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Regulatory Capture Bulletin, 2012

PseudoScience  > Casino CapitalismNeoclassical Pseudo Theories  > Corruption of Regulators

Regulatory Capture Bulletin, 2014

Regulatory Capture Bulletin, 2013 Regulatory Capture Bulletin, 2012 Regulatory Capture Bulletin, 2011 Regulatory Capture Bulletin, 2010 Regulatory Capture Bulletin, 2009
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[Dec 23, 2012] JPMorgan Hearing Market Regulators Warn They're Broke, Outgunned By Wall Street

May 22, 2012 | huffingtonpost.com

Two of the most important financial regulators in the country have a message for Congress: We need more money.

At a hearing before the Senate Banking Committee Tuesday morning, Securities and Exchange Commission Chairman Mary Schapiro and Commodity Futures Trading Commission Chairman Gary Gensler told lawmakers that the demands on their agencies to expand oversight are growing, but that their pocketbooks are not.

"We're way underfunded at the CFTC," Gensler told lawmakers, after a question on the subject from Senator Chuck Schumer (D- N.Y.). "Imagine if, all of a sudden, there are eight times the number of teams on the [football] field, but only seven refs," Gensler said. "There would be would be mayhem on the field. The fans would lose confidence."

Similarly, Gensler said, investors are losing confidence when when mayhem breaks out in the financial markets as a result of lax oversight. "They feel that the market is unfair."

SEC chief Schapiro echoed the point: "We've been asked to take on very significant new responsibilities," she said. Though the SEC has made progress in hiring new staffers and improving its technological capabilities, Schapiro conceded that, in some areas, the efforts haven't gone far enough.

"We're still way outgunned by the firms we regulate in terms of technology," she said.

The inadequacy of the SEC budget is an issue that Schapiro has raised in the past, and one that sits at the heart of criticism that the regulator is not able to fully monitor and regulate financial markets. Last month, a number of former SEC enforcement lawyers told The Huffington Post that the SEC is playing catch-up in some of its oversight. "The SEC just doesn't have the resources to be everywhere -- to regulate and to be the cop on the beat," Paul Berger, a former associate director of the SEC's enforcement division who left in 2006 for the law firm Debevoise & Plimpton told The Huffington Post at the time.

[Dec 21, 2010] Is Regulation Really for Sale

"a less-than-healthy relationship between lawmakers' political and pecuniary interests."
Dec 20, 2010 | Economist's View

Howard Davies, chair of the UK's Financial Services Authority from 1997-2003, defends regulators against the claim that they are bought and sold by the financial industry (though he's less sure about legislators), but admits they were subject to "intellectual capture" prior to the crisis:

Is Regulation Really for Sale?, by Howard Davies, Commentary, Project Syndicate: ...in narratives of the financial crisis, regulatory capture is often an important part of the story. ... How plausible is this...? Can ... regulation really be bought?
When I was a regulator, I would certainly have denied it. I had never worked in the financial industry, and knew few people who did. ... My successors have all come from the financial sector, however...
I have no first-hand knowledge of the legislative process in the United States. But, as an outsider, I am amazed at the apparent intensity of lobbying, and at the amounts of money that firms and their associations spend. Is it effective? ...
An intriguing sidelight on the relationship between Congress and business is provided in a study by Ahmed Tahoun of the London School of Economics on "The role of stock ownership by US members of Congress on the market for political favors." ... The ... results ... suggest a less-than-healthy relationship between lawmakers' political and pecuniary interests.
Regulators are typically not subject to those temptations. They are not normally allowed to own stock in financial firms... But can they nonetheless be captured?
I see two potential grounds for concern. The first is the revolving door between the industry and regulatory bodies. This is more prevalent in the US...
The second concern is what one might call intellectual capture. While I would strongly argue that the FSA in my day did not favor firms unduly, it is perhaps true that we – and in this we were exactly like US regulators – were inclined to believe that markets were generally efficient. If willing buyers and willing sellers were trading claims happily, then, as long as they were "professional" investors, there was no legitimate reason to interfere in their markets. ...
We now know that some of these market emperors had no clothes, and that their activities ... could result in severe financial instability and generate serious losses for taxpayers, not to mention precipitating a global recession. That has been a grave lesson for regulators and central banks.
So intellectual capture is a charge hard to refute. But were regulators surrogate lobbyists for the financial industry? I do not think so, and to argue as much devalues the efforts of many overworked and underpaid public servants around the world.

"Is Regulation Really for Sale?" The intellectual capture Davies owns up to was no accident, it was the product of a concerted effort -- funded in part by big money interests on the right -- to sell these ideas to policymakers, regulators, and the public more generally.

And as Paul Krugman's column notes today, it's an effort that had and continues to have considerable success. Thus, I don't think we can separate intellectual capture from lobbyist and other activity promoting the free market, anti-regulation point of view.

secondbest:

Regulatory capture theory by way of public choice school of economics assumes the same incentives are operative in the private market and government sector.

To be consistent with this intellectual capture theory would mean that regulators have been brainwashed on the one hand while in private markets it would make no difference whether markets are efficient or whether anyone believes they are.

Richard Hoogesteger:

The situation in Britain is not the same as in the United States. There are several reasons for this.

First senior regulators in Britain are generally career civil servants. In the U.S. they are political appointees.

Second the politicians who appoint them must raise enormous amounts of money to run for office. This makes conflicts of interest almost impossible to avoid.

These conflicts extend into academia which is financed by government and the business community. For an amusing though disturbing take on this see the movie "Inside Job".

rps:

Howard Davies is a day late and a dollar short.

Janet Tavakoli's Fraud as a Business Model powerpoints Mary Shapiro's appalling record at FINRA and today heads the SEC. Then there was Rubin during Clinton years who engineered the repeal of Glass-Steagall and garnered a job at Citigroup. Weill called Secretary Bailout Bob Rubin who reportedly quipped, "You're buying the government?"

Greenspan and Summers shutdown Brooksley Born on derivatives, and then there's the Paulson snake dance upon his knees to Pelosi to save his alma mater Goldman Sachs, etc....The Bush administration finished the job of clearing out employees with a conscience and integrity.

"America is a hurricane, and the only people who do not hear the sound are those fortunate if incredibly stupid and smug... who live in the center, in the serene eye of the big wind."

Norman Mailer

rps :

"The intellectual capture Davies owns up to was no accident, it was the product of a concerted effort..."

As in Dante's Inferno, we are experiencing the third circle of hell, "The gluttons lie here sightless and heedless of their neighbours, symbolising the cold, selfish, and empty sensuality of their lives..." The fourth circle, Greed, "Why do you hoard? Why do you squander?," and the Eighth circle Fraud, cantos are devoted to the fraudulent advisers or evil councillors, who are concealed within individual flames. These are not people who gave false advice, but people who used their position to advise others to engage in fraud......."

Human nature.

"The real problem is in the hearts and minds of men. It is not a problem of physics but of ethics. It is easier to denature plutonium than to denature the evil from the spirit of man." Albert Einstein

Author: Albert Einstein

Highgamma :

"Thus, I don't think we can separate intellectual capture from lobbyist and other activity promoting the free market, anti-regulation point of view."

When I think of regulatory capture, I think of the old "Ma Bell" AT&T or electric utilities. Those guys wouldn't have known a free market if it hit them on the head. I believe that you are confusing "free market, anti-regulation" with the "regulated" crony capitalism that we have.

These guys aren't getting government to stay out of their way. They're getting government to do their bidding: hobble their competitors, block entrants, strengthen their market power, and socialize their losses. There's no "free market" in any of that, but I fear that with this new drumbeat for more government control, we will get a great deal more "regulation" that will really be more crony capitalism.

Mark The Lesser :

Much of the discussion of regulatory capture misses the point. Regulators operate in the real political world, with leaders appointed by presidents. If the head of a regulatory agency is someone who is skeptical of active, aggressive enforcement actions (and private litigation against wrongdoers -- in general, the skepticism goes hand in hand) then it becomes tougher (if not impossible) to regulate and enforce the laws.

Large institutions are effectively given a pass, partially because they are too big to sue (i.e., you can't do anything to hurt them) and because top regulators (who make the decisions on whether to sue such institutions) don't believe that people of such high integrity should get sued (See Madoff, AIG, etc) or believe that such institutions just need "guidance", not an enforcement suit.

Add to the skepticism of top regulators about suing "respectable" people and institutions (which generally pervades those brought in directly from the industry) with the fact that funding and personnel can be cut if the organization is too aggressive or the jurisdiction can be taken away (See the Commodities Modernization Act) and regulators get de-toothed.

In addition, statements by former regulators (or current regulators) that they haven't been or weren't "captured" should taken with a grain of salt the size of a very large pillow unless that person has supported SUING and prosecuting violators and taking away their profits, their prerogatives and the positions in industry. Saying that one is in favor of effective enforcement means little.

It is the willingness to take strong legal action, in public and in the courts that shows a real willingness to enforce the laws. This means, for both regulators and legislators, a willingness to set tough standards for behavior, allow suits for such behavior based upon liberal, reasonable standards of proof and pleadings, and to back up those who seek to enforce the laws. While almost every regulator would deny being co-opted and would say (and perhaps believe) that they believe in vigorous, effective enforcement of the securities, commodities and other laws, when push comes to shove, most don't actually believe in enforcing the laws -- perhaps because they believe that nice people like them wouldn't violate the law. But, "nice" people violate the law all the time.

So the problem is finding leaders and lawyers (because they are the ones who really do the enforcement) who believe in actually suing people who commit fraud or violate regulations and hitting them very hard rather than working things out, but who aren't going to get too novel in their theories. Truth be told, there is almost always plenty of middle of the road enforcement to be done -- it just needs to be done in a committed way and pursued aggressively against anyone (no matter how big) who violates the law.

But until you can find and hire people who will do so and get Congress (and the presidency) out of protecting large and "respected" people and institutions, you have "capture" in a very real sense. And that has been the fate of U.S. regulation for most of the last 20 years. If we do not get regulators who are committed to and focused on bread and butter litigation and enforcement, but who are aggressive in novel ways without strong bread and butter enforcement first, we will lose whatever chance we have to get real regulation and avoid "capture" of our regulatory agencies.

Of course, that's just my opinion, and it could be wrong (not really, its right).

Mark The Lesser

[Sep 10, 2010] Sheehan on Michael Boskin By Frederick Sheehan

Jan 19, 2010 | The Big Picture

Frederick Sheehan is the co-author of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.

His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.

~~~

On January 14, 2010, an academic economist took a rare stance. Tenured professors rarely lift the veil from numbers that governments invent. In "Don't Like the Numbers? Change 'Em," Michael J. Boskin, Ph.D., formerly, an economics professor at Harvard and Yale; formerly, chairman of the Counsel of Economic Advisers in the George H.W. Bush administration; currently, T. M. Friedman Professor of Economics at Stanford University; research associate at the National Bureau of Economic Research; senior fellow at the Hoover Institution; and board member of the Exxon Mobil Corporation, Oracle Corporation and Vodafone PLC (among others), wielded his sword.

The Wall Street Journal devoted a half page to Boskin's list of offenders. Politicians are interfering with the Gross Domestic Product calculations in France and Venezuela. They have toyed with the inflation rate in Argentina. In the U.S., the Obama administration has taken the phony numbers game "to a new level." Here, Boskin is writing of the current adminstration's calculations of jobs "created or saved" from its stimulus bill.

The "created or saved" job calculation is nonsense, but the very last person one would expect to decry the miscarriages is Michael J. Boskin.

In the early 1990s, Senator Patrick Moynihan from New York warned his fellow legislators about rising social security commitments. Then the worm crawled out of his hole, so to speak. Federal Reserve Chairman Alan Greenspan testified before the Senate and House Budget Committee on January 10, 1995. He told the Committee the inflation rate was probably overestimated by 0.5% to 1.5%.

If Greenspan was correct, this was a godsend. Social security payments are increased each year at an inflation rate calculated by the federal government: the change in the Consumer Price Index (CPI). If the CPI could be increased at a lower rate in the future, benefits would rise more slowly, without Congressional action. This would reduce government spending and delight politicians, who knew of the looming crisis in social security but did not want to imperil their careers by reducing benefits, or, in this case, by cutting the rate at which social security benefits were raised each year.

The Boskin Commission was duly formed. Michael Boskin was the right man for the job. He had served as chairman of the President's Council of Economic Advisers (CEA) from 1989 to 1993, a post previously held by such government functionaries as Arthur Burns and Alan Greenspan.

Jumping to the conclusion, the Boskin Commission's Report, as it was known (formally, the "Advisory Commission to Study the Consumer Price Index") found that inflation was overstated by 1.1%. Several recommendations were made by the Commission to the Budget Committee. These were instituted with great efficiency by the Bureau of Labor Statistics.

The changes have lopped off far more than 1.1% in most years since 1997. From the time the changes were instituted through 2008, the compounding of an artificially low Consumer Price Index reduced payments to social security recipients by about half (according to John Williams, author of the newsletter Shadow Government Statistics).

How the CPI calculation was changed is not important here. (Chapter 12 of my book Panderer to Power is devoted to the Boskin Commission.) One adjustment may help to understand Boskin's contribution to the impoverishment of older Americans. "Hedonic adjustments" by government number crunchers substitute imaginary prices for prices actually paid. Hedonic adjustments (purportedly, the "quality improvement" of an item) reduce the CPI. (Hedonic adjustments had been employed before the Boskin Commission, but sparingly. Afterwards, even the prices of textbooks – if they had color graphics – were adjusted for quality.)

Steve Leuthold, founder and chief investment officer of the Leuthold Group, calculated the price of a new car in the U.S. had risen from $6,847 in 1979 to $27,940 in 2004. Using hedonic adjustments, the government calculated the price of a new car had risen from $6,847 in 1979 to $11,708 in 2004.

The Boskin Commission was one scandal that economists actually denounced. Greg Mankiw, chairman of George W. Bush's Council of Economic Advisers from 2001-2003, said at the time "the debate about the CPI was really a political debate about how, and by how much, to cut real entitlements."

Barry Bosworth of the Brookings Institute called the revised CPI an " 'immaculate conception' version of deficit reduction in which spending is cut without Congress taking the blame."

Jack Triplett of the Brookings Institute extended the argument: "What I liked least about the Commission Report was exactly what made it so influential – its guesstimate of 1.1 percentage points of bias….The Commission (and others that have followed) used ad hoc reasoning to come up with a number…."

Jacob Ryten, from the Canadian statistical office, wrote in the same vein: "Without the guesstimates, the Commission Report was just another dry, academic study to be perused by professionals… Conversations with Committee members suggest that some, at least, were ill at ease themselves with guesstimates…. My personal preference is to resist the seductive blandishments of politics and politicians…."

Jack Triplett chided the Report as succumbing "to the lure of political statements in its choice of language to describe the effect of CPI measurement errors on Social Security expenditures…. Professionals at any rate, should understand that improving the accuracy of the CPI is not the same thing as improving the basis for allocation to the dependent population…."

Professionals, at any rate, have seen fit to keep Michael Boskin at the summit after he succumbed to "seductive blandishments of politics and politicians." It cannot be said that Boskin dishonored his profession, since he is still a superstar. Other professions institute bodies such as the American Bar Association and the American Medical Association that take action against negligence.

Federal Reserve Chairman Ben S. Bernanke, another pliant alumnus of the CEA, sits before the Senate claiming there is no inflation in the economy. He uses the CPI as his measure, taking the additional step of removing food and energy costs.

Near the end of his Wall Street Journal effort, Boskin wrote of the Obama job numbers: "One piece of good news: The public isn't believing much of this out-of-control spin." He's probably correct, but spinning the number of jobs "created or saved" has no consequence, other than to increase the public's distrust of government. The distortion of the CPI should have been censured by his profession, if it is that.

Frederick Sheehan is the author of Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

[Aug 05, 2010] Taleb Calls Out Alan Blinder for Questionable Ethics

Aug 04, 2010 | nakedcapitalism.com

Nassim Nicholas Taleb has an intriguing piece at Huffington Post, "The Regulator Franchise, or the Alan Blinder Problem," with a juicy anecdote at its core. It highlights a critical issue: how we've come to accept what other eras would view as corruption as business as usual. Note that Taleb does a particularly artful job of writing in this piece; he highlights the ethics issue with finesse (as well as pointing out his own foibles), so I suggest you read it in full.

Here's the trigger: last year at Davos, Blinder interrupts Taleb's conversation with a third party to pitch a savings product, one that allows high net worth individuals to arb FDIC insurance regs by allowing them to put funds in a single account, which would then be split up among banks so that the investor would circumvent regulations that limit FDIC insurance (then $100,000 per account).

Now it's already a bit unseemly for a former Fed vice chairman to be peddling investment products personally, particularly since, per Taleb:

….it would allow the super-rich to scam taxpayers by getting free government sponsored insurance. Yes, scam taxpayers. Legally. With the help of former civil servants who have an insider edge.

I blurted out: "isn't this unethical?" I was told in response, "We have plenty of former regulators on the staff," implying that what was legal was ethical.

Taleb then goes on to stress why this matters:

Alan Blinder is certainly not the worst violation of my sense of ethics; he probably irritated me because of the prominence of his previous public position and due to the context of the Davos conversation, which was meant to save the world….

Tell me if you understand the problem in its full simplicity: former regulators and public officials who were employed by the citizens to represent their best interests can use the expertise and contacts acquired on the job to benefit from glitches in the system upon joining private employment - law firms, etc.

Think about it a bit further: the more complex the regulation, the more bureaucratic the network, the more a regulator who knows the loops and glitches would benefit from it later, as his regulator edge would be a convex function of his differential knowledge. This is a franchise. (Note that this franchise is not limited to finance the car company Toyota hired former U.S. regulators and used their "expertise" to handle investigations of its car defects).

Yves again. This may all seem to be so "dog bites man" in America so as to no longer elicit any outrage. The famed regulatory revolving door, and all the benefits that former officials and their new private sector masters gain from a legally permitted but socially destructive form of trading of insider know how is now considered business as usual in the US.

It's remarkable to see how quickly conditions have decayed in the US. One of my colleagues, Amar Bhide, wrote a Harvard Business Review story in 1994 that was completely sincere (and would have been seen as accurate then) in describing one of the critical advantages of the US capital markets was that they weren't simply the deepest, but also the cleanest in the world, with sound regulations, best investor investor protection, the most wide ranging disclosure.

Yet it is also clear that sound regulations can confer competitive advantage. When Singapore exited the British empire, the prospects for the island nation were poor: no manufacturing base, no commodities to exploit. Yet Lee Kwan Yew developed and executed what amounted to a national strategy, with two foundations. First was making sure the public was exceptionally well educated by Asian/emerging market standards, on the assumption that all he had was human capital. Second was the recognition that corruption was endemic to developing nations, and that having clean government would confer advantage. Yew set out to create a bureaucracy that would be hard to corrupt, and that rested on creating good incentives. Top bureaucrats were and are paid at the same level as private sector professionals (think top law firm partner). There's little incentive to trade on your office if you don't have much to gain. Tough internal audit was another critical aspect of this program.

But legalistic regulatory evasion has also become so commonplace as to blunt most people's sense of where to draw the lines. One of the unacknowledged problems of the crisis is that the financial system has too little equity precisely because banks and their regulator enablers pursued securitization. The effect was to de equitize huge swathes of the credit markets (the growth of the an $8 trillion, give or take a couple of trillion, shadow banking system with pretty much no equity behind it, is the end product of this development). Regulators, financiers, and academics all touted the virtues of securitization, and its cost savings. Bullshit. The process has more moving parts, more parties ripping up front fees out of the deals. So where to the vaunted cost savings come from? De equitization, from reducing risk buffers for lending that had been deemed necessary provisions against losses. The "you'll be on this bus or under the bus" charts McKinsey would show to clients in the 1980s explaining why securitization was inherently cheaper than on balance sheet lending showed two, and only two, big sources of expense savings: the elimination of bank equity and FDIC insurance costs.

So the "innovation" that regulators, academics, consultants, and banks were all advocating more than 20 years ago was regulatory arbitrage, pure and simple. When you have regulators undermining the rules and depicting it as virtuous, behavior like Blinder's is simply more of the same.

Taleb describes why this behavior has become hard to root out:

First, the more complicated the regulation, the more prone to arbitrages by insiders. So 2,300 pages of regulation will be a gold mine for former regulators. The incentive of a regulator is to have complex regulation.

Second, the difference between letter and spirit of regulation is harder to detect in a complex system. The point is technical, but complex environments with nonlinearities are easier to game than linear ones with a small number of variables. The same applies to the gap between legal and ethical.

Third, regulation, like drugs, has side effects, and like drugs, it can harm the patient - something in my work I call the iatrogenics (harm done by the healer). People do not mention that regulation helped promote the Value-at-Risk method of risk measurement in replacement to age-tested heuristics - these methods blew up banks.

Fourth, we need a more severe monitoring of the activities of public officials and a solution to the following conflict. In African countries, government officials get explicit bribes. In the United States they have the implicit, never mentioned, promise to go work for a bank at a later date with a sinecure offering, say $5 million a year, if they are seen favorably by the industry. And the "regulations" of such activities are easily skirted.

Fifth, and more philosophically: during the lunch with Arianna, the conversation kept sliding into the ethical basin of attraction, the compatibility of some professions and service of the public. The Greeks had respect for the banausoi, those who had to make a living in the professions, but many argued against trusting them in running the affairs of the city on grounds that "a funeral goods merchant would not be trusted to wish for the good health of his fellow citizens." The point has been debated through the ages, from Xenophon to Seneca (who took the opposing point), but it is even starker today in the age of lobbyists and a shift in middle class values that tolerates the "everyone needs to make a living" even when the means to "make a living" are harmful to society.

These accumulated moral hazards have blown up banks and will keep blowing up the system.

Yves here. Unfortunately, the Obama administration had the opportunity execute more fundamental reform at the outset. Worse, Obama himself recognized it; he was reading biographies and speeches of FDR as president elect, yet chose to pass on an historical opportunity.

Although I have not read Depression era politics extensively, it appears two critical elements are missing now. One is that despite the chicanery of the Roaring Twenties, ideas like character and public service still meant a great deal. Those values are pretty much dead now. Second was that Roosevelt was not cowed by bankers or businessmen. For instance, when he told his economic advisers (rather out of the blue) that he was going off the gold standard (which the US had done as an expedient, but the assumption was it would go back soon) he was met with a firestorm of criticism which he airly brushed aside. I can't imagine any senior politician now having the confidence now to defy the will of the banking industry. And it isn't simply due to the role of corporate funding in campaigning; the roots are deeper. Being in office now is all about winning, about keeping one's hold on power, so it isn't surprising that everyone has a price.

Topics: Banana republic, Banking industry, Federal Reserve, Free markets and their discontents, Politics, Regulations and regulators, Social values

Email This Post Posted by Yves Smith at 5:23 pm

Selected Comments

Mogden

This all makes eminent sense. We must be very skeptical of so-called reforms that make our already bewildering system of laws and regulation more complex. The complexity itself acts like a tax and is a huge source of corruption.

Ideally, the Federal government would be limited to a total body of laws and regulations no larger than a typical adult could remember.

Deus-DJ, August 4, 2010 at 5:33 pm
Hi Yves, just a couple of points…

When you say "how we've come to accept what other eras would view as corruption as business as usual" I think you underestimate the corruption that also pervaded other eras, even if it was a little different and applied to different circumstances. I'll leave it at that.

As to a good solution to regulatory capture, I had e-mailed you a solution that I personally came up with though I don't believe you gave yourself the time to read it. It's definitely something different…you should really take a look at what I wrote.

reslez, August 4, 2010 at 5:33 pm
The third critical element missing from the 30s is the existence of an alternative on the left - the trade union movement was decades old and quite active.

That and the heady specter of Communism convinced the wealthy that Roosevelt wasn't the worst opponent they faced.

alex, August 4, 2010 at 7:08 pm
"the heady specter of Communism convinced the wealthy that Roosevelt wasn't the worst opponent they faced"

I suspect you're right but the irony is delicious: communism was the best friend that capitalism ever had.

Dave, August 4, 2010 at 6:05 pm
Look on the bright side, stories like this are finally being told. Maybe it's not too late to turn the ship around…
The Polycapitalist
August 5, 2010 at 12:57 am
With all due respect to Yves' and Taleb's work (I'm a big fan of both) I think there are much better examples of corruption and abuse of former regulator status than this one.

The FDIC deposit insurance program does not prohibit a single individual from having multiple accounts at different banks in amounts below the FDIC insurance threshold, and therefore protected. So describing what Blinder and his company are doing as "circumvent(ing) regulations", as Yves does, is inaccurate.

One of the reasons the FDIC does not limit the number of accounts a single individual can have covered by FDIC insurance is that spreading that person's accounts across different banks diversifies risk.

Instead it would appear Blinder's firm is providing an efficient mechanism to utilize FDIC insurance within the FDIC's parameters.

bob
August 5, 2010 at 2:14 am
Why even have a limit if you can run around it with the help of wall st ,while they take their cut, and push all of the risk to the tax payers?

I'm sure it's all very efficient.

In my mind the intent and letter of the law are very plain, 250 k per person per bank. Mr. Blinder, with the help of his other ex regulators, is setting up a "supra-bank" with no real efficiency beyond that of regulatory arbitrage. They also have no capital requirements, pushing all of that "real banking stuff" on to the people below them.

They are being paid to take advantage of the system. It's that simple and unethical. You can't legislate ethics, but you can legislate banking regulations. They did this a while ago, and the unethical Mr. Blinder ran right around the law.

attempter
August 5, 2010 at 5:13 am
The regulation in principle is intended to deal with an outsider figuring out what to do on his own. The limit, of course, is intended to provide a public backstop for the public's savings, not for rich rent-seekers, i.e. criminals.

It's not set up to be worked by a "public servant" who is really a traitor, selling his public service expertise to help outsiders game the system.

(Of course by now the system's been hijacked so that e.g. the practical intent of FDIC insurance is precisely to socialize the risks and costs of criminal activity. Traitors like Blinder have dedicated their careers to making it so.

That's precisely the state of affairs Taleb is deploring here.)

As for the "efficiency" Big Lie, we know for a fact that every action of the finance sector doesn't create wealth but destroys it. It does nothing but add cost and complexity. No one ever games the system to render "the economy" more efficient; he does it to render the economy less efficent. He does it only to render his own crimes more efficient.

Here's one study which finds that banksters and speculators destroy $7 of social wealth for every $1 they create.

http://globalsociology.com/2010/07/17/the-real-value-of-work/

So did you mean efficiency or Orwellian "efficiency"? I think we know what kind the Blinders and all other system criminals always mean.

Andrew Bissell
August 4, 2010 at 6:09 pm
As Taleb himself sometimes notes, the most important element missing from the 30s is that we have not yet destroyed the bad debts choking the system, a process which was largely complete before Roosevelt even took office.

These bad debts - and the banksters who hold them - need to be liquidated. The associated economic pain cannot be avoided, and the question of whether it is done through massive defaults or inflation is mostly a matter of picking the marginal winners & losers (or, more accurately, the losers-of-a-little and the losers-of-a-lot).

DownSouth
August 4, 2010 at 8:57 pm
Andrew Bissell said: "…the most important element missing from the 30s is that we have not yet destroyed the bad debts choking the system, a process which was largely complete before Roosevelt even took office."

That is factually incorrect.

In Since Yesterday Frederick Lewis Allen describes the economic disaster Hoover's laissez faire ideology created which he then handed off to Roosevelt:

Hoover had tried to keep hands off the economic machinery of the country, to permit a supposedly flexible system to make its own adjustments of supply and demand. At two points he had intervened, to be sure: he had tried to hold up the prices of wheat and cotton, unsuccessfully, and he had tried to hold up wage-rates, with partial and temporary success; but otherwise he had mainly stood aside to let prices and profits and wages follow their natural course. But no natural adjustment could be reached unless the burdens of debt could also be naturally reduced through bankruptcies. And in America, as in other parts of the world, the economic system had now become so complex and interdependent that the possible consequences of widespread bankruptcy–to the banks, the insurance companies, the great holding-company systems, and the multitudes of people dependent upon them–had become too appalling to contemplate. The theoretically necessary adjustment became a practically unbearable adjustment. Therefore Hoover was driven to the point of intervening to protect the debt structure–first by easing temporarily the pressure of international debts without canceling them, and second by buttressing the banks and big corporations with Federal funds.

Thus a theoretically flexible economic structure became rigid at a vital point. The debt burden remained almost undiminished. Bowing under the weight of debt–and other rigid costs–business thereupon slowed still further. As it slowed, it discharged workers or put them on reduced hours, thereby reducing purchasing power and intensifying the crisis.

It is almost useless to ask whether Hoover was right or wrong. Probably the method he was driven by circumstances to adopt would have brought recovery very slowly, if at all, unless devaluation of the currency had given a fillip to recovery–and devaluation to Hoover was unthinkable. It is also almost useless to ask whether Hoover was acting with a tory heartlessness in permitting financial executives to come to Washington for a corporate dole when men and women on the edge of starvation were denied a personal dole. What is certain is that at a time of such widespread suffering no democratic government could SEEM to be aiding the financiers and SEEM to be simultaneously disregarding the plight of its humbler citizens without losing the confidence of the public. For the days had passed when men who lost their jobs could take their working tools elsewhere and contrive an independent living, or cultivate a garden patch and thus keep body and soul together, or go West and begin again on the frontier. When they lost their jobs they were helpless. Desperately they turned for aid to the only agency responsible to them for righting the wrongs done them by a blindly operating economic society: they turned to the government. How could they endorse a government which gave them–for all they could see–not bread, but a stone?

The capitalist system had become so altered that it could not function in its accustomed ways, and the consequences of its failure to function had become too cruel to be borne by free men. Events were marching, and Herbert Hoover was to be among their victims, along with the traditional economic theories of which he was the obstinate and tragic spokesman.

Unfortunately, over the past 30 years, there has been a revival of the ideologies that Hoover embraced so vehemently, and with equally disastrous results.

Andrew Bissell
August 4, 2010 at 9:09 pm
Therefore Hoover was driven to the point of intervening to protect the debt structure–first by easing temporarily the pressure of international debts without canceling them, and second by buttressing the banks and big corporations with Federal funds.

"Laissez-faire," right. Sounds more like corporatism (and very similar to Obama's policies) to me. Unless "brook no liquidation" is now considered some kind of hands-off approach to the economy.

Andrew Bissell
August 4, 2010 at 9:25 pm
As far as the historical fact on debt defaults is concerned, the default rate and credit spreads peaked around 1932/1933: http://www.moodyskmv.com/research/files/wp/21727.pdf
DownSouth
August 4, 2010 at 10:31 pm
The fact still remains that your statement was false.

As your charts show, there may have been some defaults of B-rated bonds along the way, but the debt structure for all intents and purposes was kept intact, both under Hoover and under Roosevelt. Roosevelt actually streamlined the RFC's cumbersome bureaucracy and increased its funding, which meant not only faster but more aid for failing banks.

Costard
August 4, 2010 at 10:27 pm
"But no natural adjustment could be reached unless the burdens of debt could also be naturally reduced through bankruptcies. And in America, as in other parts of the world, the economic system had now become so complex and interdependent that the possible consequences of widespread bankruptcy -– to the banks, the insurance companies, the great holding-company systems, and the multitudes of people dependent upon them –- had become too appalling to contemplate."

So your source says. And you attribute this to laissez-faire policies? What precisely, can you tell me, was laissez-faire about the federal reserve act that bound all of these banks together? Or the prior long history, dating to Washington, of federal involvement in banking? Or about the gold exchange standard that had the entire world riding on two inflating currencies? Do you attribute the first world war and all of its fallout to "laissez-faire" ideology? A word is nothing without the ability to apply it, and your examples are poor fodder if they merely emulate your penchant for ignoring all context so that you might condense history into a label too small to hold it.

DownSouth
August 4, 2010 at 11:05 pm
It never ceases to amaze how the defenders of laissez faire think they can start the clock after the disastrous consequences of its implementation come home to roost.

Quoting Frederick Lewis Allen again, this time from Only Yesterday:

Meanwhile his [Coolidge's] Secretary of Commerce, Herbert Hoover, ingeniously helped business to help itself; on the various governmental commissions, critics of contemporary commercial practices were replaced, as far as possible, by those who would look upon business with a lenient eye; and the serene flattering pronouncements upon business and assurances that prosperity was securely founded.

An uninspired and unheroic policy, you suggest? But it was sincere; Calvin Coolidge honestly believed that by asserting himself as little as possible and by lifting the tax burdens of the rich he was benefiting the whole country -– as perhaps he was. And it was perfectly in keeping with the uninspired and unheroic political temper of the times. For the lusty businessmen who in these fat years had become the arbiters of national opinion did not envisage the Government as an agency for making over the country into something a little nearer to their hearts' desire, as a champion of human rights or a redresser of wrongs.

The prosperity band-wagon was bringing them rapidly toward their hearts' desire, and politics might block the traffic. They did not want a man of action in the Presidency; they wanted as little government as possible, at as low cost as possible, and this dour New Englander who drove the prosperity band-wagon with so slack a rein embodied their idea of supreme statesmanship.

Deus-DJ
August 4, 2010 at 11:25 pm
"So your source says. And you attribute this to laissez-faire policies? What precisely, can you tell me, was laissez-faire about the federal reserve act that bound all of these banks together? Or the prior long history, dating to Washington, of federal involvement in banking? Or about the gold exchange standard that had the entire world riding on two inflating currencies? "

Oh, so the banks went under because of the fact that they were "linked together" by the federal reserve, ie they were all part of the club? My guess is you're implying they drank the same shot of whiskey, am I right? Well? Tell me more, please….and please don't give me the interest rate argument, that has nothing to do with the banks being "linked".

"Do you attribute the first world war and all of its fallout to "laissez-faire" ideology? A word is nothing without the ability to apply it, and your examples are poor fodder if they merely emulate your penchant for ignoring all context so that you might condense history into a label too small to hold it."

Ok, let's forget about the depression for a second. Explain for all of us what happened to cause this crisis, in specific detail.

And it's funny that you tell us not to apply "laissez-faire" unless we give context, when those that support it most never give context, except to say NO GOVT. Then when a crisis occurs, you still blame the government despite the fact that you previously recognized the economy as "laissez-faire" and thus your solution is that it wasn't pure enough. Simple minded fool. You're nothing more than a charlatan, fooling yourself to believe an IDEOLOGY, something you yourself never give context to and never clearly define. Indeed, when will your pure laissez faire ever occur? Let me guess…"If only…" "IF ONLY…"

Idiot.

NOTaREALmerican
August 4, 2010 at 6:10 pm

In a society of sociopaths; the sociopaths rule.

We're doomed.

(Well, unless you're lucky enough to be a sociopath or are bringing up your kids to be sociopaths. Then, you're a winner!)

Hu Flung Pu
August 4, 2010 at 6:34 pm
I agree with Taleb's point but I think his choice of examples is not particularly good. He's referencing the CDARs program which allows people with more than $100K to deposit in a bank (actually I believe it's now $250K) to essentially spread around their deposits more easily. So, if you've got $1 million to deposit, instead of going to four separate banks and depositing $250K in each one, you can just go to your local bank and the CDARs program will do it for you/them. So, you maintain the relationship with one bank and that bank handles the distribution of the funds to the other three banks through CDARs. In exchange for this service – and that's what it is – the "rich" depositor receives a lower rate of interest than they would otherwise receive. So, this isn't really a "subsidy for the rich."

The rich, after all, could do this themselves, but at a cost. The CDARs program pays them less interest in exchange for handling the diversification. I see nothing wrong in that, nor with former regulators being involved in the company that handles it. But, again, I do agree with Taleb's larger point. I just have a quibble with the specific example used.

Hu Flung Pu
August 4, 2010 at 7:57 pm
Yeah, but they're not "abusing government guarantees and subsidies" here. They're paying someone to help them do something they can legally do themselves. Now, if your argument is that NO ONE should be able to have a government guaranteed return via an FDIC-insured bank account, that is a debatable issue, but it's also a completely separate argument from the one Taleb is making.
bob
August 5, 2010 at 2:25 am

How is this any different from ticket scalpers paying people to stand in line and buy tickets for the latest greatest show? Paying another person to go to war during a draft? Buying a kidney?

The intent is clear. The cost is borne by the deposit holders of other institutions under the umbrella of the FDIC, and if that isn't enough, the US tax payer.

This is how TBTF became TBTF.

ex-PFC Chuck
August 4, 2010 at 6:39 pm
We've drifted a long way from the principles of General George Marshall, who refused to write and publish his memoirs because he believed it would have been unethical for him to personally profit from work that the government had already paid him. He lived out his declining years on his military pension and modest personal savings and investments.
Forlma
August 4, 2010 at 6:41 pm
as simple as this:

the system is corrupt from top to bottom, and that corruption with the signing of the financial reform bill is now enshrined in law

Peter T
August 4, 2010 at 7:22 pm
> Roosevelt told his economic advisers (…) that he was going off the gold standard (…) he was met with a firestorm of criticism which he airly brushed aside.

In retrospect, going off the gold standard was a major step out of the depression. Economics was the science that couldn't, and that hasn't changed, has it?

Costard
August 4, 2010 at 8:55 pm
You cannot possibly hope to prove this; every figure you could point to for improvement post-1933 is tainted by the money inflation Roosevelt brought with him. And the fact remains that the depression continued, unabated, until our factories were the only ones in the world left standing.

Suspension of specie payments was not FDR's brainchild, either. It had been occurring routinely in this nation for nearly 150 years. He was not "brave" to repeat this form of bank bailout, which had already led, long before he took office, to the creation of a corrupt and corpulent banking system. The schism between gold and paper was permanent this time only because the government, taking a cue from the banks, began issuing debt that it had no intention of paying back in full. You may call this bold, or you may call it unethical – this is, after all, a discussion that began on ethics – but do not be so convinced of success when not 80 years have elapsed, and the decisions of which we speak have yet to reach their final conclusions.

Andrew Bissell
August 4, 2010 at 9:28 pm
do not be so convinced of success when not 80 years have elapsed, and the decisions of which we speak have yet to reach their final conclusions.

It's no worse than when Bernanke would point to the Great Moderation as evidence of the success of the past 25 years of monetary policy. Oh wait ….

Costard
August 4, 2010 at 9:37 pm
No argument here. However Bernanke is only the comic relief in this play. FDR is one of the leads!
DownSouth
August 4, 2010 at 9:36 pm
Costard said: "…every figure you could point to for improvement post-1933 is tainted by the money inflation Roosevelt brought with him. And the fact remains that the depression continued, unabated, until our factories were the only ones in the world left standing."

That is factually incorrect. The "inflation" was imaginary, and the fears of inflation were unfounded and led to disastrous policy decisions.

In Since Yesterday Frederick Lewis Allen sets out what happened:

At last business conditions in the United States were definitely improving. The Federal Reserve Board's Adjusted Index of Industrial Production (which as you may recall had sunk as low as 58 and 59 in the crises of 1932 and early 1933, had leaped to 100 during the New Deal Honeymoon, had then slipped back to 72 by November, 1933, and had obstinately hung in the seventies and eighties throughout 1934) had now begun to show a pretty definite upward trend. By the beginning of 1935 it had risen as far as 90. By the end of 1935 it had reached 101. And after a brief relapse into the nineties, it swept on during 1936 to 104 in June, 108 in July and August, 109 in September, 110 in October, 114 in November, and 121 in December–within striking distance of the record figure of 125 which had been set in 1929.

[....]

Then see what happened to our familiar measure of the state of business in general, the Federal Reserve Board's adjusted Index of Industrial Production. (Do you recall its previous ups and downs? Its high of 125 in 1929, its low of 58 in 1932 and of 59 in the bank-panic month of 1933, its rush up to 100 during the New Deal Honeymoon, its decline to 72 as the Honeymoon ended, and its wobbling rise thereafter?) At the end of 1936 the index had touched 121, which looked distinctly promising. As late as August, 1937, it stood at 117. Then it ran downhill, month after month, until by May, 1938, it had sunk to 76. _In nine months it had lost just about two-thirds of the ground gained during all the New Deal years of painful ascent!

What had happened? During the latter part of 1936 and the early part of 1937 there had taken place sharp increases in the prices of goods–some of them following increases in wages during the CIO's offensive, some of them affected by armament orders from Europe, many of them accentuated by a general impression, among business men, that "inflation" might be coming and that one had better buy before it was too late. The price of copper–which you will recall especially disturbed the President–had jumped in five months from 10 cents a pound to 16. Business concerns had been accumulating big inventories. When the time came to sell these goods at retail to the public, the purchasing power to absorb them just was not there.

For new investment still lagged; and what was more, the government spending campaign, which had kept pumping new money into the economic system, had been virtually halted. During the summer of 1937, Henry Morgenthau, the Secretary of the Treasury, had persuaded the President to make a real attempt to balance the budget; and although it did not yet seem to be quite in balance, nevertheless when one took into account the Social Security taxes which were being levied (and were not counted on the credit side of the budget, being set apart in a separate account), the government was for a time actually taking in from the public more than it paid out.

Result: the goods which were piled up on the shelves moved slowly. Business men became alarmed and cut production. Two million men were thrown out of work in the space of a few months–and became all the less able to buy what was for sale. The alarm increased, for men well remembered what a depression was like and were resolved to cherish no false hopes this time. The vicious spiral of deflation moved with all the more rapidity. Thus out of that apparently clear sky–no great speculative boom in stocks or real estate, no tightness in credit, no overexpansion of capacity for making capital goods (in fact, not nearly enough expansion)–came the Recession of 1937-38.

Costard
August 4, 2010 at 9:55 pm
I specifically said "money inflation", not "inflation", with the point of reference being March 1933. Your source, speaking about 1937, concurs:

"…the government spending campaign, which had kept pumping new money into the economic system, had been virtually halted."

DownSouth
August 4, 2010 at 11:27 pm
Call it what you may, but your original assertion that the "depression continued, unabated, until our factories were the only ones in the world left standing" is patently false, as Frederick Lewis Allen amply demonstrates.
Deus-DJ
August 4, 2010 at 11:28 pm
Money inflation?

Can someone please explain to me what this plebeian is referring to?

Bo J
August 4, 2010 at 7:37 pm
This is a little off point, but a few weeks ago I heard Nicholas Taleb speak. I then read his book and thought it was amazing. Today I was reading Yves Smith's book, ECONNED, and there are parts of Ch. 2 that sounded like Smith and Taleb were either collaborators or of similar cloth. Now this post (which I wholly agree with).

I've personally witnessed this pandemic and its very sad. As an insider I know there are a lot of good people doing their work in an ethical manner. Unfortunately, like most professions, there are those who do game the system and the seduction to turn to the dark side is always implicit.

Tom Hickey
August 4, 2010 at 7:50 pm

Trouble brewing. The stuff like this is piling up.

67% of Political Class Say U.S. Heading in Right Direction, 84% of Mainstream Disagrees

alex
August 4, 2010 at 8:26 pm
"it isn't simply due to the role of corporate funding in campaigning"

No, but it's still the biggest piece of the puzzle.

Doc at the Radar Station
August 4, 2010 at 8:32 pm
This is worth a read to provide additional context:
http://www.calculatedriskblog.com/2009/07/failed-banks-and-brokered-deposits.html ;
Ronald
August 4, 2010 at 8:42 pm
"So the "innovation" that regulators, academics, consultants, and banks were all advocating more than 20 years ago was regulatory arbitrage, pure and simple. When you have regulators undermining the rules and depicting it as virtuous, behavior like Blinder's is simply more of the same."

Productive economic behavior has been left for another time while gaming the system is a full time profession. America's love affair with getting rich and richer doesn't mean risking your money rather OPM legally acquired via the political and regulatory system is what's left of our economic heritage.

purple
August 4, 2010 at 8:44 pm
The big difference is that there was a international Communist movement that scared the crap out of capitalists in the 1930's and that appealed to working people. FDR's liberal policies, like Keynes, could be sold to smarter sections of the elite as a way to 'save the system' because the alternative , expropriation of private capital, was so much worse.

Without any push back from working people, this will just continue onwards until the entire system blows up in an orgy of greed and militarism in a way that will make 2008 seem like a picnic. But that could be a long way away.

alex
August 4, 2010 at 9:16 pm
"The big difference is that there was a international Communist movement that scared the crap out of capitalists in the 1930's and that appealed to working people."

Which proves the capitalists right – competition is what makes 'em do a good job.

Ironically capitalism, without the competition of communism, has become degenerate rent seeking.

Pat Walker
August 4, 2010 at 9:07 pm
Hi Yves,

With the highest respect, people are naiive.

If the highlight of the American experience was Watergate, were without a shot being fired, the PTB were replaced in their entirety. All due to a generally educated, informed and involved populace and Congress that understood public service. Yes, our Constitutional framers would have been proud.

Now we have a specialty educated populace who is uninvolved, uninformed to the point of purely parochial, local views and completely uncaring. We let "Volunteers" do the dirty, bloody job of fighting, dying, and becoming physically and mentally scarred for life. When 66 GI's die in Afghanistan in a month, people don't demonstrate, not even a wince - they take the view that our soldiers knew the chances when they Volunteered and it comes with the occupation.

Balderdash.

Politicians, officials, most everyone makes deals - It's reasoned that the End justifies the means. In fact, they reason, there is no one to notice or care.

In fact - regulators, prosecutors, those in positions of Public Trust (How Quaint) are all part of the team effort. Look the otherway, so do the majority of American citizens - unless you are out of a job, out of benefits, and perhaps have hungry kids - Then suddenly you care, but it's too late.

Does anyone ever tell the truth ? Do people even know what truth is ?

The New Regime:

Today, we live in a complex society were labryinthe problems often require Machiavellen solutions where decisions must be only left to those who are on the inside –where the average citizen wouldn't understand, and seemingly doesn't care. Truth, Justice Equality, Integrity, Character, Ethics - They are all too often simple, quaint, too well defined concepts that have no place in today's governance. After all, most people don't question a doctor's decisions - so why should one question your leaders decisions. If a little protest helps the medicine go down, so be it.

Power Trumps Money &, Money Trumps Individual Rights

The last vestige of a bygone America that still lives are the men and women of our uniformed services - They have no collective unions to voice grievances, no petty beefs - They do as they are told for the protection of America

– That is until they are finally disillutioned - they too have families back home that struggle like the rest –

So God Bless Hollywood - America can live for ever like a Dicksonian novel.

But when the next war comes, and along with it a Draft, for ourselves and our children, - we will be expected not to question or reason, just fight and die without ever knowing why.

still have an Integrity, character, ethics have gone the way of the slide rule.

im moe green
August 4, 2010 at 9:53 pm
Pat,

Which K street lobbying firm do you work for? You sound familiar, did you used to work for Dodd and now one of the K street firms?

Pat Walker
August 4, 2010 at 10:21 pm
Dear Green,

If you are being facetious, I'm not laughing.

I'm currently unemployed, without week 1 of benefits since I was paid on a private contractor basis.

As far as Dodd, he's an old time pol - lots of kabuki, the mountain labored and didn't even give birth to a mouse --

K Street lobbyists, may not be the first, but certainly inline with each one having a personalized lamp post waiting for them.

Any other inquiries ?

NOTaREALmerican
August 4, 2010 at 11:31 pm

Jeeezz. I think you missed the cynicism entirely.

As cynicism is truth, I think it's safe to say that any cynicism expressed in public would never be uttered by a veteran (K street) lobbyist or from anyone in an important leadership position actually.

The "troops" (whoever they happen to be at the moment) ALWAYS need the fakery of optimism to allow for the greater glory of the nobility benefitting from their glorious sacrifices.

im moe green
August 4, 2010 at 9:56 pm
There are and have been honest politicians, governments and business men. Honest is not quaint – its brave and difficult. Corruption is easy….
Pat Walker
August 4, 2010 at 10:34 pm
Dear Moe,

There is a fine distinction between honest and naive.

Perhaps there have been honest individuals - history books are full of them.

In a relatively open, "honest" society, corruption is difficult at best with the most onerous consequences.

In our current society, the corruption is so brazen, it's out in the open with no one giving a good God Damn - easy as pie; - Old but true - just follow the money

Where do you fit ?

As far as brave, Brave is for heroes - the stuff of idyl dreamers, newbies who don't no better, postumhous medals, VA hospitals, and cemetaries - and for what ? –

im moe green
August 4, 2010 at 10:40 pm
Indeed sorry to hear you are out of work. Yes, it is now quixotic to be brave or principled in a true sense.

Certainly compliance with the "values" and rules of the state and powerful are the only way…..Where do I fit? Old fart, used to be economist, developer and lobbyist, I was part of the problem and then checked out so to speak, sick of the people I worked with, dealt with and ashamed of my self….

Pat Walker
August 4, 2010 at 11:17 pm
Dear Moe,

In my world, "Old Fart" is synonymous with 1. Experienced, 2. Mature, 3. Wisdom.

Since the beginning of time, the majority of the world is full of sheep that follow or pigs that feed at the common trough - the people you worked with fit one of those categories.

Since you are no longer part of the problem, by extension, you must be part of the solution.

Feeling ashamed of something past is pointless. We live in the here and now.

History is full of courageous individuals who made a difference.

Thank you for your response,
P

NOTaREALmerican
August 4, 2010 at 11:39 pm

Re: Honest is not quaint–its brave and difficult.

It's also overrated, which is why it's so rare. If it was common the liars who write the history books wouldn't need to work so hard to find examples of it.

Winning (and business and war) is about screwing somebody. The workers, management, customers, & stockholders are better off when each realizes the only motive of the others is to maximize their wealth.

Life is about the smart amoral scumbags screwing the dumbasses for fun and profit. History is allot more understandable when view in this light.

Moral: Honesty is very seldom the best policy when dealing with the smarter people.

Vangel
August 4, 2010 at 10:09 pm
There is an irony here. Taleb, who tends to be favourably oriented towards free markets and is a big fan of Hayek has often made arguments about how regulators are necessary and has stated that the libertarian position, which would eliminate most of the government functions with the exception of protecting individuals from force or fraud, was too extreme.

Blinder's actions are an example of why the libertarians are right and why being a 'moderate' on the issue of economic or social liberty is a path towards serfdom.

Deus-DJ
August 4, 2010 at 10:56 pm
Yes, in your confused little mind you may dream up whatever conclusions you want.
MichaelC
August 4, 2010 at 10:42 pm
So it takes Taleb turning on Blinder to validate what everyone with 100k already knew and adjusted to, a decade ago? We could all bundle our deposits with our dumbest broker.

I am shocked!! but reassured that the reporting of the crimes will be at least a decade delayed. Greenspan and Blinder might not be around to face their accusers.

Jay Hee
August 5, 2010 at 1:09 am
I remember in the Eighties and early Nineties when the US were accusing Japan of so many unfair and wrongful practices and one of which was the idea of senior government officials joining the private sector. It was called 'amakudari' meaning descending from heaven, as in these officials would use their influence and knowledge in public service to serve their own ends as well as for the companies they joined.

Surely the USA is no different now? In my 50s now I realised people should be slower to accuse each other especially Asians of wrongful practices when they too have their own backyards to watch. Yes I am an Asian working in Asia.

Deus-DJ
August 5, 2010 at 1:30 am
Mr. Jay Hee,

Thank you for your comments. Not only is the USA not only "no different", I'm certain it is much worse, given that there are no protections here for consumers whatsoever. Falling from grace here means finding more ways to fleece the poor without the government saying a word…in fact, BECAUSE of these former government employees they(the government) actually encourage behavior that further enriches those corporations.

Taleb's encounter with Blinder is just one small case among many larger cases.

Chris of Stumptown
August 5, 2010 at 2:04 am
So Taleb isn't complaining that regulation has exploitable gaps. No, the problem is someone is talking about the regulatory gaps. Pardon me if I demur and am not impressed with his critique.
Deus-DJ
August 5, 2010 at 2:36 am
You are not excused to demur about anything of the sort. If you want to talk about exploitable gaps there is a plethora of information out there, so much that the regular news media is able to report on it daily.

Taleb's argument is linked to regulatory capture…if you knew how much worse capture is than "exploitable gaps" then you wouldn't be making your silly comment to begin with.

Francois T
August 5, 2010 at 2:22 am
Barry Ritholz pointed out a while ago that 1,400 lobbyists working for the financial industry were ex-congresspersons and Hill staffers.

Think about that for a minute and tell me how much sleaze, corruption and law-rigging you could get with an army like that.

readerOfTeaLeaves
August 5, 2010 at 3:13 am
In other words, at least 1,400 'franchises' built on complex information, a multitude of variables, and (as Taleb points out) many 'nonlinear' relationships that make the system easy to game.

If public service were more highly valued, it would be better paid and the entries would become more rigorous (in some places, they already are). It appears that Singapore took the potential of 'human capital' more seriously than the Obama administration has done.

After 30 years of anti-government ranting in the US, we've lost sight of the enormous value that a viable, non-corrupt, respected, well paid civil service can bring to an economy.

Self-interest, unenlightened, has led to the situation in which we have 1,400 'franchisees' on FinReg alone.

JS
August 5, 2010 at 3:47 am
Yves says: "The famed regulatory revolving door, and all the benefits that former officials and their new private sector masters gain from a legally permitted but socially destructive form of trading of insider know how is now considered business as usual in the US."

Sorry, this does not hold water. There is no "insider know how" at work here. The FDIC itself makes it clear in its brochures (pick one up at your bank) that it's perfectly OK to have multiple insured deposits at multiple banks. It even gives specific examples to make sure people understand how to do it.

Nothing unethical here. The limits per depositor per bank exist to make sure the government's insurance risk is spread around to multiple banks. That's all there is to it. And many people have been doing this for a long time, without being insiders, and it's both legal and ethical.

BTW - Blinder worked in the Clinton administration, and is a pro-stimulus liberal professor of economics. Taleb is anti-stimulus and, in general, on the conservative side especially with respect to deficits.

Yves Smith
August 5, 2010 at 4:00 am
You are missing the point. The wealthy person who obtains the service does not set up multiple accounts, he has a single account. He is spared the operational hassle, which is a disincentive to having multiple accounts. The usual low risk alternative for someone who wants low hassle and no risk would be a Treasury money market fund, which involves no taxpayer support (FDIC deposit insurance is underpriced; Treasury has repeatedly had to provide support to the FDIC).

Read up on the IndyMac bankruptcy. Many of the depositors who were suffered losses by having over $100,000 at IndyMac were businesses. If you have a business with any meaningful payroll, it is pretty much impossible NOT to have an account with over $100,000 in it for more than a few days a month. Things have probably changed since then, but at that time, the software used to manage payroll processing could work only with single accounts (as in it would have been prohibitively costly to split a business account used for payroll among multiple banks).

Was the Blinder service marketed to high transaction volume customers like businesses, who really could not follow the FDIC's suggestion? Could they even have used that service (ie, did it have monthly transaction limits that would have made it unworkable for the businesses that would really have needed it?) I don't know the answer, but I suspect not.

JS
August 5, 2010 at 4:27 am
I am aware of what this business (and other similar "brokered deposit" businesses) offers. And I still say that putting together a business like this requires no "insider knowhow". Furthermore, for this to be unethical, you would have to show that the rationale for the per bank FDIC limits was to make it difficult for depositors to use multiple banks. I believe that this is a wrong assumption - rather, the government simply wanted to spread the insurance risk to multiple banks. FDIC goes out of its way, in its literature (and on its website), to make sure everyone knows about the multiple bank option. FDIC insures banks, not individuals. They just don't want the risk to be concentrated.

And by the way, do you really believe that Mr. Taleb has all his Black Swan money in a single bank account? (I'm guessing he knows a lot better how to "insure" his own portfolio, using methods and real insider knowhow that the average Joe cannot come close to). And it's always possible for any large investor to buy treasury bills in any amount - so what's the big deal here?

a
August 5, 2010 at 4:05 am
What shocks me about this is how dumb Blinder must think Taleb is. Having a financial broker diversify your cash into accounts, each with less than 100k, is an obvious trick. It's also old – I had a Merrill Lynch account which could do this back in the 80s, although sadly it never did me any good, because I never had enough money. I guess it's not the supposed corruption of the elite which worries me; it's more their stupidity.
JS
August 5, 2010 at 4:33 am
Is a mutual fund, then, also an "obvious trick"? Because, you know, it also diversifies your cash by splitting it among multiple investments. In fact, even your bank, to pay you interest on your deposits, makes multiple loans and diversifies its portfolio.
Yves Smith
August 5, 2010 at 4:46 am
With all due respect, did you read my comment above? FDIC guaranteed accounts are NOT equivalent to money market mutual funds. Revere broke the buck, remember, and Treasury only MM funds offer lower yields.

And as I indicated, FDIC deposit insurance is underpriced, so taxpayers subsidize deposits. That is not the case with mutual funds (ex the few months post the run on Revere which led them to be guaranteed, but even then only up to $250K)

JS
August 5, 2010 at 4:59 am
The comment on mutual funds was made in response to the statement "Having a financial broker diversify your cash into accounts, each with less than 100k, is an obvious trick." As it stands, this comment implied that diversifying cash into multiple investments is a trick. In any case, I think you understand that this is not the main point being argued here. What is the reason for the FDIC limits? To spread institutional risk or to limit aggregate per person coverage? And does the government want the rich to reduce their bank deposits and buy treasury bills? ;

[Aug 04, 2010] The Road to Serfdom Is Lawlessness: Inside Goldman Sachs

Jesse's Café Américain
"Giving sophisticated models and fast computers to traders is like giving handguns and tequila to teenage boys. Only complete mayhem can result (and as we saw recently, complete mayhem did result)."
Here is a piece I found interesting from a quant who left Goldman Sachs. It matches what I have seen first hand over the years doing business with the brokers and exchanges, and from friends who joined other high energy Wall Street firms including Lehman and Bear Stearns and Morgan Stanley.

The investment banks and brokers are an adolescent culture, high on macho and low on expansiveness in thinking to put it politely.

I do not have a problem with that, per se. I enjoyed hanging with most of these guys, their odd sense of irreverent cynicism and gallows humour, and the grab-asstic frat life style. It is fun, if you do not take it too seriously. I used to follow an annual race on the stairs among brokers in a large NY skyscraper with interest, a friend phoning in the results. Big money was bet on it. It's a good time, and a means of relieving the tremendous pressures of a high stress profession.

The difficulty is that over the past ten years the financial sector, including the once staid commercial banks, has been absolutely overwhelmed by the hedge fund and investment banking mentality, and that power in turn has been influencing serious policy discussions in Washington to the detriment of the nation, because money is power. Most of it had to do with deregulation.

Banks must keep up with their competitors, and if one does it, they all must do it to stay in business. That is why regulation is so vital in this highly competitive sector. One cannot be virtuous as a commercial entity with obligations to shareholders and customers under brothel rules.

Goldman Sachs is primarily a big hedge fund with a lot of political clout and an inside line with the Fed. They have a trading, hedge fund culture these days. It was not always like this. At one time a firm's reputation and their word was everything in a system founded on confidence. With a trading culture it's all about the bottom line, with profit as virtue, and deceit in the name of profit is no vice. You do not wish to have fellows with this mindset running any substantial part of your country.

Quite a bit of that came with their change in status from a predatory trader to mainstream bank in name only, with a predator's instincts and reward system. And this multiplied their potentially negative impact and influence on the entire financial system.

Even worse, their self-centered and short term thinking and clever manipulation of the rules has become the tail wagging the big dog of the country, because the political climate in Washington, and elsewhere, has been largely corrupted by money. And in a bubble economy, the financial centers are where the money is.

Wall Street is like the Gauls (or the Ferengi for the sci-fi fans), ruthlessly obvious and lacking in subtlety, wallowing in the raw and often ostentatious use of amoral power for gain. Washington, on the other hand, tends to effete decadence and studied pretense, the sly and subtle subornation of character and too often the law in the service of power. The mix of these two cultures is an antichrist on the rocks, a deadly cocktail indeed.

I had the opportunity to work with several congressional and even presidential campaigns and administrations starting with Nixon. I don't claim to be an insider, but I have seen a side of things that is transparent to most. I liked that culture as well. I used to go to Washington for the State of the Union message each year, to meet old acquaintances from the Staffs for drinks and chat at Bullfeathers or The Palm to catch up on things, while the big dogs were attending the show. You get the best view of things from the servants, especially if you are benign, an interested non-player.

The deterioration in Washington is evident. These men are not the brightest stars in the firmament, and at times they are downright ignorant of things we might take for granted because they often live a rarefied existence with access to people and information managed by staffs. That is a necessity because they are drinking from a firehose of information.

Their chief ability seems to be to know what to say and to whom, what levers to pull to get something done, making deals, gaining and trading power, and how to get elected. They are great at networking. But this leaves them terribly vulnerable to influence, and group think, and brother, inside the Beltway these days it is all about lawyers, guns (power) and money.

There has always been an element of this, but over the past twenty years, with the whole deregulatory movement, it has become supersized, like a feeding frenzy. I have had the opportunity to discuss this with some older friends in the business and they tend to agree that things have changed.

There are always creepy and seriously warped people who are attracted to the halls of power. I have met a few who were simply chilling. More common are the broken people, with drugs and drink and sex filling the holes in their being, hollowed out by the power and fame that lured them in. But these were always the exceptions.

In government there always had been an element of service to the country and a kind of dignity underpinning the system, a kind of shared camaraderie, that seems to have been tossed in a ditch of expediency and greed, and the lust for power on a mass scale.

What had been the exception is now the rule, at least beneath the urbane, often pietistic, veneer. You can still be tossed out of office in the government for doing things that would still make you a legend on Wall Street.

When the politicos were doing something wrong back then at least they knew it, and they were ashamed of it, despite the usual bluff and bravado. A stiff conversation with a federal prosecutor would make a Congressional staffer's blood run cold. Now it is more like business as usual, and even getting caught is not all that bad, given the current trend to bipartisan professional courtesy, mavericks excepted.

Greed is indeed the greatest good, the fatal flaw behind the decline of the 'me generation.'

The law, that much maligned government of regulations and restraints, abused and fallible as it may sometimes be, is the bulwark of society, and often the only thing standing between the people and packs of ravening wolves.

Those who would tear down the law in some misguided pursuit of reform, or of an adolescent anarchy or utopia of 'no rules' at all, might find it hard to stand when the cold winds of avarice and tyranny of power blow across the land, with no laws to stop or restrain them. The madness serves none, consuming all.

"Equal protection" under the law is the best safeguard that the average person enjoys. Remove the law and you remove the protection, and it is every man for himself, and the individual is irrelevant.

This is why the Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained recovery. And underpinning all of this is the integrity of the regulatory and law enforcement process, and a serious pass at campaign finance reform and limitation of the power of large corporations and organizations to buy influence with other people's money.

The story of the 21st century will be the struggle of the individual versus the organization, the machine controlled by the elite few. A cyclical theme no doubt, but the powerful few seem to become more efficient in their promotion of tyranny on each iteration.

adgrok
Why founding a three-person startup with zero revenue is better than working for Goldman Sachs
By Antonio
23 Jul, 2010

I joined Goldman Sachs in 2005, after five flailing years in a physics Ph.D. program at Berkeley.

The average salary at Goldman Sachs in 2005 was $521,000, and that's counting each and every trader, salesperson, investment banker, secretary, mail boy, shoe shine, and window cleaner on the payroll. In 2006, it was more like $633,000.

In the summer of 2005, I took one look at my offer letter and the Goldman Sachs logo above it, another look at my sordid grad student pad, and I got on a plane to New York within the week. I packed my copy of Liar's Poker for reference.

My job on arrival? I was a pricing quant on the Goldman Sachs corporate credit trading desk1. We traded credit-default swaps, both distressed and investment-grade credit, and in the bizarre trading experiment assigned to me, the equity part of the corporate capital structure as well.

There were other characters in this drama. The sales guys were complete tools, with a total IQ, summing over all of them, still safely in the double digits. The traders were crafty and quick-witted, but technically unsophisticated and with the attention span of an ADHD kid hopped up on meth and Jolly Ranchers. And the quants (strategists in Goldman speak)? Mostly failed scientists (like me) who had sold out to the man and suddenly found themselves, after making it through two years of graduate quantum mechanics, with a bat-wielding gorilla peering over their shoulder (that would be the trader) asking them where their risk report was.

Wall Street is inward-looking and all-consuming. There exists nothing beyond the money game, and nothing that can't be quantified into dollars and cents...

[Aug 04, 2010] Hey Rube, Here's Why Your Lawmakers Ignored All Those Calls and Faxes

August 2, 2010 | Jesse's Café Américain

"The financial industry has spent $251 million on lobbying so far this year as lawmakers hammered out new rules of the road for Wall Street, according to the latest lobbying reports compiled by a watchdog group."

Money Talks. And money in the hands of the man who is sitting in the offices and standing in the halls of Congress is an effective tool for buying the influence and the laws that you want.

Political campaign financing reform, including stricter limitation of direct contributions by special interests to targeted lawmakers, is at the heart of it.

Does the First Amendment cover soft bribery? That is how they will spin it.

Goldman Sachs has the right to express its opinion to your congressman, while wrapping it in a thick rolls of hundred dollar bills, charged to expenses, and paid for by you.

And while it is a nice cushion, $251 million is small potatoes compared to the real payoff in jobs and speaking engagements with huge stipends, consulting fees, and sinecures after leaving office. And that is on top of their fat pensions and cadillac benefits.

Corporatism is the parternship of big business and government. And in the organizational state, the individual (that's you Mr. Potato Head) is irrelevant. Except for comic relief, someone to be played for the fool, the emotional plaything of paid pundits and party politics. Someone whom they can whip into a frenzy, who really enjoys the show.

Yeah boy, we'll show those new crooks a thing or two, and vote the old crooks back in November. Especially the ones that make no bones about being in it for the money and the power, and appeal to the worst in us with stereotypes and caricatures. That will teach Washington something about us.

You bet it will.


CNN
Wall Street's lobbying pricetag: $251 million
By Jennifer Liberto
August 2, 2010: 2:08 PM ET

WASHINGTON (CNNMoney.com) -- The financial industry has spent $251 million on lobbying so far this year as lawmakers hammered out new rules of the road for Wall Street, according to the latest lobbying reports compiled by a watchdog group.

The financial sector spent more than any other special interest group from April through the end of June -- a whopping $126 million, according to the Center for Responsive Politics' latest estimates. Wall Street banks, as well as insurance and real estate firms, hiked the amount they spent on lobbying by 12% in the second quarter compared to the same period last year.

"Financial reform certainly drove Wall Street lobbying efforts," said Dave Levinthal, spokesman for the Center for Responsive Politics. "Even as the economy remains beaten and bruised, with some financial institutions continuing to struggle, most banks and securities houses found it in their budgets to hire lobbyists - and lots of them."

In the first half of 2010, Goldman Sachs spent $2.7 million, just $100,000 shy of the total the firm spent on lobbying in all of 2009. The firm's reports to the federal government said it lobbied Treasury, White House and the Commodity Futures Trading Commission, as well as Congress...

There was plenty of evidence of financial sector lobbying throughout in the period leading up to final passage of the Wall Street reform bill last month.

In June, during the final 20-hour meeting of the panel to reconcile differences between the House and Senate reform bills, lobbyists suddenly packed a congressional office meeting room a bit after midnight, as lawmakers started tackling the final details of making derivatives more transparent. In hallways, they cornered House members who serve on the Agriculture Committee, in particular.

In late May, JPMorgan Chase chief executive Jamie Dimon made calls to a couple of lawmakers who were expected to be named to the conference panel.JP Morgan Chase spent $3 million on lobbying in the first half of the year, about the same as in 2009, according to the Center.

While the financial sector was active, other industries also dug deep into their wallets to talk to lawmakers. Despite the fact that the health care bill passed in March, the Center said health firms spent nearly as much as Wall Street firms did in the second quarter, $125 million. So far this year, the health care industry has spent $267 million on lobbying.

Overall, all lobbying totaled $1.78 billion in the first half of the year, up 7.5% in from the same six months in 2009. If it continues at that pace, 2010 will be a record year for lobbying, according to the Center for Responsive Politics.

However, fewer lobbyists are pounding the pavement, as the number of lobbyists dropped 5% compared to the same period in 2009.
Posted by Jesse at 9:48 AM

[Jul 23, 2010] Three of every four oil and gas lobbyists worked for federal government

July 22, 2010 | Drumbeat

Three out of every four lobbyists who represent oil and gas companies previously worked in the federal government, a proportion that far exceeds the usual revolving-door standards on Capitol Hill, a Washington Post analysis shows.

Key lobbying hires include 18 former members of Congress and dozens of former presidential appointees. For other senior management positions, the industry employs two former directors of the Minerals Management Service, the since-renamed agency that regulates the industry, and several top officials from the Bush White House. Federal inspectors once assigned to monitor oil drilling in the Gulf of Mexico have landed jobs with the companies they regulated.

[Jun 18, 2010] Crocodile Tears on Wall Street by Bill Moyers

Jun 16, 2010 | huffingtonpost.com

With all due respect, we can only wish those Tea Party activists who gathered in Washington and other cities this week weren't so single-minded about just who's responsible for all their troubles, real and imagined. They're up in arms, so to speak, against Big Government, especially the Obama administration.

If they thought this through, they'd be joining forces with other grassroots Americans who in the coming weeks will be demonstrating in Washington and other cities against High Finance, taking on Wall Street and the country's biggest banks.

The original Tea Party, remember, wasn't directed just against the British redcoats. Colonial patriots also took aim at the East India Company. That was the joint-stock enterprise originally chartered by the first Queen Elizabeth. Over the years, the government granted them special rights and privileges, which the owners turned into a monopoly over trade, including tea.

It may seem a bit of a stretch from tea to credit default swaps, but the principle is the same: when enormous private wealth goes unchecked, regular folks get hurt -- badly. That's what happened in 2008 when the monied interests led us up the garden path to the great collapse.

So the Tea Party crowd should be demanding accountability from Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Wells Fargo, and scores of hedge funds and private equity firms that constitute what we loosely call Wall Street.

But are the culprits taking responsibility for devastating the lives of millions of ordinary Americans? Don't kid yourself. If you've been watching them appear before congressional committees and the Financial Crisis Inquiry Commission - the independent inquiry that's supposed to find out what really happened - you've no doubt been reaching for the Pepto-Bismol.

Here's Robert Rubin, former Treasury Secretary and director of Citigroup, testifying last week. "Almost all of us involved in the financial system, including financial firms, regulators, ratings agencies, analysts and commentators missed the powerful combination of forces at work and the serious possibility of a massive crisis," he said. "We all bear responsibility for not recognizing this, and I deeply regret that."

Okay, maybe you didn't have a crystal ball. But what about good, old-fashioned business sense? How could you make so much money and not know the score? "You are talking about a level of granularity no board will ever have," Rubin claimed. Citi paid you $120 million as a senior advisor and rainmaker and you're not responsible for knowing what's happening below you? You didn't bother to assess the risk you were peddling to clients?

The committee heard a similar alibi from Chuck Prince, who served as CEO of Citigroup during its meltdown: "Let me start by saying I'm sorry. I'm sorry that the financial crisis has had such a devastating impact on our country... And I'm sorry that our management team, starting with me, like so many others, could not see the unprecedented market collapse that lay before us."

Commission Chairman Phil Angelides, the former state treasurer of California, wasn't buying it. "The two of you, in charge of this organization, did not seem to have a grip on what was happening," he said, and to Rubin, "I don't know that you can have it two ways: you were either pulling the levers or asleep at the switch."

Nonetheless, the financiers wail, it was all an enormous accident, a once in a century calamity, an act of God. But of course that's not true. Lots of people saw it coming and made a bundle, taking off with the loot at the expense of the millions who lost their jobs, homes and savings. There's no longer any question that many bankers continued to game the system after the collapse - still paying themselves exorbitant salaries and bonuses while hitting everyday people with usurious same day paycheck loans, credit card fees and other charges -- and refusing to help small and medium-sized businesses that could be creating employment.

The Tea Party gang really should have dropped by those Senate hearings this week looking into the failure of Washington Mutual, the bank that went belly up during the meltdown in September 2008 -- the largest such failure in American history.

As an 18-month Senate investigation revealed, WaMu made subprime loans that its executives knew were rotten, then packaged them as mortgage securities and pawned them off on unsuspecting investors. Loan officers were paid by the number of mortgages they sold, and ran up the numbers by lying to customers and falsifying data so they could make bigger bucks and win trips to Maui and the Caribbean. At one Washington Mutual office in Montebello, California, 83 percent of the housing loans contained bogus information.

Then there's Lehman Brothers. Their misfortune, apart from some chicanery only now coming to light, was being small enough to fail. During those black September days two years ago, the Feds decided it was expendable and let it go, leading to America's biggest bankruptcy ever. In an admirable job of journalism this week, The New York Times reported that Lehman secretly controlled a company called Hudson Castle. Critics say it was used by Lehman to borrow money and to hide bad investments in commercial real estate and subprime mortgages.

But the week's award for sheer gall goes to a Chicago area hedge fund called Magnetar, named after a kind of neutron star that spews deadly radiation across the galaxies. Thanks to the teamwork of the investigative reporting website ProPublica, as well as public radio's Planet Money project and "This American Life," we learned that Magnetar worked with Citigroup, JPMorgan Chase, Merrill Lynch and other investment banks to create toxic CDO's -- collateralized debt obligations -- securities backed by subprime mortgages that management knew were bad. Then Magnetar took that knowledge and bet against the very same investments they had recommended to buyers, selling short and making a fortune.

To simply call all of this "creative accounting" is to do it an injustice. This is corruption, cynicism and greed on a scale that would make the Roman Emperor Caligula cringe. Or rather, the Emperor Nero. He didn't just poison the citizens of Rome; legend has it that he burned the place down, fiddling around in the ashes, just like our Wall Street tycoons.

But since we know all this, why is it so hard to hold Wall Street accountable? Which brings us to what the Tea Party people should have been complaining about this week. The banking industry and corporate America are fighting against proposed financial reform with all the money and influence at their disposal, attempting to preserve a system that would enable them to ransack the country once again.

Look at Eric Lichtblau's report this week, also in The New York Times, under the headline: "Lawmakers Regulate Banks, Then Flock to Them." The financial services industry has hired more than 125 former members of Congress and congressional staffers from both parties to help them fight off accountability.

No wonder, too, that this headline appeared in the Times this week: "GOP Takes Aim at Plans to Curb Finance Industry." That's not surprising. Earlier this year Republican politicians told Wall Street: Give us the scratch and we'll scrap reform.

The GOP's SWAT team -- also known as the United States Chamber of Commerce -- has already spent three million dollars to try to kill or cripple a key part of reform -- the proposed new Consumer Financial Protection Agency. With the Chamber as their front, corporations have bankrolled ads that make it seem like the Red Army is at our doorsteps.

Advocates for reform have countered with ads of their own, but Democrats are deeply in hock to Wall Street, too. Remember the hedge fund Magnetar that bet against its own products? The owners covered their bets with ample campaign contributions to Rahm Emanuel. Yep, the same -- President Obama's White House chief of staff. At the time he was an Illinois congressman and chair of the Democratic Congressional Campaign Committee, which collected millions of dollars from the financial services industry.

In fact, the website Politico.com reports that "the nation's ten richest hedge fund managers have dumped nearly one million dollars into campaign accounts over the past several years... consumer advocates and critics from other financial sectors say hedge funds would get off pretty easily" under the Senate reform bill.

Bottom line: "The Wall Street banks are the new American oligarchy -- a group that gains political power because of its economic power, and then uses that political power for its own benefit." So write Simon Johnson, former chief economist at the International Monetary Fund; and James Kwak, former management consultant and software entrepreneur, in their important new book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.

Their words of warning and the past year and a half make you realize that as usual, Thomas Jefferson, whose birthday we celebrate this week, had it right. Back in 1816, he wrote, "I sincerely believe... that banking establishments are more dangerous than standing armies."

[Jun 07, 2010] Surowiecki The Regulation Crisis

Economist's View

James Surowiecki argues, correctly I think, that one of the key factors in effective regulation is the societal attitude about the value of what regulators do:

The Regulation Crisis, by James Surowiecki: A few weeks after B.P.'s Deepwater Horizon oil rig blew up and crude started spewing into the Gulf, Ken Salazar, the Secretary of the Interior, ordered the breakup of the Minerals Management Service-the agency ... supposedly in charge of offshore drilling. It was a well-deserved death: during the past decade, M.M.S. officials had let oil companies shortchange the government on oil-lease payments, accepted gifts from industry representatives, and, in some cases, literally slept with the people they were regulating. When the industry protested against proposed new regulations (including rules that might have prevented the B.P. blowout), M.M.S. backed down. ...
M.M.S.'s bad behavior was unusually egregious, but it's hard to think of a recent disaster ... that wasn't abetted by inept regulation. Mining regulators... Financial regulators... The S.E.C... These failures weren't accidents. They were the all too predictable result of the deregulationary fervor that has gripped Washington in recent years, pushing the message that most regulation is unnecessary... The result is that agencies have often been led by people skeptical of their own duties. ...
The obvious problems of graft and the revolving door between government and industry, in other words, were really symptoms of a more fundamental pathology: regulation itself became delegitimatized... This view was exacerbated by the way regulation works... Too many regulators, for instance, are political appointees, instead of civil servants. This erodes the kind of institutional identity that helps create esprit de corps, and often leads to politics trumping policy. Congress, meanwhile, often takes a famine-or-feast attitude toward funding, allocating less money when times are good and reinflating regulatory budgets after the inevitable disaster occurs. ... This ... also contributes to the sense that regulation is something it's O.K. to skimp on. ...
[T]he history of regulation both here and abroad suggests that how we think about regulators, and how they think of themselves, has a profound impact on the work they do. ... So reforming the system isn't about writing a host of new rules; it's about elevating the status of regulation and regulators. More money wouldn't hurt: as ... George Stigler and Gary Becker point out, paying regulators competitive salaries ... would attract talent and reduce the temptations of corruption. It would also send a message about the value of what regulators do. That's important... If we want our regulators to do better, we have to embrace a simple idea: regulation isn't an obstacle to thriving free markets; it's a vital part of them.

[May 25, 2010] New Obama Administration Propaganda Tactic: Revisionist History

Obama's burning desire to join oligarchy might be on of the reasons of why his adminitration is completly captured by financial interests...
May 25, 2010 | nakedcapitalism.com

Wow, the Obama Administration is less than a year and a half old, and it's already twiddling with the record. I was gobsmacked to see this section in a post by Felix Salmon today, on a new book by Jonathan Alter and a New York Magazine cover story by John Heilemann:

Both Alter and Heilemann trace the decision not to nationalize to a dinner at the White House in April 2009, attended by Paul Krugman, Joe Stiglitz, Alan Blinder, Ken Rogoff, and, at least according to Heilemann, Jeff Sachs as well. Krugman and Stiglitz were in favor of nationalization, but we open about the fact that it would be an expensive and fraught course of action; Obama, faced with an alternative, sensibly took it.

Huh? This is a complete and utter fabrication. And Felix gives Alter and Heilemann a free pass for deciding to take dictation from Team Obama rather than do basic reality-checking?

It was obvious LONG before April that the Administration had NO interest in nationalizing financial firms; Geithner made that clear as of his very first policy statement on the financial services industry as new Treasury Secretary. Merely searching my archives, I find:

"Geithner Plan Smackdown Wrap." February 10, 2009:

As we, and increasingly others, have said, the Obama economic team is every bit as captive to Wall Street's interests as the Bushies were. The differences increasingly look stylistic, not substantive…

Thus Geithner's belief that government can't manage assets is sheer projection of his own inability to deliver. The FDIC winds up banks all the time. During the S&L crisis, as William Black reminds us, FSLIC appointed receivership managers that later research determined did reduce losses. Sweden, Norway, and Chile all nationalized (and relatively quickly reprivatized) dud banks during their financial crises. This isn't like trying to go the moon (which was a government initiative, lest we forget). There are plenty of models and lots of good proposals. What is lacking is will. History says that an aggressive, take-out-the-dead-banks program is the fastest and all-in cheapest way out of a financial crisis. But if you believe that something will not work, as Geithner does, it isn't at all hard to produce that outcome.

The Administration's full bore effort to talk up confidence in general and banks in particular as of March made it impossible.

"White House Says Banks Should Stay Private," February 20, 2009:

Amid fears that Citigroup Inc. and Bank of America Corp. could be on the verge of being nationalized, the White House gave assurances that it prefers banks to remain out of the government's hands.

"This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House spokesman Robert Gibbs said Friday. "That's been our belief for quite some time, and we continue to have that."

We provided a longer-form analysis this year, in "The Empire Continues to Strike Back: Team Obama Propaganda Campaign Reaches Fever Pitch." Some extracts:

The widespread, vocal opposition to the TARP was evidence that a once complacent populace had been roused. Reform, if proposed with energy and confidence, wasn't a risk; not only was it badly needed, it was just what voters wanted.

But incoming president Obama failed to act. Whether he failed to see the opportunity, didn't understand it, or was simply not interested is moot. Rather than bring vested banking interests to heel, the Obama administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff. There would be no Nixon goes to China moment from the architects of the policies that created the crisis, namely Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke, and Director of the National Economic Council Larry Summers….

Obama's repudiation of his campaign promise of change, by turning his back on meaningful reform of the financial services industry, in turn locked his Administration into a course of action. The new administration would have no choice other that working fist in glove with the banksters, supporting and amplifying their own, well established, propaganda efforts.

Thus Obama's incentives are to come up with "solutions" that paper over problems, avoid meaningful conflict with the industry, minimize complaints, and restore the old practice of using leverage and investment gains to cover up stagnation in worker incomes. Potemkin reforms dovetail with the financial service industry's goal of forestalling any measures that would interfere with its looting. So the only problem with this picture was how to fool the now-impoverished public into thinking a program of Mussolini-style corporatism represented progress.

How did the Administration and financial services message control teams work together?

The first was the refusal to consider investigations of any kind. Obama is widely reported to have studied the early days of Franklin Delano Roosevelt's administration for inspiration; it would be impossible for him to miss the dramatic steps FDR took, including supporting the continuation of a Senate Banking Committee investigation into the misdeeds of the Roaring Twenties, the Pecora Commission….

More compelling evidence of the Administration's lack of interest in reining in the money-changers came via Treasury Secretary Timothy Geithner's first presentation on his reform plan, which was more accurately a plan to have a plan. It was widely criticized for its sketchiness, but most observers missed the true significance. Had the Obama transition team done any serious thinking about the financial crisis? Obviously not, because you don't need to think too hard if the game plan is to go back to business as usual to the extent possible. Geither's presentation came nearly three weeks after Obama was sworn in, and all its initiatives were Bush/Paulson wine in new bottles: a new go at the failed idea of having the government overpay for bad bank assets; "stress tests" to put more discipline around the process of handing out TARP funds to the needy; and a mortgage modification program which pretended to be able to square the circle of saving borrowers without taking on investors in mortgage securitizations.

Geithner's not-much-of-a-plan exemplified the second tool in the Obama campaign to sell doing as little as possible to the financiers: the Theory of Positive Thinking….

Back to our current post. I also checked my assessment with Newsweek's Washington DC based commentator Michael Hirsh, who confirms that the decisions not to nationalize banks had been taken long before April, and the dinner with Stiglitz, Krugman, et al was "pro forma and largely meaningless." Hirsh, by the way, broke the story of that dinner.

Separately, it is also utterly implausible that Obama would place much weight on a decision of this magnitude on a single session with individuals outside his team. Large and at least adequately managed organizations (and the Obama crew prides itself on being buttoned down) aspire to have a deliberate, analytical approach to Big Decisions. And given how high profile this issue was, having a solid, defensible-sounding rationale would be even more important.

So why would Team Obama go to the lengths of telling a verifiably false account to at least two reporters? Perhaps events in due course will reveal why they are so eager to revise the timeline, but all I can fathom now is that for some reason the Administration is trying to make it appear that the decision not to nationalize (or to use our current Newspeak, resolve) the really sick banks was:

a. Made by Obama, as opposed a matter that either didn't interest him or one in which he deferred to Summers, Geithner & Co.

b. One that a majority of famous economists endorsed.

I'm open to other theories as to why Team Obama is going to such extremes to change the record.

Richard Kline:

We are now within the event horizon of the mid-term election cycle. Much of the populace think 'Obama hasn't done the right thing about the banks.' This is the roll-out to show that: a) he went with the advice of 'the best minds,' b) the advice was correct, and c) 'it's worked.' This is what American politics has become, lies, stacked on misstatements, all balanced for maximum spin.

Obama is a person without substance, and rapidly becoming one without integrity as well, if he ever had any.

I'm not going to fact-check on all this, but it is my distinct recollection that Obama signaled _during his transition team weeks_ before inauguration that there would be no nationalizations. I don't recall who said what or exact quotes, but I recall this as being quite unequivocal. -But if that is the accurate time frame for the signals of him and his team, that's a problem now given the scenario I outlined in the first paragraphy. You see, it's necessary to show, now that his handling of the banks is very unpopular, that this WAS SOMEONE ELSE'S (GOOD) IDEA, i.e. that he's not really responsible for it but should get the credit anyway.

Yeah, _that's_ Barack Obama's First Law of Leadership: "I just work here."

Independent Accountant:

I see this as Obama taking us to 1984. "Who controls the past controls the future. Who controls the present controls the past". The Obamites will say anything to make Him look good. I believe this administration will make its predecessor look good.

Imagine, by 2012 people will lament Jimmy Carter's "third term".

attempter:

I can't get the NYT site to download at the moment or I'd get the link, but just a few days ago on his blog even Krugman (gently) said Geithner was lying about how K had allegedly said it would cost "trillions".

I guess the purpose of this lie offensive is to claim that there was no alternative to embracing the Bush Bailout and turning it into the Obama/Bush Bailout which wouldn't have been far more expensive. That's doubly a lie, of course, since nothing could be more expensive than embarking upon the permanent Bailout (but their version continues with the lie, TARP = Bailout), while in the long run it would've been far less expensive and painful for the people (as opposed to for the criminals) to let the rotten criminal system go down, while government did whatever it had to do to bolster Main Street. We still need a New Deal level jobs program, for example, even though we know this kleptocracy would sooner machine gun the unemployed than than use public money to create jobs for them instead of handing it over to rich banksters as private loot.

As for Obama's own pathology, he's clearly a corporatist by ideology. A corporatist ideologue believes the purpose of civilization itself is to best package public property to privatize it at the greatest profit to private corporations, and to best organize human labor so that it serves as the most profitable resource mine for these corporations. That's why his policy preference in each and every case (it looks knee-jerk) is to route any and every process through a corporate toll-booth. Thus even his scam "jobs bill" has to go via the route of tax credits for employers, not direct public job creation, which would of course be vastly less expensive and more effective.

But if you made this last point to him, he'd sincerely not understand what you're talking about. If the main purpose of something isn't more rents for private interests, then he doesn't see it as having any purpose at all.

He's also a status quo elitist and bully by personality. He believes in the Rand lie about capitalist supermen. His heroes really are the likes of Blankfein and Dimon, and he really believes they're America's best human type. Meanwhile he may deplore the uncouth aspects of the Republicans, but he still respects them as rivals and peers.

His bullying hatred comes through in his disdain for the diminishing ranks of actual progressives. Them he's willing to "fight", meaning to kick down upon. He's happy to send out his thug Rahm to yell and swear at them. That's both because they're weak, and as a bully Obama sneers at perceived weakness, but also because they actually wanted to change the status quo, which in O's eyes is tantamount to metaphysical rebellion.

(In Obama's defense, the "progressives", to the extent they still cling to their delusions about him and the Democratic party, really do deserve all the scorn and contempt heaped upon them. Their position is untenable, but out of cowardice they refuse to accept that.).

Selected Comments

pros:

Why read Salmon? He's voice of Goldman Sachs.

aet :

Just like the days of the ol' Soviet Union: Why read Pravda?

Because knowing which lies are important at the moment may help to gain understanding of what transpires in the shadows, and behind the scenes.

To see behind the scenes, one must fist recognize what IS merely "scenery": placed to conceal, or to distract, or to enhance an illusion.

[Apr 24, 2010] Regulations Alone Are Never Enough, But Here's How They Can Easily Be Made Pointless

Apr 24, 2010 | jessescrossroadscafe.blogspot.com

Mr. Obama's speech at the Cooper Union today was remarkably unsatisfying. It seemed to be given from weakness, and almost obsequious as the American President politely asked his largest campaign contributors to please stop flouting the law, defrauding the people and their customers, and spending millions per day lobbying the Congress to buy changes in the reform legislation to provide them with the 'right regulators' of their choice and convenient loopholes to render it ineffective.

The reform making its way through the Congress is unlikely to be effective given the process in place, despite the political kabuki dance being conducted by the Congress and the Banks.

The solution is to put simple and effective regulations in the hand of stronger, independent, ad highly capable regulators to bear on the financial services industry, and to understand that the regulations must evolve with a dynamicly evolving business. The idea that you can erect some impregnable and unchanging Maginot line against bank fraud is laughable, a farce.

As William K. Black disclosed in his testimony the other day, the regulators always had the power to shut down the frauds, and to resolve the financial crisis without having to give away billions. They lacked the will, and the motivation.

You want to wipe that smirk off Lloyd Blankfein's face? Nominate Eliot Spitzer or Elizabeth Warren to be the head of the SEC, or the CFTC, and provide them with a adequate budget and a staff of financial experts and a few experienced prosectors.

Even with strong regulations, unless you have capable and motivated regulators, there are always ways to evade the rules, especially if they are complex and provide exceptions. The simpler they are, the stronger the regulations will be, provided they are flexible enough to be amended and expanded efficiently to match the changing and dynamic nature of the industry that they are overseeing.

This is not that difficult, and these jokers are not that smart, although part of their con is to paint themselves as the smartest, the best, and practically unstoppable.

The root of the US financial crisis is always and everywhere regulatory capture, political cronyism, and fraud. It really is that simple.

Barack Obama should to listen to a speech by Nick Clegg of the UK Liberal Democratic Party to hear what a genuine reformer sounds like. Today he sounded like a servant, but not for the public.

Marketwatch
Meet the New Goldman Sachs Derivatives Business

By David Callaway
April 22, 2010

"...So the version making its way to the Senate floor Wednesday included a host of exemptions for non-bank companies who use derivatives to hedge against quick movements in prices for resources they need. These include airlines, manufacturers, other trading corporations, and pension funds - entities like Enron, for example, or the Orange County, Ca., retirement fund - two infamous financial wizards.

So firms like Goldman, Morgan Stanley, or J.P. Morgan Chase Co. would be able to register as other entities - airlines, manufacturers, pension consultants -- and continue to trade derivatives to their hearts content.

Sounds silly, until you realize that's just what Goldman and a number of other banks did almost two decades ago to enable them to trade widely in commodities index futures. In 1981, Goldman got itself classified as a "hedger," such as a farmer or food producer, so it could trade commodities without fear of limits put on pure speculators.

Part of the fallout from that was the disastrous run-up in food and commodities prices we saw in 2009, caused by speculators, which finally forced the Commodities Futures Trading Commission to take a look at these special exemptions. See story on Goldman futures trading exemptions.

This is where the battle over the derivatives bill lies in the next several days, and where Wall Street will concentrate its efforts. The more exemptions granted; the larger the loopholes and trading opportunities. These are not stupid people, by the way.

Another provision would require the $60 trillion foreign exchange swaps industry to be overseen by the CFTC, which is the same regulator that earlier this week was considering whether traders could make markets in Hollywood movie futures, but neither of those ideas will fly - especially in foreign currency markets.

To make its derivatives regulation work, and have teeth, Congress and the Obama Administration must resist all exemptions on derivatives trading. They must instead focus on forging a global alliance in the G-20 this weekend in Washington to stand behind the creation of a transparent market in derivatives trading through clearing houses and exchanges.

Doing this would lead to cheaper trading for customers and make it easier for global regulators to supervise the creation of new products. Importantly, it would also allow the big banks to continue to participate in what is in fact a very lucrative and vital business for the global economy, not just to hedgers, but to those seeking loans to rebuild their companies, industries, or countries. Like it or not, banks are the primary lenders and they need to be allowed to do business.

Whether this in fact will happen in Washington, or whether Congress will once again descend into a chaos of partisan bickering and blind and reactionary rule making, is anybody's guess. Goldman is almost certainly betting on both outcomes.

[Apr 15, 2010] ; ; WaMu Examiner Ridiculed, Called "Housing 'bubble' boy" by CalculatedRisk

Apr 5, 2010 | CalculatedRisk

From Jim Puzzanghera at the LA Times: Regulators did little to halt reckless practices at WaMu

Federal banking examiners found serious problems at Washington Mutual Bank at least five years before its 2008 collapse, but their supervisors showed little concern ... During those five years, examiners constantly warned of "less than satisfactory" loan underwriting, the "horrible performance" of its subprime-backed mortgage securities and the failure of WaMu executives and federal regulatory supervisors to do much about it.

One examiner said he was derided by colleagues as "the housing 'bubble' boy" for his "gloom and doom" predictions for some risky loans, and another complained that critics of subprime loans were called "chicken little."
...
Former OTS Director John Reich, who served from 2005 to 2009, referred to WaMu Chief Executive Kerry Killinger as "my largest constituent" in a 2007 e-mail.

That attitude pervaded the upper levels of the agency ...

Once again the field examiners did their job, but their efforts were ridiculed. I was asked by a reporter a couple of years ago who was to blame for the housing bubble, and I said the list is long, but it starts with the regulators ...

[Apr 15, 2010] Guest Post: "Never Even a Whisper" at Fed's Open Market Committee Meetings by George Washington

Apr 13, 2010 | naked capitalism && Washington's Blog

Ben Bernanke, William Dudley and Donald L Kohn are on the Fed's Open Market Committee (FOMC).

They are also on the board of directors of the Bank for International Settlements (BIS) – often called the "central banks' central bank". And Kohn is an alternate director for BIS.

Alan Greenspan, of course, was a BIS director for many years.

Dudley is also chairman of BIS' Committee on Payment and Settlement Systems. (Tim Geithner – previously on the FOMC – previously held that post).

So there is clearly quite a bit of overlap between the two groups.

In addition, BIS' chief economist – William White – and others within BIS – repeatedly warned the Federal Reserve and other central banks that they were setting the world economy up for a fall by blowing bubbles and then using "using gimmicks and palliatives" which "will only make things worse".

As Spiegel wrote last July:

White and his team of experts observed the real estate bubble developing in the United States. They criticized the increasingly impenetrable securitization business, vehemently pointed out the perils of risky loans and provided evidence of the lack of credibility of the rating agencies. In their view, the reason for the lack of restraint in the financial markets was that there was simply too much cheap money available on the market…

As far back as 2003, White implored central bankers to rethink their strategies, noting that instability in the financial markets had triggered inflation, the "villain" in the global economy…

In the restrained world of central bankers, it would have been difficult for White to express himself more clearly…

It was probably the biggest failure of the world's central bankers since the founding of the BIS in 1930. They knew everything and did nothing. Their gigantic machinery of analysis kept spitting out new scenarios of doom, but they might as well have been transmitted directly into space…In their report, the BIS experts derisively described the techniques of rating agencies like Moody's and Standard & Poor's as "relatively crude" and noted that "some caution is in order in relation to the reliability of the results."…

In January 2005, the BIS's Committee on the Global Financial System sounded the alarm once again, noting that the risks associated with structured financial products were not being "fully appreciated by market participants." Extreme market events, the experts argued, could "have unanticipated systemic consequences."

They also cautioned against putting too much faith in the rating agencies, which suffered from a fatal flaw. Because the rating agencies were being paid by the companies they rated, the committee argued, there was a risk that they might rate some companies too highly and be reluctant to lower the ratings of others that should have been downgraded.

These comments show that the central bankers knew exactly what was going on, a full two-and-a-half years before the big bang. All the ingredients of the looming disaster had been neatly laid out on the table in front of them: defective rating agencies, loans repackaged to the point of being unrecognizable, dubious practices of American mortgage lenders, the risks of low-interest policies. But no action was taken. Meanwhile, the Fed continued to raise interest rates in nothing more than tiny increments…

The Fed chairman was not even impressed by a letter the Mortgage Insurance Companies of America (MICA), a trade association of US mortgage providers, sent to the Fed on Sept. 23, 2005. In the letter, MICA warned that it was "very concerned" about some of the risky lending practices being applied in the US real estate market. The experts even speculated that the Fed might be operating on the basis of incorrect data. Despite a sharp increase in mortgages being approved for low-income borrowers, most banks were reporting to the Fed that they had not lowered their lending standards. According to a study MICA cited entitled "This Powder Keg Is Going to Blow," there was no secondary market for these "nuclear mortgages."…

William White and his Basel team were dumbstruck. The central bankers were simply ignoring their warnings. Didn't they understand what they were being told? Or was it that they simply didn't want to understand?

Yet, White said (h/t Edward Harrison) in a short, must-see talk last week that former long-time St. Louis Fed president William Poole told him that there was never even a whisper of these basic concepts at a single FOMC meeting.

Indeed, White says that – even today - the Federal Reserve is doing the same old thing, reading off of the same playbook that caused the Latin American crisis, the Asian meltdown, the Long Term Capital meltdown, and all of the other financial crises of the last couple of decades. And see this.

White, of course, argues for more accurate models which take into account real-world factors such as debt stocks, and include a time-frame longer than 2-year inflation targets or 4-year election cycles.

But as Simon Johnson has repeatedly pointed out, economics used to acknowledge that politics had an important affect on economic policy, but now the economics profession – as a whole – tries to pretend that it is strictly a mathematical and technical art form.

And as I documented last October, economists are trained to ignore – and central bankers and regulators rewarded to the extent that they ignore – the real world.

And we cannot improve our models and understandings of how to prevent another crisis unless the truth of what caused this crisis is openly discussed (under subpoena power); and see this). If the government's entire strategy remains to cover up the truth, then we won't have the chance.

[Apr 14, 2010] ; ; Kirsten Grind Blogging the WaMu Hearing

4/13/2010 | CalculatedRisk

Kirsten Grind at the Puget Sound Business Journal is blogging from the WaMu hearing. How about this quote?

"My opinion is the OTS examiner in charge during the period of time I was there did an excellent job of finding and raising issues. Likewise, I found good performance from the FDIC examiner in charge. What I can't explain is why the superior in the agencies didn't take a tougher tone with banks, given the degree of negative findings. My experience with the OTS and OCC (Office of Comptroller of the Currency, another federal bank regulator) was completely different, so there seemed to be a tolerance there or political influence of senior management of those agencies that prevented them from taking more active stances - I mean, putting banks under letters of agreement and forcing change."
James Vanasek, who was the former chief risk and credit officer of WaMu from 1999 to 2005
We have seen this over and over. Every time the inspector general's office issues a report on a failed bank, the field examiners had correctly identified the problems - usually going back to 2003 or so - but no further action was taken.

Vanasek is arguing this was possibly because of "political influence of senior management of those agencies" - the political appointees in charge. I've heard the same thing from examiners.

Juvenal Delinquent:

In American party, apparatchiks are the life of it.

rich:

Vanasek is arguing this was possibly because of "political influence of senior management of those agencies" - the political appointees in charge. I've heard the same thing from examiners.

Vanasek was the chief risk and credit officer. It was his job, first and foremost, to hold the management of his own firm accountable for responsible lending.

He has no credibility as a witness, so why did they even call him?

some investor guy :

I found this chart interesting, FDIC: QBP Graph Book Click on Non current rates on loans secured by 1-4 family residential properties.

In Dec 09, it shows about 10% of first mortgages in default. However, it shows second mortgages with under 3% in default, and HELOCs with under 2% in default.

Any ideas how this could be happening? 1. Homes with seconds or HELOCs had better underwriting? OK, stop laughing. 2. The lenders on the seconds and helocs have some different incentives about reporting defaults? 3. Somebody made a mess of the data, or did the wrong calculations?

Suggestions?

ghostfaceinvestah:

Anyone notice that a Mish blog got mentioned in the Wamu exhibits? Page 438 of 666.

http://hsgac.senate.gov/public/_files/Financial_Crisis/041310Exhibits.pdf

CalculatedRisk:

rich, and he retired in 2005. But I think his comment is interesting ... and this hasn't been pursued although the appointees blocking regulation was a key failure..

[Mar 18, 2010] Treasury, NY Fed Backed AIG In Feud With Pay Czar -- New York Times Magazine

Mar 18, 2010 | huffingtonpost.com

During the height of the tense negotiations over executive compensation led by pay czar Kenneth Feinberg in recent months, Wall Street had an unexpected ally: the Treasury Department and the New York Federal Reserve, according to Steven Brill's new cover story in the upcoming New York Times Magazine.

After top executives at AIG refused to give back their controversial "retention payments" (read: bonuses) and insisted on all-cash pay packages, Feinberg dug in, insisting that they needed to share risk with the company's shareholders. Among the execs was CFO David Herzog, who threatened to leave the firm if he didn't get to keep his $1.5 million bonus.

"No one at A.I.G. seemed to be embarrassed to argue that the chief financial officer of Wall Street's Titanic was irreplaceable," writes Brill.

(One tantalizing tidbit that serves as the best example of AIG's tone-deafness, the firm spent $3 million -- most of which ultimately came from taxpayers -- on two compensation consultants and two Wall Street firms to file their compensation proposal to Feinberg. Among the expenditures: paying a consulting firm $500,000 to prepare a 167-page PowerPoint presentation.)

Riding to AIG's rescue were Treasury officials, including assistant secretary for financial stability Herb Allison, who met daily with Feinberg and pressed him to not require pay packages in stock.

And the New York Fed, where Treasury Secretary Tim Geithner previously was president, was even more supportive of AIG and other Wall Street giants, reports the Times. As an example of their close ties, Brill notes that the law firm advising Citigroup and General Motors in the compensation negotiations -- Davis Polk and Wardwell -- also worked for the NY Fed on TARP matters, charging from $305 to $1,055 per hour.

As reported by HuffPost earlier this month, AIG employees still haven't paid back in full the $45 million in bonuses they promised to return last spring in the wake of public outrage.

Yesterday, the Wall Street Journal reported that AIG's outgoing counsel would be paid several million dollars in severance after she resigned over Feinberg's mandated curbs on her compensation.

[Dec 8, 2009] Did Bank Executives Lose Enough to Learn their Lesson

The is an interesting correlation/interpay/interdependency between corruption of finacial regulators and corruption of the industry as a whole.
Dec 06, 2009 | Economist's View

Will the losses that financial executives suffered as a result of the crisis provide the discipline necessary to prevent excessive risk taking in the future? Not according to this analysis:

Bankers had cashed in before the music stopped, by Lucian Bebchuk, Alma Cohen, and Holger Spamann, Commentary, Financial Times: According to the standard narrative, the meltdown of Bear Stearns and Lehman Brothers largely wiped out the wealth of their top executives. Many – in the media, academia and the financial sector – have used this account to dismiss the view that pay structures caused excessive risk-taking and that reforming such structures is important. That standard narrative, however, turns out to be incorrect.

It is true that the top executives at both banks suffered significant losses on shares they held when their companies collapsed. But our analysis ... shows the banks' top five executives had cashed out such large amounts since the beginning of this decade that, even after the losses, their net pay-offs during this period were substantially positive. ...

Our analysis undermines the claims that executives' losses on shares during the collapses establish that they did not have incentives to take excessive risks. ...[R]epeatedly cashing in large amounts of performance-based compensation based on short-term results did provide perverse incentives – incentives to improve short-term results even at the cost of an excessive rise in the risk of large losses at some (uncertain) point in the future.

To be sure, executives' risk-taking might have been driven by a failure to recognise risks or by excessive optimism, and thus would have taken place even in the absence of these incentives. But given the structure of executive pay, the possibility that risk-taking was influenced by these incentives should be taken seriously.

The need to reform pay structures is not, as many have claimed, simply a politically convenient sideshow. ... To understand what has happened, and what lessons should be drawn, it is important to get the facts right. In contrast to what has been thus far largely assumed, the executives were richly rewarded for, not financially devastated by, their leadership of their banks during this decade.

It doesn't really matter whether executive compensation structures caused or contributed to the crisis or not. If the manner in which executives are paid creates perverse incentives and distorts decisions away from the best interests of shareholders, as it appears to do, then both the level and structure of the compensation should be fixed. Selected comments

Bruce Wilder:

There's a tangentially related issue, that may be more central to policy: just how much can the financial sector skim off the real economy, before the real economy croaks?

Minsky called it the shift from hedge finance to speculative finance, others have called it Casino America, but high executive compensation (and what bank executives were paid is almost nothing compared to what the top hedge fund managers take) is a core driver behind the financial sector's growth as parasite. A healthy, living economy cannot afford the size, or kind, of financial sector we have.

Bruce Wilder:

Magnitude or level is a critical issue.

There's no way, on this plane of reality, to make rewards of such magnitude contingent on any informational measure, and not create overwhelming incentives to corrupt the information, itself. Whether it is accounting fraud, or undermining ratings agencies, or bribing boards of directors, or whatever else the fertile mind of man can conjure, if there's enough money involved, it will be done.

And, there's no way honest financial services can generate the kind of profit that can generate this level of compensation. I've been told that in 2006, the top 25 hedge managers, together, took home more than the whole of the Fortune 500 top rung. The mind boggles.

It never seems to occur to University of Chicago morons that their precious Efficient Market Hypothesis -- if it was only half true -- would make such rewards highly suspect. But, put that aside, how can such rewards be funded, without making everything from home mortgages to credit cards, risky and expensive for consumers. Oh, wait, everything from home mortgages to credit cards are risky and expensive!

Bruce Wilder -> Bruce Wilder...

And, yes, I know rates are very low, at the moment, on home mortgages. But, ask those folks facing foreclosure on their pick-a-pay ARM how "cheap" their home financing turned out to be.

What I'm saying is, that to pay the CEO a hundred million plus requires transforming a community thrift into a loan shark. It requires transforming a fixed-rate 30-year into some kind Ponzi scheme cum three-card monte.

cm:

Bruce Wilder: "Did bank executives lose anything?"

According to the quoted piece, they lost (some of?) the unrealized sales value of their stock holdings of which they hadn't divested themselves yet. Aside from that, I'm not even sure they lost anything major in bonuses. They certainly didn't have to return any of the cream they had skimmed off all that time.

cm:

And on the topic, what is that lesson they ought to have learned? Gamble big enough and rub shoulders with the right people, and you will be bailed out?
;

Lafayette -> cm:

ROBBER BARON REDUX

{Gamble big enough and rub shoulders with the right people, and you will be bailed out?}

Is it this, or "Gamble big enough and should you fail, the Treasury will HAVE to bail you out"?

I suspect this was in the backs of their minds all along. And the fact that one of them was placed in the Treasury, at just about the right time, must make one think that the plutocrats (in the Bush Administration) knew what was coming and planned for it.

By the time Bo&Co arrived it was a done job.

I've had my misgivings for a great while of market consolidation and the conventional wisdom of bigger-is-better. Market concentration may allow one to touch the Holy Grail of higher efficiencies, but Goldman Sachs has proved that the failure of Lehman Bros. caused reduced competition and therefore enhanced profits for those remaining.

And how was that beneficial to the economy? Aside from benefiting a select few. It's Robber Baron Redux.

POST SCRIPTUM

And how will the present composition of Investment Banking change anything at all? They are already back to their old tricks - and the profits shall rain down upon Wall Street.

Beezer:

FDR's second inaugural address:

"Four years of new experience have not belied our historic instinct. They hold out the the clear hope that government within communities, government within the separae States, and government of the United States can do the things the times require, without yielding its democracy. Out tasks in the last four years did not force democracy to take a holiday.

Nearly all of us recognize that as inticacies of human relationships increase, so power to govern them must also increase-power to stop evil; power to do good. The essential democracy of our Nation and the safety of our people depend not upon the abseence of power, but upon lodgin it with those whom the people can change or continue at stated in intervals throuh on honest and free system of elecions. The Constitution of 1787 did no make our democracy impotent.

In fact, in these last four years, we havemade the exercise of all power more democraic; for we hve gegun to bring private autocratic powers into their proper subordination to the public's government. The legen that they were invincible--above and beyond the processes of a democracy--has been shattered. They have been challenged and beaten."

If only Obama would strike the right chords of FDR, we would not be in our current dilemma.

mrrunangun:

The lesson the banksters learned is that if you are TBTF, the bigger the risk you have on, the safer your position becomes, as the government has fewer and fewer options apart from bailing your bank out and you with it. So, the TBTF crowd has expanded the risk it has on in response to the incentives provided by the government. Ask any Goldman MD. Or check the runup in stocks, commodities, etc since the bailouts were disbursed.

Jesse:

Bruce Wilder's comments are remarkably to the point.

The bank executives and corporate America have learned the lesson of the last 30 years quite well.

Lobby hard, make connections in government, leverage up, and if you get caught breaking the rules be prepared to settle up for a wristslap, while continuing to collect outsized returns for yourself. And every once in a while feed a small fish, a relative outsider, to the mob.

Above all, get in front of the process and maximize your leverage, always. It could be known as Robert Rubin's Principle of Market Management.

Josh Stern:

Couple of related points.

1) It was very common on Wall Street for lots of even mid level employees involved in lending related activities to earn substantial bonuses as a function of the overall revenue volume of underwritten loan product, never mind the diligence quality or the ultimate default rate. Perverse short term incentives were endemic to the banking industry itself and not just the top execs.

2) The GSEs also had a structural incentive to turnover as much product as possible and their performance in this crisis has been as bad or worse than anywhere on Wall Street, their subordination to Congressional "oversight" not withstanding. Fannie and Freddie will probably end up costing the taxpayer a lot more than TARP+TALF or AIG.

3) Bruce Wilder's claim above that execs at investment banks or hedge fund managers could not *possibly* be worth their compensation is demonstrably wrong. Most of them clearly *were not* worth their compensation, but the difference between very good and very bad performance with the set of decisions their firms were involved with is much, much higher than their compensation. So the BOD's of the IBs (and the endowment and pension trustees who invest with "20+2" hedge funds) are typically wrongheaded in their beliefs about the performance they will be getting in return for this compensation structure.

cm -> Josh Stern:

On (1): That's right, but this is a feature of every sales force, in varying degree. In all (for profit) businesses I have heard about, the people whose job description includes initiating and managing sales are always on a commission style plan.

On (3): I think you are splitting a hair. Or else, you have skipped over the critical word "honest" in BW's exposition. But then of course it may be open to what interpretation of "honest business" is applied ...

Josh Stern -> cm:

"On (1)" - clearly that has been the tradition, and its also clearly true the case that in the case of, say, selling cars, the company knows a lot about its ultimate profit at the time of sale whereas in the case of lending it doesn't know until the loan is quite mature.

"On (3)" - I'm not splitting hairs. There are honest business execs and firms that "generate" that level of profit in the sense that their firms achieve many magnitudes of their compensation in profit and it is not based on illegality. The problem is that the people deciding on compensation are either a) not typically able to differentiate between good and bad execs or b) wrong about the role of chance or other factors in the trailing performance of the successful execs (e.g. naive about regression to the mean, etc), or c) corrupted by other interests than representing the shareholders they are hired to represent.

So I see fertile ground for debate about the relative merits of a), b), and c) and what to do about it, and don't see much merit in the notion that the exec compensation is earned through criminality.

OriginalFred -> Josh Stern:

In order to make the sitution with (3) clear, let's an example. An institution gives $1 billion to a hedge fund, which puts the entire $1 billion into SP500 index fund. Then, at the end of each year, the hedge fund plays a game with Goldman Sachs using the value of the SP500 index fund as its stake. Odds for winning this game are 9/10 and payoff for winning is 10%. Odds for losing are 1/10, the penalty for losing is the entire stake. So the house advantage is 10% and GS is happy to play. Each time the hedge fund wins, the hedge fund outperforms the SP500 benchmark by 10 percentage points, so the hedge fund manager collects 2% base fee, plus 20% * 10% = 4% incentive fee, less expenses, which I'll assume to be 1%. So the hedge fund manager nets 5% of $1 billion or $50 million for basically doing nothing other than taking very dangerous risks with other people's money. IMO most or all of the blame should go to the manager at the institution which provided such a foolish incentive structure. This example is not far from reality.

Josh Stern -> OriginalFred:

I mentioned above that the investors in "20+2" hedge funds are wrongheaded so there is no disagreement about that, and I also agree with the widely discussed idea that this type of compensation encourages excessive risk taking. However I don't see your "example" as having much relevance to either reality or the prior discussion. I'll note all of the following:

a) Equity based hedge funds as a class actually suffer high percentage losses less often than their equity benchmarks - hedge funds losing all shareholder capital is quite rare as a percentage of the number of funds.

b) Some large well known equity oriented hedge funds do have a track record of generating high alpha over long periods - e.g. Simon's Renaissance fund.

c) The "20+2" compensation structure practically ensures that hedge fund managers achieve very high compensation over time just by trying their best honestly, so the contrived conspiracy example isn't necessary to explain high compensation.

d) Hedge funds can take high risk by using leverage - this is widely known and doesn't involve a conspiracy with Goldman Sachs or any other organization. When they use a lot of leverage and outperform then they outperform by a lot more than 10%.

e) The academic literature that claims it is almost impossible to achieve significant alpha is actually pretty junky and simpleminded. If you are interested in restricting attention to algorithmic strategies for equities and want to roll your own, checkout the website portfolio123.com

f) Hedge funds don't seem to have all that much to do with the recent financial crisis. Of course a few playing ABS from the long side had huge losses and a few playing it from the short side had huge gains. Big deal. The largest concentrations of RMBS and CMBS were apparently in banks.

g) Not that it matters to anything, but if you work through the math, the house advantage in your contrived example was actually 1% rather than 10%.

OriginalFred -> Josh Stern:

The purpose of the contrived example was to prove a point. And yes, the reality involves leveraging up, investing in something with lots of beta compared to the benchmark, so that you do quite well until you don't. But stated as such, it won't be clear to the readers on this blog what is so crazy about the incentive structure. GS was just to add color to the example since everyone seems to be in the mood for demonizing Wall Street.

And no, the hedgies didn't cause the crisis, but their crazy incentive structure is definitely part of the larger phenomemon of no one minding the store which IS related to this crisis: institutions allowing hedge funds to play "heads I win, tails you lose" with their endowments, individuals treating the stock market like a casino, voters choosing politicians on the basis of soundbites and haircuts...

I stand corrected on the odds. And GS will be happy to play at 1% house advantage (assuming they can play a large number of times).

Josh Stern -> OriginalFred:

"The purpose of the contrived example was to prove a point."

But it didn't connect to any point I could discern. The argument in the sub-thread above was about whether the high compensation packages of bankers and hedge fund managers were in excess of what could possibly be achieved by honest means (and therefore we are invited to infer that they are committing fraud or theft). I pointed out that they were not, though generally speaking it was a statistically poor bet that the performance in question would turn out to be worth the compensation. Someone else claimed this distinction was "splitting hairs" and you replied with an example of how hedge funds work that involved fraud and wasn't similar to how hedge funds work. I'm sticking to my position that it matters quite a bit whether we are talking about fraud by financial managers or misguided choices by financial clients/shareholders.

OriginalFred -> Josh Stern:

Thank God someone has the wit to put the blame where it belongs rather than simple-mindedly blaming the banksters and hedgies for everything. Unfortunately, you didn't get point one right. Why did the shareholders permit such perverse and excessively short-term incentives? Why did Congress not establish laws so that shareholders would be in a position to vote out incompetent managers who allowed such foolish compensation structures? Why did not the people vote out Congressmen who refused to pass such laws?

Blaming everything on banksters and hedgies ensures that we will NOT get the reform we really need.

Josh Stern -> OriginalFred:

IMO, we need the SEC to reform the allowed director election processes for public corporations in order to make them more open and transparent (I have posted the same thing in a few previous threads on this site). But is that enough, or must we also require directors to have more of a financial stake in the long term performance of the companies?

The shareholders are legally in a position to vote out bad directors in theory, but this isn't working out well in practice for various reasons that need to be better understood. That is a theme I have been trying to advocate for in this and other threads.

ben -> Josh Stern:

When an auto worker decides whether to put the right part in the engine, the difference between very good and very bad performance is thousands of dollars. But we don't pay the auto worker thousands of dollars for every car that goes down the assembly line.

OriginalFred:

Whether through losses or gain, bank executives have most certainly learn this: the private sector must look towards partnership with the public sector in the future in order to reap truly outsize profits. We can thus expect more of the best and brightest to do a stint in government before moving into the private sector. Same thing we've always had the military-industrial complex, but now extended to all areas of the economy. All part of the steady progress towards Argentina-style corruption.

save_the_rustbelt:

Vanity Fair on-line has an interesting profile of Goldman Sachs (VF has been doing an excellent series on the financial crash, Madoff, etc.).

Did they learn anything? Bankers do "other people's money" times two; shareholder funds and depositor/investor funds. Why would they care about risk short of being sued into personal bankruptcy or prosecuted?

ken melvin:

I don't think that Eliot Spitzer will have any trouble finding the clients with the money to bring civil suits against these good fellows.

save_the_rustbelt -> ken melvin:

I think many lawsuits have already been filed, but it will be very difficult to get to judgment on more than a handful of executives if at all, and of course Bear and Lehman are not collectible.

Bruce Wilder:

Joel Stern: "The "20+2" compensation structure practically ensures that hedge fund managers achieve very high compensation over time just by trying their best honestly"

Well, as long as they are trying their best, I guess there's nothing to complain about, is there?

Still, I wonder where the returns come from, to fund this level of compensation. From failing pensions, perhaps. From destroying labor unions. From payday lenders. From usurious credit card rates.

Because they sure haven't come from funding vibrant, innovative new industry.

I understand, as a general principle, in competitive financial markets, high returns come associated with high risk. Are the masters of the universe creating risk to generate the return? Or, keeping the return and delivering the risk to the unsuspecting? Either way, it is likely to prove socially destructive.

One thing I'm sure of -- the returns don't come from "honest trying". Blow your smoke somewhere else.

reason:

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2009/12/bonuses-ideology.html

Lafayette:

MEGABUCKS

{MT: If the manner in which executives are paid creates perverse incentives and distorts decisions away from the best interests of shareholders, as it appears to do, then both the level and structure of the compensation should be fixed.}

And how, pray tell, must this happen if we do not tweak marginal income rates?

Are we going to have a Banksters-only income tax? No, the Supremes will slap that one down.

Let's say they made 10, 20 30 million a year over the decade in question, which was taxed at 80%. That still makes for the lowest figure mentioned a neat 2 megabucks of income and for the highest 6 megabucks.

That will alter or change their management objectives or style?

Yeah, right ...

POST SCRIPTUM

The last time the Robber Barons scammed us was that of the railroad magnates in the 1880s. There was no American income tax until 1913 ...

This time around there is one and the highest it has ever got is during WW2; up to 88% in 1942 (See here: http://en.wikipedia.org/wiki/Income_tax_in_the_United_States )

Maybe its time to put it back up to that level by means of a more highly progressive marginal tax? Why not just try it for a decade or so to see if if it "stifles innovation and entrepreneurship". How about a little real-time economic policy experimenting?

It'll do us a world of good and close the claptrap sophistry of the Replicants as regards money incentivizing.

John Emerson:

I'm and economics nihilist and a pitchfork populist, and whenever I suggest that there should be negative consequences for the malefactors I am given a string of explanations why not: a.) they lost everything themselves and have suffered enough, b.) it was a systemic problem and no one was really to blame, c.) punishing individuals will not change the systemic problem, d.) only the malefactors know how the system works, and we need their help to fix things, e.) the bad guys are still powerful enough to make things worse, and we can't make them mad, f.) populists are all ignorant Nazis g.) aren't we really all to blame? and h.) trust us, we're taking care of everything.

Based on what I've read, this collapse is a pathology of the expert elite. The experts in charge were corrupt,self-serving and arrogant, claiming an scientific understanding they really didn't have, and as they led us to disaster they feathered their nests very successfully.

I can imagine an effective, economically justified center-left response to this problem, but I can't imagine it coming from the present Democratic Party because it's too compromised (look at Barney Frank), and I can't imagine it coming from the economics profession because too many of them are also compromised, very few are willing to stick their necks out politically, and most are unwilling to take on those of their professional superiors who helped cause to the problem.

Lafayette -> John Emerson:

{I can imagine an effective, economically justified center-left response to this problem, but I can't imagine it coming from the present Democratic Party because it's too compromised (look at Barney Frank), and I can't imagine it coming from the economics profession because too many of them are also compromised, very few are willing to stick their necks out politically, and most are unwilling to take on those of their professional superiors who helped cause to the problem.}

Quite right, prostitution has its drawbacks. It forces one to keep their mouth shut.

graspthemarket:

I knid of added bits and pieces from what I read above. Thanks for some interesting insights.

1. I agree with Bruce: did bank execs lose anything? I think I'm going to file for my own personal bailout, except I'll only ask for $500 million.

2.I doubt any lesson was learned because I think more situations like Dubai will begin to surface. Who's in charge of the money still? Basically the same people, just some musical chairs.

3. Coolidge said right before he left office in 1929 to not worry about the economy. Everything is fine. We all know what happened later that year. Let's see...the general feeling out there is now is to not to worry...maybe we should be worried the most when we are told not to worry.

[Oct 3, 2009] Madoff, Finra, and the woman who would be SEC chair by Sam Jones

Absolutely hilarious
Jan 15, 2009 | FT Alphaville

Mary Schapiro is Barack Obama's nominated candidate for the post of SEC Chair. Today she faced a grilling from the Senate, which by all appearances, should have been a tough one.

Why? Primarily because of the Obama camp's pointed recent criticism of SEC incumbent Chris Cox. As Felix Salmon notes:

Mary Schapiro is going to face some very tough confirmation hearings on her way to taking over the SEC, and in the wake of a big WSJ article today, her confirmation is by no means a foregone conclusion.

Indeed, the WSJ pulls up a host of complaints against Schapiro, who - to be frank - hasn't exactly gilded her teapot during her tenure as head of Finra - the financial industry regulatory authority. Reports the Journal:

Among other things, Finra monitors brokerage firms' sales practices to determine that investors are being sold products suitable for their needs. It reviews brokerage firms' capital positions and makes sure customer funds are handled properly. It seeks to ensure that firms have adequate procedures to price hard-to-trade securities and monitors customer complaints firms receive concerning both sales practice and operational issues.

Auction rate securities? CDOs? There's two biggies that Finra rather missed. Excuse?
Frank Congemi, a financial adviser, asked what Finra was doing to regulate "packaged products" such as complex mortgage securities. Mr. Congemi says that Ms. Schapiro replied: "We have rating agencies that rate them."

Ah, bien sur.

Then of course, there's Madoff. The Journal doesn't really touch on the detail of Mary's Madoff miss. So we shall.

This paragraph caught our eye from the Boston Globe:

FINRA and its predecessor, the National Association of Securities Dealers, has been examining the records of Madoff's broker-dealer operation, Bernard L. Madoff Investment Securities, every two years since the firm started in 1960. The last exam was in 2007, Perone said.

And?

"There was no evidence of the Madoff broker-dealer executing trades for the [Madoff] investment adviser," said Herb Perone, spokesman for the regulatory group, the Financial Industry Regulatory Authority. A broker-dealer is any firm that buys and sells securities.

Finra has known since at least 2007 - presumably much earlier - that Bernard Madoff's huge $50bn investment fund did not make a single trade through its own personal brokerage, Bernard L. Madoff Securities Dealers.

Did they not think this was odd? Why would Madoff's huge fund be placing all its orders with rival brokers? Why, when Bernard L. Madoff Securities Dealers could have been taking all the handsome fees that went with said orders, as presumably, it was set up to do.

Why indeed, unless, Madoff wasn't making any trades at all. That's the Globe's conclusion anyway.

The crux of the matter is that while Schapiro probably won't be a good SEC chair, she won't be a bad one either. The worm has already turned. Regulation and oversight is going to get tougher for the banks irregardless of the SEC chair's quiescence.

Through her tenure at Finra, Schapiro went with the flow: she didn't rock the boat. And if she goes with the flow now, that'll be fine too. The SEC's power isn't, in the coming months, going to be set by its chairperson, but proscribed by the political mood at large. The influence of the SEC has already been lost.

The Treasury calls the shots now. It's Geithner who'll regulate Wall Street. Assuming, that is, there's any Wall Street left - and that Geithner gets confirmed.

All that in mind, it's disappointing that Schapiro confirmation hearing was, in fact, a total snore. The Senate Banking Committee missed a trick on this one.

This entry was posted by Sam Jones on Thursday, January 15th, 2009 at 19:05 and is filed under Capital markets, People. Tagged with Chris Cox, finra, madoff, Mary Schapiro, sec, Tim Geithner.

williambanzai7:

What we need is a prosecutor running the SEC. Say all you want about Spitzer. He connected the dots and put the fear of god in executive suiites of Wall Street.

[Oct 3, 2009] Finra get an F - 'failed to investigate' by Stacy-Marie Ishmael

Oct 02, 2009 | FT Alphaville
Finra, the main regulatory body for the US brokerage industry, issued a mea culpa on Friday in the wake of an internal report that found the agency repeatedly failed to investigate tips about accused Ponzi schemer Sir Allen Stanford and convicted Ponzi schemer Bernard Madoff.

Among other findings, the report said Finra's staff were "not adequately trained" in the conduct of investigations and that the regulator lacked procedures to bring cases to senior management or special investigators "based on the gravity and substance of the fraud allegations".

In a statement that managed to be both contrite and self-congratulatory, Finra's chief executive officer Richard Ketchum (oh, the irony) said:

Today's report by a Special Review Committee of the FINRA Board of Governors is one of a number of significant initiatives undertaken by FINRA in the wake of the Madoff and Stanford scandals to better understand and correct shortcomings in our examination program. As regulators, we owe it to investors - especially those harmed by recent scandals - to develop a better, more comprehensive response to fraud, and I am committed to taking the lessons from the report's findings to make FINRA even stronger.

Finra said it would create a new "Office of Fraud Detection and Market Intelligence" to "provide rapid response to fraud by a staff with expertise in fraud detection and investigation".

No word on where they are finding these staff.

The Finra self-flagellation comes after a similar report by the inspector general of the Securities and Exchange Commission into that regulator's conduct in investigating Sir Allen and Bernard Madoff.

On Stanford, the inspector general found the SEC did not breach its obligations to investigate the Texan businessman's empire, which stretched from Houston to Antigua via Venezuela and Canada. Sir Allen has denied all the charges against him.

But on Madoff, according to the massive 457-page report filed by the SEC's inspector, the regulator failed spectacularly.

All of which forces the question - did anyone do their jobs? Anyone?

vikram

it was all about friends up in high places i am not a conspricy theorist but a realist only when he got caught with is pants down they all scarpered

PoloPony

Errrr... wasn't it Ms. Shapiro who led Finra at a healthy salary when this lack of zeal occurred?

"Mary Schapiro, the new Securities and Exchange Commission chairman, is receiving a lump-sum payout of between $5 million and $25 million from defined-benefit retirement plans of her former employer, the Financial Industry Regulatory Authority, according to a disclosure statement released Wednesday by the U.S. Office of Government Ethics.

The payout is in addition to the $2.75 million in compensation she received last year from the authority, known as Finra, which is the brokerage industry's self-regulatory body, according to her disclosure statement.

Ms. Schapiro also reported that she received a $675,033 payout for deferred compensation from Kraft Foods Inc., where she served as a board member until resigning to take over the top post at the SEC. The company paid her $184,600 last year for her board service.

Let's hope she acts with more zeal at a lower salary.

[Sep 2, 2009] The Real Regulatory Revolving Door

Sep 2, 2009 | nakedcapitalism.com

A reader who has first hand knowledge of some of the major US financial regulators flagged a CounterPunch article by Pam Martens as the best discussion of the "revolving door" problem that he had ever seen.

The interesting thing about this article is that it highlights a problem that is not widely recognized and therefore has no safeguards against it. As our correspondent explains:

The most important aspect of this is that the "revolving door" problem is most acute, not with the actual regulated firms, but with the professional firms that provide services to regulated entities, especially law firms (it is also a serious issue with compliance consulting firms, although that is something of a separate issue.)

One reason for that is that the standards are different for lawyers than for financial professionals. Financial professionals are forbidden from joining any company they have recently examined; but lawyers are forbidden only from working on cases they have had contact with –- there are no specific prohibitions on working for law firms that have cases that they have had contact with, as long as they don't work on those cases (as if that could ever be enforced.)

That means that lawyers like Linda Thomsen, who as head of Enforcement would have been familiar with every case of significance, could go directly to work for a securities law firm already handling cases which she would most certainly have been familiar with, without Ethics making so much as a peep. I don't know how that can be seen as anything other than a serious conflict of interest.

I strongly disagree with the argument that SEC lawyers have incentives to drop cases to curry favor with future employers. On the contrary; they have every incentive to break big cases, which is the stuff that careers are made of. And it is the law firms, not the financial firms, that will most likely be their future employers.

Where they do have an incentive, however, is to quickly settle those cases; they get credit for making the case, but the penalties inflicted are not enough to cripple the big Wall Street firms that (through the law firms they hire) will be the ultimate source of income for the lawyers after they move into the private sector. If they were to do nothing, they would be seen as incompetent, and nobody would hire them; but if they do too much, they disrupt the revenue stream that ultimately feeds the securities law industry.

A key section of the Martens article, which is worth reading in its entirety:

The team that produced this report on one of the most long-running and convoluted frauds [Madoff] in the history of Wall Street included Inspector General H. David Kotz who came to the SEC-IG post in December 2007 after five years as Inspector General and Associate General Counsel for the Peace Corps. The Deputy Inspector General, Noelle Frangipane, also came to the SEC from the Peace Corps where she had served as Director of Policy and Public Information.

This lack of Wall Street cronyism by the top two in the Inspector General's office might have been refreshing to some in Congress and compensated for their not knowing the difference between puts and calls and peaks and troughs and the intricacies of Mr. Madoff's split-strike conversion strategy (he splits with your money while converting you to a pauper). But the background of the member of the team heading up the Inspector General's Office of Investigations, J. David Fielder, should have rang serious alarm bells to Congressional investigators.

For the ten years leading up to July 2007, J. David Fielder worked for the SEC as a Senior Counsel in the Division of Enforcement. In February 1999, he moved to the Division of Investment Management, first as Senior Counsel on the Task Force for Adviser Regulation, then as Advisor to the Director. In November 2000, SEC Chairman, Arthur Levitt, appointed Fielder Counsel to the Chairman.

In July 2007, Mr. Fielder was invited to join the corporate law firm, Haynes and Boone LLP, as a partner. In other words, Mr. Fielder's government issue rolodex filled with the names, home numbers and email addresses of his colleagues at the SEC along with the investigatory matters in his head is deemed fungible currency among corporate law firms and can be freely exchanged for partner status, instantaneously moving one from the lowly wages and attendant lifestyle of public servant to the rarefied bracket and luxuriant trappings of corporate law firm partner.

But what happened next is where things get interesting. In March 2009, just as the SEC Inspector General was hot in pursuit of Madoff aiders and abettors, Mr. Fielder gave up his lucrative partner status at Haynes and Boone to accept the lowly post of Assistant Inspector General of Investigations, working under a boss from the Peace Corps. In other words, he gave up big bucks for a demotion at the SEC.

What Mr. Fielder did might not raise alarm bells were it not happening on a regular basis throughout the corridors of Washington and Wall Street. To understand the implications, this maneuver deserves an appropriate name. A revolving door is assumed to mean one gets all the right connections as a public servant and cashes them in to the highest bidder in private industry. That concept doesn't typically entertain the door revolving back to public servant status. On Wall Street, they call a maneuver like that a round trip: you buy 100 shares and eventually sell the same 100 shares. You end up back where you started: a round trip.

Just how many lawyer round trippers are involved in the Madoff investigation? Enough to raise a strong stench of circular corruption.

Ina Pickle September 2, 2009 at 7:05 am

The correspondent may be right about a revolving door, but he is wrong about the ethical rules governing lawyers. You cannot work against the former client, not just on any cases you had before, but on any new cases. The client owns your loyalty for the rest of your professional life. The client can waive some conflicts, but not others.

So: the rules on lawyers are actually much stricter than the person thinks. Yes, you can SOMETIMES work for a firm that has the other side of a case or deal, provided that you are "chinese walled." But that is really not common (probably more common in transactional law than litigation). Few lawyers and law firms are willing to take the risk of an accusation – these are career ending events if you were to break the confidence and accidentally share something that hurt the former client. Also, clients get royally pissed that you affiliated with somebody who works against them. What the correspondent doesn't seem to realize is that the stricter rules tend to make you even more bound to the client because you can tend to be stuck to one large client in fields where competitors tend to sue each other. So in some fields, like oil and gas, a firm might work for several majors. In a field like investment banking, not so much.

With deals, companies will have their preferred lawyers and not change much. Also, the more you move your business around, the more you can block firms from helping your enemies. I have sometimes suspected that firms went on campaigns to sew up potential opposing counsel.

This is a little simplistic, but the person seems to have an overly negative idea of the ethics rules under which lawyers operate. Law firms take conflicts checks VERY seriously, as do individual lawyers. If practices around Wall Street have changed, it is out of necessity. Several investment banks *used* to be a hundred years old: that is a lot of conflicts history. And you would still have to get the clients' consent.

I honestly believe in regulatory capture. But what you ought to ask yourself, perhaps, is how one can take graduates from the same two or three colleges and business schools, and expect different thinking from them if they are plopped into different work environments? They are still socializing with the same bunch educated at the same two schools, still living with those people, working with those people – but one group is supposed to be policing the other. If you ask me, take a look at everybody who went to Harvard over the past 25 years, and there is the start of your revolving door. The "elites" in all fields across the East Coast already have a lot in common before they start work.

LeeAnne September 2, 2009 at 7:17 am

So Felder has been rehired by the SEC after 2 years of orientation by the law firm Haynes and Boone LLP to become counter intelligence for the Madoff operation back at the SEC? Do we have an espionage thriller here?

A lawless industry fueled by political and regulatory capture would use more than just a few tools perfected by military and criminal organizations for covert activities.

I'm looking forward to an expose of the finance industry's private investigation and para military organization hires with their personnel migration patterns.


DownSouth, September 2, 2009 at 7:43 am

Yves,

Reforming the polity at this point is more important than reforming the economy. If we attempt economic reform before political reform is accomplished, we're just going to wind up with more disasters like the 2003 drug benefit for the elderly or the recent (and ongoing) bank bailout. What with Obama's backroom deals with BigPharma that we already know about, plus heaven knows what else we don't know about, the more astute observer can already see where healthcare reform is headed–huge benefits to powerful insiders, little benefit to the general good and huge cost to taxpayers.

I notice this post, along with a couple of other recent posts dealing with the Fourth Estate http://en.wikipedia.org/wiki/Fourth_Estate , deal more with political reform than with economic reform. I believe this is key, and I salute your efforts, as I am convinced that substantive economic reform is impossible without first achieving political reform.

The most radical creed of the American Revolution was that of the separation of Church and State. As Daniel Yankelovich put it, "the enemy was entrenched inherited privilege embodied in the church and in most branches of European royalty in collusion with each other." Granted, the revolution was nominally against the British monarchy, but the Founding Fathers were acutely aware that the monarchy and the church were so inextricably interwoven as to be all but one and the same.

Today we face a similar problem, but instead of an unholy alliance between church and state, we have an equally pernicious alliance between major business corporations and state.

The first American revolution institutionalized the separation of church and state. I think we need a second American revolution that promulgates separation of big business and state.

You've already posted on a couple of the problem areas that require reform before the deathgrip that big business enjoys on the polity can be loosened. Let me repeat those and add a couple more (this is not meant to be a complete list):

• The Fourth Estate (the press, media)
• The Revolving Door
• Campaign Finance
• The Academe (and here I'm not just talking about the aberrant economics departments and their capture by business interests, but the equally perverse Nobel prize committee)

jake chase, September 2, 2009 at 1:05 pm

The truth about the SEC is not intuitive. One must have worked there as I did forty years ago (when, allegedly, it WAS enforcement minded) to understand that teh agency is a small army of bureaucrats who are simply biding their time either until retirement or escape to lucrative private practice. To the extent any enforcement takes place, it is directed against a fringle element of tin horn promoters, penny stock floggers, arrant confidence men whose pitches are so transparently idiotic that anyone falling for them really has only himself to blame. As for the top tier finaglers, they are strictly off limits. When a white shoe firm has a client with a problem, he calls the man at the top of the enforcement chain, who instructs the juniors accordingly.

Instead of this regulation tapdance, what we need to enforce honesty in business is integrity in the legal system. Unfortunately, we have defendant oriented federal judges who are universally hostile to shareholder interests, as well as state regulation which insulates management against liability in order to pile up franchise fees. Delaware is the leading culprit in this regard. The Congress could solve this problem by insisting upon federal charters for publicly traded corporations. They never will because the corporations will never permit it.

The dog that didn't bark by Beatrice Weder di Mauro, a member of the German Council of Economic Experts

It's pretty funny because Economist was the citadel of this "greed is good" delution.
Oct 1, 2009 | The Economist
In a guest article, Beatrice Weder di Mauro, a member of the German Council of Economic Experts, argues that financial regulators need better incentives

THE summitry never stops. After the G20's meeting in Pittsburgh on September 24th and 25th, the jawboning now moves to Istanbul, for the annual meetings of the International Monetary Fund and World Bank. Policymakers seldom tire of talking about distorted incentives in the private sector-pay packages that encouraged bankers to think only about the short term, for example. But they should look in the mirror, too. The public sector is also affected by huge incentive problems, which help explain why regulators were unable to clamp down on finance during the bubble and why it is so difficult to withdraw the implicit promise of state guarantees.

Perhaps the biggest problem is something that economists call "time inconsistency". Monetary policy is the best-known example of this phenomenon. Central banks try to anchor inflationary expectations by sounding tough. But if the private sector raises wages anyway, central banks are reluctant to tighten policy and cause unemployment. The knowledge that monetary policy suffers from this inconsistency over time undermines the credibility of the initial, hawkish announcement. The same sort of problem affects financial regulators and supervisors. They have incentives to announce a no-bail-out policy in order to encourage their charges to behave prudently. But as soon as crisis strikes, the optimal choice for policymakers differs from the pre-announced policy: the authorities will usually offer support. The banks anticipate this behaviour and run even more risks as a result.

Two other incentive distortions reinforce this bias towards bail-outs. The first is that most supervisors-with the notable exception of America's Federal Deposit Insurance Corporation (FDIC), which both regulates deposit-taking banks and administers their insurance fund-do not put the capital of their own institution at risk. The second is that a policy of regulatory forbearance may save the supervisor as well as the bank: hiding losses in financial institutions from public scrutiny may also help conceal regulatory and supervisory failure.

Stockholm syndrome

Incentives also help explain why regulators resist the delegation of powers to supranational institutions. Supervisors may wish to protect the local industry or secure a competitive edge over other financial centres. Even without a protectionist agenda, supervisors are prone to capture: because they talk to local institutions on a daily basis, they are likely to empathise with the competitive pressures that those banks face. Pay is also a problem. In most countries compensation structures for national supervisors will involve low salaries, no bonuses and small rewards for doing a good job. Supervisors get into trouble if they go out on a limb and make a technical mistake (and a bank sues), but face fewer problems if everybody makes the same material mistake and the system goes down. It does not help that officials are repeatedly told that the smartest people go where the money is-into the banks, in other words, not the agencies that regulate them.

That means any programme to fix finance should address the problem of flawed incentives in the public sector, in particular in supervision. But how can this be done? A good starting-point is to go back to the mechanisms designed to solve the misaligned incentives of central banks. Independence helps reduce both capture and time inconsistency. Clear targets, a powerful governor with a strong, hawkish reputation and sanctions for failure are also elements of successful monetary regimes. Some central-bank governors' wages are dependent on reaching targets. Others have to write embarrassing public explanations when they fail to reach them. All of these techniques should be applied to the realm of financial supervision.

Central banking may hold lessons for compensation, too. In many countries, central bankers earn more than the average civil servant. Almost everywhere they enjoy better career prospects and higher public esteem than bank supervisors. It is impossible to raise public-sector salaries to the levels of the private sector (even if bankers' wages fall). But higher pay and a more prominent public profile may help regulators do a better job.

Applying the lessons of monetary policy to financial supervision would be easier if central banks had responsibility for regulating financial institutions. It would also serve to align incentives better when responding to crises, since it is largely central banks' balance-sheets that are put at risk. It may complicate the conduct of monetary policy in more tranquil times, but the case for mandating central banks to maintain both price and financial stability is now seen as necessary for other reasons, too.

A higher power

The solution to the problem of local regulatory capture would be to rely more on supranational authorities. But despite the fanfare at the G20 meetings over the enlarged role of the Financial Stability Board, and the unveiling on September 23rd of plans for new European supervisory bodies, national authorities have to date resisted any real delegation of power to supranational bodies.

The usual argument in defense of the status quo is that bail-outs have to be paid for by the taxpayer, so all responsibility needs to sit with parliaments. But this line of reasoning fails to recognize that direct capital injections have been only one of the tools used during the crisis-and in most countries not even the most important one. A substantial part of the bail-out has come in the form of regulatory forbearance, enabling banks to make higher profits because of reduced competition, and implicit support from central banks. What's more, the temptation to resolve future crises using these "off-balance-sheet" methods has only got bigger. It is unlikely that any parliament will be prepared to hand over 10-20% of GDP to prop up failing banks again (at least in the medium term).

The need for a strong mandate to control systemic financial institutions at the supranational level is particularly important for Europe's integrated market. Imagine for a moment that Europe's competition policy were run only by national authorities. The fact that the European Union has largely removed competition policy from the national domain is arguably the only reason why a degree of consistency in dealing with bank bail-outs across EU countries has been maintained. Without a watchdog of this kind the bail-outs could easily have escalated into a wave of tit-for-tat subsidies for national champions. European banking oversight, at least of systemic institutions, should be entrusted to a Europe-wide supervisor modeled on America's FDIC. At the very least, the euro area should have its own body. And beyond Europe, too, policymakers ought to match their new-found focus on incentives in the private sector with more attention to their own.

Responces

Weder di Mauro roundtable: The danger of capture
Posted by:
Economist.com | WASHINGTON
Categories:
Weder di Mauro roundtable

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, and a member of the CBO's Panel of Economic Advisers. He co-founded and contributes to the popular economics blog the Baseline Scenario.

This discussion can be followed in its entirety here.

Beatrice Weder di Mauro has some very good points: we should think more about the incentives facing financial sector regulators; and raising their pay and prestige surely makes sense. Her suggestion that we look at central bank independence as a parallel is also worth serious consideration.

But there are three problems with the specific idea here-that a strong independent regulator (eg, a central bank) can control the financial sector as currently constituted in the United States or Europe.

First, we know there are long cycles in regulatory capture for any regulated industry and any institutional structure. The regulators may be strong at first, but they invariably fall under the spell-one way or another-of the people they are supposed to control.

We can live with this in regulated utilities-although it's annoying and a periodic shake-up of the regulators can be helpful. But banking is much more dangerous, because financial meltdowns disrupt the world economy with some rt-faster and probably ack into buying political favors (eg, as happened before and is apparently happening at this moment with regard to the discussion of over-the-counter derivatives on Capitol Hill).

Even if there are no direct campaign contributions, there is still the "shock and awe" effect of having built a world beating commercial enterprise. Particularly in the United States, there is a presumption that being able to amass a fortune quickly implies great wisdom and an ability-or right-to help shape public policy. ; Intellectual capture is prevalent potentially even among the most nominally independent regulators, giving rise repeatedly to a very dangerous view: What's good for Wall Street must be great for the real economy.

In this context, we should also ask whether central banks are really so independent (vis-à-vis powerful financial sector interests) given their recent track record of accentuating the cycle of banking booms and crises by providing "Greenspan", "Bernanke", and "King" puts. The ideology of central banking in industrialised countries needshe last reckless boom, and now appear hard at it again.

Third, how exactly would you target a regulator's pay to something concrete? The goals here are long term, and there is enormous scope for the regulator to cover up any flaws. Targets might just lead to bigger and more ornate lies. ;

Inflation is easily measured and it arguably makes sense to link central banker pay to that outcome (although surely avoiding disastrous asset price bubbles is also a goal). But financial regulation has much broader objectives and the innovative people are always trying to find the next trick to get around the rules; this is easier whenever the regulator has a narrower focus.

Overall, it's hard to envisage any regulatory reform proposal being effective unless there is a broader political shift towards breaking up the largest banks and requiring all financial institutions to hold much more capital.

Selected Comments
EarlyNote wrote:

October 3, 2009 0:20

Yeah, right.

On January 17, 2008, the Chairman of the Federal Reserve Board, Mr. Bernanke, testified that "A recession is probably not on the horizon, but quick passage of an economic-stimulus package plus aggressive action by the Federal Reserve are the appropriate prescription for the ailing economy.."

See:http://twisri.blogspot.com/2009/07/bernankes-history.html

For those of you wanting more of an explanation, read this.

"There weren't enough Americans with (bad) credit taking out loans to satisfy investors' appetite for the end product. The firms used (financial bets) to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn't create a second Peyton Manning to inflate the league's stats. But when (hedge funds) bought a credit-default swap, (they) enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets (hedge funds) and others made with firms like Goldman Sachs and AIG. (Hedge Funds), in effect, were paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all."

"They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," (Eisman) says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans."

Blaming the crisis on CRA or subprime lending is flat out wrong: there simply were not enough subprime borrowers to cause a catastrophe of this magnitude. For that, you needed greed-induced leverage, a complete lack of ethics, and a set of parasitic financial institutions.

As we noted in April, 2008:

"With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic."

You also need a compliant (non functioning) regulatory apparatus, something we warned about in 1998:

""The nature of financial market activities is such that significant dislocations can and do occur quickly, with great force. These dislocations strike across institutional lines. That is, they affect both banks and securities firms. The financial institution regulatory structure is not in place to effectively evaluate these risks, however. Given this, the public is at risk."

See:http://twisri.blogspot.com/2009/07/bernankes-history.html

Why the market failed - http://twisri.blogspot.com/2009/03/why-market-failed.html

Adam Smith on the Current Financial Crisis - http://twisri.blogspot.com/2009/04/adam-smith-on-current-financial-crisi...

What happened. What now. - http://twisri.blogspot.com/2009/04/commercial-and-investment-banks-used....

To REALLY see what went wrong, take a look at page 6: http://www.sec.gov/rules/proposed/s71903/wmccir122203.pdf See page 2: http://www.sec.gov/rules/proposed/s71005/wcunningham5867.pdf

Also see: http://www.ethicalmarkets.com//wp-content/uploads/2008/12/financialbailo...

pdmikk wrote:

October 2, 2009 16:43

Hmmmm... I'd rather see a general recognition by the economic and business communities that greed is not a virtue, that Friedman was wrong, that we must indeed follow a "higher power," that our true concerns must include all around us. Allowing greed to be the guiding force in economic and business activities is quite simply nothing more than succumbing to our baser natures.

linhares wrote:

October 2, 2009 12:27

"The Fed chairman ought to be a financial historian rather than an economist or a banker; he will likely be less gullible."

bampbs is right on mark here. Someone like Paul Kennedy would have never let i) liquidity skyrocket, ii) fueled by Chinese cheap goods and infinite lending, leading to iii) Banks going berzerk with all that free monay lying around.

Meanwhile, the USD was exhibiting its first signs of hyperinflation in house prices. To expect a return to normalcy soon is to keep on drinking the koolaid.

I suggest gold, canned foods, lots of ammo, and moving to Montana. This thing is going to get much much worse.

DT123 wrote:

October 2, 2009 4:25

The whole Financial and Economic System has failed.

We need new systems, regulations etc. Existing regualtions should have been adhered to and Violators should be brought to justice. Good Regulators should be rewarded.

Rewarding Regulators is quite far from being enough.

bampbs wrote:

October 1, 2009 18:43

Never forget that in 2004, the SEC raised the leverage limit for the largest investment banks from 12 to 1 to whatever they liked. This was a combination of silliness and hubris; silliness in believing that financial firms are capable of regulating themselves, hubris in believing that risk management is a precise science and not a very approximate art.

One must distinguish between the failure of an individual firm when others are solid, and a general systemic collapse. It is likely that a private rescue will occur in the former case; but in the latter, it will always be the government's responsibility to prevent a disaster. This has been especially true in this instance, where Greenspan's ideological foolishness set the stage, and Paulson's Panic last September threw the financial system off a cliff.

The time to be tough on financial firms is when everyone is fat and thinking only of getting fatter, regardless of risk. The Fed chairman ought to be a financial historian rather than an economist or a banker; he will likely be less gullible.

bampbs wrote:

October 1, 2009 18:34

The Greenspan era represents the triumph of blind ideology and economic pseudo-science over history and common sense. Financial markets are efficient only in that they reflect the beliefs of buyers and sellers; the gap between belief and reality will always be with us. Laissez-faire works in the great majority of markets for goods and services. It does not work for financial markets, which are qualitatively different - inescapably adversarial, fundamentally uncertain, warped by dominating agency irrationalities.

We have lived through a strange self-reinforcing confluence of political, social and academic delusion. Perhaps now that the results are in, we will be relatively sane for a generation.

Do Regulators Have Distorted Incentives?: Beatrice Weder di Mauro Roundtable at Free Exchange

Oct 02, 2009 | economistsview.typepad.com

I'm participating in a roundtable discussion at Free Exchange. The lead article by Beatrice Weder di Mauro argues that regulators need better incentives::

Here's my response:

Here are other responses:

Posted by Mark Thoma on Friday, October 2, 2009

Selected Comments
wjd123:

I've been thinking about how to help keep the financial industries from getting away with regulatory capture and regulating organizations away from the dangers of weak political appointees. I don't want a Harvey Pitt to be the last word on who gets investigated and who doesn't. I don't want a lack of funding for these regulating organizations tempting companies to think they can push the envelope of what is allowed and not allowed a little closer to the edge of credulity.


I've come up with a plan I like to dedicate to Troy Polamalu, a great player for the Pittsburgh Steelers who is allowed to roam the field at will and stick it to whoever needs sticking. Those in the financial industry that need sticking are those who keep trying to push the rules and regulations, not to mention ethics, closer to the edge of credulity and those who would engaged in regulatory capture.

I want those who act ethically within the financial industries to know that one man's ethics isn't another man's opportunity. I want to keep regulations enforced and regulators away from capture.

What is needed is a team of free roaming regulation enforcers that are paid moderate government salaries but who have a way of making big money. That "way" is the use of the financial industries favorite incentive: the bonus.

For every cheater they can stick it to a fine will be assessed and paid to the government. From that fine some nominal number say 10% will be placed in a escrow fund to be divided once a year by means of a merit formula amoung the free roaming enforcers and their coach. Dividing the escrow fund in this manner will lead to those who can't bring in the money being assigned cases seen as potentially less lucrative, which means that these members will receive lower year end bonuses until they can show that they know how to "stick it."

This team of enforcers should be free to reopen any case they feel wasn't properly investigated or won't be investigated because it's been given a low priority designation.

Of course, this team with their "sticking it" to the industry mentality will make itself feared and hated. In spite of this the industry still might try hiring away some of its best enforcers. This will be made harder because good enforcers on the team have a means of making very high yearly bonuses if they stay with the team. Some member may accept a companies offer and take with him or her knowledge of the free roaming teams play book, but plays are only as good as the personal who run them and new plays and players can be developed. Finally, the old enforcer, now working for a company in the industry, will be seen as someone between the team and it's bonus money.

He or she can lobby congress, but not members of the enforcement pool since their bonus depends on sticking it to the cowboys in the financial industry. In addition to this barrier, those who follow football know what happens when one team trash talks another, so lobbying congress to defund the team of free roaming enforcers would be a dangerous game for any company. Besides, why defund a team that is making money for the government while making its bonus money. If it can't do both then it should be disbanded for valid reasons: their members are not good at their jobs or they are not needed because their aren't that many compaines to stick it to.

It's not that the financial industry can't find some comody with the government and other regulators, after all it wants a fair hearing for its complaints. But it shouldn't be expected to get it form the free roaming pool of enforcers. Their job, like Troy Polamalu's, isn't to be understanding but to "stick it" whenever and wherever he gets the chance.

Some will ask, "Why should the financial industry be singled out for this kind of harsh treatement?" They shouldn't. There are other industries which would destroy the nation before accepting regulations that deserve the same scrutiny. Nevertheless, the failure of our financial system can cause widespread damage to our nation and pain to innocent people. Regulatory capture weakens out defense against disaster, and, as such, the financial industries need this extra scrutiny.

I like this "sticking it" goal because I'm not as concerned about stiffling innovation as Mark Thoma. I want to stiffle innovation it's been the cause of many of the problems we face today. It seems to me that financial services innovations offer investors ways to gamble rather than ways to make the market more efficient or provide a needed service.

Welcome to America, the World's Scariest Emerging Market by ; Desmond Lachman

March 29, 2009 | ; washingtonpost.com

By Desmond Lachman
Sunday, March 29, 2009; B01

Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.

Over the past year, I've been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking -- with other people's money -- for their personal gain.

Negotiating with Argentina's top officials during their multiple financial crises in the 1990s was always an ordeal, and sparring with Domingo Cavallo, the country's Harvard-trained finance minister at the time, was particularly trying. One always had the sense that, despite their supreme arrogance, the country's leaders never had a coherent economic strategy and that major decisions were always made on the run. I never thought that was how policy was made in the United States -- until, that is, I saw how totally at sea Treasury Secretaries Henry Paulson and Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke have appeared so many times during our country's ongoing economic and financial storm.

The parallels between U.S. policymaking and what we see in emerging markets are clearest in how we've mishandled the banking crisis. We delude ourselves that our banks face liquidity problems, rather than deeper solvency problems, and we try to fix it all on the cheap just like any run-of-the-mill emerging market economy would try to do. And after years of lecturing Asian and Latin American leaders about the importance of consistency and transparency in sorting out financial crises, we fail on both counts: In March 2008, one investment bank, Bear Stearns, is bailed out because it is thought to be too interconnected with the rest of the banking system to fail. However, six months later, another investment bank, Lehman Brothers -- for all intents and purposes indistinguishable from Bear Stearns in its financial market inter-connectedness -- is allowed to fail, with catastrophic effects on global financial markets.

In visits to Asian capitals during the region's financial crisis in the late 1990s, I often heard Asian reformers such as Singapore's Lee Kuan Yew or Japan's Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change. How fortunate, I thought then, that the United States was not similarly plagued by crony capitalism! However, watching Goldman Sachs's seeming lock on high-level U.S. Treasury jobs as well as the way that Republicans and Democrats alike tiptoed around reforming Freddie Mac and Fannie Mae -- among the largest campaign contributors to Congress -- made me wonder if the differences between the United States and the Asian economies were only a matter of degree.

On Wall Street there is an old joke that the longest river in the emerging-market economies is "de Nile." Yet how often do U.S. leaders respond to growing signs of economic dysfunctionality by spouting nationalistic rhetoric that echoes the speeches of Latin American demagogues like Peru's Alan Garcia in the 1980s and Argentina's Carlos Menem in the 1990s? (Even Garcia, currently in his second go-around as Peru's president, seems to have grown up somewhat.) But instead of facing our problems we extol the resilience of the U.S. economy, praise the most productive workers in the world, and go on and on about America's inherent ability to extricate itself from any crisis. And we ignore our proclivity as a nation to spend, year in year out, more than we produce, to put off dealing with long-term problems, and to engage in grandiose long-term programs that as a nation we can ill afford.

A singular characteristic of an emerging market heading for deep trouble is a seemingly suicidal tendency to become overly indebted to foreign creditors. That tendency underlay the spectacular collapse of the Thai, Indonesian and Korean currencies in 1997. It also led Russia to default on its debt in 1998 and plunged Argentina into its economic depression in 2001. Yet we too seem to have little difficulty becoming increasingly indebted to the tune of a few hundred billion dollars a year. To make matters worse, we do so to countries like China, Russia and an assortment of Middle Eastern oil producers -- none of which is particularly well disposed to us.

Like Argentina in its worst moments, we never seem to question whether it is reasonable to expect foreigners to keep financing our extravagance, and we forget the bad things that happen to the Argentinas or Hungarys of the world when foreigners stop financing their excesses. So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.

After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries' policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor's musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to "get their house in order" -- without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Desmond Lachman, a fellow at the American Enterprise Institute, was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund's Policy and Review Department.

WilliamBlake wrote:

dj333 wrote:

....Restore manufacturing and exports. Increase the safety net to make us more competitive with countries that have national healthcare and state-funded worker entitlements. And require in all free-trade agreements that the signatories match or exceed our labor, environmental, and safety standards within five years. If you do that, there will be plenty of money left over to take care of entitlements.
3/29/2009 4:24:42 PM
////////////////////////////////////////////////////////////////////////////////////

As part of restoring manufacturing also upgrade our infrastructure so that we have plentiful and dirt cheap electrical supplies, and bountiful supplies of inexpensive fresh water.

We must become efficient, competitive again and regain exports, reestablish our local domestic industries, industries that can compete against goods that must be transported across oceans and continents.

The worst thing we can do is impose a carbon tax on our own products, our battered and minuscule industry needs to be nurtured. (and some of its owned by the government!) Also, the USA has been reducing GHG emissions by about 1.5% a year since 2006, so the USA is already on the right track. Changing the USA electrical supplies to ultra clean and efficient hydro and nuclear power from coal will eliminate 50% of all US pollution by itself.

I think we should, though, impose a carbon & pollution tax on imported items. That might be our best way to influence any foreign polluters who refuse to clean up and stop their own pollution of our world.

3/31/2009 3:23:44 PM

;

washingtonpost3 wrote:

Remember a few years back when Bush (or the people that put him in place) wanted to privatize Social Security? That must be particularly painful to Bush and his cronies - they were force to leave a few crumbs on the table as they looted the country on the way out.
;

3/29/2009 9:33:02 PM

dj333 wrote:

So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.
________________________________________

Entitlements are not our fundamental problem: our basic issue is that we have an economy based on fictions. In the 1920s, the percentage of GDP represented by the financial industry shot up, only to drop right back to its original level by the early 1950s. The period of this weaker financial sector - roughly the early 1940s until the mid 1970s - coincided with one of the strongest periods ever seen in the American economy.

70% of our economy is based on consumer spending. How is that supposed to work? The economy is currently based on the assumption that the average household will spend more than it takes in, and whenever that changes we go into structural recession. These are issues of industrial and trade policy, not government spending.

If our economy was sound, we could all afford more taxes. Our economy isn't sound. The problem with the IMF and other such neo-liberal institutions is that they think the problem is always government spending of social programs. It isn't. When the Titanic was sinking, firing all the leisure planners wouldn't have helped.

Restore manufacturing and exports. Increase the safety net to make us more competitive with countries that have national healthcare and state-funded worker entitlements. And require in all free-trade agreements that the signatories match or exceed our labor, environmental, and safety standards within five years. If you do that, there will be plenty of money left over to take care of entitlements.

3/29/2009 4:24:42 PM ;

datdamwuf2 wrote:

/signed

Our government is run by Wall Street, the policies and the bailouts show us that so clearly. Take AIG, they keep saying it's too big to fail but they are not going to break it up...think about that. The politicians admit the system is broken but do not propose to solve the problem. Instead of putting cash in the smaller institutions that acted responsibly our gov is giving it to the big Wall Street firms that caused the problems. And every day I see smaller banks and firms being absorbed into these big financial institutions. When monopolies are broken up we get competition that is healthy. The current policies and bail outs are going to make monopolies the norm.

3/29/2009 1:29:56 PM

chris_holte wrote:

"So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford."

Speak for yourself an dump the Imperial "We" because that is self serving mallarky. Medicare and Social Security exist because private enterprise is unwilling and/or incompetent to serve the needs of the broader population. For most of us, they are a form of "savings" as most of us pay more into Social Security than we expect to get, and most of that money is spent on current retirees or funneled into the pockets of Crony Capitalists.

The irony is that by degrading the general good, they reduce the size of the slice of the pie they take even as they reduce the size of the pie and increase the size of their portion of the pie. Degrading Social Security and Medicaid will make the "we" can't afford tripe a self serving prophesy -- and also degrade the country so that "we" can't afford roads, bridges, or rich people without violence. The evidence of the past 30 years and an examination of economies around the world supports this truth. Productive investment, balanced with income transfers (SS and Medicaid), and law enforcement create prosperous societies. Crony Capitalism, neo-liberalism (called neo-conservatism here), and "supply side" degrade societies.

So, Instead of degrading and trying to destroy medicare and medicaid, and Social Security, we need to shore them up, turn them into the basis for genuine universal health care and a genuine retirement. But of course in the process we have to resist and sometimes fight these very crony capitalists who complain about the problems they try to create.

Argentina and Russia had problems largely because power was concentrated in too few hands and because of crony-capitalist (or in Russia Crony Socialists) kleptocratic governments and businesses.

A Government that serves the people can only be created from bottom up. [Eternal Vigilence and Democracy] Organizations like the World Bank and IMF that are top down tend to destroy countries by lending to exactly the wrong people, the wrong sums of money, and then helping these thoughtless and kleptocratic elites destroy the currencies and industries of the countries lent to -- so they can live larger as individuals.

Chris

3/29/2009 11:57:51 AM

JFredMugs wrote:

Finally, the Post publishes something worth reading.

3/29/2009 10:22:12 AM

aznavcat wrote:

With all the reporting on stimulus packages and getting banks to lend again, I NEVER see anything in the news about the importance of changing our lending philosophy so we do not continue the same lending mistakes that got us into this mess. This leads me to believe that we, the American public, really haven't sincerely come to terms with our economic problems. We want to go back ASAP to the way things were before the crisis, as if that's a sustainable policy.

Great article but most Americans prefer not to hear bad news. They want politicians who tell them what they want to hear.

3/29/2009 9:45:11 AM

fjamidon wrote:

"So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford."

We must address Medicare (and social security). That's why we need health care reform NOW in this country - the first step in addressing the medicare problem which will bankrupt us in the next couple of decades if we do nothing.

Social Security will have to be re-thought as well. People are living much longer so the benefits must address this if it is to remain solvent.

We need an investigation (a real one) to get to the bottom of how the financial markets ended up crashing so catastrophically and globally. Then - and only then - can we put into place the right regulations to prevent the crisis from ever occurring again.

3/29/2009 8:42:44 AM

;

Clyde4 wrote:

Scariest part of this article is the comments section.

The vicious lack of trust, blame, lack of responsibility, 'look at what these people have done to me', etc that I observe in the comments is dysfunctional and represents the attitude that people have in their hearts.

Not a good sign for our country if people have these problems.

3/29/2009 8:19:49 AM

donx65 wrote:

India said that if banks don't lend, they are not banks and should be converted into hospitals and schools and parking.

There was never a "liquidity crisis", just another way to use public funds to enrich bankers. If the problem was to lend more, then the lawyers in Congress could have reduced the banks' capital requirements and instantly created lending power/liquidity!

So far we have "fairly" supported auto workers, bank plutocrats, and mortgage plutocrats in the name of "saving the country". Where's the fairness in using the average taxpayers' wages to support plutocrats' McMansions and the greed of GM? If you help GM, then you hurt Ford. If you help NY banks, you hurt Peoria banks.

The only effective person in D.C. is Bernanke, and he has already solved the problem with monetary action (municipal bonds now trade at realistic yields, for instance).

Fiscal policy can never be fair -- it always enriches only a favored few. Monetary policy takes effect in 6 to 9 months, as we now observe. Fiscal policy twists the economy without helping those not favored, and yes, Chavez of Venezuela would be proud of our actions.

3/29/2009 8:14:53 AM ;

kent_gregory wrote:

Lachman is correct that monied interests in the US has sold out the country, with only paltry bribes we call "campaign contributions" necessary to enact laws that enrich corperations at everyone else's expense. If we, the citizens and government of America continue to spend more than we have - which appears to be the case, we'll hand over the riegns of the world economy to the Chinese.

Sometimes things happen faster than we think possible.

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3/29/2009 7:01:27 AM

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wilsan wrote:

I wonder how many of these Wall Street Geniuses have ended up in government?

At least, Corzine did.

3/28/2009 7:31:43 PM

VirginiaIndependent wrote:

A sobering wake-up call. I hope that every member of Congress reads this and grasps that the "worst case" outcome of failing to stop this nation's irresponsible borrowing and spending is not just a few years of economic stagnation.

3/28/2009 12:26:37 PM

georgejones5 wrote:

I wonder if Mr. Lachman's priorities puts him at odds with his neocon colleagues at the American Enterprise Institute. If there were ever "grandiose long-term programs that as a nation we can ill afford" surely the prime example must be the misbegotten "global war on terror". Well, neocons need a working economy too if only to support their global hegemonist agenda. Even though they may be largely motivated to deflect attention from the military-industrial-congressional complex their critique of the financial sector likely has merit.
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3/28/2009 10:46:13 AM

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TheMSMControlsUs wrote:

Bush started it, Dear Leader will finish it - we are becoming a banana republic.

Obama will triple the national debt and run the currency printing presses around the clock until the dollar is as worthless as the peso.

3/27/2009 12:29:40 PM

lug21 wrote:

Lachman wrote: "I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to 'get their house in order' -- without the slightest thought that the United States might fare no better when facing a major economic crisis."

Don't regret giving those leaders the correct advice. Regret the assumption that American leaders didn't need the same advice.
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3/27/2009 10:06:21 AM

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sw11231 wrote:

Outstanding opinion piece.

3/26/2009 8:07:17 PM

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rgosche20 wrote:

How can you be a chief financial analyst and not know the difference between capitalism (Des calls it "crony capitalism) and corporatism aka fascism?

This guy is one of our "best and brightest" economists and he is barely more versed than any practical layman?

I agree with much of what he had to say, but his all around fundamental weakness make him a lukewarm advocate.

3/26/2009 5:59:18 PM

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WilliamBlake wrote:

Check this out guys-

Heavy oil production costs $10 a bbl?

"… [W]ith light oil now hitting around $100 a barrel, it's economic to think of using heavy oil, especially since THAI can produce oil for less than $10 a barrel," Greaves said. "We've seen this project go from something that many people said would not work into something we can have confidence in, all in the space of the last 18 months."
http://petrochemical.ihs.com/news-07Q4/canada-heavy-oil.jsp

http://www.rigzone.com/howitworks/heavyoil/insight.asp?i_id=283
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3/26/2009 3:41:49 PM

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knjincvc wrote:

Not funny, The USA has always lectured other countries on fiscal responsibilities.

Now China is lecturing the U.S. on fiscal responsibilities while at the same time loaning cheney/bush and the drunken sailors in congress all the money they asked for.

3/26/2009 3:25:24 PM

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knjincvc wrote:

Not funny,
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3/26/2009 3:20:55 PM

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cgillard wrote:

Yes, Reaganomic created banana republicanism. We now have ultra-rich and ultra-poor and gigantic unearned yearly bonuses like last years hedge fund managers 1.4 Billion Dollar bonus.

A lot of people taking to the underground economy so when does the black market get going?
These people have been selling virtual assets for some time to go along with our high tech mess of expensive, unworkable, over complicated, time and money sucking devices. The we have high paid lobbyists,consultants,lawyers,Media consultants, thinktankers, superfluous scientists, finely printed insurance scams, all being added on to the cost of our goods and services.

While every one else's salaries have been going down, inflation has been miscalculated, and quality going down has been called increased productivity!

And our economic morality is just as bankrupt as our falsified wars and massive collateral damages. Our collateral has just about run out along with the US product label and no one even notices here anyway!

3/26/2009 3:08:14 PM
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debbieqd wrote:

Mr. Lachman, many roads lead to Rome. We're not taking yours this time because last time we did, we ended up in Bushville and bushwhacked. If you think we're Russia or Argentina in eight years, then we'll consider a different route.

3/26/2009 2:46:24 PM

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andfurthermore1 wrote:

...

Interesting but incomplete; another view from the Top of the Pyramid of Capitalism. Those at the top with power, wealth (obscene wealth compared to the other 90% of americans) -- may very well see the USA's financial systems and markets as resemble emerging markets.

For increasing numbers and many of the rest of us who continue to slide further down the economic scale with a declining, gaping, lacking safety net, the USA is starting to ever more resemble a third world oligarchy.

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3/26/2009 2:08:00 PM

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Susannah1 wrote:

This column was very good until the author stated that we choose to ignore the SS and Medicare "crises". I disagree that SS is about to be in crisis. SS is an important part of our economy whose funds have been mismanaged for the last several decades. Bush chose to use the surplus for tax cuts and ignore the health of the SS system. This a problem, but using the word "crisis" makes situation appear worse than it actually is.

Medicare is in crisis, but so is the rest of health care system. We must fix the entire health care system, not just Medicare, in order for economy to be healthy again.

I would like to know if Mr. Lachman wants to privatize SS. I would also like to know if he supports universal health care. Strengthening SS (NOT privatizing it) and establishing universal health care are two parts of the foundation of healthy long-term economic growth going forward.

3/26/2009 1:27:51 PM

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bigblueskies wrote:

jkoch2 wrote:
bigblueskies wrote: What, if any, plans are there being put forward to correct these outstanding problems, and bring us cheap and abundant water and power again??"

The best solution for scarce water is to let the price reflect the true scarcity. There has been far too much development in arid and semi-arid zones. More drilling will simply deplete acquifers and magnify the eventual calamity. Moneys spent on huge dams or canals might be better spent on roads and schools in water-rich zones.

////////////////////////////////////////////////////////////////////////////////////

But the population is not there, its in the warmer south. How will you force population to relocate, and how will they find employment?

Why not at the very leasy complete all the water projects just abandoned and left half done in the 1970's and 1980's??? That would help a lot. If we must then build desalination plants all along the coastlines powered by nuclear generators and pump fresh water to all the depleted aquafiers. The Great Lakes has 20% of the worlds fresh water and its all wasted draining over the Niagra and down into the Atlantic. Why not dam Niagra and drain the lakes thru a canal to the Mississippi, then a diversionary canal & siphon over the continetal divide into the Colorado River, where it will really be used to help people live and not just for a scenic view for honeymooners? What about all the watersheds of northern Canada? Can they be redirected to flow south and link into the water networks supplying Canada and the US? Remember we committed ourselves to population growth through immigration in 1965, and have grown by close to 40%- but we have done little to increase the supply of water and power and we must, since our principles have dedicated us continoued immigration and another 50% growth of population in the next 5o years. How will we supply them? Not by rationing.

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Oil is non-renewable. Existing reserves will yield diminishing marginal returns for capital invested. New reserves are in deep, remote, or dangerous places. The military and political costs of access to Mideast oil is a serious vulnerability. Conservation and substitution are the best path. The most efficient tool would be a flat tax on crude. It would help plug the deficit and encourage thrift and innovation. Anything else is self-deceptive pie-in-the-sky.

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The world has 4.7 trillion barrels of proven oil reserves at the oment, enough to supply the world at its consumption rate in 2007 for another 140 years. Its expected exploration will find a minimum of another trillion barrels of recoverable oil, without touching oil sands or shale. There is more natural gas, and even more coal than both in the worlds reserves. And just as much uranium. In addition we can make fuel, natural gas, diesel, by the Fischer Tropsch process, for a cost equivelant of about $40 a BBL, so in effect we have a infinite supply.

So I don't see a problem except a lack of will.
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3/26/2009 1:25:21 PM
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AnotherBystander wrote:

Mini22 wrote: "This piece scares me more then anything else I've read about this mess. Should be required reading for everyone."
The fact that you got scared only after reading this piece seems much scarier to me.
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3/26/2009 12:59:55 PM

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jkoch2 wrote:

bigblueskies wrote: What, if any, plans are there being put forward to correct these outstanding problems, and bring us cheap and abundant water and power again??"

The best solution for scarce water is to let the price reflect the true scarcity. There has been far too much development in arid and semi-arid zones. More drilling will simply deplete acquifers and magnify the eventual calamity. Moneys spent on huge dams or canals might be better spent on roads and schools in water-rich zones.

Oil is non-renewable. Existing reserves will yield diminishing marginal returns for capital invested. New reserves are in deep, remote, or dangerous places. The military and political costs of access to Mideast oil is a serious vulnerability. Conservation and substitution are the best path. The most efficient tool would be a flat tax on crude. It would help plug the deficit and encourage thrift and innovation. Anything else is self-deceptive pie-in-the-sky.
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3/26/2009 12:10:16 PM

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jkoch2 wrote:

And so Lachman says that the answer is for the US to do [ distant crickets chirping ].

The AEI's solution is, of course, to abolish capital gains and dividend taxes and "get the guvmint of the back" of everything, except where military expenditures involve good dues-paying contractors. The cure for depressions is to cut wages and pare back government. Hoover, any AEI pundit will complain, actually did too much.

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3/26/2009 11:58:10 AM

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valwayne wrote:

Remember just a few short weeks ago. Obama was going to solve our financial problems and put us on the path to prosperity while making America loved in the world again! Just a few short weeks! Since then we've had more broken promises, spending and debt, earmarks, and corrupt bonus guarantees passed into law than we can track. The British Prime Minister was humilated during his visit and sent away with a gift of 25 DVDs he can't even play in England, and the President of the European Union just called Obama's plans for the U.S. economy "The Road to HELL!!! We haven't seen such ineptness since Jimmy Carter, and even Jimmy Carter didn't screw things up this fast. Obama has us on "The Road to Hell" , and that's not from the Republicans that his socialist friends in Europe who "LOVE HIM" saying it!
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3/26/2009 11:53:26 AM

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rdco wrote:

A very nice piece, pointing the dangerous paths followed by others in similar straights, but without clear recommendations for how we should proceed to avoid looking like Argentina.

Certainly, a lot of our policies look familiar--but fortunately the external debt is all in dollars rather than euros or yen. And, of course, when the US expands the money supply it increases the world's supply of money not just our own, which is not always so great for the rest of the world, but it does reduce our own inflation risks a bit, relative to Argentina's.

3/26/2009 11:47:09 AM

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_BSH wrote:

Amen. Would that the small brains in the White House & Capitol could absorb this wisdom.

3/26/2009 11:23:09 AM

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car141 wrote:

As a person that had to emigrate from Argentina in the 90's, I endorse the comment by Chris Hotte. The IMF endorsed Menem policies and if there was some criticism was that the "free market reform" wasn't deep enough. Of course, it is easy to promote austerity in the federal budget over somebody else's hunger, somebody else's loss of a job, and somebody else's lack of health coverage. But that attitude cost lives. I costed lives in Latin America in the 90's and now it is costing lives in the US

3/26/2009 11:20:18 AM

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vladber wrote:

I am originally from Russia and I lived through all the debacle of Afghan war and collapse of the empire. And I've been taking notes of what's happening and trying to connect the dots.
According to my observations, unfortunately, Mr.Lachman is absolutely correct in his assessment of the situation. All the attributes proceeding the collapse of Soviet empire could be tracked in our current situation:

Mini22 commented that he/she is scared to death by this piece of Mr. Lachman. Yes, Mini22, you have all the reasons to be scared and anticipate the worst to happen.

And recession, depression or "lost decade" are, in fact, might not be the worst options...

3/26/2009 11:04:53 AM
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jtb2inky wrote:

I couldn't agree more! We are well down this slope at this point, and it's increasingly difficult to see how we will emerge from the depths. One this is certain, our country will not be the same.

3/26/2009 11:03:30 AM

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Even Jack Bauer couldn't stop 'The Goldman Conspiracy' - MarketWatch

10 reasons why Wall Street has absolute power over America's democracy
Paul B. Farrell, MarketWatch Last update: 7:13 p.m. EDT April 20, ; ; ;

ARROYO GRANDE, Calif. (MarketWatch) -- Two mind-numbing fast-paced dramas. Two parallel worlds. One real, one fiction, both deadly. Jack Bauer, mythic hero of "24." Dying from a deadly bio-pathogen leaked from weapons developed by Starkwood, a rogue mercenary army attacking the presidency, hell-bent on taking over America.

The other drama in play: "Hank the Hammer" Paulson, iconic Wall Street hero, a Trojan Horse placed inside Washington by Goldman Sachs as Treasury Secretary in control of America's $15 trillion economy. Goldman, a modern dynasty with vast financial powers much like those once used by the de' Medici, Rothschilds and Morgans to control nations.

Video: Is a correction imminent?

One of the confounding aspects of bear market rallies is that the longer they last, the more likely investors are to expect a correction, says Barron's Bob O'Brien.

Both dramas play high-stakes games with financial WMDs that have lethal consequences. Jack compresses thrills, kills and chills into 24 hours. Hank, Goldman and their army of Wall Street mercenaries move with equally blinding speed, heart-pounding action.

Drama? You bet. Six short months ago Hank led an assault on Congress. The scene parallels one in "24:" Sangala War Lord Juma's brazen attack inside the White House. But no AK-47s necessary. The Hammer assaulted Congress with just a two-and-a-half page memo in hand. Like a crack special-ops warrior, he took down the enemy, demanding $750 billion, absolute control, total secrecy, no accountability and emergency powers to act immediately ... warning that inaction was not an option, that collapse of America's banking system was imminent, would bring down the global monetary system, pushing world's economies into a "Great Depression II." Congress surrendered.

Here's the whole plot:

Scene 1. American government is now run by the 'Goldman Conspiracy'

Oh, you really think just I'm plotting a television series? Or just paranoid, exaggerating this power grab? You better read "The Usual Suspects," Matthew Malone's brilliant article in Portfolio magazine: He "exposed" the "Goldman Sachs 'conspiracy' to take over the U.S. financial system." Read it in this context: America's financial sector has exploded from 19% of corporate profits in 1986 to 41% today, becoming a magnet for every wannabe billionaire. They know why Wall Street must control Washington.

Malone focuses on the incestuous "conspiracy" of Goldman alumni in Treasury, Bank of America, Merrill Lynch, AIG, Citigroup, Washington lobbyists and politicians.

Scene 2. Huge conflicts motivating Wall Street's 'Trojan Horse'

And just in case you think any emphasis on The Hammer's conflict of interest was invented purely to increase drama, please remember that he worked at Goldman for three decades after serving under Nixon. He got $38 million his last year as CEO in 2006 before becoming Treasury Secretary.

Then during the market meltdown six months ago the $700 million personal fortune he built at Goldman was threatened by Goldman's huge $20 billion derivatives exposure at AIG: Suddenly his responsibilities at Treasury merged with a strong self-interest in protecting his personal fortune. AIG was "saved."

Scene 3. Wall Street's 'quiet coup' also runs world's banking system

There's another equally disturbing expose in "The Quiet Coup," Simon Johnson's great article in Atlantic magazine. A former chief economist at the International Monetary Fund, Johnson also warns that America's "financial industry has effectively captured our government" and is "blocking essential reform."

Worse, he says that unless we break Wall Street's stranglehold (unlikely in the new Washington) we will be unable "to prevent a true depression," warning that "we're running out of time," echoing many of our predictions of the "Great Depression II" coming soon. See previous Paul B. Farrell.

Scene 4. Wall Street used the meltdown to take over America's government

Matt Taibbi, author of "The Great Derangement," captured this drama in a Rolling Stone piece, "The Big Takeover, how Wall Street insiders are using the bailout to stage a revolution." A must-read: "As complex as all the finances are, the politics aren't hard to follow. By creating a crisis that can only be solved by those fluent in a language too complex for ordinary people to understand, the Wall Street crowd has turned the vast majority of Americans into non-participants in their own political future. ... in the age of CDS and CBO, most of us are financial illiterates."

Wall Street "used the crisis to effect a historic, revolutionary change in our political system -- transforming a democracy into a two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below."

Scene 5. How Obama is keeping alive Bush's 'disaster capitalism'

Back in 2007 at the start of the meltdown, Hank was misleading us in Fortune: "This is far and away the strongest global economy I've seen in my business lifetime." In the real world, Naomi Klein, author of "The Shock Doctrine: Rise of Disaster Capitalism," was warning us that "during boom times it's profitable to preach laissez faire, because an absentee government allows speculative bubbles."

But "when those bubbles burst, the ideology becomes a hindrance and goes dormant while big government rides to the rescue." Then, free-market "ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis." TARP paybacks: Obama has a new "disaster capitalism."

Scene 6. Wall Street's CEOs rule like dictators in a banana republic

Seriously, here's how bad Taibbi sees it: "Paulson and his cronies turned the federal government into one gigantic half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling interest in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing business."

And let's include $5.5 trillion in Fannie Mae and Freddie Mac. Wall Street's greed and stupidity resembles the self-destructive reigns of banana republic dictators.

Scene 7. Wall Street makes an un-American bet on 'disaster capitalism'

Today as you ponder buying some Goldman stock, remember, you're really betting that "disaster capitalism" is back, strong, tightening its stranglehold on Washington and on the American taxpayers, who will guarantee all Wall Street's future failures. Yes, this is un-American, but so what?

The "Goldman Conspiracy" is still probably a good short-term buy ... if you're interested in betting on America's new "democracy of capitalists, by capitalists, and for capitalists," with "The Conspiracy" leading the joint chiefs of this new mercenary army ... and it only took six short months for their "Quiet Coup!"

Scene 8. Banks recycle TARP money, pump earnings, cheat America

Here's how it worked: The Hammer conned a clueless Congress, then shelled out $350 billion of our taxpayer money (Helicopter Ben Bernanke helped by upping the ante with a couple trillion side-bet), buying toxic debt to save his ol' Wall Street buddies. They stopped lending and used the dough to doctor their balance sheets.

So no surprise that Goldman, Wells Fargo and J.P. Morgan Chase are now reporting "blockbuster" first-quarter earnings, says the New York Times, while just months ago "many of the nation's biggest banks were on life support."

Get it? They screwed taxpayers and borrowers so they can repay TARP with (you guessed it) our recycled TARP money. Now it's back to business-as-usual, with no restrictions on CEO pay and bonuses ... no thank-yous ... no admissions of guilt ... while some even arrogantly deny that they ever needed TARP money.

Scene 9. Wall Street's already set the stage for new disaster

Right after the election in November, at the peak of the banking crisis, when Hank, Goldman and the Wall Street mercenary armies were divvying up the $350 billion TARP money, we detailed 30 reasons for the "Great Depression II" likely coming around 2011. We quoted John Whitehead, former Goldman Sachs chairman, former chairman of the New York Fed, former Reagan deputy secretary of state. He warned America's problems will take years, burn trillions, result in massive deficits:

"This is a road to disaster," he said. "I've always been a positive person and optimistic, but I don't see a solution here." He did see a depression at the end of that road, one you can call the "Great Depression II."

Scene 10. Obama turned 'The Goldman Conspiracy' into a superpower

Do you see the parallels: Jack and Starkwood, Hank and Goldman? Jack's a great mythic hero. We need to believe a hero will defend the little guy, stand between us and total annihilation. But Jack Bauer's "dead." Yes, dead. Jack's not real. Never was "alive." Jack's a fiction, a figment of Main Street America's vivid imagination, the symbol of "hope" for a populist revolution. Hope that Jack, Barack or some other new hero will emerge, take power back from Wall Street and return it to the people.

Unfortunately that won't happen, folks. Yes, on TV Jack will come back from near-death, again. But in real life, Hank, Goldman and Wall Street's mercenaries are winning the war. Read and weep Portfolio's chilling finale: "Obama's victory and Geithner's appointment are the completion of Goldman's meticulously crafted plan to become a superpower. The firm now has the clout to impose its will on the financial markets, and the world."

GOP or Dems? Conservatives or liberals? It doesn't matter. We'll all controlled by "The Conspiracy." So why not surrender, let them have the power? The truth is, through their lobbyists and surrogates in Washington, they already rule America. Surrender is a mere formality.

Accept reality. Hold them accountable later. After the next crisis. After the next meltdown of disaster capitalism -- if there's anything left after the "Great Depression II" sweeps like a pandemic across the planet, consuming all economies, for a long time. But for now, Goldman and other banks may well be short-term buys. Just be ready to dump them in the near future ... a scenario that will be here sooner than you think.

Simon Johnson says Break up the banks - How the World Works - Salon.com

Thursday, April 23, 2009 09:48 PDT

Simon Johnson is the former chief economist of the International Monetary Fund and in recent months has emerged as one of the most cogent critics of how the Obama administration is addressing the banking crisis. On Tuesday, Johnson, Joseph Stiglitz and Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, testified before Congress' Joint Economic Committee on the topic of the day: "Too Big to Fail or Too Big to Save? Examining the Systemic Threats of Large Financial Institutions."

It's time to get all Teddy Roosevelt on Wall Street, declares the former chief economist of the IMF. Bring out the big antitrust artillery and fire away.

On Wednesday, Salon caught up with professor Johnson for the second time this month, and this time, managed to successfully record the interview.

You have become famous for decrying the consolidation of power by a new financial oligarchy over the politics and economy of the United States. Since our last conversation I was intrigued to learn that this isn't necessarily a new obsession of yours. In the soon-to-be-published paper "From Ancien Regime to Capitalism: The Spread of the French Revolution as a Natural Experiment," which you co-authored with Daren Acemoglu, you argue that after the French Revolution, Napoleon's armies contributed to future economic growth by breaking up local church and aristocratic oligarchies.

Oh yes! So you know that I work on longer-term issues as well as shorter-term issues. You see, there are some recurring themes here. It's about power, and you have to see it all in that light.

Does Wall Street require its own Napoleon?

Well, there was a lot of damage done the way he did it. And I don't think we currently are living under the "ancien regime." The structure of Western Germany, for example, when the French came in, was post-medieval, and they completely transformed it. I still think that we have basically a good system here today. It's just that a relatively few people got out of control. And they need to be reined in. I think that's doable.

In the Joint Economic Committee hearing on Tuesday, I thought the most the interesting stuff came from Thomas Hoenig, who had this amazing quote. I mean I was just shocked to hear him say it, to hear a Federal Reserve regional bank president say that any time you have banks that are too big to fail, you are going to have oligarchs. I thought it was brilliant. That's where I am! And I'm trying to persuade people I'm not a sensationalist, or an extremist.

In your own testimony, your basic message was pretty simple: It's time to break up the banks.

Yeah. I've been saying that for awhile, but the new piece is to use antitrust law to do it. Some good lawyers have thought about this now for us, and they are saying, certainly, changing the legislation to make this easier is the way to go. The lawyers themselves are divided on whether you can do this under the existing legal framework. But the historians are adamant that what we are saying is very much in the spirit of the original antitrust movement. What Teddy Roosevelt and his cohorts were worried about was excessive power -- political power for these oligarchs.

But you've pointed out that one of the key aspects of the triumph of finance over everything else in the last 40 years is not just the consolidation of political power, but conceptual power -- in other words, a majority of the country came to believe that what was good for Wall Street was good for everyone. How do you use antitrust to break up a belief system?

The breaking of the belief system is an outcome of the crash. The belief system is kind of a perpetuating mechanism but when the economic realities change, people stop believing the same things. I think one advantage of a society like the United States, a democracy, is that we can change our minds pretty quickly on some things, even some firmly held beliefs. I am not saying throw capitalism out with the bath water. I'm saying big finance has just become too powerful and it needs to be reined in. There are some relatively straightforward technocratic steps that can be taken that will move us in the right direction. But I'm not a starry-eyed idealist -- I don't think this is going to change massively overnight.

While researching bank deregulation this morning I found a paper by Philip Strahan from 2002 arguing that the removal of limits on interstate banking in the late '70s and early '80s "was followed by better performance of the real economy." We can quote literally thousands of papers written over the last 40 years arguing that deregulation was good for the economy. We now have a pretty dramatic counter-example, but it still raises the question of how quickly you can undo 40 years of a dominant economic orthodoxy?

Slowly. But I would also say that the Strahan-type result doesn't strike me as implausible. It's quite possible that things can be overregulated, so you deregulate them, and things operate better. But what I'm arguing is that then feeds into this political cycle where you make more money, and you plow that back into political action committees or whatever, and use that to tilt the playing field in your favor. So let's say that you have excessive regulation to start with, you bring that down to a sensible level, and then the guys making a ton of a money use that to undermine sensible regulation. That would be the kind of dynamic I would buy into.

Is there any way to get to a steady-state?

No. Come on. There's no nirvana. It's a struggle. It's always a struggle. There's got to be some kind of dialectic. I would just say the pendulum has swung too far. And you also have to worry about regulators being captured. And I don't think that just breaking up the banks eliminates the possibility of capture -- small guys can get together and capture their regulators too. But there's nothing quite as powerful as four guys walking into the room and saying, "Look, Tim, if you do this, the world will end." That's just a terrible thing for a treasury secretary to have to deal with.

While you were testifying before the Joint Economic Committee, Geithner appeared before Elizabeth Warren's Congressional Oversight Panel. I was struck by the fact that while Warren was pushing Geithner on whether liquidating and restructuring the banks were "on the table" for the Obama administration, the Republicans on the panel, John Sununu and Jeb Hensarling, were extremely suspicious of anything that even smacked of partial nationalization. Some people seem to be upset that in his first 100 days Obama hasn't already completely broken the power of Wall Street, but there are plenty of politicians in Washington who think he's already gone too far.

I do think "nationalization," the word, as a concept, is a red herring. I'm with Hoenig on this. What we need is a government-managed bankruptcy -- you can call it prepackaged bankruptcy, or you can call it conservatorship. The point is you don't throw banks into Chapter 11 because that is destructive. But you manage a bankruptcy process -- it's not nationalization, it's a government-run receivership. Technically what you do is appoint an official receiver who is either the government or is going to be an agent for the government, and that agent manages the split into a good bank and bad bank. You take the bad stuff off your balance sheet and you minimize your losses on that through some kind of Resolution Trust Corporation structure and the good bank you get back into business as soon as you can and you privatize it. I would advocate breaking it up into many competing private bits.

Hensarling appeared to be worrying that the Obama administration's strategy is a kind of backing into nationalization.

Well, I'm with him on that! That's exactly the point to make. We're stumbling into bad forms of nationalization. Joseph Stiglitz said this very well: The difference between ownership and control leads to big distortions. The government is going in with a massive amount of control, but either it's not going to have ownership or it's not going to exercise those ownership rights. My favorite line, which was in an Op-Ed we wrote for the Financial Times in January, was, "If you want to end up with the politics of Pakistan, the economy of Ukraine and the inflation rate of Zimbabwe, bank nationalization is the way to go." That's my feeling about nationalization. I want government-managed bankruptcy.

Does the government currently have the authority to put a multinational institution as large as Citigroup or a B of A into receivership?

Hoenig addressed that directly. He was asked that question. He's worked for the Fed for 30 years. He's managed a lot of bank winding downs and receiverships in his district, or he's been involved in them, and his answer to that question was yes. So, I'm no longer going to say take my word for it, I'm going to say call Mr. Hoenig. It was a striking statement. To my mind, he directly contradicted what Secretary Geithner said when he testified on the need for the resolution authority. The resolution authority would be helpful, it'll give you a better tool to use, but Hoenig definitely said it can be done, now, following the Continental Illinois model of a negotiated conservatorship. That was the most important thing said at the JEC hearing. Although I do support giving them the resolution authority.

What we have been arguing for consistently is recapitalization on the basis of a government takeover and government-managed process. So you wipe out the shareholders, and then, how much of a hit you put on the creditors depends on the political calculation. How much money can you raise, which creditors do you protect? Our priority is protect the payment system: You want to protect deposits and anything that is like a deposit. If you force people to take losses on the payments part of the system, then all hell is going to break loose. But if you protect that, then the rest of it is a calculation about how much do we want to guarantee creditors, and I think at this point, with the situation a little bit calmer than it was last fall, everyone agrees that creditors need to take some sort of hit in an organized fashion.

What do you think of the fact that these very same banks that are at the heart of this are now taking a hard line on what kind of hit they will take in the negotiations with the government on reducing the debt of Chrysler and General Motors?

The ironies just abound. Shooting yourself in the foot and then reloading and shooting yourself in the foot again.

Won't we run into the same problem when we try to get the bank creditors to deal?

Well, sure, the creditors will scream, if that's what you mean. Creditors always scream. And creditors will hold out, creditors always try to hold out. That's what the Hoenig vs. Geithner debate is about: What legal authority do you have to force them?

What do you think of the theory that a political calculation was made by the White House: They wanted to get their stimulus passed and the budget passed and push what is likely to be a pretty big political fight over the banks into the future so they could get those priorities taken care of.

I think it's an intelligent spin. The way the administration guys are now articulating it, and they said this to F.T.'s Krishna Guha on Monday: They're following a doctrine of "reversible error." Their idea is if you take the banks into bankruptcy you may regret it, so let's just see what happens. But our point is that any inaction on the banking system creates irreversible damage, so there's no free option here. If you delay you are inflicting other costs on the system including most particularly massive fiscal costs and the need for more fiscal stimulus, and an increase in the debt. As I said in the hearing yesterday I think the national debt is going to roughly double as a result of this fiasco. Which is huge. That's your taxes and my taxes.

I mean, I think the reversible error could be what they believe, I'm not saying they are lying about that, I'm just saying they are wrong about that. Are they waiting for it get to worse? I guess the view could be is they are waiting for it to get worse because then there will be political support for them to do really aggressive things, but I don't think that's going on, because when I talk to people on Capitol Hill -- which I do quite a lot -- they don't tell me that the administration is there preparing the ground for this, they say they are not coming to talk to us at all.

In your testimony before the JEC you said that as a professor of entrepreneurship at MIT you spend a lot of time interacting with entrepreneurs and venture capitalists who are "absolutely livid at the way large banks have been run." You noted that venture capitalists are betting their own money, and that's a better model than betting other people's money. I thought that was a little ironic, because during the dot-com boom, the venture capitalists did plenty of incredibly stupid things with their money too. It's not as if they are above reproach.

Let's be clear here. I am not trying to legislate away booms. And I am not trying to prevent crazy investments. I see a lot of crazy people around MIT who turn out to be brilliant and very successful and I never would have picked them. I like that. But those are equity investments, and the dot-com bubble to me is an excellent counterpoint to the housing meta-financial problem -- which was a debt-driven bubble. There's a big difference. If your equity value goes down a lot, it's painful and consumer spending may fall because of the wealth effect, but it is not a global cataclysm. The dot-com bust was a big bad bubble and it burst and it was messy and a lot of my students couldn't get jobs, and they went off and did something else.

I'm not saying venture capitalists putting their own money at risk is going to lead automatically to stability. But it does feed into innovation. I think if you look at canals, or railroads in the 19th century, or the advent of the automobile or any of the other sort of big breakthrough technologies, they often come with crazy investment booms, particularly in the United States. Anywhere that's a frontier of technology, often these breakthroughs come with a thousand firms being formed, massive amounts of money being pumped in, lots of of stupid things happening, people building two canals next to each other, or two railroads next to each other, and then there is a financial collapse, but you still get to keep the physical infrastructure. At the end of the dot-com thing we had a pretty good Internet.

What do we get out of the meta-financial crap? It's not so clear that we got useful things. Did our ATM fees come down? No.

Yesterday, Robert Reich graded the first 100 days of Obanomics. He gave the budget an A, the stimulus a B and the banking bailout an F for an overall grade of C+. What marks would you give?

I'd give the bailout an incomplete, which is allowed at MIT. Come back and finish it in the summer. Most of the other stuff I would give some sort of A. I know I am complaining a lot, it's true. But I give them an A+ on the G20 given the cards that they were dealt and I think they've made a lot of progress on other things. My worry is that the banking thing is the Achilles' heel, and that could damage the whole rest of the strategy. So it's like a report card where you are doing very well across the board, but there is this one subject that is really dragging you down. And that's very dangerous.

― Andrew Leonard

Comments

Simon Johnson's morality tale Full Article at U.S. News & World Report

Simon Johnson tells a simple and compelling story: the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets, except that Wall Street has bought its influence and power not by bribery but by shaping the ideology of our times:

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption-envelopes stuffed with $100 bills-is probably a sideshow today, Jack Abramoff notwithstanding.

Instead, the American financial industry gained political power by amassing a kind of cultural capital-a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America's position in the world.

The solution, to Simon, is equally clear. ; Finance needs to be cut down to size. ;What the U.S. needs is what the IMF would have told any country:

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

...

The second problem the U.S. faces-the power of the oligarchy-is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

As with any story built around clear villains easy solutions, there is something in this account that is quite unsatisfying. ; For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. ; But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. ; Simon himself says as much. ; So why pick on the bankers? Surely the blame must be spread much more widely. ;

And I find it astonishing that Simon would present the IMF as the voice of wisdom on these matters--the same IMF which until recently advocated capital-account liberalization for some of the poorest countries in the world and which was totally tone deaf when it came to the cost of fiscal stringency in countries going through similar upheavals (as during the Asian financial crisis). ; ; ;

Simon's account is based on a very simple, and I believe misguided, theory of politics and economics. ; It is an odd marriage of populist and technocratic visions. ; Countries fail because political elites always end up in bed with economic elites. ; The solution, apparently, is to let the technocrats (read the IMF) run your affairs.

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. ; Too many of us thought we had the right model when it turned out that we didn't. ; We pushed certain policies with much greater confidence than we should have. ; Over-confidence bred hubris (and the other way around). ;

Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris? ; ; ; ; ;

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Your points about Johnson's oversimplification of the narrative and the folly of looking to the IMF for solutions are well taken. But I don't read Johnson's article to put the blame for the current mess solely on the bankers. Johnson clearly describes several political and policy missteps that brought us to this point. The article does not merely seek to assess blame for the crises but to examine the difficulties of resolving the crises, of moving forward. If he focuses on the bankers it is because at this point they are an entrenched interest with the most to loose from a proper resolution to the crisis, which Simon believes to be nationalization. The policies of the last 40 years have created an enormously powerful industry that will not go down quietly. And they have an enormous amount of sway over the policy makers in D.C. Just look at the events of the last few days. The heads of the biggest banks in the country get a pleasant meet and greet with the president to discuss the problem. The head of GM, our largest auto maker, gets the ax.

Posted by: Ed Viguerie | March 30, 2009 at 04:51 PM


I have been a long time fan of your writing and this blog, but I am sometimes mystified by the seemingly sectarian fights you pick with what I will dub "modern political economists". I say 'sectarian' because you made so many seminal contributions to understanding the political economy of policy reform.

Dani Rodrik writes: "they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy."

Isn't THIS risking being "simple"? Do you believe the main reason we got a repeal of Glass-Steagall, and so many other changes to radically deregulate and relax supervision is because "policymakers" felt it was good for the country?

A far more compelling story is that a very powerful banking lobby spent hundreds of millions of dollars over many years to elect and then influence enough legislators to get the changes made; and that the revolving door relationship we have between financial industry and government, made it all that much easier. Why else were the banks spending all that money?

In nothing that I have read is Simon Johnson saying that he has simple technocratic solutions (I agree with you thought that little is said of the IMF's many problems in his tales). What he has written on looting and tunneling for instance suggests just how hard and messy it is to regain control over policy.

What I read him to be saying is that when economic policymaking is partly captured, and that those individuals that have earned massive economic rents at the helm of large financial institutions that are now insolvent will very rationally fight hard to hold onto their privileges and loot the treasury if necessary to do so. Why wouldn't they?

Finally he is saying that any lasting meaningful reform that gets us out of this crisis, that doesn't just socialized bankers losses, and that helps to make sure we don't repeat this all again any time soon MUST start (or at least end) with an effort limit the power of these economic elites to exert so much political influence (and systemic risk) again.

Your alternative seems to be to share the blame with economists and policymakers and their blind belief in models of one sort or another. But where do they come from? Models of the sort that are taught in the business schools or simplified by CNBC anchors are not chosen randomly out of an urn. Business schools are in the business of selling ideas -- and guess who has been paying?

Sure there is blame to go around, but it's hard to think of an explanation that does not put bankers and their influence square in the middle of this one.
More importantly, it's hard to see how to put in place better policies (and hence put better models to work) without confronting the economic and political power of this sector. Do you?

Posted by: Walras' executioner | March 30, 2009 at 05:35 PM


There has been a deliberate effort by the "vast rightwing conspiracy" to influence public policy and promote the ideas of libertarianism and the free market.

The (mostly hidden) players in this effort are known: Scaife, the Koch brothers, Olin, Ahmanson, etc. This group is behind the well-funded conservative think tanks: Hoover, Hudson, Cato, Manhattan Institute and the rest. They have also supported the economics departments at U Chicago and George Mason.

I refer you to the useful web sites run by Source Watch and Media Transparency for details.

Here's an example for Charles Koch:
http://www.sourcewatch.org/index.php?title=Koch_Family_Foundations

So politicians didn't just come by these positions naturally. They were selected to run because of their predilictions or the ability to tutor them in the dogma.

Here's another link to show how this operated as concerns the battle over the estate tax.

http://www.citizen.org/documents/EstateTaxFinal.pdf

Posted by: robertdfeinman | March 30, 2009 at 05:49 PM


;

This is what I wrote in the comment section of Baseline Scenario. You are making the same point. Simon and James Kwak are good and logical writers but are looking for easy targets than root causes. Whoever suggests that IMF and technocrats are the solution ought to go talk to people in Indonesia and ask them how did relying on their advice work out for them. "For obvious reason, some commentators have hijacked the process of analyzing the root cause of the current crisis to get to their pet peeve. The crisis, first and foremost, was the result of monumentally wrong policy judgements - using US consumption and the consequent debt growth to ward off the negative wealth effect of the busting of an equity bubble - compounded by blind mercantilist policies of Asia's net exporters - unprecendented reserve building after the Asian crisis (and following the IMF advice a bit too closely, in fact).

Clearly, growth of the financial sector and bankers' pay was the consequence of these bad judgements on the part of policy makers and foreign politicians, rather than the root cause of all evil in the world. In the current political environment, if you repeat the base assertion frequently enough - as you and others have been doing - it will of course stick. But that does not make it the correct root cause analysis. Banks and bankers are easy targets right now but focusing on them exclusively will not fix the global order - doing something about reducing consumption and increasing savings in the US (perhaps not in the near term but definitely in the medium to long term) and increasing consumption and reducing currency subsidised exports in the developing world will go a long away. You should be focusing on those issues rather than take easy shots at banks and bankers. That's like trying to solve the drug problem by arresting the street drug peddlers."
;

Posted by: livingston | March 30, 2009 at 08:47 PM


;

Dear Mr. Livingston:

You say, "Clearly, growth of the financial sector and bankers' pay was the consequence of these bad judgements on the part of policy makers and foreign politicians, rather than the root cause of all evil in the world."

May I ask for one example in which the financial services industry, the largest donator to presidential and congressional campaigns and the industry with the largest lobbying expenses, ever opposed the bad judgments on the part of the policy makers and foreign politicians? Clearly, they had power; I'd like a single example of them using it for good instead of evil.

I'm not, BTW, absolving the politicians, only asking why you are using the politicians to whitewash the financiers. Or are you really, honestly suggesting that people on Wall Street didn't understand (1) what "to big to fail" meant, and (2) how to profit from that status? Maybe I'm a cynic but I'm find too many examples of Wall Street doing exactly that. Your analysis suggests that the politicians are adults and thus morally culpable, while people on Wall Street are children, in the sense of being pre-moral. If true, something we should think about before allowing them to fund the political process, no?

Posted by: Friedrich von Blowhard | March 30, 2009 at 09:05 PM

Not the technocracy to rule, but the rule of law.

Posted by: B9 | March 31, 2009 at 09:15 AM

Dear Executioner --

Thanks for your thoughtful comments (and the kind words about my own research).

The conundrum in which the practitioners of "modern political economy" find themselves is the following: either you say that policy is determined by the interests of the politically powerful (here, banks), in which case you are left with no way out (banks will remain powerful and veto any meaningful reform). Or, you accept some autonomous role for the intellectuals and policy makers to make a difference, in which case, you can hardly attribute all the blame for the mess on the special interests.

Failure to account for the fact that both forces are at play simultaneously results in the kind of attitudes I was objecting to: holier-than-thou moralism about the insidious effect of the banks (as if economists weren't equally complicit); preference for technocratic solutions (as if the IMF wasn't equally under the influence of Wall Street and the U.S. Treasury); and over-confidence on the technocratic policy recommendations of the moment (as if we had not been equally confident on the previous set of policies that brought us here).
;

Posted by: Dani Rodrik | March 31, 2009 at 10:01 AM

Ignoring the portioning of blame, I thought the most poignant point (which Simon Johnson certainly isn't the first or only one to raise) but which I've yet to see addressed on the path we are currently on, was summed up in one simple sentence:

"Anything that is too big to fail is too big to exist."

Whoever you choose to blame, and whatever your beliefs on who wields power in these situations, can we allow businesses to grow to the point where their failure would devastate our entire economy?
;

Posted by: Walter | March 31, 2009 at 11:38 AM

If the IMF is the answer, it must have been a pretty stupid question.

Posted by: michelle color me shocked | March 31, 2009 at 02:57 PM

Dear Dani (if I may call you that),

Thanks for your thoughtful reply which helps explain your position much better.

It seems however that you are lumping "modern political economists" in together with an older and cruder camp of material determinists who, as you suggest, saw little or no possibility for 'autonomous' policy decisions to take their countries 'out of the periphery' or out of the clutches of 'bad elites'.
But my take-home lesson from the modern political economy literature -- and again this is very much influenced by reading *your* seminal works in the early 1990s on the political economy of adjustment and reforms -- is that the policies that prevail are the outcome of political contests that are conditioned on the balance of power between different interest groups, but that cannot be always perfectly predicted (except perhaps probabilistically). .

What I have also learnt from you is that autonomous policymaking plus good policy choices was necessary for success outcomes in several places, with Asian NICs being the most frequently cited. That's an important and hopeful lesson.

But embedded in this very definition of "autonomy" (pardon the intentional pun) is how much room for maneuver these governments have been able to create by insulating themselves from the strong organized attempts by economic elites to impose their prefered policies. So the real question is what determines the space for 'autonomous' decision making.

The concern that I think many of us have is that the room for autonomous policymaking in the USA has been reduced in recent years because of the rising influence of a powerful financial sector and it's political allies.
Sure I blame Larry Summers, Alan Greenspan and other policymakers for failing in the 90s and later to regulate or provide proper oversight of fast growing derivative markets that proved capable of massive destruction to the economy and the innocent. Those people do deserve blame.

But had those particular people not been there it seems very likely that other people of very similar persuasion, acceptable to the 'business community,' would have been hired instead. The politicians who appointed them would make the same political calculation that challenging the very powerful banking lobby (and its generous political contributions) did not make sense. From reading Summers own writing it is not evident that he would have always chosen not to regulate. Hence I suspect his decision was at least in part political, and not just ideological.

In summary the power of the banking industry seems a deeper structural problem that helps understand the policy choices. More so than blame we might assign to particular economists, although it is possible to imagine a more courageous politician or policymaker who might have made a difference.
In the present political battle over policymaking as citizens and as taxpayers we should get behind people like Simon Johnson who are at this time the ones most loudly and clearly saying that whatever new financial system is to emerge, it should be one where there are no more banks politically or economically too big to fail.

And just because that might sound like a morality tale, doesn't mean they are not scheming to put in the fix.

p.s. -- on what we can certainly agree, and it is unfortunate that Johnson's tale suggested otherwise, is that the IMF has generally not been the good or the enlightened guy. I suspect (and hope) that he used that mainly as a literary device ("just look at how much the US is like a banana republic").

Posted by: Walras' executioner | March 31, 2009 at 04:40 PM


We have to have an uprising over AIG bonuses before anything is done. Hedge fund managers are still having their income taxed at capital gains rates. The Tresuary Secretary is about to give these managers a sweet heart deal to bid on toxic assets with tax payer loans that needn't be repayed. Reform of the bankrupcy laws which would give home owners some leverage over the banks is gonng nowhere in congress.

The idea that these things are good for the economy has long ago been swept aside, yet the interests of the financial community allow them to persist, to have their way with congress.

Posted by: wjd123 | April 09, 2009 at 01:17 AM


Simon Johnson Is Such A Downer! - The Ticker (usnews.com)

March 31, 2009 10:45 AM ET | Kirk Shinkle | Permanent Link | Print ;

Simon Johnson, an MIT prof and former IMF chief economist, is behind the The Baseline Scenario blog, which has been a vital read during this crisis. This week he's particularly smart and scary on both upcoming policy decisions and wider structural problems that still need to be addressed in the economy.

First in the WSJ: With Peter Boone, Simon writes about Tim Geithner's "nuclear option" for the banks -- basically giving the government power to liquidate or restructure large troubled banks at the expense of bondholders and creditors who until this point have been largely protected to prevent the sort of investor flight from the banks that caused Lehman Bros./Bear Stearns-style failures. Such a move would take the impetus off of taxpayers, but would almost certainly send bond and equity markets into a severe swoon. Simon says if the government grants "resolution authority" power and regulators move quickly (as in yet another long weekend), the strategy could work. If the process takes months, uncertainty could result in market panic.

Bottom line for everyday investors: There's no real upside, other than the possibility of long-term financial stability (which might make it worth the risk). Whatever happens, if Geithner is granted authority and uses these new powers, the end result will likely be Very Bad Things for stocks even if the plan goes off without a hitch. He writes:

This route to recapitalization would not be pleasant. Bank shareholders and creditors will cry foul. There will be several months of turmoil in markets, and there will be substantial disruption since bond holders and some creditors may be required to take losses when they receive equity. It will also send shockwaves to other undercapitalized institutions around the world, and could lead to their share and debt prices falling in anticipation that other governments will follow America's example.

For a broader look at the crisis, Johnson also shows up in May's The Atlantic where he puts on his IMF hat and takes a look at the U.S. economy. What he finds are scary parallels between our current situation and the sort of structurally unsound emerging market economies forced to reach out to the IMF for help:

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there's a deeper and more disturbing similarity: elite business interests-financiers, in the case of the U.S.-played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Banana Republic, here we come? Read the whole thing.

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A so-far-bloodless imposition of fascism on the American Republic

If you know fascism from corn flakes, you know the puppeteers who run that empty-suit, that Kenyan who has occupied the White House, are speeding forward in a so-far-bloodless imposition of fascisim on the American Republic.

Ayn Rand said it best: "The main characteristic of socialism (and of communism) is public ownership of the means of production, and, therefore, the abolition of private property. The right to property is the right of use and disposal. Under fascism, men retain the semblance or pretense of private property, but the government holds total power over its use and disposal . . . . / Under fascism, citizens retain the responsibilities of owning property, without freedom to act and without any of the advantages of ownership. Under socialism, government officials acquire all the advantages of ownership, without any of the responsibilities, since they do not hold title to the property, but merely the right to use it-at least until the next purge. In either case, the government officials hold the economic, political and legal power of life or death over the citizens . . . . / Under both systems, sacrifice is invoked as a magic, omnipotent solution in any crisis-and "the public good" is the altar on which victims are immolated. But there are stylistic differences of emphasis. "The Fascist New Frontier," The Ayn Rand Column, 98. http://aynrandlexicon.com/lexicon/fascism_and_communism-socialism.html

Economist's View Rodrik Simon Johnson's Morality tale

March 30, 2009
Dani Rodrik responds to Simon Johnson:

Simon Johnson's morality tale, by Dani Rodrik: Simon Johnson tells a simple and compelling story: the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets, except that Wall Street has bought its influence and power not by bribery but by shaping the ideology of our times...

The solution, to Simon, is equally clear. ; Finance needs to be cut down to size. ; What the U.S. needs is what the IMF would have told any country...

As with any story built around clear villains easy solutions, there is something in this account that is quite unsatisfying. ; For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. ; But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. ; Simon himself says as much. ; So why pick on the bankers? Surely the blame must be spread much more widely. ;

And I find it astonishing that Simon would present the IMF as the voice of wisdom on these matters--the same IMF which until recently advocated capital-account liberalization for some of the poorest countries in the world and which was totally tone deaf when it came to the cost of fiscal stringency in countries going through similar upheavals (as during the Asian financial crisis). ; ; ;

Simon's account is based on a very simple, and I believe misguided, theory of politics and economics. ;It is an odd marriage of populist and technocratic visions. ; Countries fail because political elites always end up in bed with economic elites. ;The solution, apparently, is to let the technocrats (read the IMF) run your affairs.

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. ; Too many of us thought we had the right model when it turned out that we didn't. ; We pushed certain policies with much greater confidence than we should have. ; Over-confidence bred hubris (and the other way around). ;

Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris?

[Dani is generally opposed to a global financial authority. He says "the logic of global financial regulation is flawed." See his article and the discussion at the Rodrik Roundtable.]

Posted by Mark Thoma on Monday, March 30, 2009 at 03:15 PM in Economics, Financial System, International Finance, Regulation ;

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Bruce Wilder says...

Dani Rodrik: ". . . there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. Simon himself says as much. So why pick on the bankers?"

I find this kind of muddled thinking -- "there's plenty of blame to go around" -- much more deeply dissatisfying than Simon Johnson's morality tale.

Is Johnson's tale too simple? Well, duh. It is a narrative of a few pages, though it is backed up with considered analysis and judgment. Complaining that any narrative is too short, not comprehensive, is pretty easy, because every narrative is too short, and every narrative is a narrative, not an analysis and not empirically verified in all its particulars.

The point of a good narrative is to precisely to bring to bear "moral" considerations. The bare, "scientific" analysis is bereft of values, and prone to the paralysis of analysis. We need the moral fables to identify the "meaning" of events and to galvanize action. And, we need the moral fables to bear some reliable, verified relation to an analysis of how the work works, and what has actually happened. I won't minimize the importance of working on finding the "truth", morally and functionally.

But, it's Rodrik's "it's complicated" whine that's provoking me, here. Does it bear critical scrutiny?

First of all, let's look at that sentence where Rodrik asserts that the banks (mis)judged risks, with the aid of the economics and policymaking "community".

Really very generous of Rodrik to offer warranty protection on economic advice, financed without fee by the Federal taxpayer.

But, banksters, not banks made those judgments. Not the economist-shills appearing on Kudlow's CNBC program or sitting on Bush's CEA. Sure, blame can be spread widely. I have no objection, if Rodrik is really willing to blame. If Rodrik wants Mankiw relieved of his duties teaching impressionable freshmen bad economics, more power to him. Good luck spreading the blame at faculty meetings. Be sure to let us know how that goes.

But, if Rodrik means to let the banksters off the hook, by "spreading" the blame thinly across an unaccountable elite, insulated from the consequences -- if "blame" is going to be limited to some tactfully silent criticism of colleagues at Harvard faculty meetings, then he should just shut up on his blog, as well.

It is not clear that the banksters "misjudged" the risks -- certainly all the banksters did not "misjudge" at all. Many, many took home huge compensation packages, from carefully calculating their personal chances in a game of "heads I win, tails you (the public and the government) lose".

And, yes, they got help from the "policymaking community". That would include many advocates of aggressive "de-regulation". Like UBS Vice-Chair, Phil Gramm? Alan Greenspan. Various Bush Administration appointees, including the Chair of a long-moribund SEC.

Why do I feel that Dani Rodrik wants to "spread" the blame around widely enough to dilute it into a empathetic pat on the back and an admonition to "try harder next time"?

Deeply dissatisfying, indeed.

Posted by: Bruce Wilder | Link to comment | March 30, 2009 at 03:54 PM

SS says...

Professor Rodrik attacks the IMF and argues the need for humility but he doesn't really touch Simon Johnson's main point, that is: that a corrupt league of financial and institutional interests wields considerable political and economic power here which makes the necessary economic reforms difficult.

Wittingly or not Professor Rodrik is holding up the status quo which is a mess.

Humility is only a starting point here, after we need to identify, as does Johnson, what the problems are.

SS

Eric Dewey, Portland, Oregon says...

Agreed, Bruce. While Rodrik has some points that are worth considering (particularly regarding the need for humility), he makes no progress at all with regard to practical solutions, while Simon's work does.

Certainly there are issues with any course of action; what is interesting about Simon's solution is that it has the chance of actually playing to, and thus defusing, both the economic crisis and the increasingly violent, class-based political discontent that is manifesting itself around the world...

Rajesh Raut says...

There was not small group of people who where responsible for this crisis. It took an army of mortgage bankers, real estate agent, home builders, home owners, investment bankers, regulators, rating agencies, insurance companies, politicians. I estimate for the housing component of the bubble that 12 million people participated and that 80% were middle class. If you want a corrupt league of interests that wields considerable power with the goverment, start with the National Association of Realtors. They have been lobbying for mortgage interest deduction and other tax breaks for home ownership.

The story that a small group of people took advantage of their power is just a fairy tale. There were large industries pushing these policies in their own self interest. And the truth is just about everyone in America (and a whole lot of immigrants from Mexico) benefited indirectly from the extra spending and cheap credit.

anon says...

So apparently Rodrik suggests humility in stopping the current, immense and rapid looting by banksters. It doesn't seem to bother him that they continue to spread a lot of money to the academic, political and media elites who support them. Even though it is taxpayer money they are now using.

At this rate we will indeed reach bankruptcy before we get substantial reform. With apologists like Rodrik, it may very well be insufficient reform that simply starts the cycle anew and will before long be undermined. (Yes, I know, the government supposedly can't go bankrupt because "we have the technology", much celebrated by the noble, albeit bankrupt, economics profession - a printing press. Just like Zimbabwe and many bankrupt governments before it.)

Mbuna says...

"but they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy."

Just what policymaking community are we talking about here? Phil Gramm? Good for the economy? You actually believe that crap? What planet are you on? Get a grip!

You know I actually wandered onto this site trying to watch a video of Paul Volcker but I have to say Mr. Rodrik sounds exactly like the corporate and idealogical shill that Simon Johnson is addressing in his article.

anne says...

"And the truth is just about everyone in America (and a whole lot of immigrants from Mexico) benefited indirectly from the extra spending and cheap credit."

The truth is that credit never became cheap for ordinary people, surely never became cheap for immigrants from Mexico who were with African Americans especially victimized by excessive cost mortgages, and the truth is addition is that ordinary workers benefited surprisingly little from what extra spending of the wealthier and wealthiest there was through the Bush years.

That is the truth, rather the the rubbish that would even explain how Mexican immigrants have been so helped by excess. Why Mexican immigrants among all immigrants, I wonder? What about Chinese immigrants or British immigrants? Why Mexican immigrants in particular?

SS says...

@Rajesh Raut

You agree with me without realizing it. I never said it was a "small group of people." Marxist analysis of class recognizes the role of ruling class interests permeating the society through numerous means, not the least of which is wage labor. That middle class people participated, that working class people vote the way these interests would like, is no surprise to anyone.

As for people other than the elites benefitting in the short term, this is also no surprise. The point is what it has led to which I dare say was embedded in a system meant ultimately to be to the profit of only a few. As we see even that didn't work out for them.

SS

calmo says...

Thanks for casting this wider net (for awhile the usual net contained only Greenspan) Rajesh

I estimate for the housing component of the bubble that 12 million people participated and that 80% were middle class. If you want a corrupt league of interests that wields considerable power with the goverment, start with the National Association of Realtors. They have been lobbying for mortgage interest deduction and other tax breaks for home ownership.
Annow the tricky part of portioning this responsibility ...or would you do the demographically appealing (but perhaps inappropriate) 1 vote, 1 share of responsibility? If we are interested in something more than revenge or retribution, but legislation to ensure this...calamity is not repeated, what would you recommend...even general guidelines?
anne says...

(Yes, I know, the government supposedly can't go bankrupt because "we have the technology", much celebrated by the noble, albeit bankrupt, economics profession - a printing press. Just like Zimbabwe and many bankrupt governments before it.)

[Yes, I know, this is absurd but how the absurdity persists.

There can be no failure of Treasury bonds, since the Constitution expressly forbids failure. There can be no bankruptcy. Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries for long.]

anne says...

The reason I never write of sub-prime mortgages without emphasizing that they were excessive cost mortgages is just to emphasize that credit never became cheap for ordinary people through the Bush years, and credit was expensive for ordinary people through the years of financial innovation that was supposed to allow for cheaper credit but rather allowed for increased income for financial companies. Look to at the expense of credit card debt, for all the financial innovation. Then, look to the cost of buying financial products such as simple investments. The expense of simple investments through an investing boom from the beginning of the 1980s has been repeatedly discussed by John Bogle and David Swenson and Burton Malkiel and others, but is easily forgotten.

Still, what is more profound given the problems that have beset so many is tolerating the idea that a financial industry that became increasingly abusive was actually always helping ordinary people (especially helping the right sort of immigrants).

Bruce Wilder says...

RR: "The story that a small group of people took advantage of their power is just a fairy tale."

What SS wrote.

To which, I might add, that in a country of 300,000,000 residents, in a world of billions, everything is done by vast organizations. Still, there is leadership, and some of the leadership was conspicuous in looting on a large scale and in enabling looting on a large scale. That's not a fairy tale. That's the truth. Some powerful people you don't even know are out to get you, or at least get your money.

Jas Jain says...

--
I have been saying all along that economists have been culprits in using housing and other policies to manipulate the economy and the economic behavior of households.

There is a whole class of manipulators that are running the economy and economists are very much part of it. More failures means more work for the manipulators! We have a positive feedback loop.

Jas
;

ampersand says...

they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy.

Huh? Shouldn't he be practicing the very humility he preaches, here, on this subject?

A far more correct story is that a very powerful banking lobby spent hundreds of millions, over many years to elect and then influence enough legislators to get changes like repeal of GS, prevent regulation of derivatives. The nexus between financial industry and government, made it easy. Full regulatory capture.

Or is Rodrik saying that the banks spend all that money lobbying, for nothing?

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. Too many of us thought we had the right model when it turned out that we didn't.

Ooh. Mama. These theories were conceived without any influence.

How about if he took a look at who funded and spread these ideological propaganda which benefited the financial elite?

That must not be the same elite, per Rodrik. Who else, then?

Must be the auto industry workers who bankrolled those economic ideas.

Is Rodrik a clueless moon bat or another ideological hack?

anon says...

Anne - That's why I made the reference to Zimbabwe. If the government keeps paying off an ever increasing amount of its debt with "printed" money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy.

The only constitutional language that can prevent that would have to include limits on said "printing." Since it doesn't (yet?) contain such language, nothing else in the constitution can prevent vast amounts of reckless spending (as in the officially sanctioned bankster looting) from leading to some sort of bankruptcy. Only voters can prevent that and so far they don't seem inclined to do so, notwithstanding all of the angry rhetoric in the world. I just hope that by the time they change their mind, it won't be too late.

BTW, the current strength of the US Dollar and Treasurys should be of little comfort. Enron was going strong until it wasn't. Same for Madoff and countless other scams. It's usually quiet before the storm. Fortunately, we have the ability to analyze and anticipate what is likely to happen (though only rarely when). Unfortunately most people let that ability go to waste.

ken melvin says...

If the government is going to buy up those toxics then the banks needn't bother with foreclosing.

anne says...

"If the government keeps paying off an ever increasing amount of its debt with 'printed' money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy."

When investors think there will be increased inflation, there will be less demand for relatively longer term Treasury bonds and longer term interest rates will rise. This will in no way mean bankruptcy, the idea is meaningless, only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation.

Treasury debt will be fail either by failure to pay principle or interest or by inflation, and bond specialists understand this. Investment managers who are cautious have also been limiting durations for months, which also means taking profits on longer term debt. Treasuries were terrific investments the last 10 years, and there is a time to take profits.

flubber says...

"What about Chinese immigrants or British immigrants? Why Mexican immigrants in particular?"

Presumably Rajesh was referring to the fact that Mexican immigrants in particular, and Latin American immigrants in general, overwhelmingly worked the construction jobs that built all the new houses, and did a lot of the kitchen/bathroom renovations funded by home equity loans.

Namke von Federlein says...

It was JPM, Goldman, Citi and a very few others who humped the residential mortgages into the market. Smaller local banks (8,500 of them in the USA alone) were forced to play against the big boys in commercial real estate.

The blame is squarely on the big investment banks in the good old USA.

Simon just makes a point - the risk management was perfect? Play the flippers and gamblers into bogus mortgages, securitize the nonsense into the pension funds of corporations and governments - and when the house of cards falls down the Federal Reserve Bank will become (conveniently) an insolvent entity. Now, just use that nicely insolvent unconstitutional private entity called the Federal Reserve Bank as a dumping ground for all the toxic garbage - which forces the responsible taxpayers to pick up the bill (with taxes, underwater mortgages, trashed equity positions, annihilated pension funds and finally - devaluation of what is left through inflation).

Perfect risk management.

Which will lead to civil war in the USA? Keep in mind - last I heard there were 7 guns per American in the USA. The survivalist groups are growing rapidly. 25% of the homeless are war veterans - they know how to use guns, equipment and strategy. And the Chicago Tea Party is not about happy taxpayers just waiting for a reason to pay more taxes.

To the Fed : all that lovely Treasury stuff is not your money.

Finally, you don't need a world currency to do business (although a trading SDR would help both small countries and small companies by providing a friction-free currency hedge for international transactions). Any large business with proper concrete collateral could issue its own currency. Exxonabucks? Why not?

I'd rather trade with those than uncollateraized notes issued by an insolvent entity holding trillions in toxic assets called the Federal Reserve Bank (look carefully at your USA dollar bills and tell me what it says... last I looked it said : Federal Reserve Note : backed by the full faith and trust of a private, insolvent, unconstitutional company called the Federal Reserve Bank).

I like Simon's fine and direct style (I've never met him).

Just rambling. Thanks for an excellent blog. I would suggest : It is certainly the right time for a candid exchange of opinions.

Fred (original) says...

If the government keeps paying off an ever increasing amount of its debt with "printed" money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy.

Exactly. Anne and I have had several arguments about stocks versus bonds. Basically, she is a fine example of a the old adage "a properous fool is a grievous burden". She had her money in bonds recently, during the great disinflation from 1980 onwards, and did quite nicely, and from that she extrapolates that bonds always do well and inflation is never a problem. I actually am glad that fools like her spout off so noisily because they guide me to the truth. Indeed, I have gathered far more useful clues to the future from listening to fools, and doing the opposite what they do or recommend doing, than from listening to the wise. The wise are good for the long-term and the big picture, but the fools can indicate exactly what is going to happen in the near future. If Anne predicts no inflation and bonds doing well under inflation, you can bet we will have a lot of inflation in the future and bonds won't protect you.

anon says...

Anne - You say: "Treasury debt will be fail [sic] either by failure to pay principle or interest or by inflation..."

That's the point I was making - no government is impervious to bankruptcy.

"...and bond specialists understand this. Investment managers who are cautious have also been limiting durations..."

Ah, hope does spring eternal. That's the essence of the greater fool theory. Good luck with that, because luck is indeed what it takes (aka gambling.)

"Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation."

From your mouth to whomever's ear. There's one big problem with that: the debt can grow so huge that default becomes unavoidable (whether outright or through a currency collapse.) Here's hoping that the looting is stopped before that happens. Since we are unlikely to get advance notice of a collapse in confidence, the sooner the better. It's too bad we're headed in the wrong direction, towards disaster, at an accelerating rate (we're at about $2T/year currently, with Geithner promising much more to come.)

I find it interesting that you ignore the comments about looting. In that sense you're like most of the electorate. Even if it is stopped or it's level reduced to sustainable levels, it is still a terrible misdirection of national resources. That's putting it very mildly when you consider the tremendous and growing needs all around.

James says...

Oh sure, the plutocracy can't be blamed since it has always had the common good at heart. All for the people. And to say that it has too much influence in Washington is just...well...not true or nice. No, Wall Street has never run Washington. Nor has the capitalist mentality rotted US brains. No. God the audacity of these people and their ideas. America needs a new radical party that will soak the rich with crippling taxes, redistribute wealth and usher in a new ideology of egalitarianism. Overdue here for over a century or more.

S Brennan says...

Anne,

Care to comment on this story:

By Michael Kranish
Globe Staff / March 30, 2009

http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

WASHINGTON - Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds....

James says...

What Raut doesn't seem to understand is that decades or more of incessant "capitalism is wonderful" propaganda has rotted brains in the US in general, so that even the poor have no good idea where their interests lie or how to defend them. The plutocracy runs things and coopts enough of the population to forestall any rebellion. The US needs a, dare I say, revolutionary party that will mobilize the masses to take power in their interests and unseat the bloated plutocrats who have brought on this disaster. The one reason one can hope that it is truly a disaster is that only that can being the revolutionary change in mentality that is needed.

hapa says...

don't know or owe anything to dani rodrik; don't have credibility; but will defend this read to an extent. "bad apples" is a dangerous story. we have structural problems that extend beyond regulatory capture and malfeasance. we're heading over the ecological cliff and need to think hard how to address "fairness" in a situation where wealth no longer comes cheap. "we wuz robbed!" really really doesn't cut it.

SS says...

@Mark Thoma

Mark,

Thanks for giving us, the public in this case, the chance to voice our opinion on some of the leading establishment thinkers and their vision of our future and understanding of the past.

I think it would be a good idea to forward these comments to Professor Rodrik as the overwhelming opinion appears to be that his rebuttal has missed the mark and might even be considered harmful in terms of constructively dealing with the problem.

SS

Fred (original) says...

Anne: Care to comment on this story: ... Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

I'll comment. This is a zero-sum game here. PBGC bought a bunch of overpriced stocks while someone else sold the same. If PBGC has to bailed out by running up more federal debt, then eventually we will have to raise taxes to cope with this added debt. To some extent, those who benefitted at PBGC's expense now will have to pay these added taxes in the future. But there will also be some innocents who have to pay added taxes. Too bad. Life is full of injustices.

gordon says...

Prof. Rodrik has been campaigning against the "Washington Consensus" for a long time, and part of that campaign has been an attack on "one size fits all" economic development theories. He is an advocate for different, country-specific development policies based on his ideas about different countries facing different "binding constraints" on growth at different times.

Now he sees what looks like another attempt to impose a standard set of solutions, and doing it through the old vehicle of Washington Consensus itself - the IMF.

It's understandable that he should react against it. He perorates: "Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris"? What this means (IMHO) is that he doesn't see why a new regulatory regime would be less oppressive and/or irrelevant than the old Washington Consensus regime. It would probably even be run by the same people.

I, too, am very dubious about a single regulatory body, but for slightly different reasons. Prof. Rodrik is inclined to spread the blame, whereas I fear regulatory capture by exactly the same people that Prof. Johnson is pointing to. Why, given the history of regulatory capture that the current crisis has revealed, would a new regulatory authority be immune?

For that reason, though I certainly think that improved regulation is needed, I would not like to see any single "integrated" organisation created. A plurality of regulators is the best insurance that at least some of them will be honest some of the time.

Hal says...

The US, going forward, needs two things to happen and any useful administration would be working toward them. First, the nation needs to be freed from the strangle hold of the plutocracy, and second, it needs to be unglued from Israel. The Obama administration is doing neither. In fact it has gotten into bed with the plutocracy and kowtows to Israel whenever ordered to do so.

Posted by: Hal | Link to comment | March 30, 2009 at 08:16 PM

roger says...

I'll take the curse on both the economists approach, and put my money on Bruce Wilder's explanation - which, in this comment thread, he seems to have laid aside for the moment - that it was inequality that killed the beast - of our oversized speculative sector. It is always important to remember that the mortgages were being made on homes that were climbing from 3 times to 4, 5, and even, in LA, ten times income. And in that ration, income - the median household income - was certainly not keeping up with its average, particularly its average during a supposed boom. Jeff Madrick, in The Case for Big Government, cites the study entitled The State of Working America, 2006-2007, which found that while productivity grew by 33 percent between 1995 to 2006, compensation grew at half that.

If it had grown in tandem with productivity, would we even have had a housing bubble? I don't have a quick calculation of those figures, but I think that - to some degree - if banks were looking at the income increases of the late 90s, they might be justified in thinking that housing prices would fall back in line with the 3 to 1 ratio. This is from the Cbpp:

Employment grew at an average annual rate of only 0.9 percent from November 2001 to September 2007, as compared with an average of 2.5 percent for the comparable periods of other post-World War II expansions. In addition, real wages and salaries grew at a 1.8 percent average annual rate in the 2001-2007 expansion, as compared with a 3.8 percent average annual rate for the comparable periods of other post-World War II expansions"
http://www.cbpp.org/cms/index.cfm?fa=view&id=575

This combo of weak employment and weak rises in real wages was what was happening underneath the housing price rise. So, the banks calculated wrongly, while the bank CEOs were doing their best to make sure that wages didn't rise and corporate profits boomed. Pretending this depression/recession came out of the housing bubble essentially picks out a surface phenomenon showing a much deeper illness.

hapa says...

"pretending" ... because the credit bubble was a kind of tug-of-war opponent with conditions on the ground? ... but in that case losing collateral was as devastating as inevitable?

acerimusdux says...

"It is an odd marriage of populist and technocratic visions. Countries fail because political elites always end up in bed with economic elites. The solution, apparently, is to let the technocrats (read the IMF) run your affairs."

That certainly seems accurate enough to me.

Not that I trust the IMF to be immune from politicization either, but I do think it is generally true that there are people who understand how to make good policy, often it really isn't that complicated even, but that it is these self serving elites (or their stooges) who sabotage it all and then claim that it is so very complicated, and that it is all the fault of technocrats, or bureaucrats, or science itself, or perhaps simply the fault of everyone, or human nature itself, and thus we should all share in the blame for their looting (or, in the case of the most witless of stooges, their ignorant acquiescence in it).

Lafayette says...

From LaLa Land

Rodrick: For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community -- not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy.
And bollocks to this, Dani.

If you think that they were not motivated by the excessive sums of money to be gained, then you're walking in LaLa Land.

Talk about academic nonsense ...

a says...

"the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets"

and

"Yes, there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. "

Yes well, there can be little doubt that the cronies in our capitalism include the economics and policymaking community. Did Phil Gramm really believe he was doing what was best for the economy? Or what was best for him and a pay-off from the investment bankers in the form of a high-paying job? Look at Martin Feldstein, Harvard economist, who was and still is on the board of AIG Financial Products, that multibillion dollar black hole.

Okay, sure there are some (many?) economists and policymakers who are trying to do what is best for the economy, including our kind host. But there are enough economists and policymakers who aren't, that the good ones are corrupted in fact though not in spirit. e.g. Feldstein reviews their submissions to journals, so the good economists have to filter their ideas to ones acceptable to the corrupt.

anne says...

Correcting:

When investors think there will be increased inflation, there will be less demand for relatively longer term Treasury bonds and longer term interest rates will rise. This will in no way mean bankruptcy, the idea is meaningless, only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation.

Treasury debt will [not] fail either by failure to pay principle or interest or by inflation, and bond specialists understand this. Investment managers who are cautious have also been limiting durations for months, which also means taking profits on longer term debt. Treasuries were terrific investments the last 10 years, and there is a time to take profits.

anne says...

There can be no failure of Treasury bonds, since the Constitution expressly forbids failure. There can be no bankruptcy. Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio.

hari says...

Dani has opened a pandoras box for intellectual criticism.

Because, as Mark clarified, Dani doesn't believe in a single global regulatory authority. Then what does he consider compelling in present global meltdown circumstances....?

Dani can't deal with the inherent contradictions in current Bretton Woods setup - in which US Treasury not only wields a Veto on any (fiscal) policy it considers against its national interest, but also decides (with EU) who sits in the policy making body.

[Geithner is one of those interns from IMF]

Also - in today's link - Nick Stern/FT piece is useful
in this policy context. [The Whitehall mandarins are at it again, me thinks.]

In criticizing the intellectual bankruptcy of *Old Britannica* (and by implication US policy), I tried to identify the historical malaise as a product of Anglo-American political-economic hegemony in global decision-making, hitherto.

Neither Dani nor Simon is willing to admit the post-war system is finally bankrupt. And, I suppose, there is a good reason why they don't go there....

So, who will reform the present setup?

*EU as decided (during its last Summit) to forego its Chair at IMF (in favour of mainland China and BRICs).

*China has agreed to augment IMF coffers - with the specific understanding that first priority will go to the unmet demands of the developing countries.

*Moreover China wants dollar denomination of IMF coffers (ie. reserve currency role) to be replaced by existing SDRs or its replacement (WCU*).

*BRICs and Russia, in particular, would like to remove the role of dollar in international trade transactions.

*What will replace USD? No one seem to want to get into the substance of that debate....

In sum, what's going on here from a global policy perspective, at G20, is a desire on behalf of Anglo-American capitalism to preserve its realestate; and, inspite of its dismal record of hegemonic polical-economic performance, the end of English-speaking dominance of world capital markets is within sight.

It's now actually a q' of what form it will take...and if it will have the support of BO, in particular.

*WCU - world currency unit (my idea).

BJ Feng says...

If it is so easy to make sound policies, then why hasn't any country on Earth done it to the satisfaction of the critics here? And if these policies are so obvious, then how come only vague notions of "stopping the looting" are all that's recommended here? Where are the specific details outlining this magical policy that will finally stop the crooks and con-artists from dominating the government?

So Wall Street failed to create never ending prosperity, their models and formulas were wrong. But now we're supposed to believe that government hacks can do better, they'll come up with a working model that won't fail this time, promise--all it takes is the right policy view?

Face it, the G20 is playing the usual blame it on someone else game. Of course THEIR government, the people who were supposedly responsible for regulations in THEIR own country, couldn't possibly be at fault. No one was asleep, everyone was vigilant, please don't blame us, it was the evil rich who allowed this to happen! Yes that's it, and if you don't buy that, well it was the United States then! Anyone but us! Never mind that the United States can't craft the domestic regulations and laws that government foreign countries, no, somehow the United States is responsible and these other countries are all blameless!

If you hold Wall Street accountable for failure, when will you hold government officials accountable for their failures? Where were the regulators in all these countries? Surely not all of them can be as corrupt and evil as the ones in the U.S. right?

BJ Feng says...

"..,only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation."

But what if the FED announces something like a trillion dollar policy of quantitative easing? Might long term interest rates not rise? And what if the FED goes off the deep end and announces it will purchase ALL the long-term bonds being auctioned for a 3% yield? Humm, good thing bond managers have limited their duration. But what if inflation runs at 10% and both short term AND long term Treasuries only yield 5%? And what if the money markets only yield 2% on commercial paper to boot?

What will these wise bond managers who understand duration do to avoid being decimated by inflation? Well I suppose they still have one more option left, but what if the Treasury announces they will no longer auction TIPS because people can already buy I-bonds, and what if they set the fixed rate portion of those I-bonds to -2%?

"...there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio."

Perhaps you misspoke Anne?

Real Person from the Real World says...

Ever since the Republicans trotted out welfare queens on the road from the welfare to workfare transition, much of the populace bought into the conservative/libertarian ideas that if I work hard, I will get wealthy, and there is no such thing as a free lunch. Well, fast forward to the Obama admin: You still get the same non-sense. Safety nets for the population are "socialism." Never mind that most of the suggestions for the bailout from the BO admin, are compromises with conservatives (see PK's Market Mystique). Never mind that so many people are losing jobs, and health care is becoming a perk of the well-employed only. All I can say is that the cronies did a good job selling to all the suckers.

ken melvin says...

RPFTRW is right. Obama said it just like Ronnie and people voted for him as they did Ronnie because they wanted to believe it never mind that it is BS.

anne says...

"Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio."

Simple, a constant duration bond portfolio adjust to any interest rate change over the duration period. So, a portfolio with a 2 year duration will decline by 4% if in there is a 2% increase in interest rate, but the portfolio will return 2% a year more in interest so that the decline in price is made up be added interest over the 2 year duration.

Similarly, for the same portfolio, a 5% increase in interest rate will lead to a price decline of 10% which will in turn mean the portfolio returns an additional 5% a year in interest and the portfolio will have completely adjusted in the course of the 2 year duration period.

SS says...

@BJFeng

Sir,

The argument you put forward is hardly new but I thought didn't persist much beyond high school equivalent pundits. It suggest a la Leibniz that the world is the best of all possible worlds, therefore, any action to improve it is unnecessary and further doomed to failure.

Moving from metaphysics to the situation at hand your argument would be like seeing a teenager about to commit suicide and being able to easily stiop him. The metaphysician pauses arguing since mankind has never been able to prevent suicides preventing this one can only be a futile act. Good policies begin one at a time. The U.S. may be the best country ever, I personally doubt that but find the question ultimately absurd - - how could one know all the countries and societies and the quality of life they supported - - but even granting this absurd premise it is hardly an argument against an action or policy that would improve the country.

Those posting here are engaged in one of the oldest social pursuits, since humankind began talking, that is trying to understand and improve our condition. God knows it needs improving right now. Such national jingoism as yours if not simply "facist" - - see Umberto Ecco's Ur Fascism -- is in the least infantile.

SS

anne says...

The Vanguard long term investment-grade bond portfolio, through all sorts of interest rate change has returned 8.2% a year after costs for 35 years.

The long term Treasury portfolio has been remarkably consistent in return from the beginning:

https://personal.vanguard.com/us/funds/snapshot?FundId=0083&FundIntExt=INT#hist::tab=1

Vanguard Long-Term Treasury Bond Fund

Average annual returns as of 02/27/2009

02/28/2008 ( 7.77%)
02/28/2006 ( 7.29)
02/27/2004 ( 6.32)
02/26/1999 ( 7.19)

05/19/1986 ( 8.32)

anne says...

There are in addition Treasury inflation-protected bonds, as there are Treasury guaranteed mortgage bonds.

However, investors who have been so well served by bond portfolios for so long will respond to policy changes and to changes in economic conditions.

We have been in a liquidity trap period that began forming in January 2008, during which the Federal Reserve has continually lowered Treasury interest rates leaving investment-grade rates remarkably unchanged or even significantly higher now than in January 2008.

Investors then have adjusted bond portfolios to policy and conditions through these months in ways that differ even from the 1930s, always choosing caution as far as can be known from bond market price changes.

How cautious investors can be is found by looking the the Vanguard Treasury backed mortgage portfolio which has a 1.8 year duration, similarly the relative high yields of A rated investment-grade bond portfolios no matter the duration shows the caution.

anne says...

http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

March 30, 2009

Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds....

-- Michael Kranish

[What is necessary to understand here is that an investment manager needing to be most conservative, sold well priced bonds and bought stocks when price-earnings valuations for stocks were anywhere from 22.4 to 26.0 as the stocks were bought in 2008 and dividends were 2.0% and less.]
anne says...

"But now we're supposed to believe that government hacks can do better...."

Simply notice the language and understand what thuggishness amounts to, understand what writing with the intent of demeaning and intimidation amounts to.

To work in a government setting is to be a hack, from teachers to scientists to soldiers to accountants and on. What is intended is intimidation.

Beezer says...

I'm more in Johnson's camp if for no other reason than he's been at the table and what he sees in the U.S. now looks all to familiar.

Having said that it still appears to me that income inequality following a huge capital investment push, and subsequent leveling off, has something important to do with our current situation.

The capital push came from technological advancements in computers and networking. And this push was very heavily weighted in financial services from the mid 1980s until the beginning of this century. Then it levelled off. There were improvements but the main underlying technology was put in place earlier.

For this century, there was not so much a need for capital investment, and therefore income wealth continued to be generated without as much need to spend additional money on capital and its corresponding labor. Particularly in the financial services industry which continued to grow, in no small part, because of globalization and the spread of manufacturing around the world in search of cheap labor and new markets.

In emerging markets such as China, a lot of income did trickle down (China took almost 300 million people out of subsistance living!). But in the U.S. the effect was increasing debt levels and speculation created by the lack of new capital investment opportunities.

Unburdened by a need to keep adding to capital investment, wealth cast about for something else. As in the 1920s that something else was securities of all kinds.

And then the bubble went pop. Old wine, new bottle.

anne says...

http://krugman.blogs.nytimes.com/2009/03/31/dow-36000-and-your-pension/

March 31, 2009

"Dow 36,000″ and Your Pension
By Paul Krugman

So in 2007 the Pension Benefit Guarantee Corporation - which stands behind corporate pensions - switched from bonds only to lots of stocks, * buying in at, natch, the peak of the market. Oops. And this is big stuff: the Bush administration may have left us all a gratuitous loss of hundreds of billions.

Why did this happen? I'm sure we'll find some nasty stuff, but at least part of the reason was that the Bush administration, like many conservatives, was under the spell of the following pseudo-syllogism:

  1. The stock market captures the essential spirit of capitalism.
  2. Capitalism roolz!
  3. Therefore, stocks will go up.

The most influential disseminator of this fallacy is the Wall Street Journal, which as far as I can tell has cheered on every bubble since the 1920s, always dismissing the skeptics as fools and promoting the dumbest bull-market arguments available. I don't have time to search for it right now, but I think there was an editorial circa 2000 saying precisely that anyone who questioned the bull market of the time was anti-capitalist.

And now the cost for that attitude is falling on you and me.

* http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

Eric Dewey, Portland, Oregon says...

Hari, thanks for making that point about the decline of the Anglo-American post-war monetary system.

That is precisely the point, and precisely the challenge, that faces the world. Bretton Woods II is dying a slow death, and China has articulated that it intends to play a leadership role in the establishment of a new system.

That is the reality - and those who attempt to deny or trivialize that reality are either 1) unwilling to face it, or 2) attempting to protect their own interests.

The core question of our time will be: what anchors the value of a global monetary exchange system?

anne says...

The current bear market began in October 2007 though the market never recovered form the bear market that began in March 2000. More importantly, the stock market remained expensive even through the bear market of 2000-2002 and only became more expensive in the recovery that lasted to 2007. Even with corporate income at record or near record levels through the Bush expansion, the stock market was always more expensive than earnings could justify. The problem was that earnings could not have continued to grow so strongly indefinitely since economic growth through the Bush expansion never justified the earnings growth.

anne says...

Beyond the problem with impossible stock valuations and unjustified earnings, there had been for years an erosion of dividends that continued through the Bush expansion and made stocks continually riskier to own as stock prices increased. Nonetheless, stocks were continually recommended beyond bonds by the bulk of analysts and even cautious analysts repeatedly ignored bonds. Even tax policy, being increasingly slanted against bonds. Where though was income to come from during a bear market of any length?

calmo says...

SS writes/bites/smites (way mo than this here types)

It suggest a la Leibniz that the world is the best of all possible worlds, therefore, any action to improve it is unnecessary and further doomed to failure.
And I'm sure that the multi-lingual, multi-cultural, multi-talented Leibnitz would have been suitably impressed with "a la Leibniz" and the "therefore" clause not so much.
Does this mean you are a reader of what was once known as The Rationalists? (calmo recalls fellow traveller peering sideways "You seriously read THAT for pleasure?!"...I replied, "No, no, I read Harlequin Romances, like you...just as soon as there is the slightest turbulence." It was not the best of all possible replies...and therefore...I resolved to replace "Harlequin Romances" with "Outdoor Living"...such is my quest for improvement...even in this Best of All Possible Worlds...that have not recognized this Leibnitz character, not really...until you provide this wee comment SS.)
SS says...

@ Calmos

Thanks for caring. I can't pretend to interpret your text - - socialist not = structuralist - - at least not one for one, but if a, Calmos, is ready for self-improvement, can socialism be far behind? A propos of Outdoor Living, do you fear growing homelessness? Best

SS

roger says...

Hapa, you are right to jump on my use of the word "pretending", which has the unfortunate connotation that there is some kind of conspiracy going on. Rather, blaming the pop of the housing bubble for all our problems is a sort of programmed response from the ideological buffer that we have assimilated over the last thirty some years. This buffer has to do with making inequality some unfortunate side feature of a robust free market system. I think that isn't true - inequality has a dynamic. When you look at the incredible amounts of wealth that have accrued to the wealthiest over this period of time, one should ask why the ideologues of the system insist that this feature is intrinsic and to be defended at all costs, while inequality is extrinsic and regrettable, but no big deal.

That is the question which leads to the operating system of Reagonomics -- the battering down of labor's bargaining position and hence the stagnation and loss of median household income -- the rise of the easy money credit system, which comes in as a sort of substitute for wage increases, but one that has to be paid back with interest, and the flooding of the equities market and the wilder shadow financial system with the aggregate asset wealth - the pensions, the insurance, the 401ks - of these same household. The bubble in housing prices was -- as I think was clear to anybody in 2003 -- an intentional act . It arose out of the imperative to keep the triangle (low wage demand, easy money, inflated securities) going. The neo-liberals and the conservatives simply want to preserve this system, with the neo-liberals wanting to press on the easy money pedal, and the conservatives wanting to press on the lower wages pedal.

The organ, however, is broken.

calmo says...

SS, interpreter like me, maybe just findin a soft-spot, accidentally with me (quite fond of L and not the celebrated Newton) who likes to stay close to "caring" (we are not doin this for money or monetary equivalents, are we?...snot the place to B practicin for your Nobel Prize you deserve after reading an entire misty thread but a pretty good place for noodling...maybe not improving the noodle, but arresting its dissent, its inevitable departure from el dente.

So, do I hear tiny alarm bells with your "socialist"? I'm perplexed by that distinction structuralist/socialist...but I perplex at the drop of a hat (lookit, gravity...so unrelenting).
Absonootely about homelessness. If the job losses don't ease up from the current ~650k/mo, we are in for trouble...that even investment bankers can see. Even recognize. Even report.

;

BJ Feng says...

The answer Roger, is that inequality cannot be eliminated without reducing the populace to a subsistence level lifestyle. Plus it is NOT a zero sum game. Just because someone is wealthy does not mean that someone else has to be made poor, it depends on the system. If the rich derive their wealth from confiscation, then many will have to be made poor, but if the rich derive their wealth from adding economic value or inventing something that will increase productivity, then not only will they become richer, but the poor will also.

When I hear statements about the rich feeding off of the poor here in America, I wonder how? What is the mechanism? You might ask why income inequality rose during the past few decades and I have a very good answer for you. Globalization. With billions of new people entering the global capitalist system, the returns to labor decreased and the returns to capital increased. This wasn't a conspiracy invented by the rich to "exploit" the poor. What we are seeing is a worldwide systematic shift, this shift will create vast amounts of wealth for everyone, especially the poor in emerging nations, but it also increases income inequality here in the United States and other developed nations.

Globalization cannot be stopped, much as industrialization could not be stopped in the past. The best course of action for the poor is to move to industries that are not in direct competition with the poor in emerging nations. That is learn plumbing, or how to fix houses (many foreclosures need repairs), even dog walkers are rumored to make good money, these are just some ideas.

Obvious says...

I find both Johnson's account and Rodrick's reply to be illuminating and outstandingly useless in any practical sense. Yes, the bankers are a corrupt crowd, and yes - judging from its past performance, should the IMF have its way with the US today, Krugman would be clawing up the walls of an asylum cell tomorrow.

Neither piece lays the blame correctly or identifies any true solutions. What I found most interesting here was, as is often the case, in the comments, namely this part of Eric Dewey's comment:

"increasingly violent, class-based political discontent that is manifesting itself around the world..."

Is there a reason why the "mainstream" debate views this as a problem to be solved, rather than a solution to the immediate problem? Which is an honest question that I sincerely want to see discussed by the gurus.

;

SS says...

@BJ Feng
"you might ask why income inequality rose during the past few decades and I have a very good answer for you. Globalization. With billions of new people entering the global capitalist system, the returns to labor decreased and the returns to capital increased."

You apparently know trade theory so I have to conclude that you are not an economist. Up to this point you are right. But ask yourself how one obtains capital, hard work. . .? I think not. The original American capital, land, was stolen from the indians, since than it is systemically skimmed from the working classes. Is a CEO banker an owner of capital, consequently getting a "return on capital?" Not until he skims his millions from the workers in a class system which validates this theft. Good try your getting there.

SS

Posted by: SS | Link to comment | March 31, 2009 at 01:14 PM

hari says...

Breaking News!

Sarkosy's Finance Min says President of France will walk away from G20 Summit if a global regulatory regime is not approved by all leaders (my interpretation).

Brown is still banking on BOs support for $2T stimulus plan, as part of his Summit Declaration.

NB. There is emerging a dividing political line (tactics in the protracted negotiations) between surplus exporting countries (Germany, Japan, China and India) and current account deficit countries (eg.US/UK).

Posted by: hari | Link to comment | March 31, 2009 at 01:15 PM

roger says...

BJ, your response is based on two conservative memes. One meme is to conflate the critique of inequality with the call for radical equality. Thus, if I say that a hedge fund manager shouldn't be getting a billion per year, I'm really saying that we should all get fifteen thousand a year and live in Soviet pre-fab housing.

Well, that meme is convenient, since it substitutes an argument it can win with an argument it doesn't want to approach. In point of fact, it was political changes in the U.S., not globalization, that drove the triangle I describe. These changes were the basis for our current epoch of globalisation, with capital using its global advantage and political entrenchment to stay far ahead of labor, plus the political and military power of the U.S. to allow for the terrific accumulation of debt on the consumer level. In the U.S., the population acceded to an industrial policy that downgraded high wage manufacturing and broke apart the power of unions because they got something in return - credit and asset inflation. Now, of course, they have neither.

The second conservative meme is to massage the position that we should not have much greater equality (not absolute) by putting it in terms of the "rich" versus "poor". Of course, in developed countries, the middle class, extending from the working class to much of the white collar class, is the most populous. When conservatives float that rich vs. poor binary, they know that this middle will instinctively turn to the rich. But in fact the middle class is as dependent on a healthy state supplied social insurance network as the poor. It is really a threefold opposition: rich vs. middle vs poor. It is the middle that will benefit from greater equality - i.e. creating severe disincentives for management to make more than 20 times the amount made by the lowest salaried employee. Since globalisation is played on a field in which labor is, as yet, divided between nation states, it is up to those nation states to use state power to create more equality - if there were powerful international labor organizations, this could be left to the fight between capital and labor.

If globalization was the actually cause of the middle class stagnation and the rise of the mega-rich, there'd be every reason, then, to oppose it in the U.S. - it would, after all, be to the disadvantage of the vast majority of Americans. But I don't think that is true. While the theory of competitive advantage is an ideal never met with in real life, it is still true that a developed country should have an advantage in shedding lower skill jobs for higher knowledge jobs. Meaning that they should be going to the next plateau, creating tomorrow's products. Well, what does seem to be true is that the mega-rich, as they become entrenched as an oligarchy, play only for the highest yield, and thus lose the only economic function they really have - to seed long term R and D for their own long term profit and, more importantly, the social good. And free trade, which once justified itself in terms of production, increasingly argues in terms of cheaper consumption. The latter is an argument leading to a bad end.

If we argue not against the conservative memes, but in terms of the reality of the current state of inequality, we will get a pretty good picture of the dysfunction that has created the current slump. Which is why we should be getting out of it by attacking inequality (rebuilding the state's social insurance net, using any and all financial power to inject money into the economy outside of the narrow subsection of Wall Street that we are currently putting money into, redoing the tax system to wipe out tax havens, institute tax brackets on the wealthiest and significantly raise their marginal taxes), and so reconfiguring the operating system of American capitalism.
;

Posted by: roger | Link to comment | March 31, 2009 at 04:39 PM

gordon says...

Nice one, roger. I would suggest that the state actions necessary to attack inequality should include support for unions (a countervailing power) and expanded Government enterprise. By that I mean Government ownership and operation of the natural monopolies of power, water and public transport (maybe others would suggest more). Revitalised public education and health care are also necessary.

Posted by: gordon | Link to comment | March 31, 2009 at 10:23 PM

BJ Feng says...

Doesn't higher yield imply a great need for capital and thus, when the rich invest for higher yields, they also employ capital where it is most needed and where it can produce the most good for society? Thus factories are built in order to capture large profits, and large profits are only possible because the populace desperately wants the goods produced by the factory. The fat profits should attract enough capital until better opportunities present themselves elsewhere. By that time the populace has access to much cheaper goods.

In theory this happens, but in reality there are often barriers to entry that create monopolies. Interesting isn't it that the reasons given to prevent competition are usually to protect the consumer from being "exploited" or gouged by new firms eager to make a profit. Carlos Slim is one of the wealthiest men in the world because only he can protect the Mexican consumer from predatory pricing.

Competition is the engine that drives capitalism. The good effects of capitalism come from competition, and competition makes sure everyone gets a fair deal. Government ownership necessarily means monopoly as government has almost unlimited resources and can change the rules of the game whenever it wants. Capitalism does not work very well if there is no competition to force innovation and to ensure that firms work to fulfill customer wants. Without it, firms have no inventive to satisfy customers who are seen as a necessary burden. It should come as no surprise that Mexico's State run oil industry is in trouble thanks to malinvestment and waste. Venezuela is on the same path now that the competition was driven off and their oil assets seized.

What causes a nation to be richer and more successful? It's economic system, social structure, and laws. Property rights and stable laws are two of the most important qualities necessary for success. Governments that seize property and wealth on behalf of the poor don't do very well in the long run. Yes the society gains after the seizure, but without new investment and capital, the party soon ends. And it will take very very high rates of return to attract investment if investors believe the government will just come in and either seize or tax away all the profits once the hard work has been done and the investment becomes profitable.

Getting short on time, so to I'll only ask why do so many Nobel prize winners (of hard sciences) reside in the US or immigrate to the US after winning? How come just about all the new, revolutionary tech companies of the internet revolution popped up first in the U.S.?

Why didn't Google start in France? Why didn't Ebay or Utube or Myspace or Facebook, or Amazon etc., etc., etc. Of course the founders and the venture capital firms who first got in are very very rich now, but they've created a whole new industry and countless jobs as well as made our lives better.

Yes there are problems with the way manager compensation is handled, but that's due to the power they have to set their own pay. All that's needed is to allow shareholders, and shareholders only, to sit on executive compensation boards and decide pay for management. You won't see the ridiculous bonuses for terrible performance anymore, nor will you see golden parachutes for failed executives who run the company into the ground. The executive will be lucky if he isn't escorted out by security. Give owners the rights they should have to set pay for their employees. In reality it's a two way conversation, but right now, managers set their own pay and owners are nearly powerless to do anything about it.

says...
Roger: Which is why we should be getting out of it by attacking inequality (rebuilding the state's social insurance net, using any and all financial power to inject money into the economy outside of the narrow subsection of Wall Street that we are currently putting money into, redoing the tax system to wipe out tax havens, institute tax brackets on the wealthiest and significantly raise their marginal taxes), and so reconfiguring the operating system of American capitalism.
Ah, yet another breath of fresh air that proposes a solution in this blogathon of finger-pointing blame.

Good on ya ... we need solutions, not a tired list of the blameworthy.

Posted by: | Link to comment | April 01, 2009 at 06:18 AM

wjd123 says...

In "Trilemma," an essay by Dani on his blog, he claimed that if countries wanted "deep" global integration they would have to give up nationalism or democracy. Nationalism imposed barriers to globalism while globalism required the democratic polis to be subservient to global aims.

However, if the trilemma isn't about deep global integration but about deep international integration then there is a way for countries to achieve greater integration without giving up democracy. The EU way.

For instance under EU law woman have greater protection against discrimination in the work place than they would under the laws of any member country. EU citizenship allowes a Spaniard working in England to vote in local elections there. Internationalism the EU way has increased both the rights of woman and expanded democracy.

The ability of the global economy to arbitrage away one nations political economy against other's is lessened under deep internationalism in the same manner that is harder for speculators to make a run on the euro than it is to make a run on the pound.

Ideological questions of legitimacy that arise when global markets undermine the rules and regulations of democratic agreed upon political economies are brought back to a democratic polis

Instead of political economies being reduced to the lowest common denominator under "deep" globalization, political economies that opt for this type of "deep" internationalism swap some sovereignty for expanded democracy and expanded rights. A good deal all around.

Expanded checks and balances against oligarchic capture also opens up.

France not having interests in finance that are as great as America's or Britain's would be a check against those interest gaining too much power.

It seems to me that checks and balances on an international scale would make oligarchic capture harder than checks and balances on a national scale.

And since Dani argues that it is too easy to blame the bankers for our financial crisis because the spirit of the times after Reagan and Thatcher has been one of deregulation why not take advantage of the new spirit for regulation to forge some international solutions to international problems exposed by the financial crisis.

Dani says that GATT was a victim of its own success. How so? Is it in the Paul Krugman sense that free trade wasn't a problem until it grew big enough to become a problem. If so, we can't look backwards for solutions if we are to progress.

While it's true that the internationalism I speak of isn't working very well right now that's no reason to give up on it and revert back to nationalism. In fact since the idea of regulation is in the wind and EU countries are open to it, now would seem to be the opportune time to get international financial regulations that don't possess the weakness of the Basel I and Basel II attempts.

I agree with Dani that there can't be a one size fits all approach to regulating. This isn't one of them, it's an international way that takes small possible steps that moves us toward a greater globalism without the stumbling blocks of national restrictions or less democracy

I also agree with Dani when he writes:

;

Yet the logic of global financial regulation is flawed. The world economy will be far more stable and prosperous with a thin veneer of international co-operation superimposed on strong national regulations than with attempts to construct a bold global regulatory and supervisory framework. The risk we run is that pursuing an ambitious goal will detract us from something that is more desirable and more easily attained.
I agree, that is, if he isn't conflating his deep globalism that can't work along side democracy, with deep internationalism that can work along side democracy. I agree, that is, if he isn't conflating a globalism that can't expand our freedoms with an internationalism that can; a internationalism that can guard against capture by oligarchic interests; an internationalism that can overcome questions of legitimacy while protecting and expanding individual rights.

;

I'm excited about Dani's last blog on "Interests and Ideas." I get that way when the zeitgeist is changing, moving close enough to touch. It's like boarding a plane in the middle of a stormy night and finding you've been seated next to Angelina Jolie.

The spirit of the times is changing. Now is not the time to propagate the thesis that the American congress isn't about to give up any of our nations sovereignty. We are a democracy. Change is open to democracies. Change is easier when the winds of change are at your back.

Today the idea of international regulations is stronger then ever. Unforeseen consequences of the past are cautionary tales that should be heeded. But they are cautionary tale form another time. New ideas are in the air. The old tales should be noted but not be used to inhibit ideas that the zeitgeist is opening to. Now is the time to push for the anti-thesis.


;

Posted by: wjd123 | Link to comment | April 05, 2009 at 12:09 PM

hari says...

wjd - welcome back to globalization!

Your think piece is missing one important regulatory bridge head or regime which we established under European Court System - principally to review cases of companies/individuals not applying the laws of EU.

eg. Microsoft and now Google are subject to anti-trust laws of EU with compulsory arbitration by EU Courts and, of course, monetray punishments.

Posted by: hari | Link to comment | April 05, 2009 at 01:35 PM

Real Person from the Real World says...

Rodrik: "One problem with the global strategy is that it presumes we can get leading countries to surrender significant sovereignty to international agencies."

I think that says it succinctly.

OTOH, I do think there is crony capitalism in the US. My 3rs world employer feels that every time we get ousted as a vendor, that it's because of under the table shenanigans, and he has no aversion to practicing the same with same language speaking compatriots, himself. Whenever possible, he tries to get in with the highest level individuals he can. Furthermore, seems to me one of the minor scandals of recent years were foreign born businessmen, and lobbyists getting their pix took with past presidents. Businessmen from foreign countries are used to systems where you bribe local officials for services, and they come here expecting the same business as usual, albeit perhaps on a less obvious scale. Money sure seems to find paths of influence in this country.

Big Government Ben

It was actually Repugs, starting from Reagan, ; who brought the country to its knees. It's sad that some of them, like unforgettable ; Senator Gramm are not in jail...
Economist's View

Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point.

Just ignore them. Altering a few words:

The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the financial regulation debate is purely that of spoilers who keep shouting the old slogan - Government is always the problem, never the solution! - hoping that someone still cares.

One Salient Oversight says...

Bernanke helped create the crisis by being on the board that approved the negative real interest rate period between 2003 and 2005. During the leadup to the crisis, Bernanke was overly positive and oftentimes refused to even acknowledge that a problem existed.

In short, who cares about the GOP's motives for criticising Bernanke? So long as the guy gets fired and fired quickly, I'm happy.

ken melvin says...

While at it: Even when they had the power, the rethugs didn't care about what was good for the nation; 'twas always about the dogma (cronyism?).

beezer says...

Like him or loath him, Bernanke did what needed doing. And he never flinched. Still hasn't and I don't believe he will.

At a time when the system was about to collapse and create a Depression, of all the characters on stage, Bernanke projected the most confidence and the most clarity. More than anyone, even the President.

He said no big banks would fail. And they haven't. He said he would do everything he could to somehow pump enough liquidity into various parts of the economy in order to avoid wholesale collapse. And he has. And according to yesterday's Fed press release, he fully intends to keep doing so.

mmckinl can advocate all he likes for a total restructure, and I see his rational, but it ain't going to happen. I can keep advocating for a national bank, but it ain't going to happen.

What we are observing is the continuing self-immolation of the Republican Party. They are in a suicidal denial of their ideological failure.

If this committee comes out and hectors Bernanke, it will be a publicity nightmare. For the GOP, not the Fed.

A Democratic strategist couldn't have written a better script than that being played out by the GOP. In its current state, the GOP needs to disappear.

But first it will be ignored.

bakho says...

Republicans represent powerful wealthy special interests. This is not about Obama. It is all about doing the bidding of BOA.

"Among companies receiving TARP funds, Bank of America's investments in Washington politics last year were second only to General Motors, which totalled $15 million last year. BoA's individuals and PACs made more than $5.7 million in campaign contributions in the 2007-2008 election cycle -- the highest amount of any TARP recipients. 56% of BoA's contributions went to Democrats and 44% to Republicans.

As for lobbying, BoA/Merrill spent over $8.7 million to influence policy -- the third-highest of TARP beneficiaries."

http://www.southernstudies.org/2009/02/bank-of-america-spent-145-million-on-lobbying-contributions-in-2008.html

Three days after receiving $25 billion in federal bailout funds, Bank of America Corp. hosted a conference call with conservative activists and business officials to organize opposition to the U.S. labor community's top legislative priority.

Participants on the October 17 call -- including at least one representative from another bailout recipient, AIG -- were urged to persuade their clients to send "large contributions" to groups working against the Employee Free Choice Act (EFCA), as well as to vulnerable Senate Republicans, who could help block passage of the bill.

http://www.huffingtonpost.com/2009/01/27/bank-of-america-hosted-an_n_161248.html

"when Democrats took over Congress in 2006, after more than a decade out of power, corporate PACs rushed to send donations to Democratic leaders in early 2007 to curry favor with a party they had long ignored."

http://online.wsj.com/article/SB123905882020994793.html

beezer says...

The "unfettered free markets will provide for all" ideology is sinking. And along with it sinks its political patrons, the GOP which collectively drank far too much from that ideological well.

Under Clinton and Bush we dismantled most of what the Great Depression taught us about the need for sensible regulatory regimes. The Great Depression was 77 years ago, any almost anyone who lived at that time is long dead and buried. Memories faded.

So what happened? Reality happened. Unregulated free markets, particularly financial ones, go spectacularly bust, plunging economies into recession or worse while evaporating much of the public's savings and the Treasury's purse as well.

Time to re-learn, re-think and re-tool. It's going to take a while.

anne says...

Ben Bernanke became Federal Reserve chair in February 2006, having been chair of the President's Council of economic Advisers from June 2005. Through the period from June 2005 to March 2008, Bernanke made no effort either the urge lessening the easily understood danger of the housing-mortgage boom, * or to use the Fed's regulatory authority to identify banking problems or to limit the effect of the gathering problems.

Having failed to use an easily available authority and regulatory power from June 2005 on, what possible reason should there be for confidence in Bernanke beyond having responded as expected when financial crisis was impossible to turn from and a liquidity trap was sprung?

* Bernanke's Princeton colleague was openly warning of the housing mortgage problem from the time Bernanke went to Washington in 2005.

Lafayette says...

THE BEN AND BARACK SHOW

Wiki about Bernanke before he became head of the Fed: "In 2002, when the word "deflation" began appearing in the business news, Bernanke gave a speech about deflation.

In that speech, he mentioned that the government in a fiat money system owns the physical means of creating money. Control of the means of production for money implies that the government can always avoid deflation by simply issuing more money. ... In a footnote to his speech, Bernanke noted that "people know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation."

For example, while Greenspan publicly supported President Clinton's deficit reduction plan and the Bush tax cuts, Bernanke, when questioned about taxation policy, said that it was none of his business, his exclusive remit being monetary policy, and said that fiscal policy and wider society related issues were what politicians were for and got elected for. Indeed, in his undergraduate economics textbooks he somewhat distances himself from the rhetorical economic libertarianism of Greenspan."

Bernanke is neither Son of Ayn Rand nor a Finance Karl Marx. He's just trying to hoe his row down the middle. You have got to be sufficiently intelligent to see what he's doing, which makes it confusing for most of the Replicant Party.

The Troglodyte Right would want him to quit his job and slam the door with much media drama, all the while cursing BO&CO. Which would suit their political strategy. And he probably will not do that. He has sufficient personal honor to stay the road up till the end, come what may. I doubt seriously that he wants to be Fed Chairman forever, like Greenspan. But, also, he wants to leave having fought the good fight and (presumably) having won it. One more tenure would assist to that end.

Frankly, I bet he and Obama get along just fine. They are both intelligent minds and nowhere does their particular knowledge trespass onto the other's turf. Ben's and economist and Barack is a lawyer and never the twain shall cross one-another. (Pun intended.)

Barkley Rosser says...

Bernanke can be faulted for supporting (or not opposing) some bad policies earlier this decade. However, the bottom line is that he saved the world economy in mid-September of 2008 by his dramatic policy of massively expanding the Fed balance sheet at the moment of supreme crisis. We could have had 1931, and he, more than anybody else, prevented it.

That policy may yet lead to problems down the road, but things could have been far worse than they have been, and anybody arguing otherwise is not looking at this situation very closely.

March 2, 2009

Friedman and Schwartz Were Wrong
By Paul Krugman

It's one of Ben Bernanke's most memorable quotes: at a conference honoring Milton Friedman on his 90th birthday, he said: *

"Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

He was referring to the Friedman-Schwartz argument that the Fed could have prevented the Great Depression if only it has been more aggressive in countering the fall in the money supply. This argument later mutated into the claim that the Fed caused the Depression, but its original version still packed a strong punch. Basically, it implied that no fundamental reforms of the economy were necessary; all it takes to avoid depressions is for central banks to do their job.

But can we say that recent events appear to disprove that claim? (So did Japan's experience in the 1990s, but that lesson failed to sink in.) What we have now is a Fed that is determined not to "do it again." It has been very aggressive about monetary expansion. Here's one measure of that aggressiveness, banks' excess reserves:

[Banks' excess reserves are rocketing....]

And yet the world economy is still falling off a cliff.

Preventing depressions, it turns out, is a lot harder than we were taught.

* http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/default.htm
;

Easy Money says...

Helicopter Ben is consistent, you have to give him that. He believes no problem can't be solved by more cheap money. And he's telegraphed it so we knew what was coming.

An eternal inflationist, Ben will expose the bankruptcy of mainstream economics if he's reappointed. That has to be worth something. And we'll enjoy the ride while the currency is debased, before the Federal govt ends up worse than California.

kharris says...

Unless I misunderstand things Friedman said later in life, when the velocity of money became unstable, Friedman no longer believes that Friedman was right about a sort of hands-off monetary rule. If velocity can vary greatly, then the admission that a hands-off monetary rule isn't reliable more or less leads to an admission that a liquidity trap is possible. Friedman was a crafty enough debater that he could have found a way around the implication that fiscal policy is the right remedy in a liquidity trap, but his whole monetary edifice was badly dented by more volatile velocity, and he seemed to know it.

Barkley Rosser says...

Some have said that one does not want to look too closely at the passing of laws or the making of sausage. What Bernanke pulled off in September was making sausage squared. Given that we did not have 1931, it is easy to carp that, well, the recession is not over (and we might still have hyperinflation!!!), so, so what, and he is a bad Fed Chair, ooh ooh.

Julio says...

We're continuing to debate Bernanke's performance, while Prof. thoma has pointed us in the right dircetion:

"Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point. "

While, as usual, their reasons and reasoning are lousy, the Replicants raise an important point:

Do we really want the Fed making decisions that belong in the political arena?

Not that it is possible to maintain a pristine demarcation, but still, I'd rather not go farther in that direction. Congress needs to step up to its responsibilities regarding economic decisions.

Even if Bernanke makes the trains run on time.

Mattyoung says...

The Fed is a wholly owned subsidiary of Big Government, by law, by constitution. So, the GOP is simply restating the current law. Some might think Big Government is simply the major customer of the Fed, but it is a difference without meaning.

The issue is whether the voter likes it this way.

bob mcmanus says...

This could simply be politics. Assuming all policies being identical, Bernanke or not-Bernanke, I am sure Republicans would still rather have a Democratic-appointed Fed Chairperson to run against in 2010 and 2012.

The Danger of Discretion

The Baseline Scenario

with 9 comments

Justin Fox says that financial regulation should be simpler and should give less discretion to regulators.

The argument goes like this: the biggest flaw in current financial regulation is not that there is too little of it or too much, but that it relies on regulators knowing best. We regulate because financial systems are fragile, prone to booms and busts that can have harmful effects on the real economy. But regulators aren't immune to the boom-bust cycle. They have an understandable habit of easing up when times are good and cracking down when they're not.

As I've said before, the Obama Administration's plan is likely to give us more sophisticated regulation, but if it doesn't give us more powerful regulators with more incentive to stand up to the industry, all the sophistication in the world won't matter. Regulators didn't use the tools they had – the Fed could have policed risky mortgages (and raised interest rates), the bank regulators could have insisted on higher capital requirements, etc. – because they lacked the motivation to use them in the face of overwhelming opposition from the banking industry and, probably, the power to resist Congress and the administration, whichever party controlled them.

As Ezra Klein puts it: "When evaluating a particular financial regulation proposal, ask yourself this question: Would these regulations have worked if Alan Greenspan hadn't wanted to implement them?" That's a good question, although it's a bit unfair: if you posit a regulator who doesn't believe in regulation, then virtually any regulatory scheme is bound to fail. This is why Fox and Klein argue for ironclad rules that don't leave room for discretion. In addition, though, I think we also need to think about how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry.

By James Kwak

  1. ;

    James,
    "how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry"

    That's a good question. I think the problem of regulatory capture represents as much the power of the financial lobby as a meeting of the minds between regulators and the finance industry. My impression is that many of the people at the Fed, the SEC, and Treasury are rooted in neoclassical economics.

    This means that their default thinking is one of markets as being the best way to allocate resources, and an inability to fully comprehend the bubble mentality, let alone discern when a bubble is taking place. Greenspan might have been an extreme embodiment of this way of thinking, but I don't think people can argue that Bernanke is much different.

    In my opinion, we need regulators areas like behavioural economics and finance (even psychologists) who can better grasp the pyschological underpinnings of bubbles and market failure, and can complement the current crop of regulators.

    Alan

    Alan

    June 27, 2009 at 2:10 am ;

    Reply

  2. ;

    I think the problem is what people expect regulations to do. I'm not sure there is such a thing as an "ironclad" regulation in the face of innovation because you are assuming that (1) it will be enforced, and (2) that those drafting the regulations can anticipate innovations and what aspects of the innovations will be a problem.

    Beyond that, I think what many people are looking for regulation to accomplish is to change the culture of the industry being regulated. Culture is a much bigger issue. But a politican cannot prescribe concrete steps to address cultural issues and take credit for implementing them.

    Bond Girl

    June 27, 2009 at 2:32 am ;

    Reply

  3. ;

    Moving financial information into a standard language such as XBRL and making it public would allow regulation to be crowd-sourced. In aggregate the crowd's far less likely to have a Kool Aid drinking problem than characters like Greenspan, Summers, Geithner, Benanke, Paulson, et al.

    Gene Dieken

    June 27, 2009 at 3:00 am ;

    Reply

  4. ;

    Discretion. What an excellent choice of words by James Kwak. A lot of leeway in that word, discretion. A lot of gray area. I think just the change of Presidential leadership will help quite a bit. I think regulators knew that under George Bush the unwritten policy was "if it's not causing problems, don't stick your nose in too deep and find problems".

    I do think that the regulations and laws are important though. And I think attitudes drastically changed after the passing of Gramm-Leach-Bliley. It wasn't an attitude change that "joe six pack" could feel on main street. But the bankers worked very hard to pass Gramm-Leach-Bliley, so I'm sure there were a few champaign bottle corks popped the night that Gramm-Leach-Bliley passed. I believe Gramm-Leach-Bliley was a nonverbal communication to regulators to say "well if you just look over that way for awhile, away from banks' clandestine activities, you'll save some sweat and angst".

    Many people using this word "captive" talking about regulators relationship to bankers. I think it's a problem. Some people say we should pay regulators more so we can attract better quality workers. But there will always be a large gap in salaries between those who work in service to the public (regulators) and those in the financial field. A raise in regulators' salaries would help a little, but you'll never close that big gap.

    Brooksley Born tried to fix things….. Brooksley Born wanted to do something….. she was a regulator was she not?? And in the future there will be another Brooksley Born. What will happen when the next Brooksley Born speaks out?? Will she be rebuked and muffled??

    Ted K

    June 27, 2009 at 3:20 am ;

    Reply

  5. ;

    maybe regulators should be more like the judiciary and be able to show legislative/executive tomfoolery for what it is 'in a subtle way' and just enforce the law without someone looking over their shoulder to see if one of their 'special friends' is in hot water
    .
    cuz regardless its gunna be illegal for congress to pass unconstitutional laws that favor individuals over corporations or vis versa 'not really but kinda'

    nah

    June 27, 2009 at 5:44 am ;

    Reply

  6. ;

    Another word for discretion is judgment and the ability to exercise good judgment is not easily evidenced by the credentials required to join the financial technocracy.
    How do you write an algorithm to provide good judgments?

    Morph366

    June 27, 2009 at 7:24 am ;

    Reply

  7. ;

    if the regulators have little discretion it will be extremely easy for the regulated to game the system. No way around it.

    q

    June 27, 2009 at 8:06 am ;

    Reply

  8. ;

    The Financial Instability Hypothesis

    Janet Yellen, President of the San Francisco Federal Reserve, pointed out at the 18th annual conference honoring the work of Hyman P. Minsky that:

    "… with the financial world in turmoil, Minsky's work has become required reading. It is getting the recognition it richly deserves."

    Paul Krugman has also been re-reading Hyman Minsky's most famous book Stabilizing an Unstable Economy.

    Central to Minsky's view of how financial meltdowns occur is his Financial Instability Hypothesis (FIH) - what has come to be known as 'an investment theory of the business cycle and a financial theory of investment'. But, what is it all about? Quoting from Minsky . . .

    "The theoretical argument of the financial instability hypothesis starts from the characterization of the economy as a capitalist economy with expensive capital assets and a complex, sophisticated financial system… The focus is on an accumulating capitalist economy that moves through real calendar time…"

    Read more here http://neweconomicperspectives.blogspot.com/2009/06/financial-instability-hypothesis.html

;

Re-Regulating the Financial Markets By Barry Ritholtz

The Big Picture

- June 13th, 2009, 11:45AM

National Economic Council Director Lawrence Summers laid out five principles for re-regulating the financial markets:

1. The government must have the authority to take over and liquidate failing nonbanking financial institutions.
2. Regulators must be able to make certain that financial institutions have enough capital to weather crises.
3. Regulated entities must not be able to choose their regulators,
4. Regulators should not have to fight each other for jurisdiction.
5. The interests of consumers must trump the interests of regulated companies.

Too bad these were mostly ignored over the past 15 months . . .
;

Sheila Bair vs. John Dugan By Barry Ritholtz

The Big Picture

- June 14th, 2009, 7:44AM

"The overwhelming share of increased actual and projected costs for the fund have been caused by actual and projected failures of smaller banks, not larger ones."

-John Dugan, the comptroller of the currency

>

I don't usually insert myself into personal disputes amongst regulators, but when one of them appears to be a bit of an asshat, I feel compelled to comment.

The spat in question is between Sheila Bair, the exemplary FDIC chairwoman, and the asshat being the speaker of the above WTF quote, John C. Dugan, the comptroller of the currency. I don't know much about Dugan, other than some of the odd and indefendable statements he keeps making. He often misstates facts about the credit collapse, blames the wrong organizations for the subprime debacle, and otherwise seems to be a mouthpiece for the largest, most inept banking istitutions.

Some Dugan comments:

• "The overwhelming share of increased actual and projected costs for the fund have been caused by actual and projected failures of smaller banks, not larger ones."

• The financial crisis stemmed in part from problems at small banks;

• Stiff new insurance fees on banks as unfair to the largest banks

• The responsibility for validating risk management models lies first and foremost with the institution itself. (OCC)

Bizarre.

Part of the problem lies with the OCC itself. Its an agency that has been committed to radical deregulation. When the NY Attorney General was looking into "discriminatory mortgage lending practices," OCC filed suit to stop the NYAG from inspecting the lending records of national banks using state laws.

The OCC decision to allow banks to become commercial real estate developers failed to recognize the inherent risk involved. Even the NAR complained. A 2002 ruling by the regulatory agency prevented Credit Card insurance from being regulated by the appropriate state agencies. And why anyone at the OCC thought allowing national banks to underwrite insurance was a good idea is hard to fathom.

At just about every turn, the OCC has ruled in favor of radical deregulation, and against consumers. Why the Obama administration has retained Dugan (he's been at the OCC since 2005) is beyond my comprehension. He is a classic Bush appointee - a regulator who is against regulating - who should have been dismissed at the earliest opportunity.

Banks are in the business of taking in deposits and then lending that money out again. If they cannot do that responsibly and profitably, then they should get out of the banking business and into real estate development or insurance underwriting. But so long as the FDIC is on the hook as the insurer of these deposit accounts, banks should not be allowed to stray from their core competency into other businesses.

Stick with banking.

From Enron to the Financial Crisis, With Alan Greenspan in Between - US News and World Report

By Robert Bryce

Posted September 24, 2008

Enron was only a prelude to the current market meltdown.

In the wake of the Enron bankruptcy-which was briefly the biggest failure in U.S. history-two key lessons were obvious: Financial regulators needed lots more funding and personnel, and derivatives markets that were allowed to operate without proper regulatory oversight and reporting paved the way for financial engineers to privatize profits and socialize costs.

Related News

Today, less than seven years after Ken Lay and his accomplices drove their once solid company into the ground, the United States is facing a financial disaster that makes Enron look quaint. The bankruptcy of Lehman Brothers Holdings, America's fourth-largest investment bank, involves a whopping $613 billion in debt. When Enron failed, it claimed assets of just over $63 billion.

The implosion of Lehman-along with the federal takeovers of mortgage giants Fannie Mae and Freddie Mac and insurance behemoth AIG-is symptomatic of the same lack of oversight that existed in December 2001 when Enron failed. And that lack of oversight can most easily be understood by looking at the budget of America's single most important financial regulator, the Securities and Exchange Commission, which oversees financial markets worth tens of trillions of dollars.

In 2001, the SEC's budget was $437.9 million. In March 2002, the General Accountability Office issued a report that said that the shortage of money and manpower at the SEC had forced the agency to "be selective in its enforcement activities and...lengthened the time required to complete certain enforcement investigations." So what has happened since then? Precious little. Yes, the agency has a substantially larger budget today than it did during the Enron era. For this year, its spending authority is $906 million. And for 2009, the agency's budget is projected to increase slightly, to $913 million.

But here's the howler: The number of enforcement personnel, the people who go after the financial engineers, is expected to decline. That's right. Despite the trillion-dollar meltdown now underway, the number of SEC enforcement personnel will decline from 1,209 this year to 1,177 in 2009. In all, the SEC expects to have 3,771 employees next year. For comparison, the Smithsonian Institution budget for 2009 includes funding for 4,324 employees.

That's not meant as a slap at the Smithsonian. It houses a myriad of the nation's most treasured objects. But the SEC actually guards the nation's treasure. And yet, Congress treats it like a bastard stepchild. Indeed, Congress doles out more than five times as much money for corn subsidies ($4.9 billion in 2006, the most recent year for which data are available) as it does for the SEC.

Those pitiful numbers lead us to the innumerable problems posed by derivatives, the same financial instruments that led to the chaos at Enron, which before it failed operated a huge-and almost completely unregulated-derivatives exchange business. According to the Bank for International Settlements, the global derivatives market is now worth some $676.5 trillion. That's $676,500,000,000,000. That's a fivefold increase over the value of derivatives that were traded in 2003. Further, that $676.5 trillion is 51 times America's current gross domestic product.

In 2002, the world's smartest investor (and my pick for president this year), Omaha billionaire Warren Buffett, issued his annual letter to the shareholders of Berkshire Hathaway. In it, he called derivatives "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

Few people heeded Buffett's warning. In fact, some of America's most important financial players dismissed him out of hand. In September 2002, Federal Reserve Chairman Alan Greenspan, Treasury Secretary Paul O'Neill, Securities and Exchange Commission Chairman Harvey Pitt, and James Newsome, chairman of the Commodity Futures Trading Commission, sent a letter to a pair of U.S. senators in which they declared that financial derivatives were not a danger. Instead, they said that derivatives "have been a major contributor to our economy's ability to respond to the stresses and challenges of the last two years." Further, they declared that a then pending Senate proposal to regulate derivatives could increase "the vulnerability of our economy to potential future stresses."

In June 2003, Greenspan again defended derivatives. In another letter to members of the Senate, Greenspan-this time bolstered by Treasury Secretary John Snow and Securities and Exchange Commission Chairman William Donaldson as well as Newsome-declared:

Businesses, financial institutions, a nd investors throughout the economy rely upon derivatives to protect themselves from market volatility triggered by unexpected economic events. This ability to manage risks makes the economy more resilient, and its importance cannot be underestimated. In our judgment, the ability of private counterparty surveillance to effectively regulate these markets can be undermined by inappropriate extensions of government regulation.

Back in 2002, in Pipe Dreams, my book on the Enron disaster, I wrote that reforms were needed to deal with derivatives. I quoted one financial analyst who called derivatives "Wall Street's dirty secret." I recommended that "derivatives dealers should be required to post agreed-upon amounts of capital to collateralize their trading positions" and that "the derivatives marketplace must be made more uniform, with policing by regulators who can establish price limits, listing requirements, and other trading parameters."

I don't repeat that to brag about any foresight on my part. Many other people were arguing for the same types of reforms. The point is that the warning signs left by the Enron mess could not have been more clear. The derivatives mess created by Bear Stearns, Lehman Brothers, and the others occurred because of a regulatory vacuum where none of the players were required to post collateral to back up their positions or to disclose to investors the size of their huge derivatives positions. That lack of oversight has spawned a financial crisis that will reverberate through the global economy for years to come.

Thousands of people are losing their homes. Thousands more are losing their jobs. Taxpayer money is being used to bail out private companies that were headed by corporate bosses who routinely helped themselves to multimillion-dollar pay packages. And all of it is happening because the Bush administration and Congress refused to heed the lessons of Enron.

Robert Bryce's latest book is Gusher of Lies: The Dangerous Delusions of "Energy Independence."

Economic View - What's Free About Free Enterprise - NYTimes.com

Published: September 27, 2008

Once the federal government declares, "Thou shalt not fail," there are no limits to how far future risk-takers will go. Who will see any need to pay attention to the possible consequences for the government's budget, the market for its bonds, the taxpayers, its creditors and, indeed, the whole economic structure?

Furthermore, there are limits to how freely Washington can dispense largess. We no longer owe the national debt to ourselves, as we did in the 1930s, when deficit financing was first proposed as viable policy to overcome the Depression. Financing the government today depends heavily on foreigners' willingness to buy our bonds, but foreigners accept our obligations only when they see some kind of control over the volume of issuance. They will perceive very little control in plans whose limits are porous and uncertain.

My second issue goes to the foundations of the economic system in which most Americans believe and take for granted. Though we sometimes give it more lip service than respect, it is rooted in individual decision-making in free markets. In theory, at least, the less government intervention, the better; the mantra is that markets know best.

We often hear this refrain, and history confirms its importance in the most profound issues of economic policy. It justifies our revulsion with Communism, our philosophical distance from the current Chinese system, and our distaste when politicians, not markets, try to shape our system.

Faith in free markets made icons of Ronald Reagan and Margaret Thatcher, who made deregulation a policy cornerstone. An echo in our own time was the 1999 repeal of the Glass-Steagall Act, legislated in 1933 to separate investment banking and commercial banks. Its repeal was a key contributor to the calamities now gripping the banking system.

TODAY'S crisis thus emerged from a combination of disasters operating in free markets, but wreaking ruin as they developed. The subprime mortgage mess, the huge leverage throughout the system, the insidious impact of new kinds of derivatives and other financial paper, and, at the roots, the vast underestimation of risk could not have happened in a planned economy. A superjumbo bailout is the inescapable result, but at some point we must confront its more profound implications.

As we move into the future, and as the crisis finally passes into history, how will we deal with this earth-shaking blow to the most basic principle of our economic system? I do not know how to answer that question. But we need to ask it.

The failure of financial regulation

January 15, 2009

by FT By Michael Pomerleano

The regulation and supervision of the banking system rest on three pillars: disclosure to ensure market discipline, adequate capital and effective supervision.

Did the regulatory philosophy governing our financial markets withstand the test of the recent crisis? ; My conclusion is that all three regulatory pillars failed.

First, let's look at disclosure. Was adequate information available before the crisis erupted? ; The information on the subprime exposure was out there for anyone who had the determination to collect and analyse the (sometimes patchy) data from quarterly 10Q reports filed with the Securities and Exchange Commission for US banks, supplemented by rating agencies' and investment banks' research reports.

Using public domain data, I developed a fairly comprehensive picture, as early as October 2007, of the exposure to subprime of the top 20 largest banks in the word, the five biggest investments banks, and all the banks that had an exposure in excess of $10bn. The estimated losses were reasonably consistent with the ensuing subprime losses.

For example, Citigroup disclosed the subprime exposure in Form 10-Q for the third quarter of 2007, submitted to the SEC for the public to read. It lists on-balance sheet subprime and off-balance sheet exposure (in asset-backed commercial paper conduits and structured investment vehicles) of $223.4bn.

In this context, it is notable that Citibank's tier one (equity) capital at the end of the third quarter of 2007 was $92.3bn and the subprime exposure accounted for 242 per cent of tier one capital!

Public information already pointed to the need for major write-offs. ; For example, on December 1, 2007, Moody's Investors Service downgraded 20 SIVs sponsored by firms including Citigroup and on December 5, 2007 Markit's ABX-AAA Index fell to 77.22. Therefore, there was considerable evidence that subprime losses would exceed 20 per cent.

What are the implications for solvency? A 20 per cent loss on subprime will halve capital, while a decline of 41 per cent will wipe out tier one capital. And note that, so far, this discussion has not mentioned other sources of risk for Citi, such as leveraged buyout loans, commercial real estate and credit card debt.

Similar data were available bank by bank to a larger or lesser extent. Invariably the disclosure in the US was far better and more frequent than in Europe, and there was considerable information regarding the subprime exposure of US-based institutions.

Nevertheless, even with the limited disclosure, it was evident that numerous banks, such as HBOS and UBS, were poorly capitalised as a result of the losses. ; What can we conclude about disclosure based on the information that was publicly available? ; Several conclusions strongly suggest themselves:

- First, the situation was quite precarious and ample warnings available in the public domain in the autumn of 2007.

- With the resources available to the regulatory agencies, they should have been able to construct the information and react in a timely fashion. Instead, the response was late and haphazard.

- Finally, the fact that the data were publicly available, but not used by investors to value and discipline banks, discredits any shred of trust that markets are efficient.

A second central question to ask is how effective were the regulatory safeguards? Informed analysts knew that Basel I has glaring deficiencies that virtually encourage the creation of off-balance sheet instruments that contributed to the subprime crisis. See for instance "New Bank Capital Requirements Helped to Spread Credit Woes" (David Wessel, The Wall Street Journal, 30 August 2007.

I will not go into technical arguments, but assure the unfamiliar reader that the incentives were similar to the landing strip lights at an airport to guide the banks to create Special Purpose Vehicles off balance sheet.

Until recently I was not fully aware of the glaring deficiencies of Basel II. In December 2008 I read a compelling book written by Daniel Tarullo, President-elect Barack Obama's nominee to the board of governors of the Federal Reserve.

In Banking on Basel- the Future of International Financial Regulation (Institute of International Economics, October 2008) he points out that: "Thus, there is a strong possibility that the Basel II paradigm might eventually produce the worst of both worlds-a highly complicated and impenetrable process (except perhaps for a handful of people in the banks and regulatory agencies) for calculating capital but one that nonetheless fails to achieve high levels of actual risk sensitivity".

Tarullo notes as well that the Basel Committee itself implicitly acknowledged in spring 2008 that the revised framework would not have been adequate to contain the risks exposed by the subprime crisis.

To add to the irony, it appears that the institutions that failed were Basel II compliant. I add to Tarullo's critique, (without going into the gory technical details) that Basel II is basically a form of regulatory forbearance. ; Intuitively, while Basel II keeps the minimum capital at 8 per cent, while allowing finer granularity via the use of internal models, and therefore lowers capital requirements. It is reasonable to conclude that 15 years of deliberations by the Basel Committee have yielded a poor outcome and soul searching is warranted.

A final question we need to ask is how effective was the supervisory apparatus in this crisis? Based on the discussion in the first section we know that the regulatory authorities in the critical financial centres potentially had information on the subprime exposure (and hence potential losses) on an institution by institution basis.

Equally some organisations warned about the potential losses! For instance in January 2008 the International Monetary Fund published its $1tn estimate for the losses. Equally, some investment banks, such as Deutsche Bank and Goldman Sachs, generated bank by bank estimates. It is reasonable therefore to infer that the regulatory agencies would have taken notice of those estimates as early as the autumn of 2007. For a long time the regulatory and supervisory apparatus was silent.

We need to question why didn't any regulator add up the potential size of the losses on the sub prime exposure, based on publicly available information, and verify them with on-site examinations?

Why wasn't there a far more forceful response from the supervisory agencies? Equally, we should have expected credit rating agencies, investment research and investors to respond more forcefully. In this context, one can only express puzzlement and disappointment at the tepid regulatory reaction. ; Only after the monumental policy mistake of allowing Lehman Brothers to fail, did the authorities grasp the full significance of the problems and we witnessed a systematic effort to manage and contain the crisis.

What is a possible explanation? Martin Wolf's recent column reminds us of Keynes' view that there is a safety in collective action, even if it wrong. "A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him." ; Arguably Keynes' words apply to regulators as much as to bankers.

The conclusion is disconcerting. The entire safeguards system, consisting of disclosure, regulation and supervision failed. I hope that collectively the international financial community will come up with a better approach to financial regulation.

Michael Pomerleano is advisor on financial stability to the Bank of Israel, on external service from The World Bank. Before that he worked for two years at the secretariat of the Committee on the Global Financial System at the Bank for International Settlements

January 15th, 2009 in Assigning blame, Financial sector regulation, Regulation | Permalink

One Response to "The failure of financial regulation"

Comments

  1. Greg Fisher: Michael Pomerleano's piece demonstrated beautifully the limitations of reductionism and the essential lessons of complexity science, which I believe social scientists (including economists and finance specialists) have to learn in order to construct better economic and financial policy, including banking regulation.

    Basel I was, broadly speaking, a set of rules imposed from an external regulator, which (I believe) allowed no discretionary decision making by the regulated institution. Basel II was a move in the direction of "the individual knows best", which is consistent with economic liberalism and in the best traditions of economics since the

    Enlightenment: if the solvency of the individual company was entirely in the interests of that company, why not devolve capital weighting decisions to some degree? Adam Smith would have approved.

    But what Basel II did was accept the principle that the individual knows best for both themselves and for society more broadly. I would not disagree with the former but complexity science argues against mapping from the singular to the whole in all possible instances. Reductionism in effect implies that the whole is the sum of the parts; and Basel II implicitly assumed that what worked for one will work for all, which is an example of a reductionist approach. In complexity language, this would be ok for fractal phenomena.

    However, my interpretation is that an emergent phenomenon is the antithesis of reductionism: complex systems of interacting agents can generate these emergent phenomena, and move through phase transitions, neither of which can be explained by a local analysis of the individual agents. Symmetrically, we cannot expect to predict all macro trends and phenomena by understanding the individual alone. Human society, including the financial system, is a form of complex system; and what happened in the financial system from August 2007 was analogous to a phase transition.

    My conclusion is consistent with Michael's and leans more toward an improvement of "our" abstract conceptual framing. In a nutshell, regulators and financiers alike ought to buy a few books on complexity science, read them, hire a few complexity scientists, and then plan the improvement of the global regulatory structure. In the UK this is probably more important for the Bank of England than it is for the Financial Services Authority, as the Bank is tasked with taking a systemic view of financial stability.

    Greg Fisher worked for the Bank of England for nine years in various capacities and later as a macro-economic strategist for a macro hedge fund, Camomille Associates. He is writing in a personal capacity

December 18, 2008

New York Times Pulls Punches On Wall Street Bubble Era Pay

Why is no one willing to call things by their proper names, and instead resort to euphemism and double-speak?

A New York Times story today, "On Wall Street, Bonuses, Not Profits, Were Real," makes its most important point in its headline, and managed to get some good data points on how rich investment bank compensation was in the peak years, but otherwise glosses over the fundamental nature of what went on.

It was looting, and it is high time the media starts describing it in those terms.

Let us turn the mike over to Nobel Prize winner George Akerlof and Paul Romer. From the abstract of their 1993 Brookings paper:

Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints. To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values...

Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."


Re-read the key phrase: "pay themselves more than their firms are worth and then default on their debt obligations." This has happened en masse in what formerly were investment banks who have now become wards of the state.

But no one is willing to call this activity for what it was. In fact, some are still urging that we not squelch "financial innovation," which Martin Mayer described as

... a way to find new technology to do what has been forbidden with the old technology....Innovation allows you to go back to some scam that was prohibited under the old regime.
But we digress. Dick Fuld reportedly spends much of his days allegedly wondering why he didn't get a bailout. He should instead be thanking his lucky stars he is not in jail. Bankruptcy fraud is criminal, and fraudulent conveyance is subject to clawbacks. How could Lehman possibly have been producing financials that showed it had a positive net worth, yet have an over $100 billion hole in its balance sheet when it went under? No one has yet given an adequate answer on where the shortfalls were.

Commonwealth countries have a much simpler solution. If a company is "trading insolvent," that is, continuing to do business when it is in fact broke, its directors are personally liable.

We have said repeatedly that one of the triggers for the crisis was permitting investment banks to go public (prior to 1970, no NYSE member firm could be listed). We had dinner with one of our long-standing colleagues who was responsible for Sumitomo Bank's investment in Goldman Sachs and had (and continues to have) close and frequent dealings with the firm. He said that the change in the firm's behavior after it went public was dramatic. Before, it would deliberate (one might say agonize) important business decisions,. Waiting two years to enter a new field was not unheard of. But after the partners cashed in and were playing with other people's money, the firm quickly became aggressive in its use of capital in expanding the size and scope of its activities.

But the New York Times article gives an anodyne portrayal:

As regulators and shareholders sift through the rubble of the financial crisis, questions are being asked about what role lavish bonuses played in the debacle. Scrutiny over pay is intensifying as banks like Merrill prepare to dole out bonuses even after they have had to be propped up with billions of dollars of taxpayers' money. While bonuses are expected to be half of what they were a year ago, some bankers could still collect millions of dollars.

Critics say bonuses never should have been so big in the first place, because they were based on ephemeral earnings. These people contend that Wall Street's pay structure, in which bonuses are based on short-term profits, encouraged employees to act like gamblers at a casino - and let them collect their winnings while the roulette wheel was still spinning...

For Wall Street, much of this decade represented a new Gilded Age. Salaries were merely play money - a pittance compared to bonuses...

While top executives received the biggest bonuses, what is striking is how many employees throughout the ranks took home large paychecks. On Wall Street, the first goal was to make "a buck" - a million dollars. More than 100 people in Merrill's bond unit alone broke the million-dollar mark in 2006. Goldman Sachs paid more than $20 million apiece to more than 50 people that year, according to a person familiar with the matter. Goldman declined to comment.


The bulk of the piece is about Dow Kim, former co-president of Merrill's fixed income business, and does deliver some detail about how Kim and his subordinates were paid. But it fails to delve into how the profits were illusory, the bad decisions made, how the fixed income area in particular lead to the end of Merrill's independence. Perhaps the author, Louise Story, assumed the tale has been well told elsewhere. However one effort to demonstrate the business was on the wrong track, falls woefully short. It discusses a CDO deal that went bad, but fails to establish whether Merrill took losses by virtue of retaining a big interest ("The losses on the investment far exceed the money Merrill collected for putting the deal together" does not clearly say that Merrill, as opposed to investors, suffered. One assumes so, but the drafting is ambiguous).

Even more glaring, the story mentions Merrill's disastrous, end of cycle $1.13 billion acquisition of mortgage originator First Franklin, without mentioning that deal came a cropper (Merrill shut the unit down only a year and a couple of months after it completed the transaction).

Other stories have given some of the sordid details about Merrill's ill fated mortgage expansion (a Wall Street Journal piece, "Merrill Upped Ante as Boom In Mortgage Bonds Fizzled," is one of many examples), Giving short shrift to the staggering level of strategic errors and lax risk oversight means the article fails to pin responsibility clearly for the mess on Kim and his fellow business heads. The article simply assumes the connection, but by talking about the profits without giving sufficient detail on the colossal errors, it makes Kim and his lot seem far more innocent than they really were. ;

More on this topic (What's this?)

Study: The Analysts Aren't Wearing Any Clothes (The Razor's Edge, 12/15/08)

Finance/business graduates? Good luck and welcome aboard (Intelligent Speculator, 12/5/08)

How Did We Get Here? (Phil's Stock World - Members S..., 11/28/08)

Read more on Investment Banks at Wikinvest

Topics: Credit markets, Media watch, Regulations and regulators, Risk and risk management, Social values

; Posted by Yves Smith at 5:05 AM

33 comments:

Anonymous:
I have been saying for a while that the relationship between government and banking is the closest thing to organized crime taken over society...
December 18, 2008 5:46 AM
killben:
yves ...

essentially the whole show is emperor has no clothes .....

What foxes me are ..

how come taxpayers are allowing ... or they just bystanders ... their job being just to put the money on the table and ask no questions to be asked how it is spent

how come fed, treasury, congress are just simply mouthing a few politically correct words but allows business as usual

unless someone acts we will all be posting only ..

December 18, 2008 5:49 AM
g:
Hi Yves,

Many thanks for your insightful comments and perseverance. I don't know when you sleep. I write from Australia and am frequently disappointed when you do not update in the early morning (our time), yet you have updates late in (our) evening. I guess you must arise very early.

Hopefully these great excesses will lead to prosecutions when the panic is over and St Obama's efforts have led to little other than 20% unemployment. Then, we hope, the journals of record will be important blogs such as this and not 20th Century newspapers run and regulated by the same crooks that have led us blindly into the abyss at the same time as the major perpetrators pocket their illicit winnings.

One of your bloggers wrote that all great collapses are marked by fraud and corruption, although, sadly I missed the link. However many have reflected on the importance of the "bezzle"in bursting bubbles and this time looks no different. Personally I got out of shares when I read that today was the greatest disparity in wages (quaintly called "compensation" by the elites) since the late 1920's, and some hedge fund managers were collecting over a billion a year. Anyone who appreciates just what a billion is knows that this cannot be sustainable.

December 18, 2008 5:53 AM
fresno dan:
Well, I am thankful you bring it up. It does seem amazing the questions that don't get asked. Like, "Did Hank Paulson know how Goldman made money?" or "Did Rubin think anything Citi was doing was risky?"
"The article simply assumes the connection, but by talking about the profits without giving sufficient detail on the colossal errors, it makes Kim and his lot seem far more innocent than they really were."
There is way too much of this "whoculdhavnode" as an excuse given by CEO's as well as goobermint officials. Its there job to know. And many, many people did know (see calculated risk) about MBS's being all BS.
December 18, 2008 5:58 AM
Anonymous:
Yves,

By far this site is the most intellectually honest and your presentation of a scholarly oversight: money in America, is spot on.

Thank you.

You may wish to address this work, a link to Madoff, et al:

The Talmud, the Stock Market and Bernie the Goniff

http://revisionistreview.blogspot.com/2008/12/talmud-stock-market-and-bernie-goniff.html

My cousin once removed was/is Karl Marx. He was anti-ISM, in actuality.

We in the US must come to realize that this 60-plus year slow takeover of our country was carefully designed.

The model? Palestine.

Time to fire each and every oppressor of Palestine since the one and the same are oppressors of earth and the weapon of mass global destruction, the "credit crisis," is and has been, a highly sophisticated global overreach and Bush just said it on CSPAN: "We have half the globe."

Time to hold the "globalists" accountable for high crimes against humanity.

Thanks for your brilliant intellect and genius in writing how it genuinely happens.

December 18, 2008 6:48 AM
Anonymous:
I wonder when more people will start to realize that such scams - and a variety of others - are all but inevitable with fiat money combined with fractional reserve lending.

Without the ability to create endless amounts of money out of thin air, all of the debt financing and all of the bailouts would be impossible. By the same token, with that ability, the temptation to play these games becomes irresistable.

Sure, you can regulate for a while, but people forget and the pressure of those that stand to profit, along with their bribes, will win out causing the massive disruptions and destruction we are witnessing now and have been witnessed many times before.

While we're on the subject of calling things what they truly are, how about "counterfeiting"? How about an undemocratic transfer of wealth from productive people to scammers? etc., etc. and so forth.

Yeah, I know, hardly anyone wants to hear it - such has been the effectiveness of high powered propaganda over the decades if not centuries. Maybe someday.

December 18, 2008 6:49 AM
Jim:
I remember some fifteen years ago when I was in business school we were expecting to hear a speaker in my debt markets class who ran a prominent fixed income hedge fund. It was big for the time--around $500 billion--and used lots of derivatives and the dicier tranches of mortgage backed securities. A week before the presentation, his fund vaporized overnight, all money gone, so he didn't show.

It became clear to me then that leveraged fixed income is the height of folly. The players pretend to be rocket scientists, but in fact rely on mean variance optimization, which works until it doesn't work. While it works, the practitioners earn huge amounts of money, and when it doesn't work, they hunker down with their lawyers and try and keep what they've extracted in past years, while their investors go bust. The key personal characteristic needed to do this is to have no shame.

December 18, 2008 6:52 AM
Sandi Rubinspan:
One of the great unspoken truths of this decade is that the wall street financial looting represents the single largest threat to the long term security of the Unites States.

Homegrown financial terrorism trumps the old fashioned muzzy variety, by a mile.

December 18, 2008 7:16 AM
Mark:
"The key personal characteristic needed to do this is to have no shame."
One might wonder if our economy has been trashed by sociopaths?

Or is it simply that the repercussions are sufficiently slight and distant that they can be ignored.

Much like firing missiles from over the horizon without having to look the "collateral damage" in the eye.
(In a world where the media (SEC) doesn't to follow up reports of atrocities.)

December 18, 2008 7:32 AM
Elliott:
So if you steal a TV during the aftermath of Katrina you are a criminal, you should be shot on sight, and it signals the utter breakdown of our society.

If you steal billions of dollars as these people did, its fine because they were working hard? No... Contributing to the economy in meaningful way? No...

Oh right, they were friends with the elite and were making lots of made up money for everyone. It really steams me when the talking heads talk about all of the great profits of the the peak years. HELLO, they were based on a bubble, so in reality they created no wealth.

I'm not afraid that this country is going into its final downturn from superpower status because I think we'll come out a much better place.

e

December 18, 2008 9:54 AM
River:
It takes a minimum of two parties to make a deal. Obviously there must be greed by both parties to complete deals that seemingly are too good to be true.

The sellers are well versed in how to close a sale on baloney dressed as caviar.

The saps need more education and a tad of self restraint. Lost opportunity is preferable to lost capital. If an item for sale is too complicated to understand, it is too complicated to invest in.

December 18, 2008 9:57 AM
Anonymous:
I'm listening to Rick James' Bustin' Out.

"We're bustin out
And we don't give a damn...
...Take your stuff and scram!"

December 18, 2008 10:03 AM
Anonymous:
Why is no one willing to call things by their proper names, and instead resort to euphemism and double-speak?

For the same reason The Street's presstitute press is promoting the ridiculous partial cover-up of the Bernie Madoff affair. Harry Markopolos' 2005 letter to the SEC gives the real explanations.

http://clusterstock.alleyinsider.com/2008/12/busting-bernie-madoff-one-mans-10-year-crusade

For purposes of analysis Markopolos considered "Ponzi Pyramid" or stock trade front running as separate explanations. Given Bernie's decade plus longevity through several stiff downturns the real explanation will be found to be c) Both.

Both also explains why Bernie had his own kids turn him in to the feds. With a cooperative regulatory and legal structure Bernie can possibly take a Ponzi entirely on himself. Routine front running requires active participation from officers and traders in his broker-dealer firm. In which firm his kids are also officers.

And of course "Ponzi can be scape goated onto Bernie alone by the broader "Wall Street" community. Whereas once a genuine investigation of trade front running starts many more firms than just Bernies will get nailed.

New York New York, your day is past, your goose is cooked! Stick a fork in you, you are done. Who in their senses will ever again trust that bottomless cesspool of lies, self-dealing and shameless thievery?

December 18, 2008 10:12 AM
M.G.:
It will take time, if ever happens, for people to understand some of the inconvenient truths: it was a scam, a fraud, corruption, a Ponzi scheme, or whatever... So let's not call it recession, deflation, crisis, risk management, model, regulatory, etc. failures. The sooner we call it with the right name and admit the inconvenient truth the better

Recession uncovers what auditors can't
The alchemist

December 18, 2008 10:22 AM
Independent Accountant:
YS:
I've been saying things like this for years. Among the problems of the "Street" is poor cost accounting. I doubt most traders have any idea what cost of capital means. Does say Merrill's treasurer? But traders went to: Wharton, Harvard, Northwesten, Chicago, Tuck, etc. So?
Next, where were the CPAs? AU 314.125.A5 states in considering an entity's risks "an auditor may consider ... Key performance indicators. Employee performance measures and incentive compensation policies". Well Mark Olson of the PCAOB, will you look at all audits done of major investment banks and see where they fell short?
December 18, 2008 10:25 AM
Anonymous:
"New York, how do you screw me? Let me count the ways:"
1. Unearned salaries and bonuses exceeding public firms' capital, let alone earnings.
2. Naked short selling.
3. Front running stock trades.
4. Outright Ponzi Pyramids.
5. Unregulated derivatives sold into pension funds, insurance companies and any place else "widows and orphans" can be found.
6. Tired of the "risks" of equities? Want the safety of secured debt? Well step right up and sample some collateralized securitized mortgages! The solution to the abscess that has formed in metropolitan New York and then spread its infection is simple. Just say no.
December 18, 2008 10:40 AM
Anonymous:
Why is US justice currently asleep at the helm?
Banks 2007 accounting records were false in an Enronesque way.
I just cannot understand it. Is it a cost issue. Do you REALLY need to be rich to sue?
An appalled foreigner
December 18, 2008 10:41 AM
Anonymous:
Killben wrote:
"""how come taxpayers are allowing ... or they just bystanders ... their job being just to put the money on the table and ask no questions to be asked how it is spent

how come fed, treasury, congress are just simply mouthing a few politically correct words but allows business as usual

unless someone acts we will all be posting only """

Many of us tirelessly called, wrote, re-wrote and wrote again our congresspeople and representatives urging them not to do this.

But apparently to no avail. We will, however, vote them all out next go-around.

December 18, 2008 11:06 AM
Anonymous:
Calling it looting -- while basically true -- only serves to inflame. We are in dangerous times. I personally appreciate it when the press and politicians restrain themselves from inflamatory labeling.
December 18, 2008 11:16 AM
S:
Watch the US ride the dollar down and then try and issue in yen and euro to try and backstop the liquidity flight as the debt machine gets rolling. TPTB in those countries ought to be thinking about the Fed next move to try and protect dollar flight. The idea of us issuing foreign bonds is coming and they will try to drive dollar down and then issue to try and capture upside.
December 18, 2008 11:29 AM
Anonymous:
In January of 2007, as a soon to be retired Wall Street equity analyst, I attended a large lodging industry conference that was attended by both companies and financiers. At the conference, I listened to a panel (comprised of investment bankers from most major houses) discussion on how long the good times would last. At that moment in time, CMBS and cheap bank loans were washing over the lodging industry and CFOs stumbled around in disbelief of the affordability of money. Bankers stumbled around in disbelief of the outsized year-end bonuses (they had just or were about to receive) and the willingness of their firms to keep shoveling money out the door.

When panel members were asked about when the good times would end, the group unequivocally and unanimously agreed that not until a disaster occurred would the money stop flowing. The group was in essence saying that they couldn't figure out when liquidity would tighten or what was a good investment, so why try? As long as they were all in it together, no one would be faulted. For me the implicit admission that they (bankers) were not even going to try and stop the train wreck was appalling. However, given that they were so over compensated, it was probably imprudent for them to try and stop the train. Any mid level-to-senior banker who was taking home $2 to $5 million per year wanted to keep the train moving at full speed (if only for another year) and not impede its progress….even if it meant shooting off the rails and into the abyss.

David

December 18, 2008 11:30 AM
Anonymous:
thank you so much for this article. Like so many others it sheds more light with precise language for what can only be perceived emotionally and therefore be poorly communicated if at all.

It is imperative to assign language to these mass movements and the group behavior that characterizes them.

One can feel the looting, the colonialization of the American people over the last 25 years by corporate run government, the creation of a dumbed down elite ...

December 18, 2008 11:37 AM
Anonymous:
The sad thing is in the long term things will not change. This is Amnerican capitalism at work. It was already like this 100 years ago, the only difference might be the scale of things now with two ponzi schemes within a decade: first making money selling the worthless dot com stocks, now selling wortless mortgages. Bloomberg reported this week that bonuses on Wallstreet will be half of last year. That's right, not zero, just half, giving traders and investment bankers still bonuses of 1 to many yearly salaries. Wall street traders are the heroes of young people in University, who want to follow their footsteps of becoming rich in their twenties or thirties. If you really want change, you need a revolution in American society, turning it for example in more European style captitalism. But that is seen as socialism or communism in the US, and therefore bad, and this belief is deeply rooted in American society. Summarizing: things will not change, wallstreet is already looking out for the next big thing, the next ponzi scheme.
December 18, 2008 11:42 AM
wintermute:
Spot on Yves.

I wonder whether the regulators should be forced to sit down and watch Danny DeVito's move "Other People's Money"

http://en.wikipedia.org/wiki/Other_People%27s_Money

It just might give them the clue they need to understand what went wrong - especially the wildly floating exchange rate between OPM and USD which can be 10:1, 100:1 (or more in the case of GS, MS & co).

December 18, 2008 11:44 AM
S:
Yves,
;
One derivative of this is the entire OPE complex. i am always reminfed of the panamsat, Yell, and hertz (?) deals. The PE scam was worse as it continues. Buy, lever up and destroy the balance sheet with dividends to yourself (reduce equity exposure) and then use cov light financing for a back end cram down. The PE craft was really the high art of robbery. Shameless. but they add value...right..
December 18, 2008 12:29 PM
Jesse:
Too Big to Fail, Too Well-Connected to Jail: The Economic Underground of Bankruptcy for Profit
http://tinyurl.com/toobigtofail
December 18, 2008 12:37 PM
Anonymous:
Americans are too complacent and still believe that their elected officials are doing the right things as their proxy in the democratic process. Maybe when the breadlines return to America will Americans get angry enough to march on Washington & Wall Street demanding justice for the fall of the house of cards. In the meantime, blog away.
December 18, 2008 12:41 PM
Sandrew:
This made me think of this quote, from LOSC, in which I detected no intended irony: "If firefighters are some of the highest paid people in your county or state, with salaries well into low-six figures, great benefits and true pensions that allow you to retire at 50 and receive salaries (in perpetuity) above what they made in the 4 yrs they actually worked…well, then your your state had better be on fire or beset by fire-breathing dragons like in Reign of Fire because that's the only way to justify that level of compensation."
December 18, 2008 12:58 PM
cent21:
How has the banking industry's bonus pay differed materially from Bernie Madoff's?

Books will probably show Madoff only took fees supported by his reported assets under management, if they can ever figure that out.

I guess banking bonuses were at least based primarily on real market quotes, however distorted the quotes were. So they were more like a gamble; heads, we get big bonuses and the economy putters along as usual, because interest rates are low and real estate values never fall; tails, we get big bonuses and then get somewhat smaller bonuses funded by taxpayer bailout dollars while the economy goes into free fall.

December 18, 2008 1:07 PM
Francois:
"Why is no one willing to call things by their proper names, and instead resort to euphemism and double-speak?"

Who owns the news media today? Do they move in the same circles than the bankers? Do they meet at the x-mas parties of their elementary school children? Do they shop at the same spots? Live in particular neighborhoods?

If yes to several of these questions, then the answer to your question is obvious.

December 18, 2008 1:23 PM
Anonymous:
"It became clear to me then that leveraged fixed income is the height of folly. The players pretend to be rocket scientists, but in fact rely on mean variance optimization, which works until it doesn't work. While it works, the practitioners earn huge amounts of money, and when it doesn't work, they hunker down with their lawyers and try and keep what they've extracted in past years, while their investors go bust. The key personal characteristic needed to do this is to have no shame." - Jim

100% on the money.

The reason this can occur is human nature. The quants always have a willing audience they can scam. All they have to do is throw up a track history of say...5-10 years...and it is human nature for people to say...AH HA...this guy knows what he is doing. He has figured out all these models that show this is a free lunch.

In fact...the quant himself believes it...because that is the dogma he learned in his Ivy League B School.

It is human nature to assume that the near future (or even distant future..) will be like the recent pass.

Of course in reality the quants are collecting nickels in front of bulldozers...as Taleb says.

To me, whether they know it or not is immaterial. Either they are thieves or morons in my book.

December 18, 2008 1:48 PM
Anonymous:
I so agree with Yves, M.G., and several other posters: the kind of language we use in describing this calamity is crucial. And I strongly disagree that using the correct words is 'inflammatory'. That's absurd. It isn't inflammatory to call John Wayne Gacy a murderer; it certainly isn't inflammatory to call those who've stolen billions upon billions of dollars, thieves. We need to use the right, strong words: theft, looting, gambling, Ponzi scheme-- not because they are punitive or self-righteous--but because they are the only accurate ones to use. If we describe the problem with weak, foggy euphemisms (regulatory failures, lack of oversight, excess, blah blah) the severity of the problem and its essentially criminal nature can't be seen, let alone dealt with. Say it loud, say it proud, and say it whenever media people euphemize or minimize: what has been going on is simply, bluntly, crime!
December 18, 2008 1:57 PM
GloomBoom.com:
These bankers are simple criminals that have looted us. They need to go to jail. Instead, Fuld is rich and Paulson is King.
December 18, 2008 2:13 PM

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Simon Johnson, an MIT prof and former IMF chief economist, is behind the The Baseline Scenario blog, which has been a vital read during this crisis. He has been a critic of the Bush/Obama bailout from the start, but his devastating essay in the May issue of the Atlantic, "The Quiet Coup," may be the clearest short-form explanation yet produced of the problem and of the official paralysis that has greeted it

Squeezing the oligarchs... is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or-here's a classic Kremlin bailout technique-the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk-at least until the riots grow too large.

Old News ;-)

Who caused the economic crisis?

Economist Simon Johnson and "Obamanomics" author John Talbott say there's plenty of blame to go around

By Simon Johnson and John Talbott

Editor's note: This is the first installment in a three-part conversation between Johnson and Talbott. Read Part 2 on Thursday and the conclusion on Friday.


Jul. 22, 2009 |

;John R. Talbott is a former investment banker with Goldman Sachs and the author of "The 86 Biggest Lies on Wall Street," "Contagion," "Obamanomics," and "The Coming Crash in the Housing Market." His books predicted the housing market crash, the financial crisis and the election of Barack Obama when Obama was still a little-known underdog. Talbott is currently engaged in trying to build what he calls "a grass-roots movement of ordinary Americans who want to take back the government from lobbyists and corporate interests." Anyone interested in learning more can e-mail him at johntalbs (at) hotmail (dot) com.

Simon Johnson, the former chief economist of the International Monetary Fund (IMF), is the cofounder of BaselineScenario.com, a Web site tracking the ongoing financial crisis. He is also the Ronald A. Kurtz professor of entrepreneurship at the MIT Sloan School of Management, a member of the Congressional Budget Office's Council of Economic Advisers and a senior fellow at the Peterson Institute for International Economics in Washington, D.C. He is one of the most visible public commentators on the ongoing financial crisis and its causes and on what role the government and regulatory policy will play in moving the economy forward.

From June to July of 2009, Talbott and Johnson held an e-mail conversation on the following topic:

"The economic crisis: Who caused it? Was it preventable? Was criminal activity involved in bringing it about? And is it over?"

The exchange below is the first of three sets of e-mails. The second pair will be published Thursday, and the final pair will appear Friday.

From: John Talbott

To: Simon Johnson

Subject: A Vast Criminal Enterprise

Simon,

I believe economists are doing a very poor job of explaining to the American people who and what caused the current economic crisis. I think the reasons for this are threefold.

One: Economists and media pundits -- themselves mostly gentlemanly elites anxious to please corporate America -- are slow to make the accusation that what happened here was truly criminal, and so miss the real story. The American people understand that when a group of bankers shuffle some paper unproductively and get away with hundreds of billions of dollars in bonuses, yet cause a loss of $40 trillion in global wealth and cause approximately 100 million people to become unemployed worldwide, there is only one word to describe it: criminal. We don't have to argue about whether their actions were technically illegal or violated existing statutes, as in this conspiracy the crooks were writing their own regulations and legislation through their control of the government through lobbying.

Two: There has been no criminal investigation to date, so evidence supporting criminality has not been uncovered -- no one is looking for it. Liberals hate to think that Obama, led by Geithner and Summers, is part of a grand cover-up scheme, but that is exactly what is going on. How else can you explain the lack of criminal investigations? Why isn't the FBI breaking down the doors of the commercial and investment banks and grabbing computers so as to preserve incendiary e-mails that will most definitely implicate executives? Why are managements that caused this still in their jobs and still receiving bonuses? Are the bonuses paid to the folks at AIG that caused its collapse nothing more than hush money? How can the rating agencies still be in business? Why don't we make one arrest and lean on the bankster to see if he will fold like the cheap suit that he is and name other conspirators? The FBI spends more time investigating $2,000 drug buys than they have to date investigating the biggest heist in the history of the world: $40 trillion, that's trillion with a T, that's 40 million bags each containing $1 million.

The third reason that we have not had an easy-to-understand explanation from economists as to the cause of this mess: I think we're all trying to fit the facts as we know them into one simple story of causation. I believe there are actually three different storylines occurring contemporaneously, and all of them criminal. It is similar to what Winston Churchill said about trying to forecast Russia's next moves in 1939: "It is a riddle, wrapped in a mystery, inside an enigma."

So what are these three criminal storylines? The first, and the smallest (if you can believe it) at approximately $10 trillion, is the housing crash and the mortgage meltdown. Totally criminal, as its primary cause was banksters stuffing worthless mortgage paper into CDOs [securities known as collateralized debt obligations] and calling them AAA. Criminal at every level, as real estate agents were convincing their buyers to pay more, not less, to "earn" their fees through a winning bid, appraisers were offering non-independent and completely tainted appraisals, mortgage brokers were altering loan documents and changing income data to qualify buyers, bankers were paying rating agencies to call junk paper AAA, and principal investors like pension funds, insurance companies, and sovereign governments failed to perform even the minimum levels of due diligence demanded by their fiduciary duties.

But the second story is even bigger and extends far beyond mortgages to the entire banking system. The banks had found a way to avoid the regulation that everyone knew they needed ever since they were given federally backed depositor insurance to prevent bank runs back in the '30s. They became one of the biggest lobbyists and campaign contributors to your Congress and your presidents. Then, amazingly, they just asked that all limitations on their activities be removed -- and they were. If I paid you $2 for your vote, it would be illegal, but somehow these banks could pay hundreds of millions to our congressmen and presidents for their votes and it was all perfectly legal. Completely nuts!

So what did banks do that was criminal? Well, first they paid your government to eliminate bank restrictions, then they overleveraged, knowing they could not honor contracts with such leverage, then they lied to their shareholders about the risks and magnitudes of their positions, hid their positions illegally off balance sheet, and through the use of derivatives managed to violate minimum capital requirements on an almost daily basis. They took bank debt leverage from 8:1 to over 30:1, thus assuring that the banking system could not survive even a modest credit tightening or recession. They made crazy bets in the credit default swap market that they could never honor in a downturn. They loaned money to anyone who could fog a knife because they knew they were going to stuff it to others through securitization and CDOs. If we had a criminal investigation, we would have access to the incriminating phone calls and e-mails in which the banksters disclosed what they really thought of the assets they were pawning off on others. To see how traders incriminate themselves, watch "The Smartest Guys in the Room," about Enron's collapse.

The final storyline of criminality is the biggest of all. It is bigger than the current financial crisis. It is corporate America's complete control of our nation's elected officials, especially our Congress, through lobbying and campaign donations. Yes, the banks played this game, but the game was much bigger than just the financial industry. Coal-fired utilities have so watered down impending legislation concerning global warming that they have now come out in favor of it in the House vote. TARP money went to banking friends of Hank Paulson, although 97 percent of congressional correspondence from the American people was against it. The credit card industry took a minor slap on the wrist, but faces no limitation on the egregious interest rates it can charge its customers. Pharmaceutical and hospital corporations are fighting hard to keep Americans from having a public alternative to their healthcare, and right now are winning that fight. The transportation industry is at the government trough trying to pass a $500 billion windfall. The AARP prevents any meaningful reform of Social Security; the teachers' union does the same for education reform. Is it crazy to think that defense companies like Dick Cheney's Halliburton (which saw its stock price increase 700 percent during the Iraq war, thanks to no-bid contracts) may be promoting U.S. aggression around the world?

The American people understand that their government is corrupt; that is why they don't want to rely solely on more government regulation to solve this crisis. No, if we are to ever to see positive growth again in this country, we need to make the fundamental reforms that are necessary without relying on regulation which is so often co-opted or captured by those we are trying to regulate. This suggests we need to find a way to get corporations out of our government and ensure they never become either too big to fail or so big that they improperly influence markets and our government.

John

From: Simon Johnson

To: John Talbott

Subject: Re: A Vast Criminal Conspiracy

John

You make many good points, but I think the situation may actually be worse.

You stress that criminal acts must have been committed, and I'm sure this is right at the level of individual lenders or investment banks that packaged and resold dubious mortgages, for example. As you point out, when and if prosecutors get their hands on the right e-mails, we'll see evidence for a great deal of intentional deception (of consumers, investors, regulators and everyone else).

Given that we have a relatively decentralized criminal justice system, within which prosecutors have an incentive to build a tough reputation, and given that it takes time to build these kinds of cases, I suspect we will see more such prosecutions in the near future. Also, civil cases now under way may well uncover evidence of criminal wrongdoing -- and this will presumably be referred to prosecutors.

The bigger problem, however, is that much of what has severely damaged our economy and still jeopardizes our future is completely legal. Take, for example, campaign contributions. You rightly rail against these and the power that they confer on big donors -- primarily lobbies of various kinds. And we're all against direct favor buying that is presumably illegal. But much of what was done -- for example, in terms of financial market deregulation since the early 1990s -- was surely completely legal, but a very bad idea.

Bad ideas in public policy, of course, are always with us. What worries me most about our situation at this moment is that while our current leadership on economic strategy issues now talks about the mistakes of their (and our) past, their policies are pointing us back in the same direction. The latest evidence in this regard is the regulatory plan released by the Treasury this June.

This plan is a long list of technocratic tweaks. But when you dig through all the details, it is hard to find anything that will really make a difference to the functioning of our financial system. Most importantly, we will still have banks that are perceived as "too big to fail," and these institutions will have access to government bailouts under vague and completely open-ended terms. In what way will this encourage responsible lending in the future?

The administration does propose to add an agency protecting consumers against financial products -- and this is an implicit recognition that you are right, that the finance industry has long been ripping off consumers in various ways. But beyond that, there is nothing currently on the table that would make our banking system and -- by implication -- the world's financial system better run.

What happened? The finance industry has captured, intellectually, both public policy and a wide range of public intellectuals. People really believe that we need something like today's financial sector in order to resume reasonable growth in this country. This is despite the fact that financial innovation has added little to productivity in the past two decades, and it flies in the face of the obvious damage done recently by overborrowing at various levels.

You point out specifically that economists have not done a good job in terms of explaining the deeper causes of the crisis, and I would agree with that. But again I think this is due to the wrong mental model more than anything else. Most economists think that if we're talking about Indonesia or Korea or Russia, considerations of political economy -- i.e., who has power, what they are trying to do, etc. -- are first order. But as soon as we start to talk about the United States, many reasonable people think that the same special interest politics are second order and that the real action comes from more technical considerations, such as the "business cycle" (whatever that really means).

Implicitly, many economists see the U.S. as quite different from those middle-income countries often called "emerging markets." If these economists allow politics into their view of the world, they consider how altruistic policymakers try to balance conflicting objectives. The U.S., supposedly, is not about the competition for power and influence between strong interest groups.

My own view is that we should be dubious whenever someone says or assumes that "the U.S. is different." Most countries have powerful groups -- almost always including the financial sector, and big banks in particular -- and they are always trying to slant things their way. The U.S. may in fact have a worse problem, as our financial sector made a great deal of money in the early deregulation years of the 1980s and plowed that back into further financial influence.

Big finance, of course, was helped by two major waves of innovation: lower communication costs meant that global investing became cheaper, and lower computing costs meant that more complicated trading strategies (i.e., involving derivatives) became more profitable. Of course, to really take advantage of these changes the finance industry needed new rules: lower barriers to capital flows across borders and no regulation for derivatives trading. When they got both, by the mid-1990s, it was off to the races -- the unsustainable rise of the financial sector since that time is what has really pulled us into our current predicament.

And the way in which the Obama administration is attempting to extricate us from the crisis -- with unconditional support for big banks, regardless of costs -- is not addressing the fundamental imbalance of power that favors the financial sector. If anything, the big banks that survive in this sector have now become more powerful -- the political market share of JP Morgan Chase or Goldman Sachs has increased because Lehman and Bear Stearns are out of business.

Private equity and hedge funds, which could have been brought on board with a more reformist agenda (as they have no great love for supersized big banks), instead are lining up with everyone else for government subsidies of various kinds (e.g., through the toxic asset purchase programs organized by the Treasury). And small banks -- who have considerable potential clout through their access to the Senate -- devote most of their time to shooting down sensible changes to more general financial rules (e.g., about whether mortgages can be modified in personal bankruptcy), rather than helping to rein in big banks.

In some sense, the administration's political strategy in this area is not going at all well. But in another more profound sense, the political strategy of Big Finance is proving incredibly effective. They survived the crisis essentially intact, they will keep the rules that have served them (but not us) well, and their day-to-day influence in the corridors of Washington power has never been higher.

There will be a continuing struggle for reform -- after all, we've seen overbearing financial power reined in before in this country (e.g., by FDR and Congress, following the Pecora Hearings in the early 1930s). But it's going to be a long struggle. There is nothing on the immediate horizon that will address our fundamental problems; in fact, the economic recovery will further strengthen the hand of the largest banks, as they will argue that we should now "move on."

But as long as people like you keep writing about the deeper issues at stake, and -- by all means -- pushing everyone to look for and expose criminal wrongdoing, we will eventually move in the right direction. The battle to control finance is really an argument about ideas. What is the right way to organize the economy? How should big banks be effectively brought under control? How do we prevent anyone from exercising disproportionate influence in our open political system?

Keep at it.

Thanks,

Simon

"I would shut down the hedge fund industry"

Simon Johnson and John Talbott on downsizing banks, reducing corporate pull in D.C. and getting pissed!

By Simon Johnson and John Talbott

Editor's note: This is the second installment in a three-part conversation between Johnson and Talbott on the causes of the current economic crisis. Read Part 1, "Who caused the economic crisis?", here. The conclusion of the conversation will run Friday.


Jul. 23, 2009 |

John R. Talbott is a former investment banker with Goldman Sachs and the author of "The 86 Biggest Lies on Wall Street," "Contagion," "Obamanomics," and "The Coming Crash in the Housing Market."

Simon Johnson, the former chief economist of the International Monetary Fund (IMF), is the co-founder of the Baseline Scenario, a Web site tracking the ongoing financial crisis. He is one of the most visible public commentators on the ongoing financial crisis and its causes.

From June to July of 2009, Talbott and Johnson held an e-mail conversation on the following topic:

"The economic crisis: Who caused it? Was it preventable? Was criminal activity involved in bringing it about? And is it over?"

The exchange below is the second of three sets of e-mails. The first pair was published Wednesday, and the final pair will appear Friday.

From: John Talbott
To: Simon Johnson
Subject: Complexity With No Purpose

Simon,

You make some very good points [in your first e-mail]. Let me try to address some of them, and in so doing extend this e-mail exchange into a conversation about the real reforms needed.

Don't worry, this isn't over yet. We haven't missed our chance to enact real reform. There isn't going to be any big recovery until we address these fundamental issues. Given the debt overhang, the banks' general unwillingness to lend, the lack of transparency and trust in the markets, the possible change in people's desire for increased status-seeking through crazy borrowing and crazy consumption, a substantial decline in immigration and population growth, and the fast approaching retirement of the baby boomers, I don't see the American economy growing in real terms for years, if not decades, into the future. The real risk is that the economy will continue to suffer, unemployment will increase, and discontent will grow to the point that the Republicans stage a comeback. It may sound far-fetched now, but I can tell you: There is enormous anger out there about government spending, the increased debt, the bailouts and the fact that Washington is still taking orders from special interests. This is not the change people signed on for.

You are right -- this is much bigger than Bernie Madoff and his friends stealing billions from investors. Because the banks lobbied to change the law before they acted, their actions are technically legal. But paying elected representatives money to change laws so that you can violate them seems to me to be at the heart of what criminal activity is all about. But you are right, because the laws were changed, criminal prosecutors in the states are not going to be very effective in bringing effective prosecutions, especially given that federal enforcement agencies like the FBI and the SEC [Securities and Exchange Commission] are collecting so little useful evidence and pursuing so few leads.

It is a real question how a country can stop corruption once corruption reaches its legislature, since the legislature is the place where we would expect reform legislation to be enacted. I believe this is one of the reasons why the poorest countries of the world have remained poor for centuries. As we have seen here in the U.S., once you lose control of your legislature, accomplishing real reform is a much bigger problem. Prosecuting attorneys are not going to be much help, judges and the court system have their hands tied by corrupt legislation, and well-meaning presidents face ostracism inside the Beltway if they openly oppose Congress, lobbyists and corporate special interests.

I believe pressure for reform has to come directly from the people. And I believe that Washington is so corrupt that attempts to bring reform through the vote will be ineffectual. The two parties have too much of a lock on power while incumbents have too much money (and they have gerrymandered their districts to the point that their losing is near impossible). Congress' approval rating of 14 percent and congressional incumbents' 98.4 percent success rate at re-election fully describes the problem of attempting reform through the vote.

That is why I am starting an effort to organize Americans who are angry with the power of corporate special interests to take back their country by putting pressure not on the corrupt Congress, but on the source of their funding: our biggest banks and corporations. Follow the money. [Anyone interested in further information can contact Talbott at johntalbs (at) hotmail (dot) com.] The task is getting Americans organized, because once organized we hold the ultimate trump card. It is we Americans who make these corporations what they are today by buying their products and services. Any threat to not buy the products of big government lobbyists would certainly get their attention. I honestly believe it is also in the interest of our biggest corporations to stop influencing our government, because until they do, so our country is not going to be seeing any real economic growth. Banksters, greedy healthcare companies, a weak education system, unnecessary wars and a bankrupt government trying to fund its retirees' costs are not conducive to economic growth, and the corporations should come to realize this. This is a classic collective-action problem where each corporation cheats and steals a little, but the overall effect is to strangle the economy and prevent a truly prosperous future.

Of course, the real reforms that need to be accomplished, once we get corporations out of Washington and politics, include limiting the leverage of banks and prohibiting them from risky activities -- principal trading for their own account, derivatives trading, and many other investment banking activities -- and assuring complete transparency of all of their positions. We also need to strengthen the board supervision of management by getting managers, including the CEO and his cronies, out of the boardroom and replacing them with real shareholder representatives. We don't need to limit compensation, but we need to make sure that it is structured so that toxic waste cannot be left behind by a poorly thought-out bonus system.

But there are bigger reforms that are also needed. We need to downsize all corporations, especially the banks. We need to make sure they are not too big to fail. This downsizing will not hurt investors, as they will get two new smaller company shares of equal worth for every big old company share they held.

We need to shut down the credit default swap (CDS) market, because extensive trading of default risk makes everyone too interconnected to fail. I know the CDS market was created to limit risk through hedging, but it has done just the opposite. It has made all firms so interconnected that one cannot fail without bringing them all down. This violates the first rule of capitalism -- that firms must be allowed to fail -- and therefore it needs to be stopped completely. The only analogy I can think of to demonstrate how crazy this market has become is to go back in history to the early days of risk sharing when well-capitalized institutions on shore offered insurance against the loss of a ship at sea. The CDS market, if it were operating back then, would have allowed ships at sea themselves to guarantee the fate of other ships at sea, with very small boats such as hedge funds somehow insuring the return of very large merchant ships. The whole mess would have become so interconnected that one ship's sinking would have bankrupted everybody.

People today seem to think that just because two people want to trade something, it must be good. Because the CDS market is big, it must be useful, goes the argument. It gets at the belief system that you suggested people have adopted: that markets are inherently good. Maybe always efficient, but not always good. There are some things like company default risk that shouldn't be traded. In the past people wanted to buy and sell slaves, child pornography, women's bodies, or weapons of mass destruction, or to offer payments to elected government representatives and bribes to international governments and competitors. Just because a market can develop does not mean the functioning of that market is good for society. Markets cannot self-reflect. That is what humans do. Only we can decide if a particular market is doing more harm than good.

I would extend my reforms to include shutting down most derivatives trading. If used properly, it can be an effective hedging tool, but since its introduction it has made investment analysis moot, as no one actually knows what risks you are buying when you buy the stock of a company or bank actively engaged in derivatives. You may be bullish on gold prices, so you buy a gold mining stock -- only to find out that the company has in fact hedged its gold exposure so effectively through derivatives that it makes money only if gold prices decline, not increase.

Similarly, I would shut down the hedge fund industry. They are nothing more than enablers for these banks and companies like AIG to concoct schemes to avoid regulation or increase risk. Basic investment theory says you can't beat the markets, so I will bet that the hedge funds that are claiming to do so are doing it illegally through insider trading and market manipulation of individual stocks and asset prices. Don't take my word for it. Let's have the government tap the phones and check the e-mails of the hedge funds for a six-month period on a confidential basis and see what happens to their reported outsized profitability and trading brilliance.

John

From: Simon Johnson
To: John Talbott
Subject: Re: Complexity With No Purpose

John:

Thanks for your follow-up note.

I take your point that there should be a great deal of popular anger -- there is certainly plenty of reason for ordinary voters to be upset. But I'm not so sure this will be manifested anytime soon; for most people, what has happened is a bit abstract and rather too confusing.

On top of this, the big banks have done a great job of muddying the waters. Their message gets through to many: Everyone is to blame and no one is responsible for the crisis, so let's go back to some version of business as usual.

I actually agree there will be change, but I would suggest three other ways in which this will be manifested.

First, the financial sector has become so bloated that going back to any version of "business as usual" is inherently difficult. Even ardent supporters of the financial sector think that much of its supposed growth since the mid-1990s is likely to evaporate. And there is no one who thinks that finance can continue to expand its already high share of our national economy.

In our bubble/boom, we overbuilt, just like Japan overbuilt in the 1980s. Japan added excessive commercial real estate and too much manufacturing capacity; it took more than a decade to work off that overhang and the associated corporate debt. We overbuilt residential real estate to some degree, but mostly we overbuilt financial services. That overhang could disappear fast -- buildings decay over time, but financial services are just people sitting in front of computers. Turn off the perceived business model and there's nothing left -- except perhaps too much office space in former financial centers.

Of course, it is possible that this aggregate contraction will come in terms of exits by smaller players in the financial markets, rather than downsizing the biggest banks. This would be ironic and also dangerous -- the real problem we face is from the banks and other financial firms that are "too big to fail" because they are so large relative to the financial system. If the biggest banks end up increasing their political and economic market share, this would not be good.

In this context, my second potential mechanism will be important. As you suggest, much of what passes for "financial innovation" is actually various ways to rip off customers. The biggest, most "sophisticated" banks have become very good at getting people to overpay.

Resistance to this kind of overpayment is growing. The existing level of fees, implicit and explicit, for all kinds of financial services has moved from irksome to completely unacceptable. Disappointed customers and rising competitive pressures are forcing these fees down. All of finance will be affected, but the biggest hit should be on the banks that are more about "rent extraction" than actually intermediating money from savers to borrowers.

The big banks are definitely in this line of fire. You're going to see some aggressive new entrants, undermining all manner of previously effective cartels, at the same time as fewer transactions and lower fees.

Third, there is great frustration and mounting anger among other members of our business elite. What the big banks have gotten away with is absolutely not in the interest of "real economy" entrepreneurs and the venture capital that backs them financially. It's also not in the interest of small and medium-sized banks who find themselves under increasing pressure -- particularly as commercial real estate goes bad -- but who are small enough and politically unconnected enough to fail. And the executives who run large nonfinancial corporations are beginning to figure out how badly they got clobbered and by whom.

They are worried about the budget deficit, about the issue of money, and -- most of all -- about their future taxes. All of these worries are completely appropriate. And they understand very clearly who is responsible: the biggest of the big banks.

Why does this matter? These business elites wield great influence, partly behind the scenes. They are increasingly articulating to their contacts in the administration and on Capitol Hill that "too big to fail" is no longer acceptable.

I hear more and more, including from influential people in the financial sector, that there needs to be some sort of "tax" (speaking loosely) on size in finance. There is a growing consensus that if you are big enough to jeopardize the financial system and to require a future bailout, you should pay for that privilege.

The payment can be in terms of higher capital requirements or something else. There are many ways to make this work -- as Deng Xiaoping said, "It doesn't matter if the cat is black or white, as long as it catches mice." The cult of size within the financial sector is over.

Overall, I may be more optimistic than you about change for Big Finance being on the way. But I'm probably less positive about where this ends up more broadly for society. You have a long list of reforms throughout society, and while we can argue the details, I'm broadly sympathetic to many of your points.

These mechanisms for imposing change on Big Finance, however, would do little to move things forward on a broader front.

That needs a more comprehensive national leadership push. Personally, I have not given up on President Obama -- I think much of his strategic agenda makes sense and many of his tactics are sensible, but the banking crisis is still an Achilles' heel. If he can get past that, and put the big banks back in their (smaller) boxes, I'm optimistic that he will have the opportunity to push over time for more extensive reforms.

And if not him, who?

Thanks,

Simon

Fix the economy? Curb corporate America

Part 3: Simon Johnson and John Talbott wrap up their talk on the real causes of the economic meltdown

By Simon Johnson and John Talbott

Editor's note: This is the final installment in a three-part conversation between Johnson and Talbott on the causes of the current economic crisis. Read Part 1, "Who Caused the Economic Crisis?" here, and Part 2 here.


Jul. 24, 2009 |

John R. Talbott is a former investment banker with Goldman Sachs and the author of ; "The 86 Biggest Lies on Wall Street," "Contagion," "Obamanomics," and "The Coming Crash in the Housing Market."

Simon Johnson, the former chief economist of the International Monetary Fund (IMF), is the co-founder of the Baseline Scenario, a Web site tracking the ongoing financial crisis. He is one of the most visible public commentators on the ongoing financial crisis and its causes.

From June to July of 2009, Talbott and Johnson held an e-mail conversation on the following topic:

"The economic crisis: Who caused it? Was it preventable? Was criminal activity involved in bringing it about? And is it over?"

The exchange below is the last of three sets of e-mails. The first pair was published Wednesday, and the second pair appeared Thursday.

From: John Talbott

To: Simon Johnson

Subject: Taking Back the Country

Simon,

I think you and I and most economists suffer from an antiquated belief that if we can just figure out exactly what went wrong, policymakers will beat a path to our door to ask our help in enacting necessary reforms. Unfortunately, the world no longer works that way. Our corrupted government, our criminal businesses and banking institutions, lobbyists, special interests, and the corporate controlled media are not interested in fixing this problem. They are making trillions of dollars through a vast scheme that transfers wealth from ordinary American taxpayers and consumers to their corrupt coffers. You are right that if big business thought about it, they should support efforts at restricting lobbying so that growth-oriented government policies could be implemented without the influence of corrupting special interests. But each lobbying corporation is also its own special interest, and so such internal reform is impossible.

The million-dollar question is: Why haven't ordinary Americans reacted more passionately and angrily in taking real action to end this systemic abuse? A decade ago, I wrote my first book on the corrupting influence of big business lobbying on our government and concluded at the time that average Americans would not focus on the issue until they had suffered real pain. I concluded that you can't defuse a bomb in America until after it has gone off.

But now the bomb has exploded. Forty million Americans are unemployed, millions have lost their homes, and most have taken a very substantial hit to their incomes, retirement savings and wealth. Why aren't Americans in the streets protesting this corrupt, enormously damaging criminal enterprise? I have traveled enough around America to realize that even though the current situation is enormously complex and not all Americans can describe exactly how the CDO market works, almost without exception every American can relate to you his frustration with how corrupt this government is and how unjust corporate lobbying and special influence in Washington has become. They get it. As a matter of fact, some of my high school-educated friends from my home state of Kentucky understand it a lot better than my Harvard-educated friends from Wall Street.

So I don't think the current challenge is figuring out exactly what caused the crisis. Focusing on what caused this episode will lead to narrow regulatory reform that reminds me that we all now take off our shoes at airports because one crazy fellow had the idea of putting a bomb in his heel. So while reform is needed in subprime mortgages, securitization, derivatives, and even in the magnitude of our financial institutions, none of these get at the fundamental problem: The people of this country are no longer making the rules by which they wish to live. If subprime mortgages hadn't blown up, some other area of highly leveraged bank lending would have eventually imploded. Even if the banking industry hadn't crashed, some other sector of the corrupt business/government criminal enterprise would have. Maybe the ice shelf of Greenland would have collapsed into the North Atlantic, maybe we would have run out of oil, maybe Microsoft's monopoly position in operating systems would have led to a worldwide computer virus shutdown, maybe poor consumer safety standards with China would have led to a global disease epidemic. The point is that when corporations make the rules, the results are not always good for the inhabitants of the planet.

So we don't have to decide today exactly what the reforms will be -- we just need to get corporate America out of our government so that the people can deliberate and make these reform decisions themselves without undue influence from bankers and corporations.

But there are two huge impediments to accomplishing this. This is not a traditional economics problem, it is an organizing problem or a collective action problem. People know the system is rigged and broken and unjust, but they feel as if there is very little that any one of them can do to effect much change. The organizing task is further complicated by the fact that our media, including television networks, cable TV, radio, newspapers, and magazine and book publishing, are almost all sponsored, owned and controlled by big corporations. The only hope is the Internet, over which big business has tried but to date failed to successfully exert its dominance. The Internet will prove to be both a source of unbiased news and information as well as the communication tool concerned citizens can utilize to fight back against big government, big business and big media.

What has to happen to get this movement started? First, I think people need to see that there is a channel being constructed that has the potential to be effective in directing their anger into real positive reform and change. I am in the process of beginning just such an organization and encourage people who are interested in fighting back against the system and against corporate lobbyists and special interests to contact me at my e-mail address, johntalbs (at) hotmail (dot) com.

Next, people have to believe that if they invest their time in such an effort they have the potential of winning. In this case, this is rather straightforward and easy to explain. If we are successful in organizing 5 million to 10 million Americans who want to see real change about how business is conducted in Washington, then by definition, we will have not only substantial political and voting power, but more important, the beginnings of a real consumer movement that could easily boycott the products and services of the worst corporate lobbyers in our government.

And this is where the magic of the Internet comes in. No one person could organize a 10 million person database in his lifetime. But Obama was able to accomplish it in less than two years. How? We don't have his money. Instead, we create our own Ponzi scheme. We create the ultimate chain letter. I e-mail 30 of my friends who each e-mail 30 of their friends and so on and so on. If only four cycles of people pass on the info we end up contacting 25 million Americans. We ask people to give us their e-mails and then contact them when we want to boycott a new offender.

It is time for Americans to realize that things are not going to improve until they get involved. It will take time. But the economy is not going to improve until we straighten out our corrupt system. Do you have anything more important that you are working on than this? The survival of liberal democratic society in the world.

Thanks for a great exchange of ideas. And best of luck in your future research and work.

John

From: Simon Johnson

To: John Talbott

Subject: Re: Taking Back the Country

John:

I admire your energy and focus in trying to mobilize a broader cross section of people against the big banks in particular and the way our political-financial system operates in general. I'm sure this is worthwhile and not at all a waste of time. Any efforts you or others put into educating people -- or enabling people to better educate themselves -- will surely pay off over time.

However, my sense of the political cycle around these issues is perhaps a bit different from yours. On the first round -- the crisis, immediate policy response and first-round "reform" efforts -- the big bankers have definitely won.

You were right when you argued way back that it would take a crisis before anyone really understood that we have a problem. But even so, most people still do not fully understand what has happened to them over the past 12 months -- and why their future taxes will be so much higher. I spend quite a lot of time talking to relatively well-informed people. After an hour or so of intense discussion and argument, I would say that most people see much more clearly just what the big banks got away with, although they do not necessarily agree with the idea of stricter regulatory controls on those banks. Left to their own devices, or just relying on the usual sources, I'm not sure how clear any of this is to most people.

And I worry that e-mailing friends doesn't necessarily engage people at the necessary level. You need repeated reinforcement of the key themes -- and a lot of back and forth with people you trust -- to really change minds on something this big. Or, as you say, you need to see it again and again, and perhaps you need to worry about the consequences for your own well-being.

If the big banks could just lie low for a while, I honestly think they would get away with everything -- the backlash would fade, and we'd be setting ourselves up for another massive crisis down the road.

Fortunately (in a sense), the banks cannot back off from their most egregious behavior. Perhaps this is in their DNA; definitely it is in their organizational culture and how they see the world -- the people who run the biggest financial institutions really think they are the masters of the universe and are proceeding on that basis.

Their profits, their wages, their bonuses, and their behavior have begun to antagonize people greatly. Already, some of my contacts who are close to the administration wince at the latest news from the financial sector, be it the bonuses that were paid last year to senior people who oversaw major mistakes (some of whom are now rewarded with senior policy roles!) or the blatant bragging about political influence that some CEOs are now making public.

And even if some sensible people at these banks would like to rein in employee compensation to more moderate and reasonable levels, they have a problem. If you lower the wages for your people, another bank -- perhaps one based in Europe -- will hire them away with a crazy package. The rat race, across companies and between people, means that this can only be curtailed through regulation. But the survivor banks are so strong politically that they will defeat all meaningful regulation for compensation.

This very success makes them more vulnerable to further criticism and backlash.

I'm not saying that the banks will simply commit political suicide. Nothing is ever so simple. But they will likely undermine themselves with Congress and eventually even with the administration. The midterm elections in 2010 and the presidential election in 2012 could well be very much about restricting the power of the big banks.

American democracy does not get on well with overweening unelected individuals who pretend to great power. Andrew Jackson saw off Nicolas Biddle in the 1830s. Teddy Roosevelt stood up to -- and eventually towered over -- even J.P. Morgan at the beginning of the 20th century. And FDR remade everything in the 1930s.

As I said before, I'm optimistic that President Obama can do the same. The challenge to democracy is palpable and growing. The fact that two -- and only two -- big banks came through the crisis unscathed is a perfect symbol of the problem. In the past, part of the myth of Wall Street was that it was competitive, that many could enter the industry, and that its political power was not too concentrated. This myth, among many, has now exploded.

We see the power for what it is. Mainstream media increasingly picks up the story line. And still the big banks cannot step back and curtail their most troubling activities.

Keep explaining and let the big banks provide the supportive evidence you need.

Best wishes,

Simon

Welcome to America, the World's Scariest Emerging Market by ; Desmond Lachman

March 29, 2009 | ; washingtonpost.com

By Desmond Lachman
Sunday, March 29, 2009; B01 ;

Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.

Over the past year, I've been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking -- with other people's money -- for their personal gain.

Negotiating with Argentina's top officials during their multiple financial crises in the 1990s was always an ordeal, and sparring with Domingo Cavallo, the country's Harvard-trained finance minister at the time, was particularly trying. One always had the sense that, despite their supreme arrogance, the country's leaders never had a coherent economic strategy and that major decisions were always made on the run. I never thought that was how policy was made in the United States -- until, that is, I saw how totally at sea Treasury Secretaries Henry Paulson and Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke have appeared so many times during our country's ongoing economic and financial storm.

The parallels between U.S. policymaking and what we see in emerging markets are clearest in how we've mishandled the banking crisis. We delude ourselves that our banks face liquidity problems, rather than deeper solvency problems, and we try to fix it all on the cheap just like any run-of-the-mill emerging market economy would try to do. And after years of lecturing Asian and Latin American leaders about the importance of consistency and transparency in sorting out financial crises, we fail on both counts: In March 2008, one investment bank, Bear Stearns, is bailed out because it is thought to be too interconnected with the rest of the banking system to fail. However, six months later, another investment bank, Lehman Brothers -- for all intents and purposes indistinguishable from Bear Stearns in its financial market inter-connectedness -- is allowed to fail, with catastrophic effects on global financial markets.

In visits to Asian capitals during the region's financial crisis in the late 1990s, I often heard Asian reformers such as Singapore's Lee Kuan Yew or Japan's Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change. How fortunate, I thought then, that the United States was not similarly plagued by crony capitalism! However, watching Goldman Sachs's seeming lock on high-level U.S. Treasury jobs as well as the way that Republicans and Democrats alike tiptoed around reforming Freddie Mac and Fannie Mae -- among the largest campaign contributors to Congress -- made me wonder if the differences between the United States and the Asian economies were only a matter of degree.

On Wall Street there is an old joke that the longest river in the emerging-market economies is "de Nile." Yet how often do U.S. leaders respond to growing signs of economic dysfunctionality by spouting nationalistic rhetoric that echoes the speeches of Latin American demagogues like Peru's Alan Garcia in the 1980s and Argentina's Carlos Menem in the 1990s? (Even Garcia, currently in his second go-around as Peru's president, seems to have grown up somewhat.) But instead of facing our problems we extol the resilience of the U.S. economy, praise the most productive workers in the world, and go on and on about America's inherent ability to extricate itself from any crisis. And we ignore our proclivity as a nation to spend, year in year out, more than we produce, to put off dealing with long-term problems, and to engage in grandiose long-term programs that as a nation we can ill afford.

A singular characteristic of an emerging market heading for deep trouble is a seemingly suicidal tendency to become overly indebted to foreign creditors. That tendency underlay the spectacular collapse of the Thai, Indonesian and Korean currencies in 1997. It also led Russia to default on its debt in 1998 and plunged Argentina into its economic depression in 2001. Yet we too seem to have little difficulty becoming increasingly indebted to the tune of a few hundred billion dollars a year. To make matters worse, we do so to countries like China, Russia and an assortment of Middle Eastern oil producers -- none of which is particularly well disposed to us.

Like Argentina in its worst moments, we never seem to question whether it is reasonable to expect foreigners to keep financing our extravagance, and we forget the bad things that happen to the Argentinas or Hungarys of the world when foreigners stop financing their excesses. So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.

After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries' policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor's musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to "get their house in order" -- without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Desmond Lachman, a fellow at the American Enterprise Institute, was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund's Policy and Review Department.

WilliamBlake wrote:

dj333 wrote:

....Restore manufacturing and exports. Increase the safety net to make us more competitive with countries that have national healthcare and state-funded worker entitlements. And require in all free-trade agreements that the signatories match or exceed our labor, environmental, and safety standards within five years. If you do that, there will be plenty of money left over to take care of entitlements.

As part of restoring manufacturing also upgrade our infrastructure so that we have plentiful and dirt cheap electrical supplies, and bountiful supplies of inexpensive fresh water.

We must become efficient, competitive again and regain exports, reestablish our local domestic industries, industries that can compete against goods that must be transported across oceans and continents.

The worst thing we can do is impose a carbon tax on our own products, our battered and minuscule industry needs to be nurtured. (and some of its owned by the government!) Also, the USA has been reducing GHG emissions by about 1.5% a year since 2006, so the USA is already on the right track. Changing the USA electrical supplies to ultra clean and efficient hydro and nuclear power from coal will eliminate 50% of all US pollution by itself.

I think we should, though, impose a carbon & pollution tax on imported items. That might be our best way to influence any foreign polluters who refuse to clean up and stop their own pollution of our world.

washingtonpost3 wrote:

Remember a few years back when Bush (or the people that put him in place) wanted to privatize Social Security? That must be particularly painful to Bush and his cronies - they were force to leave a few crumbs on the table as they looted the country on the way out.
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dj333 wrote:

So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.
________________________________________

Entitlements are not our fundamental problem: our basic issue is that we have an economy based on fictions. In the 1920s, the percentage of GDP represented by the financial industry shot up, only to drop right back to its original level by the early 1950s. The period of this weaker financial sector - roughly the early 1940s until the mid 1970s - coincided with one of the strongest periods ever seen in the American economy.

70% of our economy is based on consumer spending. How is that supposed to work? The economy is currently based on the assumption that the average household will spend more than it takes in, and whenever that changes we go into structural recession. These are issues of industrial and trade policy, not government spending.

If our economy was sound, we could all afford more taxes. Our economy isn't sound. The problem with the IMF and other such neo-liberal institutions is that they think the problem is always government spending of social programs. It isn't. When the Titanic was sinking, firing all the leisure planners wouldn't have helped.

Restore manufacturing and exports. Increase the safety net to make us more competitive with countries that have national healthcare and state-funded worker entitlements. And require in all free-trade agreements that the signatories match or exceed our labor, environmental, and safety standards within five years. If you do that, there will be plenty of money left over to take care of entitlements.

datdamwuf2 wrote:

/signed

Our government is run by Wall Street, the policies and the bailouts show us that so clearly. Take AIG, they keep saying it's too big to fail but they are not going to break it up...think about that. The politicians admit the system is broken but do not propose to solve the problem. Instead of putting cash in the smaller institutions that acted responsibly our gov is giving it to the big Wall Street firms that caused the problems. And every day I see smaller banks and firms being absorbed into these big financial institutions. When monopolies are broken up we get competition that is healthy. The current policies and bail outs are going to make monopolies the norm. ;

chris_holte wrote:

"So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford."

Speak for yourself an dump the Imperial "We" because that is self serving mallarky. Medicare and Social Security exist because private enterprise is unwilling and/or incompetent to serve the needs of the broader population. For most of us, they are a form of "savings" as most of us pay more into Social Security than we expect to get, and most of that money is spent on current retirees or funneled into the pockets of Crony Capitalists.

The irony is that by degrading the general good, they reduce the size of the slice of the pie they take even as they reduce the size of the pie and increase the size of their portion of the pie. Degrading Social Security and Medicaid will make the "we" can't afford tripe a self serving prophesy -- and also degrade the country so that "we" can't afford roads, bridges, or rich people without violence. The evidence of the past 30 years and an examination of economies around the world supports this truth. Productive investment, balanced with income transfers (SS and Medicaid), and law enforcement create prosperous societies. Crony Capitalism, neo-liberalism (called neo-conservatism here), and "supply side" degrade societies.

So, Instead of degrading and trying to destroy medicare and medicaid, and Social Security, we need to shore them up, turn them into the basis for genuine universal health care and a genuine retirement. But of course in the process we have to resist and sometimes fight these very crony capitalists who complain about the problems they try to create.

Argentina and Russia had problems largely because power was concentrated in too few hands and because of crony-capitalist (or in Russia Crony Socialists) kleptocratic governments and businesses.

A Government that serves the people can only be created from bottom up. [Eternal Vigilence and Democracy] Organizations like the World Bank and IMF that are top down tend to destroy countries by lending to exactly the wrong people, the wrong sums of money, and then helping these thoughtless and kleptocratic elites destroy the currencies and industries of the countries lent to -- so they can live larger as individuals.

Chris

3/29/2009 11:57:51 AM

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JFredMugs wrote:

Finally, the Post publishes something worth reading.

3/29/2009 10:22:12 AM

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aznavcat wrote:

With all the reporting on stimulus packages and getting banks to lend again, I NEVER see anything in the news about the importance of changing our lending philosophy so we do not continue the same lending mistakes that got us into this mess. This leads me to believe that we, the American public, really haven't sincerely come to terms with our economic problems. We want to go back ASAP to the way things were before the crisis, as if that's a sustainable policy.

Great article but most Americans prefer not to hear bad news. They want politicians who tell them what they want to hear.

3/29/2009 9:45:11 AM

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fjamidon wrote:

"So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford."

We must address Medicare (and social security). That's why we need health care reform NOW in this country - the first step in addressing the medicare problem which will bankrupt us in the next couple of decades if we do nothing.

Social Security will have to be re-thought as well. People are living much longer so the benefits must address this if it is to remain solvent.

We need an investigation (a real one) to get to the bottom of how the financial markets ended up crashing so catastrophically and globally. Then - and only then - can we put into place the right regulations to prevent the crisis from ever occurring again. ;

Clyde4 wrote:

Scariest part of this article is the comments section.

The vicious lack of trust, blame, lack of responsibility, 'look at what these people have done to me', etc that I observe in the comments is dysfunctional and represents the attitude that people have in their hearts.

Not a good sign for our country if people have these problems.

donx65 wrote:

India said that if banks don't lend, they are not banks and should be converted into hospitals and schools and parking.

There was never a "liquidity crisis", just another way to use public funds to enrich bankers. If the problem was to lend more, then the lawyers in Congress could have reduced the banks' capital requirements and instantly created lending power/liquidity!

So far we have "fairly" supported auto workers, bank plutocrats, and mortgage plutocrats in the name of "saving the country". Where's the fairness in using the average taxpayers' wages to support plutocrats' McMansions and the greed of GM? If you help GM, then you hurt Ford. If you help NY banks, you hurt Peoria banks.

The only effective person in D.C. is Bernanke, and he has already solved the problem with monetary action (municipal bonds now trade at realistic yields, for instance).

Fiscal policy can never be fair -- it always enriches only a favored few. Monetary policy takes effect in 6 to 9 months, as we now observe. Fiscal policy twists the economy without helping those not favored, and yes, Chavez of Venezuela would be proud of our actions.

kent_gregory wrote:

Lachman is correct that monied interests in the US has sold out the country, with only paltry bribes we call "campaign contributions" necessary to enact laws that enrich corperations at everyone else's expense. If we, the citizens and government of America continue to spend more than we have - which appears to be the case, we'll hand over the riegns of the world economy to the Chinese.

Sometimes things happen faster than we think possible.

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Lavrat2000 wrote:

Outstanding advice. Now if only the morons in the White House and Congress and the Treasury would read, understand, and follow the advice.

3/28/2009 2:27:56 PM

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VirginiaIndependent wrote:

A sobering wake-up call. I hope that every member of Congress reads this and grasps that the "worst case" outcome of failing to stop this nation's irresponsible borrowing and spending is not just a few years of economic stagnation. ;

georgejones5 wrote:

I wonder if Mr. Lachman's priorities puts him at odds with his neocon colleagues at the American Enterprise Institute. If there were ever "grandiose long-term programs that as a nation we can ill afford" surely the prime example must be the misbegotten "global war on terror". Well, neocons need a working economy too if only to support their global hegemonist agenda. Even though they may be largely motivated to deflect attention from the military-industrial-congressional complex their critique of the financial sector likely has merit.
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TheMSMControlsUs wrote:

Bush started it, Dear Leader will finish it - we are becoming a banana republic.

Obama will triple the national debt and run the currency printing presses around the clock until the dollar is as worthless as the peso.

3/27/2009 12:29:40 PM

lug21 wrote:

Lachman wrote: "I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to 'get their house in order' -- without the slightest thought that the United States might fare no better when facing a major economic crisis."

Don't regret giving those leaders the correct advice. Regret the assumption that American leaders didn't need the same advice.

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3/27/2009 10:06:21 AM
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sw11231 wrote:

Outstanding opinion piece.

rgosche20 wrote:

How can you be a chief financial analyst and not know the difference between capitalism (Des calls it "crony capitalism) and corporatism aka fascism?

This guy is one of our "best and brightest" economists and he is barely more versed than any practical layman?

I agree with much of what he had to say, but his all around fundamental weakness make him a lukewarm advocate. ;

WilliamBlake wrote:

Check this out guys-

Heavy oil production costs $10 a bbl?

"… [W]ith light oil now hitting around $100 a barrel, it's economic to think of using heavy oil, especially since THAI can produce oil for less than $10 a barrel," Greaves said. "We've seen this project go from something that many people said would not work into something we can have confidence in, all in the space of the last 18 months."
http://petrochemical.ihs.com/news-07Q4/canada-heavy-oil.jsp

http://www.rigzone.com/howitworks/heavyoil/insight.asp?i_id=283
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3/26/2009 3:41:49 PM

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knjincvc wrote:

Not funny, The USA has always lectured other countries on fiscal responsibilities.

Now China is lecturing the U.S. on fiscal responsibilities while at the same time loaning cheney/bush and the drunken sailors in congress all the money they asked for. ; ; ;

cgillard wrote:

Yes, Reaganomic created banana republicanism. We now have ultra-rich and ultra-poor and gigantic unearned yearly bonuses like last years hedge fund managers 1.4 Billion Dollar bonus.

A lot of people taking to the underground economy so when does the black market get going?
These people have been selling virtual assets for some time to go along with our high tech mess of expensive, unworkable, over complicated, time and money sucking devices. The we have high paid lobbyists,consultants,lawyers,Media consultants, thinktankers, superfluous scientists, finely printed insurance scams, all being added on to the cost of our goods and services.

While every one else's salaries have been going down, inflation has been miscalculated, and quality going down has been called increased productivity!

And our economic morality is just as bankrupt as our falsified wars and massive collateral damages. Our collateral has just about run out along with the US product label and no one even notices here anyway!

3/26/2009 3:08:14 PM
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debbieqd wrote:

Mr. Lachman, many roads lead to Rome. We're not taking yours this time because last time we did, we ended up in Bushville and bushwhacked. If you think we're Russia or Argentina in eight years, then we'll consider a different route. ;

andfurthermore1 wrote:

...

Interesting but incomplete; another view from the Top of the Pyramid of Capitalism. Those at the top with power, wealth (obscene wealth compared to the other 90% of americans) -- may very well see the USA's financial systems and markets as resemble emerging markets.

For increasing numbers and many of the rest of us who continue to slide further down the economic scale with a declining, gaping, lacking safety net, the USA is starting to ever more resemble a third world oligarchy.

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Susannah1 wrote:

This column was very good until the author stated that we choose to ignore the SS and Medicare "crises". I disagree that SS is about to be in crisis. SS is an important part of our economy whose funds have been mismanaged for the last several decades. Bush chose to use the surplus for tax cuts and ignore the health of the SS system. This a problem, but using the word "crisis" makes situation appear worse than it actually is.

Medicare is in crisis, but so is the rest of health care system. We must fix the entire health care system, not just Medicare, in order for economy to be healthy again.

I would like to know if Mr. Lachman wants to privatize SS. I would also like to know if he supports universal health care. Strengthening SS (NOT privatizing it) and establishing universal health care are two parts of the foundation of healthy long-term economic growth going forward.

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bigblueskies wrote:

jkoch2 wrote:
bigblueskies wrote: What, if any, plans are there being put forward to correct these outstanding problems, and bring us cheap and abundant water and power again??"

The best solution for scarce water is to let the price reflect the true scarcity. There has been far too much development in arid and semi-arid zones. More drilling will simply deplete acquifers and magnify the eventual calamity. Moneys spent on huge dams or canals might be better spent on roads and schools in water-rich zones.

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But the population is not there, its in the warmer south. How will you force population to relocate, and how will they find employment?

Why not at the very leasy complete all the water projects just abandoned and left half done in the 1970's and 1980's??? That would help a lot. If we must then build desalination plants all along the coastlines powered by nuclear generators and pump fresh water to all the depleted aquafiers. The Great Lakes has 20% of the worlds fresh water and its all wasted draining over the Niagra and down into the Atlantic. Why not dam Niagra and drain the lakes thru a canal to the Mississippi, then a diversionary canal & siphon over the continetal divide into the Colorado River, where it will really be used to help people live and not just for a scenic view for honeymooners? What about all the watersheds of northern Canada? Can they be redirected to flow south and link into the water networks supplying Canada and the US? Remember we committed ourselves to population growth through immigration in 1965, and have grown by close to 40%- but we have done little to increase the supply of water and power and we must, since our principles have dedicated us continoued immigration and another 50% growth of population in the next 5o years. How will we supply them? Not by rationing.

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Oil is non-renewable. Existing reserves will yield diminishing marginal returns for capital invested. New reserves are in deep, remote, or dangerous places. The military and political costs of access to Mideast oil is a serious vulnerability. Conservation and substitution are the best path. The most efficient tool would be a flat tax on crude. It would help plug the deficit and encourage thrift and innovation. Anything else is self-deceptive pie-in-the-sky.

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The world has 4.7 trillion barrels of proven oil reserves at the oment, enough to supply the world at its consumption rate in 2007 for another 140 years. Its expected exploration will find a minimum of another trillion barrels of recoverable oil, without touching oil sands or shale. There is more natural gas, and even more coal than both in the worlds reserves. And just as much uranium. In addition we can make fuel, natural gas, diesel, by the Fischer Tropsch process, for a cost equivelant of about $40 a BBL, so in effect we have a infinite supply.

So I don't see a problem except a lack of will.
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AnotherBystander wrote:

Mini22 wrote: "This piece scares me more then anything else I've read about this mess. Should be required reading for everyone."
The fact that you got scared only after reading this piece seems much scarier to me.
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jkoch2 wrote:

bigblueskies wrote: What, if any, plans are there being put forward to correct these outstanding problems, and bring us cheap and abundant water and power again??"

The best solution for scarce water is to let the price reflect the true scarcity. There has been far too much development in arid and semi-arid zones. More drilling will simply deplete acquifers and magnify the eventual calamity. Moneys spent on huge dams or canals might be better spent on roads and schools in water-rich zones.

Oil is non-renewable. Existing reserves will yield diminishing marginal returns for capital invested. New reserves are in deep, remote, or dangerous places. The military and political costs of access to Mideast oil is a serious vulnerability. Conservation and substitution are the best path. The most efficient tool would be a flat tax on crude. It would help plug the deficit and encourage thrift and innovation. Anything else is self-deceptive pie-in-the-sky.
; ;

jkoch2 wrote:

And so Lachman says that the answer is for the US to do [ distant crickets chirping ].

The AEI's solution is, of course, to abolish capital gains and dividend taxes and "get the guvmint of the back" of everything, except where military expenditures involve good dues-paying contractors. The cure for depressions is to cut wages and pare back government. Hoover, any AEI pundit will complain, actually did too much.

;

3/26/2009 11:58:10 AM

; ;
;

valwayne wrote:

Remember just a few short weeks ago. Obama was going to solve our financial problems and put us on the path to prosperity while making America loved in the world again! Just a few short weeks! Since then we've had more broken promises, spending and debt, earmarks, and corrupt bonus guarantees passed into law than we can track. The British Prime Minister was humilated during his visit and sent away with a gift of 25 DVDs he can't even play in England, and the President of the European Union just called Obama's plans for the U.S. economy "The Road to HELL!!! We haven't seen such ineptness since Jimmy Carter, and even Jimmy Carter didn't screw things up this fast. Obama has us on "The Road to Hell" , and that's not from the Republicans that his socialist friends in Europe who "LOVE HIM" saying it!
; ;

rdco wrote:

A very nice piece, pointing the dangerous paths followed by others in similar straights, but without clear recommendations for how we should proceed to avoid looking like Argentina.

Certainly, a lot of our policies look familiar--but fortunately the external debt is all in dollars rather than euros or yen. And, of course, when the US expands the money supply it increases the world's supply of money not just our own, which is not always so great for the rest of the world, but it does reduce our own inflation risks a bit, relative to Argentina's. ;

_BSH wrote:

Amen. Would that the small brains in the White House & Capitol could absorb this wisdom. ;

car141 wrote:

As a person that had to emigrate from Argentina in the 90's, I endorse the comment by Chris Hotte. The IMF endorsed Menem policies and if there was some criticism was that the "free market reform" wasn't deep enough. Of course, it is easy to promote austerity in the federal budget over somebody else's hunger, somebody else's loss of a job, and somebody else's lack of health coverage. But that attitude cost lives. I costed lives in Latin America in the 90's and now it is costing lives in the US ;

vladber wrote:

I am originally from Russia and I lived through all the debacle of Afghan war and collapse of the empire. And I've been taking notes of what's happening and trying to connect the dots.

According to my observations, unfortunately, Mr.Lachman is absolutely correct in his assessment of the situation. All the attributes proceeding the collapse of Soviet empire could be tracked in our current situation:

Mini22 commented that he/she is scared to death by this piece of Mr. Lachman. Yes, Mini22, you have all the reasons to be scared and anticipate the worst to happen.

And recession, depression or "lost decade" are, in fact, might not be the worst options...

jtb2inky wrote:

I couldn't agree more! We are well down this slope at this point, and it's increasingly difficult to see how we will emerge from the depths. One this is certain, our country will not be the same.

Even Jack Bauer couldn't stop 'The Goldman Conspiracy' - MarketWatch

10 reasons why Wall Street has absolute power over America's democracy
Paul B. Farrell, MarketWatch Last update: 7:13 p.m. EDT April 20, ; ; ;

ARROYO GRANDE, Calif. (MarketWatch) -- Two mind-numbing fast-paced dramas. Two parallel worlds. One real, one fiction, both deadly. Jack Bauer, mythic hero of "24." Dying from a deadly bio-pathogen leaked from weapons developed by Starkwood, a rogue mercenary army attacking the presidency, hell-bent on taking over America.

The other drama in play: "Hank the Hammer" Paulson, iconic Wall Street hero, a Trojan Horse placed inside Washington by Goldman Sachs as Treasury Secretary in control of America's $15 trillion economy. Goldman, a modern dynasty with vast financial powers much like those once used by the de' Medici, Rothschilds and Morgans to control nations.

Video: Is a correction imminent?

One of the confounding aspects of bear market rallies is that the longer they last, the more likely investors are to expect a correction, says Barron's Bob O'Brien.

Both dramas play high-stakes games with financial WMDs that have lethal consequences. Jack compresses thrills, kills and chills into 24 hours. Hank, Goldman and their army of Wall Street mercenaries move with equally blinding speed, heart-pounding action.

Drama? You bet. Six short months ago Hank led an assault on Congress. The scene parallels one in "24:" Sangala War Lord Juma's brazen attack inside the White House. But no AK-47s necessary. The Hammer assaulted Congress with just a two-and-a-half page memo in hand. Like a crack special-ops warrior, he took down the enemy, demanding $750 billion, absolute control, total secrecy, no accountability and emergency powers to act immediately ... warning that inaction was not an option, that collapse of America's banking system was imminent, would bring down the global monetary system, pushing world's economies into a "Great Depression II." Congress surrendered.

Here's the whole plot:

Scene 1. American government is now run by the 'Goldman Conspiracy'

Oh, you really think just I'm plotting a television series? Or just paranoid, exaggerating this power grab? You better read "The Usual Suspects," Matthew Malone's brilliant article in Portfolio magazine: He "exposed" the "Goldman Sachs 'conspiracy' to take over the U.S. financial system." Read it in this context: America's financial sector has exploded from 19% of corporate profits in 1986 to 41% today, becoming a magnet for every wannabe billionaire. They know why Wall Street must control Washington.

Malone focuses on the incestuous "conspiracy" of Goldman alumni in Treasury, Bank of America, Merrill Lynch, AIG, Citigroup, Washington lobbyists and politicians.

Scene 2. Huge conflicts motivating Wall Street's 'Trojan Horse'

And just in case you think any emphasis on The Hammer's conflict of interest was invented purely to increase drama, please remember that he worked at Goldman for three decades after serving under Nixon. He got $38 million his last year as CEO in 2006 before becoming Treasury Secretary.

Then during the market meltdown six months ago the $700 million personal fortune he built at Goldman was threatened by Goldman's huge $20 billion derivatives exposure at AIG: Suddenly his responsibilities at Treasury merged with a strong self-interest in protecting his personal fortune. AIG was "saved."

Scene 3. Wall Street's 'quiet coup' also runs world's banking system

There's another equally disturbing expose in "The Quiet Coup," Simon Johnson's great article in Atlantic magazine. A former chief economist at the International Monetary Fund, Johnson also warns that America's "financial industry has effectively captured our government" and is "blocking essential reform."

Worse, he says that unless we break Wall Street's stranglehold (unlikely in the new Washington) we will be unable "to prevent a true depression," warning that "we're running out of time," echoing many of our predictions of the "Great Depression II" coming soon. See previous Paul B. Farrell.

Scene 4. Wall Street used the meltdown to take over America's government

Matt Taibbi, author of "The Great Derangement," captured this drama in a Rolling Stone piece, "The Big Takeover, how Wall Street insiders are using the bailout to stage a revolution." A must-read: "As complex as all the finances are, the politics aren't hard to follow. By creating a crisis that can only be solved by those fluent in a language too complex for ordinary people to understand, the Wall Street crowd has turned the vast majority of Americans into non-participants in their own political future. ... in the age of CDS and CBO, most of us are financial illiterates."

Wall Street "used the crisis to effect a historic, revolutionary change in our political system -- transforming a democracy into a two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below."

Scene 5. How Obama is keeping alive Bush's 'disaster capitalism'

Back in 2007 at the start of the meltdown, Hank was misleading us in Fortune: "This is far and away the strongest global economy I've seen in my business lifetime." In the real world, Naomi Klein, author of "The Shock Doctrine: Rise of Disaster Capitalism," was warning us that "during boom times it's profitable to preach laissez faire, because an absentee government allows speculative bubbles."

But "when those bubbles burst, the ideology becomes a hindrance and goes dormant while big government rides to the rescue." Then, free-market "ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis." TARP paybacks: Obama has a new "disaster capitalism."

Scene 6. Wall Street's CEOs rule like dictators in a banana republic

Seriously, here's how bad Taibbi sees it: "Paulson and his cronies turned the federal government into one gigantic half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling interest in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing business."

And let's include $5.5 trillion in Fannie Mae and Freddie Mac. Wall Street's greed and stupidity resembles the self-destructive reigns of banana republic dictators.

Scene 7. Wall Street makes an un-American bet on 'disaster capitalism'

Today as you ponder buying some Goldman stock, remember, you're really betting that "disaster capitalism" is back, strong, tightening its stranglehold on Washington and on the American taxpayers, who will guarantee all Wall Street's future failures. Yes, this is un-American, but so what?

The "Goldman Conspiracy" is still probably a good short-term buy ... if you're interested in betting on America's new "democracy of capitalists, by capitalists, and for capitalists," with "The Conspiracy" leading the joint chiefs of this new mercenary army ... and it only took six short months for their "Quiet Coup!"

Scene 8. Banks recycle TARP money, pump earnings, cheat America

Here's how it worked: The Hammer conned a clueless Congress, then shelled out $350 billion of our taxpayer money (Helicopter Ben Bernanke helped by upping the ante with a couple trillion side-bet), buying toxic debt to save his ol' Wall Street buddies. They stopped lending and used the dough to doctor their balance sheets.

So no surprise that Goldman, Wells Fargo and J.P. Morgan Chase are now reporting "blockbuster" first-quarter earnings, says the New York Times, while just months ago "many of the nation's biggest banks were on life support."

Get it? They screwed taxpayers and borrowers so they can repay TARP with (you guessed it) our recycled TARP money. Now it's back to business-as-usual, with no restrictions on CEO pay and bonuses ... no thank-yous ... no admissions of guilt ... while some even arrogantly deny that they ever needed TARP money.

Scene 9. Wall Street's already set the stage for new disaster

Right after the election in November, at the peak of the banking crisis, when Hank, Goldman and the Wall Street mercenary armies were divvying up the $350 billion TARP money, we detailed 30 reasons for the "Great Depression II" likely coming around 2011. We quoted John Whitehead, former Goldman Sachs chairman, former chairman of the New York Fed, former Reagan deputy secretary of state. He warned America's problems will take years, burn trillions, result in massive deficits:

"This is a road to disaster," he said. "I've always been a positive person and optimistic, but I don't see a solution here." He did see a depression at the end of that road, one you can call the "Great Depression II."

Scene 10. Obama turned 'The Goldman Conspiracy' into a superpower

Do you see the parallels: Jack and Starkwood, Hank and Goldman? Jack's a great mythic hero. We need to believe a hero will defend the little guy, stand between us and total annihilation. But Jack Bauer's "dead." Yes, dead. Jack's not real. Never was "alive." Jack's a fiction, a figment of Main Street America's vivid imagination, the symbol of "hope" for a populist revolution. Hope that Jack, Barack or some other new hero will emerge, take power back from Wall Street and return it to the people.

Unfortunately that won't happen, folks. Yes, on TV Jack will come back from near-death, again. But in real life, Hank, Goldman and Wall Street's mercenaries are winning the war. Read and weep Portfolio's chilling finale: "Obama's victory and Geithner's appointment are the completion of Goldman's meticulously crafted plan to become a superpower. The firm now has the clout to impose its will on the financial markets, and the world."

GOP or Dems? Conservatives or liberals? It doesn't matter. We'll all controlled by "The Conspiracy." So why not surrender, let them have the power? The truth is, through their lobbyists and surrogates in Washington, they already rule America. Surrender is a mere formality.

Accept reality. Hold them accountable later. After the next crisis. After the next meltdown of disaster capitalism -- if there's anything left after the "Great Depression II" sweeps like a pandemic across the planet, consuming all economies, for a long time. But for now, Goldman and other banks may well be short-term buys. Just be ready to dump them in the near future ... a scenario that will be here sooner than you think.

Simon Johnson says Break up the banks - How the World Works ;

;April 23, 2009 | Salon.com

Simon Johnson is the former chief economist of the International Monetary Fund and in recent months has emerged as one of the most cogent critics of how the Obama administration is addressing the banking crisis. On Tuesday, Johnson, Joseph Stiglitz and Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, testified before Congress' Joint Economic Committee on the topic of the day: "Too Big to Fail or Too Big to Save? Examining the Systemic Threats of Large Financial Institutions."

It's time to get all Teddy Roosevelt on Wall Street, declares the former chief economist of the IMF. Bring out the big antitrust artillery and fire away.

On Wednesday, Salon caught up with professor Johnson for the second time this month, and this time, managed to successfully record the interview.

You have become famous for decrying the consolidation of power by a new financial oligarchy over the politics and economy of the United States. Since our last conversation I was intrigued to learn that this isn't necessarily a new obsession of yours. In the soon-to-be-published paper "From Ancien Regime to Capitalism: The Spread of the French Revolution as a Natural Experiment," which you co-authored with Daren Acemoglu, you argue that after the French Revolution, Napoleon's armies contributed to future economic growth by breaking up local church and aristocratic oligarchies.

Oh yes! So you know that I work on longer-term issues as well as shorter-term issues. You see, there are some recurring themes here. It's about power, and you have to see it all in that light.

Does Wall Street require its own Napoleon?

Well, there was a lot of damage done the way he did it. And I don't think we currently are living under the "ancien regime." The structure of Western Germany, for example, when the French came in, was post-medieval, and they completely transformed it. I still think that we have basically a good system here today. It's just that a relatively few people got out of control. And they need to be reined in. I think that's doable.

In the Joint Economic Committee hearing on Tuesday, I thought the most the interesting stuff came from Thomas Hoenig, who had this amazing quote. I mean I was just shocked to hear him say it, to hear a Federal Reserve regional bank president say that any time you have banks that are too big to fail, you are going to have oligarchs. I thought it was brilliant. That's where I am! And I'm trying to persuade people I'm not a sensationalist, or an extremist.

In your own testimony, your basic message was pretty simple: It's time to break up the banks.

Yeah. I've been saying that for awhile, but the new piece is to use antitrust law to do it. Some good lawyers have thought about this now for us, and they are saying, certainly, changing the legislation to make this easier is the way to go. The lawyers themselves are divided on whether you can do this under the existing legal framework. But the historians are adamant that what we are saying is very much in the spirit of the original antitrust movement. What Teddy Roosevelt and his cohorts were worried about was excessive power -- political power for these oligarchs.

But you've pointed out that one of the key aspects of the triumph of finance over everything else in the last 40 years is not just the consolidation of political power, but conceptual power -- in other words, a majority of the country came to believe that what was good for Wall Street was good for everyone. How do you use antitrust to break up a belief system?

The breaking of the belief system is an outcome of the crash. The belief system is kind of a perpetuating mechanism but when the economic realities change, people stop believing the same things. I think one advantage of a society like the United States, a democracy, is that we can change our minds pretty quickly on some things, even some firmly held beliefs. I am not saying throw capitalism out with the bath water. I'm saying big finance has just become too powerful and it needs to be reined in. There are some relatively straightforward technocratic steps that can be taken that will move us in the right direction. But I'm not a starry-eyed idealist -- I don't think this is going to change massively overnight.

While researching bank deregulation this morning I found a paper by Philip Strahan from 2002 arguing that the removal of limits on interstate banking in the late '70s and early '80s "was followed by better performance of the real economy." We can quote literally thousands of papers written over the last 40 years arguing that deregulation was good for the economy. We now have a pretty dramatic counter-example, but it still raises the question of how quickly you can undo 40 years of a dominant economic orthodoxy?

Slowly. But I would also say that the Strahan-type result doesn't strike me as implausible. It's quite possible that things can be overregulated, so you deregulate them, and things operate better. But what I'm arguing is that then feeds into this political cycle where you make more money, and you plow that back into political action committees or whatever, and use that to tilt the playing field in your favor. So let's say that you have excessive regulation to start with, you bring that down to a sensible level, and then the guys making a ton of a money use that to undermine sensible regulation. That would be the kind of dynamic I would buy into.

Is there any way to get to a steady-state?

No. Come on. There's no nirvana. It's a struggle. It's always a struggle. There's got to be some kind of dialectic. I would just say the pendulum has swung too far. And you also have to worry about regulators being captured. And I don't think that just breaking up the banks eliminates the possibility of capture -- small guys can get together and capture their regulators too. But there's nothing quite as powerful as four guys walking into the room and saying, "Look, Tim, if you do this, the world will end." That's just a terrible thing for a treasury secretary to have to deal with.

While you were testifying before the Joint Economic Committee, Geithner appeared before Elizabeth Warren's Congressional Oversight Panel. I was struck by the fact that while Warren was pushing Geithner on whether liquidating and restructuring the banks were "on the table" for the Obama administration, the Republicans on the panel, John Sununu and Jeb Hensarling, were extremely suspicious of anything that even smacked of partial nationalization. Some people seem to be upset that in his first 100 days Obama hasn't already completely broken the power of Wall Street, but there are plenty of politicians in Washington who think he's already gone too far.

I do think "nationalization," the word, as a concept, is a red herring. I'm with Hoenig on this. What we need is a government-managed bankruptcy -- you can call it prepackaged bankruptcy, or you can call it conservatorship. The point is you don't throw banks into Chapter 11 because that is destructive. But you manage a bankruptcy process -- it's not nationalization, it's a government-run receivership. Technically what you do is appoint an official receiver who is either the government or is going to be an agent for the government, and that agent manages the split into a good bank and bad bank. You take the bad stuff off your balance sheet and you minimize your losses on that through some kind of Resolution Trust Corporation structure and the good bank you get back into business as soon as you can and you privatize it. I would advocate breaking it up into many competing private bits.

Hensarling appeared to be worrying that the Obama administration's strategy is a kind of backing into nationalization.

Well, I'm with him on that! That's exactly the point to make. We're stumbling into bad forms of nationalization. Joseph Stiglitz said this very well: The difference between ownership and control leads to big distortions. The government is going in with a massive amount of control, but either it's not going to have ownership or it's not going to exercise those ownership rights. My favorite line, which was in an Op-Ed we wrote for the Financial Times in January, was, "If you want to end up with the politics of Pakistan, the economy of Ukraine and the inflation rate of Zimbabwe, bank nationalization is the way to go." That's my feeling about nationalization. I want government-managed bankruptcy.

Does the government currently have the authority to put a multinational institution as large as Citigroup or a B of A into receivership?

Hoenig addressed that directly. He was asked that question. He's worked for the Fed for 30 years. He's managed a lot of bank winding downs and receiverships in his district, or he's been involved in them, and his answer to that question was yes. So, I'm no longer going to say take my word for it, I'm going to say call Mr. Hoenig. It was a striking statement. To my mind, he directly contradicted what Secretary Geithner said when he testified on the need for the resolution authority. The resolution authority would be helpful, it'll give you a better tool to use, but Hoenig definitely said it can be done, now, following the Continental Illinois model of a negotiated conservatorship. That was the most important thing said at the JEC hearing. Although I do support giving them the resolution authority.

What we have been arguing for consistently is recapitalization on the basis of a government takeover and government-managed process. So you wipe out the shareholders, and then, how much of a hit you put on the creditors depends on the political calculation. How much money can you raise, which creditors do you protect? Our priority is protect the payment system: You want to protect deposits and anything that is like a deposit. If you force people to take losses on the payments part of the system, then all hell is going to break loose. But if you protect that, then the rest of it is a calculation about how much do we want to guarantee creditors, and I think at this point, with the situation a little bit calmer than it was last fall, everyone agrees that creditors need to take some sort of hit in an organized fashion.

What do you think of the fact that these very same banks that are at the heart of this are now taking a hard line on what kind of hit they will take in the negotiations with the government on reducing the debt of Chrysler and General Motors?

The ironies just abound. Shooting yourself in the foot and then reloading and shooting yourself in the foot again.

Won't we run into the same problem when we try to get the bank creditors to deal?

Well, sure, the creditors will scream, if that's what you mean. Creditors always scream. And creditors will hold out, creditors always try to hold out. That's what the Hoenig vs. Geithner debate is about: What legal authority do you have to force them?

What do you think of the theory that a political calculation was made by the White House: They wanted to get their stimulus passed and the budget passed and push what is likely to be a pretty big political fight over the banks into the future so they could get those priorities taken care of.

I think it's an intelligent spin. The way the administration guys are now articulating it, and they said this to F.T.'s Krishna Guha on Monday: They're following a doctrine of "reversible error." Their idea is if you take the banks into bankruptcy you may regret it, so let's just see what happens. But our point is that any inaction on the banking system creates irreversible damage, so there's no free option here. If you delay you are inflicting other costs on the system including most particularly massive fiscal costs and the need for more fiscal stimulus, and an increase in the debt. As I said in the hearing yesterday I think the national debt is going to roughly double as a result of this fiasco. Which is huge. That's your taxes and my taxes.

I mean, I think the reversible error could be what they believe, I'm not saying they are lying about that, I'm just saying they are wrong about that. Are they waiting for it get to worse? I guess the view could be is they are waiting for it to get worse because then there will be political support for them to do really aggressive things, but I don't think that's going on, because when I talk to people on Capitol Hill -- which I do quite a lot -- they don't tell me that the administration is there preparing the ground for this, they say they are not coming to talk to us at all.

In your testimony before the JEC you said that as a professor of entrepreneurship at MIT you spend a lot of time interacting with entrepreneurs and venture capitalists who are "absolutely livid at the way large banks have been run." You noted that venture capitalists are betting their own money, and that's a better model than betting other people's money. I thought that was a little ironic, because during the dot-com boom, the venture capitalists did plenty of incredibly stupid things with their money too. It's not as if they are above reproach.

Let's be clear here. I am not trying to legislate away booms. And I am not trying to prevent crazy investments. I see a lot of crazy people around MIT who turn out to be brilliant and very successful and I never would have picked them. I like that. But those are equity investments, and the dot-com bubble to me is an excellent counterpoint to the housing meta-financial problem -- which was a debt-driven bubble. There's a big difference. If your equity value goes down a lot, it's painful and consumer spending may fall because of the wealth effect, but it is not a global cataclysm. The dot-com bust was a big bad bubble and it burst and it was messy and a lot of my students couldn't get jobs, and they went off and did something else.

I'm not saying venture capitalists putting their own money at risk is going to lead automatically to stability. But it does feed into innovation. I think if you look at canals, or railroads in the 19th century, or the advent of the automobile or any of the other sort of big breakthrough technologies, they often come with crazy investment booms, particularly in the United States. Anywhere that's a frontier of technology, often these breakthroughs come with a thousand firms being formed, massive amounts of money being pumped in, lots of of stupid things happening, people building two canals next to each other, or two railroads next to each other, and then there is a financial collapse, but you still get to keep the physical infrastructure. At the end of the dot-com thing we had a pretty good Internet.

What do we get out of the meta-financial crap? It's not so clear that we got useful things. Did our ATM fees come down? No.

Yesterday, Robert Reich graded the first 100 days of Obanomics. He gave the budget an A, the stimulus a B and the banking bailout an F for an overall grade of C+. What marks would you give?

I'd give the bailout an incomplete, which is allowed at MIT. Come back and finish it in the summer. Most of the other stuff I would give some sort of A. I know I am complaining a lot, it's true. But I give them an A+ on the G20 given the cards that they were dealt and I think they've made a lot of progress on other things. My worry is that the banking thing is the Achilles' heel, and that could damage the whole rest of the strategy. So it's like a report card where you are doing very well across the board, but there is this one subject that is really dragging you down. And that's very dangerous.

― Andrew Leonard

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[Apr 23, 2009] Simon Johnson's morality tale

Mar 30, 2009 | rodrik.typepad.com

Note: Full Article at U.S. News & World Report

Simon Johnson tells a simple and compelling story: the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets, except that Wall Street has bought its influence and power not by bribery but by shaping the ideology of our times:

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption-envelopes stuffed with $100 bills-is probably a sideshow today, Jack Abramoff notwithstanding.

Instead, the American financial industry gained political power by amassing a kind of cultural capital-a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America's position in the world.

The solution, to Simon, is equally clear. ; Finance needs to be cut down to size. ;What the U.S. needs is what the IMF would have told any country:

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

...

The second problem the U.S. faces-the power of the oligarchy-is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

As with any story built around clear villains easy solutions, there is something in this account that is quite unsatisfying. ; For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. ; But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. ; Simon himself says as much. ; So why pick on the bankers? Surely the blame must be spread much more widely. ;

And I find it astonishing that Simon would present the IMF as the voice of wisdom on these matters--the same IMF which until recently advocated capital-account liberalization for some of the poorest countries in the world and which was totally tone deaf when it came to the cost of fiscal stringency in countries going through similar upheavals (as during the Asian financial crisis). ; ; ;

Simon's account is based on a very simple, and I believe misguided, theory of politics and economics. ; It is an odd marriage of populist and technocratic visions. ; Countries fail because political elites always end up in bed with economic elites. ; The solution, apparently, is to let the technocrats (read the IMF) run your affairs.

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. ; Too many of us thought we had the right model when it turned out that we didn't. ; We pushed certain policies with much greater confidence than we should have. ; Over-confidence bred hubris (and the other way around). ;

Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris? ; ; ; ; ;

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[Apr 4, 2009] Selling Out America To Financial Elites from Prose Before Hos

Apr 4, 2009 | prosebeforehos.com

More of a passage of the day: Obama's agenda, however, became less opaque in June 2008 when he chagrined labour supporters by appointing Jason Furman, the director of the Brookings-affiliated Hamilton Project, as the head of his economic polic... [Read More]

Tracked on April 04, 2009 at 11:28 PM

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Your points about Johnson's oversimplification of the narrative and the folly of looking to the IMF for solutions are well taken. But I don't read Johnson's article to put the blame for the current mess solely on the bankers. Johnson clearly describes several political and policy missteps that brought us to this point. The article does not merely seek to assess blame for the crises but to examine the difficulties of resolving the crises, of moving forward. If he focuses on the bankers it is because at this point they are an entrenched interest with the most to loose from a proper resolution to the crisis, which Simon believes to be nationalization. The policies of the last 40 years have created an enormously powerful industry that will not go down quietly. And they have an enormous amount of sway over the policy makers in D.C. Just look at the events of the last few days. The heads of the biggest banks in the country get a pleasant meet and greet with the president to discuss the problem. The head of GM, our largest auto maker, gets the ax.

Posted by: Ed Viguerie | March 30, 2009 at 04:51 PM


I have been a long time fan of your writing and this blog, but I am sometimes mystified by the seemingly sectarian fights you pick with what I will dub "modern political economists". I say 'sectarian' because you made so many seminal contributions to understanding the political economy of policy reform.

Dani Rodrik writes: "they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy."

Isn't THIS risking being "simple"? Do you believe the main reason we got a repeal of Glass-Steagall, and so many other changes to radically deregulate and relax supervision is because "policymakers" felt it was good for the country?

A far more compelling story is that a very powerful banking lobby spent hundreds of millions of dollars over many years to elect and then influence enough legislators to get the changes made; and that the revolving door relationship we have between financial industry and government, made it all that much easier. Why else were the banks spending all that money?

In nothing that I have read is Simon Johnson saying that he has simple technocratic solutions (I agree with you thought that little is said of the IMF's many problems in his tales). What he has written on looting and tunneling for instance suggests just how hard and messy it is to regain control over policy.

What I read him to be saying is that when economic policymaking is partly captured, and that those individuals that have earned massive economic rents at the helm of large financial institutions that are now insolvent will very rationally fight hard to hold onto their privileges and loot the treasury if necessary to do so. Why wouldn't they?

Finally he is saying that any lasting meaningful reform that gets us out of this crisis, that doesn't just socialized bankers losses, and that helps to make sure we don't repeat this all again any time soon MUST start (or at least end) with an effort limit the power of these economic elites to exert so much political influence (and systemic risk) again.

Your alternative seems to be to share the blame with economists and policymakers and their blind belief in models of one sort or another. But where do they come from? Models of the sort that are taught in the business schools or simplified by CNBC anchors are not chosen randomly out of an urn. Business schools are in the business of selling ideas -- and guess who has been paying?

Sure there is blame to go around, but it's hard to think of an explanation that does not put bankers and their influence square in the middle of this one.
More importantly, it's hard to see how to put in place better policies (and hence put better models to work) without confronting the economic and political power of this sector. Do you?

Posted by: Walras' executioner | March 30, 2009 at 05:35 PM


There has been a deliberate effort by the "vast rightwing conspiracy" to influence public policy and promote the ideas of libertarianism and the free market.

The (mostly hidden) players in this effort are known: Scaife, the Koch brothers, Olin, Ahmanson, etc. This group is behind the well-funded conservative think tanks: Hoover, Hudson, Cato, Manhattan Institute and the rest. They have also supported the economics departments at U Chicago and George Mason.

I refer you to the useful web sites run by Source Watch and Media Transparency for details.

Here's an example for Charles Koch:
http://www.sourcewatch.org/index.php?title=Koch_Family_Foundations

So politicians didn't just come by these positions naturally. They were selected to run because of their predilictions or the ability to tutor them in the dogma.

Here's another link to show how this operated as concerns the battle over the estate tax.

http://www.citizen.org/documents/EstateTaxFinal.pdf

Posted by: robertdfeinman | March 30, 2009 at 05:49 PM


This is what I wrote in the comment section of Baseline Scenario. You are making the same point. Simon and James Kwak are good and logical writers but are looking for easy targets than root causes. Whoever suggests that IMF and technocrats are the solution ought to go talk to people in Indonesia and ask them how did relying on their advice work out for them. "For obvious reason, some commentators have hijacked the process of analyzing the root cause of the current crisis to get to their pet peeve. The crisis, first and foremost, was the result of monumentally wrong policy judgements - using US consumption and the consequent debt growth to ward off the negative wealth effect of the busting of an equity bubble - compounded by blind mercantilist policies of Asia's net exporters - unprecendented reserve building after the Asian crisis (and following the IMF advice a bit too closely, in fact).

Clearly, growth of the financial sector and bankers' pay was the consequence of these bad judgements on the part of policy makers and foreign politicians, rather than the root cause of all evil in the world. In the current political environment, if you repeat the base assertion frequently enough - as you and others have been doing - it will of course stick. But that does not make it the correct root cause analysis. Banks and bankers are easy targets right now but focusing on them exclusively will not fix the global order - doing something about reducing consumption and increasing savings in the US (perhaps not in the near term but definitely in the medium to long term) and increasing consumption and reducing currency subsidised exports in the developing world will go a long away. You should be focusing on those issues rather than take easy shots at banks and bankers. That's like trying to solve the drug problem by arresting the street drug peddlers."
;

Posted by: livingston | March 30, 2009 at 08:47 PM


Dear Mr. Livingston:

You say, "Clearly, growth of the financial sector and bankers' pay was the consequence of these bad judgements on the part of policy makers and foreign politicians, rather than the root cause of all evil in the world."

May I ask for one example in which the financial services industry, the largest donator to presidential and congressional campaigns and the industry with the largest lobbying expenses, ever opposed the bad judgments on the part of the policy makers and foreign politicians? Clearly, they had power; I'd like a single example of them using it for good instead of evil.

I'm not, BTW, absolving the politicians, only asking why you are using the politicians to whitewash the financiers. Or are you really, honestly suggesting that people on Wall Street didn't understand (1) what "to big to fail" meant, and (2) how to profit from that status? Maybe I'm a cynic but I'm find too many examples of Wall Street doing exactly that. Your analysis suggests that the politicians are adults and thus morally culpable, while people on Wall Street are children, in the sense of being pre-moral. If true, something we should think about before allowing them to fund the political process, no?

Posted by: Friedrich von Blowhard | March 30, 2009 at 09:05 PM

Not the technocracy to rule, but the rule of law.

Posted by: B9 | March 31, 2009 at 09:15 AM

Dear Executioner --

Thanks for your thoughtful comments (and the kind words about my own research).

The conundrum in which the practitioners of "modern political economy" find themselves is the following: either you say that policy is determined by the interests of the politically powerful (here, banks), in which case you are left with no way out (banks will remain powerful and veto any meaningful reform). Or, you accept some autonomous role for the intellectuals and policy makers to make a difference, in which case, you can hardly attribute all the blame for the mess on the special interests.

Failure to account for the fact that both forces are at play simultaneously results in the kind of attitudes I was objecting to: holier-than-thou moralism about the insidious effect of the banks (as if economists weren't equally complicit); preference for technocratic solutions (as if the IMF wasn't equally under the influence of Wall Street and the U.S. Treasury); and over-confidence on the technocratic policy recommendations of the moment (as if we had not been equally confident on the previous set of policies that brought us here).

Posted by: Dani Rodrik | March 31, 2009 at 10:01 AM

Ignoring the portioning of blame, I thought the most poignant point (which Simon Johnson certainly isn't the first or only one to raise) but which I've yet to see addressed on the path we are currently on, was summed up in one simple sentence:

"Anything that is too big to fail is too big to exist."

Whoever you choose to blame, and whatever your beliefs on who wields power in these situations, can we allow businesses to grow to the point where their failure would devastate our entire economy?

Posted by: Walter | March 31, 2009 at 11:38 AM

If the IMF is the answer, it must have been a pretty stupid question.

Posted by: michelle color me shocked | March 31, 2009 at 02:57 PM

Dear Dani (if I may call you that),

Thanks for your thoughtful reply which helps explain your position much better.

It seems however that you are lumping "modern political economists" in together with an older and cruder camp of material determinists who, as you suggest, saw little or no possibility for 'autonomous' policy decisions to take their countries 'out of the periphery' or out of the clutches of 'bad elites'.
But my take-home lesson from the modern political economy literature -- and again this is very much influenced by reading *your* seminal works in the early 1990s on the political economy of adjustment and reforms -- is that the policies that prevail are the outcome of political contests that are conditioned on the balance of power between different interest groups, but that cannot be always perfectly predicted (except perhaps probabilistically). .

What I have also learnt from you is that autonomous policymaking plus good policy choices was necessary for success outcomes in several places, with Asian NICs being the most frequently cited. That's an important and hopeful lesson.

But embedded in this very definition of "autonomy" (pardon the intentional pun) is how much room for maneuver these governments have been able to create by insulating themselves from the strong organized attempts by economic elites to impose their prefered policies. So the real question is what determines the space for 'autonomous' decision making.

The concern that I think many of us have is that the room for autonomous policymaking in the USA has been reduced in recent years because of the rising influence of a powerful financial sector and it's political allies.
Sure I blame Larry Summers, Alan Greenspan and other policymakers for failing in the 90s and later to regulate or provide proper oversight of fast growing derivative markets that proved capable of massive destruction to the economy and the innocent. Those people do deserve blame.

But had those particular people not been there it seems very likely that other people of very similar persuasion, acceptable to the 'business community,' would have been hired instead. The politicians who appointed them would make the same political calculation that challenging the very powerful banking lobby (and its generous political contributions) did not make sense. From reading Summers own writing it is not evident that he would have always chosen not to regulate. Hence I suspect his decision was at least in part political, and not just ideological.

In summary the power of the banking industry seems a deeper structural problem that helps understand the policy choices. More so than blame we might assign to particular economists, although it is possible to imagine a more courageous politician or policymaker who might have made a difference.
In the present political battle over policymaking as citizens and as taxpayers we should get behind people like Simon Johnson who are at this time the ones most loudly and clearly saying that whatever new financial system is to emerge, it should be one where there are no more banks politically or economically too big to fail.

And just because that might sound like a morality tale, doesn't mean they are not scheming to put in the fix.

p.s. -- on what we can certainly agree, and it is unfortunate that Johnson's tale suggested otherwise, is that the IMF has generally not been the good or the enlightened guy. I suspect (and hope) that he used that mainly as a literary device ("just look at how much the US is like a banana republic").

Posted by: Walras' executioner | March 31, 2009 at 04:40 PM


We have to have an uprising over AIG bonuses before anything is done. Hedge fund managers are still having their income taxed at capital gains rates. The Tresuary Secretary is about to give these managers a sweet heart deal to bid on toxic assets with tax payer loans that needn't be repayed. Reform of the bankrupcy laws which would give home owners some leverage over the banks is gonng nowhere in congress.

The idea that these things are good for the economy has long ago been swept aside, yet the interests of the financial community allow them to persist, to have their way with congress.

Posted by: wjd123 | April 09, 2009 at 01:17 AM

[Mar 31, 2009] Simon Johnson Is Such A Downer! - The Ticker (usnews.com)

March 31, 2009 | usnews.com

Simon Johnson, an MIT prof and former IMF chief economist, is behind the The Baseline Scenario blog, which has been a vital read during this crisis. This week he's particularly smart and scary on both upcoming policy decisions and wider structural problems that still need to be addressed in the economy.

First in the WSJ: With Peter Boone, Simon writes about Tim Geithner's "nuclear option" for the banks -- basically giving the government power to liquidate or restructure large troubled banks at the expense of bondholders and creditors who until this point have been largely protected to prevent the sort of investor flight from the banks that caused Lehman Bros./Bear Stearns-style failures. Such a move would take the impetus off of taxpayers, but would almost certainly send bond and equity markets into a severe swoon. Simon says if the government grants "resolution authority" power and regulators move quickly (as in yet another long weekend), the strategy could work. If the process takes months, uncertainty could result in market panic.

Bottom line for everyday investors: There's no real upside, other than the possibility of long-term financial stability (which might make it worth the risk). Whatever happens, if Geithner is granted authority and uses these new powers, the end result will likely be Very Bad Things for stocks even if the plan goes off without a hitch. He writes:

This route to recapitalization would not be pleasant. Bank shareholders and creditors will cry foul. There will be several months of turmoil in markets, and there will be substantial disruption since bond holders and some creditors may be required to take losses when they receive equity. It will also send shockwaves to other undercapitalized institutions around the world, and could lead to their share and debt prices falling in anticipation that other governments will follow America's example.

For a broader look at the crisis, Johnson also shows up in May's The Atlantic where he puts on his IMF hat and takes a look at the U.S. economy. What he finds are scary parallels between our current situation and the sort of structurally unsound emerging market economies forced to reach out to the IMF for help:

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there's a deeper and more disturbing similarity: elite business interests-financiers, in the case of the U.S.-played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

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A so-far-bloodless imposition of fascism on the American Republic

If you know fascism from corn flakes, you know the puppeteers who run that empty-suit, that Kenyan who has occupied the White House, are speeding forward in a so-far-bloodless imposition of fascisim on the American Republic.

Ayn Rand said it best: "The main characteristic of socialism (and of communism) is public ownership of the means of production, and, therefore, the abolition of private property. The right to property is the right of use and disposal. Under fascism, men retain the semblance or pretense of private property, but the government holds total power over its use and disposal . . . . / Under fascism, citizens retain the responsibilities of owning property, without freedom to act and without any of the advantages of ownership. Under socialism, government officials acquire all the advantages of ownership, without any of the responsibilities, since they do not hold title to the property, but merely the right to use it-at least until the next purge. In either case, the government officials hold the economic, political and legal power of life or death over the citizens . . . . / Under both systems, sacrifice is invoked as a magic, omnipotent solution in any crisis-and "the public good" is the altar on which victims are immolated. But there are stylistic differences of emphasis. "The Fascist New Frontier," The Ayn Rand Column, 98. http://aynrandlexicon.com/lexicon/fascism_and_communism-socialism.html

[March 30, 2009] Rodrik Simon Johnson's Morality tale

March 30, 2009 | Economist's View
Dani Rodrik responds to Simon Johnson:

Simon Johnson's morality tale, by Dani Rodrik: Simon Johnson tells a simple and compelling story: the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets, except that Wall Street has bought its influence and power not by bribery but by shaping the ideology of our times...

The solution, to Simon, is equally clear. ; Finance needs to be cut down to size. ; What the U.S. needs is what the IMF would have told any country...

As with any story built around clear villains easy solutions, there is something in this account that is quite unsatisfying. ; For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. ; But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. ; Simon himself says as much. ; So why pick on the bankers? Surely the blame must be spread much more widely. ;

And I find it astonishing that Simon would present the IMF as the voice of wisdom on these matters--the same IMF which until recently advocated capital-account liberalization for some of the poorest countries in the world and which was totally tone deaf when it came to the cost of fiscal stringency in countries going through similar upheavals (as during the Asian financial crisis). ; ; ;

Simon's account is based on a very simple, and I believe misguided, theory of politics and economics. ; It is an odd marriage of populist and technocratic visions. ; Countries fail because political elites always end up in bed with economic elites. ; The solution, apparently, is to let the technocrats (read the IMF) run your affairs.

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. ; Too many of us thought we had the right model when it turned out that we didn't. ; We pushed certain policies with much greater confidence than we should have. ; Over-confidence bred hubris (and the other way around). ;

Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris?

[Dani is generally opposed to a global financial authority. He says "the logic of global financial regulation is flawed." See his article and the discussion at the Rodrik Roundtable.]

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Bruce Wilder says...

Dani Rodrik: ". . . there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. Simon himself says as much. So why pick on the bankers?"

I find this kind of muddled thinking -- "there's plenty of blame to go around" -- much more deeply dissatisfying than Simon Johnson's morality tale.

Is Johnson's tale too simple? Well, duh. It is a narrative of a few pages, though it is backed up with considered analysis and judgment. Complaining that any narrative is too short, not comprehensive, is pretty easy, because every narrative is too short, and every narrative is a narrative, not an analysis and not empirically verified in all its particulars.

The point of a good narrative is to precisely to bring to bear "moral" considerations. The bare, "scientific" analysis is bereft of values, and prone to the paralysis of analysis. We need the moral fables to identify the "meaning" of events and to galvanize action. And, we need the moral fables to bear some reliable, verified relation to an analysis of how the work works, and what has actually happened. I won't minimize the importance of working on finding the "truth", morally and functionally.

But, it's Rodrik's "it's complicated" whine that's provoking me, here. Does it bear critical scrutiny?

First of all, let's look at that sentence where Rodrik asserts that the banks (mis)judged risks, with the aid of the economics and policymaking "community".

Really very generous of Rodrik to offer warranty protection on economic advice, financed without fee by the Federal taxpayer.

But, banksters, not banks made those judgments. Not the economist-shills appearing on Kudlow's CNBC program or sitting on Bush's CEA. Sure, blame can be spread widely. I have no objection, if Rodrik is really willing to blame. If Rodrik wants Mankiw relieved of his duties teaching impressionable freshmen bad economics, more power to him. Good luck spreading the blame at faculty meetings. Be sure to let us know how that goes.

But, if Rodrik means to let the banksters off the hook, by "spreading" the blame thinly across an unaccountable elite, insulated from the consequences -- if "blame" is going to be limited to some tactfully silent criticism of colleagues at Harvard faculty meetings, then he should just shut up on his blog, as well.

It is not clear that the banksters "misjudged" the risks -- certainly all the banksters did not "misjudge" at all. Many, many took home huge compensation packages, from carefully calculating their personal chances in a game of "heads I win, tails you (the public and the government) lose".

And, yes, they got help from the "policymaking community". That would include many advocates of aggressive "de-regulation". Like UBS Vice-Chair, Phil Gramm? Alan Greenspan. Various Bush Administration appointees, including the Chair of a long-moribund SEC.

Why do I feel that Dani Rodrik wants to "spread" the blame around widely enough to dilute it into a empathetic pat on the back and an admonition to "try harder next time"?

Deeply dissatisfying, indeed.

Posted by: Bruce Wilder | Link to comment | March 30, 2009 at 03:54 PM

SS says...

Professor Rodrik attacks the IMF and argues the need for humility but he doesn't really touch Simon Johnson's main point, that is: that a corrupt league of financial and institutional interests wields considerable political and economic power here which makes the necessary economic reforms difficult.

Wittingly or not Professor Rodrik is holding up the status quo which is a mess. Humility is only a starting point here, after we need to identify, as does Johnson, what the problems are.

SS

Posted by: SS | Link to comment | March 30, 2009 at 04:01 PM

Eric Dewey, Portland, Oregon says...

Agreed, Bruce. While Rodrik has some points that are worth considering (particularly regarding the need for humility), he makes no progress at all with regard to practical solutions, while Simon's work does.

Certainly there are issues with any course of action; what is interesting about Simon's solution is that it has the chance of actually playing to, and thus defusing, both the economic crisis and the increasingly violent, class-based political discontent that is manifesting itself around the world...
;

Posted by: Eric Dewey, Portland, Oregon | Link to comment | March 30, 2009 at 04:15 PM

Rajesh Raut says...

There was not small group of people who where responsible for this crisis. It took an army of mortgage bankers, real estate agent, home builders, home owners, investment bankers, regulators, rating agencies, insurance companies, politicians. I estimate for the housing component of the bubble that 12 million people participated and that 80% were middle class. If you want a corrupt league of interests that wields considerable power with the goverment, start with the National Association of Realtors. They have been lobbying for mortgage interest deduction and other tax breaks for home ownership.

The story that a small group of people took advantage of their power is just a fairy tale. There were large industries pushing these policies in their own self interest. And the truth is just about everyone in America (and a whole lot of immigrants from Mexico) benefited indirectly from the extra spending and cheap credit.

Posted by: Rajesh Raut | Link to comment | March 30, 2009 at 04:17 PM

anon says...

So apparently Rodrik suggests humility in stopping the current, immense and rapid looting by banksters. It doesn't seem to bother him that they continue to spread a lot of money to the academic, political and media elites who support them. Even though it is taxpayer money they are now using.

At this rate we will indeed reach bankruptcy before we get substantial reform. With apologists like Rodrik, it may very well be insufficient reform that simply starts the cycle anew and will before long be undermined. (Yes, I know, the government supposedly can't go bankrupt because "we have the technology", much celebrated by the noble, albeit bankrupt, economics profession - a printing press. Just like Zimbabwe and many bankrupt governments before it.)

Posted by: anon | Link to comment | March 30, 2009 at 04:23 PM

Mbuna says...

"but they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy."

Just what policymaking community are we talking about here? Phil Gramm? Good for the economy? You actually believe that crap? What planet are you on? Get a grip!

You know I actually wandered onto this site trying to watch a video of Paul Volcker but I have to say Mr. Rodrik sounds exactly like the corporate and idealogical shill that Simon Johnson is addressing in his article.

Posted by: Mbuna | Link to comment | March 30, 2009 at 04:26 PM

anne says...

"And the truth is just about everyone in America (and a whole lot of immigrants from Mexico) benefited indirectly from the extra spending and cheap credit."

The truth is that credit never became cheap for ordinary people, surely never became cheap for immigrants from Mexico who were with African Americans especially victimized by excessive cost mortgages, and the truth is addition is that ordinary workers benefited surprisingly little from what extra spending of the wealthier and wealthiest there was through the Bush years.

That is the truth, rather the the rubbish that would even explain how Mexican immigrants have been so helped by excess. Why Mexican immigrants among all immigrants, I wonder? What about Chinese immigrants or British immigrants? Why Mexican immigrants in particular?

Posted by: anne | Link to comment | March 30, 2009 at 04:28 PM

SS says...

@Rajesh Raut

You agree with me without realizing it. I never said it was a "small group of people." Marxist analysis of class recognizes the role of ruling class interests permeating the society through numerous means, not the least of which is wage labor. That middle class people participated, that working class people vote the way these interests would like, is no surprise to anyone.

As for people other than the elites benefitting in the short term, this is also no surprise. The point is what it has led to which I dare say was embedded in a system meant ultimately to be to the profit of only a few. As we see even that didn't work out for them.

SS

Posted by: SS | Link to comment | March 30, 2009 at 04:30 PM

calmo says...

Thanks for casting this wider net (for awhile the usual net contained only Greenspan) Rajesh

I estimate for the housing component of the bubble that 12 million people participated and that 80% were middle class. If you want a corrupt league of interests that wields considerable power with the goverment, start with the National Association of Realtors. They have been lobbying for mortgage interest deduction and other tax breaks for home ownership.
Annow the tricky part of portioning this responsibility ...or would you do the demographically appealing (but perhaps inappropriate) 1 vote, 1 share of responsibility? If we are interested in something more than revenge or retribution, but legislation to ensure this...calamity is not repeated, what would you recommend...even general guidelines?

Posted by: calmo | Link to comment | March 30, 2009 at 04:31 PM

anne says...

(Yes, I know, the government supposedly can't go bankrupt because "we have the technology", much celebrated by the noble, albeit bankrupt, economics profession - a printing press. Just like Zimbabwe and many bankrupt governments before it.)

[Yes, I know, this is absurd but how the absurdity persists.

There can be no failure of Treasury bonds, since the Constitution expressly forbids failure. There can be no bankruptcy. Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries for long.]

Posted by: anne | Link to comment | March 30, 2009 at 04:41 PM

anne says...

The reason I never write of sub-prime mortgages without emphasizing that they were excessive cost mortgages is just to emphasize that credit never became cheap for ordinary people through the Bush years, and credit was expensive for ordinary people through the years of financial innovation that was supposed to allow for cheaper credit but rather allowed for increased income for financial companies. Look to at the expense of credit card debt, for all the financial innovation. Then, look to the cost of buying financial products such as simple investments. The expense of simple investments through an investing boom from the beginning of the 1980s has been repeatedly discussed by John Bogle and David Swenson and Burton Malkiel and others, but is easily forgotten.

Still, what is more profound given the problems that have beset so many is tolerating the idea that a financial industry that became increasingly abusive was actually always helping ordinary people (especially helping the right sort of immigrants).

Posted by: anne | Link to comment | March 30, 2009 at 05:04 PM

Bruce Wilder says...

RR: "The story that a small group of people took advantage of their power is just a fairy tale."

What SS wrote.

To which, I might add, that in a country of 300,000,000 residents, in a world of billions, everything is done by vast organizations. Still, there is leadership, and some of the leadership was conspicuous in looting on a large scale and in enabling looting on a large scale. That's not a fairy tale. That's the truth. Some powerful people you don't even know are out to get you, or at least get your money.

Posted by: Bruce Wilder | Link to comment | March 30, 2009 at 05:14 PM

Jas Jain says...

--
I have been saying all along that economists have been culprits in using housing and other policies to manipulate the economy and the economic behavior of households.

There is a whole class of manipulators that are running the economy and economists are very much part of it. More failures means more work for the manipulators! We have a positive feedback loop.

Jas
;

Posted by: Jas Jain | Link to comment | March 30, 2009 at 05:14 PM

ampersand says...

they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy.

Huh? Shouldn't he be practicing the very humility he preaches, here, on this subject?

A far more correct story is that a very powerful banking lobby spent hundreds of millions, over many years to elect and then influence enough legislators to get changes like repeal of GS, prevent regulation of derivatives. The nexus between financial industry and government, made it easy. Full regulatory capture.

Or is Rodrik saying that the banks spend all that money lobbying, for nothing?

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility. Too many of us thought we had the right model when it turned out that we didn't.

Ooh. Mama. These theories were conceived without any influence.

How about if he took a look at who funded and spread these ideological propaganda which benefited the financial elite?

That must not be the same elite, per Rodrik. Who else, then?

Must be the auto industry workers who bankrolled those economic ideas.

Is Rodrik a clueless moon bat or another ideological hack?

Posted by: ampersand | Link to comment | March 30, 2009 at 05:17 PM

anon says...

Anne - That's why I made the reference to Zimbabwe. If the government keeps paying off an ever increasing amount of its debt with "printed" money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy.

The only constitutional language that can prevent that would have to include limits on said "printing." Since it doesn't (yet?) contain such language, nothing else in the constitution can prevent vast amounts of reckless spending (as in the officially sanctioned bankster looting) from leading to some sort of bankruptcy. Only voters can prevent that and so far they don't seem inclined to do so, notwithstanding all of the angry rhetoric in the world. I just hope that by the time they change their mind, it won't be too late.

BTW, the current strength of the US Dollar and Treasurys should be of little comfort. Enron was going strong until it wasn't. Same for Madoff and countless other scams. It's usually quiet before the storm. Fortunately, we have the ability to analyze and anticipate what is likely to happen (though only rarely when). Unfortunately most people let that ability go to waste.

Posted by: anon | Link to comment | March 30, 2009 at 05:22 PM

ken melvin says...

If the government is going to buy up those toxics then the banks needn't bother with foreclosing.

Posted by: ken melvin | Link to comment | March 30, 2009 at 05:40 PM

anne says...

"If the government keeps paying off an ever increasing amount of its debt with 'printed' money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy."

When investors think there will be increased inflation, there will be less demand for relatively longer term Treasury bonds and longer term interest rates will rise. This will in no way mean bankruptcy, the idea is meaningless, only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation.

Treasury debt will be fail either by failure to pay principle or interest or by inflation, and bond specialists understand this. Investment managers who are cautious have also been limiting durations for months, which also means taking profits on longer term debt. Treasuries were terrific investments the last 10 years, and there is a time to take profits.

Posted by: anne | Link to comment | March 30, 2009 at 05:51 PM

flubber says...

"What about Chinese immigrants or British immigrants? Why Mexican immigrants in particular?"

Presumably Rajesh was referring to the fact that Mexican immigrants in particular, and Latin American immigrants in general, overwhelmingly worked the construction jobs that built all the new houses, and did a lot of the kitchen/bathroom renovations funded by home equity loans.

Posted by: flubber | Link to comment | March 30, 2009 at 05:53 PM

Namke von Federlein says...

It was JPM, Goldman, Citi and a very few others who humped the residential mortgages into the market. Smaller local banks (8,500 of them in the USA alone) were forced to play against the big boys in commercial real estate.

The blame is squarely on the big investment banks in the good old USA.

Simon just makes a point - the risk management was perfect? Play the flippers and gamblers into bogus mortgages, securitize the nonsense into the pension funds of corporations and governments - and when the house of cards falls down the Federal Reserve Bank will become (conveniently) an insolvent entity. Now, just use that nicely insolvent unconstitutional private entity called the Federal Reserve Bank as a dumping ground for all the toxic garbage - which forces the responsible taxpayers to pick up the bill (with taxes, underwater mortgages, trashed equity positions, annihilated pension funds and finally - devaluation of what is left through inflation).

Perfect risk management.

Which will lead to civil war in the USA? Keep in mind - last I heard there were 7 guns per American in the USA. The survivalist groups are growing rapidly. 25% of the homeless are war veterans - they know how to use guns, equipment and strategy. And the Chicago Tea Party is not about happy taxpayers just waiting for a reason to pay more taxes.

To the Fed : all that lovely Treasury stuff is not your money.

Finally, you don't need a world currency to do business (although a trading SDR would help both small countries and small companies by providing a friction-free currency hedge for international transactions). Any large business with proper concrete collateral could issue its own currency. Exxonabucks? Why not?

I'd rather trade with those than uncollateraized notes issued by an insolvent entity holding trillions in toxic assets called the Federal Reserve Bank (look carefully at your USA dollar bills and tell me what it says... last I looked it said : Federal Reserve Note : backed by the full faith and trust of a private, insolvent, unconstitutional company called the Federal Reserve Bank).

I like Simon's fine and direct style (I've never met him).

Just rambling. Thanks for an excellent blog. I would suggest : It is certainly the right time for a candid exchange of opinions.

Posted by: Namke von Federlein | Link to comment | March 30, 2009 at 05:56 PM

Fred (original) says...

If the government keeps paying off an ever increasing amount of its debt with "printed" money, it won't be long before no one accepts it. That will be, for all intents and purposes, bankruptcy.

Exactly. Anne and I have had several arguments about stocks versus bonds. Basically, she is a fine example of a the old adage "a properous fool is a grievous burden". She had her money in bonds recently, during the great disinflation from 1980 onwards, and did quite nicely, and from that she extrapolates that bonds always do well and inflation is never a problem. I actually am glad that fools like her spout off so noisily because they guide me to the truth. Indeed, I have gathered far more useful clues to the future from listening to fools, and doing the opposite what they do or recommend doing, than from listening to the wise. The wise are good for the long-term and the big picture, but the fools can indicate exactly what is going to happen in the near future. If Anne predicts no inflation and bonds doing well under inflation, you can bet we will have a lot of inflation in the future and bonds won't protect you.

Posted by: Fred (original) | Link to comment | March 30, 2009 at 05:59 PM

anon says...

Anne - You say: "Treasury debt will be fail [sic] either by failure to pay principle or interest or by inflation..."

That's the point I was making - no government is impervious to bankruptcy.

"...and bond specialists understand this. Investment managers who are cautious have also been limiting durations..."

Ah, hope does spring eternal. That's the essence of the greater fool theory. Good luck with that, because luck is indeed what it takes (aka gambling.)

"Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation."

From your mouth to whomever's ear. There's one big problem with that: the debt can grow so huge that default becomes unavoidable (whether outright or through a currency collapse.) Here's hoping that the looting is stopped before that happens. Since we are unlikely to get advance notice of a collapse in confidence, the sooner the better. It's too bad we're headed in the wrong direction, towards disaster, at an accelerating rate (we're at about $2T/year currently, with Geithner promising much more to come.)

I find it interesting that you ignore the comments about looting. In that sense you're like most of the electorate. Even if it is stopped or it's level reduced to sustainable levels, it is still a terrible misdirection of national resources. That's putting it very mildly when you consider the tremendous and growing needs all around.

Posted by: anon | Link to comment | March 30, 2009 at 06:23 PM

James says...

Oh sure, the plutocracy can't be blamed since it has always had the common good at heart. All for the people. And to say that it has too much influence in Washington is just...well...not true or nice. No, Wall Street has never run Washington. Nor has the capitalist mentality rotted US brains. No. God the audacity of these people and their ideas. America needs a new radical party that will soak the rich with crippling taxes, redistribute wealth and usher in a new ideology of egalitarianism. Overdue here for over a century or more.

Posted by: James | Link to comment | March 30, 2009 at 06:37 PM

S Brennan says...

Anne,

Care to comment on this story:

By Michael Kranish
Globe Staff / March 30, 2009

http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

WASHINGTON - Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds....

Posted by: S Brennan | Link to comment | March 30, 2009 at 06:38 PM

James says...

What Raut doesn't seem to understand is that decades or more of incessant "capitalism is wonderful" propaganda has rotted brains in the US in general, so that even the poor have no good idea where their interests lie or how to defend them. The plutocracy runs things and coopts enough of the population to forestall any rebellion. The US needs a, dare I say, revolutionary party that will mobilize the masses to take power in their interests and unseat the bloated plutocrats who have brought on this disaster. The one reason one can hope that it is truly a disaster is that only that can being the revolutionary change in mentality that is needed.

Posted by: James | Link to comment | March 30, 2009 at 06:48 PM

hapa says...

don't know or owe anything to dani rodrik; don't have credibility; but will defend this read to an extent. "bad apples" is a dangerous story. we have structural problems that extend beyond regulatory capture and malfeasance. we're heading over the ecological cliff and need to think hard how to address "fairness" in a situation where wealth no longer comes cheap. "we wuz robbed!" really really doesn't cut it.

Posted by: hapa | Link to comment | March 30, 2009 at 07:02 PM

SS says...

@Mark Thoma

Mark,

Thanks for giving us, the public in this case, the chance to voice our opinion on some of the leading establishment thinkers and their vision of our future and understanding of the past.

I think it would be a good idea to forward these comments to Professor Rodrik as the overwhelming opinion appears to be that his rebuttal has missed the mark and might even be considered harmful in terms of constructively dealing with the problem.

SS

Posted by: SS | Link to comment | March 30, 2009 at 07:14 PM

Fred (original) says...

Anne: Care to comment on this story: ... Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

I'll comment. This is a zero-sum game here. PBGC bought a bunch of overpriced stocks while someone else sold the same. If PBGC has to bailed out by running up more federal debt, then eventually we will have to raise taxes to cope with this added debt. To some extent, those who benefitted at PBGC's expense now will have to pay these added taxes in the future. But there will also be some innocents who have to pay added taxes. Too bad. Life is full of injustices.

Posted by: Fred (original) | Link to comment | March 30, 2009 at 07:22 PM

gordon says...

Prof. Rodrik has been campaigning against the "Washington Consensus" for a long time, and part of that campaign has been an attack on "one size fits all" economic development theories. He is an advocate for different, country-specific development policies based on his ideas about different countries facing different "binding constraints" on growth at different times.

Now he sees what looks like another attempt to impose a standard set of solutions, and doing it through the old vehicle of Washington Consensus itself - the IMF.

It's understandable that he should react against it. He perorates: "Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris"? What this means (IMHO) is that he doesn't see why a new regulatory regime would be less oppressive and/or irrelevant than the old Washington Consensus regime. It would probably even be run by the same people.

I, too, am very dubious about a single regulatory body, but for slightly different reasons. Prof. Rodrik is inclined to spread the blame, whereas I fear regulatory capture by exactly the same people that Prof. Johnson is pointing to. Why, given the history of regulatory capture that the current crisis has revealed, would a new regulatory authority be immune?

For that reason, though I certainly think that improved regulation is needed, I would not like to see any single "integrated" organisation created. A plurality of regulators is the best insurance that at least some of them will be honest some of the time.

Posted by: gordon | Link to comment | March 30, 2009 at 08:06 PM

Hal says...

The US, going forward, needs two things to happen and any useful administration would be working toward them. First, the nation needs to be freed from the strangle hold of the plutocracy, and second, it needs to be unglued from Israel. The Obama administration is doing neither. In fact it has gotten into bed with the plutocracy and kowtows to Israel whenever ordered to do so.

Posted by: Hal | Link to comment | March 30, 2009 at 08:16 PM

roger says...

I'll take the curse on both the economists approach, and put my money on Bruce Wilder's explanation - which, in this comment thread, he seems to have laid aside for the moment - that it was inequality that killed the beast - of our oversized speculative sector. It is always important to remember that the mortgages were being made on homes that were climbing from 3 times to 4, 5, and even, in LA, ten times income. And in that ration, income - the median household income - was certainly not keeping up with its average, particularly its average during a supposed boom. Jeff Madrick, in The Case for Big Government, cites the study entitled The State of Working America, 2006-2007, which found that while productivity grew by 33 percent between 1995 to 2006, compensation grew at half that. If it had grown in tandem with productivity, would we even have had a housing bubble? I don't have a quick calculation of those figures, but I think that - to some degree - if banks were looking at the income increases of the late 90s, they might be justified in thinking that housing prices would fall back in line with the 3 to 1 ratio. This is from the Cbpp:

Employment grew at an average annual rate of only 0.9 percent from November 2001 to September 2007, as compared with an average of 2.5 percent for the comparable periods of other post-World War II expansions. In addition, real wages and salaries grew at a 1.8 percent average annual rate in the 2001-2007 expansion, as compared with a 3.8 percent average annual rate for the comparable periods of other post-World War II expansions"
http://www.cbpp.org/cms/index.cfm?fa=view&id=575

This combo of weak employment and weak rises in real wages was what was happening underneath the housing price rise. So, the banks calculated wrongly, while the bank CEOs were doing their best to make sure that wages didn't rise and corporate profits boomed. Pretending this depression/recession came out of the housing bubble essentially picks out a surface phenomenon showing a much deeper illness.

Posted by: roger | Link to comment | March 30, 2009 at 09:46 PM

hapa says...

"pretending" ... because the credit bubble was a kind of tug-of-war opponent with conditions on the ground? ... but in that case losing collateral was as devastating as inevitable?

Posted by: hapa | Link to comment | March 30, 2009 at 10:36 PM

acerimusdux says...

"It is an odd marriage of populist and technocratic visions. Countries fail because political elites always end up in bed with economic elites. The solution, apparently, is to let the technocrats (read the IMF) run your affairs."

That certainly seems accurate enough to me.

Not that I trust the IMF to be immune from politicization either, but I do think it is generally true that there are people who understand how to make good policy, often it really isn't that complicated even, but that it is these self serving elites (or their stooges) who sabotage it all and then claim that it is so very complicated, and that it is all the fault of technocrats, or bureaucrats, or science itself, or perhaps simply the fault of everyone, or human nature itself, and thus we should all share in the blame for their looting (or, in the case of the most witless of stooges, their ignorant acquiescence in it).
;

Posted by: acerimusdux | Link to comment | March 30, 2009 at 11:51 PM

Lafayette says...

From LaLa Land

Rodrick: For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community -- not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy.
And bollocks to this, Dani.

If you think that they were not motivated by the excessive sums of money to be gained, then you're walking in LaLa Land.

Talk about academic nonsense ...

Posted by: Lafayette | Link to comment | March 31, 2009 at 12:10 AM

a says...

"the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets"

and

"Yes, there can be little doubt that banks badly misjudged the risks they were taking on. But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy. "

Yes well, there can be little doubt that the cronies in our capitalism include the economics and policymaking community. Did Phil Gramm really believe he was doing what was best for the economy? Or what was best for him and a pay-off from the investment bankers in the form of a high-paying job? Look at Martin Feldstein, Harvard economist, who was and still is on the board of AIG Financial Products, that multibillion dollar black hole.

Okay, sure there are some (many?) economists and policymakers who are trying to do what is best for the economy, including our kind host. But there are enough economists and policymakers who aren't, that the good ones are corrupted in fact though not in spirit. e.g. Feldstein reviews their submissions to journals, so the good economists have to filter their ideas to ones acceptable to the corrupt.

Posted by: a | Link to comment | March 31, 2009 at 01:07 AM

anne says...

Correcting:

When investors think there will be increased inflation, there will be less demand for relatively longer term Treasury bonds and longer term interest rates will rise. This will in no way mean bankruptcy, the idea is meaningless, only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation.

Treasury debt will [not] fail either by failure to pay principle or interest or by inflation, and bond specialists understand this. Investment managers who are cautious have also been limiting durations for months, which also means taking profits on longer term debt. Treasuries were terrific investments the last 10 years, and there is a time to take profits.

Posted by: anne | Link to comment | March 31, 2009 at 02:08 AM

anne says...

There can be no failure of Treasury bonds, since the Constitution expressly forbids failure. There can be no bankruptcy. Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio.

Posted by: anne | Link to comment | March 31, 2009 at 02:28 AM

hari says...

Dani has opened a pandoras box for intellectual criticism.

Because, as Mark clarified, Dani doesn't believe in a single global regulatory authority. Then what does he consider compelling in present global meltdown circumstances....?

Dani can't deal with the inherent contradictions in current Bretton Woods setup - in which US Treasury not only wields a Veto on any (fiscal) policy it considers against its national interest, but also decides (with EU) who sits in the policy making body.

[Geithner is one of those interns from IMF]

Also - in today's link - Nick Stern/FT piece is useful
in this policy context. [The Whitehall mandarins are at it again, me thinks.]

In criticizing the intellectual bankruptcy of *Old Britannica* (and by implication US policy), I tried to identify the historical malaise as a product of Anglo-American political-economic hegemony in global decision-making, hitherto.

Neither Dani nor Simon is willing to admit the post-war system is finally bankrupt. And, I suppose, there is a good reason why they don't go there....

So, who will reform the present setup?

*EU as decided (during its last Summit) to forego its Chair at IMF (in favour of mainland China and BRICs).

*China has agreed to augment IMF coffers - with the specific understanding that first priority will go to the unmet demands of the developing countries.

*Moreover China wants dollar denomination of IMF coffers (ie. reserve currency role) to be replaced by existing SDRs or its replacement (WCU*).

*BRICs and Russia, in particular, would like to remove the role of dollar in international trade transactions.

*What will replace USD? No one seem to want to get into the substance of that debate....

In sum, what's going on here from a global policy perspective, at G20, is a desire on behalf of Anglo-American capitalism to preserve its realestate; and, inspite of its dismal record of hegemonic polical-economic performance, the end of English-speaking dominance of world capital markets is within sight.

It's now actually a q' of what form it will take...and if it will have the support of BO, in particular.

*WCU - world currency unit (my idea).

Posted by: hari | Link to comment | March 31, 2009 at 02:53 AM

BJ Feng says...

If it is so easy to make sound policies, then why hasn't any country on Earth done it to the satisfaction of the critics here? And if these policies are so obvious, then how come only vague notions of "stopping the looting" are all that's recommended here? Where are the specific details outlining this magical policy that will finally stop the crooks and con-artists from dominating the government?


So Wall Street failed to create never ending prosperity, their models and formulas were wrong. But now we're supposed to believe that government hacks can do better, they'll come up with a working model that won't fail this time, promise--all it takes is the right policy view?


Face it, the G20 is playing the usual blame it on someone else game. Of course THEIR government, the people who were supposedly responsible for regulations in THEIR own country, couldn't possibly be at fault. No one was asleep, everyone was vigilant, please don't blame us, it was the evil rich who allowed this to happen! Yes that's it, and if you don't buy that, well it was the United States then! Anyone but us! Never mind that the United States can't craft the domestic regulations and laws that government foreign countries, no, somehow the United States is responsible and these other countries are all blameless!

If you hold Wall Street accountable for failure, when will you hold government officials accountable for their failures? Where were the regulators in all these countries? Surely not all of them can be as corrupt and evil as the ones in the U.S. right?

Posted by: BJ Feng | Link to comment | March 31, 2009 at 04:17 AM

BJ Feng says...

"..,only that a higher interest rate will have to be offered as the Treasury sells more bonds. Higher interest rates will in turn limit the amount of additional bonds that will be offered, since the government at this point will be limiting debt creation."


But what if the FED announces something like a trillion dollar policy of quantitative easing? Might long term interest rates not rise? And what if the FED goes off the deep end and announces it will purchase ALL the long-term bonds being auctioned for a 3% yield? Humm, good thing bond managers have limited their duration. But what if inflation runs at 10% and both short term AND long term Treasuries only yield 5%? And what if the money markets only yield 2% on commercial paper to boot? What will these wise bond managers who understand duration do to avoid being decimated by inflation? Well I suppose they still have one more option left, but what if the Treasury announces they will no longer auction TIPS because people can already buy I-bonds, and what if they set the fixed rate portion of those I-bonds to -2%?

"...there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio."

Perhaps you misspoke Anne?

Posted by: BJ Feng | Link to comment | March 31, 2009 at 04:35 AM

Real Person from the Real World says...

Ever since the Republicans trotted out welfare queens on the road from the welfare to workfare transition, much of the populace bought into the conservative/libertarian ideas that if I work hard, I will get wealthy, and there is no such thing as a free lunch. Well, fast forward to the Obama admin: You still get the same non-sense. Safety nets for the population are "socialism." Never mind that most of the suggestions for the bailout from the BO admin, are compromises with conservatives (see PK's Market Mystique). Never mind that so many people are losing jobs, and health care is becoming a perk of the well-employed only. All I can say is that the cronies did a good job selling to all the suckers.

Posted by: Real Person from the Real World | Link to comment | March 31, 2009 at 05:24 AM

ken melvin says...

RPFTRW is right. Obama said it just like Ronnie and people voted for him as they did Ronnie because they wanted to believe it never mind that it is BS.

Posted by: ken melvin | Link to comment | March 31, 2009 at 06:18 AM

anne says...

"Treasury bonds will be paid, principle and interest, and experienced portfolio managers understand that by keeping fairly constant duration Treasury portfolios, and as has been done for months even limiting duration, there is no danger of American inflation undermining the value of Treasuries with a constant duration Treasury portfolio."

Simple, a constant duration bond portfolio adjust to any interest rate change over the duration period. So, a portfolio with a 2 year duration will decline by 4% if in there is a 2% increase in interest rate, but the portfolio will return 2% a year more in interest so that the decline in price is made up be added interest over the 2 year duration.

Similarly, for the same portfolio, a 5% increase in interest rate will lead to a price decline of 10% which will in turn mean the portfolio returns an additional 5% a year in interest and the portfolio will have completely adjusted in the course of the 2 year duration period.

Posted by: anne | Link to comment | March 31, 2009 at 06:33 AM

SS says...

@BJFeng

Sir,

The argument you put forward is hardly new but I thought didn't persist much beyond high school equivalent pundits. It suggest a la Leibniz that the world is the best of all possible worlds, therefore, any action to improve it is unnecessary and further doomed to failure.

Moving from metaphysics to the situation at hand your argument would be like seeing a teenager about to commit suicide and being able to easily stiop him. The metaphysician pauses arguing since mankind has never been able to prevent suicides preventing this one can only be a futile act. Good policies begin one at a time. The U.S. may be the best country ever, I personally doubt that but find the question ultimately absurd - - how could one know all the countries and societies and the quality of life they supported - - but even granting this absurd premise it is hardly an argument against an action or policy that would improve the country.

Those posting here are engaged in ne of the oldest social pursuits, since humankind began talking, that is trying to understand and improve our condition. God knows it needs improving right now. Such national jingoism as yours if not simply "facist" - - see Umberto Ecco's Ur Fascism -- is in the least infantile.

SS

Posted by: SS | Link to comment | March 31, 2009 at 06:34 AM

anne says...

The Vanguard long term investment-grade bond portfolio, through all sorts of interest rate change has returned 8.2% a year after costs for 35 years.

The long term Treasury portfolio has been remarkably consistent in return from the beginning:

https://personal.vanguard.com/us/funds/snapshot?FundId=0083&FundIntExt=INT#hist::tab=1

Vanguard Long-Term Treasury Bond Fund

Average annual returns as of 02/27/2009

02/28/2008 ( 7.77%)
02/28/2006 ( 7.29)
02/27/2004 ( 6.32)
02/26/1999 ( 7.19)

05/19/1986 ( 8.32)

Posted by: anne | Link to comment | March 31, 2009 at 06:37 AM

anne says...

There are in addition Treasury inflation-protected bonds, as there are Treasury guaranteed mortgage bonds. However, investors who have been so well served by bond portfolios for so long will respond to policy changes and to changes in economic conditions. We have been in a liquidity trap period that began forming in January 2008, during which the Federal Reserve has continually lowered Treasury interest rates leaving investment-grade rates remarkably unchanged or even significantly higher now than in January 2008. Investors then have adjusted bond portfolios to policy and conditions through these months in ways that differ even from the 1930s, always choosing caution as far as can be known from bond market price changes.

How cautious investors can be is found by looking the the Vanguard Treasury backed mortgage portfolio which has a 1.8 year duration, similarly the relative high yields of A rated investment-grade bond portfolios no matter the duration shows the caution.

Posted by: anne | Link to comment | March 31, 2009 at 06:52 AM

anne says...

http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

March 30, 2009

Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds....

-- Michael Kranish

[What is necessary to understand here is that an investment manager needing to be most conservative, sold well priced bonds and bought stocks when price-earnings valuations for stocks were anywhere from 22.4 to 26.0 as the stocks were bought in 2008 and dividends were 2.0% and less.]

Posted by: anne | Link to comment | March 31, 2009 at 07:02 AM

anne says...

"But now we're supposed to believe that government hacks can do better...."

Simply notice the language and understand what thuggishness amounts to, understand what writing with the intent of demeaning and intimidation amounts to. To work in a government setting is to be a hack, from teachers to scientists to soldiers to accountants and on. What is intended is intimidation.

Posted by: anne | Link to comment | March 31, 2009 at 07:33 AM

Beezer says...

I'm more in Johnson's camp if for no other reason than he's been at the table and what he sees in the U.S. now looks all to familiar.

Having said that it still appears to me that income inequality following a huge capital investment push, and subsequent levelling off, has something important to do with our current situation.

The capital push came from technological advancements in computers and networking. And this push was very heavily weighted in financial services from the mid 1980s until the beginning of this century. Then it levelled off. There were improvements but the main underlying technology was put in place earlier.

For this century, there was not so much a need for capital investment, and therefore income wealth continued to be generated without as much need to spend additional money on capital and its corresponding labor. Particularly in the financial services industry which continued to grow, in no small part, because of globalization and the spread of manufacturing around the world in search of cheap labor and new markets.

In emerging markets such as China, a lot of income did trickle down (China took almost 300 million people out of subsistance living!). But in the U.S. the effect was increasing debt levels and speculation created by the lack of new capital investment opportunities.

Unburdened by a need to keep adding to capital investment, wealth cast about for something else. As in the 1920s that something else was securities of all kinds.

And then the bubble went pop. Old wine, new bottle.

Posted by: Beezer | Link to comment | March 31, 2009 at 08:26 AM

anne says...

http://krugman.blogs.nytimes.com/2009/03/31/dow-36000-and-your-pension/

March 31, 2009

"Dow 36,000″ and Your Pension
By Paul Krugman

So in 2007 the Pension Benefit Guarantee Corporation - which stands behind corporate pensions - switched from bonds only to lots of stocks, * buying in at, natch, the peak of the market. Oops. And this is big stuff: the Bush administration may have left us all a gratuitous loss of hundreds of billions.

Why did this happen? I'm sure we'll find some nasty stuff, but at least part of the reason was that the Bush administration, like many conservatives, was under the spell of the following pseudo-syllogism:

1. The stock market captures the essential spirit of capitalism.

2. Capitalism roolz!

3. Therefore, stocks will go up.

The most influential disseminator of this fallacy is the Wall Street Journal, which as far as I can tell has cheered on every bubble since the 1920s, always dismissing the skeptics as fools and promoting the dumbest bull-market arguments available. I don't have time to search for it right now, but I think there was an editorial circa 2000 saying precisely that anyone who questioned the bull market of the time was anti-capitalist.

And now the cost for that attitude is falling on you and me.

* http://www.boston.com/news/nation/washington/articles/2009/03/30/pension_insurer_shifted_to_stocks/?page=full

Posted by: anne | Link to comment | March 31, 2009 at 08:35 AM

Eric Dewey, Portland, Oregon says...

Hari, thanks for making that point about the decline of the Anglo-American post-war monetary system.

That is precisely the point, and precisely the challenge, that faces the world. Bretton Woods II is dying a slow death, and China has articulated that it intends to play a leadership role in the establishment of a new system.

That is the reality - and those who attempt to deny or trivialize that reality are either 1) unwilling to face it, or 2) attempting to protect their own interests.

The core question of our time will be: what anchors the value of a global monetary exchange system?

Posted by: Eric Dewey, Portland, Oregon | Link to comment | March 31, 2009 at 08:47 AM

anne says...

The current bear market began in October 2007 though the market never recovered form the bear market that began in March 2000. More importantly, the stock market remained expensive even through the bear market of 2000-2002 and only became more expensive in the recovery that lasted to 2007. Even with corporate income at record or near record levels through the Bush expansion, the stock market was always more expensive than earnings could justify. The problem was that earnings could not have continued to grow so strongly indefinitely since economic growth through the Bush expansion never justified the earnings growth.

Posted by: anne | Link to comment | March 31, 2009 at 08:56 AM

anne says...

Beyond the problem with impossible stock valuations and unjustified earnings, there had been for years an erosion of dividends that continued through the Bush expansion and made stocks continually riskier to own as stock prices increased. Nonetheless, stocks were continually recommended beyond bonds by the bulk of analysts and even cautious analysts repeatedly ignored bonds. Even tax policy, being increasingly slanted against bonds. Where though was income to come from during a bear market of any length?

Posted by: anne | Link to comment | March 31, 2009 at 08:59 AM

calmo says...

SS writes/bites/smites (way mo than this here types)

It suggest a la Leibniz that the world is the best of all possible worlds, therefore, any action to improve it is unnecessary and further doomed to failure.
And I'm sure that the multi-lingual, multi-cultural, multi-talented Leibnitz would have been suitably impressed with "a la Leibniz" and the "therefore" clause not so much.
Does this mean you are a reader of what was once known as The Rationalists? (calmo recalls fellow traveller peering sideways "You seriously read THAT for pleasure?!"...I replied, "No, no, I read Harlequin Romances, like you...just as soon as there is the slightest turbulence." It was not the best of all possible replies...and therefore...I resolved to replace "Harlequin Romances" with "Outdoor Living"...such is my quest for improvement...even in this Best of All Possible Worlds...that have not recognized this Leibnitz character, not really...until you provide this wee comment SS.)

Posted by: calmo | Link to comment | March 31, 2009 at 10:27 AM

SS says...

@ Calmos

Thanks for caring. I can't pretend to interpret your text - - socialist not = structuralist - - at least not one for one, but if a, Calmos, is ready for self-improvement, can socialism be far behind? A propos of Outdoor Living, do you fear growing homelessness? Best

SS

Posted by: SS | Link to comment | March 31, 2009 at 10:38 AM

roger says...

Hapa, you are right to jump on my use of the word "pretending", which has the unfortunate connotation that there is some kind of conspiracy going on. Rather, blaming the pop of the housing bubble for all our problems is a sort of programmed response from the ideological buffer that we have assimilated over the last thirty some years. This buffer has to do with making inequality some unfortunate side feature of a robust free market system. I think that isn't true - inequality has a dynamic. When you look at the incredible amounts of wealth that have accrued to the wealthiest over this period of time, one should ask why the ideologues of the system insist that this feature is intrinsic and to be defended at all costs, while inequality is extrinsic and regrettable, but no big deal.

That is the question which leads to the operating system of Reagonomics - the battering down of labor's bargaining position and hence the stagnation and loss of median household income - the rise of the easy money credit system, which comes in as a sort of substitute for wage increases, but one that has to be paid back with interest, and the flooding of the equities market and the wilder shadow financial system with the aggregate asset wealth - the pensions, the insurance, the 401ks - of these same household. The bubble in housing prices was - as I think was clear to anybody in 2003 - an intentional act. It arose out of the imperative to keep the triangle (low wage demand, easy money, inflated securities) going. The neo-liberals and the conservatives simply want to preserve this system, with the neo-liberals wanting to press on the easy money pedal, and the conservatives wanting to press on the lower wages pedal.

The organ, however, is broken.

Posted by: roger | Link to comment | March 31, 2009 at 10:42 AM

calmo says...

SS, interpreter like me, maybe just findin a soft-spot, accidentally with me (quite fond of L and not the celebrated Newton) who likes to stay close to "caring" (we are not doin this for money or monetary equivalents, are we?...snot the place to B practicin for your Nobel Prize you deserve after reading an entire misty thread but a pretty good place for noodling...maybe not improving the noodle, but arresting its dissent, its inevitable departure from el dente.
So, do I hear tiny alarm bells with your "socialist"? I'm perplexed by that distinction structuralist/socialist...but I perplex at the drop of a hat (lookit, gravity...so unrelenting).
Absonootely about homelessness. If the job losses don't ease up from the current ~650k/mo, we are in for trouble...that even investment bankers can see. Even recognize. Even report.

Posted by: calmo | Link to comment | March 31, 2009 at 11:31 AM

BJ Feng says...

The answer Roger, is that inequality cannot be eliminated without reducing the populace to a subsistence level lifestyle. Plus it is NOT a zero sum game. Just because someone is wealthy does not mean that someone else has to be made poor, it depends on the system. If the rich derive their wealth from confiscation, then many will have to be made poor, but if the rich derive their wealth from adding economic value or inventing something that will increase productivity, then not only will they become richer, but the poor will also.


When I hear statements about the rich feeding off of the poor here in America, I wonder how? What is the mechanism? You might ask why income inequality rose during the past few decades and I have a very good answer for you. Globalization. With billions of new people entering the global capitalist system, the returns to labor decreased and the returns to capital increased. This wasn't a conspiracy invented by the rich to "exploit" the poor. What we are seeing is a worldwide systematic shift, this shift will create vast amounts of wealth for everyone, especially the poor in emerging nations, but it also increases income inequality here in the United States and other developed nations. Globalization cannot be stopped, much as industrialization could not be stopped in the past. The best course of action for the poor is to move to industries that are not in direct competition with the poor in emerging nations. That is learn plumbing, or how to fix houses (many foreclosures need repairs), even dog walkers are rumored to make good money, these are just some ideas.

Posted by: BJ Feng | Link to comment | March 31, 2009 at 11:44 AM

Obvious says...

I find both Johnson's account and Rodrick's reply to be illuminating and outstandingly useless in any practical sense. Yes, the bankers are a corrupt crowd, and yes - judging from its past performance, should the IMF have its way with the US today, Krugman would be clawing up the walls of an asylum cell tomorrow.

Neither piece lays the blame correctly or identifies any true solutions. What I found most interesting here was, as is often the case, in the comments, namely this part of Eric Dewey's comment:

"increasingly violent, class-based political discontent that is manifesting itself around the world..."

Is there a reason why the "mainstream" debate views this as a problem to be solved, rather than a solution to the immediate problem? Which is an honest question that I sincerely want to see discussed by the gurus.

Posted by: Obvious | Link to comment | March 31, 2009 at 12:00 PM

SS says...

@BJ Feng
"you might ask why income inequality rose during the past few decades and I have a very good answer for you. Globalization. With billions of new people entering the global capitalist system, the returns to labor decreased and the returns to capital increased."

You apparently know trade theory so I have to conclude that you are not an economist. Up to this point you are right. But ask yourself how one obtains capital, hard work. . .? I think not. The original American capital, land, was stolen from the indians, since than it is systemically skimmed from the working classes. Is a CEO banker an owner of capital, consequently getting a "return on capital?" Not until he skims his millions from the workers in a class system which validates this theft. Good try your getting there.

SS

Posted by: SS | Link to comment | March 31, 2009 at 01:14 PM

hari says...

Breaking News!

Sarkosy's Finance Min says President of France will walk away from G20 Summit if a global regulatory regime is not approved by all leaders (my interpretation).

Brown is still banking on BOs support for $2T stimulus plan, as part of his Summit Declaration.

NB. There is emerging a dividing political line (tactics in the protracted negotiations) between surplus exporting countries (Germany, Japan, China and India) and current account deficit countries (eg.US/UK).

Posted by: hari | Link to comment | March 31, 2009 at 01:15 PM

roger says...

BJ, your response is based on two conservative memes. One meme is to conflate the critique of inequality with the call for radical equality. Thus, if I say that a hedge fund manager shouldn't be getting a billion per year, I'm really saying that we should all get fifteen thousand a year and live in Soviet pre-fab housing.

Well, that meme is convenient, since it substitutes an argument it can win with an argument it doesn't want to approach. In point of fact, it was political changes in the U.S., not globalization, that drove the triangle I describe. These changes were the basis for our current epoch of globalisation, with capital using its global advantage and political entrenchment to stay far ahead of labor, plus the political and military power of the U.S. to allow for the terrific accumulation of debt on the consumer level. In the U.S., the population acceded to an industrial policy that downgraded high wage manufacturing and broke apart the power of unions because they got something in return - credit and asset inflation. Now, of course, they have neither.

The second conservative meme is to massage the position that we should not have much greater equality (not absolute) by putting it in terms of the "rich" versus "poor". Of course, in developed countries, the middle class, extending from the working class to much of the white collar class, is the most populous. When conservatives float that rich vs. poor binary, they know that this middle will instinctively turn to the rich. But in fact the middle class is as dependent on a healthy state supplied social insurance network as the poor. It is really a threefold opposition: rich vs. middle vs poor. It is the middle that will benefit from greater equality - i.e. creating severe disincentives for management to make more than 20 times the amount made by the lowest salaried employee. Since globalisation is played on a field in which labor is, as yet, divided between nation states, it is up to those nation states to use state power to create more equality - if there were powerful international labor organizations, this could be left to the fight between capital and labor.

If globalization was the actually cause of the middle class stagnation and the rise of the mega-rich, there'd be every reason, then, to oppose it in the U.S. - it would, after all, be to the disadvantage of the vast majority of Americans. But I don't think that is true. While the theory of competitive advantage is an ideal never met with in real life, it is still true that a developed country should have an advantage in shedding lower skill jobs for higher knowledge jobs. Meaning that they should be going to the next plateau, creating tomorrow's products. Well, what does seem to be true is that the mega-rich, as they become entrenched as an oligarchy, play only for the highest yield, and thus lose the only economic function they really have - to seed long term R and D for their own long term profit and, more importantly, the social good. And free trade, which once justified itself in terms of production, increasingly argues in terms of cheaper consumption. The latter is an argument leading to a bad end.

If we argue not against the conservative memes, but in terms of the reality of the current state of inequality, we will get a pretty good picture of the dysfunction that has created the current slump. Which is why we should be getting out of it by attacking inequality (rebuilding the state's social insurance net, using any and all financial power to inject money into the economy outside of the narrow subsection of Wall Street that we are currently putting money into, redoing the tax system to wipe out tax havens, institute tax brackets on the wealthiest and significantly raise their marginal taxes), and so reconfiguring the operating system of American capitalism.
;

Posted by: roger | Link to comment | March 31, 2009 at 04:39 PM

gordon says...

Nice one, roger. I would suggest that the state actions necessary to attack inequality should include support for unions (a countervailing power) and expanded Government enterprise. By that I mean Government ownership and operation of the natural monopolies of power, water and public transport (maybe others would suggest more). Revitalised public education and health care are also necessary.

Posted by: gordon | Link to comment | March 31, 2009 at 10:23 PM

BJ Feng says...

Doesn't higher yield imply a great need for capital and thus, when the rich invest for higher yields, they also employ capital where it is most needed and where it can produce the most good for society? Thus factories are built in order to capture large profits, and large profits are only possible because the populace desperately wants the goods produced by the factory. The fat profits should attract enough capital until better opportunities present themselves elsewhere. By that time the populace has access to much cheaper goods.

In theory this happens, but in reality there are often barriers to entry that create monopolies. Interesting isn't it that the reasons given to prevent competition are usually to protect the consumer from being "exploited" or gouged by new firms eager to make a profit. Carlos Slim is one of the wealthiest men in the world because only he can protect the Mexican consumer from predatory pricing.

Competition is the engine that drives capitalism. The good effects of capitalism come from competition, and competition makes sure everyone gets a fair deal. Government ownership necessarily means monopoly as government has almost unlimited resources and can change the rules of the game whenever it wants. Capitalism does not work very well if there is no competition to force innovation and to ensure that firms work to fulfill customer wants. Without it, firms have no inventive to satisfy customers who are seen as a necessary burden. It should come as no surprise that Mexico's State run oil industry is in trouble thanks to malinvestment and waste. Venezuela is on the same path now that the competition was driven off and their oil assets seized.

What causes a nation to be richer and more successful? It's economic system, social structure, and laws. Property rights and stable laws are two of the most important qualities necessary for success. Governments that seize property and wealth on behalf of the poor don't do very well in the long run. Yes the society gains after the seizure, but without new investment and capital, the party soon ends. And it will take very very high rates of return to attract investment if investors believe the government will just come in and either seize or tax away all the profits once the hard work has been done and the investment becomes profitable.

Getting short on time, so to I'll only ask why do so many Nobel prize winners (of hard sciences) reside in the US or immigrate to the US after winning? How come just about all the new, revolutionary tech companies of the internet revolution popped up first in the U.S.? Why didn't Google start in France? Why didn't Ebay or Utube or Myspace or Facebook, or Amazon etc., etc., etc. Of course the founders and the venture capital firms who first got in are very very rich now, but they've created a whole new industry and countless jobs as well as made our lives better. Yes there are problems with the way manager compensation is handled, but that's due to the power they have to set their own pay. All that's needed is to allow shareholders, and shareholders only, to sit on executive compensation boards and decide pay for management. You won't see the ridiculous bonuses for terrible performance anymore, nor will you see golden parachutes for failed executives who run the company into the ground. The executive will be lucky if he isn't escorted out by security. Give owners the rights they should have to set pay for their employees. In reality it's a two way conversation, but right now, managers set their own pay and owners are nearly powerless to do anything about it.

Posted by: BJ Feng | Link to comment | April 01, 2009 at 03:59 AM

says...

Roger: Which is why we should be getting out of it by attacking inequality (rebuilding the state's social insurance net, using any and all financial power to inject money into the economy outside of the narrow subsection of Wall Street that we are currently putting money into, redoing the tax system to wipe out tax havens, institute tax brackets on the wealthiest and significantly raise their marginal taxes), and so reconfiguring the operating system of American capitalism.

Ah, yet another breath of fresh air that proposes a solution in this blogathon of finger-pointing blame.

Good on ya ... we need solutions, not a tired list of the blameworthy.

Posted by: | Link to comment | April 01, 2009 at 06:18 AM

wjd123 says...

In "Trilemma," an essay by Dani on his blog, he claimed that if countries wanted "deep" global integration they would have to give up nationalism or democracy. Nationalism imposed barriers to globalism while globalism required the democratic polis to be subservient to global aims.

However, if the trilemma isn't about deep global integration but about deep international integration then there is a way for countries to achieve greater integration without giving up democracy. The EU way.

For instance under EU law woman have greater protection against discrimination in the work place than they would under the laws of any member country. EU citizenship allowes a Spaniard working in England to vote in local elections there. Internationalism the EU way has increased both the rights of woman and expanded democracy.

The ability of the global economy to arbitrage away one nations political economy against other's is lessened under deep internationalism in the same manner that is harder for speculators to make a run on the euro than it is to make a run on the pound.

Ideological questions of legitimacy that arise when global markets undermine the rules and regulations of democratic agreed upon political economies are brought back to a democratic polis

Instead of political economies being reduced to the lowest common denominator under "deep" globalization, political economies that opt for this type of "deep" internationalism swap some sovereignty for expanded democracy and expanded rights. A good deal all around.

Expanded checks and balances against oligarchic capture also opens up.

France not having interests in finance that are as great as America's or Britain's would be a check against those interest gaining too much power.

It seems to me that checks and balances on an international scale would make oligarchic capture harder than checks and balances on a national scale.

And since Dani argues that it is too easy to blame the bankers for our financial crisis because the spirit of the times after Reagan and Thatcher has been one of deregulation why not take advantage of the new spirit for regulation to forge some international solutions to international problems exposed by the financial crisis.

Dani says that GATT was a victim of its own success. How so? Is it in the Paul Krugman sense that free trade wasn't a problem until it grew big enough to become a problem. If so, we can't look backwards for solutions if we are to progress.

While it's true that the internationalism I speak of isn't working very well right now that's no reason to give up on it and revert back to nationalism. In fact since the idea of regulation is in the wind and EU countries are open to it, now would seem to be the opportune time to get international financial regulations that don't possess the weakness of the Basel I and Basel II attempts.

I agree with Dani that there can't be a one size fits all approach to regulating. This isn't one of them, it's an international way that takes small possible steps that moves us toward a greater globalism without the stumbling blocks of national restrictions or less democracy

I also agree with Dani when he writes:

Yet the logic of global financial regulation is flawed. The world economy will be far more stable and prosperous with a thin veneer of international co-operation superimposed on strong national regulations than with attempts to construct a bold global regulatory and supervisory framework. The risk we run is that pursuing an ambitious goal will detract us from something that is more desirable and more easily attained.
I agree, that is, if he isn't conflating his deep globalism that can't work along side democracy, with deep internationalism that can work along side democracy. I agree, that is, if he isn't conflating a globalism that can't expand our freedoms with an internationalism that can; a internationalism that can guard against capture by oligarchic interests; an internationalism that can overcome questions of legitimacy while protecting and expanding individual rights.

I'm excited about Dani's last blog on "Interests and Ideas." I get that way when the zeitgeist is changing, moving close enough to touch. It's like boarding a plane in the middle of a stormy night and finding you've been seated next to Angelina Jolie.

The spirit of the times is changing. Now is not the time to propagate the thesis that the American congress isn't about to give up any of our nations sovereignty. We are a democracy. Change is open to democracies. Change is easier when the winds of change are at your back.

Today the idea of international regulations is stronger then ever. Unforeseen consequences of the past are cautionary tales that should be heeded. But they are cautionary tale form another time. New ideas are in the air. The old tales should be noted but not be used to inhibit ideas that the zeitgeist is opening to. Now is the time to push for the anti-thesis.

Posted by: wjd123 | Link to comment | April 05, 2009 at 12:09 PM

hari says...

wjd - welcome back to globalization!

Your think piece is missing one important regulatory bridge head or regime which we established under European Court System - principally to review cases of companies/individuals not applying the laws of EU.

eg. Microsoft and now Google are subject to anti-trust laws of EU with compulsory arbitration by EU Courts and, of course, monetray punishments.

Posted by: hari | Link to comment | April 05, 2009 at 01:35 PM

Real Person from the Real World says...

Rodrik: "One problem with the global strategy is that it presumes we can get leading countries to surrender significant sovereignty to international agencies."

I think that says it succinctly.

OTOH, I do think there is crony capitalism in the US. My 3rs world employer feels that every time we get ousted as a vendor, that it's because of under the table shenanigans, and he has no aversion to practicing the same with same language speaking compatriots, himself. Whenever possible, he tries to get in with the highest level individuals he can.

Furthermore, seems to me one of the minor scandals of recent years were foreign born businessmen, and lobbyists getting their pix took with past presidents. Businessmen from foreign countries are used to systems where you bribe local officials for services, and they come here expecting the same business as usual, albeit perhaps on a less obvious scale.

Money sure seems to find paths of influence in this country.



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