April 2009 Archives

$14 trillion economy now a $13 trillion economy

The New York Times reports, “The economy is operating at 7 percent below its potential capacity, the Congressional Budget Office reported last month. If that were to continue, today’s $14 trillion economy would be a $13 trillion economy by this time next year.”

The economy has fallen so far behind full capacity that — even if the recovery began immediately — it would take years to recover:

Idled capacity, like baseball players after a winter off, takes time to bring back into robust use. So even if the recession miraculously ended tomorrow, economists estimate that at least three years would pass before full employment returned and output rose enough for the economy to operate at full throttle…

The shortfall is running at more than $1 trillion in annual sales and other transactions. Only once since the Great Depression has there been such a severe loss of output — in the 1981-82 recession — and after that downturn, it was seven years before the economy regained the lost production…

In the six years of recovery from the 2001 recession to the current one, the economy grew at an average annual rate of only 2.5 percent, adjusted for inflation. If that growth rate were to resume, just $350 billion a year would be added back, requiring three years to restore the $1 trillion in lost capacity.

But we’re not growing at all, let alone at 2.5%. In fact, we’re still contracting. And economic contraction is a vicious cycle, much like a death spiral:

“Companies cannot hire workers to make more goods and provide more services until their sales go up. But people can’t buy goods and services until they are hired — so the excess capacity just sits there.”

Posted by James on Apr 07, 2009

1% of TARP > 100% of TANF

UMass Amherst economics professor Nancy Folbre comments in “Welfare for Bankers”:

Temporary Assistance to Needy Families (TANF) is our country’s only direct cash assistance program — the family welfare program that conservatives most love to hate. The Troubled Asset Relief Program (TARP) is the cash assistance program for failing banks put in place by the Bush administration and augmented by the Obama administration — a financial welfare program that nobody fully understands.

In 2007, the latest year for which figures are available, TANF spending on cash assistance (not including child care or other subsidies) came to $4.5 billion. Total commitments to TARP since September 2008 come to $700 billion. So one year of TANF spending equals less than 1 percent of TARP. Citibank alone received $25 billion, five times the cash transferred to mothers and children receiving public assistance in 2007.

Posted by James on Apr 21, 2009

25 million underemployed. Can we call it "a depression" yet?

5.1 million U.S. jobs lost so far.

Another 650,000 to 750,000 jobs vanishing every month.

8.5% unemployment.

But the labor market is actually far sicker:

Nearly 16 percent of the people in the United States are now looking for a job, working part-time because they cannot find full-time work, or are out of work and not actively looking, the government said.

“We’re closing in on 25 million people that are underemployed in one way or another,” said Mark Zandi, founder and chief economist of Moody’s Economy.com.

Posted by James on Apr 03, 2009

401(k) plans robbing Americans in broad daylight

The list of disgusting financial scams practices perpetrated against ordinary Americans by financial institutions with the tacit approval of bribe-taking campaign contribution-soliciting Washington, DC legislators is astonishing.

60 Minutes covered one of them this week:

“There clearly has been a raid on [401(k)] funds by the people of Wall Street. And it’s cost the savers and the future retirees a lot of money that would otherwise be in their account, independent of the financial collapse,” Rep. George Miller [D-CA] said.

Congressman Miller is chairman of the House Committee on Education and Labor, and a staunch critic of the 401(k) industry, especially its practice of deducting more than a dozen undisclosed fees from its clients' 401(k) accounts.

“Now you got a bunch of economic wizards jumping in and taking money out of your retirement plan, and they don’t wanna tell you how much, you can’t decipher it in simple English, and they’re not interested in disclosing it, or having any transparency about it,” Miller told Kroft.

“And most of the people that look at their 401(k)s have no idea that these fees are being taken out?” Kroft asked.

“No. Where would you find it? Where would you find these fees in this prospectus? You can look on any page you want, and when you’re all done reading it, and you will find some of the fees and the commissions here, but you won’t find them all, and I’ll bet you won’t find half of ‘em,” Miller said.

There are legal fees, trustee fees, transactional fees, stewardship fees, bookkeeping fees, finder’s fees. The list goes on and on.

Miller’s committee has heard testimony that they can eat up half the income in some 401(k) plans over a 30-year span. But he has not been able to stop it.

“We tried to just put in some disclosure and transparency in these fees. And we felt the full fury of that financial lobby,” he said.

The worst part of this is that lack of transparency encourages a race-to-the-bottom. If 401(k) investors can’t distinguish between “good” mutual funds charging reasonable fees and “bad” ones, funds that want to be “good” must resist strong financial temptations to be “bad.”

Posted by James on Apr 19, 2009

47,000 wealthy American tax cheats, just at UBS

UBS was caught helping 47,000 rich Americans cheat their fellow taxpayers out of billions of dollars in taxes:

UBS AG now says it had about 47,000 accounts held by Americans who didn’t pay U.S. taxes on their assets, but Switzerland’s biggest bank is providing the names of only 300 American clients to the U.S. government.

The IRS has offered rich tax cheats very light penalties if they turn themselves in. Well, even though the IRS is offering to let these tax cheats off with a mere wrist slap, many wealthy tax cheats still seem unable to decide what to do:

Lawyers say they have been flooded by frantic calls from wealthy clients wondering whether to turn themselves in — and, if so, how. “One woman was very scared. She was in tears,” says Bryan Skarlatos, a lawyer at Kostelanetz & Fink in New York and chairman of the American Bar Association tax section’s committee on civil and criminal tax penalties. On the ride back to New York from a tax conference in Galloway, N.J., last Friday, Mr. Skarlatos received four calls from worried clients. Some people have “many millions of dollars” stashed abroad, he says, and “are having a hard time deciding” what to do about the IRS program, which he describes as “the classic carrot-and-stick approach.”

There are two scandals here: 1) Letting tens of thousands of wealthy tax cheats escape almost without penalty; and, 2) That wealthy tax cheats still can’t bring themselves to do the legal and honorable thing, even when faced with a real threat of being caught and prosecuted.

Posted by James on Apr 09, 2009

America already has a flat (effective) tax!

Given the constant griping of many media personalities and Republican politicians about how unfair it is that the rich are burdened with an excessive tax burden in our “progressive” taxation system, it’s surprising to learn that our tax system is actually barely progressive at all!

America effectively has a flat tax when you look at what people actually pay in all taxes rather than what their highest marginal income tax rate is.

After crunching tax numbers, Citizens for Tax Justice issued a report that concludes America’s effective tax rate is basically flat, except for the lowest-income Americans:

  • The total federal, state and local effective tax rate for the richest one percent of Americans (30.9 percent) is only slightly higher than the average effective tax rate for the remaining 99 percent of Americans (29.4 percent).

  • From the middle-income ranges upward, total effective tax rates are virtually flat across income groups.

Their report includes data and a chart.

Posted by James on Apr 21, 2009

Are Americans profligate and Chinese stingy... or is government policy responsible for trade imbalances?

Many argue that China’s immense trade surpluses and the United States' massive trade deficits reflect government policies and the U.S. dollar’s special position as the world’s reserve currency, not the cultural profligacy of Americans and the stinginess of Chinese. Peking University business school professor Michael Pettis lays out this argument pretty clearly. Here’s a brief excerpt:

Let us assume, then, that a group of countries, perhaps in response to the 1997 crisis, decide that in order to protect themselves from a repeat of that disaster decide to engineer polices aimed at accumulating reserves and limiting external debt. The most obvious way would be to put into place policies that constrain consumption and boost savings (keep wages and interest rates low, limit credit availability to consumers, limit credit availability to small and medium enterprises and especially to the service sector, maintain an undervalued currency, etc.) and direct credit to the investment and manufacturing sector. As a consequence growth in production would exceed growth in consumption and the balance would represent the trade surplus. Trade surpluses, of course, have to be recycled as investment flows (or reserve accumulation) back to the country against which they are running these surpluses. This is not a choice, or even a real lending decision. It is the automatic and necessary consequence of running a trade surplus…

US consumption must grow faster than US GDP, and the choice for the Fed is whether to target a “normal” growth in consumption, and permit rising unemployment, or a “normal” growth in GDP, and so permit rising indebtedness. The Fed must use US unemployment, in other words, as a tool to prevent Asian trade policies from leading to excess US indebtedness…

Because of the dollar’s reserve status, only the US could have possibly run the deficits necessary to absorb the huge surpluses that Asian trade policies were generating. Without the dollar’s status as a reserve currency, the Asian development model that stresses expanding production while constraining consumption – which among other things results in trade surpluses and net investment abroad (which of course is the same thing) – would have either required another reserve currency, or it would have failed.

Just as Chinese policy restricted consumer credit, U.S. deregulation combined with bank greed to fuel a credit-driven consumption orgy. Kevin Phillips spells it out from the perspective of greedy banks:

The principal building blocks that the [financial] sector used to enlarge itself from 10-12% of Gross National Product around 1980 to a mind-boggling 20.6% of Gross Domestic Product in 2004 involved essentially the same combination of credit-mongering, massive sector borrowing, highly leveraged speculation, reckless, greedy pioneering of new experimental vehicles and securities (derivatives and securitization) and mega-trillion-dollar abuse of the mortgage and housing markets that became infamous as hallmarks of the 2007-2009 disaster. During Alan Greenspan’s 1987-2006 tenure as Federal Reserve Chairman, financial bubble-blowing became a Washington art and total credit market debt in the U.S. quadrupled from $11 trillion to $46 trillion.

…[T]he financial sector hyped consumer demand – from teen-ager credit cards to mortgages for the unqualified – to make credit into one of the nation’s biggest industries; nearly $15 trillion was borrowed over two decades to leverage de facto gambling at 20:1 and 30:1 ratios; banks, investment firms, mortgage lenders, insurers et al were all merged together to do almost anything they wanted; exotic securities and instruments that even investment chiefs couldn’t understand were marketed by the trillions. To achieve fat financial-sector profits, the housing and mortgage markets might as well have been merged with Las Vegas.

The principal inventors, hustlers , borrowers and culprits were the nation’s 15-20 largest and best known financial institutions – including the ones that keep making headlines by demanding more bail-out money from Washington and giving huge bonuses. These same institutions got much of the early bail-out money and as of December 2008 they accounted for over half of the bad assets written off. The reason these needed so much money is that they government had let them merge, speculate, expand and experiment on dimensions beyond all logic. That is why the complicit politicians and regulators have to talk about $100 billion here and $1 trillion there even while they pretend that it’s all under control and that the run-amok financial sector remains sound.

Posted by James on Apr 09, 2009

Are children consumption goods or our nation's future?

Princeton economist Uwe Reinhardt says all U.S. children should receive free healthcare till age 22. He works up to his conclusion with a wonderful question. I wonder how the millions of “government-paid healthcare equals socialism” Americans would answer this question:

Do [Americans] view children as the human analogs of pets? Or do they view them, as do most Europeans and Asians, as precious national treasures? Perhaps a mixture of both?

This is not meant to be a frivolous question. Its answer informs the nation’s health policy.

If one views children primarily as the human analog of their parents’ pets, then it follows that children’s health care is primarily the parents’ financial responsibility, although one might extend public subsidies to very poor parents to help them care for their children adequately. On this view it is just and proper that, of two households with identical incomes, the one with children will have substantially less discretionary income after necessities than does the childless household.

On the other hand, if one views children as national treasures — and the nation’s economic future — then it makes sense to make the health care of children the financial responsibility of society as a whole, just as is the financing of public elementary and secondary education. Why treat children’s education as a social good, but their health care as a private consumption good?

The “children are our future” perspective is even more apt given the massive debt America is accumulating and the underfunding of future Social Security liabilities. The present generation is financing its present and future consumption on the backs of the next generation. Should we not at least be keeping them healthy as children so they can be our future in more than a slogan?

Posted by James on Apr 24, 2009

Bank bailout: $12.8 trillion and counting

Bloomberg reports:

The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year…

The money works out to $42,105 for every man, woman and child in the U.S. and 14 times the $899.8 billion of currency in circulation. The nation’s gross domestic product was $14.2 trillion in 2008…

$42,000 per man, woman and child. Wow. Just a few months ago, I was shocked to declare “Bank bailout potential cost: $10,000 per American!” In fairness, “only” $4.2 trillion has actually been spent so far. But that number will — with 100% certainty — rise dramatically.

History’s most massive robbery.

The combined commitment has increased by 73 percent since November, when Bloomberg first estimated the funding, loans and guarantees at $7.4 trillion.

After the Bush Administration, I foolishly thought things couldn’t get worse.

Posted by James on Apr 12, 2009

Bank bailout excessively costly because healthy banks also receiving taxpayer gifts

Capitalism calls for equity owners of insolvent banks to be wiped out, bond holders to suffer losses, and executives who sank their banks to be fired. So it’s bad enough the Treasury and Federal Reserve are spending trillions of taxpayer dollars to bail out insolvent banks.

But the Geithner plan’s mechanism for rescuing banks is excessively costly to taxpayers and ridiculously generous to financial firms:

Now, Paul Krugman notes that the Geithner plan for bailing out insolvent banks does so by substantially overpaying for all toxic assets… even toxic assets held by healthy banks. This indiscriminate approach costs taxpayers much more — and benefits Wall Street much more — than a direct bailout of insolvent banks would have.

The question isn’t whether “the banks” are insolvent; most surely aren’t. Instead, some banks are probably insolvent…

And that, in a broad sense, is what’s wrong with TARPish rescue schemes. They try to fix the banks by driving up the price of a whole asset class. Most of those assets are NOT held by the probably insolvent banks. So it’s a diffuse, inefficient way of tackling the problem — a taxpayer subsidy to basically anyone holding toxic waste legacy assets, rather than a direct infusion of funds where needed. Contrast it with what the FDIC does when it moves in: it doesn’t shower money on banks in general, hoping that this will solve the problem; it seizes banks that are in trouble, and recapitalizes them.

Posted by James on Apr 02, 2009

Boring banks support economic growth; risk-loving banks drive the economy off a cliff

Paul Krugman calls our attention to the sexily titled (as only economists can) Wages and Human Capital in the U.S. Financial Industry: 1909-2006. Its authors, Thomas Philippon and Ariell Reshef, find:

From 1909 to 1933 the financial sector was a high skill, high wage industry. A dramatic shift occurred during the 1930s: the financial sector rapidly lost its high human capital and its wage premium relative to the rest of the private sector. The decline continued at a more moderate pace from 1950 to 1980. By that time, wages in the financial sector were similar, on average, to wages in the rest of the economy. From 1980 onward, another dramatic shift occurred. The financial sector became once again a high skill, high wage industry. Strikingly, by the end of the sample relative wages and relative education levels went back almost exactly to their pre-1930s levels.

In other words, pre-1930 financial jobs and post-1980 financial jobs were complicated and very well paid. From 1930 through 1980, banking was boring and finance jobs didn’t pay particularly well. (The authors calculate that financial industry wages are currently 40% too high relative to what similar workers earn in other industries.)

Why? The authors say the pre-1930 and post-1980 financial industries share another characteristic: minimal regulation. The complexity of financial industry jobs and the high pay during low-regulation eras reflects creative scheming to make money in ways not permitted from 1930 through 1980:

Our investigation of the causes of this pattern reveals a very tight link between deregulation and human capital in the financial sector. Highly skilled labor left the financial sector in the wake of the Depression era regulations, and started flowing back precisely when these regulations were removed. This link holds both for finance as a whole, as well as for subsectors within finance. Along with our relative complexity indices, this suggests that regulation inhibits the ability to exploit the creativity and innovation of educated and skilled workers. Deregulation unleashes creativity and innovation and increases demand for skilled workers.

This begs the question: “Do we prefer unregulated banks that engage in complex, creative schemes to maximize their wealth or regulated, boring banks?” The question answers itself.

The pre-1930 and post-1980 eras both culminated in massive bank failures and triggered prolonged global economic downturns: “The Great Depression” and the current “Great Recession.” (Admittedly, the U.S. government has not allowed/forced megabanks into bankruptcy/reorganization, but the banks have certainly failed… Otherwise, they wouldn’t need multi-trillion-dollar bailouts.)

Conversely, the simple, well-regulated financial system that reigned from 1933 through 1980 coincided with tremendous economic growth in America and the world.

That’s why Paul Krugman is calling for strong regulation that will make banking boring again and take the huge profits (and its corollary: risk taking) out of banking. Krugman correctly views banking as an industry that should support the rest of the economy, not drive the economy… to the point of occasionally driving it off a cliff:

Policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

One final finding of the paper is the difficulty of enforcing financial regulations in a low-regulation era. Because deregulation drives up both financial industry pay and the level of financial innovation/complexity, the government’s ability to attract skilled regulators falls exactly when it most needs skilled regulators:

Following the crisis of 1930-1933 and 2007-2008, regulators have been blamed for lax oversight. In retrospect, it is clear that regulators did not have the human capital to keep up with the financial industry, and to understand it well enough to be able to exert effective regulation. Given the wage premia that we document, it was impossible for regulators to attract and retain highly-skilled financial workers, because they could not compete with private sector wages.

Posted by James on Apr 10, 2009

Broken U.S. educational system costing America $2 trillion/year!

A new McKinsey study — “The Economic Impact of the Achievement Gap in America’s Schools” — paints a shameful picture of American education and estimates that better education would increase GDP an astonishing $2 trillion per year:

If the United States had in recent years closed the gap between its educational achievement levels and those of better-performing nations such as Finland and Korea, GDP in 2008 could have been $1.3 trillion to $2.3 trillion higher. This represents 9 to 16 percent of GDP.

Before analyzing just how poorly American students perform relative to students overseas, let me start with a caveat: The “U.S. educational system” is broken, but it’s hardly just the fault of teachers and schools. Students aren’t showing up at school prepared and eager to study. Just off the top of my head, I would suggest these likely culprits: * dangerous communities (bullying, crime, guns, drugs) * strong strain of anti-intellectualism * video game culture * junk food * poor parenting * skipping breakfast * dysfunctional and broken homes (esp. missing fathers) * weak communities with few role models, few mentors, and little hope * materialistic culture & hanging out at malls * evangelical religion (esp. anathema to science education) * language and cultural barriers not present in homogeneous high-scoring nations like Finland, Korea and Japan

So, just how poorly are American students performing?

The Program for International Student Assessment (PISA) is a respected international comparison of 15-year-olds by the OECD that measures “real-world” (applied) learning and problem-solving ability. In 2006 the United States ranked 25th of 30 nations in math and 24th of 30 in science…

The longer American children are in school, the worse they perform compared to their international peers. In recent cross-country comparisons of fourth grade reading, math, and science, US students scored in the top quarter or top half of advanced nations. By age 15 these rankings drop to the bottom half…

The United States has among the smallest proportion of 15-year-olds performing at the highest levels of proficiency in math. Korea, Switzerland, Belgium, Finland, and the Czech Republic have at least five times the proportion of top performers as the United States…

The gap between students from rich and poor families is much more pronounced in the United States than in other OECD nations… A low-income student in the United States is far less likely to do well in school than a low-income student in Finland…

School spending in the United States is among the least cost-effective in the world. By one measure we get 60 percent less for our education dollars in terms of average test-score results than do other wealthy nations.

Posted by James on Apr 24, 2009

Candidate Obama vs. President Obama on "revolving door" lobbyists

I blogged two months ago about President Obama’s finance/economics advisor Larry Summers' conflicts of interest with failed banks, including Citigroup, that have received hundreds of billions in taxpayer bailouts and will soon receive hundreds of billions more, thanks to the Geithner plan.

Today’s New York Times provides a close-up look at another Summers conflict of interest, the $5.2 million he received and the two years he spent at the giant hedge fund D.E. Shaw.

Professor Summers may very well be an honorable man. He is, by every account, a brilliant man (though I’ve heard him lecture, and he’s not always a brilliant lecturer). But we’re all biased — consciously and unconsciously — by our associations and friendships and backgrounds. Only Dr. Spock could remain objective toward an institution that paid him millions, feted him, flew him around the world in high style and generally treated him like a king.

Presidential candidate Barack Obama swore to the American people that lobbyists “won’t find a job in my White House”:

We have the chance to tell all those corporate lobbyists that the days of them setting the agenda in Washington are over. …[W]hen I am President, they won’t find a job in my White House. Because real change isn’t another four years of defending lobbyists who don’t represent real Americans — it’s standing with working Americans who have seen their jobs disappear and their wages decline and their hope for the future slip further and further away.

President Barack Obama immediately made a mockery of presidential candidate Barack Obama’s promise by issuing waiver after waiver after waiver. A few of these waivers were legitimate. Advocates of the poor and voiceless who were registered Washington lobbyists deserved waivers. But advocates of the biggest megabanks seeking blockbuster bailouts aren’t “standing with working Americans” but with multinational megabanks seeking to drain taxpayers' bank accounts.

Larry Summers was never a registered lobbyist, so he’s not — technically — an exception to this “rule.” But his story epitomizes this vile revolving door that keeps Washington working for the largest multinational firms and defense contractors and insurance companies against the interests of ordinary Americans. The people appointed to top government posts all too often come from the industries they’re charged with regulating and return to those same companies after “serving the public” in Washington, DC. The revolving door is corrupt. Candidate Obama won public support by promising to shutter the very revolving door President Obama is helping swing open for agents of the largest corporations offering the largest bribes to Washington, DC decisionmakers.

Posted by James on Apr 06, 2009

CEOs anticipate lower sales, less investment, job cuts

Reuters reports:

U.S. chief executives' confidence in the economy fell further in the first quarter, setting a second consecutive all-time low…

The quarterly CEO Economic Outlook Index fell to negative 5 — the first negative reading in the survey’s six-year history — and down from a fourth-quarter reading of 16.5. A reading below 50 means CEOs expect contraction rather than growth.

The CEOs… said they now expect real U.S. gross domestic product to decline 1.9 percent this year…

71 percent — said they expected to cut their U.S. workforces over the next six months and 66 percent said they expect to reduce capital spending. That came as 67 percent said they expect lower sales over that period.

Posted by James on Apr 07, 2009

Congress and Greenspan ignored Ed Gramlich

19 months ago, the world lost an economist who fought mightily to prevent our current Great Recession:

Edward M. Gramlich, 68, a former Federal Reserve governor who unsuccessfully pushed Fed Chairman Alan Greenspan to crack down on irrational lending before the mortgage boom, died of leukemia…

Dr. Gramlich published “Subprime Mortgages: America’s Latest Boom and Bust” on a topic that he had warned about for years. Much earlier, as chairman of the Neighborhood Reinvestment Corp., he had urged lawmakers to better protect consumers against predatory lending practices and toughen the regulation of mortgage lenders and banks, calling the mortgage process “confusing, costly and far less than optimal.”

He continued that campaign as a Fed governor; in December 2000, he was among those who wanted to tighten regulation of high-cost home loans long before the current panic set in.

But as the liberal Democrat at a Fed that relied on industry self-regulation and shunned social objectives, Dr. Gramlich’s view did not often carry the day. In 2002, he again sounded the alarm, saying that the practices of subprime lenders, such as charging excessive fees and refinancing just to collect more fees, “jeopardize the twin American dreams of owning a home and building wealth.”

Posted by James on Apr 16, 2009

Dean Baker: Geithner's "reason" for rejecting bank bankruptcies is bogus

Economist Dean Baker raises some excellent objections to Treasury Secretary Geithner’s plan to “lend” an additional $1 trillion to banks and hedge funds and private equity firms (on a non-recourse basis… meaning the “loans” become gifts if the investments they buy go bad) to buy distressed assets from bankrupt megabanks.

His first objection is that $1 trillion “is equal to 300 million SCHIP kid years. Congress has had heated debates over sums that were a small fraction of this size.” Yet there has apparently been no serious consideration by Congress, the Treasury or the Federal Reserve of other options: “the Geithner crew insists that there are no alternatives to his plan; we have to just keep giving hundreds of billions of dollars to the banks.” Baker recommends funding “for the price of just a few A.I.G. executive bonuses” studies by renowned economists like (blog favorites) Simon Johnson and Joe Stiglitz. (One complaint about Baker’s article: Stiglitz, Johnson, Krugman et al. have already offered better plans than Geithner’s.)

A second objection is that even another $1 trillion may not even be enough. Taxpayers have already given banks about $700 billion. And the Federal Reserve has already given several trillion more. (No one knows the terms of the Fed gifts or even which banks received what, and even the TARP watchdog is clueless about how the $700 billion has been spent.) Megabanks' balance sheets are still opaque, so who’s to say whether even another $1 trillion will get these bankrupt banks lending again?

The Geithner plan is an effort to rescue the banks by using government funding to prop up the price of these bad loans to levels that will allow the banks to stay solvent. It is not clear that the plan is big enough to accomplish this goal, but that is the basic intention. If it doesn’t work, then presumably Geithner will come out with another TARP permutation that involves giving the banks even more money.

Baker’s biggest objection is that there’s likely a better solution — involving creditors of insolvent banks accepting less rather than being bailed out completely by taxpayers. Baker suggests that the bankers' “reason” for rejecting the bankruptcy option is disingenuous and their real motive is that they prefer a complete taxpayer-funded bailout to a capitalist-style bankruptcy in which investors take losses on their bad investments:

Geithner has supposedly ruled out the bankruptcy option because when he, along with Henry Paulson and Ben Bernanke, tried letting Lehman Brothers go under last fall, it didn’t turn out very well. Of course, it is not necessary to go the route of an uncontrolled bankruptcy that Geithner and Co. pursued with Lehman.

The government could set up an arranged bankruptcy under which creditors have accepted conditions in advance. While this may not be easy to negotiate, the government does have enormous bargaining power in pursuing such a deal. The creditors (other than insured deposits, which will be paid in full) of these banks may end up with nothing if the government just let the banks sink.

Posted by James on Apr 07, 2009

Did Bear Sterns' lenders bet it would fail and then stop lending?

Jon Stewart interviewed “House of Cards” author William Cohan:

William Cohan: [Bear Sterns] made the crucial mistake of financing themselves to the tune of $75 billion a night in what was called the Overnight Lending market, and when that confidence was lost, the people who had provided that every night didn’t want to do it any more…

Jon Stewart: Hedge fund managers… suddenly see, “Hey, nobody wants to lend to Bear Sterns any more. I’m going to bet that Bear Sterns stock goes from $70 to $25 in eight days!” …It’s the same people who [regularly lend] billions of dollars [to] Bear Sterns. So they pull their money out of Bear Sterns [and] use that money to bet that Bear Sterns is going to go down.

William Cohan: …It might even have been a criminal act. That’s what the SEC is supposedly investigating, although they’ve been doing it for a year.

Jon Stewart: Oh, I’m sure they’ll get to the bottom of it. I have all the confidence in the world.

William Cohan: That’s a good bet.

Given the secrecy of hedge funds and the many personal ties between banking institutions, it’s also possible that Banks A, B and C conspired to kill Bear Sterns while tipping off their friends at Hedge Funds D, E and F to place bets against Bear Stern’s survival.

Of course, it’s also possible Bear Sterns doomed itself. But we need a strong SEC to distinguish between conspiracy to destroy Bear Sterns and profit from its demise and Bear Sterns doing itself in through complete incompetence and reckless gambling. Markets need watchdogs or else market participants will engage in self-serving, competition-destroying behavior.

My guess: Bear Sterns doomed itself, but circling Wall Street sharks smelled blood in the water and attacked. Bear Sterns might have been terminally ill, but that doesn’t justify others killing it. If you kill a terminally ill person, it’s still murder, and you’re still prosecuted for killing that person.

Posted by James on Apr 14, 2009

Does Peter Orszag oppose Geithner's bank bailouts?

The New Yorker has an article on my old friend Peter Orszag, now Obama’s Budget Director. I’ve completely lost touch with Peter, but he was a close friend when we studied in the same economics M.Sc. program at the London School of Economics. I met the great Joe Stiglitz when Peter let me sit in on a meeting at the Council of Economic Advisors during the Clinton Administration. I ran with Peter on one of his now semi-famous jogs around DC. My wife and I attended Peter’s wedding and still eat off dishes he gave us for ours.

Enough name dropping. I mention our past friendship because it’s relevant to my analysis of Peter’s comments on the Wall Street mega-bailout. I know Peter is extremely smart. Even back in the early ‘90s, it was obvious he was destined to accomplish great things. At Harvard, Stanford and the LSE, I knew many very smart people, but few blew me away with their smarts the way Peter did. He grasped in seconds even the most difficult concepts thrown at us at the LSE.

So I’m somewhat surprised and disappointed by his apparent ignorance of the folly of Treasury Secretary Timothy Geithner’s infinite bankrupt bank subsidization program. He was like a deer trapped in the headlights by Jon Stewart’s questions:

“Why are they bailing out the banks?” Why not the borrowers? [Jon Stewart] went on, “These mortgages went bad, and then they were securitized, and blah blah blah. So that’s all there.” He held up a hand to represent mortgages. “So why not fix the mortgages, not the securities?”…

“Well, they’re doing that,” Orszag said.

“But it’s small,” Stewart said, noting that Obama’s mortgage-assistance program is tiny compared to the bank bailouts.

“Even if you just fix that”—Orszag pointed to Stewart’s hand—“you still need banks to lend to businesses.”

“But wouldn’t they, if you pay this?” Stewart waved his hand, rolling it into a fist.

“Not entirely.”

“Really? Why?”

“Paying all that would be even more expensive.” …

Stewart was not satisfied… He asked Orszag why the government didn’t just bail out borrowers who have defaulted. “The problem is, if you just focussed on the people who defaulted you create this huge incentive to default,” Orszag replied. Stewart looked at Orszag with an astonished grin. Before Stewart could finish pointing out that the government is creating an equally huge incentive by bailing out the financial firms Orszag realized that he had been backed into a corner: “Yeah, none of this is perfect!”

Stewart responded with high-pitched laughter, seeming to suggest that if Obama’s budget director doesn’t know the answer to these questions we are all doomed.

Orszag shrugged. “You know what? It’s good that I’m just the budget guy.” He added, more seriously, “I have to be more constrained, because it really is Geithner’s—so the more we talk budget the more free I can be.”

“He’s the bailout guy?”

“He’s the bailout guy,” Orszag said with a smile. “He gets sensitive about that.”

Orszag’s colleagues characterize him as something of a policy Eagle Scout, always prepared. For two months, I watched and listened to him interact with dozens of reporters—in conference calls, press breakfasts, live TV appearances from the White House—and I have interviewed him half a dozen times this year. His exchange with Stewart was the first time I saw him at a loss. After Stewart left the room, Orszag slumped on a couch and replayed the conversation. “I don’t know that I’m totally comfortable saying why are we not just helping the mortgages,” he said anxiously…

Orszag tried rehearsing a better response until he had crafted something that satisfied him. “The problem originated with mortgages, but it’s now spread well beyond,” he said, “so that even if you go back to the original problem it’s not like you’re—” He started again: “Say you initially got sick from something but then the illness is throughout your whole body.” He sounded more excited. “The infection has spread throughout your whole body! You can’t just go back and fix the hole in your arm. That’s the better answer.”

It is a better-sounding response, but it’s not truly an answer. The Peter Orszag I knew couldn’t rest until he had the answer, not an “answer.” This is a man whose then-girlfriend complained to me after they traveled throughout Italy on vacation that Peter had read an advanced mathematics book — I believe on control theory — the whole trip.

I see two possible explanations: 1) Peter is too busy with the budget to know what’s going on in the financial crisis; or, 2) Peter is not on board with the Geithner “solution” but feels compelled to defend it for political reasons, even though he knows it sucks.

I suspect it might be #2, given that Peter seems to be holding back his true thoughts (“the more we talk budget the more free I can be”) and implies that his offering opinions on the banking crisis bothers Geithner (“He gets sensitive about that”) and was close with Joe Stiglitz, an outspoken critic of the Geithner plan.

Posted by James on Apr 28, 2009

Economists finally discover what this blog long ago called the Geithner plan's biggest problem

18 days ago, I laid out the real problem with the Geithner plan. Ever since, I’ve been waiting to read that someone else figured this out too. I can’t believe it took so long, but economist Jeffrey Sachs today laid out the logic I spelled out 18 days ago:

The situation is even potentially more disastrous than we wrote. Insiders can easily game the system created by Geithner and Summers to cost up to a trillion dollars or more to the taxpayers.

Here’s how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

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

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

Paul Krugman agrees “his worries need to be taken seriously”:

I was starting to come to the conclusion that the plan would simply fizzle — that even though participating players would get a large put along with their free toaster, it wouldn’t be enough to raise the price they’re willing to pay to a level banks would be willing to sell at, rather than keep assets on the books at far above their true value. But once you take into account the possibility of insider deals, that all changes. As Jeff says, a bank can create an off-balance-sheet entity that buys bad assets for far more than they’re worth, using money borrowed from taxpayers, then defaults — in effect a straight transfer from taxpayers to stockholders.

Posted by James on Apr 08, 2009

Estate tax hits only 0.2% of estates

Tax-cut advocates try to scare ordinary Americans into supporting elimination of the estate tax by labeling it “the death tax” and pretending many Americans will have to pay it. They seldom present honest facts. The New York Times explains that the estate tax hits only the wealthiest of wealthy Americans and is far more fair than its critics claim:

The estate tax only [hits] couples with property worth more than $7 million, or individuals with property worth more than $3.5 million. That means 99.8 percent of estates will never — ever — pay a penny of estate tax.

The heirs of the remaining 0.2 percent of estates are who [Sen. Blanche] Lincoln (D-AR) and [Sen. Jon] Kyl (R-AZ) are so worried about. Their amendment would increase to $10 million the level at which the estate tax kicks in. It would also lower the top estate-tax rate to 35 percent from 45 percent…

In addition to creating the false impression that the estate tax eventually hits everyone — by mislabeling it a “death tax” — opponents routinely denounce the 45 percent top tax rate as confiscatory. In fact, the rate applies only to the portion of the estate that exceeds the exemption. As a result, even estates worth more than $20 million end up paying only about 20 percent in taxes.

Another misleading argument is that the estate tax represents double taxation. In truth, much of the wealth that is taxed at death has never been taxed before. That’s because such wealth is often accrued in the form of capital gains on stocks, real estate and other investments. Capital gains are not taxed until an asset is sold. Obviously, if someone dies owning an asset, he or she never sold it and thus never paid tax on the gain.

Posted by James on Apr 03, 2009

Even TARP watchdog clueless where taxpayer money's going

Talented and accomplished Harvard business law professor Elizabeth Warren is currently serving as “TARP watchdog,” a role she finds extremely frustrating because the Treasury is keeping her in the dark. Prof. Warren just testified before the Senate:

“We do not seem to be a priority for the Treasury Department,” said Warren.

She added that the administration’s failure to ask for more accountability has led to a situation that is difficult to oversee. “This problem starts with Treasury,” she said…

Warren argued that “continuous subsidization without vigorous oversight is exactly what got us into this.” She complimented the administration’s oversight of the auto industry, but contrasted it with the lack of the same with regard to the banks.

Posted by James on Apr 01, 2009

Fast-rising unemployment predicts further substantial house price declines

You don’t need fancy econometric analysis to see these series (British unemployment in red and average British house price in yellow) are negatively correlated:

Graph of British unemployment vs. British house prices

Original graph from MoneyWeek article.

Given that U.S. unemployment is taking off like a rocket (up from 6.9% in Q4 ‘08 to 8.5% in March '09) and many believe unemployment will exceed 10% — not to mention massive underemployment and millions more who have despaired of finding work and are thus not counted as “unemployed” — it’s virtually certain we’ll see continued substantial house price declines.

Posted by James on Apr 24, 2009

Feedback effects: Why NO ONE knows how bad things will get

When economies go haywire, forecasters look stupid because most forecasts use an algorithm that basically says “next year will look a lot like this year plus one year’s worth of trend growth.” If the trend growth rate is 2% per year, then next year will be like this year plus 2% growth.

Such simple models work reasonably well in “normal” times. But when they’re wrong, they can go horribly wrong. Why do forecasting models break down so quickly and completely?

A big reason is feedback effects. In economic equilibrium, small deviations from trend tend to adjust back toward the trend. But when any significant economic sectors or components of GDP swerve badly off course, all bets are off for the entire economy due to feedback effects.

I was reminded of this while reading “For Housing Crisis, the End Probably Isn’t Near”:

The glut of foreclosed homes creates a self-reinforcing cycle. Falling prices lead to more foreclosures. Foreclosures lead to an excess supply of homes for sale. The excess supply then leads to further price declines.

Another New York Times article, “As Housing Market Dips, More in U.S. Are Staying Put” mentions another feedback effect:

The number of people who changed residences declined to 35.2 million last year, the lowest number since 1962, when the nation had 120 million fewer people.

Experts said the lack of mobility was of concern on two fronts. It suggests that Americans were unable or unwilling to follow job opportunities around the country, as they have in the past. And they said the lack of movement itself could have an impact on the economy, reducing the economic activity generated by moves…

The American Moving and Storage Association said the number of people changing residences has been dropping for four years and fell 17.7 percent between 2007 and 2008.

Americans long took labor mobility for granted. It was easy to sell your house for a profit, easy to get a mortgage, and easy to buy a new — probably bigger — house with profits from your house sale. Consequently, moving to take a better job was simple, even if you had just lost your job.

But the current crisis has made it very hard to sell your home and harder still to borrow to buy a new home (esp. if you’ve lost your old job). So, many people are trapped in their current homes. Some of them have better opportunities elsewhere but can’t move. This hurts them (and their families) directly. It costs the government tax revenues. It costs real estate agents and mortgage companies. And it harms businesses who can no longer hire the best person for each job due to real estate market friction.

This is just one domino among many that have toppled — and will continue toppling — as our economy spirals further downward. Because the quantity, magnitude and interactions among these feedback effects are so large, no one knows how bad things will get. No forecasting model can forecast the economy with much precision. That’s a scary thought.

And — as if to prove my point — this economic uncertainty itself is another powerful domino knocking the economy even further below “normal” equilibrium. If businesses don’t know when the economy will turn around, they’ll eliminate jobs, slash costs and cut production… thereby accelerating the downturn and generating even more fear and uncertainty.

Posted by James on Apr 22, 2009

For $3 trillion less than bailout, we could have paid off every U.S. mortgage!

According to Federal Reserve data, household-owned real estate was worth about $20.6 trillion dollars at the end of 2006. That $20.6 trillion was divided almost equally between household equity ($10.8 trillion) and mortgage debt ($9.8 trillion).

So, $9.8 trillion could have paid off all residential mortgage debt in America.

In a previous post, I noted that Bloomberg reports the Federal Government and Federal Reserve have already “spent, lent or committed $12.8 trillion.”

We’ve already spent $3 trillion more than it would have cost to pay off all mortgages in America! And banks still don’t have strong balance sheets and still aren’t lending much.

Why didn’t we address the root cause of our troubles? More than 1 ½ years into this crisis, Congress is still bickering over whether to allow judges to adjust mortgage terms for homeowners who can’t cover payments and whose houses are worth less than they still owe.

And how can things be so bad that even a bailout $3 trillion larger than the value of all residential mortgage debt can’t fix things? Have some banks gambled that much on housing credit default swaps? If so, couldn’t we have solved that problem too by paying off all mortgages?

Posted by James on Apr 16, 2009

Free money: Rationalize two astonishingly inefficient sectors of U.S. economy

Two sectors of the U.S. economy — health care and education — are absurdly expensive for the value they provide.

The National Coalition on Health Care says:

Total [health care] spending was $2.4 TRILLION in 2007, or $7900 per person. Total health care spending represented 17 percent of the gross domestic product (GDP).

U.S. health care spending is expected to increase at similar levels for the next decade reaching $4.3 TRILLION in 2017, or 20 percent of GDP.

Much of that is wasted on unnecessary procedures, paperwork to screen out high-risk insurance applicants, unnecessary squabbling between insurance companies and hospitals, etc. And roughly 50 million Americans lack health insurance, so they don’t see a doctor until their health problems become severe and very expensive to treat.

Unsurprisingly, the World Health Organization’s World Health Report 2000 ranked the U.S. #1 in health spending, #37 in “overall health system performance” and #72 “On level of health.”

A personal example: My father-in-law visited an emergency room in 2007 — as the sharp pain he had experienced several hours earlier was fading away — just to be safe. The hospital insisted on admitting him over his objections. It never diagnosed or treated the problem. Just one day’s fruitless observation led to bills over $18,000. I used two different methods to estimate what the visit should have cost, and both methods suggested $2,500 was a more reasonable price.

But a patient’s “waste” is a hospital’s “profit.” And when hospitals hold the kind of monopoly power they wield over uninsured emergency room visitors (like my father-in-law who’s too old to get insurance but has not been in America on his green card long enough to qualify for government insurance), they exploit it. In America, the uninsured paradoxically pay far more for medical treatment than insurance companies pay for equivalent treatment:

In 2004, the rates charged to many uninsured and other “self-pay” patients for hospital services were often 2.5 times what most health insurers actually paid and more than three times the hospital’s Medicare-allowable costs. The gaps between rates charged to self-pay patients and those charged to other payers are much wider than they were in the mid-1980s, and they make it increasingly more difficult for some patients, especially the uninsured, to pay their hospital bills.

This is “price gouging” of desperate, sick, uninsured people who show up at your hospital and don’t have the luxury of shopping around for lower prices. (Price shopping is also impossible for non-emergency treatment because most hospitals refuse to publish their prices.) Hospitals can — and do — make up whatever prices they want for their services. Government does not regulate prices (at least here in Connecticut). I know because I complained all the way to the state Attorney General’s office and was told hospitals are free to charge whatever they want, even if hospital A is charging ten times what hospital B charges.

Education is another nightmare. Just last week, I blogged about how poorly American students perform on international tests. The facts below suggest throwing money at education won’t work. In 2003, USA Today reported that the U.S. tops the world in school spending but not test scores:

The United States spends more public and private money on education than other major countries, but its performance doesn’t measure up in areas ranging from high-school graduation rates to test scores in math, reading and science…

The United States spent $10,240 per student from elementary school through college in 2000, according to the report. The average was $6,361 among more than 25 nations…

[T]he United States… finished in the middle of the pack in its 15-year-olds' performance on math, reading and science in 2000, and its high-school graduation rate was below the international average in 2001… Declining performance as [American] students grow older served as a warning to the nation, [Education Secretary] Paige said.

In 2007, we were still not getting much for our money:

Experts say the correlation between spending and testing performance is not strong…

“It’s not necessarily so that states with higher spending have higher test scores,” said Tom Loveless, an education policy expert at the Brookings Institution think tank.

He said Washington, D.C., has among the highest spending in the country but its students have among the lowest scores on standardized tests, while some states like Montana with relatively low spending have fairly high performance on tests.

An interesting Op-Ed in The New York Times suggests waste is rampant in U.S. higher education — supposedly the envy of the world — too:

Most graduate programs in American universities produce a product for which there is no market (candidates for teaching positions that do not exist) and develop skills for which there is diminishing demand (research in subfields within subfields and publication in journals read by no one other than a few like-minded colleagues), all at a rapidly rising cost (sometimes well over $100,000 in student loans)…

[Our] mass-production university model has led to separation where there ought to be collaboration and to ever-increasing specialization. In my own religion department, for example, we have 10 faculty members, working in eight subfields, with little overlap. And as departments fragment, research and publication become more and more about less and less. Each academic becomes the trustee not of a branch of the sciences, but of limited knowledge that all too often is irrelevant for genuinely important problems. A colleague recently boasted to me that his best student was doing his dissertation on how the medieval theologian Duns Scotus used citations.

America’s broken health care and education sectors offer incredible opportunities for cutting costs while simultaneously improving outcomes. But incrementalism won’t get us there. Change requires vision plus political will. The potential savings are so immense that we should be able to buy off vested interests (i.e., compensate insurance companies, poor teachers, etc.) and still produce a better outcome for all.

Posted by James on Apr 27, 2009

"Frontline" offers peek inside corporate bribery

After criticizing a recent PBS Frontline episode on U.S. healthcare for ignoring the single-payer option despite the vocal objection of the story’s reporter, I must commend Frontline for its latest episode, Black Money.

Black Money offers a depressing glimpse inside the global world of corporate (and CIA) bribery, especially of government officials.

The show examines only a few cases already known to the public (BAE, Siemens, etc.) but demonstrates that bribery is far more widespread and substantial and salacious than I — naively — had imagined. Some firms apparently can’t sell their products and services without handing out very large bribes (like chartering a 747 for a bribees' lovely ladies and all the things they can buy that can be bought for them during their London shopping spree). And many firms fear they must bribe because everyone else is offering bribes. The show also makes clear that governments are perfectly willing to cover up illegal bribery, even after firms are caught red-handed. And journalists from different countries all agree politicians in their countries took bribes but were never punished.

One fact cheered me up: the largest bribes discussed were “only” several billion dollars. Given that we’re discussing multi-trillion-dollar taxpayer bailouts of failed banks, who could begrudge our friend “Bandar Bush” (former Saudi ambassador to the U.S. and long-time Bush family friend) a few billion dollars for greasing a military jet purchase from British Aerospace?

Former French magistrate Eva Joly nailed the truth when she said, “We are successful in fighting petty corruption and… probably medium corruption… But there [is] one rule for the powerful and other rules for other people. And the rule of law is not complete.” The same two sets of laws apply to failed small American banks (which are forced into bankruptcy) and failed mega banks (given trillions in taxpayer bailouts).

Posted by James on Apr 08, 2009

Geithner = Megabank lackey

Two weeks ago, I censored myself in my blog. I originally typed that Treasury Secretary Timothy Geithner was a long-time financial industry “lackey.” I hit the Backspace button and replaced it with “insider.”

Well, I want to uncensor myself after reading in The New York Times that “An examination of Mr. Geithner’s five years as president of the New York Fed… shows that he forged unusually close relationships with executives of Wall Street’s giant financial institutions. His actions, as a regulator and later a bailout king, often aligned with the industry’s interests and desires.”

The article begins with this astonishing story:

Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner… stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.

It documents Geithner’s cozy relationship with the megabanks he was “regulating”:

He ate lunch with senior executives from Citigroup, Goldman Sachs and Morgan Stanley at the Four Seasons restaurant or in their corporate dining rooms. He attended casual dinners at the homes of executives like Jamie Dimon, a member of the New York Fed board and the chief of JPMorgan Chase.

Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York.

Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman.

No wonder the Citibank/Goldman power brokers who gave so “generously” to the Obama campaign and run economic and finance policy in the Obama White House put Geithner in charge of the Treasury! Geithner has since given them everything they could possibly have hoped for:

The government has in many ways embraced his blue-sky prescription. Step by step, through an array of new programs, the Federal Reserve and Treasury have assumed an unprecedented role in the banking system, using unprecedented amounts of taxpayer money, to try to save the nation’s financiers from their own mistakes.

And more often than not, Mr. Geithner has been a leading architect of those bailouts, the activist at the head of the pack. He was the federal regulator most willing to “push the envelope,” said H. Rodgin Cohen, a prominent Wall Street lawyer who spoke frequently with Mr. Geithner.

…[L]awmakers, economists and even former Federal Reserve colleagues — say that the bailout Mr. Geithner has played such a central role in fashioning is overly generous to the financial industry at taxpayer expense.

As Colonel Kurtz (Marlon Brando) says in Apocalypse Now, “You’re an errand boy sent by grocery clerks to collect a bill.” Geithner is the errand boy of our current financial apocalypse.

Posted by James on Apr 27, 2009

Geithner: "Oops. We wasted your $700 billion"

The rationale for TARP (according to its marketers, who sought TARP bailouts for selfish reasons) was to get credit flowing again. Wall Street needed our trillions, we were told, because Main Street requires the big banks to lend it money.

Well, many months later, after trillions of dollars in taxpayer subsidies from the Treasury and the Federal Reserve, banks still aren’t lending much:

“To date, frankly, the evidence is mixed” that the federal assistance has eased the lending markets, Mr. Geithner said as he testified before the Congressional Oversight Panel.

This proves the crisis was never — as it was repeatedly billed by bailout proponents and a pliant financial press — a “liquidity crisis.” This crisis is about bankrupt banks and massive net worth deflation. Business and consumer consumption and investment demand plunged. Business and consumer credit-worthiness plunged. And, on the credit supply side, banks' loanable funds dried up because so many banks had gambled their way to massive negative equity.

If trillions of dollars had been spent adjusting mortgages, stimulating the economy directly and helping strengthen relatively healthy banks, rather than filling gaping holes in the sickest banks' (im)balance sheets, our economy would be much healthier today and on its way to recovery. Instead, we may now be unable to fund the stimulus we should have funded last year.

What a shame. At least if the world economy gets sucked into a black hole, we now know who to blame.

Posted by James on Apr 21, 2009

Global warming: Already past the tipping point to runaway warming?

Humanity has for so long delayed cutting fossil fuel use and researching alternative fuels that we must immediately and drastically slash fossil fuel consumption AND figure out how to entirely eliminate fossil fuel consumption within decades:

[Research by Germany’s Potsdam Institute for Climate Change Impact Research] suggests the G8 target of halving global emissions by 2050 (from 1990 levels) would leave a significant risk of breaching the 2C figure.

“Only a fast switch away from fossil fuels will give us a reasonable chance to avoid considerable warming,” said Dr Mainshausen.

“If we continue burning fossil fuels as we do, we will have exhausted the carbon budget in merely 20 years, and global warming will go well beyond 2C.”

Oxford University physicist Myles Allen says we must cut carbon emissions rapidly and figure out how to eliminate emissions entirely within a few decades. Otherwise, we’ll roast this planet:

“It took us 250 years to burn the first half trillion [tons of carbon], and on current projections we’ll burn the next half trillion in less than 40 years… To avoid dangerous climate change, we will have to limit the total amount of carbon we inject into the atmosphere, not just the emission rate in any given year… Climate policy needs an exit strategy; as well as reducing carbon emissions now, we need a plan for phasing out net emissions entirely.”

So far, global temperature has risen 0.7 degrees Celsius. Over 100 countries have pledged to do whatever necessary to keep temperatures from rising more than 2 degrees Celsius, but scientists now estimate accomplishing this will require keeping total CO2 emissions below 1 trillion tons. A 1 trillion ton limit requires humanity leave ¾ths of its known coal in the ground.

Even if we find the restraint not to burn our massive cheap coal reserves, 1 trillion tons of C02 could produce incredible warming. Reasonable estimates of the heating impact of 1 trillion tons range from 1.3C degrees to 3.9C degrees.

I fully expect the world’s efforts will prove too little, too late. We’ll likely see 4C degrees of warming within our lifetimes.

Horrifyingly, that probably means we’ll see even worse during our lifetimes because the analysis above doesn’t factored in feedback effects that could dramatically amplify the impact of humanity’s CO2 releases:

One big unknown is the stage at which dangerous tipping points would be reached that lead to further warming – for example the release of methane hydrate deposits in the Arctic. “My own feeling is that if we get to a 4 degree rise it is quite possible that we would begin to see a runaway increase,” said [the British government’s former chief scientific adviser, Sir David] King.

Given humanity’s unwillingness to slash its energy consumption before the crisis is completely obvious to all, I suspect it’s already too late to save Earth from ecological and biological catastrophe.

Our deepest shame is that we’ve denied reality for the 45 years we’ve known about this threat. We failed to use those 45 years to develop new energy sources and dramatically upgrade society’s energy efficiency (e.g., replacing cars and sprawl with vibrant cities and convenient public transportation).

We’ve now boxed ourselves into a corner. Since Americans couldn’t make even modest sacrifices one or two or three decades ago, why should anyone expect humanity to make far, far more draconian sacrifices now? The Chinese certainly feel entitled to pull themselves out of poverty by burning coal just as Americans did. A grand global bargain is possible, but I’m not optimistic. I’m praying for a breakthrough in solar or cold fusion or helium-3 harvesting.

Posted by James on Apr 30, 2009

Government boosting the economy and saving people money... in Australia

The Australian government is boosting its economy and giving residents cheap access to high-speed Internet that should further boost its economy:

The Australian government said on Tuesday that it would create a publicly owned company to build a national high-speed broadband network worth 43 billion Australian dollars, or $31 billion, in one of the largest state-sponsored Internet infrastructure upgrades in the world.

Prime Minister Kevin Rudd said the eight-year project would create up to 37,000 jobs at the peak of construction, giving a lift to the economy…

Mr. Rudd [chose] a superior but more expensive network that would deliver broadband speeds of up to 100 megabits a second — fast enough to download multiple movies simultaneously — to 90 percent of Australian buildings through fiber optic cables connected directly to the buildings. The remaining 10 percent will receive upgraded wireless access.

By contrast, Americans are stuck paying very high prices for very slow Internet access:

The fastest consumer broadband in the world is the 160-megabit-per-second service offered by J:Com, the largest cable company in Japan. Here’s how much the company had to invest to upgrade its network to provide that speed: $20 per home passed.

The cable modem needed for that speed costs about $60…

The experience in Japan suggests that the major cable systems in the United States might be able to increase the speed of their broadband service by five to 10 times right away. They might not need to charge much more for it than they do now and they’d still make as much money.

The cable industry here uses the same technology as J:Com. …[T]he monthly cost of bandwidth to connect a home to the Internet is minimal, executives say.

So what’s wrong with this picture in the United States? The cable companies, like Comcast and Cablevision, that are moving quickly to install the fast broadband technology, called Docsis 3, are charging as much as $140 a month for 50 Mbps service. Meanwhile other companies, like Time Warner Cable, are moving much more slowly to upgrade.

Competition, or the lack of it, goes a long way to explaining why the fees are higher in the United States. There is less competition in the United States than in many other countries. Broadband already has the highest profit margins of any product cable companies offer.

Why do American legislators allow telecom companies to price-gouge Americans? $$$$$$$$$, of course! Telecom companies “earn” massive profits because consumers have so few options. And consumers have so few options because telecom companies have bribed lobbied local, state and federal legislators with huge financial contributions.

When cities have attempted to provide citizens with Internet access, telecoms have fought back. Lawrence Lessig explained in March 2005:

Communism was defeated in Pennsylvania last year. Governor Ed Rendell signed into law a bill prohibiting the Reds in local government from offering free Wi-Fi throughout their municipalities. The action came after Philadelphia, where more than 50 percent of neighborhoods don’t have access to broadband, embarked on a $10 million wireless Internet project. City leaders had stepped in where the free market had failed. Of course, it’s a slippery slope from free Internet access to Karl Marx. So Rendell, the telecom industry’s latest toady, even while exempting the City of Brotherly Love, acted to spare Pennsylvania from this grave threat to its economic freedom…

[T]he communist menace has infiltrated governments everywhere. Ever notice those free photons as you walk the city at night? Ever think about the poor streetlamp companies, run out of business because municipalities deigned to do completely what private industry would do only incompletely? Or think about the scandal of public roads: How many tollbooth workers have lost their jobs because we no longer (since about the 18th century) fund all roads through private enterprise? Municipal buses compete with private taxis. City police departments hamper the growth at Pinkerton’s (now Securitas). It’s a national scandal. So let the principle that guided Rendell guide governments everywhere: If private industry can provide a service, however poorly or incompletely, then ban the government from competing. What’s true for Wi-Fi should be true for water.

No, I haven’t lost my mind. But this sort of insanity is raging across the US today. Pushed by lobbyists, at least 14 states have passed legislation similar to Pennsylvania’s. I’ve always wondered what almost $1 billion spent on lobbying state lawmakers gets you. Now I’m beginning to see.

Posted by James on Apr 07, 2009

Government of, by and for the megabanks

I’ve blogged several times since my March 21 post “Treasury invitation to screw taxpayers” about the massive collusion problem with Geithner’s plan to lend “buyers” of toxic assets up to 97% of the cost of their purchases using non-recourse loans the “buyers” can walk away from.

I was recently thrilled when an inspector general warned about this threat, and I’m now happy Bloomberg is reporting on the inspector general’s warning:

“In both the Legacy Loans Program and the Legacy Securities Program, the significant government-financed leverage presents a great incentive for collusion between the buyer and seller of the asset, or the buyer and other buyers, whereby, once again, the taxpayer takes a significant loss while others profit,” the report said.

One example from the report: Say a bank and a private- equity firm both agree that a group of the bank’s loans is worth $600 million. The private-equity firm, however, agrees to overpay for the loans and bid $840 million at auction. The private-equity firm invests $60 million, which the government matches with $60 million of TARP money, and which is leveraged by a $720 million loan guaranteed by the Federal Deposit Insurance Corp.

After the auction, the bank secretly pays the investor a $120 million kickback, or half the difference between the auction price and the real value. Even if the private-equity firm’s $60 million investment is wiped out, it still would get a $60 million profit because of the kickback. Meanwhile, the bank would make a $120 million profit, at taxpayer expense.

If I didn’t know the U.S. Treasury and U.S. Federal Reserve are both currently being run by and for the megabanks, it would simply amaze me that the U.S. Treasury would propose a plan potentially allowing banks to sell virtually worthless paper for trillions of dollars, with taxpayers picking up almost the entire cost to buy the nearly worthless junk. And it would amaze me far more that the Treasury has not (to my knowledge) altered its plan following very public alarms about collusive price manipulation to rip off taxpayers.

Posted by James on Apr 24, 2009

Highlights of Stiglitz interview

Highlights from Joe Stiglitz’s Der Spiegel interview:

It’s going to be bad, very bad. We’re experiencing the worst downturn since the Great Depression, and we haven’t reached the bottom yet. I’m very pessimistic…

The banks that survived 80 years ago continued to lend money. Today many banks aren’t lending money anymore…

We’re just throwing money at [failed banks] and they pay billions of it out in bonuses and dividends. We taxpayers are being robbed for all intents and purposes in order to reduce the losses that some wealthy people bear. This has to be changed.

We have to reorganize our bailout system for the financial sector. For one thing, any bank that actually lends should get money from the government; more money to small and medium-size banks in smaller towns and less to Wall Street institutions. The government must also accept the consequences when banks become insolvent… [T]hese institutions have to be nationalized, which even Alan Greenspan is now demanding. Then the government can close those business segments that have nothing to do with lending and make sure that the banks no longer organize esoteric stock deals that they themselves do not understand…

The American government does talk a lot about stricter regulation of financial markets. I doubt that it’s serious, though. The Americans have always been masters at changing a supposed regulation measure into further deregulation… Even within [the Obama] administration, there are a lot of officials who are only for cosmetic corrections.

Posted by James on Apr 06, 2009

IMF releases gory details on "severe recession inflicted by a massive financial crisis"

A year ago, the IMF predicted 3.8% growth for the world economy in 2009. In January, it predicted 0.5% growth. It now projects a global economic contraction of 1.9%. Three months from now???

The IMF has also raised its estimate of losses on distressed loans and securitized assets to $4.1 trillion. And it warns that its estimate of -1.9% growth may be optimistic:

The current outlook is exceptionally uncertain, with risks weighed to the downside. The dominant concern is that policies will continue to be insufficient to arrest the negative feedback between deteriorating financial conditions and weakening economies.

Its main fears that might push the global economy even lower:

  • “Rising corporate and household defaults that cause further falls in asset prices and greater losses across financial balance sheets”
  • “New systemic events that further complicate the task of restoring credibility”
  • “Fiscal and monetary policies may fail to gain traction, since high rates of precautionary saving could lower fiscal multipliers, and steps to ease funding could fail to slow the pace of deleveraging”

If you’re brave, you can read all the gruesome details or just the highlowlights or pick your favorite chapters.

Posted by James on Apr 22, 2009

Inspector General warns Geithner plan gives banks blank check from taxpayers' checkbook

I’m relieved that The Office of the Special Inspector General for the Troubled Asset Relief Program (TARP) is now warning about the threat of collusive massive overpayment for toxic assets that I warned about on March 21, one month ago:

The significant Government-financed leverage presents a great incentive for collusion between the buyer and seller of the asset, or the buyer and other buyers, whereby, once again, the taxpayer takes a significant loss while others profit.

An inspector general warning is hardly a guarantee the government will prevent banks from grabbing all the free taxpayer money they want using the insane government subsidies (non-recourse loans up to 97% of the value of assets “purchased” by private parties). But at least the concern is in the public record. Geithner can’t later claim, “I never imagined my scheme would let banks rip off taxpayers so badly.” And, hopefully, Congress or the Treasury will change the scheme to not give banks blank checks from the taxpayers' checkbook.

Posted by James on Apr 21, 2009

Joe the Nobel Prize-winner

Though Joe Stiglitz misses the biggest threat to taxpayers from the latest Geithner plan, he still argues convincingly against the plan’s massive taxpayer subsidies to “buyers”:

The administration’s plan is [supposedly] based on letting the market determine the prices of the banks’ “toxic assets”… The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets…

The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, …they primarily “value” their potential gains. This is exactly the same as being given an option.

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses…

Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan…

What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other…

So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets.

Posted by James on Apr 01, 2009

Londoners love Dubai's slaves: "That's what we come for! It's great, you can't do anything for yourself!"

The marvelous British newspaper The Independent just ran an expose titled “The Dark Side of Dubai”. The slavery stories are horrific, but I was even more appalled by the glee with which some British tourists express how much they love Dubai’s slaves:

[Dubai] was built by slaves. They are building it now…

[T]he foreign underclass who built the city… are trapped here. They are hidden in plain view. You see them everywhere, in dirt-caked blue uniforms, being shouted at by their superiors, like a chain gang…

The hundreds of thousands of young men who build Dubai are bussed from their sites to a vast concrete wasteland an hour out of town, where they are quarantined away. Until a few years ago they were shuttled back and forth on cattle trucks, but the expats complained this was unsightly, so now they are shunted on small metal buses that function like greenhouses in the desert heat…

Sonapur is a rubble-strewn patchwork of miles and miles of identical concrete buildings. Some 300,000 men live piled up here, in a place whose name in Hindi means “City of Gold”. In the first camp I stop at – riven with the smell of sewage and sweat – the men huddle around, eager to tell someone, anyone, what is happening to them.

Sahinal Monir, a slim 24-year-old from the deltas of Bangladesh. “To get you here, they tell you Dubai is heaven. Then you get here and realise it is hell,” he says. Four years ago, an employment agent arrived in Sahinal’s village in Southern Bangladesh. He told the men of the village that there was a place where they could earn 40,000 takka a month (£400) just for working nine-to-five on construction projects. It was a place where they would be given great accommodation, great food, and treated well. All they had to do was pay an up-front fee of 220,000 takka (£2,300) for the work visa – a fee they’d pay off in the first six months, easy. So Sahinal sold his family land, and took out a loan from the local lender, to head to this paradise.

As soon as he arrived at Dubai airport, his passport was taken from him by his construction company. He has not seen it since. He was told brusquely that from now on he would be working 14-hour days in the desert heat – where western tourists are advised not to stay outside for even five minutes in summer, when it hits 55 degrees [Celsius, i.e., 131 degrees Fahrenheit] – for 500 dirhams a month (£90), less than a quarter of the wage he was promised. If you don’t like it, the company told him, go home. “But how can I go home? You have my passport, and I have no money for the ticket,” he said. “Well, then you’d better get to work,” they replied.

…[H]e was going to have to work for more than two years just to pay for the cost of getting here – and all to earn less than he did in Bangladesh.

…[H]e lives [in one room] with 11 other men. …[T]he lavatories… are backed up with excrement and clouds of black flies. There is no air conditioning or fans, so the heat is “unbearable. You cannot sleep. All you do is sweat and scratch all night.” At the height of summer, people sleep on the floor, on the roof, anywhere where they can pray for a moment of breeze.

The water delivered to the camp in huge white containers isn’t properly desalinated: it tastes of salt. “It makes us sick, but we have nothing else to drink,” he says.

The work is “the worst in the world,” he says. “You have to carry 50kg [110 lbs] bricks and blocks of cement in the worst heat imaginable … This heat – it is like nothing else. You sweat so much you can’t pee, not for days or weeks. It’s like all the liquid comes out through your skin and you stink. You become dizzy and sick but you aren’t allowed to stop, except for an hour in the afternoon. You know if you drop anything or slip, you could die. If you take time off sick, your wages are docked, and you are trapped here even longer.”

…“Nobody shows their anger. You can’t. You get put in jail for a long time, then deported.” Last year, some workers went on strike after they were not given their wages for four months. The Dubai police surrounded their camps with razor-wire and water-cannons and blasted them out and back to work. The “ringleaders” were imprisoned…

Since the recession hit, they say, the electricity has been cut off in dozens of the camps, and the men have not been paid for months. Their companies have disappeared with their passports and their pay. “We have been robbed of everything. Even if somehow we get back to Bangladesh, the loan sharks will demand we repay our loans immediately, and when we can’t, we’ll be sent to prison.”

…A British man who used to work on construction projects told me: “There’s a huge number of suicides in the camps and on the construction sites, but they’re not reported. They’re described as ‘accidents’.” Even then, their families aren’t free: they simply inherit the debts.

If you’re not yet feeling ill, you will now. The journalist, Johann Hari, stopped two modern Londoners who’ve visited Dubai many times — so they must know it’s a slave city. They squeal with delight over being pampered by the slaves:

The most famous hotel in Dubai – the proud icon of the city – is the Burj al Arab hotel, sitting on the shore, shaped like a giant glass sailing boat. In the lobby, I start chatting to a couple from London who work in the City. They have been coming to Dubai for 10 years now, and they say they love it….

My patience frayed by all this excess, I find myself snapping: doesn’t the omnipresent slave class bother you? I hope they misunderstood me, because the woman replied: “That’s what we come for! It’s great, you can’t do anything for yourself!” Her husband chimes in: “When you go to the toilet, they open the door, they turn on the tap – the only thing they don’t do is take it out for you when you have a piss!” And they both fall about laughing.

I’d like to believe the author stumbled upon a completely non-representative couple, but I suspect not.

Posted by James on Apr 07, 2009

Markets are always correct... except when they're totally wrong

For several decades, banks have successfully begged Washington, DC to eliminate regulation after regulation (and neuter regulatory agency after regulatory agency) by arguing free markets know best and are self-monitoring and self-correcting.

So it’s deeply ironic that — many trillions of dollars in losses later — those same banks and bankers have successfully begged Washington, DC for multi-trillion-dollar bailouts by claiming their “losses” aren’t really losses. They claim their “toxic assets” are really quite valuable. It’s just that the mean old market is systematically under-valuing them, so they need a few trillion dollars to get themselves through this rough patch. It’s not a bailout. It’s a bridge loan. In exchange for our warehouses full of fresh $100 dollar bills, banks are oh-so-reluctantly giving the Federal Reserve their really valuable mortgage debt that the suddenly insane financial marketplace is systematically undervaluing.

The report of the Congressional Oversight panel headed by Harvard Law Professor Elizabeth Warren highlights that Treasury Secretary Geithner (a long-time banking industry insider) is playing along with the megabanks' charade by avoiding the obvious and time-tested solutions — liquidation and government reorganization — advocated by virtually all sensible unbiased economists. Geithner has instead chosen the most industry-friendly approach: massive direct and indirect subsidies, which, the report warns, carries three risks: 1) “obscuring true valuations”; 2) “distorting both specific markets and the larger economy”; and, 3) “that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery.”

One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.

If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. Current prices may, in fact, prove not to be explainable without the liquidity factor….

On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth.

So, instead of reorganizing bankrupt banks — as capitalist economies are supposed to — taxpayers are paying failed banks trillions in subsidies on Geithner’s hunch that current market prices are absurdly low and poised to bounce back strongly, a hunch completely at odds with decades of banking industry deregulation propaganda.

Posted by James on Apr 13, 2009

"No health insurance" disease kills 22,000 Americans annually

According to The Urban Institute:

In 2002, the Institute of Medicine (IOM) estimated that 18,000 Americans died in 2000 because they were uninsured. Since then, the number of uninsured has grown. Based on the IOM’s methodology and subsequent Census Bureau estimates of insurance coverage, 137,000 people died from 2000 through 2006 because they lacked health insurance, including 22,000 people in 2006.

In 2006, the U.S. economy was still “strong.” Five million Americans have recently lost their jobs, and many more are now working at lower-paying or part-time jobs that don’t offer health care. So perhaps five million American families have lost their health insurance since this estimate of 22,000 dead per year. The number is probably already much higher and continuing to rise.

Posted by James on Apr 08, 2009

Nouriel Roubini predicted financial catastrophe with "holistic" analysis

Because modern society is extremely specialized, most of us live our professional lives within a tiny intellectual box. (Many of us also work inside a tiny physical box, a “cubicle.”) We write certain kinds of computer programs. We fix certain types of cars. We handle certain types of legal cases. We install certain brands of HVAC machines.

In many fields, such extreme specialization is efficient. You don’t need to know how to cook truffles if you run a school cafeteria.

But fields requiring prediction of human (business, social, governmental) behavior require broad thinking.

Sadly, the social sciences in American universities are specialized to an extreme. While earning my degrees in government and economics at top U.S. universities, I always felt constrained in both the methodologies I could employ and the geographies I could study. For example, it was doctrine that people act rationally. Deviations from rationality were considered random mistakes, trivialities to be ignored. Psychologists had uncovered many ways in which human brains are systematically biased and flawed, but the programs I studied in never allowed psychological models to form the basis of an economic or political science model. Similarly, studying the United States was strongly encouraged. Studying Europe was acceptable. Studying other countries was frowned upon. I wanted to study China, but, 15 years ago, few U.S. academics cared about China.

Another huge problem in modern academia is the glorification of mathematical models that ignore many real-world complexities. By focusing in on an important dimension of the problem, such “toy” models can be extremely revealing. But they almost never capture every important aspect of a problem. Consequently, excessive reliance on mathematical models can produce horrible results.

One immediate example: the models used by banks and ratings agencies that said aggregations of sub-prime and Alt-A mortgages were extremely safe. These models all built into them the assumption that housing prices would keep rising because U.S. house prices had never fallen year-over-year at a national level. But huge housing crashes had occurred elsewhere, like Hong Kong and Japan. And huge price crashes had hit particular American cities, like Houston. Excessive reliance on simple models and on data from the United States led to a massive underestimate of mortgage risk.

So I’m fascinated with how those who predicted this crisis did so. Nouriel Roubini says he anticipated the crisis through knowledge of Asian and Latin American monetary crises and “holistic” analysis:

While following the Asian and Latin American monetary crises in the late 1990s, he saw similarities be­tween developing countries and the U.S., arguing that they all fostered crony capitalists and tended to run huge current-account deficits. (In other words, they spent more money than they were taking in. In the case of the U.S., it’s like we were using an in-store credit card at a retailer named China.) He became convinced that the U.S. had the potential to be the biggest bubble of all, and by 2004, he was speaking and writing about his belief that the country was facing economic catastrophe.

Roubini calls his economic approach “holistic.” Instead of primarily studying mathematical models and formulas, he says he also draws his ideas from history, literature, and international politics. He maintains that this eclectic approach is what helped him be so prescient…

The article that arguably made his career, “The Rising Risk of a Systemic Financial Meltdown: The 12 Steps to Financial Disaster,” was posted on February 5, 2008. It pegged the start of the recession to December 2007 (dead accurate, it turned out) and warned that the downturn would be extremely severe, thanks to the continuing housing bust and the bursting of the credit bubble, which would, in turn, lead to an intense credit contraction and a “serious and protracted” falloff in consumer spending. For good measure, he also predicted the failure of at least one bank with heavy exposure to mortgages and major problems in the shadow banking system, which would affect everything from hedge and money-market funds to investment banks and structured investment vehicles. Losses on credit default swaps, he predicted, could lead to the bankruptcy of a “large broker dealer,” and the entire chain of sorry events would cause an inevitable downward spiral. Bear Stearns collapsed a little more than a month later.

Posted by James on Apr 04, 2009

Obama speech shows Obama's listening only to banking industry insiders

More than two months ago I blogged that Obama, as smart as he is, doesn’t know economics and was listening to the wrong people. Sadly, today’s Obama speech shows he’s still not listening to the many informed, disinterested voices of economic reason (Stiglitz, Krugman, Johnson, et al.).

Unlike JFK during the Cuban Missile Crisis, who insisted on hearing all viewpoints, Obama is listening only to banking industry insiders. He’s not hearing from former IMF and World Bank chief economists and Nobel Prize-winning economists who have been shouting in unison that the Geithner/Summers open-ended subsidies approach is terrible.

Henry Blodget is not a great economist, but Blodget does a good job breaking down the major flaws in Obama’s speech. His conclusion:

I wish Obama didn’t spend so much time hanging out with Tim Geithner and Larry Summers, who I assume are responsible for the mistakes Obama continues to make in his diagnosis and treatment of the banking problem…

I’m glad I voted for Obama, and I’d do it again. But I wish he would spend a few minutes listening to Paul Krugman, Joe Stiglitz, or any of the dozens of other folks who have a better handle on the problem.

There’s another possible explanation for Obama’s apparent ignorance of the Krugman-Stiglitz-Johnson view, suggested in a comment on Blodget’s post:

I agree that President Obama is highly intelligent so I don’t buy the idea that he is being misled by Geithner and Summers or that he is somewhat naive about all this finance stuff. He KNOWS that his policy will save the rich at the expense of everyone else and that it will be more expensive in the long run and keep the economy weak. He KNOWS this and he is stubbornly going through with it anyway, looking every bit as close-minded on THIS issue as Dubya was on so many others. So, the question is why? And the answer isn’t pretty.

Posted by James on Apr 14, 2009

Paying off mortgages would also have provided $700 bil. stimulus via wealth effect

Half-jokingly, I yesterday noted that For $3 trillion less than bailout, we could have paid off every U.S. mortgage!.

I should have mentioned an additional attraction of bailing out bad mortgages rather than bad banks: Paying off mortgages would have dramatically stimulated the economy and pulled us back closer to potential GDP. How? By boosting demand, thereby increasing the profitability of employing currently underutilized resources, via “the wealth effect”:

A one-dollar increase in housing wealth or stock wealth each lead to a long-run increase in consumer spending of about 5.5 cents.

Eighty percent of the effect of housing wealth on consumer spending — about 4.5 cents — occurs within one year while it takes several years for stocks to have the same effect on consumer spending.

Given that “The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion”, paying mortgages rather than banks would have generated over $700 billion in stimulus.

Posted by James on Apr 17, 2009

PBS' "Frontline" biases coverage to help insurance companies

In a nation as rich as America, basic medical coverage should be a right, not a privilege purchased from private insurance firms.

We could save tens of billions by eliminating the expensive paperwork insurance companies use to screen out high-risk health insurance applicants and to deny coverage to policyholders (by digging up evidence they had a “pre-existing condition”). And the U.S. government — negotating with hospitals and pharmaceutical companies on behalf of all Americans — would have great power to negotiate major price cuts in the absurdly expensive American healthcare system.

By cutting out insurance companies, a “single-payer” system would be far more efficient than our present system. The logic is completely clear.

Why then did PBS' Frontline slant its coverage of healthcare in America to the benefit of insurance companies?

Even though Reid did the reporting for the film, he was cut out of the film when it aired this week.

And the film didn’t present Reid’s bottom line for health care reform — don’t let health insurance companies profit from selling basic health insurance. They can sell for-profit insurance for extras – breast enlargements, botox, hair transplants. But not for the basic health needs of the American people.

Instead, the film that aired Monday pushed the view that Americans be required to purchase health insurance from for-profit companies…

“We spent months shooting that film,” Reid explains. “I was the correspondent. We did our last interview on January 6. The producers went to Boston and made the documentary. About late February I saw it for the first time. And I told them I disagreed with it. They listened to me, but they didn’t want to change it.”

…“I said I’m not going to be in a film that contradicts my previous film and my book. They said – I had to be in the film because I was under contract. I insisted that I couldn’t be. And we parted ways.”

“Doctors, hospitals, nurses, labs can all be for-profit,” Reid said. “But the payment system has to be non-profit. All the other countries have agreed on that. We are the only one that allows health insurance companies to make a profit. You can’t allow a profit to be made on the basic package of health insurance.”

Posted by James on Apr 03, 2009

Robert Shiller: Stimulus "not enough"; "unemployment rate... going much higher"

Embarrassingly few economists predicted the Great Recession, so I pay special attention to those who did. Robert Shiller is on this honor roll.

So I’m thrilled that I’ll attend next week’s CT Hedge Fund Association spring symposium at which Prof. Shiller is a panelist. I’m also thrilled to have been able to watch his “Financial Markets” class lectures online, thanks to Yale’s Open Yale Courses program.

Professor Shiller, along with Nobel Prize-winning economist George Akerlof, has written a new book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism and shares some of his insights (for free) in a Maclean’s interview yesterday.

Shiller is concerned about insufficient economic stimulus:

There’s a tendency all over the world to under-stimulate. In Canada, the Harper government has created a stimulus package but it’s small change, and that is not big enough. Similarly in the U.S. we had a stimulus package earlier this year of $787 billion. Again, it’s not enough.

He also says we waited too long to act:

One thing that we learn from the study of psychology is that ideally a stimulus package should come on strong before anything serious really happens, we want to apply the stimulus before massive numbers of people are laid off, because once they’re laid off it creates a different psychology that’s hard to correct. We’ve already missed that opportunity substantially, but of course I think the unemployment rate is at risk of going much higher.

More general thoughts about psychology and markets:

A. One thing that really drives the economy is the sense of opportunity that people get at certain times, the sense that this is a good time to start a business, the sense that I can take a long shot now, and I have to move fast because otherwise I’ll be overtaken by other people who are more on the spot, and that drives the economy to a fervent degree, and it’s exactly that sense that has disappeared now. It changes slowly, through a diffusion of ideas, like a social epidemic. Ideas spread the way jokes do. You know, someone invents a joke and it just spreads through millions of people by word of mouth. In the same way we have changes in ideas about what the economy means to us and how we fit in to it.

Q: What role did animal spirits play in leading us into this mess we’re in now?

A: Certain ideas, the idea that stock market investing is a road to riches, and then later the idea that investing in housing is a road to riches. These things infect our thinking on not only decisions about which investment to make but decisions about our lives. The last decade or so has been a time when we’re re-evaluating who we are and what is our purpose. The idea that we are smart investors in a capitalist world has been taking hold. The idea that, say, labour solidarity is important and that we want to be a good, dedicated teacher or nurse or something like that is somewhat diminished. We imagine ourselves to be capitalists on some level, even though recently it’s challenged by a sense of anger at capitalists who are making big profits when the economy is going down the tubes, but we did have kind of a gold rush mindset… One thing that has happened in recent years is a wave of gambling, not just in the U.S. but all over the world. Casinos have been opening up everywhere. Fifty years ago, lotteries were considered immoral or inappropriate. And now poker has become a legitimate spectator sport—that represents a real change. I may be over-interpreting this, but Texas Hold’em and other forms of poker are games that simulate aggressive, selfish personal profit pursuit. Poker is about bluffing, it’s about being dishonest, in a sense, and it’s not a family game.

Q: You argue as well that financial bubbles tend to be accompanied by corrupt and antisocial behaviour in the economy, hence the many financial scandals in recent years. I’d have thought that bad actors are just as prevalent in good times or in bad, but that they simply have more room to play in good times.

A: In good times people are more willing not to do due diligence. They think they have to get in fast to stay ahead of the game and they have a sense that other people aren’t doing due diligence, so they go along with it. It’s a time of trust and that becomes a time of opportunity for hucksters to do things, or if they aren’t hucksters at least people who are not really acting in good faith. Afterwards, when the confidence slips, people fall into a different mode: “You can’t trust anybody, and I’m not going to do anything because I’d have to do all this research to figure it out and I’m never going to do it.”

Posted by James on Apr 17, 2009

Roubini says government rigged "stress tests" to let banks pass

If trillions in taxpayer bailouts didn’t convince you our government is doing the bidding of bankrupt megabanks, here’s more proof. Economist (and predictor of our current financial crisis) Nouriel Roubini says the government’s so-called bank “stress tests” are rigged to let obviously sick banks pass. The “really bad” economic conditions in the “stress tests” are better than current economic conditions:

Macro data for Q1 on the three variables used in the stress tests – growth rate, unemployment rate, and home price depreciation – are already worse than those in FDIC baseline scenario for 2009 AND even worse than those for the more adverse stressed scenario for 2009. Thus, the stress test results are meaningless as actual data are already running worse than the worst case scenario.

The FDIC and Treasury used assumptions for the macro variables in 2009 and 2010 both the baseline and more adverse scenarios that are so optimistic that actual data for 2009 are already worse than the adverse scenario. And for some crucial variables such as the unemployment rate – that is key to proper estimates of default rates and recovery rates (given default) for residential mortgages, commercial mortgages, credit cards, auto loans, student loans and other banks loans – current trend show that by the end of 2009 the unemployment rate will be higher than the average unemployment rate assumed in the more adverse scenario for 2010, not for 2009! In other terms, the results of the stress test – even before they are published – are not worth the paper they are written on as they make assumptions on the economy that are much more optimistic –even in the worst scenarios that the FDIC has designed – than the actual figures for Q1 of 2009.

Ironically, this same sort of wishful thinking — “House prices will NEVER fall, so we’ll lend 100% (or even more) of any house’s value to anyone, no matter that they have no income to make payments” — created the housing market bubble! We’re now recycling this “logic” to keep alive zombie banks, which George Soros fears may “suck the lifeblood of the American economy.”

Posted by James on Apr 13, 2009

Senate: Trillions for irresponsible banks: "Of course"; Banks sharing house value losses: "No way"

The Federal Government and Federal Reserve have given over $12.8 TRILLION dollars to banks that irresponsibly lent to people they knew could not afford their mortgages and would default once the housing bubble collapsed.

But the Senate can’t stomach the idea of forcing banks holding mortgages to share some of the house value losses with homeowners:

Legislation to give bankruptcy judges the power to reduce home mortgage debt–by “cramming down” the principal–doesn’t appear to have enough votes and will be stripped out of a broader housing bill in the Senate.

The cram-down effort is a major plank of President Barack Obama’s housing rescue, which also offers financial incentives to mortgage servicers to modify loans and allows some homeowners with little to no equity to refinance.

The cram-down measure already passed the House of Representatives as part of the housing rescue. But it faced heavy opposition from the banking industry.

This is insane pandering to rich corporations over ordinary Americans because the rationale for gifting the banks TRILLIONS in the first place is banks' large losses on mortgages. The Senate now says banks should keep the TRILLIONS without suffering any mortgage losses. Homeowners in cities where house prices have fallen 30% to 50% should bail themselves out.

In America, we don’t help hurricane victims (Katrina) or homeowners hit by massive losses, but we eagerly gift TRILLIONS to irresponsible banks that knowingly took excessive risks they should not have.

Posted by James on Apr 28, 2009

Sen. Dick Durbin: "The banks... own [Congress]"

Failed mega-banks own the Obama Administration. It’s been depressingly clear since January that former-and-future employees of Citibank, Goldman et al. are running the bank bailout for their former-and-future employers' benefit.

Now, Senator Dick Durbin (D-IL) says those same mega-banks own Congress too:

The banks — hard to believe in a time when we’re facing a banking crisis that many of the banks created — are still the most powerful lobby on Capitol Hill. And they frankly own the place.

How ironic: Our mega-banks are bankrupt yet have spread so many hundreds of millions of dollars around D.C. that they literally “own the place”! Washington should never have allowed these banks to grow too big to fail. Washington should never have allowed these banks to escape even minimal regulation. Washington should have forced into restructuring — not showered with trillions in taxpayer money — every bank that took massive risks and lost. And Washington absolutely should not have incented and allowed those mega-banks to swallow up their smaller (former) competitors during this crisis… making them far-too-big-to-fail and guaranteeing higher prices for future banking services.

Washington, DC is totally broken. Our president promises hope and change… then lets Washington’s biggest lobby rob several generations of taxpayers blind.

How about a Constitutional Convention banning companies from purchasing Congressmen and presidents???

Posted by James on Apr 30, 2009

Shiller: When to ignore an expert

Private equity investor Stephen Schwarzman (who co-founded Blackstone Group) lectured in Robert Shiller’s Spring 2008 “Financial Markets” course. During the following lecture, Prof. Shiller politely suggested Schwarzman had spoken above his pay grade (or, more accurately, beyond his expertise) in falsely proclaiming what a wonderful time it was to buy distressed assets because the economy would soon be healthy again.

Prof. Shiller’s comment is something everyone should remember whenever listening to any “expert”:

[Steve Schwarzman] said very confidently… that this current financial crisis ought to be over in a year and that… investing in distressed securities now is an opportunity because, I think he pointed out, AAA mortgage securities are selling for 80-some cents on the dollar and it can’t be that bad. Well, this is the same theme that we got from [Yale endowment asset manager] David Swensen and I’ve heard it from others, that that’s the opportunity now.

When I hear Steve Schwartzman proclaiming that he thinks this… business crisis will be over before long, it made me wonder: Do I know more than he does about that sort of thing? Because I don’t think it’s going to be over soon.

Then it gets back to — I think — you have to put all these people in perspective. There’s so many different kinds of expertise. And when you listen to someone, you always have to ask, “Well, what does he or she know that is specific to their expertise?” And I don’t think Schwartzman is a macroeconomist. So, I don’t want to say he’s wrong, but… he might be wrong.

With a year’s hindsight, Shiller was obviously right and Schwarzman dead wrong. What’s interesting is that Shiller KNEW Schwarzman was wrong a year ago. That’s why it’s so valuable to listen to true experts on matters about which they are true experts.

Posted by James on Apr 20, 2009

Stiglitz: "[Obama plan]’s a recipe for Japanese-style malaise"

Bloomberg.com reports that Nobel Prize-winning economist Joe Stiglitz Says White House Ties to Wall Street Doom Bank Rescue:

“All the ingredients they have so far are weak, and there are several missing ingredients,” Stiglitz said in an interview. The people who designed the plans are “either in the pocket of the banks or they’re incompetent.”

The Troubled Asset Relief Program, or TARP, isn’t large enough to recapitalize the banking system, and the administration hasn’t been direct in addressing that shortfall, he said…

“We don’t have enough money, they don’t want to go back to Congress, and they don’t want to do it in an open way and they don’t want to get control” of the banks, a set of constraints that will guarantee failure, Stiglitz said.

The return to taxpayers from the TARP is as low as 25 cents on the dollar, he said. “The bank restructuring has been an absolute mess.”

Rather than continually buying small stakes in banks, weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said…

The $75 billion mortgage relief program, meanwhile, doesn’t do enough to help Americans who can’t afford to make their monthly payments, he said. It doesn’t reduce principal, doesn’t make changes in bankruptcy law that would help people work out debts, and doesn’t change the incentive to simply stop making payments once a mortgage is greater than the value of a house.

Posted by James on Apr 16, 2009

Taleb: "We're heading in exactly the wrong direction... This is going to fail"

If you ignore the financial experts who stand to personally benefit from the financial bailout and you ignore the “experts” who really aren’t experts, you’re left with a group of economists — including Nobel Prize-winners Paul Krugman and Joe Stiglitz and former IMF chief economist Simon Johnson — who agree the financial bailout of megabanks by taxpayers is wrong, wrong, wrong.

Another who predicted this financial collapse and understands what’s going on is Nassim Talib — professor of risk management and author of The Black Swan. Taleb — clearly in the Krugman-Stiglitz-Johnson camp — says the plan is unfair and won’t work:

“We’re heading in exactly the wrong direction,” Taleb said in a Bloomberg television interview. “I want an overhaul, I want something drastic. This is going to fail, this is not it.” …

“I don’t understand why I as a taxpayer need to subsidize those who failed, by giving them options so they can rebuild their balance sheets,” he said. “Taxpayers take the downside and Wall Street as usual is going to take the upside, another classical problem of socializing the losses, privatizing the gains.”

Taleb said it’s “shocking” that the government would allow banks to estimate the value of the toxic assets that remain on their books because there is effectively no market for the securities, making them almost impossible to value.

“I don’t understand letting banks mark to market, after all this incompetence,” he said. “Why don’t we allow people to mark their house at what they think the value of their house is?”

Posted by James on Apr 04, 2009

Teaching soldiers to murder defenseless prisoners is horrifyingly easy

Now 88, Ichiro Koyama served as a Japanese army soldier in Jinan, China during Japan’s World War II occupation of China, beginning when he was just 20. He tells his story hoping younger generations will avoid his generation’s mistakes. His story makes sickeningly clear how willingly most of us — men at least — will join in even as those around us murder countless defenseless prisoners:

One day, Koyama saw seven or eight Chinese men from a village in Zaozhuang, Shandong Province, blindfolded and tied to trees. They were being punished because they would not reveal the location of the Chinese Red Army. Seasoned soldiers ordered the green recruits to execute them for not cooperating.

“I was scared to kill a man at first,” Koyama said. “I felt much guiltier killing someone with a bayonet than with a pistol from 100 meters away.”

With his comrades, he tried to pierce a man’s heart, but was unable to because the victim kept squirming to avoid being stabbed.

Koyama eventually bayoneted the man in the stomach and shoulders. After his first killing, he said he was unable to eat. But eventually he started training new recruits to also execute their prisoners, justifying his actions by arguing he had no choice because it was war.

“It was hell,” he said. “I still cannot forget their blood spraying.”

Koyama said the new recruits, by this process, also got used to killing.

Posted by James on Apr 09, 2009

"The “Great Recession” label may turn out to be too optimistic"

The world economy so far is suffering even worse than during the Great Depression:

Globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimize this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years…

The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.

Posted by James on Apr 07, 2009

The many benefits of eating less meat

Since blogging about the incredible cruelty with which animals are treated on many/most farms, I’ve cut back on my meat consumption and am encouraging my family to cut back further.

Health is a second reason to eat more fruits, nuts, vegetables, and fish and less farm-grown meat, esp. red meat:

Over 10 years, eating the equivalent of a quarter-pound hamburger daily gave men in the study a 22 percent higher risk of dying of cancer and a 27 percent higher risk of dying of heart disease. That’s compared with those who ate the least red meat, just 5 ounces per week.

A third reason is the tremendous environmental benefits of eating plant-based foods. The Huffington Post reports that just one day’s meat consumption in America consumes an additional:

● 100 billion gallons of water, enough to supply all the homes in New England for almost 4 months; ● 1.5 billion pounds of crops otherwise fed to livestock, enough to feed the state of New Mexico for more than a year; ● 70 million gallons of gas—enough to fuel all the cars of Canada and Mexico combined with plenty to spare; ● 3 million acres of land, an area more than twice the size of Delaware; ● 33 tons of antibiotics. ● Greenhouse gas emissions equivalent to 1.2 million tons of CO2, as much as produced by all of France; ● 3 million tons of soil erosion and $70 million in resulting economic damages; ● 4.5 million tons of animal excrement; ● Almost 7 tons of ammonia emissions, a major air pollutant.

…According to Environmental Defense, if every American skipped one meal of chicken per week and substituted vegetarian foods instead, the carbon dioxide savings would be the same as taking more than half a million cars off of U.S. roads.

Nutrition Action also summarizes the benefits of a low-meat diet.

Posted by James on Apr 02, 2009

Time to tear down academic economics and rebuild?

The St. Louis Fed has posted some excellent economics papers on the financial crisis. What I really like about the ones I’ve read so far is that they’re full of rich historical facts, institutional details and thoughtful analysis and completely devoid of the fancy mathematical derivations that all too often substitute for substantive thinking in academic economics.

Coincidentally, another article, titled The Financial Crisis and the Systemic Failure of Academic Economics, grabbed my attention (while I was skimming through Research Papers in Economics). It declares:

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

Many economists with wonderful U.S. academic jobs know shockingly little about real businesses, consumers, or markets, esp. anywhere outside of America. Academic economics is so model-driven that fancy theoretical models are admired, even when completely contradicted by real economic behavior. Conversely, wonderfully insightful, empirically grounded, practical analyses of real economies that take into account real-world complexities are devalued (unless presented alongside fancy equations or statistical analysis).

We shouldn’t be surprised so many economists wear blinders because psychology was — for decades — banished from economics. The core premise of modern economics (at least when I was a grad student) — that people are rational, foresightful utility-maximizers — is quite at odds with reality. People are perhaps better described as emotional, backward-looking, information-constrained, prospect theory irrationalists. By treating human beings like robots, economists have been trying to describe and predict economic behavior with their hands tied behind their backs.

Given their lack of understanding of real economies and their false premises, many economists gave up trying to explain the messy real world and instead engaged in a form of navel-gazing called “pure economic theory.” It begins with premises true in some hyper-rational alternate universe populated with greedy robots and then derives predictions about how that alternate reality operates. The math is very impressive, but its utility is close to nil. Or, as the article above puts it:

The often heard definition of economics — that it is concerned with the ‘allocation of scarce resources’ — is short-sighted and misleading. It reduces economics to the study of optimal decisions in well-specified choice problems. Such research generally loses track of the inherent dynamics of economic systems and the instability that accompanies its complex dynamics. Without an adequate understanding of these processes, one is likely to miss the major factors that influence the economic sphere of our societies. The inadequate definition of economics often leads researchers to disregard questions about the coordination of actors and the possibility of coordination failures. Indeed, analysis of these issues would require a different type of mathematics than that which is generally used now by many prominent economic models.

It’s time to refocus the field on explaining/predicting real-world economic behavior. And you can’t do that without understanding human and social behavior. The iron wall between economics and the other social sciences has been coming down over the past decade. I hope the trend continues.

Posted by James on Apr 21, 2009

U.S. government ignored massive mortgage industry fraud

We’ve all now heard about the scoundrels who took out “liar loans” for homes far more expensive than they could afford and the greedy mortgage originators who winked at such buyers.

But have you heard that many of those greedy mortgage originators also engaged in other dirty tricks to drive up their fees at home buyers' expense?

What disturbs me is not that companies systematically ripped off consumers but that the federal government did nothing about it. In fact, the federal government basically doesn’t regulate the mortgage industry:

[Ameriquest] and its affiliates had grown to become the nation’s largest subprime mortgage lender when, in January 2006, Ameriquest coughed up $325 million to settle charges that it misled borrowers and falsified loan documents. Representatives of 49 states, the District of Columbia and even Northern California’s Alameda County signed off on the deal.

But as Ameriquest and its parent company cut the deal, Uncle Sam was noticeably absent. Ameriquest… wasn’t a deposit-taking bank or savings and loan, so it wasn’t subject to scrutiny by federal bank regulators…

[Wall Street] bought the loans and bundled them into what are now vilified as “toxic assets” — the poison at the “too big to fail” banks that have received the most federal bailout funds.

Even worse, the U.S. government failed to regulate all kinds of mortgage-related insurance policies and derivative contracts, which became the roulette wheel of the U.S. banking system, whose gambling losses we taxpayers are now paying off:

State-regulated insurer American International Group Inc., the largest bailout recipient, guaranteed billions of dollars of these mortgage-based bonds…

The U.S. Securities and Exchange Commission, for example, provided little oversight of mortgage-backed securities or the credit ratings firms that blessed them, said Chapman University law Professor Kurt Eggert, an expert in this “securitization” process.

“Whole chunks of the mortgage business, including securitization, were almost completely unregulated,” said Eggert, a former member of a consumer advisory panel for the Federal Reserve.

Creators and buyers of these bonds sometimes bought guarantees for the securities… using complex financial contracts called credit default swaps, which were supposed to reimburse investors if the bonds went bad. …The credit default swaps were largely unregulated.

Posted by James on Apr 21, 2009

What if the world de-globalizes? We should stress test our economy's exposure to this Black Swan

For centuries, successive communication, transportation and business revolutions have rendered our planet ever smaller. “Globalization” is the lastest episode in this longstanding trend. But — even as pundits declare our world “flat” — some now believe globalization is being thrown into reverse by climate change, energy crises, and economic crisis-driven protectionism.

How fragile is our society? Our economy? Our business models? And how significant are the threats to the status quo? Could someone or something shut down the Internet? Could a highly contagious bird flu cripple travel and trade? Could a rapid decline in oil production bring America to our knees? Could space debris or space wars return communication technologies to the pre-satellite era? Could economic crisis cause a seizing up of global trade as nations competitively raise tariff drawbridges to block other nations' products? Could rapidly rising sea levels leave billions homeless? Will global warming intensify water wars? Will CO2 ocean acidification kill off what’s left of the world’s fish stocks?

The threats are many, so we should be stress testing our business models and economic systems against these threats. We should also be taking steps to reduce our risk exposure.

One obvious defense against a collapse of globalization is increasing self-reliance. For example, a vertically integrated firm is less dependent/vulnerable than a firm that specializes in product design and marketing and has outsourced manufacturing to a global supply chain of manufacturers and transportation firms that could go bankrupt at any moment.

At a personal and community level, some are taking de-centralization and re-localization very seriously, as reported in this New York Times article on “The Transition movement”:

The Transition movement was started four years ago by Rob Hopkins, a young British instructor of ecological design. Transition shares certain principles with environmentalism, but its vision is deeper — and more radical — than mere greenness or sustainability. “Sustainability,” Hopkins recently told me, “is about reducing the impacts of what comes out of the tailpipe of industrial society.” But that assumes our industrial society will keep running. By contrast, Hopkins said, Transition is about “building resiliency” — putting new systems in place to make a given community as self-sufficient as possible, bracing it to withstand the shocks that will come as oil grows astronomically expensive, climate change intensifies and, maybe sooner than we think, industrial society frays or collapses entirely. For a generation, the environmental movement has told us to change our lifestyles to avoid catastrophic consequences. Transition tells us those consequences are now irreversibly switching on; we need to revolutionize our lives if we want to survive…

Hopkins insists that if an entire community faces this stark challenge together, it might be able to design an “elegant descent” from that peak. We can consciously plot a path into a lower-energy life — a life of walkable villages, local food and artisans and greater intimacy with the natural world — which, on balance, could actually be richer and more enjoyable than what we have now.

They don’t have all the answers. But they’re asking questions we should all be contemplating. Hopefully, as 60 Minutes reports, cold fusion will magically eliminate our twin fears of energy crises and relentless climate change, but we would be wise to hedge our bets.

Posted by James on Apr 20, 2009

Will China yank U.S. government's credit cards?

After Ireland’s largely unregulated banks recently crapped out at the casino, Ireland’s government committed Irish taxpayers to bailing out the banks for, potentially, “more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.”

This has forced Ireland to cut government spending and raise taxes — when it needs to be doing the opposite — further harming its already severely depressed economy.

Paul Krugman fears the same could happen here in America, esp. if we waste too much bailout money on severely insolvent banks (i.e., giving undeserved gifts to equity and bond holders of banks with large negative net worths) rather than getting banks lending again by boosting the balance sheets of solvent and minimally insolvent banks. If bank bailouts raise U.S. government debt too high, lenders may cut off our “credit cards”:

Thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market.

…[T]hat’s one reason I’m so concerned about the Obama administration’s bank plan. If, as some of us fear, taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right.

Posted by James on Apr 20, 2009

World's best investment: Buying Congressmen and presidents

Associated Press reports:

Big companies that spent hundreds of millions lobbying successfully for a tax break enacted in 2004 got a 22,000-percent return on that investment…

The [University of Kansas] report details efforts by hundreds of companies in 2003 and 2004 to push through a one-time tax “holiday” that lowered for a year the tax rate they paid on profits earned abroad. All told, U.S. companies saved about $100 billion in taxes, with pharmaceutical behemoths Pfizer and Merck & Co., technology giants IBM and Hewlett Packard, and health products maker Johnson & Johnson among the top beneficiaries.

The study zeros in on 93 firms that spent as much as $282.7 million lobbying on the issue during that period, and ultimately saved a total of $62.5 billion through the tax change…

A separate group of business professors reported last year that companies that lobbied had better market valuations and investment returns than those that did not, and that those that did so most intensively had portfolios that consistently outperformed the market.

Hui Chen of the University of Colorado, David C. Parsley of Vanderbilt University and Ya-Wen Yang of the University of Miami found that, on average, a company’s income rose by more than a half-percent for every 10 percent more it spent on lobbying. That translates into many millions of dollars for a large firm.

David Sirota offers more examples:

In the last decade, the financial industry’s $5 billion investment in campaign contributions and lobbyists resulted in deregulation, which delivered trillions to executives [and shareholders]. And when the bubble burst, there was another boatload of free money! By Bloomberg News' account, $12.8 trillion worth of taxpayer loans, grants and guarantees — all to Wall Street!

…[T]he banking industry recently paid Rahm Emanuel $16 million for about two years of work. That investment was recently paid back when, as President Obama’s chief of staff, Emanuel led the January campaign to release another $350 billion in bank bailout funds. Turning a $16 million down payment into a $350 billion payout — that’s huge!

Likewise, Goldman Sachs hired former Senate aide Mark Patterson as one of its lobbyists — an investment that proved a huge winner when Patterson became the Treasury Department’s chief of staff and the agency subsequently killed proposals to limit executive compensation at bailed-out banks. Cha-ching!

And the hedge fund industry paid economist Larry Summers $5.2 million in 2008 for part-time work — an investment that hit pay dirt when Summers became Obama’s top economic aide and the administration resisted tough international hedge fund regulations that some G-20 countries wanted.

Posted by James on Apr 11, 2009