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Home | Switchboard | Unix Administration | Red Hat | TCP/IP Networks | Neoliberalism | Toxic Managers |
| (slightly skeptical) Educational society promoting "Back to basics" movement against IT overcomplexity and bastardization of classic Unix | |||||||
| “The Fed is now actively and directly engaged in the redistribution of wealth.” The problem is that it is the redistribution from the poorer to the richer. I have no problem with people becoming richer due to talent, hard work, or innovation, but people who can’t figure out that loans have to be paid back do not deserve to keep any of their bonuses or ill conceived salaries. The Fed has embarked upon a policy of affirmative action for the stupid. |
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The term "regulatory capture" is a new term for "regulatory corruption" and refers to the subversion of regulatory agencies by the firms they regulate, not exclusively by money but by more subtle means such as revolving door policies, defunding those initiatives that run against to firms interests, changing legislation that effective emasculate the regulator, etc. This is to be distinguished from regulation that is intended by the legislative body that enacts it to serve the private interests of the regulated firms, for example by shielding them from new entry. Regulatory capture implies that the regulated firms unleashed the war on the regulatory agency and won it, turning the agency into their vassal.
How are we to judge the Federal Reserve? The Fed by its very nature has been a very opaque institution. The Fed was designed as a unique hybrid in which government would share its powers with the private banking industry. But recently it became more like agent of Wall street in government. All-in-all this is an extremely powerful, shadow organization, which after its politization by Greenspan looks not unlike Politburo of the CPSU of the USSR (which being a party body formally did not have either legislative or executive power at all).
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The Fed Chairman is the highest unelected official on the country and may be No.2 in Washington power corridors in general (In some areas he is No.1 as he does have some influence on presidential elections and can help to defeat incumbent by increasing interest rates or help the current administration to say in power by slashing rates). What truly goes on behind the closed doors of the Fed? We don't know how sycophantic are the relationships amongst the Fed Chair and Fed governors, but indirect facts like Alan Blinder short tenure under Greenspan suggest that Feds power structure is authoritarian with all-powerful Fed chairman and under some chairmen has the distinct "cult of personality" bent. Again the structure not unlike the power structure of Soviet Politburo.
The working hypothesis is that the level of "cult of personality" really resembles the same for the position of the General Secretary of CPSU. Whatever are their personal feelings and beliefs members obligingly vote for the party line proposed by the Chairman. As Greenspan once put it, any open discord undermines the Fed influence. And he has a point, although the price to pay for the fake unity might be too high. Add to this hidden relationships between Fed Open Market Committee members and Wall Street titans and their political operatives...
The financial sector has grown to be a larger part of the overall economy. The financial sectors share of credit (debt) has increased from 15% in 1974 to 41% in 2008. Consequently, the economy is now more vulnerable to the effects of a bursting credit bubble stemming from the financial sector. In other words hypertrofied financial secor is the source of systemic instability. And credit induced recessions are more severe than non-credit related recessions, such as the bursting of the high-tech bubble.
After allowing creation of banking oligopolies with their ability to distort markets, avoid competition, and corrupt politics and the regulatory system Fed became just a pawn in big game, member of the same banksters cartel. That means that Fed was not simply corrupted but it was corrupted to the core in true RICO sense.
By law, the Fed has a responsibility for the stability of the financial system and for maintain adequate reserves by the banks. Initial role of the Fed was more narrow: it was created in 1913 to provide temporary liquidity to banks to meet depositor withdrawals caused by financial panics. Fed liquidity enables banks to avoid selling assets in distressed markets where asset values might be temporarily impaired. The law allows the Fed to lend based on acceptable collateral, to otherwise solvent banks. Over time, a variety of tools have been added to fight financial panics, including FDIC insurance. Also Fed was given important regulatory functions aimed at preventing the excessive risk taking by taking too much debt (aka leverage) and maintaining too low capital levels which were one of the sources of Great Depression.
In Greenspan era the Fed has been criminally derelict in fulfilling its regulatory functions under the Federal Reserve Act, namely monitoring banking institutions to be sure the correct capital levels were being maintained. As a shrewd political operative and compulsive careerist Greenspan was mainly interested in his survival and playing the hand of bank oligopolies was a sure way to ensure his election and reelection.
In the current crisis Fed's actions departed from past responses in a number of important ways.
The size of the Fed commitment is directly related to the large credit share enjoyed by the financial sector. Fed intervention, in size and scope never before seen, has prevented the full effect of a natural downsizing that would have occurred with the bursting of the financial credit bubble. In some instances, financial firms have become bigger and more powerful. The owners of affected debt and some stockholders, are the primary beneficiaries of the bailouts. Bailouts have increased future deficits and potential taxes by unimaginable amounts. The economy’s exposure to financial sector crisis has increased.
The FED deepened the division between those perceived as less risky and those perceived as more risky with their minimum capital requirements based on perceived default risks. In most other aspects of social life such discrimination and profiling is prohibited.And this regulatory division is even more perverse in a recession when some triple-A rated clients are downgraded and the banks have to get new capital to cover these; and which mostly comes from stopping lending to those of which require even larger capital requirements. This is the most dangerous of all pro-cyclical effects of the Basel regulations, but also the most ignored.
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Mar 31, 2019 | www.nakedcapitalism.com
... ... ...Running in the background, though, was a new, darker theme: That the post-2008 reforms had gone too far in restricting policymakers' discretion in crises. The trio most responsible for making the post-Lehman bailout revolution -- Ben Bernanke, Timothy Geithner, and Henry Paulson -- expressed their misgivings in a joint op-ed :
But in its post-crisis reforms, Congress also took away some of the most powerful tools used by the FDIC, the Fed and the Treasury the FDIC can no longer issue blanket guarantees of bank debt as it did in the crisis, the Fed's emergency lending powers have been constrained, and the Treasury would not be able to repeat its guarantee of the money market funds.
These powers were critical in stopping the 2008 panic The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater.
We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.
Sotto voce fears of this sort go back to the earliest reform discussions. But the question surfaced dramatically in Timothy Geithner's 2016 Per Jacobsson Lecture, " Are We Safer? The Case for Strengthening the Bagehot Arsenal ." More recently, the Group of Thirty has advanced similar suggestions -- not too surprisingly, since Geithner was co-project manager of the report, along with Guillermo Ortiz, the former Governor of the Mexican Central Bank, who introduced the former Treasury Secretary at the Per Jacobson lecture.
Aside from the financial collapse itself, probably nothing has so shaken public confidence in democratic institutions as the wave of bailouts in the aftermath of the collapse. The redistribution of wealth and opportunity that the bailouts wrought surely helped fuel the populist surges that have swept over Europe and the United States in the last decade. The spectacle of policymakers rubber stamping literally unlimited sums for financial institutions while preaching the importance of austerity for everyone else has been unbearable to millions of people.
Especially in money-driven political systems, affording policymakers unlimited discretion also plainly courts serious risks. Put simply, too big to fail banks enjoy a uniquely splendid situation of "heads I win, tails you lose" when they take risks. Scholars whose research INET has supported, notably Edward Kane , have shown how the certainty of government bailouts advantages large financial institutions, directly affecting prices of their bonds and stocks.
For these reasons INET convened a panel at a G20 preparatory meeting in Berlin on " Moral Hazard Issues in Extended Financial Safety Nets ." The Power Point presentations of the three panelists are presented in the order in which they gave them, since the latter ones sometimes comment on Edward Kane 's analysis of the European banks. Kane, who coined the term "zombie bank" and who famously raised early alarms about American savings and loans, analyzed European banks and how regulators, including the U.S. Federal Reserve, backstop them.
Peter Bofinger , Professor of International and Monetary Economics at the University of Würzburg and an outgoing member of the German Economic Council, followed with a discussion of how the system has changed since 2008. Helene Schuberth , Head of the Foreign Research Division of the Austrian National Bank, analyzed changes in the global financial governance system since the collapse.
The panel took place as public discussion of a proposed merger between two giant German banks, the Deutsche Bank and Commerzbank, reached fever pitch. The panelists explored issues directly relevant to such fusions, without necessarily agreeing among themselves or with anyone at INET.
But the point Robert Johnson, INET's President, and I made some years back , amid an earlier wave of talk about using public money to bail out European banks, remains on target:
We are only interested observers of the arm wrestling between the various EU countries over the costs of bank rescues, state expenditures, and such. But we do think there is a clear lesson from the long history of how governments have dealt with bank failures . [If] the European Union needs to step in to save banks, there is no reason why they have to do it for free best practice in banking rescues is to save banks, but not bankers. That is, prevent the system from melting down with all the many years of broad economic losses that would bring, but force out those responsible and make sure the public gets paid back for rescuing the financial system.
The simplest way to do that is to have the state take equity in the banks it rescues and write down the equity of bank shareholders in proportion. This can be done in several ways -- direct equity as a condition for bailout, requiring warrants that can be exercised later, etc. The key points are for the state to take over the banks, get the bad loans rapidly out of those and into a "bad bank," and hold the junk for a decent interval so the rest of the market does not crater. When the banks come back to profitability, you can cash in the warrants and sell the stock if you don't like state ownership. That way the public gets its money back .at times states have even made a profit.
In 2019, another question, alas, is also piercing. In country after country, Social Democratic center-left parties have shrunk, in many instances almost to nothingness. In Germany the SPD gives every sign of following the French Socialist Party into oblivion. Would a government coalition in which the SPD holds the Finance Ministry even consider anything but guaranteeing the public a huge piece of any upside if they rescue two failing institutions?
The full article of Edward Kane
WheresOurTeddy , March 29, 2019 at 11:49 am
Enforcement of financial laws is not our thing. Just ask Chuck Schumer of the #Non-Resistance:
https://theintercept.com/2019/03/28/sec-democratic-commissioner-chuck-schumer/
Louis Fyne , March 29, 2019 at 12:17 pm
There needs to be an asset tax on/break up of the megas. End the hyper-agglomeration of deposits at the tail end. Not holding my breath though. (see NY state congressional delegation)
To be generous, tax starts at $300 billion. Even then it affects only a dozen or so US banks. But would be enough to clamp down on the hyper-scale of the largest US/world banks. The world would be better off with lot more mid-sized regional players.
thesaucymugwump , March 29, 2019 at 12:17 pm
Anyone who mentions Timmy Geithner without spitting did not pay attention during the Obama reign of terror. He and Obama crowed about the Making Home Affordable Act, implying that it would save all homeowners in mortgage trouble, but conveniently neglected to mention that less than 100 banks had signed up. The thousands of non-signatories simply continued to foreclose.
Not to mention Eric Holder's intentional non-prosecution of banksters. For these and many other reasons, especially his "Islamic State is only the JV team" crack, Obama was one of our worst presidents.
chuck roast , March 29, 2019 at 12:21 pm
Thank you Yves and Tom Ferguson.
Fergusons graph on DBK's default probabilities coincides with the ECB's ending its asset purchase programme and entering the "reinvestment phase of the asset purchase programme".
https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html
The worst of the euro zombie banks appear to be getting tense and nervous.
https://www.youtube.com/watch?v=dKpzCCuHDVY
Maybe that is why Jerome Powell did his volte-face last month on gradually raising interest rates. Note that the Fed also reduced its automatic asset roll-off. I'm curious if the other euro-zombies in the "peers" return on equity chart are are experiencing volatility also.Craig H. , March 29, 2019 at 1:04 pm
Apparently the worst fate you can suffer as long as you don't go Madoff is Fuld. According to Wikipedia his company manages a hundred million which must be humiliating. It's not as humiliating as locking the guy up in prison would be by a very long stretch.
Greenspan famously lamented that there isn't anything the regulators can really do except make empty threats. This is dishonest. The regulations are not carved in stone like the ten commandments. In China they execute incorrigible financiers all the time.
John Wright , March 30, 2019 at 10:31 am
Greenspan was never willing to counter any problem that might irritate powerful financial constituencies. For example, during the internet stock bubble of the late 1990's, Greenspan decried the "irrational exuberance" of the stock market. The Greenspan Fed could have raised the margin requirement for stocks to buttress this view, but did not. As I remembered reading, Greenspan was in poor financial shape when he got his Fed job.
His subsequent performance at the Fed apparently left him a wealthy man. Real regulation by Greenspan may have adversely affected his wealth. It may explain why Alan Greenspan would much rather let a financial bubble grow until it pops and then "fix it".
Procopius , March 31, 2019 at 12:30 am
Everybody forgets (or at least does not mention) that Greenspan was a member of the Class of '43, the (mostly Canadian) earliest members of the Objectivist Cult with guru Ayn Rand. Expecting him to act rationally is foolish. It may happen accidentally (we do not know why he chose to let the economy expand unhindered in 1999), but you cannot count on it. In a world with information asymmetry expecting markets to be concerned about reputation is ridiculous. To expect them to police themselves for long term benefit is even more ridiculous.
rd , March 29, 2019 at 3:06 pm
I think Finance is currently about 13% of the S&P 500, down from the peak of about 18% or so in 2007. I think we will have a healthy economy and improved political climate when Finance is about 8-10% of the S&P 500 which is about where I think finance plays a healthy, but not overwhelming rentier role in the economy.
Inode_buddha , March 29, 2019 at 4:51 pm
I think things will be much better when finance is about ~3% of the S&P 500, but no more than that.
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Mar 14, 2019 | jessescrossroadscafe.blogspot.com
"But the impotence one feels today -- an impotence we should never consider permanent -- does not excuse one from remaining true to oneself, nor does it excuse capitulation to the enemy, what ever mask he may wear. Not the one facing us across the frontier or the battle lines, which is not so much our enemy as our brothers' enemy, but the one that calls itself our protector and makes us its slaves. The worst betrayal will always be to subordinate ourselves to this Apparatus, and to trample underfoot, in its service, all human values in ourselves and in others."
Simone Weil
"And in some ways, it creates this false illusion that there are people out there looking out for the interest of taxpayers, the checks and balances that are built into the system are operational, when in fact they're not. And what you're going to see and what we are seeing is it'll be a breakdown of those governmental institutions. And you'll see governments that continue to have policies that feed the interests of -- and I don't want to get clichéd, but the one percent or the .1 percent -- to the detriment of everyone else...
If TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car... I think it's inevitable. I mean, I don't think how you can look at all the incentives that were in place going up to 2008 and see that in many ways they've only gotten worse and come to any other conclusion."
Neil Barofsky
"Written by Carmen Segarra, the petite lawyer turned bank examiner turned whistleblower turned one-woman swat team, the 340-page tome takes the reader along on her gut-wrenching workdays for an entire seven months inside one of the most powerful and corrupted watchdogs of the powerful and corrupted players on Wall Street – the Federal Reserve Bank of New York.
The days were literally gut-wrenching. Segarra reports that after months of being alternately gas-lighted and bullied at the New York Fed to whip her into the ranks of the corrupted, she had to go to a gastroenterologist and learned her stomach lining was gone.
She soldiered through her painful stomach ailments and secretly tape-recorded 46 hours of conversations between New York Fed officials and Goldman Sachs. After being fired for refusing to soften her examination opinion on Goldman Sachs, Segarra released the tapes to ProPublica and the radio program This American Life and the story went viral from there...
In a nutshell, the whoring works like this. There are huge financial incentives to go along, get along, and keep your mouth shut about fraud. The financial incentives encompass both the salary, pension and benefits at the New York Fed as well as the high-paying job waiting for you at a Wall Street bank or Wall Street law firm if you show you are a team player .
If the Democratic leadership of the House Financial Services Committee is smart, it will reopen the Senate's aborted inquiry into the New York Fed's labyrinthine conflicts of interest in supervising Wall Street and make removing that supervisory role a core component of the Democrat's 2020 platform. Senator Bernie Sanders' platform can certainly be expected to continue the accurate battle cry that 'the business model of Wall Street is fraud.'"
Pam Martens, Wall Street on Parade
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The New York Sun
By DAWN BENNETT,
Adapted From Financial Myth Busting | April 5, 2015http://www.nysun.com/national/the-floating-kilogram-the-editor-of-the-sun-talks/89117/
The following is adapted from an interview by Dawn Bennett, host of the radio show "Financial Myth Busting," with the editor of The New York Sun, Seth Lipsky. The broadcast aired March 8:
* * *
Ms. Bennett: Seth Lipsky is the author of a book titled "The Floating Kilogram and Other Editorials on Money from The New York Sun." Before the Sun, he spent 20 years at the Wall Street Journal where he served on the editorial board and helped launch the Asian Wall Street Journal as well as the Wall Street Journal Europe. Recently, Seth authored a column in the New York Post titled "Why does the Federal Reserve Fear a Real Audit," which is a question much on my mind. Seth, welcome.
Mr. Lipsky: Thanks, Dawn. It's nice to be with you.
Ms. Bennett: To put it charitably, Janet Yellen appears to be very alarmed that some members of Congress want to conduct a comprehensive audit of the Federal Reserve for the first time since it was created. If the Federal Reserve is doing everything correctly, why should Mrs. Yellen be alarmed and what does she have to hide?
Mr. Lipsky: Well, that's a great question. The Federal Reserve is already audited, in the sense that an accountant comes in and goes over its books. But what the Congress is talking about is a much broader look by the Governmental Accountability Office of how the central bank forms our monetary policy and what its relations are with foreign banks. The Fed has been fighting this tooth and nail as an intrusion on its independence. What Congress knows is that the Constitution gave the monetary power precisely to Congress.
Congress has a constitutional obligation and power to establish the American monetary system and regulate it, to coin money, regulate its value and that of foreign coinage. This has become a big issue where we have not taken a really systematic look at how the Fed operates in the hundred years that it's been in existence. We're starting the second century, and there is growing sentiment in the Congress to take a look at this. The audit of the Fed measure passed the House as recently as of September by a vote of 333 to 92, with 109 Democrats joining the Republicans. So the Fed is certainly growing concerned.
Ms. Bennett: The only reason Janet Yellen has the power to coin money is because Congress delegated its own power to the Federal Reserve in 1913. Isn't congressional oversight of that power something that should be considered commonsensical by the Federal Reserve?
Mr. Lipsky: The Fed was created in 1913. The Coinage power was first acted on in 1792, and coinage was given not to any Federal Reserve but to the United States Mint. When the second central bank came up to the Supreme Court it was really the tax and the borrowing power that the courts were looking at when they okayed the authority of the central bank.
Ms. Bennett: We are all accountable to someone or something, so what is wrong about the Federal Reserve being accountable to Congress?
Mr. Lipsky: Nothing whatsoever. Even Chairman Yellen acknowledges that Congress has the power. She's just pleading and warning that it not interfere. Why is Congress growing concerned about this in the first place? It's because the Great Recession has lasted six years and we still do not feel like we've recovered. What is the Fed's role in this? Could the reason that the Great Recession lasted so long be attributable to monetary policy? The value of the dollar has been allowed to collapse below one 1,100th of an ounce of gold. It was a 265th of an ounce of gold when George W. Bush was sworn in. These are huge questions, and somebody needs to ask them.
Ms. Bennett: It is quite clear to me that the Federal Reserve doesn't want the rest of us to actually be able to see what they really up to. If we did know what they're doing, do you think most Americans would just want it shut down? To your point, since 1913, the dollar has actually lost over 97% of its purchasing power. And of course, the economy has been subjected to one painful depression and a series of what I call Fed-created recessions. Despite the poor track record, we continue to support them. At the end of the day, does it matter if we even have a Federal Reserve?
Mr. Lipsky: I think the monetary questions do matter to every American in all positions. My favorite statistic is that between 1947 and 1971 the average unemployment rate was below 5%. From 1971 until today it was above 6%. What happened in 1971, when the unemployment rate began souring? What happened is we abandoned the Bretton Woods Gold Exchange System, under which the dollar was linked to gold, and the money began flowing not in the productive enterprises, but into the money markets and hedge funds and all these sorts of things and not so much into the kind of investment that created the great industrial base in America.
Ms. Bennett: Let's talk about that type of investment. According to a government report I've read, the Federal Reserve made $16.1 trillion in loans to big banks during that financial crisis. In my opinion, [it once] created the dotcom bubble and the housing bubble. Now, I think it has created the financial bubble that our markets are experiencing.
Mr. Lipsky: Asset inflation. The debate over inflation is one of the most important debates in the country. The left wing likes to say there is no inflation, but the dollar is worth only a tiny amount of the constitutional specie, which is gold and silver, compared to what it used to be worth. This is what people feel when they hear the government say there's no inflation but they try to go to the grocery store and they spend $50 or $100 on a tiny plastic bag with a few items in it.
Ms. Bennett: Yes, I know shelf inflation is huge, but I want to talk about commodities for a bit. The Department of Justice has recently said again that they're going after the big banks that have been, on an ongoing and continuous basis, manipulating gold and silver. What are your thoughts on that? Will it work this time? And, if so, is there a simple solution to stop them from doing this? They seem to get their hands slapped, apologize, and then come back and do it again, and again.
Mr. Lipsky: The news that the Justice Department is looking at something like ten or twelve major banks for possibly rigging the price of gold broke the same week that Mrs. Yellen was up on Capitol Hill testifying against an audit of the Fed.
Ms. Bennett: That's right.
Mr. Lipsky: One of the questions that The New York Sun raised is what is she afraid of then? Is it the danger that the Fed has been meddling in the gold market the way the Justice Department is alleging commercial banks have been doing it? It's the Fed that regulates commercial banks after all. I don't want to carry that argument too far. I asked it then in an editorial more in the nature of a question. But there is a movement in Congress to open up what is called a Centennial Monetary Commission that after the first hundred years of the Fed, would just take a look at how the whole system is working.
We've been in a period of fiat money, meaning dollars that have no connection in law to any gold or silver or other constitutional money. We've been in a fiat system since 1971. Previously, our dollars were always defined in terms of gold and silver, suddenly they're not. The unemployment average is much higher; the bankruptcy rate is much higher; the inequality rate has been much higher since the mid 1970's. Could this be related to the fact that we abandoned sound money in the mid 1970s?
Ms. Bennett: De-dollarization has been going on now for the last few years, and I think it's because the dollar is continuing to get weaker. Our political system and economic system aren't what they used to be. Do you think it's possible that if China, for example, standardizes the renminbi it will start taking power away from the U.S. dollar?
Mr. Lipsky: The abandonment of sound money by the U.S. has brought forth a whole chain of foreign governments that are alarmed and wonder whether a new system should be set up. China. There is talk of Russia going on a gold standard; the European Union is having its own catastrophe with the Euro, and it's wondering whether the dollar ought to be replaced as the international reserve. The United Nations, for crying out loud, has gotten involved in this.
One of my favorite moments happened in 1965, when the President of France, Charles de Gaulle, called a thousand reporters into the presidential palace sat them down and addressed them on the importance of restoring gold as the international standard. His argument was that it puts all countries on the same basis: America, France, England, China, little countries, and it takes a lot of the partisanship out of the monetary question internationally, or it takes the politics out of money. It's ironic that Fed loves to talk about how we shouldn't politicize the monetary system. If one really wants to de-politicize the monetary system, restoring a gold standard or something like it is exactly the way to do it.
Ms. Bennett: Mrs. Yellen claims that opening the Fed to an outside audit would "politicize" - her word - monetary policy.
Mr. Lipsky: Right.
Ms. Bennett: Isn't it political when Senator Schumer, for example, tells her to keep rates low every time she testifies before the Senate Banking Committee? Isn't it already happening?
Mr. Lipsky: You're exactly right. Why is it always the conservatives that are doing the politicizing and not the liberals? The big politicization of monetary policy happened in 1978 with the passage of Humphrey-Hawkins, which said that the Fed has to have a second mandate of increasing the employment rate or decreasing unemployment, in addition to affecting the value of our dollar. That opened the door to an enormous political interference in monetary policy.
Ms. Bennett: I know you're not a gold trader or silver trader...
Mr. Lipsky: I'm a newspaperman.
Ms. Bennett: There you go. But I'm certain you follow the markets. What do you think would be a simple solution to fix the ongoing and continuous manipulation of gold and silver so that we can get more stability? It does seem, whether it's a Federal Reserve or some other central bank, that they're interfering with it in order to make the fiat currency look stronger than it really is.
Mr. Lipsky: I favor a definition by law, enacted by Congress under its constitutional powers to coin money and regulate its value, and fix the standards of weights and measures - a law passed by Congress defining the dollar as a fixed amount of gold or silver. Silver was the main specie used in early years of our republic. The debate over whether gold or silver was better went on through the 19th century, and we basically decided in 1900, with the passage of the Gold Standard Act, to make gold the true national money. I think that would go a long way toward solving this problem. There are a lot of questions as to exactly how to do it, whether there should be a system like Bretton Woods, which said dollars had to be redeemed in gold if they were held by foreign governments.
Ms. Bennett: In physical gold, not paper gold. In physical gold.
Mr. Lipsky: Right.
Ms. Bennett: There's a big difference there.
Mr. Lipsky: Therefore the price at which one fixes the dollar, the value, the amount of gold, has to be carefully worked out. But the gold standard is not some flaky thing. This was believed in by George Washington, Thomas Jefferson, James Madison, Alexander Hamilton, and almost every president since, up until Richard Nixon. John Kennedy, Woodrow Wilson, Grover Cleveland - they all believed in it.
Ms. Bennett: Seth, "The Floating Kilogram and other Essays on Money from The New York Sun." For any listeners not familiar with the Sun, can you bring them up to speed?
Mr. Lipsky: The New York Sun is an online newspaper that I edit. We published in print until several years ago. It's a leading voice in journalism for a sound dollar. It supports a sound dollar, limited government, and a restoration of constitutional dollar based on gold or silver. This is the first radio interview about the book.
Ms. Bennett: Thank you.
Mr. Lipsky: This book contains on this issue 130 editorials that have been issued in the Sun in recent years. Steve Forbes calls them "brilliant," "irrefutable," and "the Federalist Papers for the gold standard." James Grant calls the book both "persuasive" and "unfailingly entertaining." It's a book for every person, not just the experts, and it's available on Amazon.com, the online bookstore, and you'll have a copy in a day or two if you place your order. "Pure gold" is the way the economist Judy Shelton described this book. The title, Dawn, comes from the discovery that the kilogram, which is the last metric weight measure based on a physical object, has been losing mass - atom by atom. The Sun in one of its editorials said, "Why don't we float the kilogram just like we float the dollar?" That's from where the title of the book comes.
Ms. Bennett: If President Obama, or our next president, were to become motivated to make reforms, what do you think the takeaway from this book would to be? Definitely a gold standard?
Mr. Lipsky: So I think the takeaway is going to be that in our monetary system at some point, the dollar has to be defined in terms of something real rather than just another dollar. At the moment, if you take your dollar to the central bank to redeem it, they'll give you another dollar. There's no reference to anything real and no classical measure of value. We have what Jim Grant likes to call the Ph.D. standard, and I think we need to move away from that to the kind of standard that sustained our country during its periods of greatest growth and strongest employment.
Ms. Bennett: We always seem to make changes in the United States when things break down, but not beforehand. What is going to be the instigator to standardize our currency?
Mr. Lipsky: People say things could become a disaster. The last six years have been a disaster.
Ms. Bennett: Exactly.
Mr. Lipsky: Huge amounts of unemployment, not just for a short period, but for six years. It's consumed almost the entire Obama presidency. People are still trying to figure out their homes, still trying to figure out how the price of college got more than halfway to $100,000 a year - you know, all these things. We've been living through this, and I think events have energized Congress to start looking at this. The Sound Dollar Act, or Centennial Monetary Commission Act, or Audit the Fed Act, or Free Competition in Currency Act. This is why Janet Yellen - to bring it back to where we came in - is fighting so hard against the Congress doing this. We're in a constitutional moment here where Congress is going to take a look at this, I predict.
Ms. Bennett: Do you think they're going to have the guts to do it?
Mr. Lipsky: I think the American people have a lot of guts.
Ms. Bennett: Me, too.
Mr. Lipsky: And at the end of the day, the Congress has to listen to the American people.
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Zero Hedge
While the world of mainstream media stock pundits would like investors to believe that there is a wall of money on the sidelines waiting anxiously to go all-in on stocks (bear in mind there's a seller for every buyer and where does the cash on the sidelines go when it is handed over to the seller in return for his stock?), as none other than Charles Schwab notes in this brief Bloomberg TV clip, "investors are less rattled" than most believe, "and have stayed invested" in large part. "There hasn't been a wholesale movement away from stocks," he goes on, busting myths asunder, adding that "investors want to see market-driven conditions, not Fed manipulated ones."
So perhaps - just perhaps - Schwab is right, if the Fed stepped away and let markets be markets once again, maybe real capital would flow once again?
Schwab goes on to discuss how the Fed's policy has hurt the older generation - "it has been a terrible thing"
Beginning at around 50 seconds, Schwab calmly dismisses one of the biggest market myths and raises a few red flags - "we see the market go up or down depending on which Fed member is speaking..."
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April 17, 2013
From the event at the Philadelphia Fed on April 17th, 2013 (04/17/2013) conference segment "Fixing the Banking System for Good" .
In video testimony to the Philadelphia Federal Reserve in April of 2013, Jeffrey Sachs, one of the world's most respected economists, expresses outrage at the extent of moral bankruptcy in the American financial system and the docile president and regulators who do nothing about it.
Jeffrey Sachs' Speech on Wall Street Corruption The Big Picture
April 30, 2013 at 9:21 am
Hmmm.
Corrupt government; corrupt financial system; corrupt business culture; corrupt legal system.
Why on earth is America inheriting the Russian model ?
Petey Wheatstraw
It's the standard for failed countries.
spooz
For those who would like to listen to other speakers at The 31st Annual Monetary and Trade Conference where Sachs presented this (including Michael Kumhof's presentation on The Chicago Plan Revisited, which starts at about 1:02, and which I would LOVE to see more economists discuss), here is the link.
Concerned Neighbour
Of course he's right. It's truly remarkable the amount of corruption out there that is visible; just imagine how much isn't.
My own pet theory is that the regulators made a deal early on in the crisis with the TBTF banks: "Help us levitate the markets, and we won't throw you in jail". If I'm right, it's obviously been a massive success.
Mark E HofferSachs, and others, may appreciate..
The Propaganda System That Has Helped Create a Permanent Overclass Is Over a Century in the Making
April 29, 2013
Print VersionBy Andrew Gavin Marshall, Blacklisted News
Where there is the possibility of democracy, there is the inevitability of elite insecurity. All through its history, democracy has been under a sustained attack by elite interests, political, economic, and cultural. There is a simple reason for this: democracy – as in true democracy – places power with people. In such circumstances, the few who hold power become threatened. With technological changes in modern history, with literacy and education, mass communication, organization and activism, elites have had to react to the changing nature of society – locally and globally.
From the late 19th century on, the "threats" to elite interests from the possibility of true democracy mobilized institutions, ideologies, and individuals in support of power. What began was a massive social engineering project with one objective: control. Through educational institutions, the social sciences, philanthropic foundations, public relations and advertising agencies, corporations, banks, and states, powerful interests sought to reform and protect their power from the potential of popular democracy…"
http://www.blacklistednews.com/The_Propaganda_System_That_Has_Helped_Create_a_Permanent_Overclass_Is_Over_a_Century_in_the_Making/25648/0/38/38/Y/M.html
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Simon Johnson continues his push against conflicts of interest within the Federal Reserve system:Three More Governance Questions for the Fed, by Simon Johnson, Commentary, NY Times: Over the last several weeks on this blog, I have expressed ... concerns about governance arrangements at the Federal Reserve Bank of New York. I have made the specific case for Jamie Dimon, the chief executive of JPMorgan Chase, to step down from the New York Fed's board because of the large, unexpected losses in his bank's London proprietary trading operation - and the fact that these activities and their disclosure are now under investigation by the Fed. ...
In addition,... I have three substantive governance concerns for the New York Fed... First and most important, why didn't Mr. Dimon step down from the board of the New York Fed in March 2008, when JPMorgan Chase bought Bear Stearns with financial support provided, in part, by the Fed? ...
The authorities worked closely with JPMorgan Chase... JPMorgan's downside risk ... was limited. ... The precise terms of this arrangement were, appropriately, subject to detailed negotiation... How was it appropriate for Mr. Dimon to remain on the board of the New York Fed while this negotiation was going on? ...
Second, I would like to raise a question about Stephen Friedman, who was a Class C director of the New York Fed - and chairman during the intense financial crisis period, from January 2008 through early 2009. ...
According to the rules established by the Federal Reserve Board,... [there is a] fairly comprehensive ban on holding financial stock... But Mr. Friedman at that time was and still is a senior executive at Stone Point Capital, where ... he is involved in the fund's investment decisions. ... How was Mr. Friedman allowed to own these shares while being a Class C director? ...
Mr. Friedman bought Goldman Sachs stock after the company was effectively rescued by the Federal Reserve... I don't understand how a Class C director could have thought it was acceptable to buy any financial services company stock. ...
Third, I have a further question about the role of Lee C. Bollinger, the president of Columbia University, who is a Class C director and chairman of the Federal Reserve Bank of New York. ...
According to the Federal Reserve Act (Section 4.20): the chairman of a Federal Reserve Bank "shall be a person of tested banking experience." Mr. Bollinger ... does not have banking experience. ... Please explain to me how having Mr. Bollinger as chairman of the New York Fed is consistent with the Federal Reserve Act.
Taken together, these three questions raise a much bigger issue. If the intent and letter of the Federal Reserve Act are being followed in some ways and not in others - without proper notification to Congress or written rules available to the public explaining exemptions and exceptions - how exactly does this help maintain the legitimacy of the Federal Reserve System?
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See also Corruption of FED
May 24, 2012By Simon Johnson
There are two diametrically opposed views of how the largest financial companies in our economy operate. On the one hand, there are those like Charles Ferguson, director of the Academy Award-winning documentary "Inside Job" and author of the new book, "Predator Nation." Mr. Ferguson takes the view that greed and immorality now prevail to an excessive degree at the heart of Wall Street.
Academics and other experts have become corrupted, the responsible regulators have been intellectually captured, and law enforcement officials refuse to act – despite the accumulation of evidence before their eyes.
"Inside Job" was gripping and emotional; "Predator Nation" contains many more specific details and evidence, as this excerpt dealing with academics (one Republican and one Democrat) makes clear.
The second view is that the people in charge of large banks and bank holding companies have done nothing wrong. To see this view in action, look no further than this week's debate about whether Jamie Dimon, chief executive of JPMorgan Chase, should resign from the board of the Federal Reserve Bank of New York. The New York Fed oversees his organization, including assessing whether it is taking dangerous risks, so there are reasonable questions about whether this creates a potential conflict of interest.
A balanced account of this debate appeared in American Banker, which kindly agreed to bring the entire article out from behind its paywall. The strongest statement from the pro-Dimon corner comes from Ernest Patrikis, a partner with White & Case L.L.P. and former general counsel of the New York Federal Reserve:
"I don't see Jamie Dimon's conflict of interest. What's the conflict? He's expected to represent the banks' view, the lenders' view."
Yet even people who are generally sympathetic to banks feel that there is a perception problem with Mr. Dimon's position. Treasury Secretary Timothy Geithner said exactly that to the "PBS NewsHour" last week.
Kenneth Guenther, the former head of the Independent Community Bankers of America, told American Banker:
"I do think there is a public perception problem when the head of the largest bank gets into a massive highly publicized trading loss, which he articulately condemns, when he's tied to the Federal Reserve Bank of New York, and the president of the Federal Reserve Bank is vice chair of the Federal Open Market Committee. There is a perception problem. I don't think there's any way around it."
What exactly is a conflict of interest? Narrowly defined, an actual conflict of interest would involve using public office for personal financial gain – and would be a matter for criminal prosecution.
There is only one case that I am aware of in which a director of the New York Fed went to prison for such a violation – Robert A. Rough was indicted in December 1988, on charges that he leaked sensitive interest-rate information to a brokerage firm. He was sentenced to six months in prison.
More broadly, however, in modern America we use the term "conflict of interest" when we believe someone may be promoting private interests while acting in a public role.
Allowing big bankers to become too influential is an important part of what Mr. Ferguson writes about. If you don't understand the channels through which influence actually works in the United States today, you need to see "Inside Job," which touched a nerve and won an Oscar precisely because it is profoundly undemocratic when powerful people are able behave in this way.
Elizabeth Warren, a Democratic candidate for the Senate in Massachusetts, said Mr. Dimon should resign from the board of the New York Fed. The recent spectacular trading losses at his company require a full investigation, which should include an examination of how the supervision process broke down. How can this be anything other than awkward for the New York Fed while Mr. Dimon – hardly known as a shrinking violet – sits on its board?
Senator Bernie Sanders, independent of Vermont, would go further, proposing legislation that would remove any bankers from the boards of Federal Reserve banks. For more background, you may want to consult Page 65 and other parts of this report from the Government Accountability Office, which deal with potential conflicts of interest in the Federal Reserve System, or at least read Senator Sanders's summary of the report.
To be clear, directors of the New York Fed are in principle kept away from bank-supervision matters – a point that was codified in December 2010, following the passage of the Dodd-Frank financial reform legislation.
Under the current bylaws, directors are not involved in appointing, monitoring or compensating the head of supervision, although they have input into the selection and remuneration of the head of research (an important position, as this person helps to shape the Fed's view on bank capital and all technical matters relative to risk management), and they oversee other management issues. Bill Dudley, the president of the New York Fed, interacts with the board at least several times a month, as you can see from his schedule.
Mr. Dudley, a former Goldman Sachs executive, was originally appointed president of the New York Fed by a board that included Mr. Dimon as a voting member. The Dodd-Frank legislation stripped so-called "Class A" directors, of which Mr. Dimon is one, from voting on such appointments. Mr. Dudley was subsequently reappointed by the Class B and Class C directors of the board. (For more on the different classes of directors, see this page)
Mr. Dimon has also been an outspoken opponent of financial reform of late – including the Volcker Rule (on proprietary trading) and attempts to strengthen capital requirements. He is an intensely political figure, despite the fact that an important footnote in the Board of Governors' policy on political activity by Reserve Bank Directors says,
In all instances, directors should avoid any political activity that would publicly identify the director as being associated with the Federal Reserve System or would embarrass the System or raise questions about the independence of the director or the ability to perform Federal Reserve duties.
Directors are allowed to lobby and engage in other specific activities. The issue is whether these actions undermine the effectiveness of the New York Fed.
There is recent precedent for New York Fed board members resigning when there is a perceived conflict of interest – and when the legitimacy of the Federal Reserve System would undoubtedly have been undermined if they had refused to resign.
Dick Fuld, the chief executive of Lehman Brothers, resigned (on Thursday, September 11, 2008) shortly before his firm collapsed (on September 15, but its last day of business was Friday, September 12) – and presumably because the New York Fed was at the center of intense discussions about who should suffer what kind of losses or get rescued. Did he resign of his own volition or was he encouraged to resign?
Stephen Friedman, then the former chief executive of Goldman Sachs, resigned in early 2009 when it became clear that he had bought Goldman stock after Goldman became a bank and therefore fell under the supervision of the New York Fed.
Mr. Friedman was chairman of the New York Fed at that time. (To be clear, Mr. Friedman was not involved in any of the decisions that saved Goldman in fall 2008, and I am not accusing him of using his public position for personal financial gain.)
For those of you keeping score at home, Mr. Fuld was a Class B director and Mr. Friedman was a Class C director.
If you think Mr. Dimon should resign from the New York Fed, you can express your opinion by signing this on-line petition, which I drafted. (For more background on why he should resign, see this blog post.)
If Mr. Dimon refuses to resign – as seems likely – he can removed by the Board of Governors of the Federal Reserve System (not by his fellow directors at the New York Fed). The petition is therefore addressed to the Board of Governors.
There is an undeniable perception problem. It is damaging the legitimacy of the Federal Reserve. As Treasury Secretary Geithner implied, this must be "addressed" – a great Washington euphemism – by Mr. Dimon leaving the board of the New York Fed.
An edited version of this blog post appeared this morning on the NYT.com's Economix; it is used here with permission. If you would like to reproduce the entire column, please contact the New York Times.
mattmossman
Not impressed by that American Banker article. If the Fed needs to get the view of the banks, is having them on the board of a regulatory agency the only way to do so? The reporter should have asked Ernest Patrikis that. If the Fed would benefit from getting perspective from outside Washington, is having Jamie Dimon on the board of the NY Fed the only way to get that? Should have asked Chip MacDonald that. If its perception and not reality, shouldn't Karen Shaw Petrou be asked why, after what's happened, she feels that way?Vern McKinleyWe all know what the common sense position is about having a bank president on the board of a banking regulator. There should be more burden of proof placed upon the people insisting that this is fine. Not enough to just cite a perception/reality gap.
This gets back to the creation of the Federal Reserve in 1913/1914. It was a creation of bankers for bankers. A much more substantial change would be to make the FRBNY subject to the Freedom of Information Act. The Board in Washington is, the FRBNY is not. Makes no sense.
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11 May 2012
...And They Repeatedly Fail to Protect the Public From It. "How can we expect righteousness to prevail when there is hardly anyone willing to stand up for a righteous cause?Such a fine, sunny day, and I have to go..."
Sophie Scholl, last words
The spin machine is revving up, and the spokesmodels are gesticulating wildly, in an effort to direct and deflect this failure of governance at JPM.
See how manfully Jamie Dimon has come clean on this. And look how well the Fed's capital standards are protecting us from a failure at JPM because of this unfortunate but 'manageable' trading mistake.A craven Congress, dominated by a hard core of one-percenter bully boys, an Obama Administration intimately tied to Wall St. cronies, and the Federal Reserve, which is a private institution of financial establishment insiders making a weak attempt at self-regulation cloaked in secrecy, have failed the public once again.Jamie and the regulators could not possibly have known (CEO defense) what was going on in their firm because the world is now so complex. They will try and work harder so don't disturb them or bad things will happen to us and it will be your fault. But this will be a buying opportunity!
Simon Johnson points out what many may miss in all this. The side effects of the continuing campaign by the banks' lobbyists to weaken reform have given us a hint of the next financial crisis to come which will be caused by a collapse in the derivatives market. And who could have seen it coming.
And I would like to make the point, and nail it to the door of the spineless media, that JPM had to admit, while the position was still open, that their 'hedge' had blown up in their faces, and that it was no hedge at all, but a thinly disguised attempt to circumvent the curbs on proprietary trading. More simply, they were preparing to flout the law and were brazenly lying about it, and their use of leverage and very risky bets in search of enormous bonuses. And they are doing the same thing on a much larger scale in other markets.
And it is no coincidence that financial fraud prosecutions under the Obama Administration are at a twenty year low, and the media and even his political opposition say almost nothing about it.
"All governments suffer a recurring problem: Power attracts pathological personalities. It is not that power corrupts but that it is magnetic to the corruptible."The credibility trap has captured our leadership. They cannot change course without admitting their failures, and to admit their failures is to weaken or even lose their grip on power. And so it's steady as she goes, onto the rocks. Better a general than a personal failure, risking other people's lives to protect your gains, because there is opportunity in a crisis as long as you still have a seat in the game.Frank Herbert
The cheating, stealing, and lying will continue until the system finally collapses, or until the people finally wake up, take responsibility for their government, and demand meaningful reform.
JP Morgan Debacle Reveals Fatal Flaw In Federal Reserve Thinking
By Simon Johnson
May 11, 2012Experienced Wall Street executives and traders concede, in private, that Bank of America is not well run and that Citigroup has long been a recipe for disaster. But they always insist that attempts to re-regulate Wall Street are misguided because risk-management has become more sophisticated – everyone, in this view, has become more like Jamie Dimon, head of JP Morgan Chase, with his legendary attention to detail and concern about quantifying the downside.
In the light of JP Morgan's stunning losses on derivatives, announced yesterday but with the full scope of total potential losses still not yet clear (and not yet determined), Jamie Dimon and his company do not look like any kind of appealing role model. But the real losers in this turn of events are the Board of Governors of the Federal Reserve System and the New York Fed, whose approach to bank capital is now demonstrated to be deeply flawed.
JP Morgan claimed to have great risk management systems – and these are widely regarded as the best on Wall Street. But what does the "best on Wall Street" mean when bank executives and key employees have an incentive to make and misrepresent big bets – they are compensated based on return on equity, unadjusted for risk? Bank executives get the upside and the downside falls on everyone else – this is what it means to be "too big to fail" in modern America.The Federal Reserve knows this, of course – it is stuffed full of smart people. Its leadership, including Chairman Ben Bernanke, Dan Tarullo (lead governor for overseeing bank capital rules), and Bill Dudley (president of the New York Fed) are all well aware that bankers want to reduce equity levels and run a more highly leveraged business (i.e., more debt relative to equity). To prevent this from occurring in an egregious manner, the Fed now runs regular "stress tests" to assess how much banks could lose – and therefore how much of a buffer they need in the form of shareholder equity.
In the spring, JP Morgan passed the latest Fed stress tests with flying colors. The Fed agreed to let JP Morgan increase its dividend and buy back shares (both of which reduce the value of shareholder equity on the books of the bank). Jamie Dimon received an official seal of approval. (Amazingly, Mr. Dimon indicated in his conference call on Thursday that the buybacks will continue; surely the Fed will step in to prevent this until the relevant losses have been capped.)
There was no hint in the stress tests that JP Morgan could be facing these kinds of potential losses. We still do not know the exact source of this disaster, but it appears to involve credit derivatives – and some reports point directly to credit default swaps (i.e., a form of insurance policy sold against losses in various kinds of debt.) Presumably there are problems with illiquid securities for which prices have fallen due to recent pressures in some markets and the general "risk-off" attitude – meaning that many investors prefer to reduce leverage and avoid high-yield/high-risk assets.
But global stress levels are not particularly high at present – certainly not compared to what they will be if the euro situation continues to spiral out of control. We are not at the end of a big global credit boom – we are still trying to recover from the last calamity. For JP Morgan to have incurred such losses at such a relatively mild part of the credit cycle is simply stunning.
The lessons from JP Morgan's losses are simple. Such banks have become too large and complex for management to control what is going on. The breakdown in internal governance is profound. The breakdown in external corporate governance is also complete - in any other industry, when faced with large losses incurred in such a haphazard way and under his direct personal supervision, the CEO would resign. No doubt Jamie Dimon will remain in place.
And the regulators also have no idea about what is going on. Attempts to oversee these banks in a sophisticated and nuanced way are not working.
The SAFE Banking Act, re-introduced by Senator Sherrod Brown on Wednesday, exactly hits the nail on the head. The discussion he instigated at the Senate Banking Committee hearing on Wednesday can only be described as prescient. Thought leaders such as Sheila Bair, Richard Fisher, and Tom Hoenig have been right all along about "too big to fail" banks (see my piece from the NYT.com on Thursday on SAFE and the growing consensus behind it).
The Financial Services Roundtable, in contrast, is spouting nonsense – they can only feel deeply embarrassed today. Continued opposition to the Volcker Rule invites ridicule. It is immaterial whether or not this particular set of trades by JP Morgan is classified as "proprietary"; all megabanks should be presumed incapable of managing their risks appropriately.
Read the rest here.
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Jesse's Café AméricainFuture generations will look back and ask themselves, 'How could they not see what was happening? Were they blind?'
The Fed is not the only problem here, but a key enabler. White collar crimes and fraud flourished amongst the robber barons even in the days of the gold standard. It just was not as convenient, as easy, to defraud the people en masse through the debasement of the currency.
The Fed has merely proven to be as vulnerable as the regulators and the Congress to the power of the monied interests. If the political campaign process had not been corrupted by money, if the fairness doctrine in the media and Glass-Steagall in banking had not been overturned by the mindless impulse to cast aside the best of the laws, many of the problems we have today would not be so great.
These fellows creates crises, and then 'save us' from them, while lining their own pockets and perpetuating the swindle for their less publicly visible puppet masters.
There is little doubt in my own mind that Greenspan knew exactly what he was doing, and made his fateful decision after a meeting with Robert Rubin in the 1990's shortly after his famous 'irrational exuberance' speech. What was said, what was promised or threatened, I cannot say. But the change in direction became clear. It became open season on the voices of reason and restraint in Washington.
What Clinton hatched, Bush brought to full fruition, particularly with his tax cuts, stock bubble, and unfunded wars. And when the Great Reformer came to Washington in the midst of the collapse, he brought back the very advisors who had helped to create the problem in the first place and betrayed the mandate of those who had elected him, prosecuting no one.
And in the aftermath of the financial collapse, the first popular reform movement that rose up in anger against the bailouts, The Tea Party, was quickly turned into a corps of willing tools that turned on the weak and the least among us, the very victims of a corrupt system, in their petulant pride and misdirected anger.
I only fear that the Fed, and some of the perpetual outsiders of history, will be made the scapegoats by the real culprits when the time of reckoning comes, and that genuine reform will be thwarted once again as it has been so many times in the past. Their hypocrisy and shamelessness knows no bounds.
NYT
Who Captured the Fed?
By DARON ACEMOGLU and SIMON JOHNSON
March 29, 2012, 5:00 am...But in the light of the crisis of 2008 and its aftermath, we have to ask: Has our central bank fallen back under the influence of special interests?
...At the dawn of the republic, Thomas Jefferson railed against the risks posed by government backing for concentrated power in the financial sector. President Andrew Jackson fought to abolish the Second Bank of the United States in the 1830s, the leading private bank of his day, which helped manage public finances and the banking system. Consequently, there was nothing resembling a central bank in the United States for much of the 19th century.
The Federal Reserve System, created in 1913, was a uniquely American compromise, trying to balance public and private interests. Banks controlled the boards of the 12 regional Feds – with big Wall Street firms holding great sway over the New York Fed, which had a disproportionate influence within the system as a whole - and still does.
This version of the system presided over a crazed and highly leveraged stock market boom in the 1920s and the catastrophic collapse of credit in the early 1930s, while protecting the big Wall Street firms.
...Unfortunately, as the United States and other countries learned after 1945, clever politicians can use central banks to manipulate the business cycle, boosting output growth and cutting unemployment ahead of elections. Richard Nixon, for example, famously pushed the Fed to ease monetary policy when it suited him.
...Increasingly, however, it seems that technocratic policy-making is just a myth. We have come full circle, and the Wall Street banks are calling the shots again.
Crucially, the idea that politics is just about electioneering misses the point. Politics is about getting what you want, not just through the ballot box but by persuading people in public office to take actions that help you. So declaring the central bank independent doesn't move it outside the orbit of politics.
Monetary policy has an impact on inflation, output and employment. But it also has a major impact on stock market prices. Any central banker raising interest rates is reducing stock market values and thus eroding the bonuses of top bankers and other chief executives.
Those people will lobby, asserting that higher interest rates will undermine the economy and cause us to plummet into recession, or worse.
In principle, the Fed could stand up to the bankers, pushing back against all specious arguments. In practice, unfortunately, the New York Fed and the Board of Governors are quite deferential to financial-sector "experts." Bankers are persuasive; many are smart people, armed with fancy models, and they offer very nice income-earning opportunities to former central bankers.
We have lost track of the number of research notes from major banks pleading for easier credit, lower capital requirements, delay in implementing financial reforms or all of the above.
In recent decades the Fed has given way completely, at the highest level and with disastrous consequences, when the bankers bring their influence to bear – for example, over deregulating finance, keeping interest rates low in the middle of a boom after 2003, providing unconditional bailouts in 2007-8 and subsequently resisting attempts to raise capital requirements by enough to make a difference.
As the American economy begins to improve, influential people in the financial sector will continue to talk about the need for a prolonged period of low interest rates. The Fed will listen.
This time will not be different."
Read the entire article here.
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A new audit of the Federal Reserve released Wednesday detailed widespread conflicts of interest involving directors of its regional banks. "The most powerful entity in the United States is riddled with conflicts of interest," Sen. Bernie Sanders said after reviewing the Government Accountability Office report.
The study required by a Sanders Amendment to last year's Wall Street reform law examined Fed practices never before subjected to such independent, expert scrutiny. "This is exactly the kind of outrageous behavior by the big banks and Wall Street that is infuriating so many Americans," Sanders said.
Sanders said he will work with leading economists to develop legislation to restructure the Fed and bar the banking industry from picking Fed directors.
The corporate affiliations of Fed directors from such banking and industry giants as General Electric, JP Morgan Chase, and Lehman Brothers pose "reputational risks" to the Federal Reserve System, the report said. Giving the banking industry the power to both elect and serve as Fed directors creates "an appearance of a conflict of interest," the report added.
The 108-page report found that at least 18 specific current and former Fed board members were affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis.
1 currency now -yogi :
"Here is what the GAO found:
- The affiliations of the Federal Reserve's board of directors with financial firms continue to pose "reputational risks" to the Federal Reserve System. (See page 32 of GAO report)
- The policy of the Federal Reserve to give members of the banking industry the power to both elect and serve on the Federal Reserve's board of directors creates "an appearance of a conflict of interest." (See page 32 of GAO report)
- The GAO identified 18 former and current members of the Federal Reserve's board affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis including General Electric, JP Morgan Chase, and Lehman Brothers. (See page 39 of GAO report)
- There are no restrictions on directors of the Federal Reserve Board from communicating concerns about their respective banks to the staff of the Federal Reserve. (See page 36 of GAO report)
- Many of the Federal Reserve's board of directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. These board members oversee the Federal Reserve's operations including salary and personnel decisions. (See page 41 of GAO report)
- Under current regulations, Fed directors who are employed by the banking industry or own stock in financial institutions can participate in decisions involving how much interest to charge to financial institutions receiving Fed loans; and the approval or disapproval of Federal Reserve credit to healthy banks and banks in "hazardous" condition. (See pages 41- 42 of GAO report)
- The Federal Reserve does not publicly disclose its conflict of interest regulations or when it grants waivers to its conflict of interest regulations. (See page 47 and 49 of GAO report)
- 21 members of the Federal Reserve's board of directors were involved in making personnel decisions in the division of supervision and regulation at the Fed. (See page 105 of GAO report)"
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January 2, 2011 | nakedcapitalism.com
This post first appeared on August 24, 2008
Go Willem Buiter! The London School of Economics prof and former Bank of England and European Bank for Reconstruction and Development official has been saying for some time that the Fed suffers from "cognitive regulatory capture" and has been far too responsive to the needs of Wall Street. It's been puzzling to watch his detailed, well argued criticisms go unnoticed, particularly when they have been offered at forums where one would think they'd be impossible to ignore (for instance, a conference co-hosted by the New York Fed where Buiter presented a pretty harsh paper on what he called the North Atlantic Financial Crisis).
Well, he finally seems to have gotten through, perhaps because he is forward enough to criticize Fed officials to their face at an event they are hosting. Or maybe it's because the pattern of conduct he decries is so patently obvious that the key actors can no longer fool themselves. From Bloomberg:
Former Bank of England policy maker Willem Buiter sparked the biggest debate at the Federal Reserve's annual mountainside symposium, saying the central bank pays too much heed to the concerns of financial institutions."The Fed listens to Wall Street and believes what it hears," Buiter said yesterday in a paper presented to the Fed's conference in Jackson Hole, Wyoming. "This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous."
The Wall Street Journal's Economics blog provides a similar account and a link to the paper.
Mr. Buiter slams the Federal Reserve, European Central Bank and Bank of England for what he says was a mishandling of the financial crisis and monetary policy over the past year. He gives the worst marks to the Fed, saying it's too close to Wall Street and financial markets - responding to their needs to the detriment of the wider economy. Mr. Buiter, a former member of the BOE's Monetary Policy Committee, said the Fed overreacted to the economic slowdown - misjudging the importance of financial stability to the overall economy - and created a deeper inflation problem as a result.The paper is quite long, but it is very well written and moves very quickly for this sort of exercise (it does get geeky from time to time). I will confess to having read only the first 30 pages, but his argument seems spot on:
My thesis is that both monetary theory and the practice of central banking have failed to keep up with key developments in the financial systems of advanced market economies, and that as a result of this, many central banks were to varying degrees ill-prepared for the financial crisis that erupted on August 9, 2007.The Fed gets disproportionate attention, in part due to the venue of the presentation, in part because Buiter contends that the Fed did the worst job of the major central banks. Note that Buiter is more of inflation hawk than we are, but as a result, Buiter thinks that letting housing prices decline is not the end of the world and implicitly, adjustments need to run their course (per his point 4). Even though we think this deleveraging will be nastier than Buiter anticipates, we think that trying to hold asset prices at inflated levels will inevitably fail and the effort will only create more damage. To Buiter again:
[T]hree factors contribute to Fed's underachievement as regards macroeconomic stability. The first is institutional: the Fed is the least independent of the three central banks and, unlike the ECB and the BoE, has a regulatory and supervisory role; fear of political encroachment on what limited independence it has and cognitive regulatory capture by the financial sector make the Fed prone to over-react to signs of weakness in the real economy and to financial sector concerns.The second is a sextet of technical and analytical errors: (1) misapplication of the 'Precautionary Principle'; (2) overestimation of the effect of house prices on economic activity; (3) mistaken focus on 'core' inflation; (4) failure to appreciate the magnitude of the macroeconomic and financial correction/adjustment required to achieve a sustainable external equilibrium and adequate national saving rate in the US following past excesses; (5) overestimation of the likely impact on the real economy of deleveraging in the financial sector; and (6) too little attention paid (especially during the asset market and credit boom
that preceded the current crisis) to the behaviour of broad monetary and credit aggregates.All three central banks have been too eager to blame repeated and persistent upwards inflation surprises on 'external factors beyond their control', specifically food, fuel and other commodity prices. The third cause of the Fed's macroeconomic underachievement has been its tendency to use the main macroeconomic stability instrument, the Federal Funds target rate, to address financial stability problems. This was an error both because the official policy rate is a rather ineffective tool for addressing liquidity and insolvency issues and because more effective tools were available, or ought to have been. The ECB, and to some extent the BoE, have assigned the official policy rate to their price stability objective and have addressed the financial crisis with the liquidity management tools available to the lender of last resort and market maker of last resort.
Of his three charges, Buiter is on solid ground on the first and third. The second set (his points 1-6) are debatable, but you can make a case for them, and he does.
Some of his comments are blunt:
In the case of the Fed, the nature of the arrangements for pricing illiquid collateral offered by primary dealers invites abuse….All three central banks have gone well beyond the provision of emergency liquidity to solvent but temporarily illiquid banks. All three have allowed themselves to be used as quasifiscal agents of the state, providing subsidies to banks and other highly leveraged institutions, and assisting in their recapitalisation, while keeping the resulting contingent exposure off the budget and balance sheet of the fiscal authorities. Such subservience to the fiscal authorities undermines the independence of the central banks even in the area of monetary policy.
There is a lot of good stuff. For instance, Buiter discusses the "asymmetric" response of regulators to asset bubbles (they let the bubble run but jump in to try to arrest the collapse) and discusses remedies.
Unfortunately, a lot of participants seemed more interested in defending the Fed than in sifting through Buiter's analysis to see what might be valid and useful:
Fed Governor Frederic Mishkin said Buiter's paper fired "a lot of unguided missiles," and former Vice Chairman Alan Blinder "respectfully disagreed" with his analysis of the central bank's crisis management…..Mishkin lashed out against Buiter's assertion that the Fed's rate reductions may cause higher consumer prices.
"I wish he had actually read some of the literature on optimal monetary policy, because it might have been very helpful in this context," said Mishkin, who collaborated with Bernanke on inflation research in the 1990s.
Mishkin, a leading advocate of the Fed's effort to sustain economic growth through rapid rate reductions, said research shows that "what you need to do is act more aggressively."
In reply, Buiter said the value of such a strategy "is not at all obvious to me."
[Bank of Isreal's Stanley] Fischer, drawing laughter from the audience, held up a red fire extinguisher saying, "I asked the organizers for some technical assistance in dealing with this discussion."
While defending the Fed, Blinder said Buiter's papers "often feature an alluring mix of brilliant insight and outrageous statements." The central bank's performance, though not flawless, has been "pretty good" given the magnitude of the crisis, he said.
European Central Bank President Jean-Claude Trichet also came to the Fed's defense, saying "what has been done until now has been pretty well done under very difficult circumstances."
Although the Wall Street Journal coverage of the response is less detailed, it says that Blinder, who was tasked with critiquing the paper, told a long-form version of the Dutch boy putting his finger in the dam, and said that Buiter would rather have the dam leak out of obedience to his belief in moral hazard, and let the dam burst.
I may be reading too much into this, but it strikes me that Blinder went out of his way to be insulting (anyone who regularly participates in critiques of academic papers please read the WSJ post and comment).
Part of the problem is stylistic. Even though Buiter is Dutch by descent and dislikes the idea of national identity, his writing style often echos the cut and thrust of Parliamentary debates, a posture that is also well received in English academe and drawing rooms but not well received in the US. So his bluntness is over-the-top by US standards.
From this vantage point, it's obvious that the Fed has become far too dependent on current Wall Street incumbents and thus can be manipulated by them (and in fairness, the people who are doing the persuading may be completely sincere in their views). There were ways to compensate: cultivate contacts with former executives who no longer have close ties, find independent analysts who have useful data and perspectives. No doubt Fed officials have extensive contacts, but it appears they have not been used in a deliberate, orchestrated fashion to test and validate information provided by those currently employed by major financial firms.
The second issue is that even if the Fed is too close to the financial services industry, it still may have made the right policy decisions. The jury is still out. Many people (probably including the Fed officials) hope the crisis has passed, while readers of this blog know there is good reason to think the worst has not arrived in earnest.
Buiter has taken a bold position, The Fed needs to be able to explain why what is good for Wall Street is also good for the economy as a whole. The sort of questions that Buiter is raising are notably absent from the media and US-based first rank economists. The Bloomberg story may not give a full enough account to be certain, but the responses to Buiter's charges do not seem persuasive. They amount to disputes over analytical methods and assertions that everything is working fine (after providing a $400 billion fix with no withdrawal plan and getting support from foreign investors equivalent to $1000 a person. So what's your next act?).
It will take some time to see if events prove Buiter right. And as Cassandras like Nouriel Roubini know, it can sometimes take longer than you anticipate for bad policies to finally yield the expected dismal harvest.
Doc Holiday:
The Recovery Illusion (OT)? HAPPY NEW YEAR & GOOD LUCK.. we will all need lots of magic!!!
Howard Davidowitz Destroys The Recovery Illusion, Debunks The Consumer Renaissance
http://www.youtube.com/watch?v=ynHIEijM420&feature=player_embedded
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This post first appeared on June 6, 2008
An article in today's Wall Street Journal, "Insider Joins Critics of the Fed, Faulting Credit-Crisis Programs," discusses at some length a recent speech by Richmond Fed president Jeffrey Lacker in which he took issue with some of the Fed's recent financial services industry rescue efforts. The article itself failed to do justice to his speech, which was more nuanced than the usual "bailing out banks creates moral hazard" argument.
In fact, as we'll discuss, the expanded charter of the Fed calls into question the appropriateness of its independence. It is increasingly making resource allocation decisions which are political in nature and should arguably be debated and determined in that realm.
In his London speech, Lacker defined two types of bank runs: non-fundamental, when the institution is sound but hit by a liquidity crisis, versus a fundamental run, where depositors and creditors wanted out because they know someone would wind up holding the bag. In the latter case, speed of exit is a virtue, since the laggards are the ones who run the risk of not recovering their assets.
The problem with central bank intervention is two-fold. It may not always be possible to parse out whether a crisis is fundamental or non-fundamental in nature. However, when a crisis is fundamental (or as we like to say here, a solvency rather than a liquidity crisis), Fed assistance distorts relative asset prices and delays the relevant markets finding clearing prices. As Lacker stated:
The ideal central bank lending policy would require making clear distinctions between different possible sources of bank or financial distress. If an episode of financial disruption is a true liquidity crisis, like a non-fundamental run on the banking system, then aggressive central bank lending can, in theory, stem the crisis and prevent unnecessary insolvencies that impose real losses on the economy. Lending when in fact the financial sector is just coping with deteriorating fundamentals, however, distorts economic allocations by artificially supporting the prices of some assets and the liabilities of some market participants. Moreover, it is likely to affect the perceptions of market participants regarding future intervention, and thus alter their incentives and future choices.But Lacker made a second set of observations, which the Journal breezed by: the existence of a central bank safety net leads banks to neglect cheap risk reduction measures they could take on their own.
For instance, the big reason that bank runs happen is that depositors go to yank all their funds out at once, when those institutions are set up to handle only a comparatively small proportion of those holdings being withdrawn on any day. But most customers don't need that much liquidity on a daily basis and can be given incentives to sacrifice such quick trigger access. As Lacker points out:
The intuition behind the classic bank run story is that banks are susceptible to runs because depositors are free, at any time, to claim all of their money on demand. This is a contractual choice, and one that makes some sense given depositors' demand for short duration, liquid savings instruments. But if a bank can restrict its depositors' ability to demand their funds on the spot in certain circumstances – in the event of heavy demands for withdrawals, for example – then the bank will be less susceptible to a run. And there is ample precedent for deposit contracts with such characteristics. In 19th century U.S. banking panics, banks preserved their liquidity, individually, by suspending the convertibility of their deposits into currency. They also had recourse to collective actions through the issuance of loan certificates by clearinghouses in the major cities, which allowed the clearinghouse members to meet their interbank obligations and customers to make interbank transfers without drawing on banks' scarce supplies of currency.While Lacker's candor is refreshing, he has not teased out the full implications of his observations. Supporting the prices of some assets has the effect of enriching certain interests at the expense of others. Similarly, shifting risk from individual banks onto the central bank is believed to be worthwhile because any collective costs are assumed to be lower than that of a financial crisis. But the degree of risk transfer we've seen in the last year, which seems close to a "heads I win, tails you lose" game for the financiers, again raises question of fairness and resource allocation.
Axel Leijonhufvud, in a Centre for Economic Policy Research paper "Keynes and the Crisis," (hat tip Richard Alford) does a first-rate job of analyzing what the credit market upheaval has revealed about the limitations of various economic models and institutional arrangement. In particular, he found that it called into question the central premise of modern central banking, including central bank independence (emphasis his):
There are two aspects of the wreckage from the current crisis that have not attracted much attention so far. One is the wreck of what was until a year ago the widely accepted central banking doctrine. The other is the damage to the macroeconomic theory that underpinned that doctrine.Critical to the central banking doctrine was the proposition that monetary policy is fundamentally only about controlling the price level.5 Using the bank's power over nominal values to try to manipulate real variables such as output and employment would have only transitory and on balance undesirable effects. The goal of monetary policy, therefore, could only be to stabilise the price level (or its rate of change). This would be most efficaciously accomplished by inflation targeting, an adaptive strategy that requires the bank to respond to any deviation of the price level from target by moving the interest rate in the opposite direction.
This strategy failed in the United States. The Federal Reserve lowered the federal funds rate drastically in an effort to counter the effects of the dot.com crash. In this, the Fed was successful. But it then maintained the rate at an extremely low level because inflation, measure by various variants of the CPI, stayed low and constant. In an inflation targeting regime this is taken to be feedback confirming that the interest rate is �right�. In the present instance, however, US consumer goods prices were being stabilised by competition from imports and the exchange rate policies of the countries of origin of those imports. American monetary policy was far too easy and led to the build-up of a serious asset price bubble, mainly in real estate, and an associated general deterioration in the quality of credit. The problems we now face are in large part due to this policy failure.
A second tenet of the doctrine was central bank independence. Since using the bank's powers to effect temporary changes in real variables was deemed dysfunctional, the central bank needed to be insulated from political pressures. This tenet was predicated on the twin ideas that a policy of stabilising nominal values would be politically neutral and that this could be achieved by inflation targeting. Monetary policy would then be a purely technical matter and the technicians would best be able to perform their task free from the interference of politicians.
Transparency of central banking was a minor lemma of the doctrine. If monetary policy is a purely technical matter, it does not hurt to have the public listen in on what the technicians are talking about doing. On the contrary, it will be a benefit all around since it allows the private sector to form more accurate expectations and to plan ahead more efficiently. But if the decisions to be taken are inherently political in the sense of having inescapable redistributive consequences, having the public listen in on all deliberations may make it all but impossible to make decisions in a timely manner.
When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians. The independence doctrine becomes impossible to uphold.
Consider as examples two columns that have appeared in the Wall Street Journal in recent weeks. One, by John Makin (April 14), argued that leaving house prices to find their own level in the present situation would lead to a disastrous depression. Policy, therefore, should be to inflate so as to stabilise them somewhere near present levels. If the Fed were to succeed in this, it might not find it easy to regain control of the inflation once it had gotten underway, particularly since some of the support of the dollar by other countries would surely be withdrawn. But in any case, the distributive consequences of Makin's proposal are obvious to all who (like myself) are on more or less fixed pensions. The other column, by Martin Feldstein (April 15), argues that the Fed had already gone too far in lowering interest rates and is courting inflation. He wasin favour of the Fed's attempts to unfreeze the blocked markets and restore liquidity by the unorthodox means that Volcker had mentioned.
The likely prospect for the United States in any case is a period of stagflation. The issue is going to be how much inflation and how much unemployment and stagnation are we going to have. To the extent that this can be determined or at least influenced by policy the choices that will have to be made are obviously not of the sort to be left to unelected technicians.
There has been a great deal of hostility towards the Fed, as witness by comments here and on other blogs, and by the existence of sites such as "Bernanke Panky News." A lot of that is Greenspan backlash. Having become too willing to take credit for general economic prosperity (and having taken too much interest in the performance of the stock market, something no previous Fed chair gave a fig about), he became the focus of anger over the credit crisis. While the Fed bears significant responsibility, messes this big have many parents.
But there has been another thread mixed in with this: resentment at the Fed salvaging the banking industry, with contingent and real costs, in the form of higher inflation, per Alford's and Leijonhufvud's analysis. Now that many of those actions may indeed have been the best among a set of bad choices (although I suspect economic historians will conclude the Fed cut rates too far too fast). However, the big issue is that they involved consequences of such magnitude that they should not have been left to the Fed. I was amazed, and was not alone, when Congress did not dress down the Fed in its hearings on the Bear rescue for the central bank's unauthorized encroachment into fiscal action (ie., if any of the $29 billion in liabilities assumed by the Fed in that rescue comes a cropper, the cost comes from the public purse). So the frustration isn't merely about outcomes, it's about process, about the sense of disenfranchisement. And that will only get worse as this crisis grinds along.
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naked capitalismThe Federal Reserve Bank of Boston recently published a paper titled: "Reasonable People Could Disagree: Optimism and Pessimism About the US Housing Market Before the Crash." The paper proposes two interrelated standards by which the Fed's role in the run-up to the recent crisis can be judged. The authors "conclude by arguing that economic theory provides little guidance as to what should be the correct level of asset prices – including housing prices. Thus, while optimistic forecasts held by many market participants in 2005 turned out to be incorrect, they were not ex ante unreasonable." The implied pass issued to the Fed for having missed the housing bubble elicited much anger and consternation from bloggers and others. Much, but not all of the criticism was directed at the failure of the Fed to recognize the bubble for what it was and for the paper's denial of the Fed's responsibility for its contribution to the crisis. The relatively narrow focus of the responses is unfortunate. A brief analysis of the lines of argument advanced by the authors reveals weaknesses in the argument and a decided shortcoming in the Fed's approach to policy formulation prior to the crisis.
As part of the first standard (consensus of economists) by which the Fed's role can be judged, the authors argued that economists were divided over the existence of a housing bubble:
i) some economists believed and argued that a bubble existed – the pessimists;
ii) a larger group of economists did not believe a bubble existed – the optimists;
iii) most economists were agnostic on whether or not a bubble existed.
Based on the divisions among economists and the high concentration of agnostics, the authors drew their conclusion: given the absence of a consensus it was not unreasonable for the Fed to adhere to the optimistic view - there is no bubble. This line of reasoning assumes that it is appropriate for a policymaker at the Fed to view and react as economists would, however nothing could be farther from the truth.
Economists have every right to hold any opinion about markets that they choose, they have every right to express it, and they have every right to be agnostic about any or every policy or issue. However, as economists they have no responsibility except to themselves and their careers. In fact, the paper suggested that most economists decided not to take a position on the existence of the housing bubble because of reputational risk, i.e., they were afraid to be wrong.
The Fed (and economic policymakers in general) is in a very different position. It does not have a right to have an opinion or not; it has a responsibility: promoting full employment and price stability. Asset prices are drivers of economic activity - business investment, residential investment, and consumption as well as determining the value of collateral that supports the financial system. Consequently, the Fed cannot fulfill its mandate by being agnostic about the possible existence of macro-economically important asset price bubbles or other economic or financial imbalances. In order to meet its responsibility, the Fed must incorporate the possible existence of an asset bubble or imbalance in to the policy formulation process. The fact that economists had not reached a consensus on the existence of a housing price bubble is irrelevant to the assessment of the Fed's role prior to the crisis.
In the second proposed economic policy evaluation standard, the authors argued that economics did not provide an analytically based means of identifying asset price bubbles. (The consensus of economists' standard discussed above may be viewed as a corollary of this standard.) The authors argued that economic theory of asset prices is insufficiently well developed to distinguish "bubble" prices from equilibrium or near-equilibrium prices. The authors then go on to argue that this represents a theoretically based justification for both economists to have been agnostic and the Fed to have been acting reasonably when it failed to see and respond the housing bubble. (Note: At the time that the Boston paper was published, Fed officials were actively arguing that there was no bubble in the prices of Treasuries.)
While the Boston Fed paper is correct in that asset price theory does not provide a means to identify bubbles with any degree of certainty, it also ignores an equally important point. Asset price theory could not rule out the existence of the bubble with certainty either. Given the absence of certainty, the process of weighing the merits of alternative policies and choosing between them should reflect the examination and weighting of all possible outcomes across all the possible policy choices and possible states of the world and not simply the outcomes associated with the assumed to be most likely current states of the world (e.g. there is no housing price bubble).
However, history suggests that the Fed assigned a higher probability to the non-existence of the bubble than it did to the existence of the bubble and then continued to set policy and otherwise act as if it knew with certainty that no bubble existed. This is reflected in policy stances (monetary and regulatory), the language in speeches given by members of the FOMC and is also consistent with the argument presented in the Boston Fed paper. If so (and the evidence indicates it was), then the Fed shirked its responsibility. In particular, evidence is consistent with the position that the Fed failed to include in its policy calculus the answer to a question that it should have, but presumably never got around to asking: What would be the implications for the housing market, the real economy, financial markets and institutions, if the Fed continues to set policies assuming that there is no bubble in real estate prices when in fact there is an unsustainable price bubble?
If the Fed had employed its tools and powers as a regulator and supervisor to research the answer to some a few aspects of that question, it would have discovered that many important players, including major financial institutions that it regulated, were not just "optimists", but were increasingly highly leveraged, maturity-mismatched, bet-the-firm "optimists". (Note: the Fed has argued that information it gleans as a regulator is important in the formulation of monetary policy. In fact, this is the principle argument it has used for retaining a regulatory role.) It also would have been able to make educated guesses about the risks inherent in some bank counterparty positions.
Combining the information available to it as a regulator with information from other regulators and publicly available information on the size of down payments, negative amortization loans, teasers rates etc., the Fed would then have been able to assess the risk it was running when it continued to set policies assuming that there was no bubble in real estate prices. It would have been in a position to foresee some of the implication of a future end to house price appreciation for mortgage defaults, losses given default, the mortgage market, the housing market, the real economy, as well as on financial instruments, markets and institutions. It would have been able to recognize the possibility of a self-reinforcing downward pressure on the prices of housing and housing-related assets that would have manifested themselves if price appreciation faltered for any reason.
If the Fed had performed the analysis, it would have discovered at least some of the growing fault lines running through the housing market and the financial system. Enough relevant information was available to the Fed to set off policy alarm bells. If the Fed had done this research, it would not have been surprised by the crisis. Had the Fed performed the analysis, it is likely that monetary and or regulatory policies would have been different than they were.
In short, history supports the argument that the Fed decided that the probability of the existence of a real estate price bubble was less than the probability of no price bubble and that it never assessed the costs to society that would arise if it continued to set policy predicated on sustainable real estate prices when in fact there was a price bubble. As a result, it incorrectly estimated the expected pay-off to maintaining policy stances that assumed no real estate bubble existed as well as underestimating the risks associated with those policy stances.
Back to the Boston Fed paper, the absence of an analytic "solution" to the question "Is there an asset price bubble?" is largely irrelevant in assessing the Fed's role prior to the crisis. The Fed failed to ask the correct questions. There were other perspectives and tools available. The Fed did not exhaust them.
Policymakers must be prepared to act when formal economics gives little or no guidance. To do that, policymakers must be willing to make decisions despite the limitations of economics, to use types of information that economists do not use or do not have access to, have the courage to act despite incomplete information and in the presence of risk and Knightian certainty. Policymakers must not assume certainty when there is none. Agnosticism and policymaking do not mix. Policymakers do not have the option of sitting on their hands, hoping for the best while trying to avoiding reputational or political risk. Policymakers cannot escape responsibility for economic underperformance, simply because economics doesn't provide a simple unambiguous policy rule.attempter:
Just more obfuscation trying to cover up criminal ideology, intent, and behavior with armchair psychoanalysis.
We know the Fed sees itself as the enforcer of Wall Street's prerogative. That's why it was established in the first place. Its one and only goal under normal cicrumstances is to manage inflation at the level preferred by the big banks. In crisis situations its goal is to bail out the big banks and assist them as disaster capitalists.
That explains everything – the systematic blowing up of the bubble, the systematic lying about it, and the systematic Bailout. (The Bailout at first seemed ad hoc, but the basic guideline is clear: Prop up MBS values and draw the line at whatever would severely hurt Goldman. Once it was clear that AIG would perish and that the contagion had rendered Goldman itself bankrupt, the Fed and Treasury went all in with the Bailout.)
Based on the divisions among economists and the high concentration of agnostics, the authors drew their conclusion: given the absence of a consensus it was not unreasonable for the Fed to adhere to the optimistic view - there is no bubble. This line of reasoning assumes that it is appropriate for a policymaker at the Fed to view and react as economists would, however nothing could be farther from the truth.
IOW once enough people are lying each feels completely absolved of any responsibility whatsoever. It's a version of the mob mentality, a riot among the elites. (But of course where the elites riot and smash the looting is far more systematic and infinitely greater, as are the lies meant to justify it.)
Economists have every right to hold any opinion about markets that they choose, they have every right to express it, and they have every right to be agnostic about any or every policy or issue.
If that means con men intent on committing fraud have a right to make fraudulent statements (like the way the ratings agencies are claiming a 1st amendment right to issue ratings based on fraud), then I'm afraid I disagree.
And I can't imagine what else it could mean.
However, as economists they have no responsibility except to themselves and their careers.
If that's true, and by "economists" we mean persons formally educated by society, in whom society has invested such resources, then why should we tolerate the existence of economists at all?
I know I'm not willing to invest one cent in the "education" of anyone who is then to have no responsibility to anything but his wretched "career".
The core of all our problems is that we tolerate the existence of such sociopaths in positions of influence. At the very least we shouldn't educate anyone to become that.
craazyman:
It's like a big totem pole of economists, each squatting directly on top of the one below, each face looking up and each nose firmly planted in the hole of the ass above. This gives it a stability when the winds of truth blow against it.
All the way from the Fed on down to the junior PhD staffers at the banks.
And all our money just trickles down from ass to nose to ass to nose. And they all get so used to the smell that they think that's what money smells like - which it does when spirit is taken out of it completely - and they are so successful at self-delusion and self-enrichment they fail completely to comprehend the mind-shit they eat every day.
hermanas:
The Wall Street pay bubble was the housing bubble. You don't know the car is moving if you don't look out the window. On mainstreet with stagnant wages since the 70's, everyone knew that when the ARMs reset, the jig was up.
Doug:
Just a question of information: Don't Minsky, Fisher and possibly others have things to say/guide about asset bubbles? Do they not count as economists? economic theory?
Caleb:
"But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"
Alan Greenspan Dec. 5th 1996
Greenspan, for one, would have known real estate was a bubble. He was the one who asked the above question before anyone else. Combine irrational exhuberance with financial engineering run amok = bubble. Seems obvious now.
stewart:
Mr. Alford, Your line of thought assumes a Fed free from political influence. The Fed is very highly politically influenced and as such, it would have had difficulty pricking the real estate bubble at an opportune time. The gerrymandered regulatory setting would have also made the problem more difficult to resolve. We'd have had a different outcome had the Fed fostered a consumer recession in 2001 (but most economists feared the impact of that on top of the dot com bubble collapse), and/or if boards of directors hadn't allowed managements to sweep away all pretense of credit analysis. All the players had a stake in perpetuating what turned into a ponzi scheme; and all must share in the blame for what has transpired.
Just a thought :
I was going to reply with the same general idea, so let me add my support to stewart (in a way)…
The faulty implication of Mr. Alford's logic is that had the Fed looked at the problem differently, or asked a different question, the policy response would have been different. The non-response was as much politics as it was economics.
That said, after the fact arguments by Boston Fed economists as to why the non-response was justified is misleading given that the policy relative to house prices was never driven by economics.
Continuously increasing prices was a requisite for the purchase of homes with virtually no money down which led to more Americans achieving their right of home ownership (sarcasm). Had the Fed considered implementing a policy that contravened the cycle of increasing asset prices, they would have been slammed as a pawn of the rich and as having no concern for the economically less-advantaged.
So they did nothing and look where it got them.
I'm afraid the effort to re-write history on this particular aspect of the financial crisis, on the part of both pro- and anti-Fed camps, is misguided. The moment Congress imposed any responsibility for home ownership / housing prices on the Federal Reserve through the Home Ownership and Equity Protection Act (HOEPA), the Fed was screwed.
There are plenty of failures that fall under policies controlled by the Federal Reserve, I don't think this is one of them.
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Last but not least, here is the soundbite of the year: "You have faith in the central bank." No further comment necessary.
Your rating: None Average: 5 (8 votes)
nmewn:
Charles Ferguson, supposedly [did the interview].
"Iceland subsequently experienced a spectacular collapse within a year of Mishkin's good report. After this, on Mishkin's CV the title incorrectly appeared as "Financial Instability in Iceland". Interviewed by film-maker Charles Ferguson on camera, Prof. Mishkin attributed the discrepancy to a typographical error.[4]"
http://en.wikipedia.org/wiki/Frederic_Mishkin
I hate wiki...but it's all I found.
Regards
scratch_and_sniff:
Ha ha, scum sucking parasite meltdown.
Cognitive Dissonance:
How dare the interviewer take something Mishkin wrote way back in March 2006 (for the blue collar wages of only $124,000) and ask him to explain his sources, reasoning and logic. I hope that impertinent bastard never works in this town again.
Mishkin I mean. One can hope, however hopeless that hope might be.
Miles Kendig
The altar of central banks are littered with the blacked bones of countless millions who came to suckle and got cindered.
putbuyer:
Looks like a "Dick with ears" to me. How be backtracts and looks nervous.
Saxxon:
Rat-fucking white collar gangsters with Ivy League degrees run the white G-7 right now. Nothing much to do besides try to make a little money front-running; and be ready to get out of the way when their virtual casino blows up. And it will.
MsCreant :
knuckles, I loved the performance. The talent is blinding. Thing is, with a sociopath, I don't think he ever worried that this shit would come back to haunt him. So I will give this an A versus the A+ that it otherwise merits. Of course if I were a rating agency and you were a too big to flail...oh, never mind.
Hephasteus :
The ultimate goal of the psycopath is to create a willing compliant victim. The other night I look out my window and I see 14 cops arresting a guy. The guy is calm compliant sitting on the ground next to his car.
The police are going through the guys trunk. It's a normal arrest scene. I look out the window again look around it seems pretty normal. I notice a federal marshal and an ATF agent. The cops are not suited. They are wearing plain clothes tactical gear and body armor.
I look again a few minutes later and they are done searching done acting professional and simply standing around shooting the shit with each other. The person they arrested is still compliant sitting next to a car but starting to slump towards the ground.
I'm getting really pissed off at this point. This has turned into theatrics. I put out my feellers into the group and get pretty much what I expect. My police department is borderline sucking. They are sitting on the fence between being bad guys and good guys, they have racial problems and tend to treat every citizen with dog psychology by being very aggressive with them. The best of them would be a shithead at a dallas or fort worth police station.
So I start picking up the psycopath in the group. It's the ATF agent. I figured it would be both the ATF and the marshall. But no it's the ATF agent. He's pumping out more hidden passive aggressive energy than 5 marines just returned from war wondering how people are going to treat them. I start threatening him with thought and energy patterns. Plotting shots into his neck and head and legs. He's got a trauma plate and I don't think my stuff will go through it. They start picking up the aggressive energy. They automatically reach down and touch their guns wanting to know they have them wanting to know they are ready. Mind you I'm not armed. I'm just doing this with energy. Their "helpers" start flooding me with fear. They are in horrible fucking tactical position. Clustered into groups of 2s and 3s making a gang of 14 nothing more than a couple of target acquiring and clearing shots.
I'm in self imposed isolation. Nothing wrong with an arrest, but they fucked up with the "show". They were done and they had to try to stand around for 45 minutes shooting the shit while this guy is on the ground being fucked to near catatonic state by the sick fucks who are supposedly "protecting" law enforcement. Trying to get a good result from semi legitimate, semi necessary correction and protection conflicts. But the line has been crossed. It no longer has anything to do with socialization and making things better. It's turned into the psychopaths dreams of making victims who won't fight back. So overpowering them with nothing more than a thugery idealization of "we're" the only legitimate source of life threatening force.
We're dealing with people who are seriously fucked in the head. Doing everything possible to hide the true nature of the world. Pretending to follow rules but the only rule they follow is what can we get away with. Flooding people with I need you energy hoping they confuse it for their own.
This is what we are dealing with.
http://en.wikipedia.org/wiki/Harry_Harlow
Gimp :
Mishkin is a total douche-bag whose credibility is somewhere below smegma. I hope those of you who are thinking of wasting hard earned money to send your kids off to one of these Ivy League conditioning camps rethink after watching this unapologetic fool. How many pensioners did he ultimately hurt? Who knows. I lik ethe way he conveniently 1) changes the title of his paper 2) forgets to mention he was paid a six-figure sum for his work of fiction.
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April 03, 2008 | Mish's Global Economic Trend Analysis
Most think the Fed follows market expectations. Count me in that group as well. However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn't the market to blame if the Fed is simply following market expectations?
This is a very interesting theoretical question. While it's true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.
For example: If market participants are expecting the Fed to cut on weakness and the Fed does, market participants gets into a psychology of expecting more cuts on more weakness. Here is another example: If market participants expect the Fed to cut rates when economic stress occurs, they will takes positions based on those expectations. These expectation cycles can be self reinforcing.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
To measure the position and velocity of any particle, you would first shine a light on it, then detect the reflection. On a macroscopic scale, the effect of photons on an object is insignificant. Unfortunately, on subatomic scales, the photons that hit the subatomic particle will cause it to move significantly, so although the position has been measured accurately, the velocity of the particle will have been altered. By learning the position, you have rendered any information you previously had on the velocity useless. In other words, the observer affects the observed.
The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.
The Fed cannot change the primary trend in interest rates. However, the Fed can exaggerate the trend, temporarily slow it, or hold the trend for an unreasonably long period of time after the market (without Fed distractions) would have acted. This leads to various distortions, primarily in the direction of the existing trend.
A good example of this is the 1% Fed Funds Rate in 2003-2004. It is highly doubtful the market on its own accord would have reduced interest rates to 1% or held them there for long if it did.
What happened in 2002-2004 was an observer/participant feedback loop that continued even after the recession had ended. The Fed held rates rates too low too long. This spawned the biggest housing bubble in history. The Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the worst possible moment.
In a free market it would be highly unlikely to get a yield curve that is as steep as the one in 2003 or as steep as it was just weeks ago when short term treasuries traded down to .21%. In other words we would not be in this mess without the Fed, or if we were, the mess would at least be smaller than the one we are in.
Would the market on its own accord be setting rates at the current Fed Funds Rate of 2.25? It's possible, but there is no way to tell.
It's even possible the Fed is behind the curve by not acting fast enough. This is of course all guesswork. I don't know, you don't know, and the Fed does not know what to do. This is part of the "Fed Uncertainty Principle" and a key reason why the Fed should be abolished. After all, how can you give such power to a group of fools that have clearly proven they have no idea what they are doing?
The Fed has so distorted the economic picture by its very existence that it is fatally flawed logic to suggest the Fed is simply following the market therefore the market is to blame. There would not be a Fed in a free market, and by implication there would be no observer/participant feedback loop.
The Fed hints at "possibility" of recession. We are already in one.
Today's headline reads Bernanke Nods at Possibility of a Recession.
In his bleakest economic assessment to date, the Federal Reserve chairman, Ben S. Bernanke, said Wednesday that the American economy could contract in the first half of 2008, meeting the technical definition of a recession, and he encouraged Congress to help homeowners caught up in the mortgage crisis.My Comment: Bernanke is passing the buck. If housing continues to collapse Bernanke will attempt to blame Congress rather that point the finger at the number one culprit in this mess: The Fed, for micromanaging interest rates and blowing bigger bubble after bigger bubble.
Mr. Bernanke, testifying before the Joint Economic Committee on Capitol Hill, said the economic situation had weakened since the Fed last reported at the end of January but that it could revive later in 2008 because of the $150 billion spending and tax cut package enacted this year.My Comment: Bernanke clearly does not understand what is happening, or if he does, he is not telling the truth about it."It now appears likely that real gross domestic product, or G.D.P., will not grow much, if at all, over the first half of 2008 and could even contract slightly," he said. "We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies."
Uncertainty Principle Corollary Number One: The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.
According to America's Research Group "Seventy percent of consumers who have received their 2007 income tax refund are using it to pay off credit cards and bills, the first time in 20 years that figure has topped 50 percent." See March Auto Roundup And Retail Sales Forecast for more on this topic.
Think you are going to get stimulus out of Bush's stimulus plan? Think again.
In separate comments, Mr. Bernanke went further than he had in the past, suggesting that the Fed would remain aggressive and vigilant to prevent a repetition of a collapse like that of Bear Stearns, though he said he saw no such problems on the horizon.My Comment: Supposedly the Fed could not see the possibility of a derivatives chain reaction coming until after it started, even though this has been openly discussed in the news media for years.Please see Who's Holding The Bag? and scroll down to the section "Warren Buffett vs. Greenspan" for a clear warning about derivatives.
By the end of his comments, it was also clear that he and the Fed were not entirely pleased with the "blueprint" for regulatory changes issued on Monday by the Treasury secretary, Henry M. Paulson Jr.My Comment: The Fed is angling for still more power. This is a very dangerous situation.That proposal called for an overhaul and consolidation of the financial regulatory system. The Fed chief, in an almost classic case of damning with faint praise, said Mr. Paulson's blueprint was "a very interesting and useful first step" for Congress to consider.
Uncertainty Principle Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Mr. Bernanke, making his first public comments about Bear Stearns, spent a considerable amount of time defending the Fed's actions in arranging for Bear Stearns to be acquired by JPMorgan Chase at a fire-sale price, and with the help of a $30 billion loan from the Fed.My Comment: It's clear the Fed acted illegally. I will have more on this below.Providing new details about the deal, which was arranged behind closed doors during the weekend of March 15, Mr. Bernanke said he and his colleagues at the Fed did not know until March 13 that Bear Stearns faced bankruptcy and that they quickly realized a failure to act would create a global crisis.
"With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence," he said. "The company's failure could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties and perhaps companies with similar businesses."My Comment: Clearly the Fed learned nothing from the collapse of Long Term Capital Management (LTCM) to have allowed banks like JPMorgan (JPM) take on trillions of dollars worth of derivative positions.Uncertainty Principle Corollary Number Three: Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Caroline Baum Blasts Fed Decisions
Caroline Baum hit one out of the park with her assessment of how the Fed handled the Bear Stearns problem. Please consider Fed Should Clarify Link to Bear Stearns Assets.
Watching the evolution of Fed policy in the last six months from focused on inflation to fearful of systemic risk; the series of aggressive, rapid-fire rate cuts; the creation of an alphabet soup of new lending facilities [TAF, TSLF, PDCF]; and the orchestration of a fire sale of Bear Stearns to JPMorgan, one has to wonder about the Fed's M.O. It all has a make-it-up-as-you-go-along quality.Fed's Actions Blatantly IllegalFaced with what it thought would be a series of cascading financial failures if Bear Stearns went down, the Fed probably knew what it wanted to do, knew it had to do it quickly, and then had to figure out "how to get it done within the confines of its legal structure," DeRosa [a partner at Mt. Lucas Management Co.] said. "The Fed used legal sleight of hand to reconcile what they wanted to do with what they're permitted to do by law."
Bernanke is sure to be grilled about his actions when he testifies before the Joint Economic Committee of Congress today and the Senate Banking Committee tomorrow. A wee bit more transparency would be nice.
Then again, if the Fed is acting first and finding legal cover later, there's a benefit to keeping the details murky.
John Hussman has this to say in his weekly column Why is Bear Stearns Trading at $6 Instead of $2?
The Federal Reserve decided last week to overstep its legal boundaries – going beyond providing liquidity to the banking system and attempting to ensure the solvency of a non-bank entity. Specifically, the Fed agreed to provide a $30 billion "non-recourse loan" to J.P. Morgan, secured only by the worst tranche of Bear Stearns' mortgage debt. But the bank – J.P. Morgan – was in no financial trouble. Instead, it was effectively offered a subsidy by the Fed at public expense. Rick Santelli of CNBC is exactly right. If this is how the U.S. government is going to operate in a democratic, free-market society, "we might as well put a hammer and sickle on the flag."Not only was the action illegal, the vote itself was illegal. The Fed needs 5 members to vote on such actions and only 4 members were present. Fed Governor Mishkin was missing in action. Was he opposed to this illegal hijacking? There was an excellent discussion of this idea in the comments section of the California Housing Forecast.The Fed did not act to save a bank, but to enrich one. Congress has the power to appropriate resources for such a deal by the representative will of the people – the Fed does not, even under Depression era banking laws. The "loan" falls outside of Section 13-3 of the Federal Reserve Act, because it is not in fact a loan to either Bear Stearns or J.P. Morgan. Bear Stearns is no longer a business entity under this agreement. And if the fiction that this is a "loan" to J.P. Morgan was true, J.P. Morgan would be obligated to pay it back, period. The only point at which the value of the "collateral" would become an issue would be in the event that J.P. Morgan itself was to fail. No, this is not a loan. It is a put option granted by the Fed to J.P. Morgan on a basket of toxic securities. And it is not legal.
This leads us to....
Uncertainty Principle Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.Let's Recap.
Fed Uncertainty Principle:
The fed, by its very existence, has completely distorted the market via self reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed's actions. There would not be a Fed in a free market, and by implication there would not be observer/participant feedback loops either.Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three:
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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August 6, 2010 | www.thenation.com
The government's $182 billion bailout of insurance giant AIG should be seen as the Rosetta Stone for understanding the financial crisis and its costly aftermath. The story of American International Group explains the larger catastrophe not because this was the biggest corporate bailout in history but because AIG's collapse and subsequent rescue involved nearly all the critical elements, including delusion and deception. These financial dealings are monstrously complicated, but this account focuses on something mere mortals can understand-moral confusion in high places, and the failure of governing institutions to fulfill their obligations to the public.
Three governmental investigative bodies have now pored through the AIG wreckage and turned up disturbing facts-the House Committee on Oversight and Reform; the Financial Crisis Inquiry Commission, which will make its report at year's end; and the Congressional Oversight Panel (COP), which issued its report on AIG in June.
The five-member COP, chaired by Harvard professor Elizabeth Warren, has produced the most devastating and comprehensive account so far. Unanimously adopted by its bipartisan members, it provides alarming insights that should be fodder for the larger debate many citizens long to hear-why Washington rushed to forgive the very interests that produced this mess, while innocent others were made to suffer the consequences. The Congressional panel's critique helps explain why bankers and their Washington allies do not want Elizabeth Warren to chair the new Consumer Financial Protection Bureau.
The report concludes that the Federal Reserve Board's intimate relations with the leading powers of Wall Street-the same banks that benefited most from the government's massive bailout-influenced its strategic decisions on AIG. The panel accuses the Fed and the Treasury Department of brushing aside alternative approaches that would have saved tens of billions in public funds by making these same banks "share the pain."
Bailing out AIG effectively meant rescuing Goldman Sachs, Morgan Stanley, Bank of America and Merrill Lynch (as well as a dozens of European banks) from huge losses. Those financial institutions played the derivatives game with AIG, the esoteric practice of placing financial bets on future events. AIG lost its bets, which led to its collapse. But other gamblers-the counterparties in AIG's derivative deals-were made whole on their bets, paid off 100 cents on the dollar. Taxpayers got stuck with the bill.
"The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America's largest financial institutions," the COP report said. This could have been avoided, the report argues, if the Fed had listened to disinterested advisers with a less parochial understanding of the public interest.
Fed and Treasury officials dismiss this critique as second-guessing of tough decisions they had to make in the fall of 2008, amid the fast-moving global crisis. Yet two years later, those controversial decisions remain highly relevant. Public anger has not abated. It fuels the election turmoil that this year threatens to bring down incumbents in both parties who voted for bank bailouts.
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Savvy bankers understand what Fed officials understand-the central bankers are trapped in a game of chicken with important banks that can call their bluff. If the Fed acts in a prompt fashion to curb or punish reckless behavior before it get dangerous, the bankers will accuse it of stifling profit and progress. Bank examiners are chastened, told to back off.
If the Fed waits too long to intervene, as it regularly did during the past twenty-five years, then it may be faced with a far more dangerous situation: given the globalization of financial markets, the system now operates with a hair-trigger response to threatening rumors or disclosures. We saw it happen in the fall of 2008. A broad panic raced around the world, freezing credit markets, collapsing financial assets and bringing down major institutions.
This discreet power struggle is never candidly acknowledged by the governing institutions (who fear it would weaken them further), but it has fed the growing instability for several decades. Fed regulators have lacked the nerve (or the hard evidence) to stop dangerous practices by banks before they reach the crisis stage. Yet once calamity appears imminent, it's feared that taking action might provoke a wider disaster-a global "run" by investors-since other banks are engaged in similar behavior.
We might feel more sympathy for the Federal Reserve, except its leaders have actively contributed to their predicament. Paul Volcker, Fed chairman in the Carter and Reagan era, privately grumbled that removing ceilings on interest rates would weaken the central bank's hand, but he reluctantly supported it. His successor, Alan Greenspan, led cheers for liberating the banks from government regulation. The consequences are now fully visible.
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August 9, 2010 | naked capitalism
We pointed out that reappointing Ben Bernanke as Federal Reserve chairman would be inconceivable in the private sector, since CEOs who preside over disasters are dismissed (captains have the good taste to go down with their ships).
But of course, Bernanke is a failure only if you believe that the Fed's official mandate – soundness and stability of the banking system, full employment and price stability – is the real one. But if you think his job, like that of Soviet apparatchiks, is to preserve the existing order, no matter how rotten it and its incumbents are, then he has succeeded admirably.
The true raison d'etre of the Fed, that of serving as the protector of large banks and their executives, is evident in the disgraceful promotion of Sarah Dahlgren, the recent head of the Federal Reserve System's Large Financial Institution Group from 2004 onward. That makes her not only the regulatory analogue of the captain of the Titanic, but to add insult to injury, she ignored warnings from outside and inside the Fed and refused to require AIG counterparties to take bigger haircuts and along with other Geithner followers, kept information from the Federal Reserve Board of Governors.
Chris Whalen of Institutional Risk Analytics offers a blistering commentary on this shameful development, which separately illustrates why a full Audit the Fed program, rather than the watered-down version included in the Dodd-Frank bill, is still badly needed.
I'm taking the liberty of reproducing this discussion, which is the bulk of his current newsletter, in full (but please do visit his site, before he turns to l'affaire Dahlgren, he presents a second bombshell, how the authorities are ignoring the deliberate blowing of a new bubble in structured credit products).
From Institutional Risk Analyst:
Shall We Reward Incompetence? The Case of Sarah Dahlgren and the Fed of New York
Despite initial indications that Congress would reduce the scope of Federal Reserve's financial company supervision, in the end the Dodd-Frank legislation substantially increases the Federal Reserve's responsibility. Chairman Ben Bernanke and other Federal Reserve officials made the argument that the Fed's supervision function didn't do any worse than any other financial regulators - an assertion we cannot validate. This combined with heavy lobbying by other Reserve Bank Presidents and the grudging acknowledgement to the Congress by Fed Chairman Bernanke and Fed Governor Daniel Tarullo that significant improvements are necessary ultimately won the day.
Given its second lease on regulatory life, one might expect that the Fed's bank supervision function would be gearing-up to take a fresh, smart, and tough line with respect to financial company oversight. However, a recent key supervisory officer appointment by the Federal Reserve Bank of New York (FRBNY) indicates this may not be the case. The largest and most important of regional Reserve Banks appears to be going back to the future with its choice of Sarah Dahlgren as Head of Supervision. See FRBNY press release link below
http://www.newyorkfed.org/newsevents/news/aboutthefed/2010/oa100723.html
If the name sounds familiar, that's because Ms Dahlgren has been at the center of many of the Federal Reserve's most embarrassing failures in the area of bank supervision and in particular with respect to the failure of American International Group (AIG). Going back in time now and remembering the period before the crisis, Dahlgren typified the arrogance and refusal of Fed officials to acknowledge warnings from various members of the financial community that the subprime mortgage market was melting down after years of unsafe and unsound lending and underwriting practices by the largest banks. Roger Kubarych, a former economist for the FRBNY, described the refusal of Fed officials to acknowledge the crisis in a 2008 interview with The IRA ('Fed Chairmen and Presidents: Roundtable with Roger Kubarych and Richard Whalen', October 30, 2008).
"It makes me so mad to think back how ignorant, arrogant, and dismissive she was with people who knew what they were talking about pre-crisis," one former Fed colleague told The IRA. Dahlgren was running the AIG show for the FRBNY. She ignored the recommendations from the Fed's own advisors and the Board of the FRBNY that AIG counterparties be forced to take haircuts. For her to ignore good advice on AIG and then deliberately take steps to hide that decision from the Congress and the public, and then be rewarded with a promotion, is quite disheartening."
Below we pull some quotes from the press release announcing Dahlgren's promotion, add some background, and pose a few questions. Our purpose is not to attack Dahlgren personally. Rather, we ask several questions about her job performance to date and whether she is the best qualified officer of the FRBNY for the job:
- First, does Dahlgren's performance with respect to AIG and other matters warrant promotion?
- Second, has her complete lack of experience in the financial industry and educational background in finance contributed to what a number of current and former colleagues at the Fed believe is a record of failure?
- Third, did her close and continuing relationship with then-FRBNY President Timothy Geithner lead Dahlgren to withhold information about AIG and other sensitive situations from Fed Chairman Bernanke and other members of the Fed's Board of Governors?
Ms. Dahlgren was responsible for the "relationship management" function in the Bank Supervision Group, with oversight responsibility for the Group's portfolios of domestic and foreign banking organizations. As the head of relationship management at the Fed, a term along with others like "business partner," "constituent" and "client" we believe should be forever eliminated from the regulatory vocabulary, Ms Dahlgren reportedly was able to stifle many pre-crisis efforts to gather and analyze data, enforce rules, and independently assess key risk areas of the largest banking companies. But Dahlgren's pandering to the big banks is hardly unique. Former Office of Thrift Supervision (OTS) head John Reich used the term "constituent" to describe his relationship with the banks he was tasked by law to supervise in Senator Carl Levin's (D-MI) hearings on the failure of Washington Mutual.
Starting in 2004 and continuing into the depths of the financial crisis, Ms. Dahlgren headed the Federal Reserve System's Large Financial Institution Group (the so-called "LFI" ) which is primarily the responsibility of the Fed of New York. The LFI group had oversight responsibility for the largest Federal Reserve supervised financial companies (e.g. Citibank, JP Morgan Chase, Bank of America, UBS, Wells Fargo, Wachovia, etc).
Working in partnership with the equally compromised Office of the Comptroller of the Currency (OCC) - the regulator of the largest nationally chartered lead banks from whom the OCC derives its operating budget - the LFI relationship management function led by Dahlgren determined, in a centralized fashion, what enterprise-wide information should be analyzed on an ongoing basis, what examinations should be performed each year, and ultimately what supervisory ratings the Federal Reserve assigned to the most important banking firms.
The issue of industry funding for the Fed and OCC's operations is an important problem that remains underappreciated by the press, the Government Accounting Office (GAO), Congress, and the American public. The heretofore chief regulatory authority of our nation's largest banks (i.e., the OCC) cannot operate without funding from those it is tasked to regulate.
A former senior Fed Central Point of Contact (CPC) for one of today's big banks told The IRA that Hugh McColl, the famed former CEO of Bank of America and Nations Bank, used to consider these OCC exam fees a call option on influence over supervisory issues, and therefore well worth the millions paid per annum. These examination fees continue to be used to subsidize additional OCC operations, and represent the same fundamental conflict that the OTS had – in extremis – with troubled institutions such as Countrywide and Washington Mutual.
Fed insiders know of the time-consuming vetting processes that large bank and holding company ratings and exam plans underwent at the NY Fed under Dahlgren's tenure. The process was described by several Fed officials as was largely a tree-killing exercise supported by minimal analysis which centered on senior LFI oligarchy, led by Dahlgren and FRBNY risk head Brian Peters. This pair would reportedly attack Fed field examiners with respect to any criticisms they dared to voice about bank risk taking. A particular vetting discussion in 2006 is paraphrased below:
Dahlgren: Can you prove this issue you are concerned with is a problem at the firm?
Examiner: No but the surrounding evidence and behavior of bank management points to problems. I think we should take a closer look
Dahlgren: Well if you just think there is a problem, we don't have the resources to chase down potential problems.
This was typical of the approach of Tim Geithner and his FRBNY supervision lieutenants such as Dahlgren:
- Don't look for evidence of wrong-doing.
- Containing problems is what the Fed should do.
- The supervisory staff is not smart enough to get ahead of problems; the LFIs have smart people that we (i.e., senior FRBNY bank supervision and executive officers) are talking to banks about potential problems.
As for the rest of this particular story, the examiner was a former Wall Street trader and very seasoned. It turned out he was bringing up a very valid issue that turned out to be a very large problem at a very large banking firm. Within months after the tongue-lashing Dahlgren administered in front of his peers, the examiner left the New York Fed. Keep in mind that Dahgren has never worked in finance and probably could not do so. But let's move on to the rest of the press release.
Previously, Ms. Dahlgren was responsible for the Group's information technology and payments systems exam programs, as well as its Year 2000 readiness efforts.
So before becoming the chief relationship manager, she ran the IT and payment-system risk side of the bank supervision function at the FRBNY. Most in the industry and within supervision know how weak the large banks' IT systems are; particularly their ability to aggregate risk exposures in the 2000s. We see no evidence of backbone or willingness by Dahlgren to push banking firms in this area.
In fact, the current Systemic Resolution Authority (SRA) that Dodd-Frank gives, in part, to the Federal Deposit Insurance Corporation (FDIC) – a regulatory agency that has been thoughtfully pursuing underlying data in its efforts to work on the living wills requirement of Dodd-Frank and enhance resolution capabilities – has already revealed that many of the largest LFIs cannot produce basic position level data, not only of certain small product lines but of entire businesses.
Keeping true to Ms. Dahlgren's historical example, the FRBNY and the OCC continue to build walls around the sharing of information both within and across regulatory authorities. Officials from the FRBNY, for example, have openly stated their desire to exclude the FDIC from participation in the Office of Financial Research in the Dodd-Frank legislation.
What about a market or credit risk management role at the Fed? Well Ms. Dahlgren did …have responsibility for the Bank's credit risk management function. But don't be confused. Dahlgren did not run the risk area that looked-over large complex banking company credit risk and risk management issues. She ran the New York Federal Reserve Bank's own credit risk (see description here: http://www.newyorkfed.org/aboutthefed/orgchart/krieger.html ). This area deals with intraday credit and discount window lending to banks. These programs became important and many adjustments (i.e. loosening) occurred once the crisis ensued, but they weren't a cause of the crisis and weren't of particular importance during Dahlgren's stewardship.
Perhaps Ms. Dahlgren has some strong financial markets background prior to joining the NY Fed?
Prior to 1990, Ms. Dahlgren was responsible for budget and policy at the Substance Abuse Intervention Division at Riker's Island, part of the New York Department of Corrections
To paraphrase, she did budgeting for a prison. A noble occupation, to be sure, but not exactly applicable to understanding the complex risks within a portfolio of synthetic CDOs, understanding interconnected risks, or developing a view on financial company regulatory capital requirements.
What about academic credentials?
Ms. Dahlgren holds a bachelor's degree from Cornell University and a master's degree from Duke University.
No PhD, but those schools certainly rank near the top. However, the release leaves out the facts that Dahlgren's master's degree is in public policy and her bachelor's is in government. Is it too much to ask that one of the most important financial supervisors have a degree in finance, accounting, or economics? At a minimum, perhaps such senior regulators should attain some, a supplemental education in finance and risk via the Professional Risk Managers International Association (PRMIA) or the CFA Institute.
Another red-flag is Ms. Dahlgren's apparent self-perception and ego. She lists herself as a central banker on her public campaign contribution filings rather than a bank supervisor. The FRBNY Board's conflicts of interest have been well-documented by now, but the modest changes in new legislation regarding Reserve Bank President appointments apparently can't change the inclinations of the people running the day-to-day operations of the Reserve Banks.
Finally, the press release notes the support of Bill Dudley, the President of the FRBNY and a former economist for Goldman Sachs (GS), a major beneficiary of Ms. Dahlgren's generosity:
Sarah is a proven leader who has been battle-tested in the crisis.
Yes, she unknowingly led the Federal Reserve Supervision function into the greatest financial crisis since the Great Depression. Before and during the crisis she was, even in the best light, technically incompetent. As noted above, Dahlgren was part of the brain-trust that secretly decided to bail-out all of AIG's counterparties at 100 cents on the dollar. The emails and contracts with her name on them are now public. See discussion of AIG bailout involvement by Dahlgren and other FRBNY officials below:
http://www.businessinsider.com/the-15-culprits-at-the-heart-of-the-aig-bailout-fiasco-2010-1#sarah-dahlgren-the-spin-doctor-3
In the final analysis this appointment sends the wrong signal to the FRBNY supervised financial companies. Dahlgren is a central figure in the financial crisis who had authority but failed to act when confronted by her own staff with evidence of financial firm excesses and risk management weaknesses. In the midst of the crisis and under a thick veil of secrecy she sent American tax dollars to sophisticated counterparties of AIG; institutions who themselves knew they deserved a haircut for their risk management failures. Now, just days after Dodd-Frank has been made the law of the land, Ms. Dahlgren becomes a primary player responsible for implementation and enforcement. We wonder, for example, if Dahgren has reported to the Board about the growing market in complex structured assets being created by the OTC derivatives community in response to ZIRP?
Even if Dahlgren had the skills to lead FRBNY supervision, her appointment makes it seem like the Fed is thumbing its nose at Main Street by appointing someone who is so publicly tarnished by the bailouts of AIG, GS and other OTC dealers. Does Governor Tarullo really believe the world wants a self-described central banker and bank relationship manager with no significant risk or financial experience, and who is tainted with supervisory failures and bailouts, to run the most important Federal Reserve Bank's financial company supervision? We thought Governor Tarullo and Chairman Bernanke had taken control of Reserve Bank supervision and was starting to enforce some accountability. But it seems the despite the McFadden Act and other legislative changes since the Fed's creation in 1913, the FRBNY still can't be controlled by the Board of Governors.
The final point to be made stems from the issue of Reserve Bank compliance with the authority of the Board and the law. During the worst part of the financial crisis, a period of open warfare reportedly existed between the FRBNY and the Fed Board in Washington as the two institutions fought over policy questions. These were difficult days and tempers were obviously short in Washington and New York.
During this time Dahlgren and other Fed officers loyal to then-President Timothy Geithner reportedly were withholding information from Chairman Bernanke and other members of the Fed Board of Governors. This is not a trivial point. All of the authority of the Reserve Banks to act in the financial supervision area comes from delegated authority from the Board. Indeed, the Board must approve all bank applications and all emergency loans that are not part of normal open market operations.
If Dahlgren was indeed part of the pro-Geithner cabal at the FRBNY which failed to provide timely information to and seek authority from the Board to act, even after Tim Geithner left the FRBNY and went to Treasury in January 2009, we think that this is a legitimate area of concern.
We think that the Congress and the General Accountability Office need to focus on the issue of governance and internal controls at the Board and the FRBNY with respect to role of Sarah Dahlgren and other officials in the bailout of AIG and other rescue operations. In particular, we think that the GAO needs to confirm the timeline of events around all of the major loans and investments made by the FRBNY and particularly when then-President Geithner obtained Board approval to make financial commitments and decisions regarding haircuts of the AIG counterparties.
IOHO, the only way that anything like the intent of Dodd-Frank will ever become a reality is if Chairman Bernanke, Governor Tarullo and the rest of the Board regain control of the shambles left behind by Tim Geithner at the FRBNY. Everybody deserves a second chance and we have no personal agenda with respect to Sarah Dahlgren, but does Chairman Bernanke and the rest of the Fed Board really want to gamble on having Sarah Dahlgren and her cohorts calling the shots as the senior bank supervisor for the largest U.S. banks? We think that the Congress needs to put that question directly to both of these men at the earliest opportunity.
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Apr 13, 2010 | http://www.zerohedge.com/ && Washington's Blog
Ben Bernanke, William Dudley and Donald L Kohn are on the Fed's Open Market Committee (FOMC).
They are also on the board of directors of the Bank for International Settlements (BIS) - often called the "central banks' central bank". And Kohn is an alternate director for BIS.
Alan Greenspan, of course, was a BIS director for many years.
Dudley is also chairman of BIS' Committee on Payment and Settlement Systems. (Tim Geithner - previously on the FOMC - previously held that post).
So there is clearly quite a bit of overlap between the two groups.
In addition, BIS' chief economist - William White - and others within BIS - repeatedly warned the Federal Reserve and other central banks that they were setting the world economy up for a fall by blowing bubbles and then using "using gimmicks and palliatives" which "will only make things worse".
As Spiegel wrote last July:
White and his team of experts observed the real estate bubble developing in the United States. They criticized the increasingly impenetrable securitization business, vehemently pointed out the perils of risky loans and provided evidence of the lack of credibility of the rating agencies. In their view, the reason for the lack of restraint in the financial markets was that there was simply too much cheap money available on the market...
As far back as 2003, White implored central bankers to rethink their strategies, noting that instability in the financial markets had triggered inflation, the "villain" in the global economy...
In the restrained world of central bankers, it would have been difficult for White to express himself more clearly...
It was probably the biggest failure of the world's central bankers since the founding of the BIS in 1930. They knew everything and did nothing. Their gigantic machinery of analysis kept spitting out new scenarios of doom, but they might as well have been transmitted directly into space...
In their report, the BIS experts derisively described the techniques of rating agencies like Moody's and Standard & Poor's as "relatively crude" and noted that "some caution is in order in relation to the reliability of the results."...
In January 2005, the BIS's Committee on the Global Financial System sounded the alarm once again, noting that the risks associated with structured financial products were not being "fully appreciated by market participants." Extreme market events, the experts argued, could "have unanticipated systemic consequences."
They also cautioned against putting too much faith in the rating agencies, which suffered from a fatal flaw. Because the rating agencies were being paid by the companies they rated, the committee argued, there was a risk that they might rate some companies too highly and be reluctant to lower the ratings of others that should have been downgraded.
These comments show that the central bankers knew exactly what was going on, a full two-and-a-half years before the big bang. All the ingredients of the looming disaster had been neatly laid out on the table in front of them: defective rating agencies, loans repackaged to the point of being unrecognizable, dubious practices of American mortgage lenders, the risks of low-interest policies. But no action was taken. Meanwhile, the Fed continued to raise interest rates in nothing more than tiny increments...
The Fed chairman was not even impressed by a letter the Mortgage Insurance Companies of America (MICA), a trade association of US mortgage providers, sent to the Fed on Sept. 23, 2005. In the letter, MICA warned that it was "very concerned" about some of the risky lending practices being applied in the US real estate market. The experts even speculated that the Fed might be operating on the basis of incorrect data. Despite a sharp increase in mortgages being approved for low-income borrowers, most banks were reporting to the Fed that they had not lowered their lending standards. According to a study MICA cited entitled "This Powder Keg Is Going to Blow," there was no secondary market for these "nuclear mortgages."...
William White and his Basel team were dumbstruck. The central bankers were simply ignoring their warnings. Didn't they understand what they were being told? Or was it that they simply didn't want to understand?
Yet, White said in a short, must-see talk last week that former long-time St. Louis Fed president William Poole told him that there was never even a whisper of these basic concepts at a single FOMC meeting.
Indeed, White says that - even today - the Federal Reserve is doing the same old thing, reading off of the same playbook that caused the Latin American crisis, the Asian meltdown, the Long Term Capital meltdown, and all of the other financial crises of the last couple of decades. And see this.
White, of course, argues for more accurate models which take into account real-world factors such as debt stocks, and include a time-frame longer than 2-year inflation targets or 4-year election cycles.
But as Simon Johnson has repeatedly pointed out, economics used to acknowledge that politics had an important affect on economic policy, but now the economics profession - as a whole - tries to pretend that it is strictly a mathematical and technical art form.
And as I documented last October, economists are trained to ignore - and central bankers and regulators rewarded to the extent that they ignore - the real world.
And we cannot improve our models and understandings of how to prevent another crisis unless the truth of what caused this crisis is openly discussed (under subpoena power). If the government's entire strategy remains to cover up the truth, then we won't have the chance.
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Regulators like the Fed and SEC have said they didn't know about Lehman's use of Repo 105s to hide its mountain of debt.
But in a must-read New York Times Op-Ed, law school professors Susan P. Koniak, George M. Cohen, David A. Dana, and Thomas Ross point out:
Our bank regulators were not, as they would like us to believe, outside the disco, deaf and blind to the revelry going on within. They were bouncing to the same beat. In 2006, the agencies jointly published something called the "Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities." It became official policy the following year.
What are "complex structured finance" transactions? As defined by the regulators, these include deals that "lack economic or business purpose" and are "designed or used primarily for questionable accounting, regulatory or tax objectives, particularly when the transactions are executed at year end or at the end of a reporting period."
How does one propose "sound practices" for practices that are inherently unsound? Yet that is what our regulatory guardians did. The statement is powerful evidence of the permissive approach bank regulators took toward the debt-dissolving financial products that our banks had been developing, hawking and using themselves for years. And it's good reason for Americans to be outraged by the "who me, what, where?" reaction of Mr. Bernanke and the S.E.C. to the revelation of Lehman's Repo 105 scam.
***
The interagency statement on "sound practices" of 2006 … was greeted with effusive praise from bankers, their lawyers and accountants. Gone was the requirement [proposed by the law professors and others] to ensure that customers understood these instruments and that the banks document that they would not be used to phony-up a company's books.
The focus on complexity was also gone, as was the concern over transactions "with significant leverage" - that is, deals with little real cash underneath, another unfortunate deletion because attending to excessive leverage would have served us well.
Instead, the only products that the banks were asked to handle with special care were so narrowly defined and so obviously fraudulent that suggesting that they could be sold at all was outrageous. These included "circular transfers of risk … that lack economic substance" and transactions that "involve oral or undocumented agreements that … would have a material impact on regulatory, tax or accounting treatment." [and these weren't banned, but apparently only required special disclosures by the banks]
Just as troubling, at least in retrospect, the new statement specifically exempted C.D.O.'s from the need for any special care ..
Only two years later, these same regulators were explaining that the complexity and opaqueness of instruments like C.D.O.'s had contributed significantly to the economic collapse…
Moreover, the collapse was characterized by institutions supposedly healthy one day and on the verge of collapse the next, due in no small part to their extraordinary debt burdens - debt burdens that complex instruments magically removed from the books.
To this day, that final interagency statement (which was adopted in 2007) has not been repealed or replaced. It can still be found on the S.E.C. Web site, along with the letters from industry representatives praising the 2006 draft.
As the law professors point out, you can have all sorts of laws on the books, but if regulators aren't enforcing them, they are not worth the paper they are written on.
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April 1, 2010
The Fed has finally came clean. It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank's bad loans – in order to smooth Bear Stearns' takeover by JPMorgan Chase. The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed. The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.
The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook. But the public never knew. There was no congressional oversight. It was all done behind closed doors. And the New York Fed – then run by Tim Geithner – was very much in the center of the action.
This raises three issues.
First, only Congress is supposed to risk taxpayer dollars. The Fed is not part of the legislative branch. Its secret deals, announced almost two years after they were done, violate the democratic process, if not the Constitution itself. Thomas Jefferson put a stop to Alexander Hamilton's idea of a powerful central bank out of fear it would be unaccountable to the public. The Fed has just proven Jefferson's point.
Second, if the Fed can secretly bail out big banks, the problem of "moral hazard" – bankers taking irresponsible risks because they know they'll be rescued – is far greater than anyone assumed after Congress and the Bush and Obama administrations bailed out the banks. Big banks will always be too big to fail because they know the Fed will secretly back them up if they get into trouble, even if Congress won't do it openly.
Third, the announcement throws a monkey wrench into the financial reform bill now on Capitol Hill, which gives the Fed additional authority by, for example, creating a consumer protection bureau inside it. Only yesterday, Sen. Jim DeMint (R-S.C.) blasted the Dodd bill for expanding the Fed's authority "even as it remains shrouded in secrecy."
The Fed has a big problem. It acts in secret. That makes it an odd duck in a democracy. As long as it's merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk - choosing winners and losers in the capitalist system - its legitimacy is questionable.
That it chose to reveal the truth about its activities during a week when Congress is out of town, when much of official Washington and the Washington media have gone on vacation, and only after several federal courts have held that the Fed must release documents related to its bailout of Bear Stearns, suggests it would rather remain secret than become transparent.
Much of what Ben Bernanke and Tim Geithner did (when Geithner was at the New York Fed) in 2008 was presumably necessary. But the public has no way of knowing. The public doesn't even know who else the Fed has bailed out, or what entities it will bail out in the future. All we know is the Fed secretly bailed out Bear Stearns and AIG and thereby subjected taxpayers to risks that remain even today, without informing the public. That's not a record on which to build public trust.
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March 3, 2010 | The Huffington Post
One of the world's leading economists said Wednesday that the very structure of the Federal Reserve system is so fraught with conflicts that it's "corrupt."
Nobel laureate Joseph Stiglitz, a former chief economist at the World Bank, said that if a country had applied for World Bank aid during his tenure, with a financial regulatory system similar to the Federal Reserve's -- in which regional Feds are partly governed by the very banks they're supposed to police -- it would have raised alarms.
"If we had seen a governance structure that corresponds to our Federal Reserve system, we would have been yelling and screaming and saying that country does not deserve any assistance, this is a corrupt governing structure," Stiglitz said during a conference on financial reform in New York. "It's time for us to reflect on our own structure today, and to say there are parts that can be improved."
Stiglitz made the remarks at a conference held by the Roosevelt Institute. He and other speakers, including Harvard Law Professor and federal bailout watchdog Elizabeth Warren and legendary investor George Soros, had bold ideas about reforming the nation's financial system.
After the conference, Stiglitz said that his remarks on the Fed were "maybe a little hyperbole," but then again made the case that if another country had presented a plan to reform its financial system, and included a regulatory regime that copied the makeup of the Federal Reserve system, "it would have been a big signal that something is wrong."
To Stiglitz, the core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.
The New York Fed, which was led by current Treasury Secretary Timothy Geithner during the time leading Wall Street firms like Citigroup, JPMorgan Chase, AIG, and Goldman Sachs were given hundreds of billions of dollars in taxpayer bailouts, presently has on its board of directors Jamie Dimon, the head of JPMorgan Chase. He's been there for three years. He replaced former Citigroup chairman Sanford "Sandy" Weill.
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December 9, 2009 THE book on Greenspan by the #1 world expert, by Fernando del Pino Calvo (Madrid, Spain)
Fred Sheehan is THE expert on Alan Greenspan and, in my view, this is THE book to know about him and his years at the Fed. Sheehan has written extensively about Greenspan and his policies for many years, being first skeptical and then critical when everyone else believed in the Maestro myth, which of course Greenspan himself and the media helped create through the long bull market. Thoroughly researched, the book is mostly factual, based on FOMC transcripts, memories from other Fed officials, conversations with colleagues, and other sources, each of them duly mentioned by the author. Among many eye opening issues, like his mediocre real forecasting track record, the transcript of the Senate confirmation hearing of the soon-to-be Fed Chairman back in 1987 will surely impress you. This is a serious book which shows the man behind the myth, and the politician - not the expert - Greenspan really was. Not only did he help create the bubble: he probably was a bubble himself. Finally, the book is a deep reflection on the flaws of the Federal Reserve as an institution. In the end, we must always focus on systems, not individuals. What has happened is not about a fallible man; it is about the flawed system that allowed him to do damage.December 5, 2009 Tremendously revealing and unusually sound, by Jeffrey Tucker "Jeffrey Tucker " (Auburn, Alabama)I figured that this book might be just another in the huge outpouring of post-crash reflections. I was wrong. The prose is impeccable. The research is extensive: I felt nearly a sense of guilt that the author did all the work and I had to do none. The theoretical framework is what surprised me most: he really understands debt, inflation, sound money, and power politics. So far, I would say that this book is the definitive account. It hits Greenspan in the only way that really matters: not whether his policies were as good as they might have been but the extent to which they served the cause of the State. I'm supremely impressed with this work. I should add too that I literally could NOT put this book down once I started it. My congratulations to the author who has produced a work that stands above the rest - head and shoulders above them.A final note here: I think this might be the only book so far to fully explain the nature of the relationship between Greenspan and Rand.
December 5, 2009 Tremendously revealing and unusually sound, by Michael E. LewittThis book is an insightful study of the profound failures of Alan Greenspan's tenure as Federal Reserve Chairman. Fred Sheehan clearly articulates how Greenspan created a system that privatizes profit and socializes risk. In doing so, he performs an extremely important task in speaking truth to power about a man who was unquestionably revered by virtually every powerful sector of the financial sector. Mr. Sheehan shows why this was the case - because Greenspan was serving the interests of Wall Street at the expense of Main Street.
This book provides an indispensable explanation of the Greenspan years, and serves as a bold warning regarding the misguided policies that continue to lead this nation down the wrong path. Mr. Sheehan deserves great praise for this book, which should be read by every person who wants to understand what is happening to our system.
January 20, 2010 The Truth Behind Alan Greenspan, by Norman Horn (Austin, TX United States) -Originally published at the LibertarianChristians Blog:
For the bulk of my life so far, I have lived in the age of Alan Greenspan, the chairman of the Federal Reserve Bank from 1987 to 2006. Mentioning a Federal Reserve chair like this in the past would not have been considered normal, yet Mr. Greenspan has a sort of legendary status associated with him. Well, at least some people consider him to be an iconic figure, but more and more the general public is coming to realize the destructive effect he has had on the world economy. Books like Frederick Sheehan's "Panderer to Power" have something to do with the dispelling of the myth.
Sheehan's book is the first critical, post-crash biography of Greenspan. Using Greenspan's own words, Sheehan tracks Greenspan's education as a young man, early professional life, his meteoric rise to stardom as a celebrity figure, and his tenure as Federal Reserve chair. The questions primarily raised are: What kind of man is this who has so much power over the world, and what did he do that has led us to today's economic crisis? The answers are quite surprising. Here are some of the things I learned about Greenspan.
* Greenspan was supposedly a disciple of Ayn Rand, yet he probably did not understand what Rand generally was talking about. Nathaniel Branden wrote later, "I wondered to what extent he was aware of Rand's opinions." Apparently, he would even argue the question of his own existence with the objectivist coterie. Rand herself wondered, "Do you think Alan might basically be a social climber?"
* Even in his pre-Fed years, Greenspan was actually a rather mediocre economist and forecaster. Time after time he would make highly-publicized predictions and yet the exact opposite would occur (see pages 43, 54, and chapter 7).
* Greenspan was a master self-marketer, which is probably the reason for his rise to stardom. He constantly engaged the media and the New York financier social scene, hence he had everyone's ear without the wisdom to back it up. How else can you be both a professional economist and yet date Barbara Walters?
* Even though Greenspan has supposedly had a historically apolitical career, he was a master politician (read: liar). One only need look to his involvement during the Nixon and Carter presidencies to realize that he knew how to play the political game brilliantly.
* Greenspan's policies during his Fed years were incredibly political as well. He frequently timed his actions in accordance with what was politically expedient. Wall Street and the fat cat Congress could count on the legendary "Greenspan Put" to be their savior when things were looking down.
* Post-crash, Greenspan has tried to play his own game of historical revisionism about his policies that led to the economic crisis. Sheehan exposes these and many other lies.
* Greenspan has been hired as a consultant by many of the firms who profited from the economic crisis via government handouts. Go figure, the man who enriches Wall Street and causes the meltdown gets the extra paycheck...Clearly, there is much yet to learn about the man whom many called "the second-most powerful man in the world" for nearly twenty years.
In summary, Sheehan's retrospective on Greenspan is a fascinating read, and I anticipate it will become a valued resource for those looking to understand the Greenspan years from a perspective that offers more than tacit approval of inflationism and government intervention in the economy. Keep in mind, though, it is not an easy read. Economics is discussed at a fairly high, but understandable level. You will probably end up like me, referring to Wikipedia and other sources to recall certain investment and econ topics. Nevertheless, Panderer to Power is worth your time if you desire more knowledge about the Greenspan legacy.
Indrajith A. Weeraratne "Andrew Weeraratne " (Miami, Flordia, USA)
It is a timely written horror story that you won't be able to put down if you are into money. A loud wakeup call to the citizens as the USA has been descending on a path of corruption decade after decade with each succeeding decade getting deeper into foul play following the historical footsteps of ancient Rome, this book, on a personal level will make you understand the trends affecting the financial markets. Thus anybody who wants to make money in the markets should read this book because unless you know the system insightfully you will not be able to make money through the system. The author, Fred Sheehan, does not give us his opinion but give us facts using the synopses of speeches made by those in power during the decade of greed. However be prepared to be overwhelmed as the book, within its limited pages, attempts to cover a whole lot of material that took the financial markets in an unprecedented roller coaster.
It is the story of Alan Greenspan who rose from a non-illustrious career with no track record to write home about to be probably the most powerful man in the world as the Chairman of the Federal Reserve Board and held that position longer than any other. As you read you will realize that if there is a prize for the best politician ever lived, Greenspan to be a formidable candidate for that position for it was his skill at politics gotten him there. You cannot blame Greenspan. After all he was the product of the environment that facilitated his meteoric rise. There is an instance where the author describes a party that Greenspan attended (where people were being awestruck by the mere appearance of Greenspan the economist rock star) where he mentions also the attendance of Jerzy Kosinski the author of "Being There." "Being There" tells the story of a simpleton come to be admired as a genius by the President of the USA and others around him because they begin to interpret everything he says as words of a sage.
Sheehan points out that Greenspan was elevated into cult status by the system in spite of the fact that enough sophisticated people were alarmed as to the direction the country was heading warning how he could push the whole global economy into a tailspin. It is impossible to figure out why it went to such an extent in a country with more Nobel-prize-winners than any other nation. The conclusion I could reach is that people in power knew the scam being carried on by Greenspan as the Fed Chair but kept quiet because by knowing what was going on they could make unimaginable amount of wealth. No other point in history has insiders have made so much wealth as stocks went over thousands of percent. So all insiders had to do was to own shares of companies and keep quiet watching the money being created by the Federal Reserve snowballing values into stratospheric levels.
Greenspan is an enigma because he seems like a man who would understand that an economy cannot be sustained forever if the system has to depend on creating more and more money and the money being created end up only in the hands of a few. Then the question is why did he continue to carry on with such disastrous policies. The author attributes it to pandering to power. But reading the book I got the impression that Greenspan estimated as long as the Federal Reserve has the power to create unlimited amount of money he could carry on that scheme till he retires and when the crumbling down finally comes, people to place the blame on his successor. His involvement with president Reagan who turned this country from the greatest creditor to the biggest debtor nation paving the way for runaway deficits and still being loved deeply may have given him the impetus for that. However, he may have misjudged the courage of people such as Fred Sheehan to bear it all. In the current atmosphere, the only place people will be able to read such an inside account is in books such as this. Do not expect the corporate-owned media to give you such factual accounts.
The author shows how the current Chairman of the Federal Reserve, Ben Bernanke stood behind Greenspan loyally fanning the fire of speculation. Let's hope the President and the Senate that planning on confirming the current Chair to another term will read Sheehan's book. It is impossible to believe that recession induced by the actions of the reckless Fed is over, especially when the medicine they use to cure is the same old medicine that took us there. So the epilogue for these actions may be written yet in the future. Stay tuned.
MacKenzie (New London CT) Alan Greenspan was widely regarded as an economic genius, as wise statesman who guided the American economy through troubled waters. Events of the past years cast doubt upon Greenspan's credibility. Sheehan has removed all doubt on this matter: Greenspan was most certainly not a wise and responsible steward of the American financial system.
Real history shows that Greenspan was a just a player in a inefficient politicized system. Readers might be tempted to see Greenspan as a villain, but I think there is a broader lesson here. Nobody can make our Fed regulated banking system work. Sheehan makes it clear that Greenspan is a smart man, but there is simply no way anyone can resist the political pressures of this system. Sheehan has done a great service by debunking the Greenspan Myth, and the mythology of the Fed in general. Let's hope that we never see the development of a Bernanke Myth.December 8, 2009 An Essential Eye-opener, By Vincent F. Celli "VFC" (ST Augustine, Fl)
Mr. Sheehan has written an insightful analysis of the Greenspan years, which throws light on the darker side of Greenspan's tenure at the Federal Reserve Bank. Like many who listened to Greenspan speak, I was often puzzled as to what he meant. Mr. Sheehan, with an impeccable understanding of economic forces, reveals why and how Mr. Greenspan left us with our present economic disaster. He consistently provided access to gobs of capital for financial interests, and completely abandoned his duties of oversight. The result: the financial sector grew from 10% to 40% of GDP, while billions of dollars flowed into financial profits, only to be sucked into the inevitable black hole that had been created. Mr. Sheehan illuminates this process brillianty and is to be complimented for his efforts. I was entranced by the book and urge anyone who wants to understand the downside of Greenspan's legacy to pick up this book. Your time will be well spent. The best book I have read to help you understand our current economic woes and why they happened.
December 7, 2009 A penetrating complement to "Age of Turbulence", Hughes" (Northfield, New Jersey United States)This is a well written, deeply researched and thoughtfully analyzed account of Alan Greenspan's ascent to power. Author Fred Sheehan provides a critical account of the Fed Chairman's rise to prominence to support the proposition that Greenspan betrayed his principles--early and often-- to further his own personal ambitions. This book is an indictment of the man and the system that allowed him to flourish. It should be read as a complement to "Age of Turbulence", Greenspan's own interesting but overly sympathetic recollection of history.
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naked capitalism
By Joshua Rosner, a managing director of an independent financial services research firm who writes for New Deal 2.0
In Geithner's AIG testimony before the House Oversight Committee, the Secretary again tried to sell the notion that 'if we didn't act then, millions more would have lost their jobs and thousands of factories would have closed'. Even if this were true, why did they have to pay these counterparties one hundred cents on the dollar? The answer may be because, as President of the New York Fed, the counterparties you paid out on AIG owned your company.
To simply say "we had to" is an oversimplification and a partial story. Those of us who saw the crisis coming and recognized the fragility of the system before the Fed or Treasury disagree with the "we had to act" line, but the story is actually larger than that, and predates the unfolding of the crisis. The full story puts Tim Geithner and Larry Summers dead center in creating the environment that drove us to crisis.
Secretary Geithner can keep repeating his assertion he has worked in public service his whole life. Never mind that this calls into question his tangible market experience, this claim begs the question: How does he define working in the public service?
Geithner's last job, as the President of the New York Fed highlights that question. The NY Fed's most important jobs, arguably, are safety and soundness supervision and capital market supervision. Success in carrying out those responsibilities should be the basic litmus test for the measuring how well the NY Fed is serving the public trust. In these roles it is supposed to examine, regulate and oversee the Federal Reserve regulated bank holding companies in the NY Fed's region, the largest bank holding companies in the country, many of which were AIG's counterparties.
The New York Fed is not government-owned. Most people fail to recognize this fact. Simply, the Federal Reserve Board (responsible for monetary policy, with a dual mandate of full employment and price stability) is an independent part of the federal government, while the New York Fed is a shareholder-owned or private corporation. In other words, where the Federal Reserve Board is www.frb.gov, the District Bank is www.newyorkfed.org. Historically, the New York Fed has been among the most profitable shareholder-owned corporations in the world. Yet it keeps the details of its shareholders' ownership information private. What we do know is that its owners include precisely those institutions it is tasked to regulate and supervise and those is has obviously failed to adequately supervise. Unlike the other District Banks of the Federal Reserve system, which have overseen their banks quite well, the New York Fed's concentration of the largest banks, coupled with its unique role of managing the market operations of the entire Fed system, has built a culture where it sees itself as a market participant and peer to those firms it regulates.
The President of the NY Fed is chosen by, paid by and reports to the private shareholders of that private institution. Only three of the nine Directors of the Board of the New York Fed are chosen by the Federal Reserve Board and, until this year, the NY Fed's Chair - chosen by the Federal Reserve Board in Washington - was a former Chairman of Goldman Sachs who still sits on Goldman's Board.
We do not know the full roster of shareholders, but the list of the NY Fed's Board and management group is particularly interesting, reading like a Who's Who of sell-side financial corporations that the taxpayer has bailed out and whose systemic riskiness Washington would rather take indirect and half measures to address rather than take a head-on approach of resolving.
In truth, Geithner's ineffectiveness in his role at NY Fed President and his current political posturing - without any policy substance to directly address too-big-to-fail or the Fed's flawed powers to bailout firms - seems to have resulted from design rather than accident. After all, in a previous "public service" role, Geithner was the lead negotiator for the WTO's General Agreement on Tarrifs and Trade for financial services. In this role, Geithner reported to Larry Summers, who in turn reported to Secretary of Treasury Robert Rubin. In 1998, this team won the banks EVERYTHING they requested from that treaty. From open access to new markets to unrestricted growth in equity and credit derivatives, they opened the door to rapid and deregulated growth of the large multinational banks, allowing them to become "too big to fail". Moreover, the terms of the agreement has made it almost impossible to put the "too big to fail" genie back in the bottle without running afoul of rules of this international agreement. That was the work of Geithner as "public servant".
It appears that his reward for this work was nomination to run the privately owned NY Fed. The nomination was orchestrated by many of those same banks that own the NY Fed and for whom he delivered on that GATT (General Agreement on Tariffs and Trade) "Understanding on Commitments in Financial Service" (an international agreement, won by arm-twisting, that led to global deregulation of the fnancial services industry and encouraged the largest firms to enter new business lines and new financialmarkets without resistance).
I expect documents to come to light that will show that Geithner and Summers did the WTO negotiations on behalf of the industry and viewed the completion as a 'deliverable' to their financial constituents. How can Obama say, while Summers and Geithner are his team, "if the banks want a fight, I am ready to fight them"?
Geithner's comment from January 1998 demonstrates that he was working on behalf of the industry and not necessarily the public:
Second, we, I think, established - I hope you agree, Bob - very effective cooperation with the U.S. financial community, both in defining priorities, and more importantly in some ways… mobilizing a coordinated approach with other globally active financial institutions in other jurisdictions…Fourth, we worked very closely with the international financial institutions so that they made a very strong, compelling analytical case for the benefits of liberalization, so that they built specific conditions into programs where that was appropriate, and so that they provided technical support and technical assistance to countries who were trying to find the right path of liberalization in an environment of considerable financial stress… the agreement establishes quite substantial new opportunities for access to these rapidly growing markets, with substantial increases in the equity thresholds open to foreign firms… the agreement provides protection for the substantial existing presence of U.S. financial institutions from the threat of future discrimination or future protection. And this is not a static commitment. It means that they can participate fully in the growth of these markets as they evolve further.
I expect more damning statements of Geithner and Summers using the office of the Treasury to work on behalf of the bankers.
So how did this WTO process to liberalize the global financial regulatory structure begin? Well, according to the "Financial Services and the GATS 2000 Round" report:
In 1975 Pan American, which was still there, and American International Group (AIG) took a shot at trade in services. In 1979, I was in New York with the American Express Company and was in charge of strategic planning and acquisitions. We were having problems, which we now call market access problems (we did not have this kind of terminology at that time), in thirty or forty countries. We had no remedy under the trade laws or under the General Agreement on Tariffs and Trade (GATT), which only covered goods.
To make a long story short, we decided that we would have to change that, which meant starting a new round of trade negotiations including services. My boss, Jim Robinson, chief executive officer (CEO) of American Express, asked me to start a new trade round as soon as possible. He asked, 'How long will it take?' I said, 'I don't know, ten years maybe. I don't know. I have never done it. I am just reading this book by Ken Dam called the GATT.' He said, 'Well, do it as soon as you can.' I said, 'I need some money.' He said, 'Don't worry about money. This is so important, you will have an unlimited budget." If there was one phrase that really pushed trade and services, that was it. We put a person in Brussels, a person in Tokyo, two or three people in Washington, three people in New York, and so forth.
We enlisted the aid, which was really important, of Citicorp and also AIG. John Reed came along a few years later as CEO. We had an alliance in which Jim Robinson of American Express, John Reed, and Hank Greenberg of AIG were working together. I was the go-between. Having those three men with a lot of staff was the key. We went from zero probability of success to having a chance…One of the things that distinguish the American private sector from the rest of the world again is its relationship to the media, which is very good. All kinds of events are held with the U.S. media and sometimes the foreign media in attendance. This is very, very important. We do not see this any- where else in the world.
Finally, in 1998 Geithner and Summers delivered. What did they deliver? What are the realities of the "Understanding on Commitments in Financial Services" in the GATT agreement that were thrust on the global sovereign world? Well, as two small examples from the document:
Notwithstanding Article XIII of the Agreement, each Member shall ensure that financial service suppliers of any other Member established in its territory are accorded most-favoured-nation treatment and national treatment as regards the purchase or acquisition of financial services by public entities of the Member in its territory.
And:
A Member shall permit financial service suppliers of any other Member established in its territory to offer in its territory any new financial service.
If being a public servant is funneling unreasonable amounts of taxpayer capital, without market discipline, to the largest and most poorly managed banks, then Geithner's selection as Secretary of Treasury makes sense. The same logic that allows senior officers of Lehman, Pepsi, Pfizer, GE, and Loews to be selected as 'Class B Directors' of the New York Fed, chosen as "representatives of the public" makes Geithner the perfect "public servant" to oversee those instutions these largest banks have successfully robbed. To be fair, it is also the same twisted logic that seated the last Treasury Secretary, a man who is being publically whitewashed in the media today - even though, as Chairman of Goldman, he single handedly convinced the SEC to allow Goldman and other investment banks to lever-up so wrecklessley that they would need to be bailed out as AIG counterparties.
- It's Britain's Fault… And We Want Our Money Back (Investment U, 2/3/10)
- Geithner to make like Kashkari and cash in? (The Mess That Greenspan Made, 1/26/10)
- Damage Control Team Arrives to Save Geithner (Fund my Mutual Fund, 1/7/10)
gruntled:
Josh:Rosner's article is highly revealing. And depressing. There really is an incestuous relationship between the Wall Street and the White House, with the New York Fed serving as a facilitator of sorts.
I had to look at the status of the FRB versus the individual regional banks in the last few years, and came away surprised with the result.
There is one thing to add though. There are court decisions out there that construe the individual regional banks as quasi-governmental when they are deemed to act as agents/instruments of the government. Its a bit arcane, and our research was not extensive, but the dichotomy between the governmental FRB and the privately-held individual banks is there as described in Rosner's article. The article does a great job explaining who Geithner was working for at the time.
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January 30, 2010
"I have to think this train is probably going to leave the station soon and we need to focus our efforts on explaining the story as best we can. There were too many people involved in the deals -- too many counterparties, too many lawyers and advisors, too many people from AIG -- to keep a determined Congress from the information." James P. Bergin, NY Fed, in an email to his Fed colleagues'Though it is hard to divine much understanding from the unredacted filing, it has become clear that Goldman had more involvement than previously believed: In addition to the credit default swaps it bought from AIG, the filing shows that Goldman Sachs also originated many of the underlying assets that AIG and the New York Fed bought back from Société Générale.
The American people have the right to know how their tax dollars were spent and who benefited most from this back-door bailout," said Kurt Bardella, spokesman for Issa. "Now that it's public, let's see if the sky really does fall as the New York Fed said it would to justify its coverup."
Other lawmakers believed that the New York Fed was trying to hide its ties to Goldman Sachs.' AIG Reveals the Story - CNN
"Wednesday's hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.
We're talking about the Federal Reserve Bank of New York, whose role as the most influential part of the federal-reserve system -- apart from the matter of AIG's bailout -- deserves further congressional scrutiny...
By pursuing this line of inquiry, the hearing revealed some of the inner workings of the New York Fed and the outsized role it plays in banking. This insight is especially valuable given that the New York Fed is a quasi-governmental institution that isn't subject to citizen intrusions such as freedom of information requests, unlike the Federal Reserve.
This impenetrability comes in handy since the bank is the preferred vehicle for many of the Fed's bailout programs. It's as though the New York Fed was a black-ops outfit for the nation's central bank...
New York Fed staff and outside lawyers from Davis Polk & Wardell edited AIG communications to investors and intervened with the Securities and Exchange Commission to shield details about the buyout transactions, according to a report by Issa.
That the New York Fed, a quasi-governmental body, was able to push around the SEC, an executive-branch agency, deserves a congressional hearing all by itself." Secret Banking Cabal Emerges From AIG Shadows - Reilly - Bloomberg
And this is the same Federal Reserve that was proposed by the Obama economic team to be the 'super regulator' with broad powers and consumer protection responsibilities over the entire financial system.
The Fed is a private agency, quasi-governmental, but not subject to discretionary audit or review by the government, except at arms length, through managed testimony. They make a point of demanding secrecy and independence at their own discretion, oversight on their terms.
This is a choice promoted by Geithner and Summers, who are creatures of the Fed and the banking system, almost sure to return to sinecures there after leaving government. And it is tempting choice for a president and congressmen of a weak character. If the Fed bears the responsibility they do not have to budget money and manage the process, and they can point fingers at its every failure. It is a formula for conflicts of interest, soft bribery and corruption. Confidence does matter.
The Fed and Blackrock are becoming to the Obama Administration what Halliburton and KBR were to Bush and Cheney, and the banking crisis -- the new Iraq. Can the handling of it be so inept that it becomes Obama's Watergate as well?
The Fed must be audited, and its power to disburse public money to private banks, except in the normal course of open market operations, curtailed. Only the Congress has the right to tax the people, and the Fed's ability to disburse billions of funds at its own discretion to domestic and foreign banks is a de facto form of taxation, since the Fed operates on a cost plus basis, without budgetary allotment from the Congress. The obligations of the Federal Reserve flow directly from its balance sheet, which is the basis for the national currency.
And despite the arguments from the Financial Times to 'stop snooping' the press and the Congress should delve deeply into the AIG bailout, because enough has already been exposed that it smells to high heaven.
It is remniscent of Watergate and Enron to see Timmy, Ben, and Hank falling all overthemselves in establishing that they had no knowledge or involvement in the payments of billions to AIG.
The truth must come out.
My own suspicion is that Goldman 'set up' AIG for a proper face ripping with its financial arrangements, playing both sides of the deal. There is further evidence of money flowing from Goldman to AIG executives before the bailout occurred. And at the least the major players saw what was happening and turned a blind eye to it, busying themselves with other things and establishing their plausible deniability.
A proper investigation can establish any specific guilt. It is a shocking scandal that the FBI and Justice Department are still not more actively involved in real investigation rather than these staged hearings.
But this incident should make it absolutely clear why the Fed cannot enjoy the expansion of its role as the regulator of the system. It is too conflicted in its mission of monetary independence, and at the same time the creature of the banks, to be a true civil servant fully answerable to the Congress.
Yes I understand the distinctions between the Fed Board of Governors and the NY Fed with regard to FOIA requests, and the appointmet process. What I am saying is that the distinctions obviously do not hold, do not work. The Fed is one organization. These distinctions are remniscent of the banking scandals exposed by then AG Elliot Spitzer. They simply do not work. They are a thin facade.
As Representative Marcy Kaptur told Geithner at the hearing: "A lot of people think that the president of the New York Fed works for the U.S. government. But in fact you work for the private banks that elected you."
One difference I have noted, compared to the English and the Japanese, is that the American officials and CEO's never hesitate to hide behind the incompetency defense, but rarely have the dignity to resign when they do so. This is because they have no shame, no real loyalty to anyone but themselves.
And at the very least Geithner should be fired, if not for complicity, then for sheer inability to do the job.
- Timeline of NY Fed Payments and Cover-Up: BusinessWeek
- Financial Crisis Ahead - Thomas Donlan - Barron's
- Paulson's People Colluded with Goldman to Destroy AIG and Get a Backdoor Bailout - Fiderer - Huffington
- Sham Transactions That Led to AIG's Downfall - Fiderer - Huffington
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January 26, 2010
E-mails among in-house lawyers at the Federal Reserve Bank of New York show they worked feverishly in early January 2009 to find a way to keep secret the details behind American International Group, Inc.'s $60 billion in payments to counterparties in risky credit default swaps. And, the e-mails show, the lawyers weren't trying to hide the details just from the public but also from Congress.
A Fed spokesman was not immediately available for comment.
The records show that in-house counsel James Bergin wrote to New York Fed general counsel Thomas Baxter Jr. on Jan. 8 that the Securities and Exchange Commission had asked AIG to either disclose the payment schedule, including the counterparties' names and the amount of payments, or file a request for confidentiality. With the request, the SEC requires filers to send the confidential material so it could be reviewed by staff. It also requires the filer to consent to disclosure to Congress and other agencies, he said.
"This requirement is giving us some pause," Bergin wrote to Baxter, "since we haven't otherwise disclosed this information to Congress." Copied were various Fed lawyers, including deputy general counsel Joyce Hansen and banking supervisor Stephanie Heller. Congress had approved AIG's bailout funds, which were used in the payments. Bergin said Fed lawyers were considering their options on the SEC's request.
On the morning of Jan. 13, according to another Bergin e-mail to in-house lawyers, he spoke by phone to SEC staff members who were "receptive" to his request for confidentiality. Included on the call, he said, was Alison Thro, senior counsel for Freedom of Information Act matters at the Fed. The SEC agreed to consider Bergin's request for an alternative procedure for reviewing the schedule - "rather than it [the schedule] becoming an SEC record subject to their FOIA process."
Later that same day Diego Rotsztain, a lawyer then with Davis Polk & Wardwell which was representing the New York Fed, wrote to AIG deputy general counsel Kathleen Shannon about "special SEC procedures." The e-mail said AIG should expect a call from the SEC about delivering the confidential data "via courier to a specific person who will be responsible for ensuring that the letter does not get into the wrong hands and is afforded the appropriate attention."
At 8:46 p.m. that evening, Bergin sent an e-mail updating Baxter, Hansen, and the other in-house attorneys. It said the SEC had agreed to "implement special security procedures for handling of the document," including limiting the reviewing staff to two people, keeping it in a locked safe during the process and, if confidentiality was approved, "providing for its storage in a special area at the SEC where national security related files are kept."
The e-mails are part of some 250,000 documents produced by the New York Fed in response to a subpoena from the House Committee on Oversight and Government Reform. The committee has scheduled a hearing on the AIG bailout on Wednesday, and among the witnesses testifying will be Baxter and Treasury Secretary Timothy Geithner, who was Baxter's boss and president of the regional Fed during the bailout crisis.
The committee wants to know why the counterparties were paid nearly 100 cents on the dollar when other banks were negotiating much lower percentages on credit default debt, and why the Fed tried to hide the information.
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Jan 29, 2010 | CJR
Bloomberg's David Reilly has a terrific column up today on the New York Federal Reserve and what's wrong with its secrecy on the AIG bailout (and on everything else, for that matter).
Reilly kicks things off with a half-joke :
The idea of secret banking cabals that control the country and global economy are a given among conspiracy theorists who stockpile ammo, bottled water and peanut butter. After this week's congressional hearing into the bailout of American International Group Inc., you have to wonder if those folks are crazy after all.Wednesday's hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.
We're talking about the Federal Reserve Bank of New York, whose role as the most influential part of the federal-reserve system - apart from the matter of AIG's bailout - deserves further congressional scrutiny.
Yes it does. And it deserves further press scrutiny, too. I'd like to read some deep dives on the organization. It's a tough nut to crack, no doubt. But if, say, CIA reporters can do this kind of thing, so can business reporters.
As concerns the financial press, Reilly's would be the opposite tack of the anti-journalistic sentiment expressed in the FT's Lex column yesterday, when it called for everyone to stop nosing around in the mess. Let's hope this was some rogue columnist's idea and not anything that might infect the pink paper's news staff.
Because what Lex apparently doesn't get is that this story isn't just about AIG, it's also about the Federal Reserve as an institution, and democracy itself. We've questioned many times the idea of giving the secretive, virtually unaccountable Fed more power in regulation reform. That's not a Jacksonian anti-bank thing. It's a fundamental press concern: advocating transparency and accountability. You can't take tens of billions of taxpayer dollars (in addition to the hundreds already laid down), hand it to bankers, many of whom, as Reilly is excellent to point out, elected you to your position on the Fed and essentially control it, and then cover it up.
We quoted this Fed exec the other day, and Reilly points it out, too:
"I have to think this train is probably going to leave the station soon and we need to focus our efforts on explaining the story as best we can. There were too many people involved in the deals - too many counterparties, too many lawyers and advisors, too many people from AIG - to keep a determined Congress from the information."Think of the enormity of that statement. A staffer at a body with little public accountability and that exists to serve bankers is lamenting the inability to keep Congress in the dark.
We already know that the Fed told AIG (and the SEC, the pushovers!) to conceal its counterparties, which AIG thought it had to disclose, from investors in order to keep it from the press and Congress. The New York Fed's former chief, now Treasury Secretary, Tim Geithner, tells the inspector general that "the financial condition of the counterparties was not a relevant factor" in the bailout. We also know that the New York Fed reacted to a FOIA request (to another agency, no less-the New York Fed as Reilly is excellent to point out, is exempt from FOIA, unlike the Fed itself!) from a reporter by denying it and increasing its secrecy. Here's what the same Fed executive, James P. Bergin, quoted two graphs up, said regarding that:
It's less of a legally motivated worry than a worry that including the column headings could further incite FOIA requests or litigation-that if people know the counterparty names and amounts are indeed on this schedule, they will be all the more likely to want to request it.Now you see why Reilly is only half-joking in the lede.
… when unelected and unaccountable agencies pick banking winners while trying to end-run Congress, even as taxpayers are forced to lend, spend and guarantee about $8 trillion to prop up the financial system, our collective blood should boil.Yes. We need to read more, not less, about the New York Fed.
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naked capitalism
No matter which way you look at it, the picture that is emerging of the Federal Reserve, as revealed by the ongoing probes into its AIG bailout, is singularly unflattering.
The explanations for its actions can only support one of two interpretations: that the Fed was a chump, taken by the financiers, or a crony, and was fully aware that it was not just rescuing AIG, but doing so in an overly generous way so as to assist financial firms in a way it hoped would not be widely noticed or understood. The problem with this sort of back-door subsidy, aside from its dubious propriety, is that at best, it's sorta random (who benefits isn't necessarily who is in most need or more deserving of help, just who happens to be lucky enough to be associated with AIG train wreck), and at worst, it rewards stupidity and duplicity.
For the Fed, if it was mainly engaged in "Fed as crony" behavior, that bodes ill for the central bank's future, since it means it has been lying to the public as to why it did what it did. As investigators keep digging, for they will be certain to find evidence that the various explanations that the Fed has given for its actions will be at odds with its internal debates. If you think the Fed's reputation is bad now, just wait to see what happens if it emerges that it was engaged in deception.
Although the focus of press and public attention has been the decision to pay out "100%", this issue has not been framed as crisply as it should be. Remember, the underlying transactions were crap CDOs that the banks (or bank customers, a subject we will turn to later) owned, and on which the banks had gotten credit default swaps from AIG. The Fed in fact paid out WELL MORE than 100% on the value of the AIG credit default swaps by virtue of also buying the CDOs.
Recall the sequence:
1. Fed authorized $85 billion credit facility in September 2008
2. In early October, AIG pays out an additional $18.7 billion to its CDO counterparties, bringing their total collateral to $35 billion (against CDOs with a par value of $62.1 billion) So the dealers had already received 56% of par value at this point (remember, possession is 9/10 of the law).
3. In early November, it looks as if AIG will have to pony up more to its counterparties if it is downgraded, as it presumably will be once it releases crappy earnings. Resulting collateral calls might exceed the remaining amount of the $85 billion loan facility. Fed goes into panicked overdrive, decides of all its options for dealing with the AIG black hole, the best is to buy the CDOs, thus eliminating the need to worry about those pesky CDS.
What we need to stress here, before going into the chump vs. crony theories, is that buying the CDOs in order to terminate credit default swaps is not normal protocol. The Fed could have negotiated a cash settlement (which probably would have amounted to letting the counterparties keep the collateral, with some further adjustments based on the usual arm wrestling. This by the way, could have constituted a 100% payout on the credit default swaps (ie. the decision to pay out in full on the CDS was separate from the decisions to acquire the CDOs), but it would have left the banks with the CDOs. That would have been well short of $62.1 billion; all the dealers felt then that the CDOs had some value (while their marks also said that, dealers have been known to mark paper at unduly high prices to avoid reporting losses; with AIG's credit-worthiness in doubt, the bankers' accountants presumably required markdowns on the credit default swap hedges, which might give some banks an incentive to be less aggressive in reducing the value of their CDOs). That implies the credit defaults swaps themselves were worth considerably less than 100 cents on the dollar.
Buying the CDOs was an unnecessary step and increased the amount paid by the Fed, through AIG, to the counterparties. Moreover, the Fed has gone to unusual, even bizarre, lengths to keep matters regarding the CDOs themselves secret (a good bit of the discussion at the House Oversight Committee hearings on Wednesday today revolved around this issue; we've discussed previously why the Fed's arguments for secrecy do not add up; we will return to this subject at later today at Naked Capitalism).
So let's see how these theories stack up. Each has supporting evidence.
Fed as Chump
This viewpoint boils down to the old saw about poker: if you sit down at a poker table and you don't know who the mark is, by definition, it is you.
The Fed has long believed that the financial crisis was a liquidity event, that investors panicked, but the prices of securities of all sorts fell below "rational" levels. From Bernanke on down, the Fed has made various pronouncements taking up the theme that securities prices, particularly in the October 2008 through March 2009 time frame, reflected irrational despondence. Funny how once Greenspan dared admit in 1996 there might be such a thing as irrational exuberance, not only that turn of phrase, but the very concept, seems to have been expunged from permitted reasoning at the central bank. Not only does the Fed seem constitutionally unable to admit that it was asleep at the switch during the rise of a global credit bubble, but that cheap credit leads to overvalued assets. So asset prices will fall as cheap credit is withdrawn. The Fed has fought this process tooth and nail, believing it can validate asset prices by pulling the right levers (see here for a long-form version of this logic and my objections to it).
So why did they buy the CDOs? Get this: one argument is that they wanted the upside. Huh? That means:
1. They seem to have forgotten that where there is upside, there is also downside. They took a speculative position. This went well beyond what was necessary to deal with the AIG mess
2. They thought they had a better perspective on value than the banks themselves. This is staggering. They have NO idea how these deals are structured, no day-to-day involvement in the subprime, Alt-A, or commercial real estate markets. They are at a massive information disadvantage. The idea that the Fed could make a better trading bet than the banks themselves is a remarkable combination of hubris and stupidity.
While there might be reason to think that prices of liquid assets had overshot on the downside, assets like CDOs that don't trade and are (in this case) priced on cash flows which reflect, among other things, expected defaults and loss severities, are quite another matter. And here, the Fed (its valuation claims to the contrary) looks to have gotten it badly wrong. Per Tom Adam's analysis, at the time Maiden Lane III (the vehicle that bought the CDOs) was created, 19% of the portfolio had been downgraded to junk. Currently, it's 93% below Baa3 according to Moody's, the more conservative of the two major ratings agencies.
More confirmation of the "Fed as chump" theory comes via its reliance solely on BlackRock for advice on the CDOs, particularly once it had set up Maiden Lane III (and recall BlackRock is also managing Maiden Lane I, the Bear bailout entity, and Maiden Lane II, which was created to deal with AIG's securities lending mess). I'd be curious to hear additional reader input, but I am told that private managers of portfolios of this size would have at least two portfolio mangers to give them different views and to compete. But the government would set its criteria for these assignments in such a way that Pimco and BlackRock were the only viable candidates. By contrast, there are asset managers and consultants that are not as large but are very skilled in the CDO space.
The Fed was also played by the French regulators, and perhaps their banks. One of the arguments for the Fed not pushing for a haircut on the credit default swaps, as other banks had accepted in dealing with a distressed insurer, was that French law prohibited it. But this was false, since Societe Generale and BNP Paribas took very large haircuts to close out credit default swaps with Ambac, another bond insurer.
Other examples of Fed naivete comes from e-mails recently made public as a result of the House Oversight Committee investigation: its surprise that AIG might have to make disclosures regarding the bailouts, its clumsy and aggressive efforts to keep matters under wraps, and its reluctant recognition that too many people were party to what went down to maintain secrecy.
Fed as Crony
Although we'll set forth the fact pattern that gives credence to this notion, the most powerful support comes from the Fed's seeming desperation to maintain secrecy, particularly around Maiden Lane III. The Fed's arguments here do not hold up. In Congressional testimony today, the Fed, particularly the general counsel of the New York Fed, Thomas Baxter, argued that keeping transaction-level detail secret, was necessary to maximize value of Maiden Lane. As we have discussed earlier, and continue in more detail in a related post, that is bunk. And that begs the question of why the Fed is so insistent on holding the line here. While it may be imperial overreach and fear of starting down a slippery slope of disclosure, the Fed's bobbing and weaving under the hot lights FEELS like a cover-up.
Moreover, the Fed has withheld information requested via subpoena from both SIGTARP and the House Oversight Panel. That says they are awfully keen to hide…something. That sort of intransigence is a red flag before a bull. The fact they hoped they could get away with it is troubling, and strongly suggests something is amiss.
Now mind you, the Fed's cronyism does NOT have to come about via corruption or other nefarious reasons (the stonewalling could be to protect Geithner and Bernanke; for instance, they could have given testimony that is contradicted by internal evidence). The Fed appears to be captured by the industry, so badly that it is unable to recognize how distorted its perspective has become. This means it will vociferously defend the industry and individual firms.
So what is sus about the Fed's conduct? Consider:
1. The Fed's unusual step of buying the CDOs provided nearly $30 billion more in liquidity to a small number of banks. To put that in context, the first of the Fed's emergency rescue programs, the Term Auction Facility, was at its outset a $40 billion program open to a much larger universe of firms and provided 28 day loans, not a permanent transfer.
2. The insistence that the Fed was up against a hard deadline of November 10. In response to questions today, Baxter insisted that the Fed had to have a new program in place by November 10, because that was when AIG would announce earnings and a rating agency downgrade seemed inevitable, which would lead to more collateral calls.
But that is misleading. First, even if the rating agencies issued their downgrades that very day, the collateral payment was not due that day. There would be some sort of time delay, not long, but I would guess 3-5 days (I assume expert readers will advise me and I will revise the post accordingly). Perhaps more important, it is typical when parties are negotiating to agree on waivers. How hard would it be for the Fed to obtain a waiver if it were negotiating an exit from the AIG CDS? Answer: not very if good faith negotiations were under way. At worst, the Fed could have had AIG make a partial collateral payment out of the remain credit line while discussions continued.
3. The Fed had done nothing to understand the CDS market or prepare for a crisis. Many observers believe the reason that Bear was not allowed to fail was that it was a significant counterparty in the credit default swaps market, that letting any big CDS player go could produce a domino effect, creating a wave of counterparty failures that would lead to systemic collapse. Aside from the backlash against the Bear rescue, Lehman was presumably dispensable despite its larger size because it was not as big a participant in the CDS game.
Since the CDS market was obviously a major source of risk and firms that were big CDS players (Merrill, Morgan Stanley, UBS) were seen as vulnerable, it would seem to be Job Number One of the Fed/Treasury to do some meaningful investigating to see how big the risks were and do some contingency planning (don't even try telling me the Neel Kashkari "break glass" memo mentioned in Sorkin's Too Big To Fail amounted to "planning". You can't plan if you don't understand the terrain. And the "plan" was clearly too high concept to be useful when the dominoes did start to fall).
Now of course, preparation for an investment bank bankruptcy, which would lead (among other things) to a hard look at the credit default swaps market; failure to do so could fit the "Fed as chump" theory, that the authorities dropped the ball, big time. But the powers that be have shown a remarkable lack of interest in real diagnostics throughout. By contrast, the Bank of England, twice a year, puts out a Financial Stability Report than runs rings around anything I have seen the Fed prepare. When UBS got itself in so much hot water that it needed a rescue, the Swiss Banking Federation made it conduct an internal investigation (conducted by outside parties) and make two reports: one to the public, in the form of a report to shareholders that was very detailed, and an even more extensive one to the authorities.
The lack of interest in either post-mortems or planning suggests that the Fed does not want to know. And who would that lack of curiosity benefit? The Fed itself (as in not exposing past policy failures) and of course, the industry (not exposing incompetence and misconduct).
If that is not a misguided set of (implicit) priorities, I don't know what is.
4. As we discuss separately (the new post on this will be up later today), the Fed keeps trying to keep transaction-level detail on Maiden Lane III under wraps, even though its arguments defending this action make no sense. That suggests there must be other reasons. One is that ML III is really not doing so well, despite valuation reports that say otherwise; the second is that digging into the transactions would be embarrassing to the Fed or the counterparties themselves.
4. A look at transaction detail (that is, the stuff the Fed has been desperate to hide), and counterparty exposures (which we have put together, not just CDS counterparty, but lead bank on the CDO, which in a surprisingly large number of cases is different than the CDS counterparty), suggests at a minimum pervasive patterns of really abysmal counterparty risk maangement amongst the AIG counterparties; notably, massive Goldman exposure, along with apparent efforts to conceal it. Thus the reluctance of NY Fed to disclose information about the counterparties begins to look like a possible case of regulatory capture. Or maybe, yet another case of credulity of experts.
As much as the Fed seems awfully eager to close this chapter, enough parties with subpoena are taking interest that l'affaire AIG is going to be scrutinized in exhaustive detail. The dirt will come out. Given the Fed's past record on disaster planning, if there is something serious they are hiding, they are likely to be inadequately prepared for the blowback.
Selected Comments
fresno dan:
"The explanations for its actions can only support one of two interpretations: that the Fed was a chump, taken by the financiers, or a crony"
No, three.
I assert that the FED was venal AND stupid.bena gyerek:
two points:
i think an important part of the fed's rationale for intervening in aig, which you do not address, is the idea that by its very intervention the fed would help stabilise the financial markets and therefore turn around the value of the assets it was buying. i am not saying whether or not this view was justified (the jury is still out on whether the market rally of the last few months will go hand-in-hand with a sustained recovery of fundamentals a la soros reflexivity), but it does provide a good faith explanation of the fed's decision to take delivery of the underlying loans that goes beyond the "fed is chump" argument – i.e. only the fed was in a position to intervene in a way that would solve the systemic crisis, and therefore it was smart to buy the loans and benefit from the upside resulting from its own actions. of course, this does not in any way explain the subsequent cover-up behaviour.
my second completely unrelated point is that i think there is an interesting angle that has not yet been considered. goldman has been telling anyone who cares to listen that for their own part they were quite indifferent about the aig rescue, because they had already hedged their aig exposure in the market. if we took this claim at face value, it has the interesting implication that perhaps we should look through goldman (in the same way we already look through aig) to see who the real beneficiary of the rescue was.
tim:
was the real beneficiary these guys?
http://www.carlyle.com/DoctoRx:
Let's see.
1. Greenspan leaves the Fed and becomes a shill for PIMCO.
2. The NY Fed is owned by its member banks, which earn a 6% cumulative payment yearly from it.Chump?
No.
Crony?
For sure.
Scott N:
Under the Fed as crony heading what do you make of the HuffPost piece that says it was all about Goldman? It posits that Goldman was on the hook for the SocGen CDS if AIG went down and that Deutsche Bank's piece was sold to them by Goldman only after it was clear the govt was baling AIG out (in a shammy transaction to reduce the optics of the total Goldman number).
Yves Smith
Scott,
There are a lot of assertions in his piece that are just plain wrong.
For instance, he gets all high and might re the payouts made by AIG on October 7 and contends AIG didn't have to make them, they happened only because the Fed had kicked out Willmustad and installed a Liddy, who had ties to Goldman. That is just 100% inaccurate. There were collateral calls under the CDS, if AIG had refused to pay, the counterparties could declare them in default and put AIG into bankruptcy. That is what this whole exercise was meant to avoid, an AIG BK.
He is also wrong re Deutsche. The BlackRock memo makes very clear that AIG entered into those trades with Deutsche as a means of obtaining financing. This was internal, for the AIG's eyes only. AIG would have been well aware if the position had changed hands. BlackRock is clear that the Deutshce trade was to benefit AIG, and it seems to be pre bailout.
As for SocGen and Goldman, Goldman had already collected significant collateral from AIG and its marks were more aggressive than anyone else's. Yes, Goldman in theory had some exposure to SocGen, but Goldman also had CDS on AIG and was collecting collateral payments on them as AIG was being downgraded. In an AIG BK scenario, its CDS on AIG probably would have failed due to cascading counterparty defaults, but up to that point, there is no evidence of counterparty default, hence no evidence of Goldman being exposed
Dave:
What is becoming very clear from all this is that Goldman was in a heads we win, tails we win, position, and that Goldman was willing to knee-cap the entire financial system, American people be damned, to get their money. We want our money. We want our money! And they got it.
It was RANSOM paid to Goldman. No other way to look at it. The Fed and the players were sophisticated enough to know that Goldman would push AIG to the brink and would win twice-over, perhaps draining other counterparties on CDS bets on AIG's failure. The Fed knew the collateral damage would be extensive, but Goldman? Goldman was the damaged-be-damned, we want our money!
Siggy:
Yves,
Thanks for this piece. Very nice sysnopsis of the known salient facts.
What I saw in watching most of Geither and some of Paulson is a lot of dissemblement. Paulson's better at it than is Geithner.
The fixation on non disclosure is more than intriguing. I see it as a clear indication that there has been malfeasance which may, or may not have been criminal. There is no other good reason for stonewalling.
Correct me if have this wrong; the Fed's mandate to act as a lender of last resort is entirely dependent on the Bagehot premise of quality collateral and a very high interest rate. Acquisition of the CDOs is the undertaking of an equity position. I believe that it can be held that that is illegal.
My conclusion is that your two premises point to a probable third which is that those in control were both stupid and engaged in the exercise of cronyism. In the scenario I see developing it is not so much that GS is the target as that GS is the stalking horse. I see this event as a case of market participants engaging in an unwitting conspiracy by the fact that they each shared common objectives. In retrospect such events take the appearance of having been willful when in fact the conspiracy arises because of the shared common objectives. There need not be communication between the parties to establish the conspiracy, their trading actions alone establish the conspiracy. This gives rise to the desirability of maintaining wide participation in the operation of market.
I also believe that at some point the history of this occurrence will be recorded as an ideologue blunder of stunning stupidity and hubris.
I also noted that what has not been tabled in the inquiry is the consideration that AIGFP had committed a massive tort and potentially a fraud. To me it is equally important to realize that the AIG derivative contracts were subject to negotiated settlement and that the fact that AIG could not honor the contracts leads to the question as to the representations that AIG made in executing the contracts.
I have seen reports that indicate that there were 44,000 such contracts. At what point in the execution of those contracts was it self evident that AIG was incapable of honoring the contracts. Moreover, from what I heard yesterday no one seems to be very clear, or concerned, as to whether AIGFP was a separate subsidiary corporation or a department within the AIG corporation.
Enjoy your work and hope that you will keep insights coming.
Richard Kline:
So Yves, I like where you're going with the 'Chump vs. Crony' narrative.
I'm going to raise a different point, tho'. Much of the discussion of l'affaire AIG has centered around "Who authorized the giveaway?" Geithner, Bernanke, who? To me, that's not the relevant question. A better one is, "Who proposed the payout at par?" Who came up with the idea? When all the fingerprints are speced, this is who I think we'll find had their hand upon the cashbox: GS, Merrill, Morgan Stanley, UBS. That is, the beneficiaries of the steal came up with the idea and the Guvmint guys went for it, whether with a wink and a nod or a blink and a quiver. Since we're speculatin' on the peculation, I'm of the opinion that one or more of them-GS one supposes-said something to the effect of "We don't think we can prevent an event if we don't get complete payout." And Paulson, Geithner, Bernanke and their inner ring just pulled out the public checkbook and said, "How much do you need?" No attempt to value the positions. No attempt to negotiate. No attempt to regulate. No attempt to get a receipt, really. . . . And we'll find that those CDSs, while bad, weren't so bad _then_ to justify either the claim of incipient 'eventuation' or the Government rush to give billions to malefactors fo great wealth. As long as nobody can do the forensics on what the positions were at the point the pass-throughs were authorized, we can't really tell if 'it was necessary' or whether 'the fix was in.' So naturally, all parties to l'affaire are desperate to keep the positions from public view.
I suspect that the alpha banks essentially told the coves at the Guvmint to pay them off, and the confirmation suits just did as they were bidden. There was a panic alright: the Guvmint types were panicked-by the sharps. And only too willingly.
Independent Accountant:
YS:
I've posted on this issue extensively. In my less than humble opinion, the Fed, headed by Zimbabwe Ben (ZB, 1590 SATs, more than I got) was a crony. It is inconceivable to me that ZB didn't know he was bailing out the Vampire Squid. If nothing else, Henry Paulson told him.
Cullpepper:
This is great, btw…
Marcy Kaptur chews out Tim Geithner over AIG:
http://www.youtube.com/watch?v=JtwVRM0OG58
What a weasel. I'm no mind-reader, but I know a liar when I see one…
rita:
Third possibility: one part chump, one part crony and one part panicked. They may have felt that they didn't have the time on their side. How many deals have impossible deadlines to meet with such a rush to close that some docs have to be redone after close?
Large financial institutions know how to game the regulators and often the regulators are either too unsophisticated to know they are being gamed and/or know they are being gamed but for political reasons go along with it. Rightly or wrongly, the regulators/government identify likely survivors and/or institutions that have to survive and then assist them openly or covertly. Like any banker, the Fed really doesn't want to do deals in the open. Perhaps it will in the future.
csissoko:
"So why did they buy the CDOs?"
Another possibility: They wanted to avoid supporting CDS that were not protecting the value of real assets. Don't know that this was the best way to do it, but at least by insisting on the transfer of the CDOs, they didn't end up paying off purely speculative positions.
I just read MichaelC after writing this paragraph. To argue in favor of the Fed's decisions: If you accept that it was necessary to honor the terms of the CDS contracts to avoid an EoD and keep AIG out of BK, then at least they managed to do this without providing an official government guarantee of the speculative positions.
Another related issue (that Richard Alford has also raised): Why did Treasury refuse to act as the fiscal agent of the government in the bailout and push that position on the Fed? And why did the Fed accept this situation?
bobh:
The story Geithner and Bernanke (and Hank Paulson) tell is that they did everything, however personally repugnant it was to them as dedicated stewards of public funds, to keep the entire financial system from collapsing. And they are sticking to this story no matter what.
People who study the details know they did so many things that had nothing to do with saving the world, both during the early days when they were shoveling money out the door into their friends' limos and later when they started hiding their tracks and working to preserve Wall Street's ability to pull off new scams in the future, that the only real question is whether they are crooks or cronies.
Nevertheless, most Americans, including people I know and like, believe the end-of-the-world comic book version, in which life as we know it was preserved by three superhero geniuses–a nerdy professor from Princeton who understood financial collapses better than anyone else on the planet and two financial wizards with nerves of steel who were on loan from Wall Street. People hear versions of this story every day, from people they trust, from Time Magazine and the New York Times, from Paul Krugman and Brad DeLong and Mark Thoma, from Barack Obama and Larry King and, probably, from Oprah. More than sixty U.S. Senators are about to endorse this version of reality. What can you do?
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September 8, 2009 | The New Republic
In 2002, Ben Bernanke issued an apology on behalf of the Fed--but not for anything he had done. Bernanke was apologizing for the Fed's role in causing the Great Depression. He was referring to the fact that the Fed's monetary policy had been too tight from 1929 to 1933, allowing too many banks to fail. But this is only half the story. During the heady days of summer 1927, the Fed had done something else that would contribute to the Great Depression: It lowered interest rates. Markets responded to the rate cuts with a strong rally in the second half of 1927, and the Fed then decided to raise rates from 3.5 percent to 5 percent in 1928. But it stopped there. A higher rate would have choked off farmers who needed capital and were facing falling commodity prices throughout the decade. Moreover, it would have ended the bonanza of stock price gains that was benefiting the financial sector. To reduce risk, the Fed could have used its powers to convince banks to stop providing loans for stock purchases and to increase their capital, but this too would have ended the bonanza. It was a classic Fed dilemma: Should it raise rates and take other actions to curtail financial speculation involving excessive risk-taking, but possibly slow down the rest of the (real, not financial) economy in the process--and bear the resulting political damage? The Fed decided to stand aside. And so, history's most damaging economic bubble was created.
After 1929, the government considerably tightened the rules controlling banks, securities transactions, and risk-taking more generally. For a while, the system worked reasonably well. But, eventually, banks would learn how to play the new game. They would spend serious money lobbying to keep regulations lax, hiring lawyers and accountants to find methods to minimize or avoid regulations, and incentivizing employees to hide risk from regulators. While the banking sector became more risky, creditors to banks (such as depositors and lenders) knew they could count on the Fed to engineer bailouts via lower interest rates and access to credit if times got tough -- so banks had no trouble raising funding from creditors, and our financial system grew rapidly.
The Fed did not create this atmosphere of elevated risk, but it ended up playing a central role in perpetuating it. Since the 1970s, successive financial crises have required ever more dramatic reactions from the Fed. Every time there is a potential financial meltdown, the Federal Open Market Committee quickly cuts short-term interest rates. These cuts have become larger and larger over time, now essentially taking interest rates to zero. Each round of interest-rate cuts has made sense when a given crisis breaks. But these cuts--which effectively function as bailouts for banks that have gotten into trouble--often helped bring about the next financial crisis. And the crises are getting larger, not smaller, over time.
Every crisis of the past few decades has had its distinctive features, of course, but the broad pattern is the same. Paul Volcker cut interest rates after the Latin American debt crisis broke in the early 1980s; this lowered the cost of funding speculative real-estate deals and--combined with regulatory breakdown--helped pave the way for the S&L crisis. Ironically, Volcker--seen as the very model of a traditional anti-inflation central banker--presided over the first major modern instance of using interest policy to help banks get back on their feet. Next, Alan Greenspan cut interest rates following the stock-market crash of 1987 and the development of commercial real-estate problems in the late 1980s and early '90s. The resulting credit boom helped push (unregulated) financial exuberance into emerging markets. One by one, there would be crises in those emerging markets: Mexico, Thailand, Indonesia, Malaysia, Korea, Russia, and Brazil all experienced economic calamity between 1995 and 1998.
In September 1998, we saw the failure of a single lightly regulated U.S. hedge fund, Long-Term Capital Management. This threatened our financial system, and the Fed cut rates preemptively--making popular the term "Greenspan put." (A put is a contract that gives the owner the right to sell assets at a fixed price, and it is often used to lock in profits or limit losses. So, if your assets fell in value, Greenspan would effectively buy them or -- literally -- put a floor under their value. Stocks, for example, are underpinned by future expected company earnings; the value today of those future flows goes up when interest rates are lower--so any cut by the Fed is welcomed by stock-market investors.) In a bright shining moment, markets realized that the Fed was prepared, through interest rate cuts and loose credit, to do whatever it took to bail out financiers facing large losses. Risk-taking without fear for the consequences became the name of the game, at least for our largest financial players: They get the upside if things go well, and the Fed will limit their downside when the speculative frenzy of the day finally runs out of steam.
This environment helped feed the technology bubble--and bust. And this led to further rate cuts--championed by Bernanke, then working under Greenspan. Those 2001 rate cuts--and subsequent decisions to hold interest rates low--encouraged our housing bubble. The phrase "Bernanke put" is now catching hold, meaning an explosive burst of bailouts, liquidity provision, and supportive fiscal stimulus far larger than anything implemented under Greenspan. But Bernanke's mega-put is just one further step along a path that was established long ago, back in 1913 when the Federal Reserve was founded.
Over the past century, we have moved away from a system where bank shareholders and senior executives paid dearly for bad management--and toward a system where fired bank bosses make off with fortunes or launch brilliant political careers. No one is on the financial hook, other than the taxpayer. Consider the case of Citigroup, a seriously troubled bank. Chuck Prince, the CEO who fell flat on his face, walked away with close to $100 million. Win Bischoff, former chairman and interim CEO of Citigroup during the debacle, has just been appointed chairman of Lloyds Banking Group in the United Kingdom--reflecting the high esteem in which he is apparently still held. And Robert Rubin, Treasury secretary under Clinton, made over $100 million as board member and chair of Citigroup. In an interview late in 2008, he brushed off any responsibility for the mismanagement of anything. And so, our recurring financial crises are not isolated random events; they emerge from a pattern of private and public sector behavior. Enabled by the Fed, our system's tolerance for risk is out of control. This is an increasingly dangerous system. It is only a matter of time until it collapses again.
What will that collapse look like? The bubbles this time will likely appear abroad. Parts of Asia and Latin America, a tiny fraction of the size of the U.S. economy, are experiencing large capital inflows, low interest rates, and the beginnings of a major boom. Countries with intact banking systems and access to global capital markets will lead the next speculative wave. The United States will be pulled in--probably soon enough that we will all be surprised by a supposedly robust recovery, fed by continued low interest rates and loose credit. We all know these episodes end in tears, but they can be spectacular while they last.
Just like in the late 1920s, most central banks--the Fed among them--will undoubtedly wait a long time to raise interest rates. Inflation remains low, and bankers will surely argue that financial-sector fragility means we should be cautious. It would take a tremendous political battle to stop the next bubble; who wants to take away the punch bowl in the midst of a perceived boom? By the time the Fed and other central banks get around to tightening monetary policy, it will already be too late.
Based on what we have seen over the past two decades, the cost of the next collapse will invariably be steep. Since the early 1980s, the Fed has gone back to its origins as the bailout machine for the financial sector. The only difference is that this sector has become much larger since 1907 or 1913. Back then, it accounted for around one percent of GDP. Now it is closer to 8 percent. The cost of bailouts--the current one and those to come--has skyrocketed as a result.
In June 2009, Treasury Secretary Timothy Geithner unveiled the administration's plans for reforming our financial sector and preventing a major crisis from happening again. The cornerstone of the proposal is to (slightly) reduce the number of agencies carrying out regulation, and to give new powers to the Fed.
Unfortunately, these changes are unlikely to work. They do not alter the enormous incentive our banks have to take excessive risks. They don't address the fact that strong financial groups can lobby our lawmakers and beat down regulators until they are largely ineffective. And they don't affect our propagation mechanism: The printing presses at the Fed remain open and available for when the next crash comes, and that makes creditors confident that they can lend without risk to our heavily leveraged financial sector. As long as this combination remains in place, today's financial executives fully understand that the party goes on.
Consider the lessons learned in the past twelve months by our major banks. If they again get into serious financial trouble, the Fed can be counted on to lend them essentially unlimited amounts at effectively zero interest rates. What would you do with free money? You'd pay off all your old debts, then you'd find something to invest in that would yield a decent return. But then you'd reckon--why not take more risk? After all, if things go badly, you'll get more free money.
We don't need to repeat history and make bank owners subject to "unlimited liability" -- but we do need to make their financial outcomes more closely linked to the risks they take. First, we should sharply raise capital requirements at banks so that the shareholders have more at stake. Shareholders need to feel that when a bank takes gambles, their money is truly at risk. Under our current regulations, a bank like Goldman Sachs puts up only $1 billion of equity for every $13 billion of assets. Who is taking this risk? It is us--as taxpayers.
How much capital is enough? This is a hard question, with no definite answer. One answer, offered by Nobel Prize winner Robert Merton in 1995, is: not much. Merton reasoned that modern risk management and the availability of sophisticated hedging strategies meant that more and more of what banks do is essentially riskless and, therefore, does not need capital. Of course, Merton was deeply involved in the failure of Long-Term Capital Management in 1998, as well as the broader ideological development that underpinned the highly leveraged strategies built around housing during the early 2000s. His view remains theoretically elegant but completely ignores the reality that our financial system -- because we bail it out every time things go wrong--provides strong incentives to take bad gambles.
The idea that banks should carry an "equity cushion" (to absorb losses before anyone has to turn to the government) worth around only 6 or 8 percent of their assets is a quite modern idea. (As recently as the mid-nineteenth century, banks financed significantly more of their assets with equity.) Perhaps a low equity cushion made sense when banks were tightly regulated and limited in the risks they could take, say from 1935 to around 1980. But leading students of central banking today, such as Charles Goodhart, argue strongly that, with the collapse of effective regulation over the past two decades, thin equity layers at many leading banks (in combination with limited liability of shareholders) are completely inappropriate for maintaining a stable financial system.
Second, the managers and boards of directors of financial institutions should be personally liable up to a reasonable sum when their companies fail. They should lose a portion of past salaries and bonuses, while also seeing their bank-provided pensions reduced substantially. Richard Parsons, the chair of Citigroup since February 2009, is estimated to be worth more than $100 million. Yet he reports that he owns only around $750,000 of Citi stock. Such negligible personal downside risk for the board of directors is the norm in high finance today. We should let bank executives be paid well when they are successful--but they should truly lose if they take risks that lead to taxpayer bailouts. It can take up to a decade before the success or failure of past business decisions really becomes evident in banking, so reductions in pensions, and clawback of bonuses, should take this into account.
Third, we need to set rules so that our regulators and public servants, who have the role of protecting taxpayers, are not financially conflicted. Today, the revolving door from government leads directly into the lobbies of our major banks. We need a rule that all employees of the Fed, the U.S. Treasury, and other regulatory bodies are not permitted to work in finance for at least five years after they leave office. If government employees have joined a regulatory authority from the financial sector, they should have a "cooling off" period within which they are prohibited from any official role in the design or implementation of regulation or bailouts.
Finally, we need more assertive leadership at the Fed regarding broader system issues. The Fed, of course, will protest, "This is not our job." It will say that Treasury is responsible for the administration's approach and that authority ultimately rests with Congress.
This is true, strictly speaking. The Fed did not create our current atmosphere of deregulated risk-taking. But neither is the Fed blameless. The Fed is partly a prisoner of the current system -- but it is also partly a jailer. In the moments when the Fed is presented with a rescue-the-banks-or-the-economy-will-collapse scenario, it is a prisoner. But the Fed, and especially the chairman of the Fed's board, has plenty of power to shape the environment that produces this choice. And it has taken on the challenge of shaping the financial climate before.
During the 1930s, Fed chair Marriner Eccles was an advocate for change across the financial system. Now, Bernanke needs to play the same role. He needs to advocate for rules and regulations that ensure financial leaders will bear serious costs when there is a future failure due to excessive risk-taking. Otherwise, the Fed will continue to be a handmaiden to repeated bailouts. And, with each bailout laying the groundwork for the next one, the peril facing our financial system will only grow worse.
Peter Boone is chairman of Effective Intervention, a Britain-based charity, and a research associate at the London School of Economics's Centre for Economic Performance. Simon Johnson is a professor at MIT's Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. They write for The Baseline Scenario, a blog on economics.
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William Black is a former senior bank regulator, now associate professor of economics and law at the University of Missouri – Kansas City (UMKC), who writes for New Deal 2.0.
The first decade of this century proved how essential effective regulators are to prevent economic catastrophe and epidemics of fraud. The most severe failure was at the Federal Reserve. The Fed's failure was the most harmful because it had unique authority to prevent the fraud epidemic and the resulting economic crisis. The Fed refused to exercise that authority despite knowing of the fraud epidemic and potential for crisis.
The Fed's failures were legion, but five are worthy of particular note.
- Greenspan believed that the Fed should not regulate v. fraud
- Bernanke believed that the Fed should rely on self-regulation by "the market"
- (Former) Federal Reserve Bank of New York President Geithner testified that he had never been a regulator (a true statement, but not one he's supposed to admit)
- Bernanke gave the key support to the Chamber of Commerce's effort to gimmick bank accounting rules to cover up their massive losses - allowing them to report fictional profits and "earn" tens of billions of dollars of bonuses
- Bernanke recently appointed Dr. Patrick Parkinson as the Fed's top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS, a.k.a the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.
Each error arises from the intersection of ideology and bad economics.
The Fed's regulatory failures pose severe risks today. Three of the key failed anti-regulators occupy some of the most important regulatory positions in the world. Each was a serial failure as regulator. Each has failed to take accountability for their failures. Last week, Dr. Bernanke asserted that bad regulation caused the crisis - yet he was one of the most senior bad regulators that failed to respond to the fraud epidemic and prevent the crisis. As Dr. Bernanke's appointment of Dr. Parkinson as the Fed's top supervisor demonstrates, the Fed's senior leadership has failed, despite the Great Recession, to learn from the crisis and abandon their faith in the theories and policies that caused the crisis. Worst of all, the Fed is an imperial anti-regulatory seeking vastly greater regulatory scope at the expense of (modestly) more effective sister regulatory agencies. The Fed's failed leadership is setting us up for repeated, more severe financial crises.
Dr. Parkinson as Anti-Regulator
This essay focuses on Chairman Bernanke recent appointment of Dr. Parkinson to lead the Fed's examination and supervision. My central point is that Dr. Bernanke appointed Dr. Parkinson because he shared Dr. Bernanke's anti-regulatory ideology and has never changed those views, even in the face of the Great Recession. The anti-regulator policies that Bernanke and Parkinson championed were the principal drivers of the fraud epidemic that have produced recurrent, intensifying crises.
Bernanke's appointment as the Fed's top supervisor of an individual that had no experience in regulation, in the midst of the greatest crisis of our lifetime, is irresponsible and dangerous on its face. No ideology has proven more disabling in this crisis than neoclassical economics. Dr. Parkinson is a neoclassical economist. The "skills" an economist would purportedly bring to supervision have proven to be disabilities in identifying and understanding fraud and risk.
We need not rely on generalities - Dr. Parkinson has a record relevant to supervision that we can evaluate. The most revealing aspects of that record fall into three categories. First, Dr. Parkinson was a leading proponent of the obscene (and successful) effort to prevent Commodity Futures Trading Commission Chair Brooksley Born from taking regulatory action to prevent destructive credit default swaps (CDS). Second, Dr. Parkinson, like Greenspan and Bernanke, subscribed to the naïve view that fraud was impossible in sophisticated financial markets and that credit rating agencies were reliable.
Third, Dr. Parkinson endorsed the international "competition in regulatory laxity" that Dr. Bernanke (belatedly) warned has degraded regulation on a global basis. Here are the key passages from Dr. Parkinson's congressional testimony:Professional counterparties to privately negotiated contracts also have demonstrated their ability to protect themselves from losses from counterparty insolvencies and from fraud. In particular, they have insisted that dealers have financial strength sufficient to warrant a credit rating of A or higher. This, in turn, provides substantial protection against losses from fraud.
If this opportunity is lost, the Board is concerned that market participants will abandon hope for regulatory reform in the United States and take critical steps to shift their activity to jurisdictions that provide more appropriate legal and regulatory frameworks.
The "opportunity" Dr. Parkinson feared would be "lost" was to remove the CFTC's ability to regulate CDS. Anti-regulation would "win" the international competition in laxity. His policies made possible the catastrophe that is AIG. Dr. Bernanke is aware of Dr. Parkinson's record of anti-regulatory failure. He chose Dr. Parkinson because of that record in order to ensure that the Fed would not take regulatory actions that would upset the biggest banks, particularly the systemically dangerous institutions (SDIs) that are the real governors of the Fed's anti-regulatory policies.
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January 10, 2010 | naked capitalism
By L. Randall Wray, Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute, who writes for New Deal 2.0.
There is a growing consensus that it is time for President Obama to fire Treasury Secretary Timothy Geithner. While he is at it, he needs to clean house by firing Larry Summers, by banning Robert Rubin from Washington, and by appointing a replacement for Chairman Bernanke. It is time for a fresh start.
Geithner is facing renewed scrutiny due to his questionable actions while at the NYFed. As reported on Bloomberg and in the NYT, secret emails show that the NYFed under Geithner's command prohibited AIG from reporting that it was passing government bail-out funds directly to counterparties, including Goldman Sachs. AIG had been negotiating with the banks, asking them to take as little as 40 cents on the dollar against bad CDOs they held. AIG was the biggest insurer in the country and had provided $62 billion of credit default "insurance" to these banks. The CDOs went bad and AIG could not cover claims. It was forced into insolvency and the government came to the rescue, with $182 billion of bailout funds through last June. By all rights, its counterparties should have lost big on their bad bets. Apparently, Geithner arranged the bailout of AIG with full knowledge that it would pass the bailout funds directly to the banks. Whether or not some protection should have been provided to the banks, it clearly was not good public policy to provide dollar-for-dollar protection to them. If you are a favored Wall Street bank, no bet can go bad!
Geithner's relations with Wall Street bankers have always been incestuous, raising serious questions about his intentions. Note that Geithner worked with then Treasury Secretary Paulson to broker the AIG deal. Paulson, of course, had been the CEO of Goldman. Geithner is the protégé of Clinton's Treasury Secretary Rubin, also from Goldman, and he got his job at the NYFed through the efforts of Pete Peterson. In addition to the AIG deal, Geithner had the NYFed provide $29 billion of funding for J.P Morgan Chase's hostile takeover of Bear Stearns. In the deal, the NYFed got $30 billion of questionable collateral. Geithner hired Blackrock in a no-bid contract to manage these assets. Blackrock is a spin-off of Pete Peterson's Blackstone Group, and was 49% owned by Merrill Lynch, headed by John Thain (another Goldman alum). As head of the NYFed, Geithner's closest advisors were Thain, William McDonough (Vice Chairman at Merrill), Gerald Corrigan (Managing Director at Goldman), Jamie Dimon (also Goldman), and Richard Fuld of Lehman's. The head of the NYFed's Board of Directors was Stephen Friedman, former Goldman Sachs Chairman. As Gary Weiss put it back in 2008, "Thus Geithner reports to a board that is composed of people who are not only under his purview but would also benefit from any potential bailouts. The structure of the New York Fed's board bears more than a passing resemblance to that of the New York Stock Exchange in the bad old days, when member firms, regulated by the N.Y.S.E., were heavily represented on its board". The AIG deal seems to have been business as usual for Geithner.
According to Representative Darrell Issa, Republican of California, "It appears that the New York Fed deliberately pressured AIG to restrict and delay the disclosure of important information to the S.E.C.". Not only did Geithner want to keep this information from the public, but also from fellow regulators. (Whoops, Geithner admitted he was never a regulator while at the NYFed.) Indeed, at the time, Geithner refused to even tell Congress who the counterparties were-until overwhelming pressure required that he release the names. This smells fishy because it is.
The Fed's justification for such secrecy was that it was trying to preserve the value of the taxpayer's investment in AIG. (Vice President Donald Kohn explicitly made this argument before the Senate.) But that is nonsense-there was no value to preserve. This was just a give-away to protect Goldman and other counterparties. Later when AIG's executives demanded that compensation limits be lifted so that they could get their bonuses, Geithner came to their rescue, arguing that contracts are contracts no matter how putrid they might appear. We now know that the executives were demanding cash rather than stocks in their own firm because they expect the stocks will prove to be worthless-they are managing a firm that will never have any value and they know it. This is something Geithner refuses to tell the public.
Remember, this is the same guy who "forgot" to pay his taxes. Worse, he improperly claimed a tax deduction for a summer camp for his kids. He is ethically challenged. Should he be running the Treasury?
More important than such blunders, however, is that Geithner's policies are not working. As Republican Congressman Brady of Texas put it, "Conservatives agree that, as point person, you've failed. Liberals are growing in that consensus as well. Poll after poll shows the public has lost confidence in this president's ability to handle the economy. For the sake of our jobs, will you step down from your post?" here Today's employment figures show that rather than a recovery, our economy is still hemorrhaging jobs at a scary pace. While the payroll number was down "only" 85,000 jobs, the household survey was down 589,000 for December. Over the past three months we have lost an average of 325,000 jobs. And that is in spite of the fiscal stimulus as well as the trillions of bail-out funds provided to the financial sector. We are at least 26 million jobs short. Even if the job losses stopped, real recovery will require job creation on a massive scale. The problem is that Congress, and the public, no longer has sufficient faith in the Administration to provide new funding-and the stimulus will soon run out. Rep. Peter DeFazio of Oregon put it this way: "We may have to sacrifice just two more jobs to get millions back for Americans."
Of course it is not quite that simple, but it is a first step.
We need an economic team that recognizes the following:
- Banks do not face a liquidity crisis, rather they are massively insolvent. Reported profits are due entirely to trading activities-which amount to nothing more than a game of Old Maid, with institutions selling bad assets to each other at inflated prices on a quid-pro-quo basis. As such, they need to be shut down and resolved. Geithner is not the right person to head such an effort because his past resolutions have always been designed to protect Wall Street, not Mainstreet.
- Saving financial institutions does not save the economy. The financialization of the economy promoted by Greenspan and Rubin has led to a financial sector that is at least three orders of magnitude too big. If anything, all the efforts directed toward saving Wall Street have only made the economy more fragile. Another financial crash is inevitable because the financial system is still too large to be supported by the economy-even if the economy could recover. We need a Treasury Secretary who recognizes that the best course of action is to downsize the financial system. Geithner is not that guy.
- As such, all of the bail-outs and guarantees provided to financial institutions (over $20 trillion) need to be unwound. Not because we cannot "afford" them but because they are dangerous. Unfortunately, Congress has come to see all of these trillions of dollars committed to Wall Street as a barrier to spending more on Mainstreet. Thus, even if the Wall Street bail-outs were not dangerous, they need to be reversed to generate fiscal policy space for another economic stimulus package. It will not be easy to convince Congress that the solution to our economic crisis is more government spending. And Geithner is not the Treasury Secretary to lead such an effort because he has lost the confidence of Congress and the public.
- Finally, we need an economic team that understands government finance. The current team is hopelessly confused, led and misguided by Robert Rubin. He thinks government is nothing but a big household, which must balance its budget. He continues to believe that the Clinton boom was due to federal budget surpluses, not recognizing that it was actually due to an unsustainable boom of household borrowing. Indeed, as Clinton's Treasury Secretary, he oversaw the creation of the conditions that led to this current crisis. The new team must have no connection to Rubin (or Pete Peterson) and his anti-deficit hysteria. The Great Depression of the 1930s only ended with the massive spending of WWII, when the budget deficit reached 25% of GDP. Our current situation is not yet that severe, and it is likely that a sustained recovery can be obtained long before the budget deficit reaches such a level. However, the longer that Geithner, Summers, Bernanke, and Rubin remain in charge, the greater the probability that this could still turn into another Great Depression.
Selected Comments
Robespierre:
If all you can expect as a corrupt government official is just to get fired corruption will march on. What it is required is jail time to those who broke the law. And the only way to know who did that is to investigate. The problem of course is that Obama refuses to do so. My guess is that he has something to hide.
attempter:
And yet, even a political disaster looms, Obama and the Dems dig in on every cadre, no matter how compromised and no matter how expendable by historical standards.
Wingnut welfare has been taken to such extremes by now.
I wonder if the very fact that leaders have deprived themselves of what was historically a standard trick, to fire a hated high-profile subordinate to take some of the heat off yourself and recover some time and political capital, will render it all the more damaging if we can force the likes of Geithner and Bernanke out of office.
I'd hope that if Obama were finally forced to relinquish Geithner, that everyone would see how he had done it only under duress, and that he wouldn't derive and political benefit from it. Rather, that it would highlight the criminal character of this whole administration.
Well, maybe we'll get to find out.
In the end nothing short of a Nuremburg-style tribunal, with the same beginning, middle, and end, shall suffice.
Eric:
Secretary Geithner is faithfully executing President Obama's vision. This vision is correctly alluded to by a previous commenter, being the "solution" of the insolvency crisis of firms (and individuals) associated with the political power structure of the company by the dedication of very large amounts of taxpayers' resources.
Since the losses that need to be dealt with are real, these actions boil down to the use of government power to transfer the losses from those that ran the risks and would have otherwise reaped the rewards to the public.
The decision to do this is being taken at a political level above Sec. Geithner. In the current administration's defense, it isn't likely that electing the other candidate would have given much different results as the interested parties have done such a good job in capturing the attention of both parties.
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Jan 07, 2010
The AIG CDS story has been smoldering for so long now that most ordinary mortals are left either confused or bemused, or both.
What is it that Janet Tavaoli keeps rabbiting on about? Are those Bloomberg guys obsessed, or what?
But then, out of the blue, along comes a development that is easy to understand, that is sitting there in black and white, available for the public to read.
And it says "Yes, there was a cover up. The authorities didn't want the public to know how handsomely Wall Street was being bailed out with their money."
That's easy for everyone to understand. Whether it was understandable at the time – in the latter months of 2008, when the US authorities were quite literally working to save the financial system – is a debate that still has to reach a conclusion.
The disclosure on Thursday, on Bloomberg and the NYT's Dealbook, of documents suggesting that the Federal Bank of New York actively (and successfully) sought to prevent AIG from disclosing full details of the payments it was making to the likes of Goldman Sachs and Deutsche Bank, will hurry that debate along.
It might also encourage the departure of Tim Geithner, now US treasury secretary, who happened to be running the NY Fed at the time.
If so, the shot that finally pierced Mr Geithner's skin will be attributed to Republican congressman Darrell Issa, who used his position on the House Oversight and Government Reform Committee to get copies of the smoking documents.
This is all redolent of that congressional testimony offered up by the Peterson Institute economist (and UK MPC member) Adam Posen back in February last year, when he argued that the only way to end a banking crisis was to sack all those in charge at the time – including the supervisors and regulators.
In the mid-1980s in the United States and most of the 1990s in Japan, bank supervisors engaged in regulatory forbearance, meaning they held off intervening in or closing banks with insufficient capital in the hope that time would restore asset values and heal the wounds. One can easily imagine the incentives for the bank supervisors, well documented in historical cases and the economic data, not to have a prominent bank fail on their watch. The problem, also evident in these historical cases and in the economic data, is that top management and shareholders of banks know that supervisors have this interest, and respond accordingly. The managers and shareholders do everything they can to avoid outright failing, which fits their own personal incentives…
That self-preservation, not profit-maximization, strategy by the banks usually entails calling in or selling off good loans, so as to get cash for what is liquid, while rolling over loans to bad risks or holding on to impaired assets, so as to avoid taking obvious losses, and gambling that they will return to value. The result of this dynamic is to create the credit crunch of the sort we are seeing today, and this only adds to the eventual losses of the banks when these losses are finally recognized.2 The economy as a whole, and nonfinancial small businesses in particular, suffer in order to spare the positions of current bank shareholders and top management (and, on the firing line, bank supervisors).
In the US and elsewhere, a few more scalps are required before we can declare this crisis over.
Related links:
- AIG Bailout Keeps Dogging Tim Geithner – WSJ's Deal Journal
- Goldman's collateral damage – FT Alphaville
- New York Fed under fire over crisis bank payments – FT
pegnu:
Geithner should be under criminal investigation for fraud and other criminality. So should Bernanke, Paulson and the rest of the kleptocracy.
This crisis will not be over until the fraudsters and banksters are rotting in prison.
Smoker:
Geithner is old baggage. Obama should lighten up and get a fresh start in the new year unless he approved the November 10, 2008 payments as president elect. That would explain why he protects Geithner. And Bernanke too.
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Economist's View
When Ben Bernanke was asked about the "too big to fail" problem not too long ago, the WSJ Economics blog reports:
Federal Reserve Chairman Ben Bernanke voiced skepticism that breaking-up big banks is the way to solve the so-called too big to fail problem...
Asked for his thoughts on Bank of England Gov. Mervyn King's recent speech that advocated breaking up banks that were so large that their failure would represent a risk to the broader financial system, Bernanke said that making banks smaller would not necessarily be the solution to the problem. Smaller banks can also play important roles in financial systems, he said. He noted that during the 1930s, the U.S. didn't have too many large bank failures, but the country suffered thousands of failures of smaller banks that added to the woes of the Great Depression. "I don't think simply making banks smaller is the way to do it," he said.
Still, more than once during his comments to the Economic Club of New York, Bernanke emphasized that it is crucial that large financial firms be allowed to fail in order to return market discipline to the financial system.
It is not at all clear to me that breaking large banks into smaller pieces addresses the connectedness issue. Smaller banks can be just as interconnected as larger banks, and hence simply breaking banks up without examining the effect it has on the underlying financial network connections may not reduce systemic risk.
Joseph Stiglitz says break them up whenever possible, regulate them heavily when it's not possible:
Too Big to Live, by Joseph E. Stiglitz, Commentary, Project Syndicate: A global controversy is raging... Mervyn King, the governor of the Bank of England, has called for restrictions on the kinds of activities in which mega-banks can engage. ... King is right to demand that banks that are too big to fail be reined in. In the United States, the United Kingdom, and elsewhere, large banks have been responsible for the bulk of the cost to taxpayers. ...The crisis is a result of at least eight distinct but related failures:... There are, of course, costs to regulations, but the costs of having an inadequate regulatory structure are enormous. We have not done nearly enough to prevent another crisis... King is right: banks that are too big to fail are too big to exist. If they continue to exist, they must exist in what is sometimes called a "utility" model, meaning that they are heavily regulated.
- Too-big-to-fail banks have perverse incentives; if they gamble and win, they walk off with the proceeds; if they fail, taxpayers pick up the tab.
- Financial institutions are too intertwined to fail...
- Even if individual banks are small, if they engage in correlated behavior – using the same models – their behavior can fuel systemic risk;
- Incentive structures within banks are designed to encourage short-sighted behavior and excessive risk taking.
- In assessing their own risk, banks do not look at the externalities that they (or their failure) would impose on others, which is one reason why we need regulation in the first place.
- · Banks have done a bad job in risk assessment – the models they were using were deeply flawed.
- · Investors, seemingly even less informed about the risk of excessive leverage than banks, put enormous pressure on banks to undertake excessive risk.
- · Regulators, who are supposed to understand all of this and prevent actions that spur systemic risk, failed. They, too, used flawed models and had flawed incentives; too many didn't understand the role of regulation; and too many became "captured" by those they were supposed to be regulating.
In particular, allowing such banks to continue engaging in proprietary trading distorts financial markets. Why should they be allowed to gamble, with taxpayers underwriting their losses? What are the "synergies"? Can they possibly outweigh the costs? Some large banks are now involved in a sufficiently large share of trading ... that they have, in effect, gained the same unfair advantage that any inside trader has.
This may generate higher profits for them, but at the expense of others. It is a skewed playing field – and one increasingly skewed against smaller players. Who wouldn't prefer a credit default swap underwritten by the US or UK government; no wonder that too-big-to-fail institutions dominate this market.
The one thing nowadays that economists agree upon is that incentives matter. ... Given the lack of understanding of risk by investors, and deficiencies in corporate governance, bankers had an incentive not to design good incentive structures. It is vital to correct such flaws – at the level of the organization and of the individual manager.
That means breaking up too-important-to fail (or too-complex-to-fix) institutions. Where this is not possible, it means stringently restricting what they can do and imposing higher taxes and capital-adequacy requirements, thereby helping level the playing field. ...
Even if we fix bank incentive structures perfectly ... the banks will still represent a big risk. The bigger the bank, and the more risk-taking in which big banks are allowed to engage, the greater the threat to our economies and our societies. ... What is required is a multi-prong approach, including special taxes, increased capital requirements, tighter supervision, and limits on size and risk-taking activities.
Such an approach won't prevent another crisis, but it would make one less likely – and less costly if it did occur.I think limiting connectedness and limiting leverage ratios are both essential elements of reform. There will always be vulnerabilities, even in a system that has only small financial institutions, and we may not be able to identify the vulnerabilities in time. Shocks are going to happen. Limiting connectedness and leverage ratios for both big and small firms (along with regulation on what types of activities they can engage in, which addresses an aspect of connectedness) will reduce the magnitude of the damage to the financial system and the broader economy that those inevitable shocks are able to bring about.
Selected Comments
JohnH said...Interesting that the whole discussion circumvents the issue of banking oligopolies, their ability to distort markets, avoid competition, and corrupt politics and the regulatory system.Lyle said in reply to econproph...Oligopolistic banks and investment houses should be considered too big to live for precisely the same reasons that Standard Oil was too big to exist. Arguing about systemic risk gives insiders something to argue about as a way to avoid talking about the real issue--shared monopoly.
econproph said in reply to JohnH...You are absolutely right. A key passage from Stiglitz was:
"allowing such banks to continue engaging in proprietary trading distorts financial markets. Why should they be allowed to gamble, with taxpayers underwriting their losses? What are the "synergies"? Can they possibly outweigh the costs? Some large banks are now involved in a sufficiently large share of trading ... that they have, in effect, gained the same unfair advantage that any inside trader has."
In other words, these banks that are TBTF are corrupting with insider info & oligopolistic power our bond, stock, & financial markets. The markets are no longer rational in part because they are no longer competitive.
There is no proof of any economies of scale and even less proof that if such economies of scale existed that they in any way accrue benefit to the public and not solely the bank mgts.
Separate the hedge funds(proprietary trading desks) from the utility banks. 2 Utility banks making loans to the hedge funds have to hold 3x the capital on those loans as on others. You can be a customer service organization or a hedge fund you can not do both.don said in reply to JohnH...
In reading The Partnership (a history of Goldman Sacks) it becomes clear that the de-control of commissions is one of the root causes of all of the current troubles. It resulted in the partnerships looking for more money to keep their profits up, once they started looking they brought bright young people in who figured out how to trade trade trade. (See also the history of Lehman and Pete Peterson)Another nice point.Reality Bites said...Confiscatory taxes aren't going to help much, companies already pay nearly all the taxes for their executives, that's because executives control the compensation board and can get whatever they want. John Bogle identified the change from owner's capitalism, where corporations were run for the benefit of the shareholder/owner, to today's manager's capitalism, where corporations are run for the benefit of the management. He identifies several reasons for this shift. Amongst the biggest is the transfer of share ownership into mutual funds and pensions (or IRA/401K trusts) from the direct ownership of the past. Mutual funds have become increasingly short sighted, the average holding period is just a matter of months as evidenced by the average turnover ratio. These funds who are looking to make a quick buck instead of long term investing don't care about how a company is managed over the long term. They do not challenge management proposals and always vote their shares in favor of whatever management proposes. This has caused tremendous damage and allowed management to run corporations for their own benefit. Golden parachutes and ridiculous retirement benefits including lifetime use of corporate jets, and in many cases, a monthly stipend along with a corporate funded residence (think Jack Welch) have become standard abuses. How these giveaways benefit shareholders or the company since the executives have already left the company or are retired is a question that goes unanswered. Yet again and again we see these compensation plans being approved thanks to mutual fund and custodial accounts voting with the management. There has to be reform that makes mutual funds and other custodial services vote on behalf of the shareholder instead of management.Fred C. Dobbs said...Right now, there are perverse incentives for mutual fund companies and 401k/IRA providers to vote with management. If they don't, management might steer other business away from these funds which are often part of a larger corporation. And the 401K services which management decides who the provider will be, is another carrot/stick by which management can get mutual fund support. Vote against a generous compensation package and management will decide to shift the 401K services to another company.
Unfortunately, no one so far in power has even proposed changing the system or reforming it in a meaningful way. The anger Congress displays seems to be entirely for show, where are the meaningful reforms that attack the problem at the root?
There also hasn't been any mention of the objection I raise to compensation in the financial sector. Much of the profits come from risk-taking, that is a firm makes money by taking a particular risk, like the risk of default, or the risk that interest rates will go up, etc. These risks cannot be diversified away, only by unloading the risk itself can the risk by mitigated, but so will profits since they are generated through the willingness to take risk. Why should executives be rewarded for profits generated through risk taking? Only the shareholders, the owners who have capital invested and whose capital is at risk, should reap the rewards of risk taking. Much like a casino, the dealer who accepts bets should not get a bonus should the player lose his bet. If the player bets on red and the ball falls on black, why should the dealer, who did nothing more than accept the bet on behalf of the casino, be compensated for the casino's win? Same for financial executives. If the company makes a billion through accepting risks that paid off, the executives should get nothing because it wasn't their money at risk and it took no skill to generate the profit. Accepting the risk is what produced the profit.
Yet my perspective has not been discussed at all anywhere! Not on blogs, not in newspapers, and certainly not in Congress. I suppose a part of it has been discussed on blogs with the heads I win, tails you lose analysis, but people have not taken it to its logical conclusion. As for other media sources, I'm afraid journalists are just too ignorant to understand what is being discussed, shameful how journalists these days know very little other than how to write. They can analyze Tiger Woods in great detail, going over every move and piecing together different facts, but go beyond celebrity and the analysis is dumb as a piece of rock.
Anne from Chicago said..."It is not at all clear to me that breaking large banks into smaller pieces addresses the connectedness issue. Smaller banks can be just as interconnected as larger banks, and hence simply breaking banks up without examining the effect it has on the underlying financial network connections may not reduce systemic risk."
First of all, the government did not bail out just "banks." They bailed out investment firms (different, in my view, than "banks"), large US automakers and spent massive amounts of money to bailout an insurance company, leaving the process open to accusations that the AIG bailout was a "backdoor" bailout of large investment banks like Goldman Sachs.
Second, what smaller banks were "rescued" in this bailout? Last I checked, CIT, a "smaller" bank with lots of relationships with smaller businesses, was allowed to head off into rough waters without a federal lifeline.
Third, how can a large number of smaller banks require the same kind of massive federal bailout? Not clear on how the small and interconnected banks would create the same massive issues we saw last year. Is there really a sense that all small banks would act as recklessly as the big banks did in the run up to the collapse?
Well, 'too big to fail' is only a way of saying that such failures must be quite catastrophic, lots of collateral damage. Breaking mega-banks up into smaller pieces is only so that, should a smaller piece or 2 fail, catastrophe is averted. Obviously?
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I offer a "compromise".
• The Fed agrees to cease and desist from lending to any capital impaired institution unless specifically authorized by law.
• The Fed agrees to cease and desist from acting in a fiscal role.
• The Fed agrees to never again assume management responsibility for a capital impaired institution unless specifically authorized by Congress
• Treasury assumes all the Fed assets related to AIG and Bear. I believe that there is enough TARP money left.
• The selection process for reserve bank presidents is left unchanged.
• The audit provisions are left unchanged.DownSouth:
Richard Alford,
As much as I admire the analysis you do, I must disagree with the compromise you offer.
The requirement that the only repentance the Fed be made to do is to "cease and desist" in its future dealings rings entirely too much like Obama's exculpation of other war and white-collar criminals.
Whatever happened to concepts like investigating and punishing crimes? What has happened to concepts like trying to recover stolen property, such as the property the Fed and its accomplices stole from the American people when the Fed conspired with them in its illegal fiscal role?
There's something that exists in a functioning society called "strong reciprocity":
By strong reciprocity we mean a propensity, in the context of a shared social task, to cooperate with others similarly disposed, even at personal cost, and a willingness to punish those who violate cooperative norms, even when punishing is personally costly.
http://www.umass.edu/preferen/gintis/SocJusticeRes.pdfI fully understand that the Unites States' descent into the moral and social abyss began a long time ago, with the most pronounced downward swing during the Vietnam War.
But just because it's been like this for a long time doesn't mean there can't be a restoration of morality and civil society in America. Anything short of that and I'm afraid the nation has seen its better days.
The rank and file must demand it, because our "elites," who really aren't elites at all but a bunch of low-life criminals, will never make the needed changes on their own.
sgt_doom:
Alford's article is soooo lame, one doesn't almost know where to begin. First, any Brookings Institution report is generally faulty to begin with - this subject needs no further comment.
Secondly, had the Fed not been criminally derelict in fulfilling its functions under the Federal Reserve Act, namely monitoring banking institutions to be sure the correct capital levels were being maintained, the AIG situation would have become glariling obvious - assuming they weren't aware of it all along.
Thirdly, AIG had truly sterling directors on their board who should have been aware of this situation: Richard Holbrooke - now doing his equally expert work over in Afghanistan (heaven help us with that fool onboard!), and Martin Feldstein, frequently touted as a "respected Harvard economics professor" (pardon me while I barf!!!).
Since Feldstein is also on the board (or was on the BoDillion in criminal penalties for Medicare fraud billing), as well as AIG (largest insurance swindle in human history, writing all those policies with no capital on hand to back them up, as well as various criminal penalties for accounting fraud, that one involving Brightpoint comes immediately to mind) and Eli Lilly (we know about those guys!), as well as his membership in Group of Thirty, the Bretton Woods Committee (most anti-worker, anti-union, anti-American bunch around), perhaps we should lay the bulk of the blame with their board of directors who were missing in action?
Brian:
Any compromise such as Mr. Alford's requires a level of confidence and trust in the Federal Reserve. Today's announcement regarding the retirement of $25 billion in debt between AIG and the Federal Reserve Bank of New York makes a mockery of any illusion of trust or confidence that remained.
The government is canceling $25 billion owed by AIG to the taxpayers of the United States, in exchange for preferred stock in two AIG subsidiaries that we already own (79.9%). Is this $25 billion based on some market value? No. AIG has been trying to sell these subsidiaries for a year now, and has not gotten an offer at any price, let alone $25 billion.
Why is this being done? Well, because it suits the purposes of both parties. The Fed gets to pretend that the loans to AIG were a disaster for the taxpayer, and AIG is very happy to get $25 billion in debt in exchange for preferred stock in a company that the taxpayer already owns. And by the way, if this preferred stock is like the preferred we own and the holding company, no dividend need be paid. Ever. Here's a question for the investing audience - how do you value preferred stock, with no voting rights and no convertible feature, that pays no dividend?
psychohistorian:
This is where I put the tin foil hat on.
Where are the state AG's and the rest of the judicial system? Is the whole legal system corrupt to its base?
I don't want to believe it but the facts are becoming insurmountable. No shred of a civilized society left….pityful.
Doug Terpstra:
Alford writes "How exactly was the Fed supposed to develop contingency plans for a business about which it knew next to nothing, attached to an industry- insurance-about which it knew nothing and was not subject to any oversight by any Federal agency?"
It seems this really excuses willfull blindness. This derivative nonsense, "about which [the Fed] knew nothing" was propagated for many, many years, all of it closely tied to instruments under the Fed's direct regulation with serious implications for leveraged risk. How could they possibly miss that? And if it knew nothing about it, well, duh, why should they be regulating anything?
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The Baseline Scenario
As everyone knows by now, Neil Barofsky, special inspector general for TARP, has a new report out on the decision by the Federal Reserve Bank of New York last Fall to make various AIG counterparties (primarily some very big banks with names you know) whole on the the CDS protection they had bought from AIG to cover their risk on some CDOs. The potentially juicy bit has to do with the Maiden Lane III transaction (New York Fed summary here).
There are a couple of details I can't quite reconcile (for example, the Fed balance sheet shows initial funding of $29.3 billion, but everyone says Maiden Lane III paid $29.6 billion for the CDOs), but essentially it went like this. The banks had bought CDS protection on $62.1 billion of CDOs (some of those CDOs they owned - some they did not, meaning those were "naked" CDS*). As of November, the market value of those CDOs was $29.6 billion. At that point, the banks already held $35.0 billion in cash collateral from AIG to cover the difference. (If you have a derivatives contract with someone under which your counterparty may have to pay you a huge amount of money, you generally negotiate a term under which the counterparty has to give you money as the trade moves against him, to protect you from default. In this case, a lot of the collateral came from the $85 billion credit line the Fed gave to AIG in September - otherwise AIG would have gone bankrupt because of collateral calls.)
In the transaction (I'm working off the New York Fed summary), first AIG contributed $5 billion to Maiden Lane III and the New York Fed gave it a $24.3 billion loan. Then Maiden Lane III gave all $26.8 billion to the banks in exchange for the CDOs. (The banks accepted $26.8 billion because they already held $35.0 billion in collateral; together that makes $61.8 billion - as I said, I can't get $300 million to reconcile.) Then Maiden Lane III gave $2.5 billion right back to AIG (this is the amount by which AIG had overcollateralized). As part of the deal, the banks agreed to tear up the original CDS on the CDOs, so AIG couldn't lose any more on the CDS (which, remember, are separate from the CDOs).
The controversy is not over paying $29.3 (or $29.6) billion for the CDOs, since that was the market price. The controversy is over whether AIG should have agreed to settle the CDS at 100 cents on the dollar (meaning that the banks get the difference between the face value of the CDOs and their current market value). Bloomberg reported a while back that prior to the government bailout, AIG had been trying to negotiate a settlement at 60-70 cents on the dollar, but that that portion of the term sheet was crossed out in the final agreement. The implication is that paying the swaps off in full was a back-door, off-the-books way of funneling cash to banks that we didn't want to fail.
The argument for the NY Fed is that the banks had legal contracts that entitled them to the money. AIG might have been able to negotiate a haircut because it was going bankrupt and counterparties will take less money up front rather than risk getting even less in bankruptcy. However, once the government stepped in, it had no way to abrogate the contracts. The Agonist has a long post with much more detail than I have provided, arguing in conclusion that Federal Reserve Bank presidents are technocrats, and technocrats abide by the advice of their lawyers, which was almost certainly that AIG had to pay off the swaps in full. (He says the mistake was bailing out AIG in the first place back in September.)
Various people have argued, however, that the Fed could have negotiated a better deal. The Epicurean Dealmaker argues that, given the considerable powers of the Federal Reserve and the federal government in general, the banks could have been intimidated into accepting a modest haircut.
Robert Pozen, in his very worth reading book Too Big to Save?, says (p. 79) that AIGFP could have been forced into bankruptcy without putting the rest of AIG into bankruptcy; threatening to put AIGFP into bankruptcy would have provided the leverage to induce the banks to take a haircut. Lucian Bebchuk, a Harvard law professor, argued back in March that because AIG had guaranteed the obligations of AIGFP, this would constitute a default by AIG - but that wouldn't affect AIG's insurance subsidiaries, which could stand alone quite nicely (insurance companies get most of their money from customer premiums, not from debt).
I think that given the state of the world in November 2008, paying the banks off in full was definitely the easy choice - it's always easier to abide by the contract and pay up, especially when you have very deep pockets. And the fact that it helped out the banks as well was probably seen as another argument for it, given the perceived need within the government to bolster the banks' balance sheets by any means necessary.
* Apparently there is some controversy about this. In an interview, Representative Peter DeFazio said the following:
"Geithner would not answer my question when I said, 'Were those naked credit default swaps by Goldman or were they a counter party?' He said, 'I will not answer that question.'"
From the New York Fed web site:
"AIGFP, the LLC and the New York Fed have entered into agreements with AIGFP's credit derivative counterparties to terminate approximately $53.5 billion notional amount of credit derivatives and purchase the related multi-sector CDOs. Of these, CDOs with a principal amount of approximately $46.1 billion settled on November 25, 2008. Settlement on the remaining $7.4 billion is contingent upon the ability of the related counterparty to obtain the related multi-sector CDOs and thereby settle with the LLC and terminate the related credit derivative contracts with AIGFP" (emphasis added).
By James Kwak
25 Responses
Bond GirlA better deal was not negotiated because even the, um, French can push around our current Treasury Secretary.
Strong reforms are coming. Really.
markets.aurelius
That was truly hilarious - the French govt negotiating with the NY Fed on behalf of the French banks, who asserted they could not and would not settle for less than 100 cents on the dollar. And Geithner caved! Mon dieu! Would that such resolve was shown by the French in the 1940s …
anne
And what was Obama's response? Reward that skinny man who forgot to pay his taxes and caved to the French with a promotion to Treasury Secretary. Because he's got the goods that will lead us out of crisis back into growth.
NOT!
tippygolden
James,
You write: "The implication is that paying the swaps off in full was a back-door, off-the-books way of funneling cash to banks that we didn't want to fail."
This is not just an implication. It was clearly stated by Edward Liddy, the head of AIG, in March: "He said A.I.G. was acting as a sort of conduit to funnel money from the government to dozens of financial institutions around the world."
http://dealbook.blogs.nytimes.com/2009/03/02/aig-chief-calls-new-aid-a-backup/?ref=business
There should be no controversy about this point.
From the very beginning, the AIG bailout was a way of bailing out banks to the tune of tens of billions of dollars without any accountability or oversight or demand in return. Free money from taxpayer to banks.
There isn't much point in recounting the story here, I think. Most readers of your blog probably agree about the contempt Wall Street banks have for the rest of us, even as they cash their bonus checks made possible by our largesse. P.T. Barnum had a word for what we are.
The Key:
The point you miss Mr. Kwak is that the legal advice Timmy was getting was mostly coming from Wachtell, Lipton and Sullivan & Cromwell. Both Ed Herlihy and Rodgin Cohen, respectively, had vested interests in protecting their clients – the financial institutions at risk – and were in no mood to offer creative solutions to an overwhelmed and overmatched NY Fed president. Bail out the big guys or else. It was the same tactics used by Paulson and Bernanke with Congress. You didn't have any other voices in the room arguing that maybe there is another way out here.
Don't let the lawyers off the hook. They are the secret sauce that allowed the stew to simmer to perfection. We are starting to see that in the Merrill/BofA investigations. Use the lawyers as cover for a larger conspiracy to save Wall St.'s ass at the expense of the rest of the nation.
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From Tim Duy: The Fed in a Corner
There is much more in the piece....But what about the years before Lehman, when the crisis was building? Where was the Fed then? Did they abdicate regulatory responsibility? How did banks develop such incredible exposure to off-balance sheet SIV's? How could the Fed ignore increasingly predatory lending in the mortgage market? What exactly was Timothy Geithner, then president of the all important New York Fed, regulating and supervising? Clearly not Citibank.
... ... ....
I don't think the Fed can regain the trust of the public while at the same time protecting the secrecy of their actions to save Wall Street (moreover, it is not clear that such secrecy is now needed in any event). The relationship between policymakers and financiers is now seen as far too cozy from the perspective of the public. I think the Fed needs to make clear that they work for the people, not for Wall Street. A strong statement by Federal Reserve Chairman Ben Bernanke that a firm that is too big too fail is simply too big - that we should no longer tolerate the expansion of financial firms to the point that they pose systemic risk - would be a good start.Simply put, Bernanke's choice set is dwindling - either risk losing independence, or step up to the regulatory and policy plate like you intend to hit one out of the park. If Wall Street is no longer working for Main Street, it is time to side with Main Street.
Clearly the Fed (and other regulators) failed to properly supervise financial firms. We need to understand how and why this happened. (See The Failure of Regulatory Oversight)
Nanoo-Nanoo :
I read that earlier and found it compelling. I know that Ron Paul's "Audit the Fed" got passed in the House. I seriously doubt it will pass the Senate but as everyone now knows, I'm the ultimate pessimist or maybe realist? The Fed has still not honored the Bloomberg lawsuit to name names in who got support claiming it would pose "systemic risk". There are also some articles about a new PR nightmare beyond the TBTF that now includes the federal reserve, treasury, the quality of data they produce in economic reporting and just whose interests they are serving.
I also found this an interesting read this morning and wonder if anyone wishes to comment further. I think it was Volker the Viking who stated this wasn't a recession as recessions, relatively speaking, are short lived. Semantics are silly in this crisis as there are lots of pigs with lipstick on them.
Generally speaking, (I'm no economist) I think central banks have run out of bullets. Monetary policy changes are basically exhausted, quantitative easing can go on just how long before the rubber band snaps back?
Effective Demand:
We need to understand how and why this happened.
How: Greenspan
Why: He believed in the free marketsThe one problem with the one "Super regulator" model being bandied about what happens when the guy in charge of that agency doesn't believe in regulation? Then we get what we just had again. All the financial companies will be pushing to get the least restrictive person installed as the head of that agency.
Anne from Chicago:
John Huss said in reply to Anne from Chicago..."The purpose of Wall Street is supposed to be to channel investment funds into Main Street."
If there is anything the crisis has proved without a doubt is that Wall Street's purpose is to channel funds into their own bonus package.
We see that in GS's recent response to the shareholders who want a piece of the bonus pie - the PR spin from GS was that the shareholders are too stupid to realize that if GS employees weren't paid billions in bonuses, the company wouldn't be able to deliver whatever it is it delivers to customers and shareholders.
Blankfein and his colleagues seem incapable of understanding that the nation is in a terrible economic crisis right now and their bonuses, piled up to the stratosphere thanks to the actions of the fed and treasury, are an unseemly contrast to the wreckage spread out across the country. Wreckage resulting from a crash engineered in large part thanks to "innovation" at banks.
Their focus is on themselves. Main Street is flesh to be devoured. The Fed has been letting it happen for years. No wonder there's a crisis of "confidence."
bakho:I'm not sure that Wall St fails to understand that the nation is in a terrible economic crisis.
I suspect that Wall St doesn't especially care, as long as the masters of the universe can continue to line their pockets.
Lay the blame at the feet of the banksters. These elites don't care at all about the millions of unemployed Americans. The elite banksters refused any sacrifice at all from their own pockets. They are letting their CEOs eat cake while millions go without a paycheck.
This is not fair. This is overreach by the banksters. If they really want to head it off, their needs to be some economic sacrifice by the bankster CEOs and their profits need to be taxed to pay back the revenues. HAIRCUT!!!
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By George Washington of Washington's Blog.
Ron Paul tells Bloomberg that Congressman Watt has just more or less killed the bill to audit the fed:
Representative Ron Paul, the Texas Republican who has called for an end to the Federal Reserve, said legislation he introduced to audit monetary policy has been "gutted" while moving toward a possible vote in the Democratic-controlled House.
The bill, with 308 co-sponsors, has been stripped of provisions that would remove Fed exemptions from audits of transactions with foreign central banks, monetary policy deliberations, transactions made under the direction of the Federal Open Market Committee and communications between the Board, the reserve banks and staff, Paul said today.
"There's nothing left, it's been gutted," he said in a telephone interview. "This is not a partisan issue. People all over the country want to know what the Fed is up to, and this legislation was supposed to help them do that."..
Paul, a member of the House Financial Services Committee, said Mel Watt, a Democrat from North Carolina, has eliminated "just about everything" while preparing the legislation for formal consideration. Watt is chairman of the panel's domestic monetary policy and technology subcommittee.
Congress is also suggesting that the Fed be given more powers, making it the chief risk regulator of the entire banking system.
Specifically, as summarized by Huffington Post, a new bill introduced by Democrats in Congress "gives the Federal Reserve the power to determine which firms are actually 'too big to fail' and pose systemic risk to the financial system."
Given the Fed's history (as discussed below), that is like appointing the head of the Medellin drug cartel as drug tzar.
Admittedly, the Congressional bill allows other agencies a seat at the risk regulator table. But those are likely token seats. If the drug tzar's office was staffed by the head of the Medellin drug cartel – who had the majority vote – and some law enforcement officers who have a history of either (a) being on the take or (b) looking the other way, what do you think would the result would be?
High-Level Fed Officials Speak Out
High-level officials of the Fed itself have criticized the Fed's actions. For example, the head of the Federal Reserve bank of San Francisco – during a talk on how runaway bubbles can lead to depressions – admitted:
Fed monetary policy may also have contributed to the U.S. credit boom and the associated house price bubble …
Fed Vice Chairman Donald Kohn conceded that the government's actions "will reduce [companies'] incentive to be careful in the future." In other words, he's admitting that the government's actions will encourage financial companies to make even riskier gambles in the future.
Kansas City Fed President and veteran Fed official Thomas Hoenig said:
Too big has failed….
The sequence of [the government's] actions, unfortunately, has added to market uncertainty. Investors are understandably watching to see which institutions will receive public money and survive as wards of the state…
Any financial crisis leaves a stream of losses among the various participants, and these losses must ultimately be borne by someone. To start the resolution process, management responsible for the problems must be replaced and the losses identified and taken. Until these actions are taken, there is little chance to restore market confidence and get credit markets flowing. It is not a question of avoiding these losses, but one of how soon we will take them and get on to the process of recovery….
Many of the [government's current policy revolves around the idea of] "too big to fail" …. History, however, may show us a different experience. When examining previous financial crises, both in other countries as well as the United States, large institutions have been allowed to fail. Banking authorities have been successful in placing new and more responsible managers and directions in charge and then reprivatizing them. There is also evidence suggesting that countries that have tried to avoid taking such steps have been much slower to recover, and the ultimate cost to taxpayers has been larger…
The current head of the Philadelphia fed bank, Charles Plosser, disagrees with Bernanke's strategy of the endless printing-press and ever-increasing fed balance sheet:
Plosser urged the Fed to "proceed with caution" with the new policy. Others outside the Fed are much more strident and want plans in place immediately to reverse it. They believe an inflation storm is already in train.***Bernanke argued that focusing on the size of the balance sheet misses the point, arguing the Fed's various asset purchase programs are not easily summarized in a single number.
But Plosser said that the growth of the Fed's balance sheet was a key metric."It is not appropriate to ignore quantitative metrics in this new policy environment," Plosser said.***
Plosser is bringing the spotlight right back to the Fed's balance sheet."The size of the balance sheet does offer a possible nominal anchor for monitoring the volume of our liquidity provisions," Plosser said.
The former head of the Fed's Open Market Operations says the bailout might make things worse. Specifically, the former head of the Fed's open market operation – the key Fed agency which has been loaning hundreds of billions of dollars to Wall Street companies and banks – was quoted in Bloomberg as saying:
"Every time you tinker with this delicate system even small changes can create big ripples," said Dino Kos, former head of the New York Fed's open-market operations . . . "This is the impossible situation they are in. The risks are that the government's $700 billion purchase of assets disturbs markets even more."
And William Poole, who recently left his post as president of the St. Louis Fed, is essentially calling Bernanke a communist:
Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said.
The current situation at the Fed seems eerily similar, he said."What is discipline – where are the hard choices – when does Fed say our resources are exhausted?" Poole asked.
But the strongest criticism may be from the former Vice President of Dallas Federal Reserve, who said that the failure of the government to provide more information about the bailout could signal corruption. As ABC writes:
Gerald O'Driscoll, a former vice president at the Federal Reserve Bank of Dallas and a senior fellow at the Cato Institute, a libertarian think tank, said he worried that the failure of the government to provide more information about its rescue spending could signal corruption.
"Nontransparency in government programs is always associated with corruption in other countries, so I don't see why it wouldn't be here," he said.
Of course, former Fed chairman Paul Volcker has also strongly criticized current Fed policies.
Global Agencies Speak Out
BIS – the central banks' central bank – slammed the Fed and other central banks for blowing bubbles and then "using gimmicks and palliatives" which "will only make things worse".
The head of the World Bank also says:
Central banks [including the Fed] failed to address risks building in the new economy. They seemingly mastered product price inflation in the 1980s, but most decided that asset price bubbles were difficult to identify and to restrain with monetary policy. They argued that damage to the 'real economy' of jobs, production, savings, and consumption could be contained once bubbles burst, through aggressive easing of interest rates. They turned out to be wrong.
Economists Speak Out
Stephen Roach (former chief economist for Morgan Stanley, and now director of Morgan Stanley Asia) is one of the most influential and respected American economists.
Roach told Charlie Rose this week that we have had terrible Federal Reserve policy for the past 12 years under Greenspan and Bernanke, that they concocted hair-brained theories (for example, that we should let the boom and bust cycle occur, but then "clean up the mess" once things fall apart), and that we really need to reform the Fed.
Specifically, here's the must-read portion of the interview:
STEPHEN ROACH: And what's missing in the debate that drives me nuts is going back to the very function of central banking that's at the core of our financial system. Do we have the right model for the Fed to go forward? And, you know, I think we've minimized the role that the custodians, the stewards of our financial
system, the Federal Reserve, played in leading to this crisis and in making sure that we will never have this again. I think we've had horrible central banking in the United States for the past dozen of years. I mean, we elevate our central bankers, we probably .CHARLIE ROSE: From Greenspan to Bernanke.
STEPHEN ROACH: Yeah.
CHARLIE ROSE: Both.
STEPHEN ROACH: We call them maestro, and, you know, we make them
sound larger than life. And, you know, and the fact is, they condoned
policies that took us from one bubble to another. They failed to live up
to their regulatory responsibility granted them by law. They concocted new
theories to explain why these things could go on forever, and they harbored
the belief, mistakenly in my view, that monetary policy is too big and
blunt an instrument, and so you just bring it in to clean up the mess
afterwards rather than prevent a mess ahead of time. Well, look at the
mess we're in right now. We need a different approach here. We really do.Leading economist Anna Schwartz, co-author of the leading book on the Great Depression with Milton Friedman, told the Wall Street journal that the Fed's entire strategy in dealing with the financial crisis is wrong. Specifically, the Fed is treating it as a liquidity problem, when it is really an insolvency crisis.
Moreover, prominent Wall Street economist Henry Kaufman says that the Federal Reserve is primarily to blame for the financial crisis:
"I am convinced that the misbehavior of some would have been much rarer - and far less damaging to our economy - if the Federal Reserve and, to a lesser extent, other supervisory authorities, had measured up to their responsibilities …
Kaufman directly criticized former Federal Reserve Chairman Alan Greenspan for not using his position to dissuade big banks and others from taking big risks.
"Alan Greenspan spoke about irrational exuberance only as a theoretical concept, not as a warning to the market to curb excessive behavior," Kaufman said. "It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective."
Partly because the Fed did not strongly oppose the repeal in 1999 of the Depression-era Glass-Steagall Act, more large financial conglomerates that were "too big to fail" have formed, Kaufman said, citing a factor that has made the global credit crisis especially acute.
"Financial conglomerates have become more and more opaque, especially about their massive off-balance-sheet activities," he said. "The Fed failed to rein in the problem."…
"Much of the recent extreme financial behavior is rooted in faulty monetary policies," he said. "Poor policies encourage excessive risk taking."
Economist Marc Faber says that central bankers are money printers who create bubbles, and that the system would be much better now if the Fed hadn't intervened. Specifically, Faber says that – if the Fed hadn't intervened – the system would be cleaned out, the system would be healthier because debt load and burden on taxpayers would be reduced.
Economist Jane D'Arista has shown that the Fed has failed miserably at its main task: providing a "counter-cyclical" influence (that is, taking the punch bowl away before the party gets too wild).
The Fed has also failed miserably in its role as regulator of banks and their affiliates. As well-known economist James Galbraith says:
The Federal Reserve has never been an effective regulator for the straightforward reason that it is dominated by economists and bankers and not by dedicated skeptics who make bank regulation a full-time profession.
The Fed has performed terribly in many other tasks as well.
And the Fed is unlawfully refusing to disclose to Congress or the American people who it's giving money to and what it is really doing.
Conclusion
Given the above, isn't it obvious that Congress is attempting to give the Fed more powers at a time when it should be audited, and then ended?
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Tim Geithner should be given the option to resign immediately, or be fired. He is either incompetent, too conflicted to do his job with the banks properly, or possibly both.
Stephen Friedman should be investigated for $5.4 million in profits made through potential insider trading. His breach of fiduciary responsibility as chairman of the NY Fed is shocking.
The entire integrity of the Federal Reserve bank should be called into question. There is no place for the Fed to be the primary regulator of the financial system given their perchance for secrecy and cronyism, and their inability to manage their own shop from such scandalous conflicts of interest. They are a private company owned by the banks. The proposal to give them that level of public policy discretion and authority is patently absurd. This trend to outsourcing of responsibility so the politicians can critique the results as outsider observers must stop.
Obama's administration of the financial system, cloaked in secrecy, potential conflicts of interest, and enormous payoffs to campaign contributors demands a Congressional investigation, except those that would be doing the investigating are most likely also involved in the scandal, on both sides of the aisle. Big Finance did not buy the US government overnight.
An appointment of an independent prosecutor to investigate the Treasury and Fed bailouts is the decent thing for the Justice Department to do in any presidential administration, much less a reform government that had promised transparency and an end to lobbyists running the political process. And some of the lobbyists may actually be on the payroll in key government positions. But since there is no tawdry sexual misconduct involved the Americans may not have a sufficient level of interest to demand it.
From what we can see, Obama appears to be heavily influenced by a cartel of special interests including Big Healthcare and Big Finance, that are heavy campaign contributors of money and people for his administration.
Will we see a new phrase, crisis profiteering, enter the American lexicon? Because it is not too great a leap to say that the relief funds that should be flowing to the American public, from their own debts and taxes, are being waylaid by a small group of financiers and diverted to their own personal bonuses, stocks options, dividends, and profits, and the campaign contributions and lobbyist proceeds being taken by the politicians overseeing the distributions.
Shame. Shame and scandal. And it may yet end in disgrace.
New York Fed's Secret Choice to Pay for Swaps Hits Taxpayers
By Richard Teitelbaum and Hugh SonOct. 27 (Bloomberg) -- In the months leading up to the September 2008 collapse of giant insurer American International Group Inc., Elias Habayeb and his colleagues worked nights and weekends negotiating with banks that had bought $62 billion of credit-default swaps from AIG, according to a person who has worked with Habayeb.
Habayeb, 37, was chief financial officer for the AIG division that oversaw AIG Financial Products, the unit that had sold the swaps to the banks. One of his goals was to persuade the banks to accept discounts of as much as 40 cents on the dollar, according to people familiar with the matter.
Among AIG's bank counterparties were New York-based Goldman Sachs Group Inc. and Merrill Lynch & Co., Paris-based Societe Generale SA and Frankfurt-based Deutsche Bank AG.
By Sept. 16, 2008, AIG, once the world's largest insurer, was running out of cash, and the U.S. government stepped in with a rescue plan. The Federal Reserve Bank of New York, the regional Fed office with special responsibility for Wall Street, opened an $85 billion credit line for New York-based AIG. That bought it 77.9 percent of AIG and effective control of the insurer.
The government's commitment to AIG through credit facilities and investments would eventually add up to $182.3 billion.
Beginning late in the week of Nov. 3, the New York Fed, led by President Timothy Geithner, took over negotiations with the banks from AIG, together with the Treasury Department and Chairman Ben S. Bernanke's Federal Reserve. Geithner's team circulated a draft term sheet outlining how the New York Fed wanted to deal with the swaps -- insurance-like contracts that backed soured collateralized-debt obligations.
Subprime Mortgages
CDOs are bundles of debt including subprime mortgages and corporate loans sold to investors by banks.
Part of a sentence in the document was crossed out. It contained a blank space that was intended to show the amount of the haircut the banks would take, according to people who saw the term sheet. After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public.
The New York Fed's decision to pay the banks in full cost AIG -- and thus American taxpayers -- at least $13 billion. That's 40 percent of the $32.5 billion AIG paid to retire the swaps. Under the agreement, the government and its taxpayers became owners of the dubious CDOs, whose face value was $62 billion and for which AIG paid the market price of $29.6 billion. The CDOs were shunted into a Fed-run entity called Maiden Lane III.
Habayeb, who left AIG in May, did not return phone calls and an e-mail.
Goldman Sachs
The deal contributed to the more than $14 billion that over 18 months was handed to Goldman Sachs, whose former chairman, Stephen Friedman, was chairman of the board of directors of the New York Fed when the decision was made. Friedman, 71, resigned in May, days after it was disclosed by the Wall Street Journal that he had bought more than 50,000 shares of Goldman Sachs stock following the takeover of AIG. He declined to comment for this article.
In his resignation letter, Friedman said his continued role as chairman had been mischaracterized as improper. Goldman Sachs spokesman Michael DuVally declined to comment.
AIG paid Societe General $16.5 billion, Deutsche Bank $8.5 billion and Merrill Lynch $6.2 billion.
New York Fed
The New York Fed, one of the 12 regional Reserve Banks that are part of the Federal Reserve System, is unique in that it implements monetary policy through the buying and selling of Treasury securities in the secondary market. It also supervises financial institutions in the New York region.
The New York Fed board, which normally consists of nine directors, in November 2008 included Jamie Dimon, chief executive officer of JPMorgan Chase & Co., and Friedman. The directors have no direct role in bank supervision. They're responsible for advising on regional economic conditions and electing the bank president.
Janet Tavakoli, founder of Chicago-based Tavakoli Structured Finance Inc., a financial consulting firm, says the government squandered billions in the AIG deal.
"There's no way they should have paid at par," she says. "AIG was basically bankrupt."
Citigroup Inc. agreed last year to accept about 60 cents on the dollar from New York-based bond insurer Ambac Financial Group Inc. to retire protection on a $1.4 billion CDO.
Unwinding Derivatives
In March 2009, congressional hearings and public demonstrations targeted AIG after it was disclosed it had paid $165 million in bonuses that month to the employees of AIGFP, which is unwinding billions of dollars in derivatives under the supervision of Gerry Pasciucco, a former Morgan Stanley managing director who joined AIG after the CDS payments were mandated.
Far more money was wasted in paying the banks for their swaps, says Donn Vickrey of financial research firm Gradient Analytics Inc. "In cases like this, the outcome is always along the lines of 50, 60 or 70 cents on the dollar," Vickrey says.
A spokeswoman for Geithner, now secretary of the Treasury Department, declined to comment. Jack Gutt, a spokesman for the New York Fed, also had no comment.
One reason par was paid was because some counterparties insisted on being paid in full and the New York Fed did not want to negotiate separate deals, says a person close to the transaction. "Some of those banks needed 100 cents on the dollar or they risked failure," Vickrey says.
A Range of Options
People familiar with the transaction say the New York Fed considered a range of options, including guaranteeing the banks' CDOs. They say that by buying the securities, AIG got the best deal it could.
According to a quarterly New York Fed report on its holdings, the $29.6 billion in securities held by Maiden Lane III had declined in value by about $7 billion as of June 30.
Edward Grebeck, CEO of Stamford, Connecticut-based debt consulting firm Tempus Advisors, says the most serious breach by the government was to keep the process of approving the bank payments secret.
"It's inexcusable," says Grebeck, who teaches a course on CDSs at New York University. "Everybody should be privy to the negotiations that went on. We can't have bailouts like this happening behind closed doors."
Secret Deliberations
The deliberations of the New York Fed are not made public. In this case, even the identities of the AIG counterparties weren't disclosed until March 2009, when U.S. Senator Christopher Dodd, head of the Senate Finance Committee, demanded they be made public.
Bloomberg News has filed a Freedom of Information Act request seeking copies of the term sheets related to AIG's counterparty payments, along with e-mails and the logs of phone calls and meetings among Geithner, Friedman and other New York Fed and AIG officials. The request is pending.
The Federal Reserve has been reluctant to publish information on its efforts to stabilize the financial system since the crisis began. The Fed has loaned more than $2 trillion, yet it refuses to name the recipients of the loans, or cite the amount they borrowed, saying that doing so may set off a run by depositors and unsettle shareholders.
Bloomberg LP, the parent of Bloomberg News, sued in November 2008 under the Freedom of Information Act for disclosure of details about 11 Fed lending programs. In August, Manhattan Chief U.S. District Judge Loretta Preska ruled in Bloomberg's favor, saying the central bank had to provide details of the loans.
The Fed has appealed to the Second Circuit Court of Appeals, and the data remain secret while the appeal proceeds.
'Cataclysmic Financial Crisis'
Information on the borrowers is "central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression," attorneys for Bloomberg said in the Nov. 7 suit.
Questions about the New York Fed transactions may be answered by Neil Barofsky, inspector general for the Troubled Asset Relief Program, or TARP. He is working on a report, which may be released next month, on whether AIG overpaid the banks. TARP is the vehicle through which the Treasury invested more than $200 billion in some 600 U.S. financial institutions.
William Poole, a former president of the Federal Reserve Bank of St. Louis, defends the New York Fed's action. The financial system had suffered through months of crisis at the time, he says. The investment bank Bear Stearns Cos. had been swallowed by JPMorgan; mortgage packagers Fannie Mae and Freddie Mac had been taken over by the government; and the day before AIG was rescued, Lehman Brothers Holdings Inc. had filed for bankruptcy.
'Enough Trouble'
"I think the Federal Reserve was trying to stop the spread of fear in the market," Poole says. "The market was having enough trouble dealing with Lehman. If you add, on top of that, AIG paying off some fraction of its liabilities, a system which is already substantially frozen would freeze rock-solid."
Still, officials at AIG object to the secrecy that surrounded the transactions. One top AIG executive who asked not to be identified says he was pressured by New York Fed officials not to file documents with the U.S. Securities and Exchange Commission that would divulge details.
"They'd tell us that they don't think that this or that should be disclosed," the executive says. "They'd say, 'Don't you think your counterparties will be concerned?' It was much more about protecting the Fed."
'An Outrage'Friedman's role remains controversial. In December 2008, weeks after the payments to the banks were authorized in November, Friedman bought 37,300 shares of Goldman stock at $80.78 a share, according to SEC filings. On Jan. 22, he bought 15,300 more at $66.61.
Both purchases took place before the payments to Goldman Sachs were publicly disclosed under pressure from Senator Dodd in March. On Oct. 26, Goldman Sachs stock closed at $179.37 a share, meaning Friedman had paper profits of $5.4 million.
Jerry Jordan, former president of the Federal Reserve Bank of Cleveland, says Friedman should have resigned from the New York Fed as soon as it became clear that Goldman stood to benefit from its actions.
"It's an outrage," Jordan says. "He needed to either resign from the Fed board or from Goldman and proceed to sell his stock."
98,600 Goldman Shares
Friedman remains a member of Goldman's board and held a total of 98,600 shares of the firm's stock as of Jan. 22.
Vickrey says that one reason the New York Fed should have insisted on discounted payments for AIG's CDSs is that the banks likely had hedges against their insured CDOs or had already written down their value. On March 20, Goldman Sachs CFO David Viniar said in a conference call with investors that Goldman was protected.
"We limited our overall credit exposure to AIG through a combination of collateral and market hedges," Viniar said. "There would have been no credit losses if AIG had failed."
In any event, former St. Louis Fed President Poole says the entire process should have been public and transparent. "There should be a high bar against not disclosing," Poole says. "The taxpayer has every right to understand in detail what happened."
[Hat tip to Janet Tavakoli et al. for sending this news piece to us. We have been following it for some time. The Friedman scandal was a particular red flag.]
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Federal Reserve policy makers like to explain the world in terms of feedback loops, except those of their own making.Fed Uncertainty PrincipleLast year, a negative feedback loop threatened to deepen the financial crisis as a weak economy and a teetering banking system led to layoffs and production cutbacks, which led to even bigger declines in output and employment.
Last month, officials heralded the onset of a "positive feedback loop," wherein better financial conditions and stronger growth in employment and output lead to a stronger stock market and improved financial conditions, according to minutes from the Fed's Sept. 22-23 meeting.
At some point, of course, the loop gets broken. Otherwise, the economy would head in one direction, up or down, forever.
Where is the discussion of the Fed's inflation expectations feedback loop, which yields no feedback and less information?
Expectations Loop-de-Loop
If I have this right, we're waiting for the Fed to do or say something to help us decide whether we should hoard cash (because we expect the dollar to buy more tomorrow if prices are falling) or buy and hoard hard goods (if we expect inflation to diminish the dollar's purchasing power).
The Fed, in turn, is waiting for us to do something so it can decide what to do: either raise the volume on its anti- inflation rhetoric with talk of exit strategies and price stability; or talk softly to allay fears of premature rate increases to keep market rates from rising.
If I read the minutes and other Fed communications correctly, policy makers are relying on us to tell them what to do, we're relying on them for direction, and we're locked in this no-way-out feedback loop that provides no useful information for either party.
To say that you and I have the ability to create inflation on our own flies in the face of monetary theory. If we did have a set of keys to the printing press, the Fed would have more than just inflation expectations to funnel through its feedback loop.
Caroline asks: "Where is the discussion of the Fed's inflation expectations feedback loop, which yields no feedback and less information?"
The answer is right here, in the Fed Uncertainty Principle, written April 3, 2008.
Most think the Fed follows market expectations. Count me in that group as well. However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn't the market to blame if the Fed is simply following market expectations?Where The Hell Is The Outrage?This is a very interesting theoretical question. While it's true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.
For example: If market participants are expecting the Fed to cut on weakness and the Fed does, market participants gets into a psychology of expecting more cuts on more weakness. Here is another example: If market participants expect the Fed to cut rates when economic stress occurs, they will takes positions based on those expectations. These expectation cycles can be self reinforcing.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
To measure the position and velocity of any particle, you would first shine a light on it, then detect the reflection. On a macroscopic scale, the effect of photons on an object is insignificant. Unfortunately, on subatomic scales, the photons that hit the subatomic particle will cause it to move significantly, so although the position has been measured accurately, the velocity of the particle will have been altered. By learning the position, you have rendered any information you previously had on the velocity useless. In other words, the observer affects the observed.
The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.
What happened in 2002-2004 was an observer/participant feedback loop that continued even after the recession had ended. The Fed held rates rates too low too long. This spawned the biggest housing bubble in history. The Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the worst possible moment.
Would the market on its own accord be setting rates at the current Fed Funds Rate of 2.25? It's possible, but there is no way to tell.
It's even possible the Fed is behind the curve by not acting fast enough. This is of course all guesswork. I don't know, you don't know, and the Fed does not know what to do. This is part of the "Fed Uncertainty Principle" and a key reason why the Fed should be abolished. After all, how can you give such power to a group of fools that have clearly proven they have no idea what they are doing?
The Fed has so distorted the economic picture by its very existence that it is fatally flawed logic to suggest the Fed is simply following the market therefore the market is to blame. There would not be a Fed in a free market, and by implication there would be no observer/participant feedback loop.
Fed Uncertainty Principle:
The fed, by its very existence, has completely distorted the market via self reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed's actions. There would not be a Fed in a free market, and by implication there would not be observer/participant feedback loops either.Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three:
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
I added a few more points to Where The Hell Is The Outrage? to take care of the above issues. Here they are:
I am outraged at a Fed that purports to be "inflation fighters" when the only source of inflation in the word are central bankers, and their fractional reserve lending policies.
I am outraged that Greenspan and Bernanke could not see a housing bubble that 1000 bloggers could see.
I am outraged at the selective memory of Bernanke when speaking to Congress about these problems.
I am outraged that Bernanke's one sided response to asset bubbles, letting them grow without end, then bailing out the financial institutions that cause them.
I am outraged the Fed exists at all. It is a useless organization that cannot see bubbles, that panders to banks, that supports inflationary policies that are tantamount to theft by fraud.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People's Daily; CNBC). US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up. Read the rest of this entry "
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October 3, 2009 | The Baseline Scenario
At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman's shareholdings.
Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People's Daily; CNBC). US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up.
Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion? If this is temporary, is it envisaged that Goldman will cease being a bank holding company, or that it will divest itself shortly of activities not usually allowed (and with good reason) by banks? Or will all bank holding companies be allowed to expand on the same basis. (The relevant rules appear to be here in general and here specifically; do tell me what I am missing.)
Increasingly, the issue of "too big to regulate" in the public interest is being brought up – an issue that has historically attracted the interest of the Department of Justice's Antitrust Division in sectors other than finance. Should Goldman Sachs now be placed in this category?
Given that the Fed has slipped up so many times and in so many ways with regard to regulation over the past decade, and given the current debate on Capitol Hill, now might be a good time to get ahead of this issue.
In addition, there is the obvious carry trade (borrow cheaply; lend at higher rates) developing from cheap Fed dollar funding to the growing speculative frenzy in emerging markets, particularly China. Are we heading for another speculative bubble that will end up damaging US bank balance sheets and all American taxpayers?
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By George Washington of Washington's Blog.
How well has the Federal Reserve performed for America? Mainstream pundits, of course, say that Bernanke has saved the world . . . . but they said the same thing about Greenspan. So let's look at the actual historical record to determine how well the Fed has done.
Initially, Milton Friedman and Ben Bernanke have both said that the Federal Reserve caused (or at least failed to cure) the Great Depression through its poor monetary policy.
Many also blame the Fed for blowing an unsustainable bubble between 2001-2007 through artificially low interest rates. If this sounds too much like an Austrian economics perspective, that may be true. But remember that Hayek won the Nobel prize in 1974 partly for arguing that artificially low interest rates lead to the misallocation of capital and to bubbles, which in turn lead to busts.
Moreover, one of the Fed's main justification has been that it can provide a "counter-cyclical" balance. In other words, during boom times it can put on the brakes ("take the punch bowl away right as the party gets started"), and during busts it can get things moving again. But as economist Jane D'Arista has shown, the Fed has failed miserably at that task:
Jane D'Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit [has a] devastating critique of the central bank. The Federal Reserve, she explains, has failed in its most essential function: to serve as the balance wheel that keeps economic cycles from going too far. It is supposed to be a moderating force in American capitalism on the upside and on the downside, the role popularly described as "leaning against the wind." By applying its leverage on the available supply of credit, the Fed can slow down a boom that is dangerously overwrought or, likewise, stimulate the economy if it is sinking into recession. The Fed's job, a former chairman once joked, is "to take away the punch bowl just when the party gets going." Economists know this function as "counter-cyclical policy."
The Fed not only lost control, D'Arista asserts, but its policy actions have unintentionally become "pro-cyclical"–encouraging financial excesses instead of countering the extremes. "The pattern that has developed over the last two decades," she wrote in 2008, "suggests that relying on changes in interest rates as the primary tool of monetary policy can set off pro-cyclical foreign capital flows that tend to reverse the intended result of the action taken. As a result, monetary policy can no longer reliably perform its counter-cyclical function–its raison d'être–and its attempts to do so may exacerbate instability."…
The Fed is also supposed to act as a regulator for banks and their affiliates, but failed miserably in that role as well.
Indeed, the central bankers' central banker – BIS – has itself slammed the Fed:
In a pointed attack on the US Federal Reserve, [BIS and its chief economist William White] said central banks would not find it easy to "clean up" once property bubbles have burst…
Nor does it exonerate the watchdogs. "How could such a huge shadow banking system emerge without provoking clear statements of official concern?"
"The fundamental cause of today's emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low," [White] said.
The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning…
"Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.
"To deny this through the use of gimmicks and palliatives will only make things worse in the end," he said.
As PhD economist Steve Keen has pointed out, the Fed (along with Treasury) has also given money to the wrong people to kick-start the economy.
Remember also that Greenspan acted as one of the main supporters of derivatives (including credit default swaps) between the late 1990's and the present (and see this).
Greenspan was also one of the main cheerleaders for subprime loans (and see this).
The above list is only partial. And it ignores:
(1) allegations that the Fed has manipulated the markets; and
(2) claims that the Federal Reserve System saddles the U.S. government and American people with trillions of dollars in unnecessary debt (that would not be incurred if the government took back the "power to coin money" granted to the government itself in the Constitution).
Even so, it shows that the Federal Reserve has performed very poorly indeed.
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September 15, 2009 | naked capitalism
By Richard Alford, a former economist at the New York Fed. Since them, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
Evaluating the recent performance of the Fed is not a straight forward exercise. The turmoil in the financial system, the recession, the law-bending actions of the Fed in support of certain financial institutions, the decision by the Fed to become involved in the allocation of credit, as well as becoming embroiled in partisan political issues confirm the obvious: there is much more to central banking than setting the cost of overnight money. Any accurate assessment of Fed policy and how we got where we are today will certainly be more involved and less clear cut than the standard assessment based on comparing the actual course of the Fed Funds rate to that deemed appropriate by the chosen variant of the Taylor Rule.
However, the costs of the current recession must receive a significant weight. The ultimate goal of Fed policy has been and remains sustained trend growth with full employment, or equivalently minimizing the opportunity costs associated with "lost" output, idle and misallocated resources experienced during recessions.
Inflation targeting was adopted to reduce deviation from full employment. However, the opportunity costs associated with the deleveraging of the financial system and the economy since the recent asset bubbles burst will very likely exceed the costs experienced during the post-inflation recessionary period of 1980-1983. The current Fed through errors of omission (failure to adequately exercise its regulatory and supervisory responsibilities) and commission (keeping short-term interest rates too low for too long) made policy errors that will prove to be more costly than the inflation inducing policy errors made by the Burns and G William Miller Feds.
In addition, the Fed has allowed itself to become enmeshed in a jury-rigged system by which it decides which firms are allowed to live or die, and in the micro management of the allocation of credit and liquidity by type of counterparties, type of collateral and market. The Fed is now actively and directly engaged in the redistribution of wealth. It is impossible to assess the exact size of policy induced wealth redistributions that result from either the inflation of the 1970s or from Fed policy since 2000 with anything like precision. However, it is possible that recent policy induced wealth transfers from taxpayers and households to financial institutions are of the same order of magnitude as the intersectoral wealth transfer of the 1970s.
In the Charts below, the opportunity costs of the post-inflation recession(s) starting in 1980 and the recession of 2007 are compared. These costs are dattributable to lost output, underemployment of resources, misallocation of resources. The CBO economic forecast will be used for the years 2009-2012. (This forecast assumes a V-shaped trough. Readers, who believe this scenario to be optimistic, are free to substitute a recovery profile of their own choosing).
Lost Output and Idle Resources
An examination of the output gaps during the 5 years preceding and following the cycle peaks in 1980 (including the subsequent double dip recession) and 2007 (assuming CBO forecasts for 2009-2012) suggests the current loss of output as a Percentage of GDP will exceed output loss experienced during the Volcker years. (The output gap is calculated as (real GDP-Potential GDP)/Potential GDP. Real GDP is from the BEA plus CBO forecasts for 2009-2012). "Potential output" is the CBO estimate of potential output.
A quick examination of the labor market and capacity utilization leads to a similar result. Comparing excess unemployment (the average actual unemployment rate for each year (including the CBO forecast for 2009-2012) minus the CBO estimate of the average natural rate for each year.) reveals that more labor resources (as a percentage of the labor force) will be wasted/idle post 2007 than were post 1980. So it appears that unwinding of the asset price bubble will be costly in terms of idle labor resources than was the unwinding of the inflationary economy of the 1970s.
A chart (courtesy of the St Louis Fed) also indicates that the trough in the capacity utilization rate is already well below that reached 1983. Given the shallower recoveries of both output and the unemployment rate forecasted by the CBO, it safe to assume that the CBO also anticipates a slower than normal rebound in capacity utilization.
Misallocation of Resources
Another cost associated with the inflation of the 1970s was channeling of invest into residential construction as households attempted to insulate themselves from the cost of inflation by buying real assets financed with fixed rate mortgages. As the charts below indicate, the asset price bubble 2000-2007 resulted in more resources as a % of GDP being allocated to residential investment than occurred during the inflation bubble of the 1970s.
Perhaps more telling is residential investment as a % of total investment. As a fraction of investment, residential construction in 2006 was approximately 125% of the peak of its peak in 1977.
The relatively quick decline from the peak in 2006 suggests that much of the investment in residential real estate was speculative in nature. The declines in real estate prices also imply that more investment capital (absolutely and relatively) was misallocated to residential construction in 2002-2006 than in the inflationary 1970s. To the extent that residential investment replaced real investment and drove increased debt supported consumption, US productivity, competitiveness, and incomes will suffer more in the future.
Wealth Redistributions
In addition to the costs of idled and misallocated resources, there is another dimension to the disruptions caused by both inflation and asset bubbles and their collapse. Wealth is redistributed by both unanticipated inflation and Fed decisions to manipulate markets and prices for various classes of assets. Unlike "lost output" or idle resources (assuming away from definitional and relatively small scale measurement problems), it is impossible to directly observe and measure the redistributions.
Doepke and Schneider (in Doepke and Schneider, Inflation and the Redistribution of Nominal Wealth, Journal of Political Economy, 2006, vol. 114, no. 6) devised a framework within which they simulate the redistributional effects of an unanticipated inflation over a ten year period. . The framework assumes a number of stylized "facts" based upon the US experience of the 1970s. The scale of the inter-sectoral redistrbutional gains and losses generated by the model and the standardized inflation "shock" vary considerably over time. In the mid-1950s, the model indicates that standardized shock would generate a wealth transfer from Households to Government in excess of 10% of GDP. By 1970, it would have been about 4% of GDP. By 1980, it would have been about 1% of GDP. The estimated inter-sector transfer reversed course and increased in absolute size till 1985. However, from about 2000 on, the simulations suggest that both the Household sector and the Government sector would have enjoyed net gains from the inflation induced redistribution of wealth. The "Rest of World" sector which had been quantitatively unimportant as late as the early 1980s was the "simulated" sole net loser to the tune of about 6% of GDP. This may help explain why some foreign holders of US debt have become more interested in US monetary policy as of late. They may perceive US policymakers as more willing to tolerate inflation than it has been recently since a higher proportion, if not all, the net losses will be borne by non-nationals.
The wealth redistribution driven by the recent bubbles was very different than that of the inflation-driven redistributions. The inflation-driven wealth redistribution was driven by a single readily observable factor: inflation. The wealth redistributions of the 1990s and 2000s were driven by a vast array of rollercoaster rides in relative prices. The asset price inflation was characterized by non-uniform changes in various prices, e.g. real estate and various forms of financial assets. The bursting of the asset bubbles has been followed by an explosion government involvement in the financial markets. This includes support for various private sector industries, institutions and various classes of people (e.g. certain home owners, certain home buyers, investors in particular firms, and owners of selected assets including "clunkers".) The bursting of the asset bubble has result in transfers of wealth from the government sector (taxpayers) to the private. The growth in real debt and contingent obligation of the Federal government and its agencies in part reflects these transfers of wealth. .
Some of the transfers are simply impossible to estimate. However, an estimate of one component is just a few assumptions way from being "ballparkable". The Fed has cut short-term rates to near zero with an eye to among other things allow financial institution that borrow short and lend long a chance to" earn" their way back to financial health and resume "normal" lending. This represents a transfer wealth from depositors and holders of short-term investment vehicles to those institutions which borrow short to lend long. The scale of the wealth transfer in terms of a % of GDP can then be "guestimated". Given a chosen measure of short-term assets (as a % Of GDP); an estimate on how much lower on average the interest paid on those instruments is than it would "normally": and ) the length of time that the Fed will be holding short-term rates at artificially low levels. Given the Dollar volume of outstanding short-term paper and the likelihood the money market rates will remain substantially below where they would have been in the absence of the crises, it seems likely that policy induced transfer from savers to the financial institutions post 2007 will be of the same order of magnitude of net wealth transfer that occurred between households and the government sector in the 1970s.Your choice, the current Fed: 1) actively promoted the asset bubbles which precipitated the most costly business downturn since the Great depression; 2) passively sat by ignoring its regulatory and supervisory responsibilities allowing the growth of imbalances that led to the worst business downturn since the Great depression; or 3) both of the above. The US did not experience a significant acceleration in the rate of inflation (thanks to globalization) between 200 and 2007. However, the economic and financial imbalances that built up between 2000 and 2007 will generate the opportunity costs in terms of lost output and idle and misallocated resources that will exceed the costs inherent in the economic and financial imbalances reflected in the most expensive anti-inflation fight ever fought by the Fed (1980-1983). The US financial system remains on life support. Furthermore, the Fed has played a part in allocating credit and in engineering redistributions of wealth on a scale that is likely to on the same scale as the redistribution of wealth from the household sector to government during the inflation ridden 1970s. The independence of the Fed has been compromised. Many in the Congress want to audit the Fed and limit its ability to make loans in future emergencies. The Fed is seen by many as an agency of the Treasury. Defenders of the Fed are quick to note that it could have been worst: we could have experienced another Great Depression.
In 1980, the then current Chairman, G William Miller, resigned. Bernanke publically campaigned for and was nominated for a second term.
fresno dan says:"The Fed is now actively and directly engaged in the redistribution of wealth."
The problem is that it is the redistribution from the poorer to the richer. I have no problem with people becoming richer due to talent, hard work, or innovation, but people who can't figure out that loans have to be paid back do not deserve to keep any of their bonuses or ill conceived salaries.
The Fed has embarked upon a policy of affirmative action for the stupid.
Siggy:
Are you sure that its a policy of affirmative action for the stupid?
Could it be a policy of affirmative for the primary dealer banks that the Treasury and the Fed desparetly need to fund the operation of the Federal Government.
Bonuses in the face of operating losses are very difficult to accomodate, maintaining bank that are insolvent is equally difficult to understand.
ECONOMISTA NON GRATA:
Here's an MSM guy who seems to have a good grip on reality…..
I picked this up from Barry Ritholtz's Big Picture…. Dylan Ratigan hosts the show Morning Meeting with Dylan Ratigan, which airs weekday mornings from 9 to 11 A.M. ET.
--
The American people have been taken hostage to a broken system.
It is a system that remains in place to this day.
A system where bank lobbyists have been spending in record numbers to make sure it stays that way.
A system that corrupts the most basic principles of competition and fair play, principles upon which this country was built.
It is a system that so far has forced the taxpayer to provide the banks with the use of $14 trillion from the Federal Reserve, much of the $7 trillion outstanding at the US Treasury and $2.3 trillion at the FDIC.
A system partially built by the very people who currently advise our President, run our Treasury Department and are charged with its reform.
And most stunningly - it is a system that no one in our government has yet made any effort to fundamentally change.
Like health care, this is a referendum on our government's ability to function on behalf of the American people. Ask yourself how long you are willing to be held hostage? How long will you let our elected officials be the agents of those whose business it is to exploit our government and the American people at any cost?
As hostages - was there any sum of money we wouldn't have given AIG?
Why did we pay Goldman Sachs and all the other banks 100 cents on the dollar for their contracts with AIG, using taxpayer money, while we forced GM and others to take massive payment cuts?
Why hasn't any of the bonus money paid to the CEOs that built this financial nuclear bomb been clawed back?
And more than anything else - why does the US Congress refuse to outlaw the most anti-competitive structure known to our economy, one summed up as TOO BIG TOO FAIL?
It has become startlingly clear that we as a country, and I as a journalist, had made a grave error in affording those who built and ran those banks and insurance companies the honorable treatment of being called capitalists. When in fact the exact opposite was true, these people were more like vampires using the threat of Too Big Too Fail to hold us hostage and collect ongoing ransom from the US Government and the American taxpayer.
This was no unlucky accident. The massive spike in unemployment, the utter destruction of retirement wealth, the collapse in the value of our homes, the worst recession since the Great Depression all resulted directly from these actions.
Even with all that - the only changes that have been made, have been made to prop up and hide the massive flaws on behalf of those who perpetuated them. Still utterly nothing has been done to disclose the flaws in this system, improve it or rebuild it.
Last fall was an awakening for me, as it was for many in our country.
And yet, our Congress has yet to open its eyes, much less do anything about it. In fact conditions have never been better for the banks or worse for the rest of us.
Why is this? Who does our Government work for? How much longer will we as Americans tolerate it? And what, if anything, can we do about it?
As we approach the anniversary of the bailouts for our banks and insurers - and watch the multi-trillion taxpayer-funded programs at the Federal Reserve continue to support banks and subsidize their multibillion bonus pools, we must ask if our politicians represent the interests of America? Or those who would rob America of its money and its future?
As a country, we must demand that our politicians stop serving those whose business models are based on systemic theft and start serving those who seek to create value for others - the workers, innovators and investors who have made this country great.
Originally published at the Huffington Post;
~~~
I can attest that what he says is true…
In Debt We Trust:
The Fed actually stimulated equity issuance.
I'm not making these numbers up - data from SIFMA.
Secondary Offerings At All Time High
Second quarter secondary market issuance totaled at an all time high $107.9 billion, a ten fold increase from the previous quarter of $10.8 billion and nearly twice the amount of the previous record, set in 2008.
Equity Underwriting
Equity underwriting increased substantially this quarter from the prior quarter, a 777.8 percent increase to $111.6 billion from 12.7 billion.
Many corporate finance departments have taken advantage of the unprecedented liquidity from the Federal Reserve to raise cash by undertaking secondary offerings in order to pay off existing debt obligations. After all, debt - the other word for leverage - is what got so many of them in trouble in the first place in Fall 2008.
http://debtsofanation.blogspot.com/2009/09/debts-of-spenders-secondary-offerings.html
Mike NY:
And now Bubble Ben is actively seeking to re-inflate asset bubbles to solve the hangover from the last ones.
Our Fed does nothing but trash the currency (and the country).
john bougearel:
Richard,
You indict the Greenspan-Bernanke Fed era as worse than the Burns-Miller Fed era, during that 1970s inflation era. I hesitated to draw that same conclusion, as I don't think we have enough evidence of the collateral damage this is all going to cost us yet. However, I have given the matter some thought. My bottom line is that it will take years before we can accurately assess which Fed era was more shameful. For the Greespan-Bernanke Fed era to be compared to the inflationary 1970s, the US economy has to return to full employment. It will likely take at least 4 years from now to return to the employment levels of 2007 given that job growth does not "monster-spring" like other post WWII recessions after 2000. When in 2013 or beyond, the slack in labor resources have been absorbed, ( a big if, if we are in a 1930s debt-deflation deleveraging spiral, we will witness how well the Bernanke Fed can inflationary pressures. If the inflation genie does not escape her bottle in the next decade, comparing the two Fed eras will be more of a study in contrasts.
About the Burns-Miller Fed era,in my book Riding the Storm Out, I made a few observations:
The worry is that they will be all-too-successful in their endeavors and inflation will spiral out of control, as it did under the Arthur Burns and G. William Miller Federal Reserves. Arthur Burns was chairman of the Federal Reserve from 1970-78. G. William Miller was chairman of the Federal Reserve in 1978-79. Consumer price inflation was running at 6% in 1970. Under the Arthur Burns Fed, annual consumer price inflation averaged 9%.
G. William Miller inherited an economy with high inflation. But he believed that inflation could "prime the pump" of the economy, and that once the economy fired up, the high inflation rate would be self-correcting. His monetary policies were extremely accommodative, and Miller strongly opposed raising interest rates during his term. This sent the dollar into another downward spiral. Eleven months into his term, "the dollar had fallen nearly 34% against the German mark." His inflationary policies did nothing to spur the economy. With respect to the Federal reserve under Arthur Burns and G. William Miller, Federal Reserve analyst Steven Beckner said "the Fed provided the monetary fuel for an inflation that began as a flicker and grew into a fearsome blaze…If…Burns lit the fire, Miller poured gasoline on it" during the Carter administration.
Carter had to implement a "dollar rescue package" and bring Paul Volcker in to succeed G. William Miller as head of the Federal Reserve. Volcker provided "shock therapy" to counter the high inflation rate that raged under the previous two Fed Chairmen. Volker's restrictive monetary policies threw the U.S. economy back into a recession from 1980-82.
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The Huffington Post
The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.
This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.
"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."
One critical way the Fed exerts control on academic economists is through its relationships with the field's gatekeepers. For instance, at the Journal of Monetary Economics, a must-publish venue for rising economists, more than half of the editorial board members are currently on the Fed payroll -- and the rest have been in the past.
The Fed failed to see the housing bubble as it happened, insisting that the rise in housing prices was normal. In 2004, after "flipping" had become a term cops and janitors were using to describe the way to get rich in real estate, then-Federal Reserve Chairman Alan Greenspan said that "a national severe price distortion [is] most unlikely." A year later, current Chairman Ben Bernanke said that the boom "largely reflect strong economic fundamentals."
The Fed also failed to sufficiently regulate major financial institutions, with Greenspan -- and the dominant economists -- believing that the banks would regulate themselves in their own self-interest.
...."Try to publish an article critical of the Fed with an editor who works for the Fed," says Galbraith. And the journals, in turn, determine which economists get tenure and what ideas are considered respectable....Galbraith, a Fed critic, has seen the Fed's influence on academia first hand. He and co-authors Olivier Giovannoni and Ann Russo found that in the year before a presidential election, there is a significantly tighter monetary policy coming from the Fed if a Democrat is in office and a significantly looser policy if a Republican is in office. The effects are both statistically significant, allowing for controls, and economically important.They submitted a paper with their findings to the Review of Economics and Statistics in 2008, but the paper was rejected. "The editor assigned to it turned out to be a fellow at the Fed and that was after I requested that it not be assigned to someone affiliated with the Fed," Galbraith says.
...
Take the case of Alan Blinder. Though he's squarely within the mainstream and considered one of the great economic minds of his generation, he lasted a mere year and a half as vice chairman of the Fed, leaving in January 1996.Rob Johnson, who watched the Blinder ordeal, says Blinder made the mistake of behaving as if the Fed was a place where competing ideas and assumptions were debated. "Sociologically, what was happening was the Fed staff was really afraid of Blinder. At some level, as an applied empirical economist, Alan Blinder is really brilliant," says Johnson.
In closed-door meetings, Blinder did what so few do: challenged assumptions. "The Fed staff would come out and their ritual is: Greenspan has kind of told them what to conclude and they produce studies in which they conclude this. And Blinder treated it more like an open academic debate when he first got there and he'd come out and say, 'Well, that's not true. If you change this assumption and change this assumption and use this kind of assumption you get a completely different result.' And it just created a stir inside--it was sort of like the whole pipeline of Greenspan-arriving-at-decisions was
disrupted."It didn't sit well with Greenspan or his staff. "A lot of senior staff...were pissed off about Blinder -- how should we say? -- not playing by the customs that they were accustomed to," Johnson says.
And celebrity is no shield against Fed excommunication. Paul Krugman, in fact, has gotten rough treatment. "I've been blackballed from the Fed summer conference at Jackson Hole, which I used to be a regular at, ever since I criticized him," Krugman said of Greenspan in a 2007 interview with Pacifica Radio's Democracy Now! "Nobody really wants to cross him."
An invitation to the annual conference, or some other blessing from the Fed, is a signal to the economic profession that you're a certified member of the club. Even Krugman seems a bit burned by the slight. "And two years ago," he said in 2007, "the conference was devoted to a field, new economic geography, that I invented, and I wasn't invited."
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www.thenation.com
The financial crisis has propelled the Federal Reserve into an excruciating political dilemma. The Fed is at the zenith of its influence, using its extraordinary powers to rescue the economy. Yet the extreme irregularity of its behavior is producing a legitimacy crisis for the central bank. The remote technocrats at the Fed who decide money and credit policy for the nation are deliberately opaque and little understood by most Americans. For the first time in generations, they are now threatened with popular rebellion.
During the past year, the Fed has flooded the streets with money--distributing trillions of dollars to banks, financial markets and commercial interests--in an attempt to revive the credit system and get the economy growing again. As a result, the awesome authority of this cloistered institution is visible to many ordinary Americans for the first time. People and politicians are shocked and confused, and also angered, by what they see. They are beginning to ask some hard questions for which Federal Reserve governors do not have satisfactory answers.Where did the central bank get all the money it is handing out? Basically, the Fed printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really--not Congress or the president. The Federal Reserve Board, alone among government agencies, does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities.
Representative Wright Patman, the Texas populist who was a scourge of central bankers, once described the Federal Reserve as "a pretty queer duck." Congress created the Fed in 1913 with the presumption that it would be "independent" from the rest of government, aloof from regular politics and deliberately shielded from the hot breath of voters or the grasping appetites of private interests--with one powerful exception: the bankers.
The Fed was designed as a unique hybrid in which government would share its powers with the private banking industry. Bankers collaborate closely on Fed policy. Banks are the "shareholders" who ostensibly own the twelve regional Federal Reserve banks. Bankers sit on the boards of directors, proposing interest-rate changes for Fed governors in Washington to decide. Bankers also have a special advisory council that meets privately with governors to critique monetary policy and management of the economy. Sometimes, the Fed pretends to be a private organization. Other times, it admits to being part of the government.
The antiquated quality of this institution is reflected in the map of the Fed's twelve regional banks. Five of them are located in the Midwest (better known today as the industrial Rust Belt). Missouri has two Federal Reserve banks (St. Louis and Kansas City), while the entire West Coast has only one (located in San Francisco, not Los Angeles or Seattle). Virginia has one; Florida does not. Among its functions, the Federal Reserve directly regulates the largest banks, but it also looks out for their well-being--providing regular liquidity loans for those caught short and bailing out endangered banks it deems "too big to fail." Critics look askance at these peculiar arrangements and see "conspiracy." But it's not really secret. This duck was created by an act of Congress. The Fed's favoritism toward bankers is embedded in its DNA.
This awkward reality explains the dilemma facing the Fed. It cannot stand too much visibility, nor can it easily explain or justify its peculiar status. The Federal Reserve is the black hole of our democracy--the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That's why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank's cover. Many in Congress are alarmed, demanding greater transparency. More than 250 House members are seeking an independent audit of Fed accounts. House Speaker Nancy Pelosi observed that the Fed seems to be poaching on Congressional functions--handing out public money without the bother of public decision-making.
"Many of us were...if not surprised, taken aback, when the Fed had $80 billion to invest in AIG just out of the blue," Pelosi said. "All of a sudden, we wake up one morning and AIG was receiving $80 billion from the Fed. So of course we're saying, Where is this money coming from? 'Oh, we have it. And not only that, we have more.'" So who needs Congress? Pelosi sounded guileless, but she knows very well where the Fed gets its money. She was slyly tweaking the central bankers on their vulnerability.
Fed chair Ben Bernanke responded with the usual aloofness. An audit, he insisted, would amount to "a takeover of monetary policy by the Congress." He did not appear to recognize how arrogant that sounded. Congress created the Fed, but it must not look too deeply into the Fed's private business. The mystique intimidates many politicians. The Fed's power depends crucially upon the people not knowing exactly what it does.
Basically, what the central bank is trying to do with its aggressive distribution of trillions is avoid repeating the great mistake the Fed made after the 1929 stock market crash. The central bankers responded hesitantly then and allowed the money supply to collapse, which led to the ultimate catastrophe of full-blown monetary deflation and created the Great Depression. Bernanke has not yet won this struggle against falling prices and production--deflationary symptoms remain visible around the world--but he has not lost either. He might get more public sympathy if Fed officials explained this dilemma in plain English. Instead, they are shielding people from understanding the full dimensions of our predicament.
President Obama inadvertently made the political problem worse for the Fed in June, when he proposed to make the central bank the supercop to guard against "systemic risk" and decide the terms for regulating the largest commercial banks and some heavyweight industrial corporations engaged in finance. The House Financial Services Committee intends to draft the legislation quickly, but many members want to learn more first. Obama's proposal gives the central bank even greater power, including broad power to pick winners and losers in the private economy and behind closed doors. Yet Obama did not propose any changes in the Fed's privileged status. Instead, he asked Fed governors to consider the matter. But perhaps it is the Federal Reserve that needs to be reformed.
A few months back, I ran into a retired Fed official who had been a good source twenty years ago when I was writing my book about the central bank, Secrets of the Temple: How the Federal Reserve Runs the Country. He is a Fed loyalist and did not leak damaging secrets. But he helped me understand how the supposedly nonpolitical Fed does its politics, behind the veil of disinterested expertise. When we met recently, he said the central bank is already making preparations to celebrate its approaching centennial. Some of us, I responded, have a different idea for 2013.
"We think that would be a good time to dismantle the temple," I playfully told my old friend. "Democratize the Fed. Or tear it down. Create something new in its place that's accountable to the public."
The Fed man did not react well to my teasing. He got a stricken look. His voice tightened. Please, he pleaded, do not go down that road. The Fed has made mistakes, he agreed, but the country needs its central bank. His nervous reaction told me this venerable institution is feeling insecure about its future.
Six reasons why granting the Fed even more power is a really bad idea:
1. It would reward failure. Like the largest banks that have been bailed out, the Fed was a co-author of the destruction. During the past twenty-five years, it failed to protect the country against reckless banking and finance adventures. It also failed in its most basic function--moderating the expansion of credit to keep it in balance with economic growth. The Fed instead allowed, even encouraged, the explosion of debt and inflation of financial assets that have now collapsed. The central bank was derelict in enforcing regulations and led cheers for dismantling them. Above all, the Fed did not see this disaster coming, or so it claims. It certainly did nothing to warn people.
2. Cumulatively, Fed policy was a central force in destabilizing the US economy. Its extreme swings in monetary policy, combined with utter disregard for timely regulatory enforcement, steadily shifted economic rewards away from the real economy of production, work and wages and toward the financial realm, where profits and incomes were wildly inflated by false valuations. Abandoning its role as neutral arbitrator, the Fed tilted in favor of capital over labor. The institution was remolded to conform with the right-wing market doctrine of chairman Alan Greenspan, and it was blinded to reality by his ideology (see my Nation article "The One-Eyed Chairman," September 19, 2005).
3. The Fed cannot possibly examine "systemic risk" objectively because it helped to create the very structural flaws that led to breakdown. The Fed served as midwife to Citigroup, the failed conglomerate now on government life support. Greenspan unilaterally authorized this new financial/banking combine in the 1990s--even before Congress had repealed the Glass-Steagall Act, which prohibited such mergers. Now the Fed keeps Citigroup alive with a $300 billion loan guarantee. The central bank, in other words, is deeply invested in protecting the banking behemoths that it promoted, if only to cover its own mistakes.
4. The Fed can't be trusted to defend the public in its private deal-making with bank executives. The numerous revelations of collusion have shocked the public, and more scandals are certain if Congress conducts a thorough investigation. When Treasury Secretary Timothy Geithner was president of the New York Fed, he supervised the demise of Bear Stearns with a sweet deal for JPMorgan Chase, which took over the failed brokerage--$30 billion to cover any losses. Geithner was negotiating with Morgan Chase CEO and New York Fed board member Jamie Dimon. Goldman Sachs CEO Lloyd Blankfein got similar solicitude when the Fed bailed out insurance giant AIG, a Goldman counterparty: a side-door payout of $13 billion. The new president at the New York Fed, William Dudley, is another Goldman man.
5. Instead of disowning the notorious policy of "too big to fail," the Fed will be bound to embrace the doctrine more explicitly as "systemic risk" regulator. A new superclass of forty or fifty financial giants will emerge as the born-again "money trust" that citizens railed against 100 years ago. But this time, it will be armed with a permanent line of credit from Washington. The Fed, having restored and consolidated the battered Wall Street club, will doubtless also shield a few of the largest industrial-financial corporations, like General Electric (whose CEO also sits on the New York Fed board). Whatever officials may claim, financial-market investors will understand that these mammoth institutions are insured against failure. Everyone else gets to experience capitalism in the raw.
6. This road leads to the corporate state--a fusion of private and public power, a privileged club that dominates everything else from the top down. This will likely foster even greater concentration of financial power, since any large company left out of the protected class will want to join by growing larger and acquiring the banking elements needed to qualify. Most enterprises in banking and commerce will compete with the big boys at greater disadvantage, vulnerable to predatory power plays the Fed has implicitly blessed.
Whatever good intentions the central bank enunciates, it will be deeply conflicted in its actions, always pulled in opposite directions. If the Fed tries to curb the growth of the megabanks or prohibit their reckless practices, it will be accused of damaging profitability and thus threatening the stability of the system. If it allows overconfident bankers to wander again into dangerous territory, it will be blamed for creating the mess and stuck with cleaning it up. Obama's reform might prevail in the short run. The biggest banks, after all, will be lobbying alongside him in favor of the Fed, and Congress may not have the backbone to resist. The Fed, however, is sure to remain in the cross hairs. Too many different interests will be damaged--thousands of smaller banks, all the companies left out of the club, organized labor, consumers and other sectors, not to mention libertarian conservatives like Texas Representative Ron Paul. They will recognize that the "money trust" once again has its boot on their neck, and that this time the government arranged it.
The obstacles to democratizing the Fed are obviously formidable. Tampering with the temple is politically taboo. But this crisis has demonstrated that the present arrangement no longer works for the public interest. The society of 1913 no longer exists, nor does the New Deal economic order that carried us to twentieth-century prosperity. The country thus has a rare opportunity to reconstitute the Federal Reserve as a normal government agency, shorn of the bankers' preferential trappings and the fallacious claim to "independent" status as well as the claustrophobic demand for secrecy.
Progressives in the early twentieth century, drawn from the growing ranks of managerial professionals, believed "good government" required technocratic experts who would be shielded from the unruly populace and especially from radical voices of organized labor, populism, socialism and other upstart movements. The pretensions of "scientific" decision-making by remote governing elites--both the mysterious wisdom of central bankers and the inventive wizardry of financial titans--failed spectacularly in our current catastrophe. The Fed was never independent in any real sense. Its power depended on taking care of its one true constituency in banking and finance.
A reconstituted central bank might keep the famous name and presidentially appointed governors, confirmed by Congress, but it would forfeit the mystique and submit to the usual standards of transparency and public scrutiny. The institution would be directed to concentrate on the Fed's one great purpose--making monetary policy and controlling credit expansion to produce balanced economic growth and stable money. Most regulatory functions would be located elsewhere, in a new enforcement agency that would oversee regulated commercial banks as well as the "shadow banking" of hedge funds, private equity firms and others.
The Fed would thus be relieved of its conflicted objectives. Bank examiners would be free of the insider pressures that inevitably emanate from the Fed's cozy relations with major banks. All of the private-public ambiguities concocted in 1913 would be swept away, including bank ownership of the twelve Federal Reserve banks, which could be reorganized as branch offices with a focus on regional economies.
Altering the central bank would also give Congress an opening to reclaim its primacy in this most important matter. That sounds farfetched to modern sensibilities, and traditionalists will scream that it is a recipe for inflationary disaster. But this is what the Constitution prescribes: "The Congress shall have the power to coin money [and] regulate the value thereof." It does not grant the president or the treasury secretary this power. Nor does it envision a secretive central bank that interacts murkily with the executive branch.
Given Congress's weakened condition and its weak grasp of the complexities of monetary policy, these changes cannot take place overnight. But the gradual realignment of power can start with Congress and an internal reorganization aimed at building its expertise and educating members on how to develop a critical perspective. Congress has already created models for how to do this. The Congressional Budget Office is a respected authority on fiscal policy, reliably nonpartisan. Congress needs to create something similar for monetary policy.
Instead of consigning monetary policy to backwater subcommittees, each chamber should create a major new committee to supervise money and credit, limited in size to members willing to concentrate on becoming responsible stewards for the long run. The monetary committees, working in tandem with the Fed's board of governors, would occasionally recommend (and sometimes command) new policy directions at the federal agency and also review its spending.
Setting monetary policy is a very different process from enacting laws. The Fed operates through a continuum of decisions and rolling adjustments spread over months, even years. Congress would have to learn how to respond to deeper economic conditions that may not become clear until after the next election. The education could help the institution mature.
Congress also needs a "council of public elders"--a rotating board of outside advisers drawn from diverse interests and empowered to speak their minds in public. They could second-guess the makers of monetary policy but also Congress. These might include retired pols, labor leaders, academics and state governors--preferably people whose thinking is no longer defined by party politics or personal ambitions. The public could nominate representatives too. No financial wizards need apply.
A revived Congress armed with this kind of experience would be better equipped to enact substantive law rather than simply turning problems over to regulatory agencies with hollow laws that are merely hortatory suggestions. Reordering the financial system and the economy will require hard rules--classic laws of "Thou shalt" and "Thou shalt not" that command different behavior from certain private interests and prohibit what has proved reckless and destructive. If "too big to fail" is the problem, don't leave it to private negotiations between banks and the Federal Reserve. Restore anti-monopoly laws and make big banks get smaller. If the financial system's risky innovations are too complicated for bank examiners to understand, then those innovations should probably be illegal.
Many in Congress will be afraid to take on the temple and reluctant to violate the taboo surrounding the Fed. It will probably require popular rebellion to make this happen, and that requires citizens who see through the temple's secrets. But the present crisis has not only exposed the Fed's worst failures and structural flaws; it has also introduced citizens to the vast potential of monetary policy to serve the common good. If Ben Bernanke can create trillions of dollars at will and spread them around the financial system, could government do the same thing to finance important public projects the people want and need? Daring as it sounds, the answer is, Yes, we can.
The central bank's most mysterious power--to create money with a few computer keystrokes--is dauntingly complicated, and the mechanics are not widely understood. But the essential thing to understand is that this power relies on democratic consent--the people's trust, their willingness to accept the currency and use it in exchange. This is not entirely voluntary, since the government also requires people to pay their taxes in dollars, not euros or yen. But citizens conferred the power on government through their elected representatives. Newly created money is often called the "pure credit" of the nation. In principle, it exists for the benefit of all.
In this emergency, Bernanke essentially used the Fed's money-creation power in a way that resembles the "greenbacks" Abraham Lincoln printed to fight the Civil War. Lincoln was faced with rising costs and shrinking revenues (because the Confederate states had left the Union). The president authorized issuance of a novel national currency--the "greenback"--that had no backing in gold reserves and therefore outraged orthodox thinking. But the greenbacks worked. The expanded money supply helped pay for war mobilization and kept the economy booming. In a sense, Lincoln won the war by relying on the "full faith and credit" of the people, much as Bernanke is printing money freely to fight off financial collapse and deflation.
If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects--like sorely needed improvements to the nation's infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation). But here is an example of how it would work.
President Obama has announced the goal of building a high-speed rail system. Ours is the only advanced industrial society that doesn't have one (ride the modern trains in France or Japan to see what our society is missing). Trouble is, Obama has only budgeted a pittance ($8 billion) for this project. Spain, by comparison, has committed more than $100 billion to its fifteen-year railroad-building project. Given the vast shortcomings in US infrastructure, the country will never catch up with the backlog through the regular financing of taxing and borrowing.
Instead, Congress should create a stand-alone development fund for long-term capital investment projects (this would require the long-sought reform of the federal budget, which makes no distinction between current operating spending and long-term investment). The Fed would continue to create money only as needed by the economy; but instead of injecting this money into the banking system, a portion of it would go directly to the capital investment fund, earmarked by Congress for specific projects of great urgency. The idea of direct financing for infrastructure has been proposed periodically for many years by groups from right and left. Transportation Secretary Ray LaHood co-sponsored legislation along these lines a decade ago when he was a Republican Congressman from Illinois.
This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public's money-creation process--just as Lincoln did and Bernanke is now doing.
The bankers would howl, for good reason. They profit enormously from the present system and share in the money-creation process. When the Fed injects more reserves into the banking system, it automatically multiplies the banks' capacity to create money by increasing their lending (and banks, in turn, collect interest on their new loans). The direct-financing approach would not halt the banking industry's role in allocating new credit, since the newly created money would still wind up in the banks as deposits. But the government would now decide how to allocate new credit to preferred public projects rather than let private banks make all the decisions for us.
The reform of monetary policy, in other words, has promising possibilities for revitalizing democracy. Congress is a human institution and therefore fallible. Mistakes will be made, for sure. But we might ask ourselves, If Congress were empowered to manage monetary policy, could it do any worse than those experts who brought us to ruin?
William Greider: Congress should step up its investigations of the roots of the financial crisis and slow down the rush to weak solutions--especially the empowerment of the Federal Reserve.
Christopher Hayes: How can we expect the experts to reform the financial system when it's experts who got us into this mess to begin with?
- The Deification of Gentle Ben
William Greider: While the mainstream press portrays newly reappointed Fed Chairman Ben Bernanke as a mild-mannered hero, the reality is he is responsible for much of the economic pain Americans are feeling.
- Squandered Opportunity
William Greider: After a brilliant beginning, President Obama appears to be abandoning his principles on healthcare by hedging on a public option. What should disappointed Democrats do?
- A Rancid Deal with Big Pharma
William Greider: Did Obama sell out? If House Democrats don't insist on the government's prerogative to bargain for lower prices, reform is impossible.
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The way it's supposed to work is that the way the Fed "controls" the US economy is mainly by adjusting short-term interest rates; lower rates and more money sloshes around the system and GDP goes up, but that can be inflationary, so the Fed keeps a wary eye on that, and if the dangerous iceberg of inflation is "spotted" it raises rates.That's why whenever "Captain" Greenspan would mumble something unintelligible on prime time, the world would hold its breath, and then there would be a frenzy of debate about what he meant, and more important what he was going to do next?
But the captain of the ship was a wily old hand who could keep the world guessing. And he stood resolutely on deck, fair weather or foul, scanning the horizon for icebergs; deftly" easing 25 basis point here and "tightening" 50 basis points there, stroking that steering wheel with deliberate calm concentration and skill.
Then in about 2000 some hooligans disconnected the mechanism linking the steering wheel to the rudder. It looks like he didn't notice (the economy is like an oil tanker it takes time to react (unless you hit a credit crunch)), but from that time on "someone" else was steering the ship. And then, over the next seven years, they bled America dry.
The precise "tool" used to hijack the ship was securitization.
The Fed can increase or decrease the money supply by buying Treasuries (that increases it) or by selling them (that decreases it).
So can the Shadow Banking System (well it could), from 2000 to 2007 it bought $17 trillion of mortgages and re-packaged those into securities; leaving aside where it got the money to pay for those mortgages in the first place, and what that did for the money-supply, they sold half of their "output" to foreigners, so that increased the money supply by $8.5 trillion right there (they used the money to buy more mortgages). As a yardstick, over that period the Treasury sold about $2 trillion of bonds to foreigners.
In that context what Chairman Greenspan was doing with interest rates and the other tools he had at his disposal, was irrelevant.
I wrote an article recently about that. My Big Idea was that over the past ten years securitization was the main "supplier" of credit to USA, my thesis was if the government wants to "fix" things, then it needs to fix or facilitate fixing that.
One comment I got back was (I paraphrase); "securitization caused the problem in the first place (and good riddance)."
Perhaps I missed something obvious? Well that has happened before (more than I care to admit), so I had a look.
This is a plot of the cumulative total amount of residential mortgaged backed securities (RMBS) plus collateralized debt obligations (CDO) issued in USA since 2000 up to the "pop" of the bubble in 2006, compared to where the S&P Case-Shiller Index reached at the end of the year in question (i.e. December).
Looks like a "fit" to me.
OK that's only seven paired points of data but the correlation (R-Squared) is 99.6%, what that means is that up to the "pop", 99.6% of changes in the Index can be explained by securitization (which "predicts" the index +/- 4% at the 95% confidence level).
Of course another way of reading the chart is to say that 99.6% of changes in the level of securitization can be explained by changes in the Index, i.e. the issue is either (a) did house prices going up drive demand for credit, or (b) did an over-supply of credit drive up house prices? Take your pick; my guess is that it was a feedback loop.
Perhaps it wasn't Greenspan's "fault" after all?
What I had always assumed (and I think a lot of other people did too), was that what happened was:
- For some reason (why is irrelevant) in 2001 he dropped interest rates to the floor.
- Then for some other reason(s) (also irrelevant), but as a direct consequence of that and obviously something to do with easy money and/or credit there was a housing bubble.
- Then the bubble popped and here we are.
Q.E.D.
There are some other theories like "yes but what about Clinton and the lobbyists" (not my words), "pressurizing mortgage originators to make loans to "deadbeats"?" (Not my words either); there are other theories.
This is a plot of the change in the S&P Case-Shiller 20 City Index compared to the yield on the Fed Rate (one divided by the rate), which is a sort of measure of the "inflatability" of the Fed Rate (I put it like that because it's easier to eyeball).
Well I suppose if you stand on one leg and squint, you can say that there was perhaps some sort of correlation.
The thing is that house prices were going up pretty "healthily" before Chairman Greenspan put his foot on the gas. So the annual increase went up from about 10% a year to about 15% a year, so what?
The Law of ONE
Only ONE thing causes catastrophe; the rest is noise.
- Roger Boisjoly an engineer warned his superiors that an O-ring used on the Challenger Space Shuttle rocket was likely to fail particularly below Minus 1 Degrees Centigrade, his boss overruled him, the launch went ahead, and the rocket broke up. ONE Thing.
- The story I was told is that in Air France the pilots get rated on how much fuel they use, the more fuel you load up with the more you use. The way I heard it when the pilot of the airliner that went down recently, saw the dangerous tropical storm ahead, he had no choice, he didn't have enough fuel to go round so his only option was to turn back, so he risked it; forget about finding the black box, all they need to do is check how much fuel he bought. ONE Thing.
- I drove for thirty-five years and I never had an accident, six months ago I was driving my brother to the rail-station through Scotland. It started to snow and the temperature dropped to zero, we were late, I was pushing it. Came into a corner too fast, hit some ice or some slush, lost it and rammed dead center into the only tree for two hundred yards in any direction. I was driving too fast on a road I did not know in lousy conditions. ONE thing.
ONE thing caused the bubble that caused the credit crunch.
Chairman Greenspan thought he was the captain of the ship, but in fact, at least with regard to one of the most important "unnatural" disasters in American History, he was irrelevant, he thought he was steering, but he wasn't.
What was relevant was the huge amount of credit that was being created by (defective) securitization and being pumped into the economy, and the driver for the creation of that credit had little or nothing to do with short-term interest rates, it was driven by the perception that house prices would go on going up faster that mortgage rates, forever.
The hooligans had much more money at their disposal than the Fed; listen to all the wailing about the $3 trillion the Fed pumped into the bail outs so far [2], the Shadow Bankers would "manufacture" that much in a good year.
Go figure who was "in charge".
What happened was that the major source of "economic activity" in USA was no longer controlled by the Fed, it was controlled by the Shadow Central Bank that had staged a coup d'état by stealth, and then once it had control, it bled America like a vampire.
And the irony is that the Fed handed over another $3 trillion of taxpayer's money to "save" them. Talk about having your cake and eating it.
Securitization is dead, long live securitization
There is nothing wrong with securitization, it is a tool and used properly and responsibly it is a very effective tool.
The US government borrows money against the promise that it can tax its citizens in the future to pay back the loans, which is fine, if you believe that in the future the citizens will be willing or able to be taxed at that rate.
Securitization borrows against assets, and so long as the value of the collateral is more than the value of the loan at the point in time that the loan goes bad (if it goes bad) that is perfectly safe.
How you corrupt that system is as old as the hills.
You just find a way to not do the valuations properly. That was achieved by the corruption of the rating agencies and the audit profession, who were persuaded to sign off that there was a very reasonable expectation that the assets could be sold, in the future, for much more than in reality they could be.
Dr. William Black, the guy who unearthed how the frauds were done to create the S&L debacle, explains how that was done in his video.
I never suggested that the corrupt procedures of the past should be revived, and I still stand by my argument that America will be stuck in a deflationary spiral until securitization is fixed. And I don't believe that increasing the liability of the US taxpayers by providing deadbeat bankers with insurance at less than what they can buy it in the marketplace is anything less than lunacy, I suggested just two things:
Only allow covered bonds to be used instead of Treasuries when calculating capital adequacy, until such a time as a viable and safe alternative system is found (if ever). That's like the "old" originate and hold banking, except that the loans can be bought and sold.
- Mandate that every line item on every loan that was ever subsequently securitized is published in the public domain, that's what Dr. William Black calls the "tapes". That would allow the "market" to do proper valuations, and that would start off the process of dealing with the pile of rotting toxic assets that threaten to poison America and the world, like a heaving garbage tip.
I still find that hard to believe Dr. Black's claim that the rating agencies often didn't even review the "tapes" before putting their AAA stamp on; certainly every time I ever put in something to get rated we would include all the details of the underlying collateral, whether they looked at it or not I have no idea.
But if indeed they didn't, perhaps it wouldn't be a bad idea to do what Dr. Black suggests and to get the FBI to investigate every single toxic asset that went bad, and identify every single individual who signed off on a rating, a valuation or an audit, without checking the "tapes", and to arrange for them to be prosecuted for criminal negligence and/or racketeering. Black said that after the S&L debacle 1,000 people went to jail, well this is ten times bigger, so rough numbers that's 10,000; which sounds about right.
And if the FBI doesn't to that job, well expect chaos, because that's what happens when hooligans find out they can get away with murder. I just wonder how much of the $4 trillion that has been thrown at the "problem" so far, is going to get spent recruiting and deploying prosecutors and investigators?
Or perhaps the hooligans are still in charge?
Disclosure: No positions.
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Let finance skeptics take over, by Dani Rodrik, Commentary, Project Syndicate: ...Federal Reserve Chairman Ben Bernanke's term ends in January, and President Barack Obama must decide before then: either re-appoint Bernanke or go with someone else...[I]n recent decades central banks have become even more significant as a consequence of the development of financial markets. Even when not formally designated as such, central banks have become the guardians of financial-market sanity. The dangers of failing at this task have been made painfully clear in the sub-prime mortgage debacle. ...
This is a job at which former Fed Chairman Alan Greenspan proved to be a spectacular failure. ... As a member of the Fed's Board of Governors under Greenspan..., Bernanke can also be faulted...
What hampered Greenspan and Bernanke as financial regulators was that they were excessively in awe of Wall Street... They operated under the assumption that what is good for Wall Street is good for Main Street. This will no doubt change as a result of the crisis, even if Bernanke remains at the helm. But what the world needs is a Fed chairman who is instinctively skeptical of financial markets and their social value.
Here are some of the lies that the finance industry tells itself and others, and which any new Fed chairman will need to resist.
Prices set by financial markets are the right ones for allocating capital and other resources to their most productive uses. That is what textbooks and financiers tell you, but ... there are far too many "market failures" in finance for these prices to be a good guide for resource allocation. ... Implicit or explicit bailout guarantees, moreover, induce too much risk-taking. ... So the prices that financial markets generate are as likely to send the wrong signals as they are to send the right ones.
Financial markets discipline governments. This is one of the most commonly stated benefits of financial markets, yet the claim is patently false. ... If in doubt, ask scores of emerging-market governments that had no difficulty borrowing in international markets, typically in the run-up to an eventual payments crisis.
In many of these cases ... financial markets enabled irresponsible governments to embark on unsustainable borrowing sprees. When "market discipline" comes, it is usually too late, too severe, and applied indiscriminately.
The spread of financial markets is an unmitigated good. Well, no. Financial globalisation was supposed to have enabled poor, undercapitalised countries to gain access to the savings of rich countries. It was supposed to have promoted risk-sharing globally. In fact, neither expectation was fulfilled. ...
Financial innovation is a great engine of productivity growth and economic well-being. Again, no. Imagine that we had asked five years ago for examples of really useful kinds of financial innovation. We would have heard about a long list of mortgage-related instruments... The truth lies closer to Paul Volcker's view that for most people the automated teller machine (ATM) has brought bigger benefits than any financially-engineered bond.
The world economy has been run for too long by finance enthusiasts. It is time that finance skeptics began to take over.
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wjd123 says...
"Failing to diagnose a disease is different from not knowing what to do once you figure it out. The disease was a difficult one to diagnose or it wouldn't have missed so widely, and it wasn't clear at first precisely what was wrong, but in every case, once they understood the problem, they took the proper course of action."Here's the question I ask myself. If I were to suddenly come down with the same disease, would I want the current group with it's current leadership in charge of bringing me back to health, or would I want a different group led by someone new who thinks they know what to do, but has never actually been through it? I'd want this group, the one with experience. They're likely to have learned enough to spot the disease the next time and head it off all together, one hopes so. But if not and I get the disease, they are also likely to know just what to do - while avoiding the missteps they took the first time - to get me back on my feet as fast as possible (and please don't let politicians second guess them)" --Mark Thoma
I can't agree with Mark here. Bernanke either didn't see the disease progressing or he saw it and wasn't willing to act. I don't see how he could have missed the housing bubble forming. But he did miss the fact that financial markets couldn't handle the risk they were taking on. How do investment banks leverage 30 to 1 and claim that risk is diverse enough to handle it. At what point does the Fed step in?
As for spotting the disease next time, notice that Wall Street is once more ratcheting up risk and Bernenke is silent. And why expect that it will be the same disease next time? The danger lies in the fact that accommodaters are accommodaters. Bernanke, Geithner, and Summers are accommodaters, and they should all go. You need someone at the Fed who is willing to take the punch bowl away before a potential disease becomes life threatening to the economy.Wall Street isn't performing an important task for our society. It's speculating or investing with an eye to its cut. It's not spreading capital around in the economy efficiently. In fact it's harming our society. it wasn't long ago that a retired health insurance executive was complaining that shareholder's expectations of quarterly return set by Wall Street were terrorizing health insurance companies into denying claims.
Wall Street doesn't help Main Street; it helps itself. We need more than a financial skeptic as head of the Fed. We need a financial ogre who is willing to terrorize Wall Street.
Posted by: wjd123 | Link to comment | Aug 13, 2009 at 02:55 AM
bob mcmanus says...
Matt Tabibi for Fed Chairman.Posted by: bob mcmanus | Link to comment | Aug 13, 2009 at 03:28 AM
bob mcmanus says...
Oh, and I think there will be other seats for Obama to fill.So Elisabeth Warren, L Randall Wray, and Jan Toborowski.
Palley or Perelman would be fine.
Posted by: bob mcmanus | Link to comment | Aug 13, 2009 at 03:32 AM
vimothy says...
I thought that before the crisis hit, risk premia in all asset classes were being reduced, which was why despite widespread consensus that something was going to give, it was very hard to call precisely where that would be. Did Rodrik call it exactly right?Posted by: vimothy | Link to comment | Aug 13, 2009 at 03:55 AM
bakho says...
I am not sure that a person with otherwise qualifications for the Fed would also be sufficiently skeptical to suit Rodrik. I do think that we would be better off with someone more favorable to regulations than Bernanke.Posted by: bakho | Link to comment | Aug 13, 2009 at 04:22 AM
bakho says...
Obama is a "don't rock the boat" kind of guy. Bernanke could be the compromise choice. Clinton kept Greenspan in part because he did not want a confirmation fight with the Republicans. That did not work out so well. Keeping FBI Director Freeh worked out even worse.What would happen if the Senate blocked a Fed Chair the same way they are blocking the Secretary of the Army in a time of war?
http://www.wwnytv.com/news/local/52627962.html
Posted by: bakho | Link to comment | Aug 13, 2009 at 04:28 AM
ken melvin says...
The financial problem was but a wee bit of the overall that hasn't yet been meaningfully addressed. If Bernanke's the man to run the Fed the question remains as to who is best to for Secretary of Treasury, and, even who best to be President.Posted by: ken melvin | Link to comment | Aug 13, 2009 at 05:13 AM
OrganicGeorge says...
wjd123Amen
Posted by: OrganicGeorge | Link to comment | Aug 13, 2009 at 05:21 AM
Robbie says...
"Even when not formally designated as such, central banks have become the guardians of financial-market sanity. The dangers of failing at this task have been made painfully clear in the sub-prime mortgage debacle. ..."Bernanke is nothing more than a glorified janitor. As a custodian of monetary policies he has been great, but he seems to lack any sense of anguish when dealing with regulation of credit and systemic risks.
It does not take a genius to open up the discount window. So don't confuse the reaction to crises as a the only qualification for a great leader of money.
Dani Rodrik is correct when asking for the anti-Greenspan; We need a FED chief that is going to make finance sweat from the heat of a stern and omnipotent regulator.
Mike Bryan cautions about difficulties in interpreting seasonally adjusted numbers for new unemployment claims and inflation when the cyclical downturn has been as severe as this one.Tim Duy looks at the ISM indexes, consumption, and auto sales, and concludes "mounting evidence points to the formation of a rather clear bottom in the most recent stage of this economic cycle." Even so, Tim's forecast is on the pessimistic side.
I joined many of my colleagues in urging Congress and the President to remember just how valuable an independent central bank is for the ordinary citizens of this country. You may not pay much attention to central bank independence. But you'll miss it when it's gone.
And Paul Krugman has this to say about record profits for Goldman Sachs:
First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America. Second, it shows that Wall Street's bad habits-- above all, the system of compensation that helped cause the financial crisis-- have not gone away. Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.
Posted by James Hamilton at July 17, 2009 01:33 PM
Comments
Paul Krugman objected early to the Paulson proposal to purchase toxic assets. He proposed direct infusion of cash into the banking system instead. Paulson later accepted his proposal.Both solutions share a common characteristic. They propose to rescue the banking system without reforming it. The focus on stimulus shares the same defect - more spending money without guarding against past mistakes.
Paul is a brilliant writer but he can be wrong sometimes, just like the rest of us.
This country needs reform, not an attempt to keep the old system going.
Posted by: ReformerR at July 17, 2009 05:56 PM
"You may not pay much attention to central bank independence. But you'll miss it when it's gone."First, please redefine the mission. Fighting inflation is acceptable. how about "supporting economic growth" or "preserving the banking system"?
Congress needs to decide what the Central Bank should not do under what conditions and retain the right to reign them in when they exceed their mandate.
Preserving the banking system is a valid goal so long as said system is serving the interests of the economy by providing money to fund business and credit to households. When the banking system begins to focus on serving its own ends (creating profits out of gambling with each other in a rigged system), Congress should have some way of saying "Stop - turn around".
Independence in terms of deciding how to accomplish its mission. Not independence in deciding when it has strayed beyond its mission.
Posted by: ReformerRay at July 17, 2009 06:10 PM
The banks profits are fallacy, they would deserve to be re audited through sampling. The ongoing complicity in the financial spheres does not seem to be conductive of a real rehabilitation of the economies.
Nothing has changed Banks outsmarting the real economy and the rest struggling.
P Krugman is right,all the seeds and sediments are still here to blossom in a new crisis (most likely to be a debt crisis)Posted by: PPCm at July 17, 2009 10:27 PM
"the evidence for economic recovery"Evidence? Are you a commie? You appear to be stuck in the reality based industry. What you don't understand is that Larry, Timmy and Ben are part of the empire that creates reality.
Posted by: Barack W. O'Bushma at July 18, 2009 07:10 AM
Central Bank independence is not something that you legislate. Sure- you can insulate the bank somewhat through , for example, lengthy terms of service, but the core of independence is in the backbone and vision of the Chairman and other members that serve. In recent years the Fed has lost its vision - it gave us multiple bubbles and it failed to prevent the derivatives debacle. Now the Fed is trying to redeem itself through massive backdoor spending. Fed policies may be characterized as institutional convenience - a win/win situation for them. For example, the Fed acquiesced and supported financial deregulation and the general hands off approach to financial markets consistent with the governing political party. The Fed had no shortage of justifications for their stance. On bubbles, the Fed told us that they were hard to identify, that the market would self-correct, that the time lags in Fed policy might do more harm than good, that it was not the Feds job to substitute its opinion for the markets'. In other words, it was convenient for the Fed to subordinate itself to the going political climate - that way you avoid the resulting "heat" - a win for the Fed. The story gets even better for the Fed. When events go badly, as with the derivatives debacle, you can save the nation with massive backdoor spending. It's a win/win policy for the Fed.Posted by: fwm at July 18, 2009 08:13 AM
The Federal Reserve has only two congressional mandates as confirmed by both Alan Greenspan and Ben Bernanke: to promote 1) full employment and 2) stable prices.This mandate does not allow the FED to be independent forcing the FED to attempt to hit two targets with one arrow. This mandate has created a paradox for the FED. Based on Keynesian-Phillips curve theory they expand the money supply in an attempt to increase employment but then prices become unstable so they institute policies to hold prices down which in theory creates more unemployment.
The result is that the FED works directly with Treasury and must coordinate with congress as they pass legislation.
Professor, I understand your intent, but perhaps more importantly I understand the intent of Treasury and Congress and they absolutely will not allow an independent FED. Since money was invented government has used it to steal from the people whether clipping coins or imposing stimulus plans.
Posted by: DickF at July 20, 2009 07:11 AM
Paul Krugman wrote:...it shows that Wall Street's bad habits - above all, the system of compensation that helped cause the financial crisis - have not gone away.
This is just another example of a whole list of examples of how awful a writer Krugman is. Not one person lost a house because someone at Goldman got a raise. They lost their home because, as Krugman does correctly point out, "Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman, famously, made a lot of money selling securities backed by subprime mortgages - then made a lot more money by selling mortgage-backed securities short, just before their value crashed. All of this was perfectly legal, but the net effect was that Goldman made profits by playing the rest of us for suckers." But these subprime mortgages and mortgage-backed securities were created by Fannie and Freddie so that they could continue to feed the real estate boom. Goldman and others were simply the instruments to flow these toxic assets to other investors. Goldman Execs got huge raises because they were good at doing what the government (can you say Barnie Frank) wanted them to do and the goverment has rewarded them handsomely for it.
One last Krugman stupidity, the economy was not "financialized" because of deregulation by the Reagan administration. It became "financialized" after Richard "we are all Keynesians now" Nixon floated the dollar and institutions stepped up to create instruments to hedge against monetary instability. The Reagan years were years of monetary stability in a sea of monetary instability that has once again reared its ugly head.
Posted by: Anonymous at July 20, 2009 09:03 AM
"Central bank independence" is a fig leaf. Central banks were created by governments to serve their long term financial needs, when nations outgrew the ability of commercial banks to satisfy those needs. Holland,I think, was first in the 1600s. The fig leaf is useful for governments to sell the idea to the populus. Its also useful for the central bank to give them maneuvering room. So both parties maintain the mantra. When governments stop getting the long term results they want from their central bank, they change them. Its called reform, but so much for "central bank independence". Check out the history of central banks - you'll see - Bank of England, J.P. Morgan saving the US system in 1907, etc.Posted by: Mike Laird at July 20, 2009 02:09 PM
Mike Laird: The Federal Reserve Act was passed in 1913. What is the U.S. central bank of 1907 to which you refer?I do not see how anyone could deny that the ECB is institutionally better insulated from fiscal pressures than the U.S. Federal Reserve, or that the U.S. Federal Reserve is institutionally better insulated from fiscal pressures than is the Reserve Bank of Zimbabwe.
Posted by: JDH at July 20, 2009 03:16 PM
As an Obama supporter (overall, versus the - ugh! - alternatives), I cringed when I saw the GS numbers. GS is clearly earning its profits primarily from politics, not markets, and I don't doubt that some of that will be obvious enough for Republican muckrakers to figure out and utilize in the 2010 campaign.
Posted by: Tom at July 20, 2009 03:26 PM
JDH, as you know, there wasn't a US central bank in 1907. You probably know that J.P. Morgan, as a private banker, provided the funds to stop the panic of 1907, when governments were unable. But he really tweaked the President and other Federal officials in his behavior while providing the funds. The financial panic and the personal abuse of government officials made it clear that a central bank was needed in the US because private commercial banks could not be counted on. The US had out-grown them. That's my point. Hence the Fed Act in 1913. It has happened in every major economy since the 1600s.I presume you are correct about various central banks being better or worse insulated from day to day pressures. Still, central banks are created by and serve as an instrument of a national government. When the national government does not get the results they want, change happens. Central banks are not independent - only insulated to varying degrees from various pressures. Maybe that's what you meant to say? It leads to a discussion of what pressures and what insulation is appropriate, rather than blanket statements about "independence" that does not exist.
Posted by: Mike Laird at July 22, 2009 02:13 PM
Regarding Fed independence.The fed sets policy. Policy is political.
If you don't like politics, that's understandable. However, the idea that the Fed can somehow really be above politics is merely to engage in self-deception.
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This may turn your head upside down but real conservatives would be progressive right now; the "conservative" movement is actually reactionary, authoritarian, and opposed to the freedoms outlined in the constitution, itself a progressive document.
America goes through cycles of corruption and reform in our religious, political, and economic lives. Markets, banks, and the wealthy have attained outlandish powers in the past, only to crash in panics, banking scandals, and personal and professional misfeasance or failure. Our founding fathers were anti-religious in the sense that the Catholic-Anglican Protestant conflicts of Europe were part of the founding of the colonies, a dumping ground for religious outcasts that resulted in conflict and later the Great Awakening.
We are in a crisis right now. The conservative move would be to use what has worked repeatedly in the past under Progressives. Root out corruption. Provide for the common defense, promote the general welfare and secure the blessings of liberty to ourselves and our posterity yada yada yada.
The reactionary move is to consolidate everything under a king or an oligarch and reject democratic government (Michigan), multiculturalism (Buchanan), Gitmo gulags, open society and secularism, go back to gold backed money (Beck, Pauls), maybe establish a national church (Southern Baptist vs mall church vs Catholics).
I don't think we will get to a happier medium without some painful convulsions.