In light of the recent allegations of trade secrets theft at Goldman Sachs, Ethan S. Burger and Kenneth Gray look at whether corporate security and policy are prepared to handle a “new generation of economic disruption”. Read Goldman Sachs’ Code and the Elephant in the Room.
Aug 042009
New York Fed President William C. Dudley served 10 years as Goldman Sachs’s chief economist. (By Kevin Clark — The Washington Post)
By
Washington Post Staff Writer Monday, July 20, 2009
NEW YORK — The low-slung cubicles wrap around the ninth floor of a building three blocks from Wall Street, each manned by a young staffer staring at flashing numbers on a flat-screen computer monitor and working the phones to gather the latest chatter from financial markets around the world.
It could be any investment bank or hedge fund. Instead, it is the markets group of the Federal Reserve Bank of New York, which has been on the front lines of the government’s response to the financial crisis. Federal Reserve and Treasury Department officials make the major decisions, but the New York Fed executes them. The information gathered there provides crucial insights into the financial world for top policymakers. But the bank is so close to Wall Street — physically, culturally and intellectually — that some economic experts worry that the New York Fed puts the interests of the financial industry ahead of those of ordinary Americans. “The New York Fed sticks out as being not just very, very close to Wall Street, but to the most powerful people on Wall Street,” said Simon Johnson, an economist at MIT. “I worry that they pay too much deference to the expertise and presumed wisdom of a sector that screwed up massively.” Even some former insiders at the Fed say the bank does not pay enough attention to the fundamental flaws in the country’s financial system or to the risks associated with bailing out financial firms — for instance, the chance that banks will be encouraged to take more unwise gambles. These experts worry that the New York Fed has adopted the mindset of a trading floor: well attuned to ripples in financial markets but not to long-term trends and dangers. Last month, for instance, Wall Street bond traders wanted the central bank to ramp up its purchase of Treasury bonds, which would help the traders by driving up prices. But Fed officials in Washington and around the country concluded that such a move would be counterproductive in the longer run, in contrast to some New York Fed staffers, whose views more closely mirrored those on Wall Street. New York Fed employees “play a very valuable role, day in, day out, with detailed contacts with the big financial firms,” said William Poole, a former president of the Federal Reserve Bank of St. Louis who is now at the Cato Institute. “What I think is missing is a longer-run perspective. They tend to be sort of short-term in their outlook, which is true of a lot of the financial firms. Traders have a horizon of a few hours or a few weeks, at most.” The New York Fed’s home is a fortresslike building, with bars securing the windows on lower floors. Its main lobby resembles a Gothic cathedral: dim, quiet, with stone walls, as if to inspire a mix of fear and awe. Like the other 11 regional Federal Reserve banks, the New York Fed is a curious mix of public and private, part of a system Congress created in 1913 to avoid concentrated power in Washington or New York alone. Its board of directors is composed of bankers, businesspeople and community leaders, who select the bank president with approval from Fed governors in Washington. Banks in New York, Connecticut and parts of New Jersey own shares in the New York Fed, though its profits are returned to the U.S. Treasury. The man in charge is a soft-spoken economist named William C. Dudley, who took over as president in January, replacing Timothy F. Geithner when he became Treasury secretary. With a proclivity for button-down Oxford shirts and rumpled suits, Dudley does not fit the mold of a Wall Street executive. He has won fans across the Federal Reserve System for a collaborative style, as well as a talent for explaining complicated problems in the financial world and drawing up solutions to them. It is his résumé that alarms some critics, who see an example of a too-cozy relationship between financial firms and their lead regulator. One of several bank officials who have worked in the private sector, Dudley was at Goldman Sachs for two decades, including 10 years as chief economist, before joining the New York Fed in 2007. Some Fear N.Y. Fed Too Influenced by Wall Street – Washington Post
How to Turn a Recession Into a Depression – Bill Niskanen, Cato Institute
Upgrading Our China Outlook – Wang, Yam & Zhang, Morgan Stanley
Weekly Economic & Financial Commentary – Wells Fargo Economics
Weekly Economic Report – Diana Furchtgott-Roth, Hudson Institute
Jul 222009
Hank Paulson appeared before the House committee on (Lack of) Oversight and (Prevention of) Government Reform last week to defend his actions in the Bank of America/Merrill Lynch deal. For those of you who haven’t been following along, Bank of America CEO Ken Lewis has accused Ben Bernanke and Hank Paulson of pressuring him to complete the Merill acquisition even after discovering that the losses at Merrill were several orders of magnitude higher than what he thought when the deal was struck. Bernanke and Paulson allegedly told Lewis that he and the entire board would be replaced if he didn’t conceal the losses until the deal was approved by shareholders.
I didn’t think Hammerin’ Hank’s reputation could fall any further but after listening to his arrogant testimony this week, I think I have to revise that. Paulson cast himself as the hero in his testimony:
“Many more Americans would be without their homes, their jobs, their businesses, their savings and their way of life,” he said in written testimony prepared for a hearing Thursday.
While losses have been staggering, “that suffering would have been far more profound and disturbing” had the government not intervened, he will tell the House Oversight and Government Reform Committee.
“Our responses were not perfect … But, having had the benefit of some time to reflect, and to consider views expressed by others, I am confident that our responses were substantially correct and they saved this nation from great peril,” Paulson wrote.
Well, gee, thanks Hank. There is no way to know how things would have turned out if you hadn’t bailed out every firm that acted as a counterparty to your net worth (Goldman Sachs), but it’s nice to know it hasn’t affected your self esteem.
While Bernanke prudently fell back on the “I don’t recall” defense, Paulson, believe it or not, defended his threat to Lewis:
Paulson said he told Lewis that reneging on the promise to purchase Merrill would show “a colossal lack of judgment.” He then pointed out to Lewis that the Fed could remove management at the bank if it saw fit, he said.
“By referring to the Federal Reserve’s supervisory powers, I intended to deliver a strong message reinforcing the view that had been consistently expressed by the Federal Reserve, as Bank of America’s regulator, and shared by the Treasury, that it would be unthinkable for Bank of America to take this destructive action for which there was no reasonable legal basis and which would show a lack of judgment,” Paulson said.
Paulson said he believed his remarks to Lewis were “appropriate.”
Faced with being forced out with only a golden parachute to cushion his fall, Lewis decided that maybe those Merrill losses weren’t really so important that they needed to be disclosed to BAC shareholders prior to voting on the merger. Based on the performance of BAC’s stock price since then, shareholders might disagree, but hey that’s a small price to pay for saving the “system”, right?
The charge that the failure of large financial institutions represents a systemic risk is one that suffers from a lack of evidence. Is the system really better off maintaining Citigroup on life support rather than letting it die a natural death? Is the system really better off by expanding the allegedly already too large to fail Bank of America? Is the system really better off when poorly managed companies are rescued at the expense of those who acted more prudently? Is the system really better off when losses are spread far and wide rather than concentrated with those who took the risks? What message does it send to prudent managers when their imprudent competitors are bailed out? Will they be so prudent next time?
The economic success of the US is not dependent on maintaining the status quo. Capitalism is a system which requires failure to advance. The failure of a few companies is not evidence that capitalism has failed but evidence that it is working. Failure sends a message to other market participants that the practices that caused the failure should be avoided. That message applies not only to private companies but to the government institutions that also failed us in this crisis. Attempting to return to the status quo rather than allowing private company failures and reforming failed government institutions does not advance us as a society. It mires us in mediocrity.
It is Paulson, Bernanke and Bush who showed a colossal lack of judgment. It is the management of Bear Stearns, AIG, Lehman, Merrill Lynch, Fannie Mae and Freddie Mac who showed a colossal lack of judgment. It is Alan Greenspan and all the member of the Federal Reserve who showed a colossal lack of judgment. It is most of Congress that showed a colossal lack of judgment. It is Tim Geithner and President Obama who continue to show a colossal lack of judgment. And it is the American taxpayer who will have to pay the tab for the colossal lack of judgment shown by all of them.
The long term consequences of government actions over the last two years will become evident to investors in the coming years, but for now, attention is focused on the immediate situation. And the immediate situation is still improving. The stock market rallied 7% last week as earnings season kicked off with some highly visible positive surprises. Goldman Sachs, JP Morgan, Bank of America and Citigroup all reported better than expected earnings (thanks in large part to the implicit guarantee of the government) and the remainder of the financial sector seems likely to follow suit in the coming weeks. Intel and IBM got the tech sector off to a good start. Next week will see a flood of companies reporting their second quarter results and while there will be a few disappointments such as Google last week, I believe the aggregate numbers will continue to be better than the market expects.
Paulson: A Colossal Lack of Judgment – Joseph Calhoun, Alhambra Inv.
The Peking-Washington connection: is it real?
A Growing List Of One Term Presidents, China and the Treasuries - A Dependency Relationship, Global Trade, Obama's Hypocrisy, The excellent adventures of Ben Bernanke, The Geithner Resignation Watch, The Global Economy, Unindicted Co-Conspiritors, US Trade Imbalance, We Have Become Beggars To The World
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Jul 202009
Is there a clandestine understanding between the world’s two most powerful central banks, the Federal Reserve and the People’s Bank of China?
Naturally, no one can talk about it, let alone confirm or deny anything. But it’s not too difficult to make out the broad outlines of how Chinese-American monetary cooperation may be working.
People’s Bank governor Zhou Xiaochuan and other figures in the Chinese leadership seem to use every opportunity to broadcast finely calibrated skepticism over the dollar’s future. Such Jeremiahs feed on and — in turn — feed doubts about potential American inflation caused by the Fed’s quantitative easing and exploding budget deficits.
But both Washington and Beijing appear to recognize — whatever the saber-rattling — that large-scale shifts in the currency composition of Chinese currency reserves are more or less impossible. Roughly two-thirds of Chinese reserves of more than $2 trillion are thought to be held in the greenback.
Heavy Chinese sales, or even a deliberate policy of diverting export proceeds into Euro or yen by re-dominating sales contracts, would depress the U.S. currency and lower the value of Chinese reserves. It’s the well-known Beijing dollar trap. And it has to be said: the Chinese have maneuvered themselves into it of their own volition, and in full knowledge of the potential problem.
So Governor Zhou’s strictures are, to a certain extent, shadow boxing. However, in return for a tacit standstill agreement on the currency composition of reserves, the Americans have to acknowledge that the renminbi’s value will rise only moderately.
If the Chinese continue taking in dollars, logic tells us the Chinese currency can hardly revalue strongly. A signal of the U.S. authorities’ acceptance of this state of affairs is that the word “manipulation” for Chinese currency management now clearly is banned.
There is another, still more intriguing, side to Chinese currency pronouncements. The doubts voiced from Beijing on the dollar’s stability, far from unsettling the U.S. monetary authorities, are actually manna from heaven for the Federal Reserve. The Obama administration hardly can go in for years of reckless deficit spending when the country’s largest creditor is emitting so many warning signals.
More importantly, the Fed is getting a certain amount of cover from Beijing for its eventual “exit strategy” — a reversal of quantitative easing and a rise in interest rates as soon as economic recovery gets under way.
The Chinese even are giving a strong tailwind to Fed Chairman Ben Bernanke’s bid for re-nomination after his initial four-year term ends in January. The reason? With the Chinese appearing to turn the knife through gloom-laden dollar prognostications, President Obama knows that appointing a heavily political successor to Bernanke would be fraught with great risks.
Any Fed chairman who looks less than squeaky-clean on currency stability is likely to send dollar holders heading for the exits — and could spark the full-scale currency collapse that Wall Street bears have been growling about for months.
So, if Obama wishes to replace Bernanke, he can do so only by bringing in a full-scale monetary hawk — a step that he must rule out on domestic political grounds. The conclusion is that the Chinese maneuverings leave Obama with no choice but to re-appoint Bernanke, whatever the doubts about his stewardship that have arisen in recent months.
When Bernanke a little later this year eventually is confirmed in a second term of office, what’s the betting that a laconic red-rimmed telegram from Governor Zhou will turn up in his in-tray?
The missive and its contents, of course, will remain secret. We can only guess at the possibility that the two men, just for a moment, will share the opportunity for a modicum of discreet self-congratulation.
David Marsh is chairman of London and Oxford Capital Markets. The Marsh on Monday column appears in German in the newspaper Handelsblatt.
A Deal Between the Fed and Bank of China? – David Marsh, MarketWatch
Jul 142009
Most of them did not see the crisis coming; many were deep in denial about the recession long after it started. They missed the housing boom and bust, the credit crisis. They continued to see phantom bottoms and false recoveries again and again.
In general, they were institutionally biased, preternaturally accepting of questionable data, and wed to outmoded belief systems of efficient markets. Oh, and if you listened to their advice, you lost shitloads of money.
Now, I don’t wish to paint with too broad a brush. There were plenty of individual economists who have done an outstanding job in terms of 1) seeing the coming crisis; 2) making reality-based observations about the present situation; and 3) provided helpful insight to investors and traders. Not to name names, but you frequently see their superior work highlighted here.
It reminds me of an grad school classmate, a fellow cum laude — an amusing asshole who obnoxiously said at graduation “those of us in the top 10% want to thank the rest of you for making all this possible.” Rude, but with an element of truthiness in it: You can’t have outstanding anything without a vast bulk of mediocrities.
Which brings me back to the original question: Why should anyone listen to these folks as a group? Do we want to get it wrong yet again, or do you still have some remaining cash to lose . . . ?
Why Should You Care If Economists Raise U.S. Outlook? – The Big Picture
Jun 192009
The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a central bank, following strongly restrictionary policies to fight inflation, eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time—interest rates are already as low as they can possibly go. So I can see no reason to anticipate a rapid recovery and rising employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery—a V rather than an L for the shape of the recession—is not just possible but probable.
How Far We’ve Come from Last December – Brad DeLong, Free Exchange
Onetime presidential hopeful and current Republican congressman Ron Paul has an interesting piece of legislation wending its way through the US capitol. HR1206 calls for “a complete audit of the Federal Reserve and removes any significant barriers towards transparency in our monetary system” says Paul’s website.
This bill now has nearly 170 cosponsors, with support from both Republicans and Democrats. Senator Bernie Sanders has introduced a companion bill in the Senate S 604, which will hopefully begin to gain momentum as well. I am very encouraged to see so many of my colleagues in Congress stand with me for greater transparency in government.
Congressman Paul continues:
Fundamentally, you cannot defend the Federal Reserve and the free market at the same time. The Fed negates the very foundation of a free market by artificially manipulating the price and supply of money – the lifeblood of the economy. In a free market, interest rates, like the price of any other consumer good, are decentralized and set by the market. The only legitimate, Constitutional role of government in monetary policy is to protect the integrity of the monetary unit and defend against counterfeiters.
And indeed, continues:
Instead, Congress has abdicated this responsibility to a cabal of elite, quasi-governmental banks who, instead of stabilizing the economy, have destabilized it. It took less than two decades for the Federal Reserve to bring on the Great Depression of the 1930’s. It has also inflated away the value of our currency by over 96 percent since its inception. It has invisibly stolen from the poor and given to the rich through this controlled inflation, and now openly stolen through recent bank bailouts. It has predictably exacerbated the very problems it was meant to solve.
All of which we’d have been quite likely to dismiss out of hand, were it not for its relevence in light of an excellent essay from historian Simon Schama in last weekend’s FT, on the central-bank hating tendencies of President Jackson, and more broadly, the long and rich seam of bankphobia than cleaves through American history:
Jackson, who was in the White House from 1829-1837, was a new brand of politician in American life. No one would confuse him with the Virginian gentlemen-planters who had dominated high office in the early republic. He had been Indian fighter, scourge of the British and darling of the frontier crowds. But what really got his dander up was the Bank of the United States, the institution granted the monopoly to print paper money. The “Monster”, he declared at the height of his presidential knock-down battle with its president Nicholas Biddle, “wants to kill me but I will kill it”.
And destroy the Bank of the United States Jackson did, vetoing the Senate’s renewal of its charter in 1832 and running for re-election as the champion of People v Monster. The result of the liquidation of monetary regulation was predictable: wildcat speculation. Two months after Jackson left office in March 1837, the second of the great American financial meltdowns was under way (the first was in 1819). Another swiftly followed in 1839 under the administration of Jackson’s hand-picked successor, Martin Van Buren. On the eve of the civil war, Jackson’s wish for monetary decentralisation had come true beyond his wildest dreams There were 7,000 local currencies circulating in the republic and an epidemic of counterfeiting. It took Lincoln’s Banking Act of 1862, born of a desperate need for dependable credit to fight the war, for a modicum of monetary order to be salvaged from what Biddle had accurately prophesied would be monetary anarchy.
Jackson tapped into a pulsing vein of American insecurity about the moral character of money.
In fact, in the unstable conditions of America in the 1830s, the paper of the Bank of the United States was by far the most dependable medium of transactions from Maine to Louisiana. But Jackson was convinced that unless the Bank perished, American democracy would always be infected by its machinations. What was at stake was the battle of rural and urban values for the economic soul of America. In some ways this was almost as momentous as the struggle between the slave south and the free north for it went to the heart of what America was supposed to be: a place where simplicity and transparency ruled in small moral communities, or a self-energising machine of unlimited economic growth and power: Field of Dreams or Citizen Kane?
Interesting times we live in.
America has a long tradition of central bank antagonism. (FT Alphaville)
Beggars Are We All…..
Insolvency, Integrity and Responsibility, Let's Call What It Is - DEPRESSION, Negative Cash Flow, Patience is a virtue...Delusion is a vice, Political Chaos, Sub-Prime anytime, The End of American Capitalism As We Know It? - Discuss, The excellent adventures of Ben Bernanke, The Financial Elite, The Geithner Resignation Watch, We Have Become Beggars To The World
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May 252009
http://jessescrossroadscafe.blogspot.com/
Bernanke’s wager is on a virtual free lunch by printing money.
“Fed chair Ben Bernanke has long argued that central banks can bring down long-term borrowing rates by purchasing bonds “at essentially no cost”. His frequent writings rarely ask whether foreigner investors – from a different cultural universe – will tolerate such conduct. Mr Bernanke is betting that under a floating currency regime there is no risk of repeating the disaster of October 1931, when the Fed had to raise rates twice to stem foreign gold withdrawals, with catastrophic consequences.”
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May 092009
The Banks Are No Longer The Problem
From THE INSTITUTIONAL RISK ANALYST
http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=358
“You think that’s air you’re breathing?” Morpheus to Neo
The Matrix
The Matrix
We are gratified to see that Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke take our suggestion of several weeks ago on CNBC not to allow the TARP banks to repay the government debt until they prove the ability to function in the debt markets without reliance upon a government guarantee. Washington has indeed fixed the solvency problems of the large zombie banks — not with additional capital or stress tests, as many of us seem to think. Rather, the banks have been stabilized by turning them into GSEs via FDIC guarantees on their debt. Those banks which can end their dependence on federal guarantees will be the visible winners in the post stress test market, and valuations and spreads will reflect this divergence between zombies and viable private banks. Seen from this perspective, Chrysler, General Motors (NYSE:GM) and the large banks are GSEs rather than private companies, parestatales as they know them in Mexico. To talk about a rally in the equity of large US financials seems truly ridiculous, at least to us, especially true when you look at how the public sector subsidies being applied to the banks have distorted their financial statements. Maybe by the end of next year, when we know which banks can or cannot shed the need for government subsidies, then we can talk about investible equity in these GSEs. To that point, turning Bank of America (NYES:BAC), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) into GSEs was just the first battle, Vol. II of the Lord of the Rings, to use another cinematic metaphor. Next comes dealing with the dysfunction in the non-bank market for securitization and financing, the real battle to save the US economy from a truly dreadful year-end 2009 and beyond. By the way, is it not remarkable that the FDIC has run dozens of resolutions and bank sales processes over the past 18 months without a single leak or breach of confidentiality of these sensitive transactions, including both the WaMu and Wachovia transactions? Yet the Fed and Treasury run a confidential stress test process via overt leaks the press! One thing we learned years ago working at the Fed of New York, the senior man never talks to the media and never goes to the meeting. Maybe our friend Nouriel Roubini could whisper this into Secretary Geithner’s ear next time they spend quality time. We hear from the Big Media, BTW, that Tim Geithner’s growing corps of handlers directs media inquiries to Roubini for “an objective view” of the Secretary’s handling of the financial crisis. One Democrat asks: Could it be Larry Summers to the Fed, Roubini to the White House? And speaking of the fall of the elites, FRBNY Chairman Steve Friedman finally resigned yesterday, ending a scandalous period when the greater community of present and past employees of Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM) and other dealers was arguably in control of the most important arm of the US central bank. The fact that the Board of Governors appointed former GS ibanker Freidman as a “C” class director, who are meant to represent the public interest and not be past officers of regulated banks, was scandal enough. But then, when GS formally became a bank holding company last year, the Board failed to remove Friedman when his conflict became acute. The Board also failed too to appoint another “C” class director, making it almost seem that the Board wanted to assist in the GS operation to influence the operations of a Federal Reserve Bank. Remember that the board of directors of the FRBNY selected Tim Geithner as President, who then bailed out AIG to the benefit of GS and the other OTC derivatives dealers that were facing AIG. That is why a congressional inquiry is needed to understand just why the Fed Board and, in particular, Fed Vice Chairman Don Kohn, tolerated the Freidman conflict and arguably neglected their statutory duty to ensure the proper governance and operation of a Federal Reserve Bank. But hold that thought. Earlier this week, IRA released to subscribers to our Advisory Service preliminary Q1 ratings for the 7,000 or so banks that have submitted their call reports to the FDIC. Users of the IRA Bank Monitor professional edition may view the preliminary ratings for the units of their BHCs as the reports are released by the FDIC. Once we are finished testing this preliminary dataset, we will also enable these displays in the consumer version of the IRA Bank Monitor. Click here to go to our Picking Nits blog where IRA CEO Dennis Santiago provides his take on the preliminary data from the FDIC and some observations about what the data suggests for 2009. While the idea of public stress testing is a new concept in Washington, we’ve been conducting a census of all US banks for years, first via our public Basel II benchmarks and Economic Capital model, and more recently with the bank ratings from our Bank Stress Index. Each quarter, we ask two basic questions about all US banks: Stressed View: First, how did you do this past quarter? Looking at factors such as capital, lending, realized losses, income and efficiency, we grade all US banks on a six notch scale, which forms the basis for our “A+” through “F” ratings. Risk Adjusted View: Second, we calculate Economic Capital or “EC” factors for all US banks, and compare the “stressed,” maximum probable loss from trading, investing and lending to their current capital, from tangible common equity up through the various regulatory measures. By looking at EC, we provide users of the IRA Bank Monitor with a second, risk-adjusted perspective on the safety and soundness of the institution. Based on the institutions for which data has been released by the FDIC, it is pretty clear in our latest stress test that the condition of the US banking industry is continuing to deteriorate and that we are still several quarters away from the peak in realized losses for most banks. The key telltale in the Q1 FDIC data is that ROE degradation, not charge-offs, still leads the rising stress evidenced by the IRA Banking Stress Index. Remember that provisions are a leading indicator, while charge-offs lag the credit cycle. Once you see ROE performance improving, meaning a decline in the need to build loss reserves to buffer future losses, and charge-offs are the leading factor in our index, then you’ll be able to test the thesis that the worst is over for US banks and valuations are beginning to stabilize. So based on what we see now, is it time to be being financials? One IRA reader in SF named Jonathan asks: “This market for financial stocks must have some of your clients scratching their heads. What do you make of things? Is this irrational exuberance or have we turned?” We’ll be addressing the Q1, post stress test valuations for the largest banks as the rest of the units in the bank universe fill in their FDIC CALL reports. No, in our opinion we have not turned the corner in financials. The current FDIC data suggests that bank loss rates may not peak until next year. We are not yet even on the right block to make the turn, in our view. Suffice to say that the composition of the Q1 loss data we see from the FDIC makes us believe that the peak in terms of losses for the US banking industry will be closer to Q4 2009 than our original target of Q2 2009. Given where large bank loss rates were in Q1 2009, just imagine where we’ll be by Q4. Or put another way, now you know why regulators are pushing BAC and WFC to raise additional capital. The bank stress tests conducted by regulators are not so much about capital adequacy through the current economic cycle as identifying enough capital to get the large zombie banks through the end of the year. While Larry Summers and the other economic seers who populate the Obama Administration actually believe that we’ll see an economic bounce in Q3 2009 – a key assumption that also underlies the regulators’ approach to designing the bank stress tests – we see nothing in the credit channel that suggests improvement in the real economy. Both residential real estate or “RES” and commercial real estate or “CRE” markets in the NY area, for example, are starting to see an acceleration in price declines, this as the swelling population of frustrated sellers is starting to capitulate in the face of few or no buyers. But the chief reason for this sad tale above is that there is no financing for jumbo loans in the RES market. Indeed, as one of the bankers who participated in the “Market & Liquidity Risk Management for Financial Institutions” conference sponsored by PRMIA at the FDIC University on Monday noted, banks are not originating any RES paper that cannot be sold to Fannie Mae or Freddie Mac, soon to be merged into “Frannie Mae,” as we noted earlier. During a luncheon keynote address at that event, Josh Rosner of Graham Fisher & Co. noted much of the “growth” in non-conforming real estate markets during the final years of the boom was fueled by speculative buying and that the lack of financing in the jumbo, non-conforming RES markets is forcing price compression in markets like the urban RES and CRE markets of NY, CA, MA, etc. “The lack of attention paid to the creation of industry wide standards and a more solid legal basis for securitzation has only hindered the recovery of a financial intermediation in a market that once funded about 50 percent of all consumer revolving and non-revolving credit,” Rosner told The IRA. While regulators think that stabilizing the banks was the real battle, is it in fact the dysfunction of the non-bank securitization markets and the effect of this dysfunction on valuations in the RES and CRE real estate markets that is now driving the US economic meltdown? While the Fed as a good bit to the toxic securitizations in cold storage on its balance sheet, the central bank’s best efforts at adding liquidity facilities cannot replace this multi-trillion dollar market if banks won’t originate paper. If you want to learn more about the problems in the non-bank sector and how products like ARMs are about to push the US economy into a meltdown, take a look at the presentation from the PRMIA event on Monday by Alan Boyce, the former CFC executive and now chief executive officer of Absalon, a joint venture between George Soros and the Danish financial system that is assisting in the organization of a standardized mortgage-backed securities market for Mexico. Go to the last slide. This is an illustration of the Option Adjusted Duration (“OAD”) of the US mortgage markets. Notice that the OAD calculated by Boyce has grown from a low of $23 trillion in Sep 05, which just happens to be the nadir of loan defaults for the US mortgage market, to $45 trillion in Mar 09. The OAD is set to grow significantly as US interest rates rise or as the slope of the interest rate curve steepens. OAD is essentially a way to measure the economic weight of debt, basically time x money or the price response for a given move in interest rates. Using existing data and some clever suppositions, Boyce constructed an alternate explanation of “the conundrum” of 2003 to 2006. This was driven by the Fed’s very predictable interest rate policy, which flattened the interest rate curve and compressed interest rate volatility. Homeowners were encouraged to refinance into ARMs and there was significant cash out refinancing into premium fixed rate mortgages. Interest rate risk was transferred to US consumers and created a ticking time bomb for US markets in terms of the future duration of the total corpus of outstanding mortgage debt. During the PRMIA conference, Boyce echoed the view of other participants that the failure to act on securitization ensures further RES and CRE price compression. In a rising rate environment the OAD of this RES exposure in particular will grow exponentially and dwarf the “weight” or OAD of the UST debt issuance. The US homeowner will be trapped in their homes, unable to sell as nominal mortgage debt exceeds house values. Of note, in the Danish system, rising interest rates do not create negative equity for home owners, performing borrowers may redeem their mortgage by purchasing the associated bond at the prevailing market rate. Credit risk is kept out of the bond market, making the mortgage bonds a pure reflection of the associated interest rate risks. By efficiently splitting credit and interest rate risk, there are no surprises as each risk resides where it is best analyzed and hedged. Bottom line is that securitization machine operated by Wall Street doubled the outstanding stock of mortgages during the last five years of the boom, but the falling OAD driven by Fed rate policy hid the growth. Unfortunately, in their wisdom, federal regulators actually encouraged US mortgage originators to use ARMs and other products to push interest rate risk onto the backs of homeowners and bond market investors ill-equipped to understand let along manage such risks. Boyce and many others believe that without a complete refinancing for all performing mortgage borrowers, the US real estate markets – and thus the financial industry – will in trapped in a deflationary environment for years to come. The only way to fix this mess, Boyce suggested at the conference, is to refinance the entire performing mortgage market into standardized, transparent, callable, fixed rate loans, which allow the homeowner to value his liability at the market price. The interest of the mortgage originator needs to closely aligned to that of the borrower via a minimum 10% first loss risk sharing. Rosner told The IRA he doubts that America’s political and business sectors are ready or willing to embrace the transparency and consumer-friendliness of Denmark’s mortgage sector, but the fact that Boyce and George Soros are advancing this example as a solution may be significant – especially as the year-end deadline for resolving the conservatorships of Fannie Mae and Freddie Mac approaches. Rosner and Boyce believe that the restructuring of the housing GSEs presents an opportunity to set a new, consistent standard for securitization in the US. More on this issue of “reformation” of the non-bank financial sector in a future issue of The IRA.
H/T TO JESSE”S CAFE AMERICAIN
‘Conceived By Someone Who Never Worked in a Real Job’
Financial Armageddon has long highlighted the disconnect between Main Street and Wall Street. Even now, after an extraordinary number of banks and brokers have failed or are still being bailed out, and thousands of financial industry workers have lost their jobs (excluding those at the top, who should have been the first to go) or had bonuses and salaries slashed, there are still plenty of clueless “experts” running around — including those who have the power to invest other people’s money — who claim to see all manner of “green shoots” sprouting up throughout the economy. While I could be wrong when it comes to my admittedly pessimistic views about where the bottom is (and when we might reach that point), even a cursory glance at what is happening around the country makes me feel reasonably confident that we aren’t there yet. To cite just one example, I refer to the following post from Clusterstock, entitled “About That GDP Inventory Decline…”
An executive who works for a massive global industrial company observes that the much-celebrated decline in inventories in the GDP numbers should not be taken as a sign that GDP is suddenly about to start accelerating:
I watched with some amusement as analysts decided that reduced Inventories in the GDP data boded well for future GDP figures. While, all else equal, certainly lower would be better, the fact is we are slashing inventories (and trying to do so even more) because there are no orders. None. We do take “orders” (non-binding, no cash down payment) which are what is optimistically shared with the Street but binding orders with cash down payments do not exist today, haven’t for over 8 months now. When one lands it is company news and because a government entity somewhere backed it. And trust me, if we aren’t getting orders neither are the next 5 guys.
I suppose either the analysts – and the market, which has been juicing our stock (thanks for that) – are correct and the orders are about to start rolling in, or they are going to be somewhat disappointed later this year when our backlog starts to run dry. I hope they’re right. But I assure you the absolute last thing that’s going to happen is for us to start *growing* inventories without the orders - that strategy can only possibly be conceived in a cubicle somewhere, occupied by someone that never worked in a real job. [MP here: don't you just love that last bit?]
Apr 292009
Google the expression “damned if you do, damned if you don’t,” and a picture of Timothy F. Geithner ought to pop up. The Treasury secretary embodies everything that’s perceived to be wrong with the government’s response to the economic and financial crisis. Since taking the Treasury job, he has been a lightning rod for criticism. And it’s about to get worse.
In the next week, as the Treasury and Federal Reserve complete their closely watched stress tests on the largest U.S. banks and announce how they will proceed to keep the financial system functioning, Geithner will assuredly come in for new blasts from all points on the political spectrum. The potential for this stress test process to add to the economy’s woes is significant. And no matter what he does, it will be judged wrong by someone.
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From critics on the left, Geithner has already drawn flack for not moving aggressively to nationalize the biggest banks — at least those that are seen as the most unstable. Because the potential collapse of these tottering institutions poses an enormous risk, the thinking goes, government regulators should take them over now and run them for the benefit of the public — before they can do even more damage.
From the right, the fear is that nationalization is exactly what Geithner intends. Whether by design or by default, the Treasury might end up as the biggest holder of common stock in some of these banks and would possess the ability to dictate their operations in ways that even the most aggressive regulators never could.
Criticism of the stress tests — and fear about where they will lead — comes even from precincts that are relatively politically neutral. For instance, the decision to release details about these high-profile reviews of bank books was a mistake, says longtime bank stock analyst Richard Bove of Rochdale Securities in Lutz, Fla.
In a note last week to his clients, Bove said the reviews may reveal potential losses on various types of loans of between 4 percent and 6 percent in each of the next two years, and up to 10 percent on credit cards. That’s several times the level of losses ever experienced, he said. The result could be a mandated pullback in the availability of credit, which would further sink the economy.
Geithner has put himself in a box, Bove argued in an e-mailed elaboration. If the stress tests show big troubles, shareholders and depositors alike might flee those institutions, leading to failures of weak banks and takeovers by the Federal Deposit Insurance Corporation. If the tests show little immediate problem, the public and the rest of the financial system won’t trust the results.
“There is no good exit strategy here,” Bove wrote. “The history of bank regulation is clear, the results of bank audits are not to be made public. The reason is that the potential for panicking the public is high.”
READ THE ENTIRE COMMENTARY AT http://www.cqpolitics.com/wmspage.cfm?parm1=5
Apr 272009
From the New York Times:
Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.
Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele A. Smith, then an assistant Treasury secretary.
The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars…..
But in the 10 months since then, the government has in many ways embraced his blue-sky prescription….
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.
Today, Mr. Geithner ….finds himself a locus of discontent… range of critics — lawmakers, 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.
An examination of Mr. Geithner’s five years as president of the New York Fed, an era of unbridled and ultimately disastrous risk taking by the financial industry, 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, according to interviews with financiers, regulators and analysts and a review of Federal Reserve records.
In a pair of recent interviews and an exchange of e-mail messages, Mr. Geithner defended his record, saying that from very early on, he was “a consistently dark voice about the potential risks ahead, and a principal source of initiatives designed to make the system stronger” before the markets melted down.
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….for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked signs that the bank — along with the rest of the financial system — was falling apart. When he did spot trouble, analysts say, his responses were too measured, or too late.
In 2005, for instance, Mr. Geithner raised questions about how well Wall Street was tracking its trading of complex financial products known as derivatives, yet he pressed reforms only at the margins…..
To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view….
In theory, having financiers on the New York Fed’s board should help the president be Washington’s eyes and ears on Wall Street. But critics, including some current and former Federal Reserve officials, say the New York Fed is often more of a Wall Street mouthpiece than a cop.
Willem H. Buiter, a professor at the London School of Economics and Political Science who caused a stir at a Fed retreat last year with a paper concluding that the Federal Reserve had been co-opted by the financial industry, said the structure ensured that “Wall Street gets what it wants” in its New York president: “A safe pair of hands, someone who is bright, intelligent, hard-working, but not someone who intends to reform the system root and branch.”….
Throughout the spring and summer of 2007, as subprime lenders began to fail and government officials reassured the public that the problems were contained, Mr. Geithner met repeatedly with members of Citigroup’s management, records show
From mid-May to mid-June alone, he met over breakfast with Charles O. Prince, the company’s chief executive at the time, traveled to Citigroup headquarters in Midtown Manhattan to meet with Lewis B. Kaden, the company’s vice chairman, and had coffee with Thomas G. Maheras, who ran some of the bank’s biggest trading operations.(Mr. Maheras’s unit would later be roundly criticized for taking many of the risks that led Citigroup aground.)
His calendar shows that during that period he also had breakfast with Mr. Rubin. But in his conversations with Mr. Rubin, Mr. Geithner said, he did not discuss bank matters. “I did not do supervision with Bob Rubin,” he said.
In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr. Geithner praised the strength of the nation’s top financial institutions, saying that innovations like derivatives had “improved the capacity to measure and manage risk” and declaring that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”
Two days later, interviews and records show, he lobbied behind the scenes for a plan that a government study said could lead banks to reduce the amount of capital they kept on hand.
His calendars from 2007 and 2008 show that those interactions were a mix of the professional and the private.A bill sent recently by the Treasury to Capitol Hill would give the Obama administration extensive new powers to inject money into or seize systemically important firms in danger of failure. It was drafted in large measure by Davis Polk & Wardwell, a law firm that represents many banks and the financial industry’s lobbying group. Mr. Geithner also hired Davis Polk to represent the New York Fed during the A.I.G. bailout.
Treasury officials say they inadvertently used a copy of Davis Polk’s draft sent to them by the Federal Reserve as a template for their own bill, with the result that the proposed legislation Treasury sent to Capitol Hill bore the law firm’s computer footprints. And they point to several significant changes to that draft that “better protect the taxpayer,” in the words of Andrew Williams, a Treasury spokesman.
But others say important provisions in the original industry bill remain. Most significant, the bill does not require that any government rescue of a troubled firm be done at the lowest possible cost, as is required by the F.D.I.C. when it takes over a failed bank.
Traditionally, the New York Fed president’s intelligence-gathering role has involved routine consultation with financiers, though Mr. Geithner’s recent predecessors generally did not meet with them unless senior aides were also present, according to the bank’s former general counsel.
By those standards, Mr. Geithner’s reliance on bankers, hedge fund managers and others to assess the market’s health — and provide guidance once it faltered — stood out.
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This storm, like the tax fracas, will pass. But Geithner is nevertheless looking more and more like damaged goods. Geithner is captured by the industry. It will now be much easier for Obama to cut Geithner loose should that prove necessary. But with Summers still in the mix, I’m dubious that even an outster of Geithner would produce much of a change in policy direction.
AT THE WSJ: http://online.wsj.com/article/SB123940537361509771.html
As an early supporter of Barack Obama, Paul Volcker gave the young presidential candidate gravitas and advice. He frequently sat by Mr. Obama’s side at key economic events, and started carrying a cellphone for the first time, just to be able to brainstorm with the candidate from the campaign trail.
In the Obama White House, the role of the 81-year-old former chairman of the Federal Reserve has been more limited.
The one-time central banker has been put in charge of a presidential advisory board that hasn’t yet had a formal meeting. It has been nearly a month since he has seen Mr. Obama. Mr. Volcker hasn’t been a main player in key decisions handling the global financial crisis.
Treasury Secretary Timothy Geithner unveiled the administration’s plans for handling troubled financial institutions and the housing crisis without seeking input from Mr. Volcker, associates say. “Paul was surprised” at the failure to consult him, particularly on issues of financial rescue after his dominant role in resolving financial crises in the 1980s, says one person who has spoken to Mr. Volcker recently.
On the eve of one announcement, a Wall Street executive ran into Mr. Volcker at a cocktail party and asked what he expected from the Treasury secretary’s imminent announcement. “I have no idea what Tim’s going to say,” he responded, according to somebody there.
A Treasury spokeswoman said Mr. Volcker was “briefed” on all plans, including the latest one addressing banks’ toxic assets. A White House spokeswoman said that Mr. Volcker “is a valued economic adviser to the president and the administration.” She said that his “advice on issues including regulatory reform and financial stability are invaluable to the administration.”
Mr. Volcker, who recently had a pacemaker implanted in what he told friends was a “trivial procedure,” said in a brief telephone interview Wednesday that he has no complaints about his role. “How they use me is up to them,” Mr. Volcker said. “I’m conflicted about wanting to go fishing and being responsive….I might get busier than I want to be.” He declined to comment about specific areas where he was or wasn’t consulted.
When Mr. Obama announced the blue-ribbon advisory group on Feb. 6, he praised Mr. Volcker as “one of the world’s foremost economic policy experts.” With big names like General Electric Co. Chief Executive Jeffrey Immelt, the group, Mr. Obama said, would provide “voices to come from beyond the Washington echo chamber….” At a ceremony in the White House’s East Room, the president added that the group would “meet regularly” with him.
So far, the full group hasn’t met. “The whole organizational side of this has been a nightmare,” Mr. Volcker says. A White House spokeswoman says it will hold its first quarterly meeting in mid-May.
In the meantime, Mr. Volcker and his members have divided themselves into subgroups such as financial regulation, employment growth and housing, and are holding conference calls, two members say.
When Mr. Volcker was in town earlier this week, he met with Mr. Geithner, Lawrence Summers, the chief White House economic adviser, and Christina Romer, the chairwoman of the Council of Economic Advisers, to discuss financial regulation.
A key ally for Mr. Volcker inside the White House is Austan Goolsbee, the chief economist of his panel, and a member of the council. The pair grew close during the campaign when Mr. Goolsbee, Mr. Obama’s chief economic adviser, worked to bring in Mr. Volcker after he indicated his support for the underdog candidate.
Mr. Goolsbee says he talks with Mr. Volcker three or four times a week and helps get his views to the president and to senior administration officials. The task force, and particularly Mr. Volcker’s input, “is meant to serve a role akin to an economic version of the president’s BlackBerry,” Mr. Goolsbee says. Messrs. Volcker and Goolsbee also send periodic memos to the president on the issues.
Mr. Volcker’s advice hasn’t always been heeded. The former Fed chairman urged the administration to “slow down” its push for regulatory changes. “Paul thought it was important to take enough time to fill holes in the regulatory framework and not get caught up in the current atmosphere,” says former Securities and Exchange Commission Chairman William Donaldson, who’s on the Volcker panel.
When a former Fed official, attorney John Walker, recently met Mr. Volcker, Mr. Walker told him the administration “isn’t getting the best use of you.” Mr. Volcker shrugged it off, saying he’s comfortable with his role. Mr. Walker says Mr. Volcker added: “I’m 81 years old.”
AT THE FINANCIAL TIMES: http://www.ft.com/cms/s/0/3d89a930-220d-11de-8380-00144feabdc0.html?nclick_check=1
The rare nature of this recession precludes a cyclically normal US recovery. Instead, we are consigned to a slow, painful climb-out, as are nations such as Japan and Mexico that depend on US demand. The implications for US policy include a likely second round of stimulus, much more federal capital for the banking system and stunning budget deficits that will slow key initiatives for President Barack Obama, such as healthcare and energy reform.
What is unusual is that this is a balance-sheet driven recession, centred on the damaged financial condition of both households and banks. These weaknesses mandate sub-normal levels of consumer spending and overall lending for about three years.
In contrast, most postwar recessions had a different sequence – rising inflationary pressures, a monetary tightening to counter them and, then, a slowdown in response to higher interest rates. This was the pattern of the sharp 1980-81 slowdown.
None of that happened here. Instead, we saw a housing and credit market collapse that caused enormous losses among households and banks. The result was a steep drop in discretionary consumer spending and a halt to lending. To see why recovery will be slow, we can look at the balance sheet damage. For households, net worth peaked in mid-2007 at $64,400bn (€47,750, £43,449bn) but fell to $51,500bn at the end of 2008, a swift 20 per cent fall. With average family income at $50,000, and falling in real terms since 2000, a 20 per cent drop in net worth is big – especially when household debt reached 130 per cent of income in 2008.
This debt derived from Americans spending more than their income, reflecting the positive wealth effect. Households felt wealthier, despite pressure on incomes, because home and financial asset values were rising. Now that wealth effect has reversed with a vengeance. The crisis and unemployment have frightened households into raising savings rates for the first time in years. They had been stagnant at 1-2 per cent of income but have surged to nearly 5 per cent. With reduced incomes, only cutting discretionary spending can produce higher savings. This explains why personal consumption expenditures fell at record rates at the end of 2008.
Consumer spending, however, has approximated 70 per cent of US gross domestic product for the past decade and dominates our economy. But household balance sheets will not be rebuilt soon. Home values will keep falling through mid-2010 and there is no precedent for equity markets, still down 45 per cent from their peak, to make those losses up in just two years. It is illogical, therefore, to expect a full snap-back in the consumer sector in 2010 or 2011. This alone mandates a drawn-out, weak recovery.
The second key sector is the financial one. According to the International Monetary Fund, western financial institutions, mostly in the US, have realised $1,000bn of losses on US-originated assets since the crisis began. The IMF has estimated that unrealised losses may amount to another $1,000bn. With residential and commercial real estate steadily declining, this is possible. This is why the banking sector cannot make new loans. These losses are eating into banks’ capital and shrinking their capacity to add assets. Funds from the Troubled Asset Relief Program are only replacing lost capital, not increasing it. When might they end? With key categories of toxic assets still losing value, the answer is: not soon. The scale of lending needed to support a normal cyclical recovery will not materialise.
A third constraint on recovery may involve the federal balance sheet. The fiscal and monetary engines are currently on full throttle. But, within two years, concerns over budget deficits and inflation may revive, compelling the Federal Reserve to raise interest rates and Congress to adopt deficit reduction steps. These actions, contractionary by definition, could occur before a full recovery has asserted itself. On that basis, the federal balance sheet would also limit a full recovery.
This weak outlook is likely to force a second injection of spending rises and tax cuts in 2010 to prod demand. Despite public opposition, substantially more federal capital will be required for banks. The deficit outlook will worsen, perhaps to $1,000bn annually over 10 years. That will force a slowing of Mr Obama’s investment plans. That is a shame, because those investments are needed, but this balance sheet recession will be too deep.
The writer is chairman and CEO of Evercore Partners and former deputy Treasury secretary in the Clinton Administration
Apr 052009
The United States treasury’s plan to deal with “toxic assets” relies on the very financial institutions that created the economic whirlwind. The young presidency is already in a vice, says Godfrey Hodgson.
President Barack Obama joked in his press conference on 24 March 2009 that the euphoria of his inauguration two months earlier had lasted only a single day. The hope he had the audacity to proclaim is not yet dead. But – even as he prepares to leave for a trip to Europe that will encompass the G20 summit in London (2 April), the Nato anniversary summit jointly hosted by France and Germany (3-4 April), and visits to the Czech Republic (4-5 April) and Turkey (6-7 April) – the future prospects of his presidency are already in the balance.
Among openDemocracy’s articles on the economic crisis:
Willem Buiter, “The end of American capitalism (as we knew it)” (17 September 2008)
Ann Pettifor, “The week that changed everything” (22 September 2008)
Will Hutton, “Wanted: a fairer capitalism” (6 October 2008)
Avinash Persaud, “Europe’s financial crisis: the integration lesson” (7 October 2008)
Paul Rogers, “A world in flux: crisis to agency” (16 October 2008)
Andre Wilkens, “The global financial crisis: opportunities for change” (10 November 2008)
Simon Maxwell & Dirk Messner, “A new global order: Bretton Woods II…and San Francisco II” (11 November 2008)
Larry Elliott, “From G8 to G20: the end of exclusion” (16 November 2008)
Krzysztof Rybinski, “A new world order” (4 December 2008)
Paul Rogers, “A world in revolt” (12 February 2009)
Katinka Barysch, “The real G20 agenda: from technics to politics” (16 March 2009)
Krzysztof Rybinski, “There is no zombie free lunch” (18 March 2009)
Sue Branford, “The G20′s missing voice” (26 March 2009)
Will Hutton, “A G20 deal: power bends to protest” (29 March 2009)
With great courage, Obama has insisted that he would stick to his promises to tackle long-term failings in American society, even as he struggled to heal the economic crisis. He continues to press for these reforms – in climate-change policy, healthcare, public education, dependence on imported oil, and growing inequality – even as he grapples with the blocking of credit and the terrible unemployment that is one of its consequences.
The week of 23-29 March saw a new twist: the emergence of a deadly dilemma that the president has to resolve. He has learned that he cannot unblock credit without going a long way to appease the interests of the bankers who caused the problem in the first place. At the same time he has become aware of the rising fury among everyday Americans triggered by the huge bonuses paid to executives at AIG, the giant insurance company that in 2008 posted the biggest losses in American business history.
Everyone agrees that the knot that has to be cut is the astronomical quantity of “toxic assets” poisoning the balance sheets of American banks – as well as those European banks (the Royal Bank of Scotland, Paribas, Deutsche Bank and UBS among them), which thought it was clever to copycat every Wall Street fashion.
The plan unveiled by Obama’s treasury secretary Timothy Geithner on 23 March hands to the banks the juiciest of “sweetheart” deals to persuade them to buy up what Geithner calls “legacy assets” (the financial crisis has given free rein to American public life’s culture of euphemism).
The president’s vice
Geithner’s plan distinguishes between securities based on truly valueless loans and those whose value has simply been depressed by the economic downturn. It proposes that the treasury and “private investors” – which in practice can only mean the investment banks, commercial banks and hedge-funds which created and invested in the toxic assets in the first place – will buy equal amounts of the unsaleable assets. But private investors will only be able to do so thanks to a far larger injection of money to be lent by a government agency, the Federal Deposit Insurance Corporation (FDIC).
Altogether it is calculated that private investors will contribute 6% or 7% of the money to clean up the banks’ balance-sheets. The taxpayer, in the shape of the treasury and FDIC, will put up more than 90%. That, in the good old days before Wall Street collapsed, used to be called “leverage” of perhaps thirteen-to-one. With government standing behind them to that extent, why wouldn’t the banks buy trash at prices kited with government money?
Timothy Geithner makes much of the importance of keeping the rescue in the private sector, which it patently is not. He also speaks warmly of the professional skills that will be devoted to the task by the very speculators who brought the economy to its knees.
The liberal economic intelligentsia don’t like it. Jeffrey Sachs calls it a “massive transfer of wealth from taxpayers to bank shareholders”. In a deadly back-of-the-envelope calculation he estimates that the plan will hand $276 billion – even today a not inconsiderable sum – directly from the taxpayers to bank shareholders (see Jeffrey Sachs, “Will Geithner and Summers Succeed in Raiding the FDIC and Fed?“, VoxEU, 25 March 2009).
The Nobel laureate and New York Times columnist Paul Krugman dismisses the plan as not much more than a revival of the George W Bush administration’s plan to absorb the banks’ toxic assets: just more “cash for trash”. The economist and former labour secretary, Robert Reich, and the Columbia University scholar Joseph Stiglitz are equally acerbic (see Edward Luce, “America’s liberals lay into Obama“, Financial Times, 27 March 2009).
The co-editor of The American Prospect and respected commentator, Robert Kuttner, says the Obama administration has chosen “the most expensive and risky way of trying to recapitalise the banks, and the least likely to succeed”. Kuttner also identifies a point that is likely to be the target of much angry criticism, namely that the president has turned to “the same Wall Street crew” who failed to handle the situation under the Bush administration, and indeed who were largely responsible for what went wrong in the first place: Robert Rubin, Laurence Summers, and their protégés (see Robert Kuttner, “Geithner’s last stand“, Huffington Post, 22 March 2009).
If anyone had any doubts about who would benefit from the Geithner “public-private partnership”, they had only to watch how the stock market responded. Bank shares overall rose by 10% in the aftermath, but the biggest banks that have survived did better than that. Citigroup was up 19%; Bank of America shot up 26% in heavy trading; Wells Fargo’s shares rose by 24%, and J.P. Morgan Chase‘s by 25%. A day later, however, the wave of market enthusiasm had subsided.
The truth is that Obama now finds himself in a new vice. He feels he needs people from Wall Street to solve the street’s problems. That is one reason why it has taken him so long to fill the key jobs at the treasury under Geithner. At the same time he clearly underestimated the rage Main Street citizens feel both at the AIG bonuses and the broader proposition: that while they face losing their jobs and their homes because of the folly and greed of the financial sector, the only people who walk away laughing are the folks who caused the disaster in the first place.
No wonder that questions are being asked about the ubiquitous presence of present and former executives of Goldman Sachs in the Obama administration, just as in the ranks of its precedessor.
A time to choose
Barack Obama showed in his long campaign for the presidency that he is a very skilled politician. He is also by temperament cautious, even conservative. His instinct is to “reach across the aisle” in order to cure what he sees as the excessive partisanship of the years since the “Reagan revolution“. He is too a patient man. But now he understands that he has got to move fast if he is to save the hopes of his presidency (see “Barack Obama: don’t waste the crisis“, 6 February 2009).
In this the president is both beneficiary and victim of larger historic forces. The same event that cleared his way to the White House, the financial crisis symbolised by the fall of Lehman Brothers on 15 September 15 2008, may have made it impossible to govern; or at the least, may mean that he will have to sacrifice at least some of his hopes of long-term reform (see “The week that democracy won“, 29 September 2008).
In the short term, in order to heal the financial crisis it looks as though he has had to put the fate of his administration in the hands of the men from Wall Street.
Amid the stock-market panic of 1907, the financier JP Morgan was surprised that President Theodore Roosevelt didn’t “send your man to fix things up with my man”. It couldn’t be done like that then, and it can’t be done now. But the young president and his even younger treasury secretary have nonetheless been taught a hard lesson in political economy.
To govern is to choose, as Aneurin Bevan – the Welsh architect of Britain’s post-1945 national healthcare system – said. It is now clear that inviting the poachers to act as gamekeepers was a mistake. Many Americans long accepted the conservative contention that government was the problem, not the solution. That phase of history seems to have ended, and a progressive president finds himself coping with a new wave of populism of a kind that seemed to have disappeared from America politics for generations. He means to govern, and he will have to choose.
Godfrey Hodgson was director of the Reuters’ Foundation Programme at Oxford University, and before that the Observer’s correspondent in the United States and foreign editor of the Independent. His books include The World Turned Right Side Up: a history of the conservative ascendancy in America (Houghton Mifflin, 1996); More Equal Than Others: America from Nixon to the New Century (Princeton University Press, 2006), and A Great and Godly Adventure: The Pilgrims and the Myth of the First Thanksgiving (PublicAffairs, 2007)
At Open Democracy: http://www.opendemocracy.net/article/barack-obama-end-of-the-beginning
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G8 signals the end of the financial crisis, but what caused it?
The weekend G8 communiqué, coming after four months of stabilisation in most financial markets, seemed to mark the official end of the financial crisis. If so, what lessons should be learnt for economic and financial policies in the months ahead? The history of the crisis in the next few paragraphs may not be the standard version presented by most commentators and economists, yet recent events suggest it to be a plausible account of what went wrong.
The blunders that produced last autumn’s financial crisis had nothing to do with the supposedly inflationary monetary policies of Alan Greenspan, or the fiscal profligacy of Gordon Brown, or with Mervyn King’s lack of practical market experience, or Hu Jintao’s mercantilist approach to currencies and exports. All these and many other factors contributed to the vulnerability of the world economy, but none of them would have been enough to cause its near-collapse last autumn. For that we can blame the unforced errors of a man almost forgotten since he slipped quietly out of office at the beginning of this year: Henry Paulson, the former US Treasury Secretary and ex-chairman of Goldman Sachs.
To understand how a localised financial problem in one segment of the US mortgage market turned into a near-collapse of the global financial system we need to recall Mr Paulson’s astonishing misuse of mark-to-market accounting standards to expropriate the shareholders of Fannie Mae and then to bankrupt Lehman Brothers. What made matters even worse was his inability to understand the systemic consequences of what he was doing. Anyone who doubts the importance of individuals in economic history should recall that the single worst day of last autumn’s entire financial crisis, as measured by the widening of risk spreads on interbank credit, was September 23. That was the day Mr Paulson appeared before the Senate Finance Committee to explain what he wanted to do with the $700 billion he had requested from Congress. This was the moment when everyone realised the world’s most powerful economic official did not know what he was doing.
Once the key role of personalities and financial policies is recognised, it is hardly surprising that things began to improve almost as soon as Mr Paulson was replaced by a competent Treasury Secretary, Tim Geithner. A collapse of share prices on Wall Street triggered by the Lehman bankruptcy in September ended the very day after President Obama responded to attacks on Mr Geithner’s personal probity by offering his unqualified support. A week later, the suicidal mark-to-market accounting regulations were dismantled. And it is no coincidence that the financial crisis, at least in America and Britain, effectively ended that week. From that point onwards, the US Government found itself collecting tens of billions of dollars in repayments from supposedly insolvent banks. Far from being forced to nationalise almost every bank and running out of money with which to refinance toxic assets, as predicted by panic-mongering Nobel Laureate economists, the US Treasury now finds itself almost embarrassed by the hundreds of billions of dollars it has budgeted for supporting a banking system that no longer needs state support.
Paulson Caused the Financial Crisis – Anatole Kaletsky, Times of London