Saturday, October 31, 2009

Chairman of the Department of Economics at George Mason University: Politicians Are NOT Prostitutes ... They Are Pimps

Many people have called politicians prostitutes.

True, Obama has received more donations from Goldman Sachs and the rest of the financial industry than almost anyone else.

And Summers and the rest of Obama's economic team have made many millions - even recently - from the financial industry.

And Congress has largely been bought and paid for, and two powerful congressmen have said that banks run Congress.

So yes, they have certainly sold their goods to the highest bidders.

Indeed, at least some people trust prostitutes more than elected officials.

But the prostitution analogy is inaccurate.

Specifically, as the chairman of the Department of Economics at George Mason University (Donald J. Boudreaux) points out:

Real whores, after all, personally supply the services their customers seek. Prostitutes do not steal; their customers pay them voluntarily. And their customers pay only with money belonging to these customers.

In contrast, members of Congress routinely truck and barter with other people's property...

Members of Congress are less like whores than they are like pimps for persons unwillingly conscripted to perform unpleasant services.

Consider, for example, agricultural subsidies. Each year a handful of farmers and agribusinesses receive billions of taxpayer dollars. These are dollars that government forcibly takes from the pockets of taxpayers and then transfers to farmers.

The customers, in this case, are the farmers and agribusinesses. The suppliers of the services performed for these customers are taxpayers, for it's the taxpayers who possess the ultimate asset -- money -- that farmers and agribusinesses lust after. And the intermediaries who oblige the suppliers to satisfy the base lusts of the customers are politicians. Just as pimps facilitate their customers' access to prostitutes' assets, politicians facilitate their customers' access to taxpayers' assets.

We taxpayers have less say in the matter than we like to think. Sure, we can vote. But if even just 50.00001 percent of voters cast their ballots for the candidate proposing higher taxes, the assets of not only our pro-tax citizens, but also those of the remaining 49.00009 percent of us anti-tax citizens are put at the disposal of our pimps' customers. (And note that many of those who vote for higher taxes are not among those persons actually subject to higher taxation)...

Politicians force taxpayers to pony it up -- just as the services rendered for a pimp's customers are rendered not by that pimp personally, but by the ladies under his charge. The pimp pockets the bulk of each payment; he's pleased with the transaction. His customer gets serviced well in return; he's pleased with the transaction. The only loser is the prostitute forced to share her precious assets with strangers whom she doesn't particularly care for and who care nothing for her.

Also like the ladies under pimps' power, taxpayers who resist being exploited risk serious consequences to their persons and pocketbooks. Uncle Sam doesn't treat kindly taxpayers who try to avoid the obligations that he assigns to them. Government is a great deal more powerful, and often nastier, than is the typical taxpayer. Practically speaking, the taxpayer has little choice but to perform as government demands.

So to call politicians "whores" is to unduly insult women who either choose or who are forced into the profession of prostitution. These women aggress against no one; like all other respectable human beings, they do their best to get by as well as they can without violating other people's rights.

The real villains in the prostitution arena are those pimps who coerce women into satisfying the lusts of strangers. Such pimps pocket most of the gains earned by the toil and risks involuntarily imposed upon the prostitutes they control. No one thinks this arrangement is fair or justified. No one gives pimps the title of "Honorable." Decent people don't care what pimps think or suppose that pimps have any special insights into what is good or bad for the women under their command. Decent people don't pretend that pimps act chiefly for the benefit of their prostitutes. Decent people believe that pimps should be in prison.

Yet Americans continue to imagine that the typical representative or senator is an upstanding citizen, a human being worthy of being feted and listened to as if he or she possesses some unusually high moral or intellectual stature.

It's closer to the truth to see politicians as pimps who force ordinary men and women to pony up freedoms and assets for the benefit of clients we call "special-interest groups."

Note 1: The best analogy might be a man who kidnaps girls and then sells them into sexual slavery. Such a man does not provide the "protection" that a pimp might provide to voluntary prostitutes.

Note 2: There are a handful of honest politicians, fighting for the American people. But the exception proves the rule.

Congressman Watt Guts Bill to Audit the Fed

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.

Update: Ron Paul give perspective on Watt's action, pointing out that - while we've lost a battle - we haven't yet lost the war:

Friday, October 30, 2009

America Is Repeating the Mistakes Which Led to the Fall of the Hapsburg Empire

William R. Hawkins (formerly an economics professor at Appalachian State University, the University of North Carolina-Asheville, and Radford University) argues that America is repeating the mistakes which led to the fall of the Hapsburg empire:

Spain was the first global Superpower...With Spain as its political base, and gold and silver flowing in from its American colonies, the Hapsburg dynasty became the dominant power in Europe. It controlled rich parts of Italy through Naples and Milan, and Central Europe from the Netherlands through the Holy Roman Empire to Austria. In the 16th century it added the far distant Philippine islands to its empire. The Hapsburgs held off the Ottoman Turks, whose resurgent wave of Islamic conquest in the 16th century swept across the Balkans and nearly captured Vienna.

The Hapsburgs went into decline in the 17th century, and while any such momentous event has many causes, for our purposes the focus will be on the economic collapse of Spain, which not only sapped the empire of strength but served to build up the power of its rivals.

The demands of empire required a strong and growing economy, but Spain did not keep up with the economic expansion that was taking place in other parts of Europe. Madrid’s financial base fell out from under its empire. Spain could continue to consume in the short term because of the flow of precious metals from American mines, but it could not produce the goods it needed at home, which in the long-run proved fatal to its standing as a Great Power and as an advanced society.

Spanish imports were double exports and the precious metals became scarce within weeks of the arrival of the American treasure fleets as the money flowed to Spain's many creditors. What industry there was, along with banking and shipping, was in the hands of foreign owners. As a modern historian, Jaime Vicens Vives, has concluded, “This was one of the fundamental causes of the Spanish economy's profound decline in the seventeenth century, maritime trade had fallen into the hands of foreigners.” This, plus the “opening of the internal market to foreign goods,” produced a “fatal result.” Spain's exports were at the same time under heavy pressure by competitors in third country markets. A nation that cannot control its domestic market will seldom be able to sustain itself in foreign markets, which are inherently less accessible and more unstable.

Yet, Spanish leaders were deluded by a sense of false prosperity. This is testified by the statement of a prominent official, Alfonso Nunez de Castro in 1675: “Let London manufacture those fine fabrics of hers to her heart's content; let Holland her chambrays; Florence her cloth; the Indies their beaver and vicuna; Milan her brocade, Italy and Flanders their long as our capital can enjoy them; the only thing it proves is that all nations train their journeymen for Madrid, and that Madrid is the queen of Parliaments, for all the world serves her and she serves nobody.” A few years later, the Madrid government was bankrupt. The Spanish nobleman had foolishly elevated consumption, a use for wealth, above production, the creation of wealth.

Historians have traced the flow of Spanish gold and silver across the markets of Europe. Those who “served” Spain by establishing industries to manufacture goods for the Spanish market gained the money. Spain’s rivals, France, Holland (which started a successful revolt in 1568) and England, prospered by their trade surpluses, and reinvested the money to expand their own capabilities. Another modern expert on Hapsburg history, Henry Kamen, has cited contemporary sources who referred to 17th century Spain as “the Indies for the foreigner.” The military empire of the Hapsburgs became the economic colony of other powers, or, to use a current phrase, Spain was the “engine of growth” for the rest of the continent.

Where there were jobs and prosperity, there was also rapid population growth, and rising tax revenue. Rival powers were able to field and finance military forces that could defeat the once superior Spanish forces both on land and at sea. The irony of this is that Spain was ruled by a warrior aristocracy tempered by centuries of constant warfare against Islamic hordes and Christian heretics. These nobles looked down on merchants and manufacturers and disparaged their mundane professions only to find that without a strong domestic business class they could not afford the fleets and armies that guarded the empire they had built.

Today, the American “empire” is also trying to consume more than it produces. The U.S. trade deficit is nearing Spain’s nadir of imports being double exports. Both government spending and private consumption are financed heavily by debt. Washington is printing money, the modern equivalent of digging gold out of the ground, rather than earning the means to pay its bills. And the political and military elites are apparently indifferent to the fate of domestic business and industry. Americans must learn ... from the Spanish experience ... and take corrective action while they still can.

Hat tip to Chuck Graves.

Breaking Up The Too Big to Fails Will NOT Harm America's Ability to Compete with Foreign Banks

I have previously debunked numerous false arguments used to defend the too big to fails. See this and this.

But the apologists for the TBTFs are now arguing that breaking up the beached whales ... er, giant banks ... will harm America's ability to compete with foreign banks.

Joshua Rosner (managing director of an independent financial services research firm), has written an important essay debunking this argument:

Those who argue against a more proactive reduction in risk and size of TBTF institutions will, as always, revert to an argument that strikes a natural chord in every American’s heart: ‘Doing so would create an unleveled international playing field for our institutions relative to their international competitors’. Level playing fields are a worthy goal, but this is not a relevant argument. Instead, this tired bromide must be resoundingly dismissed on several counts:

  • Those countries with the largest banks as a percentage of GDP (Iceland, Ireland, Switzerland) demonstrated that a concentration of banking power can cause significant sovereign risk and tilt global economic playing fields away from that country.
  • The likely breakups of ING, Lloyds and KBC suggest that it is we who seek to support an unlevel playing field where we subsidize our TBTF banks while other nations recognize the policy failures of moral hazard. If we continue down this path we will likely be at risk of violating international fair trade regimes.
  • When the “unlevel playing field” argument is cited, keep in mind this reasoning supports the disadvantaging of 8000+ community banks relative to our largest banks, all in the name of protecting big banks from governmentally- subsidized international competition.
  • There is no longer any evidence that, beyond a cost of capital advantage that comes with implied government support, there are sustainable and tangible economies of scale arising from being the largest. The financial supermarket concept has been proven a failure. The only ones who benefit are the high-level executives.
  • We must demand that our legislators no longer allow unelected officials at the independent Federal Reserve to sign international accords created by the TBTF banks through supra-national bodies like the Basel Committee.
  • Are we to believe that if we did not have such large and globally dominant firms, US borrowers might be paying more that the 29% interest that several of the TBTF firms are now charging on their card accounts? Perhaps we should think about what advantage our population has gained as a result of our financial institutions being such a large part of our economy or being globally dominant.
  • Since when did we accept a national strategy of following rather than leading? When we do what is right, others follow. As example, consider the bank secrecy havens – they made money for a bit. Now, even the Swiss and the Cayman authorities are coming around to our view.
  • We are already at a disadvantage given that the largest foreign banks operate in the US without any tier one capital requirement and yet mostlarge foreign banks have not built a bricks and mortar presence here. Nobody screams about their undercapitalization nor has that undercapitalization caused deposits to migrate to foreign banks.
What fake excuse will the apologists for the TBTFs throw out next?

That breaking up the giants and letting small and mid-sized banks, credit unions and state public banks compete fairly will shift the Earth's gravitational field as deposits shift away from the money centers?

Note: Rosner has a funny and potentially effective idea for putting pressure on Congress. He suggests that we all call our representatives and ask how much the lobbyists have paid them to destroy America's economy by propping up the too big to fail banks.

Rosner's actual language is somewhat over-the-top:
If leadership won’t add such language [reigning in the TBTFs], call your elected official and ask how much they actually receive when they agree to put on the kneepads.

The "Too Big to Fails" Are Playing Us for Fools

In September 2008, I wrote:

In the 1974 comedy Blazing Saddles, Cleavon Little plays the new sheriff in an old Western town. The sheriff is African-American, and when he rides into town for the first time, the [racist] townspeople pull out their guns and are about to shoot him.

But he quickly puts a gun to his own head, pretends he's scared of his own gun, and says "BACK OFF OR THE AFRICAN-AMERICAN GUY GETS IT!!!" The townspeople are dumb and fall for it, suddenly terrified that he'll kill himself. Here's the scene.

That's what Wall Street is doing with the bailout.

The fat cats on Wall Street are saying "give us a lot of money, and buy all of our bad debt for a lot more than its worth, or Wall Street will get it and we'll go into a depression!"

Are Americans stupid enough to fall for it?

In a recent interview, William K. Black uses the exact same Blazing Saddles sheriff-bank analogy.

Miles Kendig has a different - but parallel - analogy for the giant banks:

In essence, what we have here folks is a characterization of the banks and the government that has assumed the risk profile of these banks as some sort of 1,000 pound men, unable to move without assistance. They have suckered everyone else into the idea that if anything is done to move these overweight, unhealthy "persons" to health they will have a heart attack and kill us all since they sit upon the crossroads of commerce and have sold most folks the idea that they are the heart of the nation and indeed the world. Given these "objective" circumstance the government is not only beholden to the 1,000 pound persons, but is one of them itself, will do everything to make the rest of us carry them so as to save them the indignity of actually addressing their morbid obesity and the cycle of codependency that enables them all to remain so fat.

Any way you look at it, the too big to fails are not needed and they are dragging our economy into a black hole. Like the sheriff in Blazing Saddles or Kendig's 1,000 pound men, they are playing us for fools.

Update: Yves Smith shared another analogy with me: a man with 15lbs. of Semtex strapped to his waist. She says "any surprise people in the vicinity are very attentive to his desires?"

Thursday, October 29, 2009

Congress: We Can't Help the American Public Because The Dog Ate Our Homework

Elizabeth Warren sums things up pretty succinctly:

The banking lobby is as powerful and deeply entrenched as ever, but it was powerful in the 1930s, too. Nonetheless, the New Dealers learned the Great Lesson: Powerful insiders cannot be permitted to write the rules, and prosperity and security depend on a playing field that supports a vibrant middle class. Today, we face a similar set of questions as we faced then. Will the institutions that created the crisis continue calling the shots and writing the rules, or will Washington take the side of families? Have we learned the Great Lesson?
To date, of course, the White House and Congress are siding with "the institutions that created the crisis" and not families.

As PhD economist Craig Pirrong makes clear, all of the talk of "reform" and "regulation" coming out of Washington is just for show (without any substance), to appease the populist anger:
Rather than a serious effort to address systemic risk, this [proposal on bank oversight] seems to be populist boob bait, a response to popular outrage against taxpayer banking bailouts, rather than a serious attempt to address TBTF. Not a surprise, and quite understandable, but not a major improvement of incentives.
Indeed, a 725-word story from Harper's proves (again) that Congress is trying to fool the American people:
Everyone rational knows that there is an enormous need to seriously reform the derivatives market, but [on October 7th, the House Financial Services] committee, headed by Congressman Barney Frank (D-Wall Street), invited a panel of eight guests who were distinguished by their uniformly pro-industry positions...

In response to complaints from Americans for Financial Reform, which represents hundreds of consumer groups and labor unions, the committee issued an invitation—the night before the hearing was held — to Rob Johnson of the Roosevelt Institute. For the committee, the last minute inclusion of Johnson — a former managing director at Bankers Trust Company and former economist at the Senate Banking Committee and Senate Budget Committee — apparently constituted sufficient balance.

Predictably, witnesses at the hearing trotted out positions urging caution in regard to the matter of reform. Derivatives and other exotic financial devices have reaped the finance industry vast profits, but for Hixson of Cargill the common man and woman would be the real losers if Congress were to act too severely. “We offer customized hedges to help bakeries manage price volatility of their flour so that their retail prices for baked goods can be as stable as possible for consumers and grocery stores,” he told the committee’s wagging heads. “We offer customized hedges to help a restaurant chain maintain stable prices on their chicken so that the company can offer consistent prices and value for their retail customers when selling chicken sandwiches.”

Johnson, who came last, offered the only serious critical viewpoint, saying that the American public had been “quite demoralized by…the bailouts that we experienced last fall.” After about five minutes of his testimony, Congresswoman Melissa Bean—another industry-funded committee member who chaired the hearing because Frank was absent—had heard enough. “I’m just going to ask you to wrap up because we’re running out of time,” she told Johnson.

Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.

“I do need a final comment,” Bean interjected seconds later.

That put an end to Johnson’s testimony. “I was just called to this hearing last night, so I will provide detailed comments on your bill and a statement for the record that will finish my comments,” he concluded.

About five days later Johnson submitted his full testimony to the committee, to be included on its website along with the statements of the other eight panelists. When it wasn’t posted, Johnson asked Lynn Parramore, editor of the Roosevelt Institute’s blog, to see what was up. Parramore emailed and spoke to staffers at the Financial Services Committee, and received a number of explanations for why Johnson’s testimony had not been posted: first she was told it hadn’t been received, then that it had to be submitted as a PDF, then that the committee was having IT problems. “I couldn’t decide whether it was incompetence or mischief, but I began to suspect the latter,” Parramore told me.

Finally, she was informed that the committee’s general counsel would not allow posting of the testimony because Johnson had not submitted it during the hearing. (Of course, since Johnson had been invited at the last minute it was impossible for him to fulfill this pointless requirement.) So you still can’t read Johnson’s prepared testimony at the committee website, but you can check it out on the Roosevelt Institute’s blog.

Meanwhile, Frank’s committee has put forth its “reform” bill. “Too tepid, too weak, too late,” Johnson says of the legislation. “Very industry influenced. We had a crisis and they are pandering to the perpetrators.”
Yves Smith summed it up well:
The House Financial Services Committee has refused to publish his testimony, offering “the dog ate my homework” level excuses.

"Money Multipliers Have Collapsed Everywhere...Confidence Is Missing. I Don't See Any Way To Stabilise M3 In Such Circumstances"

Former officials are often more honest than current ones, since they aren't under pressure to spread happy talk.

Former European Central Bank chief economist Otmar Issing recently said what current officials aren't addressing:

Nobody can be sure that we have a self-sustaining recovery. The challenges facing the ECB are tremendous. "Money multipliers have collapsed everywhere. What M3 is telling us is that confidence is missing. I don't see any way to stabilise M3 in such circumstances.

As Ambrose Evans-Pritchard notes:

Data from the European Central Bank shows that the M3 broad money supply has contracted over the last six months, confounding expectations that ultra-low interest rates would soon boost monetary growth. Loans to the private sector fell 0.3pc from a year earlier, the first such decline since the data started in 1983.

The M3 figures include a wide range of bank accounts...

The picture is even starker in America where M3 has shrunk at an annual rate of 6.5pc over the last three months, a pace of contraction not seen since the 1930s. US bank loans have plummeted since May.
(While the Fed stopped reporting M3 in 2006, people are still tracking it).

How can M3 have collapsed when governments world-wide are printing money faster than IHOP can cook pancakes?

Well, professor Tim Congdon from International Monetary Research says:
A key reason for credit contraction is pressure on banks to raise their capital ratios... "The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances," he said. "It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010."
But isn't it good that governments are requiring banks to raise their capital rations?

Sure, but unless they force the banks to write off their bad debts, they will remain giant black holes, and will never be adequately capitalized. If they are never adequately capitalized, they will never release money out into the economy through loans and other economic activity which increases M3.

As just one example, remember that the nominative amount of outsanding derivatives dwarfs the size of the global economy. As another example, remember that several of the too big to fails have close to a trillion dollars each in toxic assets in off-book SIVs.

IMF chief Dominique Strauss-Kahn says that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

As many people have repeatedly written (including me), the world's governments must restore sound economic fundamentals - which includes forcing banks to write down their bad assets - instead of cranking up the printing presses and trying to paper over all of the problems.

Moreover, as Mish, Michael Rivero, and many others have pointed out, governments can create all the credit they want, but if people do not have jobs, they will not borrow that money.

In addition, the amount of credit and wealth destroyed exceeds the amount of money pumped into the system.

When will the politicians listen? Will they wait until after the next huge market crash? When there are tent cities everywhere? After their governments default and they essentially lose sovereignty under "austerity measures" imposed by the IMF, World Bank or other agency?

Conservatives and Liberals Agree: Proposed Bank Oversight Bill Will Make Things Worse

When a liberal labor leader and a conservative financial policy analyst unite against something, you know that something is really bad (actually, I don't believe in the whole false left-right dichotomy; I think its Americans versus those trying to steal our wallets and our rights, but that's another story).

Today, AFL-CIO president Richard Trumka has slammed the Fed and the proposed "Tarp on steroids" legislation in his testimony to Congress today. Here are the must-read parts of Trumka's prepared remarks to the House Financial Services Committee:

We are deeply concerned that the Committee’s work thus far on the fundamental issues of regulating shadow financial markets and institutions will allow the very practices that led to the financial crisis to continue. The loopholes in the derivatives bill and the failure to require any public disclosures by hedge funds and private equity funds fundamentally will leave the shadow markets in the shadows. We urge the Committee to work with the leadership to strengthen these bills before they come to the House floor.

However, these powers must be given to a fully public body, and one that is able to
benefit from the information and perspective of the routine regulators of the financial system. We believe a new agency, with a board made up of a mixture of the heads of the routine regulators and direct Presidential appointees would be the best structure. However, if the Federal Reserve were made a fully public body, it would be an acceptable alternative.

But we cannot support the discussion draft made public earlier this week because it gives dramatic new powers to the Federal Reserve without reforming its governance so that the banks themselves are removed from the governance of the Federal Reserve System. Even more alarmingly, the discussion draft would appear to give power to the Federal Reserve to preempt a wide range of rules regulating the capital markets—power which could be used to gut investor and consumer protections. If this Committee wishes to give more power to the Federal Reserve, it must make clear this power is only to strengthen safety and soundness regulation and it must simultaneously reform the Federal Reserve’s governance. Reform cannot be put off until another day.

The Federal Reserve currently is the regulator for bank holding companies. In that
capacity, it was responsible throughout the period of the bubble for regulating the parent companies of the nation’s largest banks. While regulatory authority rests in the Board of Governors of the Federal Reserve in Washington, routine responsibility for regulatory oversight has been delegated by the Board of Governors to the regional Federal Reserve Banks. The Federal Reserve System’s regulatory expertise resides in these regional banks.

The problem is that these regional Federal Reserve Banks are actually controlled by their member banks—the very banks whose holding companies the Fed regulates. The member banks control the selection of the majority of the regional bank boards, and the boards pick the regional bank presidents, who are effectively the CEO’s of the regulatory staff.

These arrangements may explain why the Federal Reserve has never given any account of how it allowed bank holding companies like Citigroup and Bank of America to arrive at a point where they required tens of billions of dollars of direct equity infusions from the public purse to avoid bankruptcy.

Giving the Federal Reserve with its current governance control over which financial
institutions are bailed out in a crisis is effectively giving the banks the ability to raid the Treasury for their own benefit.

We are also deeply troubled by provisions in the discussion draft that would allow the Federal Reserve to use taxpayer funds to rescue failing banks, and then bill other nonfailing banks for the costs. The incentive structure created by this system seems likely to increase systemic risk.

We believe it would be more appropriate to require financial institutions to pay into an insurance fund on an ongoing basis. Financial institutions should be subject to progressively higher fee assessments, and stricter capital requirements, as they get larger. This would be a way of actually discouraging “too big to fail.”

In addition, language in the draft that appears to limit taxpayer bailouts of bank
stockholders actually does no such thing, rather it simply ensures that when stockholders are rescued with public funds, bondholders and other creditors are rescued with them...

Finally, and not least, the discussion draft appears to envision a process for identifying and regulating systemically significant institutions, and for resolving failing institutions, that is secretive and optional—in other words, the Federal Reserve could choose to take no steps to strengthen the safety and soundness regulation of systemically significant institutions. In these respects, the discussion draft appears to take the most problematic and unpopular aspects of the TARP and makes them the model for permanent legislation.

Instead of repeating and deepening the mistakes associated with the bank bailout,
Congress should be looking to create transparent, fully publicly accountable mechanisms for regulating systemic risk and for acting to protect our economy in any future financial crises.

Conservative Peter Wallison - financial policy study analyst at the American Enterprise Institute - largely agrees. In his prepared remarks to Congress, Wallison says:

The Discussion Draft of October 27 contains an extremely troubling set of proposals which, if adopted, will bring economic growth in this country to a standstill, essentially turn over the control of the financial system to the government, and seriously impair competition in all areas of finance.

Rather than ending too big to fail, the Draft makes it national policy. By designating certain companies for special prudential regulation, the Draft would signal to the markets that these companies are too big to fail, creating Fannies and Freddies in every sector of the economy where they are designated. This will impair competition by giving large companies funding and other advantages over small ones.

The idea that the designation of these companies will be kept secret is, with all due respect, absurd; securities laws alone will require them to disclose their special status; simple truthfulness will do the rest...

If this legislation is passed, every industry will be in Washington, asking for special treatment or exemption. Competition in the market will become competition before this committee or in the halls of the Fed, lobbyist-to-lobbyist and lawyer-to-lawyer...

This will not only create uncertainty and moral hazard, but it will give the large and powerful companies special advantages over small ones. Those that seem likely to be taken over by the government will have easier access to credit, at lower rates, than those likely to be sent to bankruptcy.

In other words, the Draft proposes nothing more or less than a permanent TARP, using government money to bail out the large or politically favored companies, and then taxes the remaining healthy companies to reimburse the government for its costs of competing with them...

The [proposed bill] would take control of the financial industry in the United States, stifle risk-taking and initiative, and change competitive conditions in every sector of the economy so that they favor large, government-backed, too big to fail enterprises...

The Draft ... would now give the Fed authority to regulate any financial company that the Council determines should be subject to “heightened prudential standards,” even if there is no insured bank in the group...

The result is that the question becomes one of political clout, with industries fighting in Congress for the competitive result they want. Some industries want to invade others’ turf; the invaded industry uses the law to fend off the competition; consumers are the losers. Congress becomes the battleground. It’s not just unseemly; it’s a frightening example of what happens when the government starts picking winners...

Congress will be injecting itself into competitive fights between firms and industries, further politicizing what should be economic or financial decisions...

The Designated Companies are under the complete control of the Fed. They will not be able to initiate new activities without the Fed’s approval, or enter new competitive fields, or perhaps even open new offices in new places. This is a degree of political control of business that has never been attempted before. Not only will it place the dead hand of government on the activities of financial companies, but it will almost certainly drive many financial companies out of the United States before they submit to these restrictions.

The effect of these restrictions for the U.S. economy will be dire. First, Designated Companies will clearly have been labeled as too big to fail. In effect, the government has notified the capital markets that these firms will not be allowed to go into bankruptcy—they will be rescued in the ways I will describe below. This means they will be less risky borrowers than smaller companies that are not going to be controlled in the same way. As less risky borrowers, the Designated Companies will have lower costs of funding and will be able to drive smaller competitors from the markets they enter. Sound familiar? Yes, it’s Fannie Mae and Freddie Mac all over again. The existence of these Designated Companies will impair competition in every market they are allowed to enter, and will force the consolidation of competitors so that markets become dominated by government-backed giants like themselves....

[The bill assumes that] our entire financial system must be subjected, today, to far-reaching control by the Federal Reserve Board. With all due respect, this is absurd, and certainly disastrous for economic growth in the future.

The Draft also contains language that suggest some of the problems of identifying Designated Companies in advance—and thus creating the Fannie/Freddie too big to fail problem—can be avoided if the designation of these companies is not disclosed to the public. This, too, with all due respect, is absurd...

In addition, there is very little incentive for the government not to rescue failing Designated Companies, because the Draft provides that the surviving members of the financial industry larger than $10 billion in assets—whether Designated Companies or not—will be taxed to reimburse the government for its costs in the bailout...

As in the GM and Chrysler bailouts, preferences are going to go to favored groups, and disfavored groups will suffer disproportionate losses. It will be a political free for all, with important legislators pressing the FDIC to treat their constituents better than someone else’s constituents.

What we know is that no losses will be taken immediately by creditors. This is because the objective of the resolution authority is to prevent a “disorderly” failure, which actually means a failure in which creditors suffer immediate losses...

The proposals in the Draft reflect very bad policy—far more likely to be destructive of the financial system and damaging to the economy than an improvement on what exists today.

Wednesday, October 28, 2009

Europe Is Breaking Up Its Too Big to Fails

The American government is doing everything it can to avoid breaking up the too big to fails, even though there is absolutely no reason not to (see this and this).

As Reuters columnist Rolfe Winkler writes today:

The new legislation unveiled by Representative Barney Frank doesn’t end “too big to fail” — it codifies it. It also puts taxpayers on the hook for a large portion of future bailouts.

But Europe is in the process of breaking up:

  • And potentially other banks

What's the matter with the yanks?

Government Is Trying to Make Bailouts for the Giant Banks PERMANENT

On September 25th, I wrote:

Paul Volcker and senior Harvard economist Jeffrey Miron both testified to Congress this week that the government is trying to make bailouts for the giant banks permanent.

Writing Wednesday in The Hill, Congressman Brad Sherman pointed out that :

In my opinion, Geithner’s proposal is “TARP on steroids.” Section 1204 of the proposal [the proposal being the "Resolution Authority for Large, Interconnected Financial Companies Act of 2009"] allows the executive branch to use taxpayer money to make loans to, or invest in, the largest financial institutions to avoid a systemic risk to the economy.

Geithner’s proposal reminds me of the Troubled Asset Relief Program (TARP), the $700 billion Wall Street bailout adopted last year, but the TARP was limited to two years, and to a maximum of $700 billion. Section 1204 is unlimited in dollar amount and is a permanent grant of power to the executive branch. TARP contained some limits on executive compensation and an array of special oversight authorities. Section 1204 contains absolutely no limits on executive compensation and no special oversight.

When I asked Geithner whether he would accept a $1 trillion limit on the new bailout authority (if the executive branch wanted to spend more, it would have to come back to Congress), he rejected a $1 trillion limit, insisting that the executive branch be able to respond without coming back to Congress.

Both TARP and the Treasury proposal have vague provisions under which taxpayers might possibly recover any money lost through a special tax on the financial services industry. Under the Treasury proposal, only the very largest institutions could benefit from a bailout, but the special tax, if ever collected, would fall chiefly on medium-sized institutions.

Thus, the medium-sized institutions will be at a competitive disadvantage for two reasons. First, the largest institutions will be able to borrow money more cheaply because their creditors will believe that if the institution is unable to pay, the taxpayers will. Second, if there ever is a bailout benefitting a very large financial institution, the tax will be imposed on the medium-sized institutions.

Sherman is a senior member of the House Financial Services Committee and a certified public accountant, so he has a good nose for analyzing proposed financial regulations.

Last week, Sherman made the following comments to the Washington Independent regarding Congress' proposed bill on the too big to fails:

That is a huge gravy train to the top 20 [financial institutions] because it allows them to borrow money at a lower rate. Think of what this does to moral hazard.

I’m not looking for a TARP on steroids with oversight. I’m looking for an end of TARP.

The House Committee on Financial Services will hold a hearing on the bill tomorrow, with Tim Geithner, Sheila Bair, John C. Dugan (Comptroller of the Currency), Daniel K. Tarullo (Governor, Board of Governors of the Federal Reserve System), John E. Bowman (Acting Director, Office of Thrift Supervision), Richard Trumka (President, AFLCIO), and others as witnesses.

As the Washington Independent points out, Sherman is going to try to take Tarp off of steroids:

Sherman said he intends to offer a series of amendments addressing the issue during the Financial Services panel’s markup of the bill, which has yet to be scheduled. Included will be a provision to cap the president’s bailout authority at $1 trillion, and another to strip out the resolution authority language entirely. A potential third proposal — to create an oversight panel like that monitoring TARP funds — is one he’s leaning against.

Bill Gross: V-Shape Recovery is Unlikely

Forget the permabears, even Pimco's Bill Gross is now saying a V-shaped recovery is unlikely:

The total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.

Should We Give the Fed More Power ... Or Less?

Congress is 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: 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.


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?

Tuesday, October 27, 2009

Former Chairman of Citigroup: Restore Glass-Steagall

The former chairman of Citigroup, John S. Reed, wrote a letter to the editor of the New York Times calling for a reinstatement of Glass-Steagall:

As another older banker and one who has experienced both the pre- and post-Glass-Steagall world, I would agree with Paul A. Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense.

But for Barney Frank, Tim Geithner and the rest of the boys, it is business as usual.

Hat tip Barry Ritholtz.

Big Banks Are NOT More Efficient

I have repeatedly pointed out that big banks are not more efficient than smaller banks.

For example, I previously noted that an article in Fortune concluded:

The largest banks often don't show the greatest efficiency. This now seems unsurprising given the deep problems that the biggest institutions have faced over the past year.

"They actually experience diseconomies of scale," [Celent analyst Bart] Narter wrote of the biggest banks. "There are so many large autonomous divisions of the bank that the complexity of connecting them overwhelms the advantage of size."

Now, James Kwak has done some sleuthing and discovered that even Fed economists don't buy the bigger-is-more-efficient argument. Kwak points out that New York Fed economist Kevin J. Stiroh found that most of the increase in efficiency during part of the time in which banks were consolidating was due to the increased use of information technologies:
His main explanation for the productivity growth is not consolidation, but information technology: “The finding of steady productivity growth, in particular, is important since it is consistent with the idea that the massive investment in new technology is working to improve the performance of the banking industry.” This is not proven in this paper, but Stiroh went on to write a bunch of other papers on the link between information technology and productivity. For example, this paper (on the entire economy, not just banking) concludes:

“IT-producing and IT-using industries account for virtually all of the productivity revival that is attributable to the direct contributions from specific industries, while industries that are relatively isolated from the IT revolution essentially made no contribution to the U.S. productivity revival. Thus, the U.S. productivity revival seems to be fundamentally linked to IT.”

Stiroh also wrote a paper on banks in Switzerland, concluding:

“We find evidence of economies of scale for small and mid-size banks, but little evidence that significant scale economies remain for the very largest banks. Finally, evidence on scope economies is weak for the largest banks that are involved in a wide variety of activities. These results suggest few obvious benefits from the trend toward larger universal banks.”

The kicker is that Stiroh is the main source cited by those claiming that bigger banks produce greater efficiencies.

The bottom line is that there is absolutely no reason not to break up the too big to fails.

Tavakoli on AIG Swaps: "There’s No Way They Should Have Paid at Par. AIG Was Basically Bankrupt"

Derivatives expert Janet Tavakoli made the following comments by email about the Bloomberg article "New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers":

“There’s no way they should have paid at par,” she says. “AIG was basically bankrupt.”

I agree.

By way of contrast, Tavakoli points out that:

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.

Gross, Roubini, Ritholtz and Smithers All Forecast a Correction

Bill Gross says assets are overvalued and the rally is over.

Nouriel Roubini - who called last year's crash - said last week that "a big crash is coming":

There’s a huge bubble, because we have zero rates in the U.S., zero rates around the world and a huge carry trade. Everyone is borrowing at zero interest rates in dollars and getting a capital gain because the dollar is weakening, so they are borrowing at negative rates. And then they invest in risky assets:commodities, equities, credit. We’re creating a bigger bubble than before.

It’s going to go crashing down, in an ugly way. That’s the basics of the argument...

There is a wall of liquidity chasing assets. That liquidity can chase those assets higher for the time being until the huge carry trade—the asset bubble and the wall of liquidity—comes crashing down. You can still have all the risky assets going higher. Of course, the higher they go, the more they diverge from fundamentals, and the riskier the situation becomes. But eventually, if the recovery of the economy is going to be anemic, sub-par, below-trend and U-shaped, there is going to be a correction. And therefore my view is to stay away from risky assets. Stay in liquid assets. I don’t know when the correction is going to occur, it could be a while longer, but eventually it will be a pretty ugly correction, across many different asset classes.

Barry Ritholtz, who has been very bullish for some time, is now looking for a correction:

I see a significant increase in the odds for a fairly substantial correction — in the 5 – 15% range — over the next 60 days.

5 factors are making me more cautious:

1) Over the past 4 days, we have had 3 failed rallies;

2) The number of New Highs on the major indices is contracting;

3) Stocks seem to be reacting far less enthusiastically to earnings beats then they had been;

4) The Transports have been acting squirrelly lately;

5) The S&P is forming an Ascending Wedge (more on this later today).

Here's the Ascending Wedge he's talking about.

And, as Bloomberg writes:

The U.S. Standard & Poor’s 500 Index is about 40 percent overvalued and headed for a drop as central banks pull back on securities purchases that pushed up asset prices, according to economist Andrew Smithers.

Monday, October 26, 2009

FDIC Head Sheila Bair Tells Protesters: "It's Time to Put an End to the 'Too Big to Fail' Doctrine... No More Bailouts!"

On her way inside the Banking Convention, where she was about to deliver a speech, FDIC Chair Sheila Bair told protesters:

It's time to put an end to the 'Too Big to Fail' doctrine... No more bailouts, no more bailouts!

This is without doubt the most important populist moment so far this year.

Galbraith: Fed is Unlawfully Withholding Information from Congress

The Federal Reserve is unlawfully withholding information from Congress.

Says who?

Says noted economist James Galbraith:

To this day, Chairman Ben Bernanke has refused to disclose to Congress exactly who has received help under the many crisis measures and under what terms. The legal and constitutional situation is clear: Congress has a right to this information. There are no plausible national security concerns.
Galbraith also slams the idea that the Fed should be the main regulator:

Finally, there is the question of financial reform. In the new effort to bring systemically dangerous institutions (now called “Tier One Financial Holding Companies”) under effective supervision, the administration proposes to vest regulation of those entities in the Federal Reserve. The Federal Reserve naturally agrees. But 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.

If you think Galbraith is wrong about the Fed's capacity to act as regulator-in-chief, look at this article by the Washington Post.

Bank Charge Off Rate Is Worse Than During the Great Depression

In May, analyst Mike Mayo predicted that the bank loan loss rate would be higher than during the Great Depression.

In a new report, Moody's has just confirmed (as summarized by Zero Hedge):

The most recent rate of bank charge offs, which hit $45 billion in the past quarter, and have now reached a total of $116 billion, is at 3.4%, which is substantially higher than the 2.25% hit in 1932, before peaking at at 3.4% rate by 1934.

And see this.

Here's a chart summarizing the findings:

(click here for full chart).

Sunday, October 25, 2009

Capitalism, Socialism or Fascism?

What is the current American economy: capitalism, socialism or fascism?


Many people call the Bush and Obama administration's approach to the economic crisis "socialism".

Are they right?

Well, Nouriel Roubini writes in a recent essay:

This is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest...

The releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending.

Roubini has previously written:

We're essentially continuing a system where profits are privatized and...losses socialized.

Nassim Nicholas Taleb says the same thing:

After finishing The Black Swan, I realized there was a cancer. The cancer was a huge buildup of risk-taking based on the lack of understanding of reality. The second problem is the hidden risk with new financial products. And the third is the interdependence among financial institutions.

[Interviewer]: But aren't those the very problems we're supposed to be fixing?

NT: They're all still here. Today we still have the same amount of debt, but it belongs to governments. Normally debt would get destroyed and turn to air. Debt is a mistake between lender and borrower, and both should suffer. But the government is socializing all these losses by transforming them into liabilities for your children and grandchildren and great-grandchildren. What is the effect? The doctor has shown up and relieved the patient's symptoms – and transformed the tumour into a metastatic tumour. We still have the same disease. We still have too much debt, too many big banks, too much state sponsorship of risk-taking. And now we have six million more Americans who are unemployed – a lot more than that if you count hidden unemployment.

[Interviewer]: Are you saying the U.S. shouldn't have done all those bailouts? What was the alternative?

NT: Blood, sweat and tears. A lot of the growth of the past few years was fake growth from debt. So swallow the losses, be dignified and move on. Suck it up. I gather you're not too impressed with the folks in Washington who are handling this crisis.

Ben Bernanke saved nothing! He shouldn't be allowed in Washington. He's like a doctor who misses the metastatic tumour and says the patient is doing very well.
Nobel prize winning economist Joseph Stiglitz calls it "socialism for the rich". So do many others.


Some, however, argue that the economy is more like fascism than socialism. For example, leading journalist Robert Scheer writes:
What is proposed is not the nationalization of private corporations but rather a corporate takeover of government. The marriage of highly concentrated corporate power with an authoritarian state that services the politico-economic elite at the expense of the people is more accurately referred to as "financial fascism" [than socialism]. After all, even Hitler never nationalized the Mercedes-Benz company but rather entered into a very profitable partnership with the current car company's corporate ancestor, which made out quite well until Hitler's bubble burst.

And Italian historian Gaetano Salvemini argued in 1936 that fascism makes taxpayers responsible to private enterprise, because "the State pays for the blunders of private enterprise... Profit is private and individual. Loss is public and social" (page 416).

This perfectly mirrors Roubini's statement about the American government's bailout plan.

Remember that one of the best definitions of fascism - the one used by Mussolini - is the "merger of state and corporate power".

That could never happen in America, right?


  • The government has given trillions in bailout or other emergency funds to private companies, but is largely refusing to disclose to either the media, the American people or even Congress where the money went
  • The head of the Federal Reserve Bank of Kansas City, the former Vice President of the Dallas Federal Reserve, and two top IMF officials have all said that we have - or are in danger of having - oligarchy in the U.S.


As pointed out in May (it is worth quoting the essay at some length, as this is an important concept), looting has replaced free market capitalism:

Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing
the causes of the S&L crisis and other financial meltdowns. As summarized
by the New York Times:

In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer [co-author of the paper, and himself a leading expert on economic growth] said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

The Times does a good job of explaining the looting dynamic:

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greesnspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all...Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains...

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it...Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

In fact, the big banks and sellers of exotic instruments pretended that the boom would last forever, siphoning off huge profits during the boom with the knowledge that - when the bust ultimately happened - the governments of the world would bail them out.

As Akerlof wrote in his paper:

[Looting is the] common thread [when] countries took on excessive
foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust...Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Indeed, Akerlof predicted in 1993 that the next form the looting dynamic would take was through credit default swaps - then a very-obscure financial instrument (indeed, one interpretation of why CDS have been so deadly is that they were the simply the favored instrument for the current round of looting).

Is Looting A Thing of the Past?

Now that Wall Street has been humbled by this financial crash, and the dangers of CDS are widely known, are we past the bad old days of looting?

Unfortunately, as the Times points out, the answer is no:

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Bottom Line

So what do we really have: socialism-for-the-giants, fascism or an economy which calls itself "capitalism" but which allows looting?

Ultimately, it doesn't matter. They are just different brand names for the same basic type of economy. All three systems allow giant businesses which are friendly to the government to keep enormous private profits but to pass the losses on to the government and ultimately the citizens.

Whether we use the terminology regarding socialism-for-the-giants ("socialized losses"), of fascism ("public and social losses"), or of looting ("left the government holding the bag for their eventual and predictable losses"), it amounts to the exact same thing.

Whatever we have, it isn't free market capitalism.

Note: Yves Smith has called the financial services pay arrangement of "heads I win, tails you lose" looting, and has also argued that our form of capitalism is evolving into Mussolini style corpocracy, meaning fascism. But the label most often pinned on the Obama administration is socialism.

The bottom line is that I don't put much stock in what socialists might label a system, any more than what fascists or corporate looters would label a system. Whatever you call it, if the giants get all the benefits and pawn all of the losses off on the public, it is a very dangerous system.