Thursday, April 30, 2009

GOP Fearmongering

Remember those heady days after 9/11 when all the Republicans had to do to win an election was invoke Osama Bin Laden or the Twin Towers? Well, John Boehner certainly does.

This is Exhibit A in the intellectual bankruptcy of the GOP. On the major questions of the day - the banking/economic crisis, the healthcare crisis, the energy/climate crisis - they have no answers. They quite literally have nothing to say except for no. Well, that's not entirely true: they still recycle their old talking points, insisting that cutting corporate and capital gains taxes will be an economic panacea; that every American has adequate healthcare since they can go the ER; and that despite all scientific evidence to the contrary, global warming is not man-made.

So what's left for the Republican party? Answer: trying to scare the crap out of people. Unfortunately for them, it's not 2002 anymore. Voters by and large rejected this type of crass fearmongering during the past election, when conservatives played on fears that Barack Hussein Obama was a Muslim-terrorist-communist. But Boehner & Co. did not get the memo. Either did not notice that these scare tactics have lost their effectiveness, or it's simply all they know or have left at this point. It's a sad commentary on a pathetic political movement.

Condi Rice Needs A Lawyer...

Because the "it's-not-illegal-if-the-president-tells-you-to-do-it" defense does not work. Ask Nixon officials.

There's a lot of BS and specious reasoning to unpack here. The three points that really stand out, though, are her implication that Al Qaeda was a more significant threat after 9/11 than Nazi Germany was during World War II because Al Qaeda attacked our "homeland", that the Guantanamo was a model prison, and that waterboarding is not torture because the President said it would not be so defined.

As to the first point: yes, Nazi Germany did not attack the "homeland", but her ally Imperial Japan did. Or is Hawaii too exotic to count? The Nazis also tried to develop nuclear weapons, and would have used them given the opportunity. Oh, and between the two of them, Germany and Japan controlled nearly half the world, not a few caves in an ungovernable corner of the world. The Axis really did pose an existential threat to the United States; Al Qaeda does not. Frankly, this is an embarrassing argument for a professor of international relations to make.

Her claim that Guantanamo was a model prison is laughably disingenuous. As Scott Horton points out, the OSCE report Rice cited that described Guantanamo as a "model medium security prison" referred only to the physical facilities. The same report referred to the treatment of the prisoners as torture.

Reviving the Nixonion "it's-not-illegal-when-the-president-does-it" defense is pathetic. That the president got unscrupulous lawyers to write a memo saying that torture is not torture does not make it legal. If this is the best justification she has for assenting to the torture archipelago the Bush administration instituted, then she needs a lawyer. And she should probably stop giving interviews - especially to non-media people who will actually ask tough questions.

Durbin: Banks Own Capitol Hill

It's official: Wall Street still runs Washington. The latest example of how our bankrupt oligarchs continue to shape policy is the recently defeated mortgage cramdown amendment. Cramdowns, which would allow bankruptcy judges to renegotiate the value of mortgages, are understandably unpopular with banks and investors who hold securitized mortgages. But as foreclosures mount, driving home prices further down, leaving more and more households underwater on their mortgages, there's certainly a compelling argument to be made for trying to put a floor on housing prices by renegotiating existing mortgages. Households - like banks - need debt reduction. Simply reducing the interest owed via refinancing likely won't be enough to seriously mitigate spiking foreclosures.

Given financiers' deep unpopularity, cramdowns would seem to be a - apologies to George Tenet - political slam dunk: looking out for Main Street rather than Wall Street. But this naive view ignores the enduring power of the banking lobby despite the ongoing banking crisis. And so cramdowns went down. Senator Dick Durbin, who championed the cramdown legislation, was particulary galled by how much influence the bankers retain. Durbin bluntly admitted that:
"the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place".
Is that enough evidence for the New Republic that Wall Street has captured our government?

Tuesday, April 28, 2009

Bair: FDIC Can Handle This Crisis

On the heels of the New York Times profile of Geithner that repeatedly juxtaposed his apparent affinity for the bankers he was supposed to be monitoring with Sheila Bair's reported concern about protecting the taxpayers comes this speech from Bair calling for greater power for the FDIC to deal with troubled financial institutions. Was this timing a coincidence? With all the behind the scenes jockeying going on between the different agencies, it is certainly not implausible that FDIC officials anonymously leaked unflattering anecdotes about Geithner to set the stage for their boss' big speech.

Regardless, the substance of Bair's speech deserves attention. Rather than promoting endless subsidies for the banks, Bair suggests closing down failed financial institutions. Imagine that! Failure being punished - it's so...capitalist. The main points of her proposal:
  • Allow the FDIC to shut down bank-holding companies and other financial institutions (read: AIG) in addition to commercial banks
  • Use a good bank-bad bank model for seized firms. Equityholders and unsecured creditors would take the losses for the bad bank, which would be either be sold off to private investors or held by the government. The healthy assets of the company would go into the good bank.
Unsecured creditors taking losses before the taxpayers? It's almost as if Bair has been listening to Joe Stiglitz. There may yet be hope that Bill Gross won't continue to shamelessly gorge himself at the public trough. Still, the bankers are predictably against inflicting such harm on the banks, and they still rather unfathomably seem to call the shots on Capitol Hill. From Bloomberg:
The American Bankers Association has challenged the idea of giving the authority to the FDIC, saying the agency’s mission would be jeopardized and banks may bear unnecessary costs.

“The direct use of the FDIC for resolutions of non-banks would severely confuse the public about FDIC deposit insurance,” Edward Yingling, the Washington-based industry group’s president, wrote in an April 14 letter. He suggested instead giving the authority to a council of the FDIC, Fed and Treasury to avoid giving too much power to the FDIC.
No doubt a Treasury department seemingly staffed exclusively by ex-Wall Streeters and the clubby Fed would serve as powerful checks on the FDIC taking a firm stand against too-big-to-fail financial institutions. We can only hope that Bair wins the backroom political game for control over this process. At least she gets it, that taxpayers should not be used to make bondholders whole on their bad investments - a point which certainly seems to elude Geithner.

Monday, April 27, 2009

Geithner Is Wall Street's Guy

Should we bring back the Geithner Death Watch? This New York Times profile in regulatory capture certainly sets up the it-was-Geithner's-fault narrative if the economy dramatically worsens. Some of the highlights from the article, with between the lines translations:
Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.

The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars.
People thought, ‘Wow, that’s kind of out there,’ ” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward.
Translation: Geithner wanted to put taxpayers on the hook for all the mistakes bankers, their counterparties, and their bondholders made, with no real upside for the public. Is a more bank-friendly proposal possible? Back to the piece:
Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York.

Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman, serving on the board of a charity Mr. Weill led. As the bank was entering a financial tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi’s chief executive.
But for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked signs that the bank — along with the rest of the financial system — was falling apart. When he did spot trouble, analysts say, his responses were too measured, or too late.
Translation: Despite being so close to Citi officials that they wanted him as CEO, he was clueless as to how much trouble there were in. This is a nice double whammy: show that Geithner was close - too close - to the bankers he was supposed to be supervising, and then that he was ineffective at supervising them. Was he unaware because his closeness compromised his judgment, or simply because he was not good at his job? Back to the article:
To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view.
“I don’t think that Tim Geithner was motivated by anything other than concern to get the financial system working again,” Mr. Stiglitz said. “But I think that mindsets can be shaped by people you associate with, and you come to think that what’s good for Wall Street is good for America.”
Translation: Geithner is a textbook example of regulatory capture. Back to the article:
In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr. Geithner praised the strength of the nation’s top financial institutions, saying that innovations like derivatives had “improved the capacity to measure and manage risk” and declaring that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”

Two days later, interviews and records show, he lobbied behind the scenes for a plan that a government study said could lead banks to reduce the amount of capital they kept on hand.

While waiting for a breakfast meeting with Mr. Weill at the Four Seasons Hotel in Manhattan, Mr. Geithner phoned Mr. Dugan, the comptroller of the currency, according to both men’s calendars. Both Citigroup and JPMorgan Chase were pushing for the new standards, which they said would make them more competitive. Records show that earlier that week, Mr. Geithner had discussed the issue with JPMorgan’s chief, Mr. Dimon.

At the Federal Deposit Insurance Corporation, which insures bank deposits, the chairwoman, Sheila C. Bair, argued that the new standards were tantamount to letting the banks set their own capital levels. Taxpayers, she warned, could be left “holding the bag” in a downturn. But Mr. Geithner believed that the standards would make the banks more sensitive to risk, Mr. Dugan recalled. The standards were adopted but have yet to go into effect.
Translation: Geithner is a fool - perhaps what Rubin would call a useful idiot - who shilled for the bankers. While Geithner was hardly alone in believing that derivatives helped manage risk by spreading it to those most able to bear it, pointing out that he still trumpeted their virtures in 2007 makes him look rather clueless. And if Geithner really believed that lowering bank capital levels would make them more cautious and sensitive to risk, rather than simply more vulnerable to any downturn, then I have a Nigerian friend for him who can help him score big if he'll just send a check. Back to the piece:
In making the Bear deal, the New York Fed agreed to accept Bear’s own calculation of the value of assets acquired with taxpayer money, even though those values were almost certain to decline as the economy deteriorated. Although Fed officials argue that they can hold onto those assets until they increase in value, to date taxpayers have lost $3.4 billion. Even these losses are probably understated, given how the Federal Reserve priced the holdings, said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “You can assume that it has used magical thinking in valuing these assets,” she said.
Translation: This paragraph doesn't even require any between the lines reading; it explicitly says that Geithner accepted Bear Stearns' fake values for assets, with the taxpayers making up the difference. Back to the article:
Over Columbus Day weekend last fall, with the market gripped by fear and banks refusing to lend to one another, a somber group gathered in an ornate conference room across from Mr. Paulson’s office at the Treasury.

Mr. Paulson, Mr. Bernanke, Ms. Bair and others listened as Mr. Geithner made his pitch, according to four participants. Mr. Geithner, in the words of one participant, was “hell bent” on a plan to use the Federal Deposit Insurance Corporation to guarantee debt issued by bank holding companies.
It was a variation on Mr. Geithner’s once-unthinkable plan to have the government guarantee all bank debt.

The idea of putting the government behind debt issued by banking and investment companies was a momentous shift, an assistant Treasury secretary, David G. Nason, argued. Mr. Geithner wanted to give the banks the guarantee free, saying in a recent interview that he felt that charging them would be “counterproductive.” But Ms. Bair worried that her agency — and ultimately taxpayers — would be left vulnerable in the event of a default.

Mr. Geithner’s program was enacted and to date has guaranteed $340 billion in loans to banks. But Ms. Bair prevailed on taking fees for the guarantees, and the government so far has collected $7 billion.
Translation: The vast guarantees of bank debts were Geithner's brainchild. Time and again, the article poses Sheila Bair and the FDIC as unsuccessfully trying to thwart Geithner's plans, worrying that they put the taxpayers at too much risk. It's certainly not good for his image that Geithner is repeatedly depicted as standing up for the banks' interests, while other government officials, usually from the FDIC, stand up for the taxpayers (although this does seem to be a fairly accurate description). Might the unnamed "others" in the room have been FDIC officials with an axe to grind, hoping to make their boss Bair look better? Back to the article:
Mr. Geithner has also faced scrutiny over how well taxpayers were served by his handling of another aspect of the bailout: three no-bid contracts the New York Fed awarded to BlackRock, a money management firm, to oversee troubled assets acquired by the bank.

BlackRock was well known to the Fed. Mr. Geithner socialized with Ralph L. Schlosstein, who founded the company and remains a large shareholder, and has dined at his Manhattan home. Peter R. Fisher, who was a senior official at the New York Fed until 2001, is a managing director at BlackRock....

For months, New York Fed officials declined to make public details of the contract, which has become a flash point with some lawmakers who say the Fed’s handling of the bailout is too secretive. New York Fed officials initially said in interviews that they could not disclose the fees because they had agreed with BlackRock to keep them confidential in exchange for a discount.

The contract terms they subsequently disclosed to The New York Times show that the contract is worth at least $71.3 million over three years. While that rate is largely in keeping with comparable fees for such services, analysts say it is hardly discounted.
Translation: Geithner gave lucrative contracts to close acquaintances. Even if this is not a case of clear cut corruption, there is an appearance of impropriety.

The obvious question this article raises is why publish it now? The populist fervor over the AIG bonuses has died down, and the market rebound over the last six weeks has quieted other (read: CNBC and their ilk) critics. Several possibilities jump out:
  • FDIC officials are wary of being implicated in the PPIP scheme, and want to separate themselves from Geithner.
  • Officials are worried not enough banks are willing to participate in the PPIP since the prices the leverage the government will provide will not be enough to prevent banks from taking large losses, so they want to lay the groundwork for blaming Geithner.
  • Administration officials are jockeying for Geithner's job (yes, that means you Larry), and are setting him up as the fall guy once it becomes clear the green shoots are just a blip on our downward trajectory.
  • The politicos like Rahm and Axelrod - who already distanced themselves from Geithner when he rolled out the PPIP - are positioning themselves to take a much tougher line on the banks, and need to scapegoat Geithner first (though is it really scapegoating if the blame is justified?). The fact that the article quotes several liberal critics of the bailouts - Stiglitz, Buiter, and Roubini - suggests that their ideas are gaining currency with whoever pushed this story. This would be a very positive development.
We can only hope that Geithner is feeling the heat within the administration and that Obama will reconsider whether he wants to tie himself to these unpopular bailouts Geithner has championed. Now if we could just someone besides Summer or Rattner to become Treasury Secretary, we might avoid a lost decade. Would Roubini give up his hard partying ways to take the job?

Bamboo Shoots?

China bulls have pointed to its large stimulus package, the surge in credit over the past months, and the sharp rebound in the stock exchange as signs that China may lead the world out of this global slump. But the latest data on power usage and generation - a leading indicator of economic activity - belies these sanguine predictions of an imminent turnaround in China. From China Stakes:
A February bounce in power generation that continued in the first half of March was welcomed by economic policy makers, not least Premier Wen Jiabao, as a sign of recovery. It was, perhaps, a false hope as power generation again declined in late March. China Electricity Regulatory Commission officials predict a 4% decline in power generation in April....

According to statistics from the State Grid, power generation dropped 0.7% year on year in March, after a rise of 5.9% in February and a fall of 12.3% in January. Experts believe the fallback indicates economic uncertainties. State Grid figures also show that power generation in the first quarter of this year dropped 2.25%, year on year.

Sunday, April 26, 2009

Meyerson: Simon Johnson is Right

Harold Meyerson certainly seems to agree with Simon Johnson's argument that the financial sector has become both too large economically and too powerful politically. In his last column, Meyerson essentially paraphrases Johnson's recommendations for dealing with this crisis. From the Washington Post:
The Democrat in the White House and the Democrats on the Hill are committed to legislation that regulates our dysfunctional wards in the banking industry, but regulations by themselves won't solve the problem of the banks being too big to fail -- and so big that they dominate campaign finance and, with it, much of the business of lawmaking. We need to amend our antitrust laws so we can scale down banks to the point that they no longer imperil our economic and political systems. As things stand now, it's we who are serving their needs, not they who are serving ours. It's time to turn that around.
While many in the media have been quick to dismiss Johnson as a radical, it is certainly encouraging to see his ideas gain some currency among more mainstream voices. Because if we do not build a consensus about checking the outsized influence of Wall Street, we will only set ourselves up for an even bigger crisis in the future, assuming we make it through this one over the next year or two.

Our Broken System

Most of the public understands that the legalized bribery known euphemistically as lobbying has to a great extent made our government unresponsive to actual citizens - except, of course, when we demand that members of Congress grandstand against AIG bonuses without actually doing anything substantive. Obama ran against this acceptable corruption in large part, and this line of attack certainly resonated with a sizable segment of the electorate (whether reality matches the rhetoric is another matter entirely). Indeed, we wouldn't need change we can believe in if we didn't think the system was rotten, with inside-dealing and kickbacks being the rule.

Given this, the recent report in the New York Times that a consortium of some of the country's largest companies lobbied Congress against taking action to mitigate global warming despite their own scientists' reports that human activity had unequivocally contributed to global warming should not be shocking. As the Times reports:
For more than a decade the Global Climate Coalition, a group representing industries with profits tied to fossil fuels, led an aggressive lobbying and public relations campaign against the idea that emissions of heat-trapping gases could lead to global warming.

“The role of greenhouse gases in climate change is not well understood,” the coalition said in a scientific “backgrounder” provided to lawmakers and journalists through the early 1990s, adding that “scientists differ” on the issue.

But a document filed in a federal lawsuit demonstrates that even as the coalition worked to sway opinion, its own scientific and technical experts were advising that the science backing the role of greenhouse gases in global warming could not be refuted.

“The scientific basis for the Greenhouse Effect and the potential impact of human emissions of greenhouse gases such as CO2 on climate is well established and cannot be denied,” the experts wrote in an internal report compiled for the coalition in 1995.

The coalition was financed by fees from large corporations and trade groups representing the oil, coal and auto industries, among others. In 1997, the year an international climate agreement that came to be known as the Kyoto Protocol was negotiated, its budget totaled $1.68 million, according to tax records obtained by environmental groups.

Throughout the 1990s, when the coalition conducted a multimillion-dollar advertising campaign challenging the merits of an international agreement, policy makers and pundits were fiercely debating whether humans could dangerously warm the planet.
I am shocked, shocked that oil and automobile companies would misrepresent the science of global warming! And yet on some level this latest revelation is somewhat surprising. This is not cigarette companies lying about smoking causing cancer. This is worse. Much worse. Smoking (mostly) only effects smokers; global warming will effect everyone. That such short-sighted business interests so effectively controlled government policy brings to mind Mancur Olson's theory about how great nations decline: economic interests capture the government, maximizing their own interests at the expense of the common good. This eventually leads to economic stagnation. Is this how a great nation ends? Not with a bang but with a bailout - and tax breaks?

Saturday, April 25, 2009

Feldstein: The Coming Inflation

Harvard professor and former Reagan chief economic adviser has been making the rounds warning that sharp inflation threatens to choke off any economic recovery on the horizon. Here he is on Bloomberg explaining the case he made in a recent op-ed in the Financial Times. From the FT:
The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.
This is slightly misleading. Yes, excluding food and energy, consumer prices were up 1.8% from last year, but almost all of that increase came from price increases in tobacco products due to new taxes. Deflation is still the most immediate threat to the economy. Back to the piece:
The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.
In short: fiscal deficits alone will not cause inflation; loose monetary policy is the key issue. As Mark Thoma and Scott Sumner recently explained, expansionary fiscal policy need not lead to the economy overheating if monetary policy counteracts it (this is why our multiplier estimates are largely questions of theory rather than empirical fact). Since the Fed normally tries to meet its inflation targets, it normally acts as such a countervailing force. In this deflationary environment, however, Bernanke & Co. have been so desperately trying to induce inflation that they risk unleashing it on a much larger scale than they want. As Feldstein explains:
But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now....

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.
Once the economy begins to recover - something Feldstein doesn't see happening until 2010 - banks will likely begin putting these excess reserves to work. The Fed's ability to pull back the money supply will be hampered by not only a lack of T-bills to sell, but also by the fact that so much of the collateral it has to sell are toxic assets of dubious value. From a deflationary spiral to stagflation, here we come!

Given these considerations, it is difficult to see what alternative policies Feldstein wishes Bernanke would pursue. Feldstein readily admits that the banks will be struggling to survive for the next two years, and that aggregate demand will remain weak. In this context, the Fed's massive injections of liquidity certainly seem defensible. And yet if the Fed succeeds in mitigating this downward pressure on the economy, the chances of them successfully pulling back the massive liquidity it has injected look negligible. Do we have any other options? And isn't stagflation preferrable to a deflationary spiral? At least the Fed can easily cure stagflation - pull a Volcker and raise short-term rates until the inflation is wrung out of the economy. Deflation is an altogether different beast. Whether the Fed actually can get us out of this liquidity trap and halt the downard pressure on prices is more a matter of theory than fact. We seem to only have bad and less bad choices ahead.

Rogoff: Unemployment to 11%

Here's Harvard professor and former IMF Chief Economist Ken Rogoff on Bloomberg talking about the prospects of an economic turnaround. Rogoff is still bearish - his analysis of past financial crises shows that these types of slumps tend to last longer than typical recessions, and the recoveries are weaker - and he sees unemployment rising to 11% by 2011. If this prediction turns out to be correct, there are two immediately obvious implications: the farcical stress tests will be even more inadequate than pessimists have pointed out, and Obama will go into the reelection cycle with the cratering economy weighing him down. If the Republicans can manage to pick a credible candidate and shed their current craziness, they might be able to win by default. Of course, if the public perceives the Obama administration as generally being on their side, and trying to alleviate economic suffering, while the Republicans continue to shill for the top 1%, Obama might get a pass for a crummy economy he inherited. But by not biting the financial bullet and getting all of the worst news out of the way - putting insolvent banks into receivership and realizing all financial sector losses - Obama risks extending this downturn, and opening himself up to an electoral challenge. It is baffling that a politician as savvy as Obama does not seem to appreciate this possibility.

Friday, April 24, 2009

Waterboarding Is Torture

Keith Olbermann at his sanctimonious best. Yes: waterboarding is torture. It always has and it always will be. Getting a lawyer to write a speciously reasoned memo asserting that waterboarding is not torture does not change this fact. Sadly, this needs to be said.

Update: As usual, Andrew Sullivan forcefully argues that waterboarding is torture, and the failure of the media to speak its name as such is an abdication of their responsibilities. Money quote:
In the face of this, are there any legal decisions, judgments or trials in the last five centuries in which waterboarding has not been deemed torture? None that I am aware of. And this is not surprising. If waterboarding someone 183 times is not torture, then nothing is torture.

Shiller: Against Market Fundamentalism

Far too often, debates devolve into black-and-white affairs, with strawmen on both sides taking a pummeling. Robert Shiller's latest piece in the Wall Street Journal takes on this type of Manichean thinking, as he adopts the Herculean task of convincing economic conservatives that not all financial regulation is bad. From the WSJ:
The principal long-term result of the current financial crisis should be improved financial regulation. After the immediate crisis is over, we need to restructure our fragmented system. This process will take years to complete since, if properly done, it should get at the heart of the regulatory structure.

This is not as radical as it sounds, for while many observers equate U.S.-style capitalism with unconstrained free markets, the story is more complicated. Americans have long understood that for the economy to work well, government must play an important supporting role. They've also long understood the important role that self-regulatory organizations (SROs), such as trade associations and exchanges, play in cooperation with government regulation.

An understanding of animal spirits -- the human psychology and culture at the heart of economic activity -- confirms the need for restoring the role of regulators as guiding hands in a healthy, productive free-enterprise system. History -- including recent history -- shows that without regulation, animal spirits will drive economic activity to extremes....

Such a world of animal spirits justifies the economic intervention of government. Its role is not to harness animal spirits but really to set them free, to allow them to be maximally creative. A brilliant player wants a referee, for only when the game has appropriate rules can he really show his talents. While the sports of baseball and football haven't changed much in the last century, the economy has -- and American financial regulation hasn't had an overhaul in 70 years. The challenge for the Obama administration, along with the U.S. Congress and our SROs, is to invent a new and better American version of the capitalist game.
You might think this is an uncontroversial point. Unfortunately, it is not. What was that about Dark Ages again?

Tuesday, April 21, 2009

Ireland: Keynsianism's Worst Nightmare

Question: what keeps Paul Krugman up at night? Answer: not being able to perform fiscal stimulus because of a skittish bond market. Unfortunately for the Irish, this is the situation they now find themselves in. As Krugman explains:
to satisfy nervous lenders, Ireland is being forced to raise taxes and slash government spending in the face of an economic slump — policies that will further deepen the slump.

And it’s that closing off of policy options that I’m afraid might happen to the rest of us.
And how did the Irish get in this predicament? Again back to Krugman:
On the eve of the crisis Ireland seemed to be in good shape, fiscally speaking, with a balanced budget and a low level of public debt. But the government’s revenue — which had become strongly dependent on the housing boom — collapsed along with the bubble.

Even more important, the Irish government found itself having to take responsibility for the mistakes of private bankers. Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.

The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks’ bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders.

Luckily for the United States, our banking sector isn't so outsized that our too-big-to-fail institutions are too-big-to-save. Small comfort. And the United States' government debt-to-GDP ratio is at a lower starting point than that of most European nations, so we have quite a bit more runway than our friends across the pond. Still, if the PPIP is as inefficient and ineffective as its critics fear, then every day could seem like St. Paddy's Day: we'll have run up too much debt to save the banks to commit to any other spending, cutting vital counter-cyclical programs at the worst moment. Again, back to Krugman:
For now, the United States isn’t confined by an Irish-type fiscal straitjacket: the financial markets still consider U.S. government debt safer than anything else.

But we can’t assume that this will always be true. Unfortunately, we didn’t save for a rainy day: thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market.

Not to put too fine a point on it, that’s one reason I’m so concerned about the Obama administration’s bank plan. If, as some of us fear, taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right.

And the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.
The brouhaha over the AIG bonuses will be remembered fondly as a time of sober judgment if we turn Irish, and bail out the bankers, while cutting services for the public at large. But even this obvious political reality seems unlikely to change policy towards the banks - after all, it's much easier to simply cross your fingers and hope the banks can earn their way out of this crisis a la 1982, than take serious steps to restructure them. Japan circa 1995, here we come!

Some of Life Has To Be Mysterious

It's difficult to imagine a more embarrassing, intellectually vapid defense of war crimes than this. Magic acts need to be mysterious. Authorizing torture at the highest levels of government is the type of criminality we must investigate. No one is above the law. Wishing this abhorrent period away, out of the recesses of our collective memories, only tacitly endorses this abominable behavior, and sets the precedent that a president can break the law with impunity. This is a pathetic, partisan defense of the indefensible in the name of "bipartisan" comity.

I suspect this cringeworthy performance will be remembered as the coda of a dark era. At the end, torture apologists could only plea for us "keep on walking" rather than investigate any abuses. Claims that torture, and only torture, could keep us safe have been debunked. And so Republican loyalists are only left to describe torture prosecutions as a "partisan witchhunt" and call on us to be "forward-looking." I wonder how that defense would have worked at Nuremberg.

Monday, April 20, 2009

A Horse, A Horse, My Kingdom For A Horse

You know things are bad when a racehorse is the only glimmer of hope. From the New York Times:
A racehorse bought for a pittance has turned into a national hero in crisis-stricken Hungary.

The thoroughbred known as Overdose pounded down the stretch here at Kincsem Park on Sunday to extend his record to 12 wins in 12 races, his jockey clad in the red, white and green of the Hungarian flag.

And for an afternoon at least, the crowd of more than 20,000 in the grandstand and lining the rail, along with all the Hungarians watching at home, could forget about the resignation of the prime minister and their currency’s nosedive.

As times have gotten tougher here, the 4-year-old Overdose has become the Hungarian Seabiscuit, a symbol of hope for Americans during the Great Depression. He appears to remind Hungarians of themselves: undervalued and underestimated....

The horse’s popularity has even attracted politicians. On Friday, Viktor Orban, chairman of the center-right Fidesz Party and a former prime minister who hopes to reclaim the job in next year’s election, turned up with a crowd of television cameras to pose with the star.

“Failure is the most often heard expression in Hungary today — failure, mistake, pessimism. When even a horse is able to make a miracle from nowhere, it’s a sign of hope that we can get out from the desperate situation we are now in,” Mr. Orban said.

“If I were a politician, I would do the same, because Overdose is one of the most famous persons in Hungary,” said Mr. Horvath, “even though he is a horse.”

How long before the US looks for its own modern Seabiscuit?

Ukraine Time Bomb Exploding

Remember last summer after Russia invaded Georgia, and neoconservatives hyperventilated, declaring it the most significant development in world history since the fall of the Berlin Wall? Yeah - oops. If Georgia was the Sudetenland in Robert Kagan's wet dream about the reemergence of a Nazi state, then Ukraine was Austria - the next domino to fall. Turns out that the greatest threat to Ukraine's stability and territorial sovereignty didn't come from the Russian bear next door, but rather from the ravages of economic depression the financial crisis has unleashed. From the New York Times:
Few areas of Europe have taken such a body blow from the world economic crisis as the industrial heartland of eastern Ukraine, home to giant enterprises in the steel and metals industry in which orders have dried up nearly completely and prices have plummeted.

In the Donetsk region, home to 4.6 million people, around 80 percent of the economy is tied to the metals industry. In January, when industrial production dropped by a precipitous one-third throughout Ukraine as a whole, in Donetsk it fell by half against the previous year....

In the absence of a galvanizing voice rallying the workers, or a politician in the Ukrainian capital, Kiev, to marshal the popular anger, Mr. Yeryomin and many others are focusing their unhappiness on the borders of this part of Europe, sliced and diced in countless wars through the centuries.

“I look with pride at Russia,” said Mr. Yeryomin, who lived in Russia as a child and counts himself among the 40 percent of inhabitants of the Donetsk region who are considered ethnically Russian. “We should cut Ukraine in two, and give half to Poland and half to Russia.”

This part of eastern Ukraine has always felt more attached to Russia than to western Ukraine and neighboring Poland. For many here, the fraying economy is accompanied by a sense that officials in Kiev, where the government is paralyzed by political infighting, have abandoned Ukrainians to their fate.

Just last week, more than 10,000 protesters gathered in Kiev to demand a change of government, prompting President Viktor A. Yushchenko to issue a surprise announcement that he was considering early presidential and parliamentary elections.

Whether any politician can allay both the global and the homegrown troubles of the metals industry in Ukraine is unclear. For now, the national currency, the hryvnia, has lost 40 percent of its value against the dollar from its high last year, and the reforms demanded by the International Monetary Fund as a condition for receiving a life-giving $16.4 billion loan are the subject of endless wrangles in an argumentative Parliament.
Economic volatility, ethnic divisions, and the frontier of a former empire: sounds like Niall Ferguson's recipe for upheaval.

Saturday, April 18, 2009

Rattner Probe

Is anyone in the administration working on the bailouts clean? The latest revelation that car czar Steve Rattner is being investigated for his potential role in a kickback scheme with the New York state pension fund does little to contradict the perception that political and financial insiders play by a different set of rules, and have gamed the system at the public's expense. From the WSJ:
A Securities and Exchange Commission complaint says a "senior executive" of Mr. Rattner's investment firm met in 2004 with a politically connected consultant about a finder's fee. Later, the complaint says, the firm received an investment from the state pension fund and paid $1.1 million in fees.

The "senior executive," not named in the complaint, is Mr. Rattner, according to the person familiar with the matter. He is co-founder of the investment firm, Quadrangle Group, which he left to join the Treasury Department to oversee the auto task force earlier this year....

In the long-running pay-to-play case, authorities allege that about 20 investment firms made payments in exchange for investments from the $122 billion New York State Common Retirement Fund....

The main legal issue for the investment firms turns on whether they knew, or should have known, that fees they paid to certain entities for access to the New York fund were legitimate or were improper kickbacks, and whether they were properly disclosed, according to people familiar with the matter.
Even if there was no wrongdoing, this appearance of impropriety and insider dealing is horrible press. Nothing galvanizes populist rage like financial and political elites playing the system for themselves. I guess this will take Rattner out of the running as potential Treasury Secretary-in-waiting, should Geithner ultimately "decide to spend more time with his family."

Thursday, April 16, 2009


Is the Geithner PPIP already over? Clusterstock reports that Jamie Dimon announced that he does not foresee JP Morgan participating in the PPIP, either as a buyer or a seller. From Clusterstock:
Speaking on the company's just-concluded conference call, JP Morgan (JPM) CEO Jamie Dimon downplayed the PPIP, saying the bank had nothing to sell into it, and that it certainly had no interest in partnering with the government as a buyer.

What's more, he said, he didn't consider the PPIP to be that big of a deal, suggesting that it's just one small piece of what Treasury is doing to prop up the system.

Remember, this is coming from the bank that has 10% of all mortgages. They're saying they have nothing to sell and that toxic asset prices aren't the problem.
I guess 6X leverage isn't enough to bid up the prices of toxic assets high enough for banks to still not take enormous losses. This was fairly predictable. Now what's the plan?

Wednesday, April 15, 2009

Goldman Disappears December

Gone. Vanished. Kaput. That's what the boy (and girl) wonders at Goldman did to the month of December - they disappeared it Pablo Escobar-style. Via Floyd Norris, we learn that when Goldman Sachs switched from being an investment bank to a bank holding company, it changed its fiscal year from beginning in December to January. So its Q4 2008 earnings go through November 30, 2008, and its Q1 2009 earnings begin on January 1, 2009.

What happened in December then? Write-downs. Lots of write-downs. Over a billion dollars worth, pre-tax. So much for that $1.8 billion first quarter profit. But now we know why they pay them the big bucks. They turn financial chicanery into an art.

Ireland Takes One for Germany

Here's Ambrose Evans-Pritchard at his gloomy, apocalyptic best describing the danger of Ireland falling into a debt deflation cycle not seen since the 1930s. As Evans-Pritchard notes, the most tragic part of this slow-motion trainwreck is that it does not have to happen: if the ECB aggressively cut rates, and Ireland had monetary sovereignty to devalue its currency, then they could perhaps settle for a lost decade instead of an outright depression. Unfortunately for the Celts, the Germans exert de facto control over the ECB, and the Germans are far too worried about the potential inflationary pressures of quantitative easing to pursue such heterodox monetary policies. Apparently memories of needing a wheelbarrow of cash to pay for a loaf of bread scar a nation's collective psyche for generations. From the Telegraph:
If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system.

The Irish central bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.

Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.

Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone....

Brian Lenihan, Ireland's finance minister, said the economy would contract 8pc this year on top of the terrifying 7.1pc drop in the final quarter of last year.

But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing.

This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.

Don't blame the victim. Ireland has been betrayed twice in this saga. Once by New Labour, which led Dublin to believe that Britain would join EMU at the same time – covering Ireland's dangerously exposed flank of Sterling trade.

It was betrayed again by the European Central Bank, which opened the monetary floodgates early this decade to nurse Germany through a slump, holding rates at 2pc until late 2005, despite flagrant breach of the ECB's own M3 money targets. Fast-growing Ireland and the Club Med over-heaters were sacrificed to help Germany. They were left to cope with credit bubbles as best they could.

Ireland struggled. Construction reached 21pc of GDP – a world record? – compared with 11pc in the US at the peak. Mr Lenihan hopes to shield banks from the calamitous consequences by creating a buffer agency. It will soak up €80bn to €90bn in toxic debt – or 50pc of GDP.
He borrowed the plan from Sweden's bank rescues in the early 1990s, but overlooks the key point – it was not the bail-out that saved Sweden's financial system, the country recovered only by ditching its exchange peg and regaining its freedom of action.

Without that sort of liberation, Ireland's property slump will grind on for years and more multinationals will join Dell in decamping to cheaper plants in Poland. Ireland risks a deflationary slide into bankruptcy.

Of course, it is not the job of the ECB to set policy for Dublin's needs. But it would at least help if Frankfurt began to set policy for Europe's needs. Has the ECB noticed the collapse of industrial output in Spain (-24pc), Germany (-23pc), Italy (-21pc), France (-14pc)?
If Europe fell into depression, would the ECB notice? Don't answer.

Macro-Economists Have No Good Multiplier Estimates

This discussion between Mark Thoma and Scott Sumner touches on two key issues: first, this is a balance sheet recession; and second, macro-economists do not have good multiplier estimates for fiscal policy in a depressed economy.

Regarding the difference between the current downturn and garden variety business cycle recessions, Thoma explains that insolvency is the distinguishing characteristic. While policymakers have mostly focused on the banks, household balance sheets are in bad shape as well, as the following chart of household debt-to-GDP shows.

Since households are still more or less swamped in debt, they will likely use any tax cuts to save or pay down debts. While this won't prop up aggregate demand, it should speed up recovery. Indeed, since consumer spending makes up such a large part of the American economy - some 70% at the peak of the bubble - there will not be a sustained recovery until households regain their financial footing. And as tax cuts will help households pay off what they owe quicker, there is a compelling argument for including them in any stimulus. Nonetheless, to prevent aggregate demand from completing collapsing into a deflationary spiral, Thoma argues for the necessity of fiscal stimulus.

And here's where things get interesting. Sumner and Thoma agree that macro-economists have no good estimates for fiscal multipliers. As Sumner explains, under normal economic conditions, if fiscal policy created an inflationary pressure, the Fed would raise rates in order to meet its inflation targets. In other words, monetary policy would counteract fiscal policy to prevent the economy from heating up too much. Consequently, we don't have good estimates of what the multipliers of fiscal policy would be, holding all else equal. Of course, today we are in a situation where the Fed is desperately trying to create inflation, so we do not have to worry about fiscal and monetary policies working at cross purposes. But when economists argue about the different multipliers of different types of tax cuts or spending, they are largely flying blind, relying on theory rather than empirical tests. In other words, economics is much, much less a science than its adherents usually like to pretend.

And Now You Find Yourself In '82?

As Simon Johnson notes, the administration seems to be following a different script for dealing with the banks from the liquidation/receivership/subsidization troika Elizabeth Warren outlined in her last TARP oversight report. This fourth option - what Simon Johnson calls "forebearance" - is essentially hoping banks can earn their way out of insolvency. By relaxing accounting rules on mark-to-market and providing just enough capital to keep banks operating, the administration hopes that a rebounding economy along with cheap money will provide enough earnings opportunities for banks to work their way back to health. Johnson points out that this is more or less the approach Volcker took with the banks after the 1982 Latin American debt crisis likely pushed many into de facto insolvency. But Johnson sees three factors that make such a policy succeeding today unlikely:
  • this is a global slump
  • the real economy will probably keep deteriorating, unlike the 1982 recession when there was a sharp turnaround after the Fed lowered rates
  • there are more speculative attacks on banks today
Hedged Bet argued that forebearance was the real Geithner plan after Warren Buffet hinted as much on CNBC last month. It seemed like a plan to emulate Japan's zombie banks then, and it still does now. Let's hope this really isn't the plan.

Hungary On The Brink?

As Eastern European governments fall victim to the global financial crisis, the issue of social and political instability gets injected into what is already a Gordian knot of an economic crisis. The specter of economic nationalism and sovereign defaults haunts the international system. While the G20's steps to shore up the financing of the IMF undoubtedly mark a positive step in the direction of global stability, the question of what to do with countries such as Ukraine and Hungary that cannot or will not enact IMF fiscal austerity measures still looms. This concern is even more acute given that Hungary's prime minister stepped down a few weeks ago, amidst the political fallout that trying to follow the IMF's spending restrictions generated. From the New York Times:

As for Hungary, the $25 billion agreement it signed with the monetary fund last year has put it in an awful policy vise. Mandated to squeeze its budget deficit below 3 percent of gross domestic product, the government is in no position to stimulate an economy estimated to sink by as much as 6 percent this year.

There is no painless path to recovery.

“Hungary has an uphill struggle, but we know that,” Gordon Bajnai, the economy minister, said in an interview in late March. “We need a reform-minded government.”

On Monday, Prime Minister Ferenc Gyurcsany, the former Communist who has led the country since 2004, appointed Mr. Bajnai, a 41-year-old former businessman, to lead that effort as his successor.

But furious opposition from Hungary’s right wing — which has called for elections — may limit the scope of his ambitions.

Lajos Bokros, a former finance minister, says that the alternative to not meeting the monetary fund’s conditions is bankruptcy. He worries that the forint will fall even further amid the political uncertainty — a concern underscored by downgrades of Hungary’s credit rating by Standard & Poor’s and Moody’s this week.
The social dimensions of this crisis are only beginning to be felt. Hopefully this climate of political and economic fear will not usher in a new era of extremism.

Establishment Media: We Hope Liberal Critics Are Wrong (Though We Doubt It)

Liberal critics of the Paulson/Geithner bailouts have levied three main criticisms to date: first, subsidies to banks represent highly costly transfers of wealth from taxpayers to bankers; second, insolvent banks need to be put into receivership, rather than subsidized; and third, policymakers have avoided restructuring banks because of they are still enthralled in the ideology of market worship/the banking lobby has captured the government. Paul Krugman and Joseph Stiglitz have popularized the first two points, while former IMF chief economist Simon Johnson provocatively advanced the third point in his recent piece in the Atantic.

What has been the response from the administration and the establishment media to these fairly devastating critiques? Government officials have suggested those calling for temporary nationalization are either naive or simply wrong; leading media voices, meanwhile, have expressed unease - unease because they hope these liberal critics are wrong, but they're not confident of it. From Newsweek:

If you are of the establishment persuasion (and I am), reading Krugman makes you uneasy. You hope he's wrong, and you sense he's being a little harsh (especially about Geithner), but you have a creeping feeling that he knows something that others cannot, or will not, see. By definition, establishments believe in propping up the existing order. Members of the ruling class have a vested interest in keeping things pretty much the way they are. Safeguarding the status quo, protecting traditional institutions, can be healthy and useful, stabilizing and reassuring. But sometimes, beneath the pleasant murmur and tinkle of cocktails, the old guard cannot hear the sound of ice cracking. The in crowd of any age can be deceived by self-confidence, as Liaquat Ahamed has shown in "Lords of Finance," his new book about the folly of central bankers before the Great Depression, and David Halberstam revealed in his Vietnam War classic, "The Best and the Brightest." Krugman may be exaggerating the decay of the financial system or the devotion of Obama's team to preserving it. But what if he's right, or part right? What if President Obama is squandering his only chance to step in and nationalize—well, maybe not nationalize, that loaded word—but restructure the banks before they collapse altogether?
And this from a New Republic piece on Simon Johnson:

there's something that bothers me ever-so-slightly about the piece. It turns up as Johnson shifts from the political economy of an emerging-market financial crisis to the political economy of American finance over the last 25 years to the political economy of this particular crisis....

In the United States, Johnson argues, the situation is even more insidious in some ways. Our own financial elites have not only been politically ascendant for the last generation, but intellectually ascendant, too. Policymakers blithely adopted the view that vast unregulated flows of capital were in the national interest--a view that just happened to overlap with Wall Street's self-interest. "A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true," Simon writes. A bit hyperbolic, I'd say, but definitely a kernel of truth here.

It's the last pivot where Johnson loses me. Well, he doesn't exactly lose me, because I worry he may be right. But he certainly leaves me a little cold. Johnson concludes that American financial elites "are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive." He adds that we're afflicted by "a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support." Johnson's preferred solution--one I'm sympathetic to--is that the government seize weak banks, recapitalize them, and sell them off in pieces. But he thinks this is next-to-impossible so long as Wall Street stays so powerful.

Now, certainly there are a lot of data points consistent with the financial sector having a veto over public policy. As Johnson notes, a lot of the bailouts the Fed and Treasury have arranged left the banks basically intact. By most reasonable measures, the terms have been more favorable to bankers than to taxpayers, which raises questions about who controls whom. Likewise, the Geithner plan certainly goes to elaborate lengths to avoid seizing banks, which also looks on its face like the work of an overly-solicitous policy mind.

On the other hand ... we just don't know. Johnson has performed a service by marshalling the available data points and drawing some provocative connections, but he's not great at establishing what's driving what....

The point is that figuring out whether financial interests control public policy is a question that needs to be answered directly--with documents and testimony. You can't just infer it from a bunch of circumstantial evidence.

This unease comes from fear that populists may be right. For our elites, populism is a knee-jerk reaction on the part of the uneducated, unsophisticated masses. It is almost always wrong. But today, as Simon Johnson points out below, some of the most respected members of the economics profession - along with members of the educated classes spanning the political spectrum - could easily be mistaken for full-blown populists.

This creates cognitive dissonance within establishment circles, especially traditional left-of-center publications that place great weight in the opinions of experts such as Krugman, Stiglitz and Johnson. They would seem to have only two choices: either claim that such denunciations are wrongheaded, or admit that the critics are right. Instead, they have hedged their bets, explaining that the critics make compelling cases, but perhaps they go too far; these critics can't prove what they're saying in a court of law, after all. This is nothing more than a craven refusal to perform their roles as journalists. Instead of investigating the claims of critics, they try to assuage the public's anger at the bailouts with flimsy defenses of the establishment, while acknowledging that something might be rotten in the District of Columbia. Their ostensible role as public watchdogs demands that they do more than simply cross their fingers that we don't live in a banana republic.

Deflation Alert

CPI down 0.1%. In the twelve months ending in March, prices declined 0.4% - the first yearly decline since 1955. How long will goldbugs continue to insist that ending up like Weimar Germany rather than USA circa 1933 is the real danger facing our economy?

Tuesday, April 14, 2009

Richard Cohen Is Not Very Bright

In an otherwise unremarkable column about the myriad failures of the Bush presidency, Richard Cohen throws us this brilliant line on foreign policy:
Whether you supported the war or opposed it, you have to concede that it should have ended years ago and, along with the invasion of Grenada, be a fit dissertation subject for a desperate PhD candidate and not, as it remains, a festering debacle.
Does Cohen really think that regime change in a small Caribbean island, and in a much larger, ethnically heterogeneous Middle Eastern state are comparable? Was this the "logic" he used for supporting the invasion of Iraq? Perhaps he should stick to what he knows - serving as a faithful stenographer for our elites - and leave the policy analysis to people who can actually think (the kind of people who understand cultural and historical factors matter when you're talking about toppling a government and occupying a nation indefinitely).

Frank Rich Indicts Finance's Takeover of Higher Education

As usual, Frank Rich captures the zeitgeist like no other in his column on Larry Summers. While most commentators have focused solely on any potential conflicts of interest Summers might have in his role as chief economic advisor after his comfy job at DE Shaw, Rich draws attention to how finance has effectively hijacked higher education. From Rich:
But perhaps I’ve become numb to the perennial and bipartisan revolving-door incestuousness of Washington and Wall Street. I was less shocked by the White House’s disclosure of Summers’s recent paydays than by a bit of reporting that appeared deep down in the Times follow-up article on that initial news. The reporter Louise Story wrote that Summers had done consulting work for another hedge fund, Taconic Capital Advisors, from 2004 to 2006, while still president of Harvard.

That the highly paid leader of arguably America’s most esteemed educational institution (disclosure: I went there) would simultaneously freelance as a hedge-fund guy might stand as a symbol for the values of our time. At the start of his stormy and short-lived presidency, Summers picked a fight with Cornel West for allegedly neglecting his professorial duties by taking on such extracurricular tasks as cutting a spoken-word CD. Yet Summers saw no conflict with moonlighting in the money racket while running the entire university. The students didn’t even get a CD for his efforts — and Harvard’s deflated endowment, now in a daunting liquidity crisis, didn’t exactly benefit either.

Summers’s dual portfolio in Cambridge has already led to one potential intermingling of private business and public policy in his new White House post. He tried — and, mercifully, failed — to install the co-founder of Taconic in the job of running the TARP bailouts. But again, Summers’s potential conflicts of interest seem less telling than the conflict of values that his Harvard double-résumé exemplifies.

In the bubble decade, making money as an end in itself boomed as a calling among students at elite universities like Harvard, siphoning off gifted undergraduates who might otherwise have been scientists, teachers, doctors, entrepreneurs, artists or inventors. The Harvard Crimson reported that in the class of 2007, 58 percent of the men and 43 percent of the women entering the work force took jobs in the finance and consulting industries. The figures were similar everywhere, from Duke to the University of Pennsylvania. Dan Rather, on his HDNet television program in December, reported that at Penn this was even true of “over half the students who graduated with engineering degrees — not a field commonly associated with Wall Street.”

I couldn't agree more. Maybe now we'll get a more rational allocation of our human capital. Instead of piling all of our best minds into conniving new ways to pile leverage on top of itself, we'll devote more attention to addressing the structural issues we face in energy and healthcare.

Defending Gaming the Geithner Plan

The inevitable gaming-the-PPIP-backlash backlash is on. After Joseph Stiglitz and Jeffrey Sachs lambasted Geithner's plan as a taxpayer rip-off, Noam Scheiber has taken to TNR with his oh-so-contrarian take that the PPIP being a scam isn't necessarily a bad thing. From TNR:
But is this really such a bad thing [if banks game the PPIP]? It sounds a lot like a good bank/bad bank model, in which we recapitalize Citibank to the tune of $925,000 and take the toxic asset off its books and stick it in another entity--a "bad bank"--created for that purpose. As I've said before, there may be moral objections to such an arrangement. (It is offensive that taxpayers have to bail Citibank out.) And the Geithner plan may not have enough money to recapitalize all the banks this way. But that's different from arguing that it can't work....

The only real difference, so far as I can tell, is who pays. Under Sachs's preferred approach, the bondholders and stockholders take most of the hit, while under his hypothetical gaming approach, the taxpayers do. Again, that's not fair. But being unfair doesn't doom something to fail. And I'd take an unfair success over a fair failure. (Though successful and fair would be ideal, and Sachs's proposal may get us close.)
What's a few trillion dollars between friends? But Scheiber ignores the very real possibility that the PPIP will not be enough - that bank losses will go well beyond the funding Geithner can manufacture with the FDIC and the Fed, and that the administration will have to go back to Congress. In that case, if the entire bailout process is perceived as an indefensible giveaway to Wall Street, then there is little hope of convincing Congress to pony up for more. If that happens we could be back where we were last September - financial panic as too-big-to-fail institutions fail.

Therefore, there is a premium on finding a policy that not only will work, but the public will see as being fair. Geithner seems to understand this, which is likely why he has resurrected the Paulson cash-for-trash plan with a few bells and whistles to distract the public (like any good magician, Geithner knows misdirection is key). But rather than trying to trick the public, wouldn't a much simpler plan that put insolvent banks into some form of receivership-on-steroids and restructured them make more sense? This would not only be good policy, but good politics as well; Axelrod and Emmanuel certainly understand that getting tough on Wall Street would be a popular position.

These are issues that Scheiber completely ignores. He seems to have completely bought the administration/banks' line that we must save the bankers to save the economy. But saving the banks does not mean saving the bankers who got us in this mess. Oops - I guess that makes me a radical populist.

Wells Fargo: Profitable Does Not Mean Solvent

One week you're announcing "record profits," the next analysts are saying you need $50 billion more in capital. As Matthew Yglesias notes:
This is why nothing you near from the financial sector about how all’s well should be taken too seriously. It’s true that given very bank-friendly monetary policy it’s easy for banks to run an operating profit. But most of these large banks are zombies—insolvent. They’re only able to run an operating profit because they’re not going out of business and being liquidated. And the reason they’re not being liquidated is government guarantees. It’s as if I had a profitable business selling cookies, except I didn’t actually have any cookies to sell and was just putting government-provided cookies in boxes, then bragging about how profitable my company is and how the government should stop hassling me about paying myself a bonus.
How long will it take for banks to earn their way out of insolvency? If the administration thinks the type of hands off approach Volcker took with probably insolvent banks in 1982 will work today, they're most likely wrong. As Krugman points out, any economic recovery probably won't be as steep today as it was then, creating a more difficult environment for lenders and borrowers. Please tell us this isn't really the plan.

Scraping the Bottom of the Barrel...

with Richard Cohen. Amidst the outcry over Larry Summers' $5 million sinecure at the hedge fund DE Shaw, Cohen takes to the Washington Post to voice his unsurprisingly contrarian dissent from the simmering populist rage. Cohen, after all, has made a career out of defending the prerogatives of the elite - from government officials who lied us into war, to the very journalists (such as himself) who failed to investigate these lies, to financial journalists who couldn't be bothered to ask questions about the housing bubble. But with the Summers-DE Shaw flap, Cohen takes his standard establishment hagiography to new Orwellian heights: we should not censure Summers for his ties to the financial industry, but, rather, lavish praise on him for passing up the riches of our new robber barons to re-enter public service. In other news from Robert Cohen: war is peace; freedom is slavery; ignorace is strength. From Cohen:
The recent headlines about Lawrence Summers had it all wrong. They announced with an implied breathlessness that he earned around $8 million last year -- much of it from the hedge fund D.E. Shaw. Here's what I would have written: "Man Takes More Than $7.9 Million Cut in Pay." Somewhere in the Diagnostic and Statistical Manual of Mental Disorders, the bible of shrinks, there should be an entry for "public servant." They are all, bless their hearts, a little nuts....

In our scandal-soaked culture, it is de rigueur to denigrate public officials and to search for the inevitable conflict of interest. But here are people, such as Summers, who have put aside wealth and lavish perks for government service. They have their reasons, sure, but whatever they are, we -- not they -- are the richer for it.
Unfortunately, Cohen is hardly alone in this establishment defense. Indeed, most of the establishment deign to indulge the masses with bouts of populist fury - AIG bonuses anyone - only to later lead the backlash against the backlash; informing the uneducated and unsophisticated masses why focusing on such details is trivial. The following discussion between Noam Scheiber of TNR and Megan McArdle of the Atlantic typifies this attitude.

This misses the point. For Scheiber, as long as there is no quid pro quo between Summers and DE Shaw, there is no scandal. Maybe. But does anyone believe that Summers will push for oversight or regulation of hedge funds/derivatives if he thinks a very lucrative post-government career at a hedge fund awaits him? The cognitive capture of our government, media, and academic elites by Wall Street is of vital importance. If our elites believe that what is good for Wall Street is good for America, then they will likely try to revive the status quo ante. Beyond whether this is even possible, it should be asked whether it is even desirable. Unfortunately, most establishment figures deem that a silly, unserious question.

Sunday, April 12, 2009

Relaxation Tests

About those "stress" tests...turns out they're not so stressful. From the New York Times:
Regulators say all 19 banks undergoing the exams will pass them. Indeed, they say this is a test that a bank simply will not fail: if the examiners determine that a bank needs “exceptional assistance,” the government, that is, taxpayers, will provide it.
This is beyond farcical. If banks cannot fail the stress test by definition, then it is not a stress test. The notion that banks can both require "exceptional assistance" and "pass" their stress test is so absurd that it boggles the mind that anyone will fall for this. But, of course, some investors and talking heads (read: CNBC) will go bonkers when they see the headlines that the banks all passed, and they will pour into financials. Eventually, once writedowns continue to exceed puffed up earnings, even the slowest investors will realize that the banks are a bad bet. At that point, it will become apparent what an enormous waste of time this entire stress test exercise has been.

The saddest part is that the stress tests could have been the first step in a viable banking rescue. If Geithner had honestly assessed the banks' books and put hopelessly insolvent banks into receivership, there would be justified public confidence in the remaining banks. This is what FDR's banking holiday accomplished during the Great Depression. Unfortunately, Geithner seems to think that the minimal appearance of transparency and accountability is a good substitute for actual transparency and accountability. He is badly mistaken.

Pretending insolvent banks are healthy, pouring endless subsidies into them to prop zombie institutions up - it's all so Japanese. Weren't we supposed to have learned from their lost decade? And with each dollar siphoned off to Wall Street, Obama is throwing his presidency away...Maybe Obama and his political advisers will wake up and realize that flirting with economic stagnation is not a path to electoral success. We can only hope that they finally admit what an unmitigated disaster Geithner has been, and undo this mistake.

Saturday, April 11, 2009

Sachs: PPIP Is A Scam

Columbia professor Jeffrey Sachs has joined the chorus of those proclaiming Geithner's PPIP a swindle. In the wake of the FT reporting that banks are considering bidding on each others assets, Sachs explains that while most commentators have worried about outsiders profiting at taxpayer expense, the potential for insiders gaming the system is even worse. From Sachs:
Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

The earlier criticisms of the Geithner-Summers plan showed that even outside bidders generally have the incentive to bid far too much for the toxic assets, since they too get a free ride from the government loans. But once we acknowledge the insider-bidding route, the potential to game the plan at the cost of the taxpayers becomes extraordinary. And the gaming of the system doesn't have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi's assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same.
Are there any assurances that something like this would not happen? And is there anyone outside the administration willing to defend this plan?

Friday, April 10, 2009

Pinch Me, Thomas Friedman Is Making Sense

Even a broken clock is right twice a day. Or, when it comes to Thomas Friedman, even Captain Obvious writes a moderately insightful column every few weeks. In his latest column, Friedman makes a fairly persuasive case for preferring a carbon tax to cap-and-trade. The pluses:
  • a carbon tax is transparent, and easy to understand
  • cap-and-trade could be gamed by Wall Street, making a simple carbon tax preferable
  • offsetting a carbon tax with a commensurate payroll tax cut is an easy way to make it revenue neutral, so opponents can't criticize it a regressive burden on working families; whereas the opacity of cap-and-trade is open to this line of political attack (this is the point of cap-and-trade: hide where the tax is coming from)
Of course, the Obama administration is planning on generating some $600 billion in revenue from selling carbon permits, so they probably wouldn't be too keen on a revenue neutral plan.
More from Friedman:
Since the opponents of cap-and-trade are going to pillory it as a tax anyway, why not go for the real thing — a simple, transparent, economy-wide carbon tax?

Representative John B. Larson, chairman of the House Democratic Caucus, has circulated a draft bill that would impose “a per-unit tax on the carbon-dioxide content of fossil fuels, beginning at a rate of $15 per metric ton of CO2 and increasing by $10 each year.” The bill sets a goal, rather than a cap, on emissions at 80 percent below 2005 levels by 2050, and if the goal for the first five years is not met, the tax automatically increases by an additional $5 per metric ton. The bill implements a fee on carbon-intensive imports, as well, to press China to follow suit. Larson would use most of the income to reduce people’s payroll taxes: We tax your carbon sins and un-tax your payroll wins.

People get that — and simplicity matters. Americans will be willing to pay a tax for their children to be less threatened, breathe cleaner air and live in a more sustainable world with a stronger America. They are much less likely to support a firm in London trading offsets from an electric bill in Boston with a derivatives firm in New York in order to help fund an aluminum smelter in Beijing, which is what cap-and-trade is all about. People won’t support what they can’t explain.
Don't worry: I'm sure the Tom Friedman we all know and despise will be back next week. He'll probably be telling us yet again why we must pay banks whatever they want if we're going to fix the economy.


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