Month: March 2009 Page 1 of 4

A lot of folks are beginning to notice that Obama isn’t a liberal in economic terms.  His policies and the advisers he’s surrounded himself with make that increasingly difficult to ignore.

Democrats, liberals and progressives have no excuse not to know this.  It was clear during the primaries.  No lesser person than Paul Krugman noted it repeatedly, as did lesser comenters like myself.

Next time Paul Krugman tells you something like “Politician X is the least economically progressive of the 3 major candidates”, please listen.  Or if I tell you, consider at least listening.

Yes, saying “I told you so” is bad manners, but frankly, I’m a little bitter about this.  I don’t know if  Clinton or Edwards would have been noticeably better, but I do know that their concrete, actual policy proposals at the time were more progressive than Obama’s were, so the odds were at least slightly better.

Oh well, maybe we’ll get another chance to do it right in 4 to 8 to 12 years.  In the meantime we are reduced to hoping that dear leader will have a change of heart and that Congress will still be cooperative enough if or when he does for it to matter.

The saddest thing is that it was a Democratic year.  Odds are that almost any of the Democratic candidates could have won the general.  So the candidate could have been more progressive and still been elected.

Well, well, well.  I see Obama has pulled out another card from the Bush playbook.  Not only has he forced GM’s CEO to resign, he’s threatening to send them into bankruptcy if they don’t get enough concessions from workers and bondholders (Tom Bratwaithe, FT, not online as of this writing):

Officials said on Sunday night that Chrysler would be given 30 days and GM 60 days to reach agreement with debtholders and unions, with new tougher targets for cost cutting, or they would lose their last chance for a government bailout, almost certainly sending them into bankruptcy.

Wow.  Tough talk, maybe even tough action.  I’m impressed.  Impressed by his willingness to talk this way and act this way towards non-financial companies that is.  Somehow when it comes to banks and brokers Obama’s practically begging them to keep the money they’ve been given, and assuring everyone that they won’t be forced into bankruptcy or nationalized.  Somehow his words of outrage at bonuses don’t include forcing companies like AIG, Bank of America and Citigroup to renegotiate thier compensation contracts by saying “do it or you go down”.

Nope, it’s not people making high 6 figures, or 7 figure salaries and bonsues who are forced to take a haircut. It’s not bondholders of financial corporations like Freddie and Fannie who are forced to share in the pain.  It’s only workers and bondholders of industrial companies.  Imagine that.

There are a ton of cynical things I could say about this, but I’m going to point out something more fundamental: long run the US needs its industrial sector healthy and strong more than it needs an overpriced, overpaid financial sector.  One major long term problem the US has is its trade deficit.  Financial companies don’t noticeably help that, what they do instead is package up paper assets for sales to foreigners, but those assets are almost all debts.  Everytime the US sells a collateralized debt ogligation, it’s selling its future to foreigners.  Every time it sells a car, it’s getting money now for a real item now.

Smart restructuring of the economy would mean figuring out how to create a car industry and an industrial sector that stays in the US and doesn’t move all its production and R&D overseas, rather than trying to restart the paper for money financial economy, an economy which caused this financial meltdown and which has been partially responsible for stagnant wages for Americans for 30 years now.

I will also note that a real bankruptcy for the Big 3, would cause in excess of two million job losses and worsen the US’s trade deficit.

Tough love isn’t necessarily a bad idea, but I hope Obama is playing chicken and isn’t entirely serious.  Because if the Big 3 go under, well, this economic downturn will get a lot, lot worse.  And perhaps, just perhaps, he might somehow find whatever it takes to apply some of this tough love to the financial companies who caused this crisis, rather than the car companies who are largely collateral damage?

Because I find it very hard, as a matter of basic fairness, and a matter of basic policy, to stomach seeing workers earning 5 figures being forced to take wage cuts while bankers are still making huge 6 and 7 figure salaries.

Image by J. McPherson

Here’s a partial scorecard for looking at the administration’s regulation plans next week.  What Obama should, in my opinion, of course, do, along with notes on how likely I think it is.

Is Obama going to regulate Collateralized Debt Swaps like insurance, meaning that you can’t insure something if you can’t pay it back and you have to use government mandated tables, make sure there’s insurable interest, not allow over-insurance and so on?

Will Obama do this?  He may do some of it, but I doubt he’ll do all of it.

Is he going to limit leverage properly, by which I mean not just not allowing leverage rations above 10:1, for anyone, but not allowing leverage on leverage – not allowing someone to use a leveraged asset to leverage off of.

Will Obama do this?  Maybe, maybe not.

Is he going to properly regulate securitization? By which I mean not allowing securitization of already securitized assets, full reform of the ratings agencies so they have no incentive to over-rate securities, not allowing collateralized assets to have higher ratings than the underlying securities, and not allowing financial innovation which is not approved by regulators?

Will Obama do this?  We’ll see.

Move to highly progressive taxation. If he doesn’t do this executives will always have an incentive to create bubbles because they will be able to make so much money in a few years that it doesn’t matter what happens to their companies in the long term.

Will Obama do this?  No.

Is he going to move to a financial transactions tax like the Tobin tax in which every transaction is taxed a little bit so that if the government gets stuck with the bill again, it’s been collecting cash for the job of cleaning up banker’s messes?

Will Obama do this?  Hardly.

Is he going to break up the “too big to fail” banks and other financial firms so that in the future failed financial firms can just be put into receivership and can’t hold the economy bankrupt?

Will Obama do this?  Don’t make me laugh.

Is he going to reinstitute the Glass-Steagall provisions to not allow brokers, investment banks, commercial banks and insurance companies to conglomerate?

Will Obama do this? Hardly.

Is he going to tell his Attorney General to engage in widespread fraud investigations as to whether mortgages were sold fraudulently, Collateralized Debt Obligations were created fraudulently, and Debt Swaps were sold fraudulently?

Will Obama do this?  Probably a few prosecutions, but nothing wide ranging.

Is he going to try and pass anti-usury laws?

He’ll try.  But somehow they won’t pass.

Is he going to spend as much money, or even half as much money, helping homeowners and people who  lost their jobs as has been given to banks and financial firms?

Will Obama do this?  No.

I’m hoping to be surprised on the upside here.  Of course, any regulations are only as strong as the regulators will and resources to enforce them, so the other question will be “is this all for form?”

We’ll see.

So very, very tiresome:

If populist outcries over bank compensation continue, no company will touch “any other government program with a ten-foot pole,” Stephen Stanley, chief economist at RBS Greenwich Capital Markets, wrote in a March 19 note.

This is what happens when firms are too big to fail and they know that the government doesn’t have the guts to nationalize them or really look hard at their books and make them go into bankruptcy if they’re, well, bankrupt.

No bank which doesn’t need the money should have the money.  But because there has been an unwillingness to really look hard at bank books and to evaluate them, we don’t actually know if they need it.  The “stress” tests which are underway don’t count since they don’t include hard looks at the loans and securities real values, and use an overly optimistic economic scenario.

But assuming that real financial audits had been done, you’d know whether banks need money.  If they did, you give them two options:

1) Take it.

2) We’ll put you in receivership or nationalize it.

It shouldn’t be a goal to force money on banks that don’t need it.  Either they need it, or they don’t.  If they don’t, by all means, let them go about their business.

As for getting lending again, the simplest solution is still nationalization and using the banks nationalized to lend, since once the government controls them it controls whether they lend.  The second easiest is to have the Fed just lend directly to consumers and businesses, rather than trying to do it through unwilling banks.

Instead we have this silliness where the banks, who have had trillions of losses, say they don’t need help but will take it for the good of the country.

Of course, it’s getting more and more true.  Once the Treasury, Fed and FDIC take all their bad bets off their hands at prices which are more than they could get in the real free market, then they’ll be able to go back to paying themselves ridiculous bonuses for being incompetent fools who blew up the entire world’s financial system.  Until that happens, they’ll whine, but do enough of what they’re told to not upset the gravy train.

And that’s because neither Bush nor Obama had the guts to toss the vast majority of them out on their ears.  Because of that we will have another crisis, guaranteed.

In poker they say “bet the people, not the cards” and I’m willing to bet these incompetent greedy fools have another disaster in them.  It may take another 4 to 8 years, but having gotten away with this one, they’ll do it again.

Bet on it.

Image By Ennor

I have become increasingly concerned that some in the Obama administration are treating this economic crisis as a Black Swan event. Nassim Nicholas Taleb coined the term to describe an event that is very rare, random and unpredictable. The imporant thing about Black Swans is that, because they are random and unpredictable, you can’t stop them from happening; you can only create your systems able to  handle Black Swans if they occur. For example, a flu pandemic that kills tens of millions might be a Black Swan, and it’s one that we’re completely unprepared for, as we don’t have the excess medical capacity to handle it.

The most recent event which made me think of Black Swans is the news thatnew SEC Chair Mary Schapiro doesn’t plan on reforming ratings agencies. Now, ratings agencies were one of the key actors in this mess—they certified mortgage backed securities and other toxic derivatives as AAA quality. If they had not done so, almost no one would have bought them.

The ratings agencies are paid by the companies whose securities they rate. I trust you see the problem.

If you think that the current economic crisis is just random, a once in a century disaster (or at least once every few decades), then you won’t think making major changes is necessary. Get through the problem, go back to how you were doing things before, and everything will be fine.

But, of course, the economic and financial crisis unfolding right now was not random. This crisis was predicted by multiple people, and it was predicted because of policy steps taken by government and widely-known private actions.

We could all read the charts showing a bubble in housing prices and sales. We could all see that derivatives were also in a bubble. We knew that leverage was out of control, ballooning to 30X or in many cases even higher numbers. We knew that with financial deregulation firms had started being involved in multiple types of businesses, putting retail banks at risk from their insurance or brokerage or investment banking arms. We all knew that the US savings rate had hit unsustainable lows and that the trade deficit was too high. We knew that the carry trade was introducing tons of hot money to the system (borrowing for nothing in Japan and using that money for leveraged plays elsewhere).

And, perhaps most importantly, we should have known that executives in the financial sector paying themselves huge bonuses were concentrating on short term gains and did not care about long term viability of their companies or even care about the honesty of what they were doing, because hey, by the time it all fell apart, they’d be rich, rich, rich and never need to work again.

All of which is to say the crisis was caused by a number of factors. It was not random. It was predictable and predicted. If we just muddle through this current meltdown—spend a lot of money bailing out the banks, throw some stimulus around—and don’t fix the fundamentally-flawed incentives and structures of the system, it will likely happen again.

Alas, Mary Schapiro’s actions imply that there was nothing really fundamentally wrong with how business was done.

At the very least, the US needs to make the following changes:

• Reduce executive compensation—significantly,
• Bring all securities under regulation (i.e. Credit Default Swaps must be regulated as insurance including reserve requirements and the necessity to use government approved actuarial charts),
• Reduce overall leverage to 10X for everyone,
• Break financial companies back into functional firms (i.e. break brokerages and insurance companies and investment banks off of retail banks),
• Disallow financial innovation which is not expressly approved by regulators and is not then fully regulated,
• Fix its trade imbalances,
• Fix its savings rate,
• Move off of the oil economy,
• Ensure that lending is done responsibly and at relatively low markups from the Fed Funds rate, and
• Enact anti-usury laws.

If these changes aren’t made, then you can bet dollars to the donuts that a financial crisis will happen again in some form. This crisis is a structural problem, not a random mess caused by bad luck.

Originally Posted at FDL, February 19th, 2009. I’d say nothing has changed, but in fact it has, we now know pretty much for certain that the Obama administration thinks this is a Black Swan event.  The Geithner plan makes that very clear.