to place, with some areas needing and creating more currency than others. The solvency of local federal public credit banks would be guaranteed by collateral put up by borrowers, and the money supply would be stabilized by repayment of loans as they came due. The interchangeability of public credit bank notes would ensure a wide circulation for the new money...
To achieve a stable currency, Kellogg insisted that this rate be fixed by law; perhaps today it would take a constitutional amendment.
People of good faith debate whether the gold standard, or national, state or local public banking is the best solution.
But they agree that the current fiat currency system where the creation of credit is controlled by the private banks has pushed us into an economic crisis and a credit crunch, with little hope of stability for the future.
Changing to a public banking system and/or reimplementing the gold standard would clearly be a large change. But remember - as Buckminster Fuller pointed out - building a new model is often easier than fighting the existing one.
The time is right for a new model.
Afterword: Is a Gold Standard Incompatible with Public Banking?
Many people assume that a gold standard is incompatible with public banking. But that might not necessarily be true.
An analysis of ways in which a gold standard might possibly complement public banking is beyond the scope of this essay, and I have not yet even thought it through myself. But before ruling out the possibility, I invite financial experts to brainstorm on this issue to see if we can have the best of both worlds.
After all, when currency speculation is removed from the equation, money simply acts as a yardstick to measure the exchange of goods and services so that barter is not necessary. People may be able to create a money system which has the stability and discipline created by a gold backed system. with the credit availability of a public banking system.
Admittedly, the gold standard may at first blush be seen as more conservative than public banking, as the former limits money expansion while the latter encourages it. But as with all liberal-conservative dichotomies, it is important to get beyond labels and to determine what is actually best. Indeed, public banking - especially if it is on the state or local level - would not create easy credit for the government to launch new imperial adventures.
The Inverse Relationship Between Dollar and Gold
I think gold will do well long-term. See this and this.
But as I have previously argued, I think gold is surging right now mainly due to weakness in the dollar. See this and this.
Indeed, Nouriel Roubini says that commodity prices have risen largely because of the huge carry trade in dollars, and that - when the carry trade unwinds - there will be a huge crash in virtually all asset crashes. And see Tyler Durden's thoughts.Again, I am bullish on gold in the long-term, but I think there might be a large correction in the short run when the dollar rises.
And contrary to what some people think, I agree with Roubini: the dollar will rally sizably at some point in the not-too-distant future (just like it did during the credit crunch last year), before crashing rather definitively.
Update: Gold and the dollar both rose today, but the rise in gold is being attributed to India's purchase of 200 metric tons of gold.
Note: I am not an investment advisor and this should not be taken as investment advice.
India, China, Russia and Some EU Central Banks Buying Gold
India's central bank is buying 200 metric tons of gold from the IMF, at $1,045 an ounce.
China, Russia and some EU central banks have also expressed interest in buying gold from the IMF or elsewhere.
Therefore, Bloomberg's article of today saying that "Central Banks Will Become Net Buyers of Gold, WGC CEO Says" is not controversial.
Given that the IMF has only authorized the sale of 403.3 metric tons of gold at this time, the IMFs sales won't drive gold prices down. Indeed, the other 203.3 metric tons should go pretty quickly, and there will almost certainly be left over demand from the world's central banks. Remember, China itself previously considered purchasing the entire 403.3 metric tons.
For the big picture on gold, see this.
Monday, November 2, 2009
Trillions in Unnecessary Interest Costs to the American People
Many people - including former analyst for the U.S. Treasury Richard Cook - argue that credit is too important a function to be left to the private banks. AFL-CIO president Richard Trumka told Congress recently:
If the Federal Reserve were made a fully public body, it would be an acceptable alternative.Bloomberg News columnist Matthew Lynn writes:
The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people...Michael Moore recommends that the American people demand:
Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues...
Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies -- and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies -- you name it. If a company's primary motive to exist is to make a profit, then it needs a set of stringent rules to live by -- and the first rule is "Do no harm." The second rule: The question must always be asked -- "Is this for the common good?" (Click here for some info about the state-owned Bank of North Dakota.)As Moore notes, the state of North Dakota already has such a bank, and - because of that - North Dakota is just about the only state which is not running a huge deficit.
California considered creation of a state bank modeled after North Dakota's bank in 1977.
The Massachusetts state Senate is currently considering creation of a state public bank.
PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks. See this for details.
If the power to create credit were taken away from the Federal Reserve system and its private banks and given back to the government (as the Constitution envisioned), then American taxpayers would save hundreds of billions or trillions of dollars in unnecessary interest charges in paying off the national debt, as the government would not have to pay interest to finance its debt (sovereign nations such as the U.S. and England have the power to create credit and money; see this, this, this, and this).
Given that America is already deeply in debt, how can we justify the ongoing mountain of interest debts placed on the backs of the American people by the private credit-creation system of which the Fed is a part?
When Everyone is On the Same Side of a Trade, the Market is About to Crash
Economist Blake LeBaron has discovered an important cause of stock market crashes:
During the run-up to a crash, population diversity falls. Agents begin using very similar trading strategies as their common good performance is reinforced. This makes the population very brittle...In other words, when everyone is making the same trade, it will likely lead to a crash.
Tyler Durden summarizes this idea even more succinctly:
When everyone is on the same side of the boat, it always inevitably capsizes.A related concept is that - if your waitress or cabbie is telling you to buy something - that probably means that the market is overbought, and you might want to consider selling.
Roubini: "Deleveraging Requires The Writing Down Of Debt As Reflationary Policies Are Not A Free Lunch And Won't Solve The Debt Overhang Problem"
Nouriel Roubini writes:
Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won't solve the debt overhang problem (Dr. Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn). Rather than a sign of inflation, higher long-term yields may be pointing to higher real interest rates which are compatible with a deflationary environment (BofA). The equilibrium coexistence of zero interest rates, high unemployment, deflation, rising cash balances and excess reserves points to a liquidity trap environment as during the Great Depression and Japan's lost decade.
But America's economic "leadership" (Geithner, Summers, Bernanke and company) are doing everything in their power to keep the giant banks from writing down bad debt (see this, this, this and this).
When will they be fired?
China: Caution May Be Warranted | Japan: Real Troubles
As I have repeatedly noted, China has been blowing a bubble with easy credit. MarketWatch's Craig Stephen warns investors to be wary of a potential correction, at least in some sectors:
Policy tightening could soon become the dominant market theme, meaning it's time for a rethink. After recent rate hikes in Australia and Norway, tightening is back on the agenda in many countries, including China. And with the U.S. just clocking up 3.5% annualized GDP growth for the third quarter, dollar bears will have something to think about.
Nomura says its time to get a little more defensive in the face of what they call a "cappuccino recovery" - one-third espresso, one-third milk and one-third froth.
They argue investors face a dilemma on how to discriminate between genuine and sustainable areas of economic growth and the sharp rise in asset prices, often aided by excess liquidity.
The Nomura analysts advise switching out of high beta regional exchanges, which was a recent call.
This change is worth paying attention to, as Nomura's strategists were among the first to link quantitative easing to raising the risk profile of investors and lifting equity markets early this year.
Exchanges and brokerages have been some of the big winners of resuscitated financial markets, while in China, banks and insurers have been a great play on the huge money-supply expansion. Last Friday we saw China's new GEM market launched, with all stocks more than doubling in intraday trading -- will this be a new high-water mark?
Another area where asset prices may have peaked is property...Runaway prices are not foremost on officials' minds, rather the possibility of a reversal. According to a story in the South China Morning Post quoting an unnamed official, there are no plans to introduce substantial measures to control the surge in the property market. Instead, it said, the government is more worried about a sharp fall in property prices.
Perhaps investors should take note. In Hong Kong, the government effectively controls the price of land. Moreover, property and banking stocks make up more than half of the Hang Seng Index.
If loose money conditions that have been so good to financial and property assets do reverse, Nomura suggests a good place to be positioned is in the under-performing telecom sector, which looks attractive on a yield basis...
Another area that offers similar attributes to those of telecoms and is likely to see continued strong growth is the China Internet sector. A new report from Macquarie on China Internet leader Tencent orecasts growth will remain robust. One statistic that caught my eye was that its QQ instant-messaging services now caters to 448 million active accounts. Tencent is expanding its range of services to this massive user base and is consolidating its first-mover advantage.
In case you haven't been keeping up with Japan, Ambrose-Evans Pritchard does a great job of summing up that nation's dire financial circumstances:
Japan is drifting helplessly towards a dramatic fiscal crisis...We're not talking about Iceland or Latvia here. Japan is the world's second biggest economy. If Japan tanked, it would dramatically affect the world economy.
The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers. Credit default swaps (CDS) on five-year Japanese debt have risen from 35 to 63 basis points since early September. Japan has suddenly decoupled from Germany (21), France (22), the US (22), and even Britain (47)...
"Markets are worried that Japan is going to hit a brick wall: the sums are gargantuan," said Albert Edwards, a Japan-veteran at Société Générale.
Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default"..."Can these benign conditions be expected to continue in the face of even-larger increases in public debt? Going forward, the markets capacity to absorb debt is likely to diminish as population ageing reduces saving," said the IMF.
The savings rate has crashed from 15pc in 1990 to near 2pc today, half America's rate. Japan's $1.5 trillion state pension fund (the world's biggest) has become a net seller of government bonds this year, as it must to meet pay-out obligations. The demographic crunch has hit. The workforce been contracting since 2005.
Japan Post Bank is balking at further additions to its $1.7 trillion holdings of state debt. The pillars of the government debt market are crumbling. Little wonder that the Ministry of Finance has begun advertising bonds in Tokyo taxis, featuring Koyuki from The Last Samurai. If Japan's bond rates rise to global levels of 3pc to 4pc, interest costs will shatter state finances.
No one knows exactly when a country tips into a debt compound trap. But Japan must be close, even allowing for the fact that liabilities of the state Loan Programme (FILP) have fallen by 40pc of GDP since 2000.
"The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this."
Mr Hatoyama inherited a country that was already hurtling into sovereign "Chapter 11". The Great Recession has eaten up 27pc in tax revenues. Industrial output is down 19pc, even after the summer rebound; exports are down 31pc; the economy is 10pc smaller today in "nominal" terms than a year ago – and nominal is what matters for debt.
Tokyo's price index fell 2.4pc in October, the deepest deflation in modern Japanese history. Real interest rates have risen 300 basis points in a year. It reads like a page from Irving Fisher's 1933 paper, Debt Deflation Causes of Great Depressions...
"This is incredibly dangerous," said Russell Jones from the RBC Capital Markets. "The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral."
For more on Japan's lousy age demographics, see this.
Note: I am not an investment advisor and this should not be taken as investment advice.
We Can't Even BEGIN to Debate Keynesian Stimulus Until We Know the Facts
Keynesians argue that we must increase fiscal stimulus to prevent a full-scale depression.
They argue that "deficit hawks" are wrong when they say that we can't afford any more stimulus, and that worrying about debt in a crisis of this size is penny wise and pound foolish, given the bleak unemployment figures and other fundamentals. They also point out that America's debt as a percentage of GDP is far less than Japan's.
On the other hand, those worried about the giant debt overhang argue that massive debt and the failure to write down worthless assets and "purge malinvestments" from the system are the main problems.
Many also argue that the 1930s Keynesian stimulus programs did not work, and that the Depression did not end until World War II. And they also argue that every dollar in additional debt incurred now is another burden added to our childrens' shoulders.
Who is right?
Before deciding, you might want to look at two pieces of data.
Different Bangs for the Buck
Initially, many Keynesian academics argue that it doesn't matter where the stimulus money is spent, just as long as it is spent on something. However, this is untrue. For example, it should be obvious that spending in some areas will have more and quicker turnover (increasing money velocity) as compared to others. And, in fact, economists have documented that some types of stimulus spending have more bang for the buck than others.
So it is idiotic to talk about "fiscal spending" in the abstract. Without a cost-benefit analysis as to each category of proposed spending, any analysis is hollow.
Aggressive Fiscal Stimulus Only Buys Two Quarters
Moreover, as former chief IMF economist and MIT professor Simon Johnson points out:
Perhaps the best analysis regarding the impact of fiscal policy on recessions was done by the IMF. In their retrospective study of financial crises across countries, they found that nations with “aggressive fiscal stimulus” policies tended to get out of recessions 2 quarters earlier than those without aggressive policies. This is a striking conclusion – should we (or anyone) really increase our deficit further and build up more debt (domestic and foreign) in order to avoid 2 extra quarters of contraction?Indeed, many experts say that continuing to cover-up the fraud which led to the financial crisis will extend the crisis for many years. In other words, failure to investigate and prosecute those responsible for bringing about the crisis may extend the crisis longer than any failure to spend more on stimulus.
(And investigations and prosecutions for fraud - unlike stimulus spending - would not increase America's debt or tax burden.)
A real debate about whether we should spend more on stimulus - and if so, what types of stimulus - cannot even begin unless and until the aforementioned data is considered.
Note: Others have calculated bang for the buck from stimulus packages. For example, here are the Congressional Budget Office's estimates (look for "Estimated Policy Multiplier"):
Sunday, November 1, 2009
Has the Government Broken the Social Contract with the American People?
In a provocative comment to an essay I wrote, Kevin de Bruxelles argues that the government has broken the social contract with the American people, and discusses the ultimate meaning of such a breach of contract:
One only needs to consult Hobbes to see where the answer lies.
In Leviathan, Hobbes contrasts two states for human society. The first being a state of nature which is described as perpetual war between individuals. The moral logic of the state of nature is that there is no right or wrong: “To this war of every man against every man, this is also consequent, that nothing can be unjust. The notion of right or wrong, justice and injustice have no place. Where there is no common power, there is no law: where there is no law, no injustices. Force and fraud, are in war the two cardinal virtues.” (13.13) And then Hobbes goes on to describe the moral logic of the state of nature: “And because the condition of man is a condition of war of every one against every one; in which case every one is governed by his own reason; and there is nothing he can make use of, that may not be a help unto him, in preserving his life against his enemies, it followeth, that in such a condition, every man has a right to every thing, even to another’s body. (14.4)
In order to transcend the state of nature, men accede to a social contract with each other to submit to a sovereign and in the process establish a civil society. To Hobbes (later diminished by Locke) the sovereign is almost all powerful. His job is to keep the peace, to install laws and justice, and to coerce the population to live within the limits he sets. But the one of the few limiting factors on his subject's duty to submit to the sovereign is “The obligation of subjects to the sovereign, is understood to last as long, and no longer, that the power lasteth, by which he is able to protect them. For the right men have by nature to protect themselves, when none else can protect them, can by no covenant be relinquished.” (21.21)
What is clear is that in the United States, where the sovereign is the elected government, an elite segment of society, namely bankers and other extremely wealthy individuals, are playing by the old rules, the rules of the state of nature, and they are grabbing as much of the pie as they can. All this while the sovereign has at best lost the ability to resist this crime, or at worst, is actively complicit. But the vast majority of citizens are sitting by idly still thinking they live in a commonwealth with laws and justice.
There are two ways out of this mess. Either the sovereign must start playing his role and start enforcing the law and justice for all, or alternatively the citizens must stop submitting to this sovereign, overthrow this system government, and start all over again to find a sovereign since living in a state of nature is not an option.
Galbraith: Administration's Sole Goal is to Restore System of 5 or 10 Years Ago, But Confidence Won't be Restored Unless Fraud is Prosecuted
As I have repeatedly written, the largest U.S. banks have repeatedly gone bankrupt due to wild speculation which was blessed by the Fed, and then the government covered up their bankruptcy.
Indeed, the New York Times writes today about one of the too big to fails:
Over the past 80 years, the United States government has engineered not one, not two, not three, but at least four rescues of the institution now known as Citigroup.But prominent economist James Galbraith recently told Bill Moyers:
JAMES GALBRAITH: The overwhelming emphasis, in the administration's program, I think, has been to return things to a condition of normalcy, to use a 1920s word, that prevailed five and ten years ago. That is to say, we're back to a world in which Wall Street and the major banks are leading, and setting the path--In other words - as I have repeatedly written - the administration's talk of reform is just talk ... the boys are just trying to restore the status quo.
BILL MOYERS: To restore what was.
JAMES GALBRAITH: To restore what was--
BILL MOYERS: Instead of reform what is.
JAMES GALBRAITH: And I don't think what was can be restored.
BILL MOYERS: And you say that's the objective of the administration's policies? Geithner, Bernanke, Summers, the President himself?
JAMES GALBRAITH: To the extent that there's a defined objective, that's it, yes. I think in the immediate day-to-day work, they've largely been preoccupied with keeping the existing system from collapsing. And the government is powerful. It has substantially succeeded at that, but you really have to think about, do you want to have a financial sector dominated by a small number of very large institutions, very difficult to manage, practically impossible to regulate, and ruled by, essentially, the same people and the same culture that caused the crisis in the first place.
Galbraith also pointed out - as many other experts have - that confidence in the system cannot be restored unless the fraud which led to the crash is investigated:
JAMES GALBRAITH: That's the point about the crisis, is that it could have been prevented. The people in authority two, three, five years ago, knew how to prevent it. They chose not to act, because they were getting a political and an economic benefit out of the speculative explosion that was occurring.As the New York Times article notes, the lack of transparency is ongoing, even as between different branches of government:
BILL MOYERS: You mean, the people who could have prevented the dam from breaking were too busy fishing above it, and reaping big rewards to want to fix the crack in it?
JAMES GALBRAITH: Sure. The Federal Reserve, in particular, knew that the dam was cracking. Alan Greenspan, I think, almost surely knew this, and chose to wait until it had washed away.
BILL MOYERS: Why?
JAMES GALBRAITH: They let all of this run, because they were getting a superficially stronger economy out of it. The ownership society, all that was a scam, basically, designed to lure people who could never afford these mortgages into accepting them. And yes, I think they, any rational person, certainly people in the industry, knew that this was not going to last. There was a little industry code, I've learned, IBGYBG. "I'll be gone. You'll be gone."
BILL MOYERS: Really?
JAMES GALBRAITH: Yeah.
BILL MOYERS: The industry being the securities industry?
JAMES GALBRAITH: Well, and the mortgage originators and the bankers, generally.
BILL MOYERS: But that's criminal fraud.
JAMES GALBRAITH: Oh sure. There was a huge amount of it. The Bush administration did not actively investigate the fraud that they knew, that the FBI knew was occurring, from 2004 onward. And there will have to be full-scale investigation and cleaning up of the residue of that, before you can have, I think, a return of confidence in the financial sector. And that's a process which needs to get underway.
Representative Lloyd Doggett, a Texas Democrat on the House Ways and Means Committee, recently registered unease about the government’s guarantee of $300 billion in Citigroup assets and how effectively the Treasury secretary, Timothy F. Geithner, was monitoring the bank.Mario Seccareccia - editor of the International Journal of Political Economy - points out:
“We cannot know the full scope of the taxpayers’ potential cost from these hasty guarantees,” Mr. Doggett said last week in an e-mail message. “Inexplicably, Secretary Geithner appears unwilling to commit to conduct an analysis, despite my specific request to him in March. A critical and transparent examination of the response to the financial crisis is essential not only to learn from past mistakes, but also to prevent further erosion of the public’s trust in government.”
Without a thorough investigation like the Pecora Commission, and without prosecuting those who are guilty, confidence and hope in the future will not be restored, consumer confidence will remain depressed, and we will remain in an economic slump.The Great Crash of 1929 taught us that a modern monetary market economy is governed by confidence. As John Maynard Keynes put it, monetary relations and, more precisely, asset values, are held up by one's belief in the future. Without it, the whole credit-driven economic system comes to a halt and economic agents scramble for cover by seeking to acquire liquidity.
While in a non commodity-based monetary system a central bank can quite easily supply liquidity in its role as lender of last resort, a central bank cannot single-handedly instill confidence in the future. When confidence is lost, monetary policy is impotent in building up asset values, which can only be sustained if people believe in future revenue arising from future production. The economy remains trapped in a state of paralysis in which everyone is seeking to remain liquid. History tells the tale: Excessive optimism prior to the Great Crash turned to hopelessness during the early 1930s.
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