Ian Welsh

The horizon is not so far as we can see, but as far as we can imagine

Category: Financial Crisis Page 10 of 12

The Fed and the Pay Czar’s Executive Compensation Restriction Plans

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On October 23, 2009

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So, the Fed has unveiled its plan.  Details are somewhat sparse, but as best I can tell:

  • It won’t significantly reduce pay
  • It will concentrate on risk management, which is to say trying to tie pay to longer term measures rather than shorter term measures
  • The big banks will have to give their compensation packages to the Fed upfront, but the review will be confidential.  Only the bank and the Fed will know the contents of the review.
  • Small banks will have their pay reviewed when they are examined.

Meanwhile, Feinberg, the pay czar, has restricted compensation at bailout recipients.  Cash compensation is restricted to 500K a year until they pay back the bailouts, but once they do they can receive more, and they do have bonuses tied to various goals given by the treasury till then.

I am skeptical.  The end result of Feinberg’s plan will simply be that the companies will pay off the bailouts as fast as they can, even if that means borrowing the money at higher rates than the feds have loaned it to them.

As for the Fed’s plan, it requires us to trust the Federal Reserve to really restrict pay and to really understand what type of compensation creates long and short term risks. Given the Federal Reserve’s track record in understanding systemic risk, which indicates they have no understanding of systemic risk worth speaking of, I’m skeptical that they can do this.  And that assumes one trusts the Fed to tell its friends in the banks they can’t have what they want, which, again, given their track record, is questionable.  Especially when the Federal Reserve itself seems to essentially be run by Goldman Sachs.

Furthermore, the Federal Reserve is confused.  When they say it’s not about “social equity” it’s about risk, what they mean is “we don’t mind them getting paid a lot of money if it doesn’t lead to risky behavior”.  But receiving enough money in a year or 3 years to retire inevitably means that people will engage in risky behavior because they don’t need the job.  They may want to keep it, they may like it, but if their company goes under, at the end of the day, they’re still going to be rich, rich, rich—and never have to work another day of their lives.  And, after all, even if they do blow it, this crisis shows that the government will probably bail them out so they probably will keep their jobs.

Paul Volcker, the last good central banker the US had, is right.  This finicky micromanaging won’t work.  He’s right to want to break the banks back up, dividing retail banking from investment banking. And while as far as I’m aware he hasn’t suggested high marginal taxation as a solution to the perverse wage incentive issue, that’s my suggestion.  Just tax every dollar after 1 million, on all income equally and with no deductions, at 90%.  Tax every dollar after 5 million at 95%.

The objection to this sort of taxation, or any other severe restrictions on excessive pay is:

But, bowing to concerns that too heavy a hand could lead to a mass exodus of executives, both the Treasury and Fed policies will permit top earners to reap millions of dollars.

This is insane.  These executives are the folks who lead the world to the greatest financial crisis since the great depression.  The goal shouldn’t be to keep them working, the goal should be to convince them to quit.  Let some middle managers take over, it is beyond comprehension that they could cause a greater disaster, and if they are only earning a few hundred K a year, they’ll have every incentive to turn their banks around so they can keep their jobs, which they’ll actually need to keep unlike the current generation of overpaid, incompetent, executives.

These executives’ management lead to the greatest destruction of wealth and the largest job downturn in post-war history.  They did so by pushing products and practices which were frankly fraudulent. In a sane world, huge criminal investigations would be ongoing and most of them would be spending all of their time huddled with their lawyers, rather than sending out millions of dollars worth of lobbyists.

However, as a second best scenario, their pay should be restricted, and if that makes them leave, well, that’s a bonus.  Let them go work for companies in any country stupid enough to want them.  Hopefully if not operating from the US anymore they’ll only be able to trash their new host economy, and not the entire world economy.  These men and (a few) women, are parasites who feed off and damage their hosts.  They are not a benefit to the country or company they work for, but an active hazard.

I’m glad to see the Fed and Feinberg doing something.  But it’s not nearly enough, and it won’t be sufficient to stop the same suspects from causing yet another financial crisis.

Actually 1930s solutions stopped financial crises for decades and would work now

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On October 22, 2009

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Mervyn King, the Governor of the Bank of England had the temerity to suggest that banks be broken up into retail banks and investment banks, thus reducing risk and making them smaller so they aren’t “too big to fail”.

Today the Labor government shot back that such a solution is a 1930s solution, but these days it wouldn’t work. The conservatives suggested that they would only follow King’s suggestion if every other country did too. Which is to say, they wouldn’t.

There’s a strange idea in Britain that the financial sector, which is to say “the City”, represents a comparative advantage for them. This idea mirrors the American belief. Both countries are wrong. What has happened instead is that over-sized fraudulent leveraged returns in the financial sector have driven out investment in the real economy. And since those returns were and are fraudulent, when the collapse came the real economy, aka: taxpayers, had to bail them out.

Over-sized, over-powerful financial sectors are parasitical on the real economy, and actually damage it. This is a clear lesson historically, where economic financialization of any country larger than a city state is almost inevitably disastrous.

What is occurring right now in England is a huge amount of slashing of basic services, as both Labor and Conservatives compete to cut, cut, cut. Huge amounts were spent on bailing out the banks, and now it will be paid for by ordinary people. This is a direct transfer of wealth from the real economy, to the financial economy.

England would be better off with a much smaller, weaker financial sector composed of banks small enough to be allowed to fail. If the possibility of them being taken over is Brown’s real fear (and it may well be) then simply create some ownership restrictions to keep them in British hands.

Splitting banks into retail and investment banks, keeping brokerages and insurance companies separate as well is part of a solution set which kept major financial crises like the recent one from happening for most of the second half of the 20th century. It was put in place by people who were experiencing the Great Depression and had learned the lessons of the roaring 20s.

The inability of our decision makers, whether British, American, Canadian or otherwise to understand those lessons and take action is why it is inevitable at this point that we will have an economic collapse. It is, at this point, all but inevitable, not because nothing could be done to stop it, but because no one will do what it takes.

Such a collapse may be as far as two economic cycles out, or it may be sooner, but it will happen. And the sort of non-argument made by Brown “not a 21st century solution”, which is content empty, is why. The real reason is cupidity. Both the British and American governments are completely captured by monied interests and will do nothing significant to reign in those interests, no matter what the costs or consequences for the majority of the population.

And so those consequences will ensure. By not making another financial crisis impossible, they are making another financial crisis inevitable, and next time it will be even worse.

Um Yeah, TARP is “profitable”

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On August 31, 2009

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Seriously, the idea that TARP is making money is overly narrow, and those who are claiming TARP is turning “profits” don’t understand how this works.

The FED has large special loan facilities to banks, in which it gives them money in exchange for underwater securities.  The FDIC has guaranteed huge amounts of debt issue by the banks.  The FED is letting banks keep bad securities on their books at whatever value they want to claim.  And they are loaning out money at concessionary rates while banks jack up interest rates to consumers, earning spreads of well over 20%.

So yes, the banks are making “profits” and so is TARP.  But not only wouldn’t they be making profits without massive subsidization and what amounts to accounting fraud, whether or not the government is making money overall, or will in the end, on its full panolpy of loans, guarantees and cheap cash is unclear.

Money is fungible.  Give money to one part of an entity, or enable it to borrow money cheaper than it should be able to (that’s what FDIC guarantees are about), or don’t make it recognize losses on its books, and it can take the “profits” it creates and send some of them to repay TARP loans.

TARP is making money because it was decided that it had to make money.  So instead of forcing banks to take losses, or withdrawing special loan facilities, or ending concessionary rates, or making banks retire guaranteed bond issues and reissue them  without the guarantee the banks were encouraged to “repay” TARP.

But if you think that means that the overall panolpy of government aid to banks was profitable, you aren’t looking at the whole picture. It’s like making 5 loans to your deadbeat cousin, and he pays back one while not being able to pay back the others and you say “I made a profit!”  Not yet.

But I’m sure Bernanke and Geithner are pleased that so many folks have fallen for their shell game.

No Banks Means No Banking Crisis

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On August 29, 2009

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Joseph Stiglitz, the Nobel Prize-winning economist, is suggesting we let banks fail.

This is a slightly more radical version of what I’ve been saying* for some time:

  • We don’t need the current banks.
  • If they won’t lend, let them go under.
  • If the Fed can lend to banks, it can lend directly to banks and consumers.

The following article was originally published Feb 2, 2009.  I am reprising it here because the reminder seems necessary.

No Banks Means No Banking Crisis

Banks exist to act as intermediaries between central banks and those who need credit.  Banks are given the ability to create (yes, create) money through fractional reserve money, and they also have the right to borrow money at rates that no one else can receive.

Image by Twolf

Image by Twolf

If you could take your money, multiply it by 10 (that’s not the exact number, but as an example) and lend it out, do you think you could make a profit?  If you could borrow money at 1- 5% and then lend it out for more than that, in some cases 15% more, do you think you could make money? That’s how banks operate.

Banks are thus given an incredibly valuable privilege by governments.  It’s really hard to overstate how easy it is to make steady returns as a bank as long as you don’t get greedy.

In exchange for the right to create money and borrow it at rates no one else gets, banks are expected to add some value to the equation.  Specifically, banks are expected to figure out who is a good credit risk, and where money should best be loaned and used.  There are two sides of this arrangement:

  1. Money should be loaned where it has a high return.
  2. It should also be loaned to people who can pay it back.  And it should be invested in the same way, return averaged with risk.

Banks have not been doing this.

Banks have been seeking out the highest return without taking risk into account .  Instead, they have been seeking out high risk for high returns.  They haven’t been adding value.  They also haven’t been performing the taks of getting money to the people who can use it best.  Banks took the money and invested in securities which were essentially fraudulent, in a bubble that any idiot could see would not last, in non-productive financial industries.  They didn’t invest in manufacturing, by and large, or new technologies or alternative energy, or anything particularly useful.  They didn’t use money to actually grow the economy—GDP was going up, and profits were going up, but the illusion of growth was based on multiple financial bubbles that weren’t sustainable and didn’t indicate any real prosperity underneath.

And when it came to loaning to ordinary people, in many cases, they were lending at usurious interest rates.  (What’s your credit card’s interest rate?)

In exchange for the very valuable privilege of creating money and borrowing at lower rates than anyone else get, banks weren’t creating value for the economy; they were destroying value.

Stiglitz is right.  There’s no reason to keep banks around, at least not this bunch of banks.  Let private investors take their losses, guarantee deposits, do a clean up as best you can and create new banks.  Or in the case of the US, maybe not…

Instead, what needs to be done is to just have the Fed lend directly to consumers and businesses.  Let everyone switch their credit card to a Fed card, and as a one time thing everyone can switch over up to a $10,000 balance.  The interest rate?  How about the top end of the Fed Funds rate +4%?  Right now, that would mean a 4.25% interest rate.  If people default, well, garnish their wages.  You’re the government.

Start lending to businesses.  Base lending it off credit ratings after you take over the ratings agencies, or force reform, because the rating agencies demonstrated they are worthless when they rated much of the junk that’s now imploded as great credit risks.

In time the central bank makes these loans conditional—you can borrow money from the Fed only for certain things:

  • Want to buy a house to live in?  Sure, you can borrow the money in one of 5 standard mortgage styles.
  • Want a vacation home or an investment home?  Go to a commercial lender.
  • On your credit card, want to buy food?  Great.
  • Want to put a vacation on your card?  Forget it.
  • Want to buy a fuel efficient car?  Sure.
  • Want to buy a gas guzzler? Get your financing somewhere else. (Not that this is much of an issue, given the low rates car companies give.)

Of course, the Fed may not want to be in the business of looking into too many things too deeply.  So something like banks is useful for when folks do want that vacation, or that second home, or to borrow money to start a business as opposed to just a credit line for one that’s ongoing.

Fortunately there is one group of financial institutions in the economy which has done a good job as banks, even though they aren’t called banks: America’s credit unions.

Help credit unions expand, offer them better credit, get them together to set up wide ranging ATMs so folks can get their money anywhere.  Use the one part of the system which, because they aren’t stock companies driven by quarterly results and don’t expect multi-million dollar bonuses, didn’t get involved very much in the greed driven stupidity of the last few decades.

As for the banks, if they can survive on their own, great.  If they can’t, nationalize the banks and slowly wind them down.  It may take years, but so be it.  Wipe out the shareholders completely (they took the money in the good years).  Give the creditors what they deserve, if there’s anything left for them.  Move the deposits over to healthy banks or credit unions.

Stop throwing good money after bad.  Something like $8 trillion has been spent, loaned and guaranteed so far and it hasn’t stopped the crisis.  Take the losses, find out where the bottom is and build a new system.

This will also lead to a more vibrant society in the long run.  Banks have been abusing the privileges they received and as a result credit for the things America really needs has dried up.  Wanted a loan for a hedge fund?  No problem.  Wanted a loan for a new company employing hundreds that would only make 5% to 8% a year?  Probably not.

But it was the hedge funds returns that were fake.  And it was the small businesses that never started because they could only make 5% a year which could have produced real value and lasting jobs.  If you want people to start new businesses, if you want consumers to spend, then giving them credit at reasonable rates, and making that credit available, is what has to be done.

At the same time, due diligence has to come back into the equation.  Everyone in America needs a credit card.  Might as well just give them one.  Without it you can’t rent a car, stay in a hotel or really interact in a modern society. But eveyone doesn’t need or deserve the same credit limit.  And everyone doesn’t need a home equity loan, in fact very few people do.  Let the Fed do the drop dead easy lending “you have an income of $50,000 a year, you want a mortgage where you will pay $10,000 a year, that’s under 30%, you can have it”.  Have the credit unions and the few remaining banks do the more speculative lending, but watch them like hawks.  And take the credit bureaus and the ratings agencies under government sway, and either nationalize them or regulate the heck out of them, so that the ratings they give mean something.

Add in some federal anti-usury laws (no interest rates above fed funds + 15%, on anything, including fees) and you’ve got yourself a full new banking system where credit is available to those who need it at reasonable rates, while reasonable oversight is occuring.  And because so many investors and lenders were wiped out, well, the lesson will have been learned, for a couple generations, that if you do really really stupid things, the government won’t just bail you out.

No more privatizing profits and socializing losses.

*For more on this topic

Memory Lane on the Paulson/Goldman Stickup: What I wrote Sept 20, 2008 and why it matters today

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On July 17, 2009

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Because sometimes, I told you so is necessary, in the hope that next time people might listen.  This is what I wrote September 20th, 2008:

This is a stickup. Paulson is trying to stampede the Congressional herd into giving him powers and money that he knows they would never give if they had time to think it through carefully. It worked with the Patriot Act. It worked with the AUMF. He’s betting it’ll work again. Create a crisis (or lie one into existence) then demand dictatorial powers and unlimited spending authority to deal with it.

Congress needs to not succumb to fear or to explicit or implicit blackmail. If the crisis was as severe as Paulson makes it out to be, virtually the end of market capitalism, he wouldn’t be quibbling over whether or not CEOs get to keep their golden parachutes.

In effect, that quibble is like you walking into your local bank and saying “I need you to loan me a million bucks. Here are the conditions I must insist are met before I let you lend me the money. First…”

Say what?

He’s given his tell, that he’s a liar, a thief and a scam artist.

Time for Congress to call his bluff, and to see that the financial crisis is dealt with on their terms, with strict oversight by people they can trust, not by a scam artist and liar like Paulson.

Of course, Congress didn’t call his bluff and Congress did fall for it.  But let’s remember our history.  The House voted against.  Nancy Pelosi indicated that she would not pass TARP unless Republicans voted for it in the same proportion as Democrats.  They weren’t going to do that, so TARP was dead.

Then Barack Obama stepped in and started twisting arms.  TARP is Obama’s baby.  If you like it, or don’t like it, remember, without Barack Obama it would have died.

This is the fundamental problem right now with Democrats.  They passed a lousy stimulus, they made TARP Democratic policy by passing it with majority Democratic votes and they are on their way to passing a lousy healthcare bill which won’t even kick in till 2013.

Bad policy leads to bad outcomes.  Bad outcomes get blamed on the incumbents (as they should).  TARP, the Stimulus, healthcare and the economy become less and less the Republican’s problem every month that passed.  Even if they screwed it up, Democrats control the House, Congress and the Presidency.  It’s up to them to fix George Bush’s mess, and if they don’t they will be judged as failures, and that judgment will be accurate and deserved.

And the outcomes are going to be bad.  The stimulus bill was both badly put together (too many tax cuts, not properly targeted) and too small.  The healthcare bill should be single payor, because single payor is proven to work and the witch’s brew that Congress has put together isn’t proven to work and they can’t afford to fail.  And TARP was, and is, a piece of crap, but the differences between Bush/Paulson financial policy and Obama/Geithner are so thin as to be largely cosmetic.

Policy has consequences.  The “compromise” position between “doing it right” and “doing it wrong” may work sometimes, but it doesn’t work when a nation is in crisis and has spent 30 years digging itself into a hole.

By the time Obama comes up for reelection, Americans won’t have better healthcare and they will have less jobs than before the recession and the stimulus.

That’s what he’ll be judged on, and all because he signed on for Paulson/Bush financial policies, and compromised his key domestic and economic policies to the point where they wouldn’t work.

The consequences of (yet again) failing to stand up to the banks

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On May 14, 2009

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sunset-by-vj-fliksThe Senate just stopped limits on credit card rates.  Sometimes it takes a socialist to say the obvious:

“When banks are charging 30 percent interest rates, they are not making credit available,” said Mr. Sanders, who noted credit unions are limited to 15 percent. “They are engaged in loan-sharking.”

The banks have been given, loaned and guaranteed trillions. They are given access to money at very close to zero percent.  They then lend it out at much much higher rates.  As Sanders notes, 1/3 of credit card holders are being charged more than 20%, some as high as 40%.

That’s usury.  More to the point, it means that for all intents and purposes they aren’t making credit available.

Does anyone wonder why consumer spending dropped again?  Would you borrow at 20% to 40% to buy anything other than food or pay for housing, when jobs are still being lost at over half a million a month?  No one with any sense would.

Months ago I noted that the simplest way to get banks lending again would be to either have the Fed lend directly to consumers, or have the FDIC take over a major bank like Citigroup or Bank of America and use that bank to lend at decent rates.

Instead of doing that, the Bush and then Obama administrations decided to give money, guarantees, loans and nearly free money to banks which were impaired and which needed to gouge their customers as hard as they could to make a profit.  The result is that treasury secretary Timothy Geithner keeps saying the financial sector is fine, while more Americans lose jobs, consumer spending drops, banks won’t allow homeowners to get out from under bad mortgages even when it would save the bank money, and a new round of foreclosures is on its way.

On top of that, the mark to market rule was changed to allow banks to keep assets on their books at mark to model (ie. mark to fantasy) values.

All of this money will have to be paid back eventually.  The strategy is simple enough.

1) Give the banks money.

2) Let them not acknowledge as much of their losses as possible.

3) Allow them to gouge taxpayers for as much as possible, to dig themselves out of the hole over a number of years.

The end result of this is going to be Japanification—at best.  Not a “lost decade” as many folks have said, but a semi-permanent wavering between slight job gains and job losses, where a good economy never, ever, comes back.  And because the US, unlike Japan, is not a net exporter, it’s questionable how long Japanification can work in the US, in any case.

The banks took trillions of dollars of losses.  The refusal to make them take their losses; the refusal to wind up any of the big banks; the refusal to recognize that what is important isn’t the banking system but what the banking system does, and thus the unwillingness to cut past the big banks and lend directly means that those trillions of dollars of losses are going to have to be paid back by consumers and taxpayers.  You will pay.  You will pay not just in high interest rates, but in lower wages, and for many of you, a lack of jobs.  The economy will not, before the next recession after this downturn, return to the same level of employment the US had before this crisis.

All of this because neither party, and neither President, had what it took to stand up to the banks.

(What a good policy would have looked like.)

Central Bank Inflation Targeting Wasn’t Quite the Problem

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On May 6, 2009

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Martin Wolf, one of the best economics commenters, notes that the widespread idea that central banks, over the past 30 years, had found the holy grail of policy in inflation targeting, was clearly wrong.  That’s good as far as it goes, and he’s right.  But it’s worth taking farther—the problems with inflation targeting included the definition of inflation, the inflation target and the uncontrolled flow of money

Inflation as measured during this period did not take into account asset bubbles.  Wolf almost notices this, when he notes that the Fed didn’t see it as its job to stop asset bubbles.  But he doesn’t go quite far enough: asset price increases are a type of inflation.  If it costs more to buy a dollar of future income, a house, or a share in a company, that’s inflation.  To manage inflation properly, as a central bank, requires first to know what inflation is, and that means adding asset inflation into an inflation index.  This would be the opposite of the current “core inflation” index, which is non-asset inflation minus food and energy prices, ostensibly to remove volatility (which is not the way to remove volatility, the way to remove volatility is to use a moving average.)  Of course, in the real world, increases in fuel prices and energy prices are, well, inflation.  Add in credit price increases as well, and you’d have a measure which actually measures inflation.  Target that, and you’d be targeting something real.

The second issue is simpler, the inflation target was too low.  It seems like inflation being low is nothing but good, but in fact the lower it is, the more sectors of the economy are actually in deflation at any given time.  If inflation is 5% and consumer goods, say, are 4% less than that, they aren’t in deflation.  If inflation is at 3% and consumer goods are at 4% less, they’re at -1% and are deflating. As the last little while (and the Great Depression) have taught us, deflation is not a good thing, and yet for a long time large parts of the economy have been in and out of deflation fairly constantly.  In addition, a higher rate of inflation discounts past economic activity, which isn’t an entirely bad thing, as it means people have to be agressive with their money.  In a world where fraud and financial speculation wasn’t the best way to make returns, that is a good thing.  (In our world, perhaps not, admittedly.)

Finally, open financial flows turn bank policies into something of a joke.  As Wolf himself notes, foreign central bank independence from the Fed was largely chimerical: other central banks had to lower interest rates along with the Fed, and if they didn’t, then hot money would pour in from the US, or for that matter, from Japan, which was running its interest at zero or near zero for much of the past 20 years.

As a result, the effective interest rate was whatever the lowest interest rate of a large credible central bank with relatively stable currency was.  (If you’re borrowing from a country with an unstable currency, and the currency appreciates suddenly, your apparent low interest rate can turn into a trap which costs you greatly.)

This meant that even if central banks wanted money to be expensive, for those people and corprorations able to borrow from foreign sources, it wasn’t, and the asset bubbles, inflation and so on which came from that came even if the bank was trying to be conservative.  Real independent monetary policy is greatly damaged by free money flows between countries, which is even before you get to its damaging effect on real free trade and comparative advantage.

And old management maxim is that you get what you measure.  Central banks weren’t measuring all inflation, and so they weren’t managing asset inflation, which is one main reason we got asset bubbles.  Add to that that even where they were targetting inflation, they were targetting it at too low a level and that international money flows made it difficult to run an independent bank policy even in countries which might have wanted to, and you had a very flawed central banking system in virtually every country in the world.

So it’s not clear to me that inflation targetting is necessarily a bad policy.  It seems more likely that it might have been a good policy, implemented in a very bad way.  It disciplined the small actors in the economy, small businesses and ordinary workers—restricting their wages and their goods inflation, while allowing rampant inflation in securities and real-estate and (in the 90s) stocks.

The people who weren’t disciplined, then, drove a truck through the hole created and caused a disaster.  The lesson isn’t “we shouldn’t target inflation”, the lesson is “we need to target all inflation” not just inflation which effects some people.

The FDIC Is Levying Money From Banks To Spend: Not For “Confidence”

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On May 3, 2009

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Brian Angliss notes that the FDIC is levying a huge 20 cent per 100 dollars on deposit at the bank fee. He notes that the largest banks, having received lots of TARP money, will be able to pay that off using their taxpayer money, while smaller banks will get hammered and may either go under or be forced to cut back on jobs, branches and so on.

But Brian seems to take the FDIC’s announcement that they are doing this to improve confidence at face value.  I think, rather, the FDIC has made this sudden cash grab for a different reason: it needs the money for Geithners plan to buy up toxic assets.

Remember that the FDIC is providing most of the cash of the first part of the plan, up to 850 billion dollars worth of it.  That’s a lot of money.  Of course, the levy won’t raise that much, but it can and will be leveraged to buy up the toxic assets.  So what is taken away from the banks will be given back, in the form of removing toxic assets at overvalued prices.

The question though, is which banks will benefit. By and large, so far, the largest banks have received the majority of help from the Feds.  If assets are not proportionally bought from all the banks (and they won’t be) this could well lead to exactly what Brian fears—money being taken from small banks disproportionately, which will damage them and cause many to fail.

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