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by JackRiddler » Sun Dec 16, 2012 12:12 am
by Elvis » Sat Dec 29, 2012 2:37 am
Finance Stocks Dominate The Market In 2012 Despite Continuous Fines, Scandals And Fraud (CHART)
The Huffington Post | By Mark Gongloff
Posted: 12/28/2012 8:17 am EST | Updated: 12/28/2012 8:20 am EST
Quick, what was the best-performing stock sector in the U.S. in 2012? Here's a hint: It was the sector that could not stop getting into trouble and paying billions of dollars in fines on a near-weekly basis.
Yes, financial stocks in the Standard & Poor's 500-stock index had a better 2012 than any other group in the stock market, jumping more than 26 percent for the year through December 26, according to FactSet data. That increase far outpaced the broader S&P 500, which gained a still-respectable 13 percent this year, according to FactSet.
The jump happened despite the fact that banks spent 2012 doing violent injury to themselves and each other, like a year-long Three Stooges revival. At least once per month, and often more frequently than that, there was an announcement of a major bank settlement or screw-up.
And all along, their stock prices kept rising.
Why, you might be asking? For one thing, bank stocks are, generally speaking, super-cheap. The biggest banks trade at or below their "book value," meaning the amount of cash you'd get if you just put them out of their misery and sold off their parts. They're cheap because their bigger problems -- including still more legal headaches and fines to come -- have not really been solved.
But this cheapness also means their stocks can generate some serious returns without much effort if the financial winds start to blow their way. That happened this summer as worries about the collapse of the European Union, which would have hit banks hard, faded.
Though banks' stock prices were higher this year, they could possibly be higher still -- if the banks were smaller and less prone to committing disastrous mistakes and/or crimes.
Still, the strength of bank stocks has been remarkable, especially when contrasted with the absolute horror show that has been their public relations this year. Why, it is almost as if investors think these banks are essentially getting away with incompetence and fraud at a massive scale, with only the occasional stinging wrist slap to fear!
Come with us now on a trip down memory lane, to soak in the absolute disastrousness of the banks this year and to marvel at just how little investors cared.
February 9: Mortgage Foreclosure Settlement: Several big banks agree to pay $25 billion to settle charges of sloppy and/or downright fraudulent mortgage-foreclosure practices. Already on this day, financial stocks were up 13 percent on the year, matching the full-year performance of the S&P 500.
March 13: Stress Test Fails: Citigroup and three other major banks flunk Federal Reserve "stress tests," meaning they didn't plan to have enough capital to survive a major downturn. Bank stocks were up 18 percent on the year.
March 14: Greg Smith Eruption: Former Goldman Sachs banker Greg Smith takes to The New York Times to explain that he left Goldman because it had become a soulless place that existed only to rip off clients. Bank stocks still up 18 percent.
April 5: London Whale Surfaces: Bloomberg writes that a trader working for JPMorgan Chase's chief investment office in London has accumulated such a massive position in credit derivatives that he is known as the "London Whale." JPMorgan dismisses the story. Bank stocks up 19 percent on the year.
April 13: The Tempest: JPMorgan Chase CEO Jamie Dimon dimisses the London Whale story as a "tempest in a teapot." Bank stocks were up 16 percent at this point amid worries about Europe and maybe some very short-lived anxiety about the London Whale.
April 17: Citigroup Rejection: Shareholders deliver Citigroup a stunning reversal, rejecting its pay plan for CEO Vikram Pandit. Bank stocks are back up 19 percent on the year.
May 10: London Whale Resurfaces: JPMorgan admits its London Whale's trades were actually "egregious" and warns it could lose billions. Bank stocks now up a mere 15 percent on the year.
May 18: Facebook Flop: Facebook's IPO, overpriced by Morgan Stanley and other banks and overhyped by the media, flops miserably. Bank stocks up a mere 6 percent on the year, oh noes.
June 15: Gupta Guilty: A jury finds former Goldman Sachs board member Rajat Gupta guilty of insider-trading charges. Bank stocks now up 10 percent on the year.
June 27: Barclays Settlement: British bank Barclays Capital agrees to pay $450 million to settle charges of manipulating the key interest rate Libor. The bank was done in by moronic trader emails. Within days of the settlement, both the chairman and CEO of Barclays step down. Bank stocks still up about 10 percent.
July 3: JPMorgan's Power Problem: The Financial Times reports that JPMorgan, already dealing with its London Whale problem, is also under investigation by the Federal Energy Regulatory Commission on charges of manipulating the market for electricity in California and other states. Bank stocks back up nearly 14 percent on the year.
July 16: HSBC's Money-Laundering Problem: A Senate subcommittee report accuses British bank HSBC of years-long failure to monitor money laundering in its branches by Mexican drug lords and other ne'er-do-wells. HSBC executives apologize to the Senate and promise to do better. Bank stocks up 13 percent.
August 6: Standard Chartered's Money-Laundering Problem: New York's bank regulator accuses British bank Standard Chartered of ignoring money being laundered by Iranians in its U.S. branches. Bank stocks up 14 percent.
Sep. 12: Bank Of America Layoffs: BofA announces 30,000 job cuts. Bank stocks up 21 percent.
Oct 1: Bear Stearns Sued From Beyond The Grave: New York's attorney general brought civil charges against Bear Stearns, now owned by JPMorgan Chase, accusing it of lying to investors about the quality of mortgages it sold before the crisis. Once again, dumb emails were involved. Bank stocks up 20 percent.
Oct 15: Greg Smith Eruption II: Details from Greg Smith's book, "Why I Left Goldman Sachs," start circulating around Wall Street. Most focus on details like a naked Lloyd Blankfein and mild cruelty to interns. Bank stocks up 23 percent.
Oct. 16: Pandit's Defenestration: Just a day after hosting an earnings conference call, CEO Vikram Pandit is unceremoniously shown the window. Bank stocks up 24 percent.
Nov. 6: Worst Trade Of The Year: After spending heavily on the presidential candidacy of Mitt Romney, Wall Street watches in horror as Romney is drubbed by the man they backed in 2008 but abandoned in 2012, President Obama. Meanwhile, bete noir Elizabeth Warren is elected to the Senate. Bank stocks up 24 percent.
Nov. 16: Swiss-American Settlement: JPMorgan and Credit Suisse together agreed to pay $400 million to settle charges that they misled investors about the quality of mortgage bonds they sold before the crisis. Bank stocks up a mere 17 percent, following a minor post-election market selloff.
Dec. 5: Deutsche Bank Big Losses: The Financial Times reports that former employees are accusing Deutsche Bank of hiding $12 billion in losses to make itself look better during the financial crisis. Separately, Citigroup announces 11,000 job cuts. Bank stocks up 21 percent.
Dec. 10: HSBC's Big Wrist Slap: The British bank agrees to pay $1.9 billion to settle charges that it ignored money laundering, but it will not be charged with any crime. Bank stocks up 22 percent.
Dec. 18: UBS's Bigger Wrist Slap: Swiss bank UBS agrees to pay $1.5 billion to settle charges that it rampantly manipulated Libor for years. A couple of its former traders are arrested, and the bank's Japan unit pleads guilty to criminal charges, a rarity. Bank stocks up 27 percent.
by JackRiddler » Mon Dec 31, 2012 4:39 pm
by justdrew » Mon Dec 31, 2012 4:59 pm
Ooyala is delivering segmented files and the player is playing them as if they were a playlist with no pauses between separate files. Also notice that the Ooyala file segments are sent at different bit rates. The player is undoubtedly able to switch to different bit rates on the fly. So even assuming you could glue the segments back together, they probably wouldn't play as a single file because of the different bit rates. Your theorhetical "downloader" would also have to be able to re-encode the files at the same bit rate at the same time it was stitching them together seamlessly. If you go to the "Monetize" section of the page you will note that Ooyala is able to patch ads into the videos as well, delivering them in between the file segments I'm guessing. So the "downloader" would also have to be able to know what parts to ignore to get rid of the ads. In other words, you would probably need the help of someone at Ooyala to build this "downloader" (which would probably be painfully slow anyway) and since Ooyala is a business who's interest is providing fast streaming files that are purposefully difficult to download, my guess is they aren't going to be any help in developing such a tool.
by JackRiddler » Mon Dec 31, 2012 8:26 pm
by JackRiddler » Sat Jan 05, 2013 4:51 pm
Secret and Lies of the Bailout
The federal rescue of Wall Street didn’t fix the economy – it created a permanent bailout state based on a Ponzi-like confidence scheme. And the worst may be yet to come
By MATT TAIBBI
January 4, 2013 4:25 PM ET
Illustration by Victor Juhasz
It has been four long winters since the federal government, in the hulking, shaven-skulled, Alien Nation-esque form of then-Treasury Secretary Hank Paulson, committed $700 billion in taxpayer money to rescue Wall Street from its own chicanery and greed. To listen to the bankers and their allies in Washington tell it, you'd think the bailout was the best thing to hit the American economy since the invention of the assembly line. Not only did it prevent another Great Depression, we've been told, but the money has all been paid back, and the government even made a profit. No harm, no foul – right?
Wrong.
It was all a lie – one of the biggest and most elaborate falsehoods ever sold to the American people. We were told that the taxpayer was stepping in – only temporarily, mind you – to prop up the economy and save the world from financial catastrophe. What we actually ended up doing was the exact opposite: committing American taxpayers to permanent, blind support of an ungovernable, unregulatable, hyperconcentrated new financial system that exacerbates the greed and inequality that caused the crash, and forces Wall Street banks like Goldman Sachs and Citigroup to increase risk rather than reduce it. The result is one of those deals where one wrong decision early on blossoms into a lush nightmare of unintended consequences. We thought we were just letting a friend crash at the house for a few days; we ended up with a family of hillbillies who moved in forever, sleeping nine to a bed and building a meth lab on the front lawn.
How Wall Street Killed Financial Reform
But the most appalling part is the lying. The public has been lied to so shamelessly and so often in the course of the past four years that the failure to tell the truth to the general populace has become a kind of baked-in, official feature of the financial rescue. Money wasn't the only thing the government gave Wall Street – it also conferred the right to hide the truth from the rest of us. And it was all done in the name of helping regular people and creating jobs. "It is," says former bailout Inspector General Neil Barofsky, "the ultimate bait-and-switch."
The bailout deceptions came early, late and in between. There were lies told in the first moments of their inception, and others still being told four years later. The lies, in fact, were the most important mechanisms of the bailout. The only reason investors haven't run screaming from an obviously corrupt financial marketplace is because the government has gone to such extraordinary lengths to sell the narrative that the problems of 2008 have been fixed. Investors may not actually believe the lie, but they are impressed by how totally committed the government has been, from the very beginning, to selling it.
THEY LIED TO PASS THE BAILOUT
Today what few remember about the bailouts is that we had to approve them. It wasn't like Paulson could just go out and unilaterally commit trillions of public dollars to rescue Goldman Sachs and Citigroup from their own stupidity and bad management (although the government ended up doing just that, later on). Much as with a declaration of war, a similarly extreme and expensive commitment of public resources, Paulson needed at least a film of congressional approval. And much like the Iraq War resolution, which was only secured after George W. Bush ludicrously warned that Saddam was planning to send drones to spray poison over New York City, the bailouts were pushed through Congress with a series of threats and promises that ranged from the merely ridiculous to the outright deceptive. At one meeting to discuss the original bailout bill – at 11 a.m. on September 18th, 2008 – Paulson actually told members of Congress that $5.5 trillion in wealth would disappear by 2 p.m. that day unless the government took immediate action, and that the world economy would collapse "within 24 hours."
To be fair, Paulson started out by trying to tell the truth in his own ham-headed, narcissistic way. His first TARP proposal was a three-page absurdity pulled straight from a Beavis and Butt-Head episode – it was basically Paulson saying, "Can you, like, give me some money?" Sen. Sherrod Brown, a Democrat from Ohio, remembers a call with Paulson and Federal Reserve chairman Ben Bernanke. "We need $700 billion," they told Brown, "and we need it in three days." What's more, the plan stipulated, Paulson could spend the money however he pleased, without review "by any court of law or any administrative agency."
The White House and leaders of both parties actually agreed to this preposterous document, but it died in the House when 95 Democrats lined up against it. For an all-too-rare moment during the Bush administration, something resembling sanity prevailed in Washington.
So Paulson came up with a more convincing lie. On paper, the Emergency Economic Stabilization Act of 2008 was simple: Treasury would buy $700 billion of troubled mortgages from the banks and then modify them to help struggling homeowners. Section 109 of the act, in fact, specifically empowered the Treasury secretary to "facilitate loan modifications to prevent avoidable foreclosures." With that promise on the table, wary Democrats finally approved the bailout on October 3rd, 2008. "That provision," says Barofsky, "is what got the bill passed."
But within days of passage, the Fed and the Treasury unilaterally decided to abandon the planned purchase of toxic assets in favor of direct injections of billions in cash into companies like Goldman and Citigroup. Overnight, Section 109 was unceremoniously ditched, and what was pitched as a bailout of both banks and homeowners instantly became a bank-only operation – marking the first in a long series of moves in which bailout officials either casually ignored or openly defied their own promises with regard to TARP.
Congress was furious. "We've been lied to," fumed Rep. David Scott, a Democrat from Georgia. Rep. Elijah Cummings, a Democrat from Maryland, raged at transparently douchey TARP administrator (and Goldman banker) Neel Kashkari, calling him a "chump" for the banks. And the anger was bipartisan: Republican senators David Vitter of Louisiana and James Inhofe of Oklahoma were so mad about the unilateral changes and lack of oversight that they sponsored a bill in January 2009 to cancel the remaining $350 billion of TARP.
So what did bailout officials do? They put together a proposal full of even bigger deceptions to get it past Congress a second time. That process began almost exactly four years ago – on January 12th and 15th, 2009 – when Larry Summers, the senior economic adviser to President-elect Barack Obama, sent a pair of letters to Congress. The pudgy, stubbyfingered former World Bank economist, who had been forced out as Harvard president for suggesting that women lack a natural aptitude for math and science, begged legislators to reject Vitter's bill and leave TARP alone.
In the letters, Summers laid out a five-point plan in which the bailout was pitched as a kind of giant populist program to help ordinary Americans. Obama, Summers vowed, would use the money to stimulate bank lending to put people back to work. He even went so far as to say that banks would be denied funding unless they agreed to "increase lending above baseline levels." He promised that "tough and transparent conditions" would be imposed on bailout recipients, who would not be allowed to use bailout funds toward "enriching shareholders or executives." As in the original TARP bill, he pledged that bailout money would be used to aid homeowners in foreclosure. And lastly, he promised that the bailouts would be temporary – with a "plan for exit of government intervention" implemented "as quickly as possible."
The reassurances worked. Once again, TARP survived in Congress – and once again, the bailouts were greenlighted with the aid of Democrats who fell for the old "it'll help ordinary people" sales pitch. "I feel like they've given me a lot of commitment on the housing front," explained Sen. Mark Begich, a Democrat from Alaska.
But in the end, almost nothing Summers promised actually materialized. A small slice of TARP was earmarked for foreclosure relief, but the resultant aid programs for homeowners turned out to be riddled with problems, for the perfectly logical reason that none of the bailout's architects gave a shit about them. They were drawn up practically overnight and rushed out the door for purely political reasons – to trick Congress into handing over tons of instant cash for Wall Street, with no strings attached. "Without those assurances, the level of opposition would have remained the same," says Rep. Raúl Grijalva, a leading progressive who voted against TARP. The promise of housing aid, in particular, turned out to be a "paper tiger."
HAMP, the signature program to aid poor homeowners, was announced by President Obama on February 18th, 2009. The move inspired CNBC commentator Rick Santelli to go berserk the next day – the infamous viral rant that essentially birthed the Tea Party. Reacting to the news that Obama was planning to use bailout funds to help poor and (presumably) minority homeowners facing foreclosure, Santelli fumed that the president wanted to "subsidize the losers' mortgages" when he should "reward people that could carry the water, instead of drink the water." The tirade against "water drinkers" led to the sort of spontaneous nationwide protests one might have expected months before, when we essentially gave a taxpayer-funded blank check to Gamblers Anonymous addicts, the millionaire and billionaire class.
In fact, the amount of money that eventually got spent on homeowner aid now stands as a kind of grotesque joke compared to the Himalayan mountain range of cash that got moved onto the balance sheets of the big banks more or less instantly in the first months of the bailouts. At the start, $50 billion of TARP funds were earmarked for HAMP. In 2010, the size of the program was cut to $30 billion. As of November of last year, a mere $4 billion total has been spent for loan modifications and other homeowner aid.
In short, the bailout program designed to help those lazy, job-averse, "water-drinking" minority homeowners – the one that gave birth to the Tea Party – turns out to have comprised about one percent of total TARP spending. "It's amazing," says Paul Kiel, who monitors bailout spending for ProPublica. "It's probably one of the biggest failures of the Obama administration."
The failure of HAMP underscores another damning truth – that the Bush-Obama bailout was as purely bipartisan a program as we've had. Imagine Obama retaining Don Rumsfeld as defense secretary and still digging for WMDs in the Iraqi desert four years after his election: That's what it was like when he left Tim Geithner, one of the chief architects of Bush's bailout, in command of the no-stringsattached rescue four years after Bush left office.
Yet Obama's HAMP program, as lame as it turned out to be, still stands out as one of the few pre-bailout promises that was even partially fulfilled. Virtually every other promise Summers made in his letters turned out to be total bullshit. And that includes maybe the most important promise of all – the pledge to use the bailout money to put people back to work.
THEY LIED ABOUT LENDING
Once TARP passed, the government quickly began loaning out billions to some 500 banks that it deemed "healthy" and "viable." A few were cash loans, repayable at five percent within the first five years; other deals came due when a bank stock hit a predetermined price. As long as banks held TARP money, they were barred from paying out big cash bonuses to top executives.
But even before Summers promised Congress that banks would be required to increase lending as a condition for receiving bailout funds, officials had already decided not to even ask the banks to use the money to increase lending. In fact, they'd decided not to even ask banks to monitor what they did with the bailout money. Barofsky, the TARP inspector, asked Treasury to include a requirement forcing recipients to explain what they did with the taxpayer money. He was stunned when TARP administrator Kashkari rejected his proposal, telling him lenders would walk away from the program if they had to deal with too many conditions. "The banks won't participate," Kashkari said.
Barofsky, a former high-level drug prosecutor who was one of the only bailout officials who didn't come from Wall Street, didn't buy that cash-desperate banks would somehow turn down billions in aid. "It was like they were trembling with fear that the banks wouldn't take the money," he says. "I never found that terribly convincing."
In the end, there was no lending requirement attached to any aspect of the bailout, and there never would be. Banks used their hundreds of billions for almost every purpose under the sun – everything, that is, but lending to the homeowners and small businesses and cities they had destroyed. And one of the most disgusting uses they found for all their billions in free government money was to help them earn even more free government money.
To guarantee their soundness, all major banks are required to keep a certain amount of reserve cash at the Fed. In years past, that money didn't earn interest, for the logical reason that banks shouldn't get paid to stay solvent. But in 2006 – arguing that banks were losing profits on cash parked at the Fed – regulators agreed to make small interest payments on the money. The move wasn't set to go into effect until 2011, but when the crash hit, a section was written into TARP that launched the interest payments in October 2008.
In theory, there should never be much money in such reserve accounts, because any halfway-competent bank could make far more money lending the cash out than parking it at the Fed, where it earns a measly quarter of a percent. In August 2008, before the bailout began, there were just $2 billion in excess reserves at the Fed. But by that October, the number had ballooned to $267 billion – and by January 2009, it had grown to $843 billion. That means there was suddenly more money sitting uselessly in Fed accounts than Congress had approved for either the TARP bailout or the much-loathed Obama stimulus. Instead of lending their new cash to struggling homeowners and small businesses, as Summers had promised, the banks were literally sitting on it.
Today, excess reserves at the Fed total an astonishing $1.4 trillion."The money is just doing nothing," says Nomi Prins, a former Goldman executive who has spent years monitoring the distribution of bailout money.
Nothing, that is, except earning a few crumbs of risk-free interest for the banks. Prins estimates that the annual haul in interest on Fed reserves is about $3.6 billion – a relatively tiny subsidy in the scheme of things, but one that, ironically, just about matches the total amount of bailout money spent on aid to homeowners. Put another way, banks are getting paid about as much every year for not lending money as 1 million Americans received for mortgage modifications and other housing aid in the whole of the past four years.
Moreover, instead of using the bailout money as promised – to jump-start the economy – Wall Street used the funds to make the economy more dangerous. From the start, taxpayer money was used to subsidize a string of finance mergers, from the Chase-Bear Stearns deal to the Wells FargoWachovia merger to Bank of America's acquisition of Merrill Lynch. Aided by bailout funds, being Too Big to Fail was suddenly Too Good to Pass Up.
Other banks found more creative uses for bailout money. In October 2010, Obama signed a new bailout bill creating a program called the Small Business Lending Fund, in which firms with fewer than $10 billion in assets could apply to share in a pool of $4 billion in public money. As it turned out, however, about a third of the 332 companies that took part in the program used at least some of the money to repay their original TARP loans. Small banks that still owed TARP money essentially took out cheaper loans from the government to repay their more expensive TARP loans – a move that conveniently exempted them from the limits on executive bonuses mandated by the bailout. All told, studies show, $2.2 billion of the $4 billion ended up being spent not on small-business loans, but on TARP repayment. "It's a bit of a shell game," admitted John Schmidt, chief operating officer of Iowa-based Heartland Financial, which took $81.7 million from the SBLF and used every penny of it to repay TARP.
Using small-business funds to pay down their own debts, parking huge amounts of cash at the Fed in the midst of a stalled economy – it's all just evidence of what most Americans know instinctively: that the bailouts didn't result in much new business lending. If anything, the bailouts actually hindered lending, as banks became more like house pets that grow fat and lazy on two guaranteed meals a day than wild animals that have to go out into the jungle and hunt for opportunities in order to eat. The Fed's own analysis bears this out: In the first three months of the bailout, as taxpayer billions poured in, TARP recipients slowed down lending at a rate more than double that of banks that didn't receive TARP funds. The biggest drop in lending – 3.1 percent – came from the biggest bailout recipient, Citigroup. A year later, the inspector general for the bailout found that lending among the nine biggest TARP recipients "did not, in fact, increase." The bailout didn't flood the banking system with billions in loans for small businesses, as promised. It just flooded the banking system with billions for the banks.
THEY LIED ABOUT THE HEALTH OF THE BANKS
The main reason banks didn't lend out bailout funds is actually pretty simple: Many of them needed the money just to survive. Which leads to another of the bailout's broken promises – that taxpayer money would only be handed out to "viable" banks.
Soon after TARP passed, Paulson and other officials announced the guidelines for their unilaterally changed bailout plan. Congress had approved $700 billion to buy up toxic mortgages, but $250 billion of the money was now shifted to direct capital injections for banks. (Although Paulson claimed at the time that handing money directly to the banks was a faster way to restore market confidence than lending it to homeowners, he later confessed that he had been contemplating the direct-cash-injection plan even before the vote.) This new let's-just-fork-over-cash portion of the bailout was called the Capital Purchase Program. Under the CPP, nine of America's largest banks – including Citi, Wells Fargo, Goldman, Morgan Stanley, Bank of America, State Street and Bank of New York Mellon – received $125 billion, or half of the funds being doled out. Since those nine firms accounted for 75 percent of all assets held in America's banks – $11 trillion – it made sense they would get the lion's share of the money. But in announcing the CPP, Paulson and Co. promised that they would only be stuffing cash into "healthy and viable" banks. This, at the core, was the entire justification for the bailout: That the huge infusion of taxpayer cash would not be used to rescue individual banks, but to kick-start the economy as a whole by helping healthy banks start lending again.
The Scam Wall Street Learned From the Mafia
This announcement marked the beginning of the legend that certain Wall Street banks only took the bailout money because they were forced to – they didn't need all those billions, you understand, they just did it for the good of the country. "We did not, at that point, need TARP," Chase chief Jamie Dimon later claimed, insisting that he only took the money "because we were asked to by the secretary of Treasury." Goldman chief Lloyd Blankfein similarly claimed that his bank never needed the money, and that he wouldn't have taken it if he'd known it was "this pregnant with potential for backlash." A joint statement by Paulson, Bernanke and FDIC chief Sheila Bair praised the nine leading banks as "healthy institutions" that were taking the cash only to "enhance the overall performance of the U.S. economy."
But right after the bailouts began, soon-to-be Treasury Secretary Tim Geithner admitted to Barofsky, the inspector general, that he and his cohorts had picked the first nine bailout recipients because of their size, without bothering to assess their health and viability. Paulson, meanwhile, later admitted that he had serious concerns about at least one of the nine firms he had publicly pronounced healthy. And in November 2009, Bernanke gave a closed-door interview to the Financial Crisis Inquiry Commission, the body charged with investigating the causes of the economic meltdown, in which he admitted that 12 of the 13 most prominent financial companies in America were on the brink of failure during the time of the initial bailouts.
On the inside, at least, almost everyone connected with the bailout knew that the top banks were in deep trouble. "It became obvious pretty much as soon as I took the job that these companies weren't really healthy and viable," says Barofsky, who stepped down as TARP inspector in 2011.
This early episode would prove to be a crucial moment in the history of the bailout. It set the precedent of the government allowing unhealthy banks to not only call themselves healthy, but to get the government to endorse their claims. Projecting an image of soundness was, to the government, more important than disclosing the truth. Officials like Geithner and Paulson seemed to genuinely believe that the market's fears about corruption in the banking system was a bigger problem than the corruption itself. Time and again, they justified TARP as a move needed to "bolster confidence" in the system – and a key to that effort was keeping the banks' insolvency a secret. In doing so, they created a bizarre new two-tiered financial market, divided between those who knew the truth about how bad things were and those who did not.
A month or so after the bailout team called the top nine banks "healthy," it became clear that the biggest recipient, Citigroup, had actually flat-lined on the ER table. Only weeks after Paulson and Co. gave the firm $25 billion in TARP funds, Citi – which was in the midst of posting a quarterly loss of more than $17 billion – came back begging for more. In November 2008, Citi received another $20 billion in cash and more than $300 billion in guarantees.
What's most amazing about this isn't that Citi got so much money, but that government-endorsed, fraudulent health ratings magically became part of its bailout. The chief financial regulators – the Fed, the FDIC and the Office of the Comptroller of the Currency – use a ratings system called CAMELS to measure the fitness of institutions. CAMELS stands for Capital, Assets, Management, Earnings, Liquidity and Sensitivity to risk, and it rates firms from one to five, with one being the best and five the crappiest. In the heat of the crisis, just as Citi was receiving the second of what would turn out to be three massive federal bailouts, the bank inexplicably enjoyed a three rating – the financial equivalent of a passing grade. In her book, Bull by the Horns, then-FDIC chief Sheila Bair recounts expressing astonishment to OCC head John Dugan as to why "Citi rated as a CAMELS 3 when it was on the brink of failure." Dugan essentially answered that "since the government planned on bailing Citi out, the OCC did not plan to change its supervisory rating." Similarly, the FDIC ended up granting a "systemic risk exception" to Citi, allowing it access to FDIC-bailout help even though the agency knew the bank was on the verge of collapse.
The sweeping impact of these crucial decisions has never been fully appreciated. In the years preceding the bailouts, banks like Citi had been perpetuating a kind of fraud upon the public by pretending to be far healthier than they really were. In some cases, the fraud was outright, as in the case of Lehman Brothers, which was using an arcane accounting trick to book tens of billions of loans as revenues each quarter, making it look like it had more cash than it really did. In other cases, the fraud was more indirect, as in the case of Citi, which in 2007 paid out the third-highest dividend in America – $10.7 billion – despite the fact that it had lost $9.8 billion in the fourth quarter of that year alone. The whole financial sector, in fact, had taken on Ponzi-like characteristics, as many banks were hugely dependent on a continual influx of new money from things like sales of subprime mortgages to cover up massive future liabilities from toxic investments that, sooner or later, were going to come to the surface.
Now, instead of using the bailouts as a clear-the-air moment, the government decided to double down on such fraud, awarding healthy ratings to these failing banks and even twisting its numerical audits and assessments to fit the cooked-up narrative. A major component of the original TARP bailout was a promise to ensure "full and accurate accounting" by conducting regular "stress tests" of the bailout recipients. When Geithner announced his stress-test plan in February 2009, a reporter instantly blasted him with an obvious and damning question: Doesn't the fact that you have to conduct these tests prove that bank regulators, who should already know plenty about banks' solvency, actually have no idea who is solvent and who isn't?
The government did wind up conducting regular stress tests of all the major bailout recipients, but the methodology proved to be such an obvious joke that it was even lampooned on Saturday Night Live. (In the skit, Geithner abandons a planned numerical score system because it would unfairly penalize bankers who were "not good at banking.") In 2009, just after the first round of tests was released, it came out that the Fed had allowed banks to literally rejigger the numbers to make their bottom lines look better. When the Fed found Bank of America had a $50 billion capital hole, for instance, the bank persuaded examiners to cut that number by more than $15 billion because of what it said were "errors made by examiners in the analysis." Citigroup got its number slashed from $35 billion to $5.5 billion when the bank pleaded with the Fed to give it credit for "pending transactions."
Such meaningless parodies of oversight continue to this day. Earlier this year, Regions Financial Corp. – a company that had failed to pay back $3.5 billion in TARP loans – passed its stress test. A subsequent analysis by Bloomberg View found that Regions was effectively $525 million in the red. Nonetheless, the bank's CEO proclaimed that the stress test "demonstrates the strength of our company." Shortly after the test was concluded, the bank issued $900 million in stock and said it planned on using the cash to pay back some of the money it had borrowed under TARP.
This episode underscores a key feature of the bailout: the government's decision to use lies as a form of monetary aid. State hands over taxpayer money to functionally insolvent bank; state gives regulatory thumbs up to said bank; bank uses that thumbs up to sell stock; bank pays cash back to state. What's critical here is not that investors actually buy the Fed's bullshit accounting – all they have to do is believe the government will backstop Regions either way, healthy or not. "Clearly, the Fed wanted it to attract new investors," observed Bloomberg, "and those who put fresh capital into Regions this week believe the government won't let it die."
Through behavior like this, the government has turned the entire financial system into a kind of vast confidence game – a Ponzi-like scam in which the value of just about everything in the system is inflated because of the widespread belief that the government will step in to prevent losses. Clearly, a government that's already in debt over its eyes for the next million years does not have enough capital on hand to rescue every Citigroup or Regions Bank in the land should they all go bust tomorrow. But the market is behaving as if Daddy will step in to once again pay the rent the next time any or all of these kids sets the couch on fire and skips out on his security deposit. Just like an actual Ponzi scheme, it works only as long as they don't have to make good on all the promises they've made. They're building an economy based not on real accounting and real numbers, but on belief. And while the signs of growth and recovery in this new faith-based economy may be fake, one aspect of the bailout has been consistently concrete: the broken promises over executive pay.
|THEY LIED ABOUT BONUSES
That executive bonuses on Wall Street were a political hot potato for the bailout's architects was obvious from the start. That's why Summers, in saving the bailout from the ire of Congress, vowed to "limit executive compensation" and devote public money to prevent another financial crisis. And it's true, TARP did bar recipients from a whole range of exorbitant pay practices, which is one reason the biggest banks, like Goldman Sachs, worked so quickly to repay their TARP loans.
But there were all sorts of ways around the restrictions. Banks could apply to the Fed and other regulators for waivers, which were often approved (one senior FDIC official tells me he recommended denying "golden parachute" payments to Citigroup officials, only to see them approved by superiors). They could get bailouts through programs other than TARP that did not place limits on bonuses. Or they could simply pay bonuses not prohibited under TARP. In one of the worst episodes, the notorious lenders Fannie Mae and Freddie Mac paid out more than $200 million in bonuses between 2008 and 2010, even though the firms (a) lost more than $100 billion in 2008 alone, and (b) required nearly $400 billion in federal assistance during the bailout period.
Even worse was the incredible episode in which bailout recipient AIG paid more than $1 million each to 73 employees of AIG Financial Products, the tiny unit widely blamed for having destroyed the insurance giant (and perhaps even triggered the whole crisis) with its reckless issuance of nearly half a trillion dollars in toxic credit-default swaps. The "retention bonuses," paid after the bailout, went to 11 employees who no longer worked for AIG.
But all of these "exceptions" to the bonus restrictions are far less infuriating, it turns out, than the rule itself. TARP did indeed bar big cash-bonus payouts by firms that still owed money to the government. But those firms were allowed to issue extra compensation to executives in the form of long-term restricted stock. An independent research firm asked to analyze the stock options for The New York Times found that the top five executives at each of the 18 biggest bailout recipients received a total of $142 million in stocks and options. That's plenty of money all by itself – but thanks in large part to the government's overt display of support for those firms, the value of those options has soared to $457 million, an average of $4 million per executive.
In other words, we didn't just allow banks theoretically barred from paying bonuses to pay bonuses. We actually allowed them to pay bigger bonuses than they otherwise could have. Instead of forcing the firms to reward top executives in cash, we allowed them to pay in depressed stock, the value of which we then inflated due to the government's implicit endorsement of those firms.
All of which leads us to the last and most important deception of the bailouts:
THEY LIED ABOUT THE BAILOUT BEING TEMPORARY
The bailout ended up being much bigger than anyone expected, expanded far beyond TARP to include more obscure (and in some cases far larger) programs with names like TALF, TAF, PPIP and TLGP. What's more, some parts of the bailout were designed to extend far into the future. Companies like AIG, GM and Citigroup, for instance, were given tens of billions of deferred tax assets – allowing them to carry losses from 2008 forward to offset future profits and keep future tax bills down. Official estimates of the bailout's costs do not include such ongoing giveaways. "This is stuff that's never going to appear on any report," says Barofsky.
Citigroup, all by itself, boasts more than $50 billion in deferred tax credits – which is how the firm managed to pay less in taxes in 2011 (it actually received a $144 million credit) than it paid in compensation that year to its since-ousted dingbat CEO, Vikram Pandit (who pocketed $14.9 million). The bailout, in short, enabled the very banks and financial institutions that cratered the global economy to write off the losses from their toxic deals for years to come – further depriving the government of much-needed tax revenues it could have used to help homeowners and small businesses who were screwed over by the banks in the first place.
Even worse, the $700 billion in TARP loans ended up being dwarfed by more than $7.7 trillion in secret emergency lending that the Fed awarded to Wall Street – loans that were only disclosed to the public after Congress forced an extraordinary one-time audit of the Federal Reserve. The extent of this "secret bailout" didn't come out until November 2011, when Bloomberg Markets, which went to court to win the right to publish the data, detailed how the country's biggest firms secretly received trillions in near-free money throughout the crisis.
Goldman Sachs, which had made such a big show of being reluctant about accepting $10 billion in TARP money, was quick to cash in on the secret loans being offered by the Fed. By the end of 2008, Goldman had snarfed up $34 billion in federal loans – and it was paying an interest rate of as low as just 0.01 percent for the huge cash infusion. Yet that funding was never disclosed to shareholders or taxpayers, a fact Goldman confirms. "We did not disclose the amount of our participation in the two programs you identify," says Goldman spokesman Michael Duvally.
Goldman CEO Blankfein later dismissed the importance of the loans, telling the Financial Crisis Inquiry Commission that the bank wasn't "relying on those mechanisms." But in his book, Bailout, Barofsky says that Paulson told him that he believed Morgan Stanley was "just days" from collapse before government intervention, while Bernanke later admitted that Goldman would have been the next to fall.
Meanwhile, at the same moment that leading banks were taking trillions in secret loans from the Fed, top officials at those firms were buying up stock in their companies, privy to insider info that was not available to the public at large. Stephen Friedman, a Goldman director who was also chairman of the New York Fed, bought more than $4 million of Goldman stock over a five-week period in December 2008 and January 2009 – years before the extent of the firm's lifeline from the Fed was made public. Citigroup CEO Vikram Pandit bought nearly $7 million in Citi stock in November 2008, just as his firm was secretly taking out $99.5 billion in Fed loans. Jamie Dimon bought more than $11 million in Chase stock in early 2009, at a time when his firm was receiving as much as $60 billion in secret Fed loans. When asked by Rolling Stone, Chase could not point to any disclosure of the bank's borrowing from the Fed until more than a year later, when Dimon wrote about it in a letter to shareholders in March 2010.
The stock purchases by America's top bankers raise serious questions of insider trading. Two former high-ranking financial regulators tell Rolling Stone that the secret loans were likely subject to a 1989 guideline, issued by the Securities and Exchange Commission in the heat of the savings and loan crisis, which said that financial institutions should disclose the "nature, amounts and effects" of any government aid. At the end of 2011, in fact, the SEC sent letters to Citigroup, Chase, Goldman Sachs, Bank of America and Wells Fargo asking them why they hadn't fully disclosed their secret borrowing. All five megabanks essentially replied, to varying degrees of absurdity, that their massive borrowing from the Fed was not "material," or that the piecemeal disclosure they had engaged in was adequate. Never mind that the law says investors have to be informed right away if CEOs like Dimon and Pandit decide to give themselves a $10,000 raise. According to the banks, it's none of your business if those same CEOs are making use of a secret $50 billion charge card from the Fed.
The implications here go far beyond the question of whether Dimon and Co. committed insider trading by buying and selling stock while they had access to material nonpublic information about the bailouts. The broader and more pressing concern is the clear implication that by failing to act, federal regulators have tacitly approved the nondisclosure. Instead of trusting the markets to do the right thing when provided with accurate information, the government has instead channeled Jack Nicholson – and decided that the public just can't handle the truth.
All of this – the willingness to call dying banks healthy, the sham stress tests, the failure to enforce bonus rules, the seeming indifference to public disclosure, not to mention the shocking lack of criminal investigations into fraud committed by bailout recipients before the crash – comprised the largest and most valuable bailout of all. Brick by brick, statement by reassuring statement, bailout officials have spent years building the government's great Implicit Guarantee to the biggest companies on Wall Street: We will be there for you, always, no matter how much you screw up. We will lie for you and let you get away with just about anything. We will make this ongoing bailout a pervasive and permanent part of the financial system. And most important of all, we will publicly commit to this policy, being so obvious about it that the markets will be able to put an exact price tag on the value of our preferential treatment.
The first independent study that attempted to put a numerical value on the Implicit Guarantee popped up about a year after the crash, in September 2009, when Dean Baker and Travis McArthur of the Center for Economic and Policy Research published a paper called "The Value of the 'Too Big to Fail' Big Bank Subsidy." Baker and McArthur found that prior to the last quarter of 2007, just before the start of the crisis, financial firms with $100 billion or more in assets were paying on average about 0.29 percent less to borrow money than smaller firms.
By the second quarter of 2009, however, once the bailouts were in full swing, that spread had widened to 0.78 percent. The conclusion was simple: Lenders were about a half a point more willing to lend to a bank with implied government backing – even a proven-stupid bank – than they were to lend to companies who "must borrow based on their own credit worthiness." The economists estimated that the lending gap amounted to an annual subsidy of $34 billion a year to the nation's 18 biggest banks.
Today the borrowing advantage of a big bank remains almost exactly what it was three years ago – about 50 basis points, or half a percent. "These megabanks still receive subsidies in the sense that they can borrow on the capital markets at a discount rate of 50 or 70 points because of the implicit view that these banks are Too Big to Fail," says Sen. Brown.
Why does the market believe that? Because the officials who administered the bailouts made that point explicitly, over and over again. When Geithner announced the implementation of the stress tests in 2009, for instance, he declared that banks who didn't have enough money to pass the test could get it from the government. "We're going to help this process by providing a new program of capital support for those institutions that need it," Geithner said. The message, says Barofsky, was clear: "If the banks cannot raise capital, we will do it for them." It was an Implicit Guarantee that the banks would not be allowed to fail – a point that Geithner and other officials repeatedly stressed over the years. "The markets took all those little comments by Geithner as a clue that the government is looking out for them," says Baker. That psychological signaling, he concludes, is responsible for the crucial half-point borrowing spread.
The inherent advantage of bigger banks – the permanent, ongoing bailout they are still receiving from the government – has led to a host of gruesome consequences. All the big banks have paid back their TARP loans, while more than 300 smaller firms are still struggling to repay their bailout debts. Even worse, the big banks, instead of breaking down into manageable parts and becoming more efficient, have grown even bigger and more unmanageable, making the economy far more concentrated and dangerous than it was before. America's six largest banks – Bank of America, JP Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley – now have a combined 14,420 subsidiaries, making them so big as to be effectively beyond regulation. A recent study by the Kansas City Fed found that it would take 70,000 examiners to inspect such trillion-dollar banks with the same level of attention normally given to a community bank. "The complexity is so overwhelming that no regulator can follow it well enough to regulate the way we need to," says Sen. Brown, who is drafting a bill to break up the megabanks.
Worst of all, the Implicit Guarantee has led to a dangerous shift in banking behavior. With an apparently endless stream of free or almost-free money available to banks – coupled with a well-founded feeling among bankers that the government will back them up if anything goes wrong – banks have made a dramatic move into riskier and more speculative investments, including everything from high-risk corporate bonds to mortgagebacked securities to payday loans, the sleaziest and most disreputable end of the financial system. In 2011, banks increased their investments in junk-rated companies by 74 percent, and began systematically easing their lending standards in search of more high-yield customers to lend to.
This is a virtual repeat of the financial crisis, in which a wave of greed caused bankers to recklessly chase yield everywhere, to the point where lowering lending standards became the norm. Now the government, with its Implicit Guarantee, is causing exactly the same behavior – meaning the bailouts have brought us right back to where we started. "Government intervention," says Klaus Schaeck, an expert on bailouts who has served as a World Bank consultant, "has definitely resulted in increased risk."
And while the economy still mostly sucks overall, there's never been a better time to be a Too Big to Fail bank. Wells Fargo reported a third-quarter profit of nearly $5 billion last year, while JP Morgan Chase pocketed $5.3 billion – roughly double what both banks earned in the third quarter of 2006, at the height of the mortgage bubble. As the driver of their success, both banks cite strong performance in – you guessed it – the mortgage market.
So what exactly did the bailout accomplish? It built a banking system that discriminates against community banks, makes Too Big to Fail banks even Too Bigger to Failier, increases risk, discourages sound business lending and punishes savings by making it even easier and more profitable to chase high-yield investments than to compete for small depositors. The bailout has also made lying on behalf of our biggest and most corrupt banks the official policy of the United States government. And if any one of those banks fails, it will cause another financial crisis, meaning we're essentially wedded to that policy for the rest of eternity – or at least until the markets call our bluff, which could happen any minute now.
Other than that, the bailout was a smashing success.
Switzerland's oldest bank Wegelin to close after pleading guilty to aiding US tax evasion
Wegelin & Co, the oldest Swiss private bank, said it would shut its doors permanently after more than two-and-a-half centuries, following its guilty plea to charges of helping wealthy Americans evade taxes through secret accounts.
Under a plea agreement, Wegelin agreed to pay $57.8m, which includes of $20m in restitution to the Internal Revenue Service and a civil forfeiture of $15.8m
Reuters6:39AM GMT 04 Jan 2013
It is also potentially a major turning point in a battle by US authorities against Swiss bank secrecy.
The plea leaves open a major question: Has the bank turned over, or does it plan to disclose, names of American clients to US authorities? That is a key demand in a broad US investigation of tax evasion through Swiss banks.
"It is unclear whether the bank was required to turn over American client names who held secret Swiss bank accounts," said Jeffrey Neiman, a former federal prosecutor involved in other Swiss bank investigations who is now in private law practice in Fort Lauderdale, Florida.
"What is clear is that the Justice Department is aggressively pursuing foreign banks who have helped Americans commit overseas tax evasion," he said.
Charles Miller, a Justice Department spokesman, declined to comment immediately.
Wegelin admitted to charges of conspiracy in helping Americans evade taxes on at least $1.2bn (£743m) for nearly a decade. Wegelin agreed to pay $57.8m to the United States in restitution and fines.
Otto Bruderer, a managing partner at the bank, said in court that "Wegelin was aware that this conduct was wrong."
He said that "from about 2002 through about 2010, Wegelin agreed with certain US taxpayers to evade the U.S. tax obligations of these US taxpayer clients, who filed false tax returns with the IRS."
When Wegelin last February became the first foreign bank in recent memory to be indicted by US authorities, it vowed to resist the charges. The bank, founded in 1741, was declared a fugitive from justice when its Swiss-based executives failed to appear in US court.
The surprise plea effectively ended the US case against Wegelin, one of the most aggressive bank crackdowns in US history.
"Once the matter is finally concluded, Wegelin will cease to operate as a bank," Wegelin said in a statement on Thursday from its headquarters in the remote, small town of St. Gallen next to the Appenzell Alps near the German-Austrian border.
But the fate of three Wegelin bankers, indicted in January 2012 on charges later modified to include the bank, remains up in the air. Under criminal procedural rules, the cases of the three bankers - Michael Berlinka, Urs Frei and Roger Keller - are still pending.
Although Wegelin had about a dozen branches, all in Switzerland, at the time of its indictment, it moved quickly to wind down its business, partly through a sale of its non-US assets to regional Swiss bank Raiffesen Gruppe.
A corporate indictment can be a death knell. In 2002, accounting firm Arthur Andersen went out of business after being found guilty over its role in failed energy company Enron Corp. A 2005 Supreme Court ruling later overturned the conviction, but it was too late to save the company.
Wegelin, a partnership of Swiss private bankers, was already a shadow of its former self - it effectively broke itself up following the indictment last year by selling the non-US portion of its business.
Dozens of Swiss bankers and their clients have been indicted in recent years, following a 2009 agreement by UBS, the largest Swiss bank, to enter into a deferred-prosecution agreement, turn over 4,450 client names and pay a $780m fine after admitting to criminal wrongdoing in selling tax-evasion services to wealthy Americans.
William Sharp, a tax lawyer in Tampa, Florida, with many US clients of Swiss banks, said Wegelin's plea "should serve as a wake-up call" to the world banking community servicing US clients to takes steps to ensure compliance with U.S. law.
Sharp called Wegelin's change of heart "shocking."
Banks under US criminal investigation in the wider probe include Credit Suisse, which disclosed last July it had received a target letter saying it was under a grand jury investigation.
In a statement after the plea, Assistant US Attorney General Kathryn Keneally said it was a top Justice Department priority "to find those who continue to shirk their tax obligations," as well as those who help them and profit from it.
"The best deal now for these folks is to come in and 'get right' with the IRS, before either the IRS or the Justice Department finds them," she said.
Under its plea, Wegelin agreed to pay the $20m in restitution to the IRS as well a civil forfeiture of $15.8m, the Justice Department said.
Wegelin also agreed to pay an additional $22.05m fine, the Justice Department said. US District Judge Jed Rakoff, who must approve the monetary penalties, set a hearing in the case for March 4 for sentencing.
Since Wegelin has no branches outside Switzerland, it used UBS for correspondent banking services, a standard industry practice, to handle money for US-based clients.
by JackRiddler » Sat Jan 05, 2013 4:55 pm
http://www.counterpunch.org/2012/12/31/ ... utes/print
December 31, 2012
In the Dumps
All You Wanted to Know About Housing in Three Minutes
by MIKE WHITNEY
There’s a terrific video at Bloomberg News that will tell you everything you want to know about housing in just under 3 minutes. Unfortunately, the video hasn’t gotten much attention, probably because it veers from the MSMs fairytale about a housing recovery. Even so, I have transcribed the interview below so that readers can judge for themselves whether housing is really bouncing back or it’s just a bunch of baloney.
Keep in mind that Robert Shiller, who predicted both the dot.com and housing bubbles, is widely regarded as the nation’s top housing market expert. Also, the S&P Case-Shiller Home Price Index, which he co-founded, is the benchmark index for home price trends in the country’s 20 largest cities. Here’s the interview (with some commentary):
Bloomberg anchor:
“According to the latest Case-Shiller Home Price Index, which we got yesterday, home values are up over 4 percent on the year. Can this positive housing news weather the fiscal cliff and all the uncertainty into 2013?
For a closer look at what the housing recovery means for the economy, we turn to Robert Shiller of Yale University, the co-founder of the Case-Shiller Home Price Index.
Good morning Bob. You’ve been very, very hesitant to call a bottom for home prices and an all-out housing recovery, but don’t the data pretty broadly speak to the fact that housing is on the mend?
Robert Shiller: “Well, it all depends on what you mean by “on the mend” and what time horizon you are trying to forecast over. If you’re talking about the real short-run, then it’s on the way down, because the monthly data was down just a smidgen because it’s the Fall season. But, maybe, it IS on the way up in the short run. But I think homeowners care mostly about the longer run. Most people are putting their money in to invest for years, and there, the outlook is very fuzzy. I don’t know why there’s such enthusiasm for that (fuzzy) outlook right now?
(Me: Notice how Shiller dismisses the claim that housing is bouncing back. No, says Shiller, that’s not what the data say. What the data says is that the future is very uncertain.)
Bloomberg Anchor (again): What is making you say that? What is “fuzzy” in your eyes?
Shiller: We’ve seen a decline in general interest in homeownership. We’ve seen rentals rise. Our permit data shows that new construction is tilted towards multi-family. So, if you are sitting in a suburban house,–single family detached–what is your outlook now. I think it is highly uncertain. It’s risky. It could be up? I just don’t see how anybody knows.”
(Me: This is great point, but one that everyone in the media seems to miss, which is, that fewer people actually want to own a home now. That’s why the homeownership rate is actually falling. (See: “Falling homeownership rate and the housing market”, Sober Look) The reason that prices are going up, is because speculators are piling into the market thinking they can make a killing flipping houses or through property management. In other words, investors are driving the market, not organic sales. Just take a look at this at CNBC:
“Up to now the housing recovery had been fuelled by investors buying up thousands of distressed properties, the bulk of them in western states like Arizona, Nevada and California. This helped shrink supplies in those states and boost prices by double digits.” (Mortgage Recovery Still Rocky“, CNBC)
Or this, from Investor Place:
“Housing sales aren’t being fueled by average folks looking to buy a home. Just 61% of buyers are purchasing primary residences, the lowest number since 2005 and down from 70% in 2008. Meanwhile, speculators accounted for 27% of housing sales. They’re buying homes to rehab and subsequently flip or rent.” (“Housing recovery?”, Investor Place)
Keep in mind, that speculation isn’t a sign of market strength. It’s a sign of weakness and instability.
(Back to the interview)
Bloomberg Anchor: When you look at housing in the context of many, many years, then how far are we from a “normal” housing market at this point?
Shiller: Well, in terms of real home values, it looks pretty normal, right now. We’ve come way down from the peak. We’re almost 40 percent down in inflation corrected terms. But that puts us back in the normal range. So, I think that another really plausible forecast for the next 5 years is, Hey, I think it’s going to stay where it is right now. You know, the new Zillow survey of homeprice experts came out with a forecast for the next 5 years that implied a 1.3% real increase per year. So, that’s what those experts are saying. I think they’re a little bit on the optimistic side, but it’s certainly a plausible forecast. Not exciting, but positive.”
Bingo! What Shiller means is that there’s no reason to expect prices to rise any faster. Absent another bubble, prices should continue to plod along at their historic (slow) pace, which means that –for many people–the biggest investment of their lives, is going to be a complete bust. Home equity appreciation is just not going to produce the windfall nestegg that many Boomers are going to need to avoid a life of destitution in their waning years. They’re going to have to look for other ways to increase their savings or keep punching the clock until they keel over.
And, it’s not just prices that are back to normal either. Sales are, too. Just get a load of this from economist Dean Baker at CEPR:
“Both the NYT and USA Today have convinced themselves that house sales are well below their trend level, with the latter telling us that a 5.5 million annual sales rate of existing homes considered healthy. In fact, we are pretty much back to trend levels of sales. In the mid-90s before the bubble began to distort the market, sales averaged about 3.5 million a year. A simple adjustment for the 15 percent population growth over this period would imply an annual sales rate of 4 million existing homes. That is somewhat below the current 4.5 million sales rate.” (“Housing Sales Are Back to Trend”, CEPR)
Since Baker wrote that post in August 2012, existing homes sales have shot up even higher to an annual rate of 5.04 million in November. (According to the National Association of Realtors or NAR) That means that sales are already significantly above trend and well-into bubble territory.
So, here’s the million dollar question: If prices are already at “normal”, and sales are already above trend, and President Obama isn’t going to approve another round of fiscal stimulus, (He won’t) and the Fed’s $85 billion per month QE4 program continues to have no impact on sales (it doesn’t), then what magical force is going to push the market higher?
The only way that prices can continue to rise is if the banks start issuing loans to unqualified mortgage applicants en masse like they did back in 2005-2006. Otherwise, the market’s going to stay right where it is today, in the dumps.
MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at fergiewhitney@msn.com.
by JackRiddler » Sat Jan 05, 2013 5:08 pm
http://www.counterpunch.org/2012/12/28/ ... tory/print
Weekend Edition December 28-30, 2012
Looting the Future
Economic Plunder in Recent History
by ROB URIE
In the mid 1990s Republican New Jersey Governor Christine Todd Whitman re-directed contributions from the pension fund for state employees to the state general account while giving tax cuts to wealthy state residents. By purposely under-funding the pension plan Ms. Whitman was able to ‘balance’ the state budget while cutting taxes. And through pension accounting loopholes, the move provided the illusion the pension plan was adequately funded as massive deficits accrued.
Cut to 2011, current Republican New Jersey Governor Chris Christie and the New Jersey legislature pass bi-partisan pension ‘reform’ that ‘solves’ the systematic looting of the pension plan by cutting promised payouts to pensioners. The cynical political / economic calculation of 1994 that provided the illusion of fiscal probity while rewarding rich constituents with tax cuts was ‘resolved’ in the new age of austerity by stealing the compensation state employees earned in good faith and is due them.
Was this not emblematic of broad moves over three decades by states, municipalities, corporations, and now the Federal government, to systematically loot the savings of labor and present it as an unfortunate fact of nature to be resolved at labor’s expense the story might be of limited interest. More to the point, current political / economic circumstance results from decades of historical development—earnest recommendations from economists and pundits to solve current economic ‘problems’ with the factors that brought them about left intact support these factors against the future.
The wholesale looting of public and private pensions and health care plans didn’t just ‘happen.’ The salary and benefit negotiations New Jersey state employees engaged in in 1994 were contingent on future events only past the point where the state did what it agreed it would do. The state didn’t do what it agreed it would do. There are no facts of nature or accidents of history behind the benefit shortfalls. They resulted from the systematic transfer of wealth from labor to wealthy state residents. Yet current circumstance, the downturn in the economy, is used as cover to hide what is straightforwardly theft.
Putting the outcomes of economic exploitation and domination in natural terms has a very long history. Nearly three centuries ago Scottish economist Adam Smith posited the ‘invisible hand’ as metaphor for the intersection of social existence and nature he believed to be behind economic life. Western economists in the late 19th century co-opted mathematical models from physicists to (1) give capitalist economics a patina of scientific respectability and (2) continue the deception the economics these economists were promoting were based on ‘laws of nature.’
The historical development coincident with the widespread looting of pension and healthcare plans included the revival of neo-liberal capitalism—international capitalism devoid of the rules upon which capitalism as an economic system is theorized to ‘work.’ Premised on cartoon assumptions regarding human motivation, neo-liberalism joins Victorian economism to Adam Smith’s naturalized political economy. The assumptions place economistic striving as the motivating force in a frictionless world. The absence of friction provides the morality play behind economic distribution—in a world with no friction everyone is equal and economic outcomes result from personal capacity—effort plus skill.
Couched in a language designed to fit models developed for other purposes (and discarded a century ago by their developers), neo-liberalism reduces historical development to irrelevance—it doesn’t matter how ‘we’ got here because all residual consequences are mere psychological artifacts. The models (theories) support capitalism in a world that is identical to the models. As no world is, there is no inherent reason to believe capitalism does ‘work.’ This is the reason for free-trade agreements and other accoutrement of rank ideology posturing as ‘science,’—to make ‘the world’ resemble the economic models. Under capitalist theory the failings of capitalism always result from ‘the world’ not being pure enough to support it. This is one reason why the economic calamity of recent years has resulted in calls for more of the same—only more so.
As the first link in this piece (above) illustrates,
http://www.nytimes.com/1995/02/22/opini ... uture.html
the consequence of inadequately funding state pension plans was well understood when the decisions to do so were made (a national wave of similar practices quickly followed). The accounting regulations governing public and private (corporate) pension and healthcare plans are designed to facilitate looting by insiders. They allow the substitution of ‘expected’ rates of return for actual in calculating funding ratios. Christine Todd Whitman sought political advantage through looting—the tax cuts bought political allegiance from recipients and the illusion of fiscal probity from ‘balanced’ budgets fit the Republican deception of competent fiscal stewardship. And the capitalist fantasy that state expenditure derives from undue taking from the frictionless ‘private’ sector from whence all ‘real’ wealth comes is used to naturalize straightforward theft.
Cut to the present. A significant proportion of the West is in economic depression. As many people are unemployed today as were at the height of the Great Depression (the total population has grown). Those who lose jobs remain unemployed for longer than at any time since the Great Depression. After stagnating for several decades, median wages declined in 2008 and have yet to recover. Meanwhile, measures of income dispersion—the difference between the incomes of the wealthiest and the rest of us, continued increasing through the economic downturn and turned exponentially higher during the Democratic President’s first term. (See U-6 unemployment, average duration of unemployment and Gini Coefficient here). These are facts, not an effort to ‘poor mouth’ economic circumstance.
Early on neo-Keynesians made good and detailed recommendations that went beyond short term economic patches that maintained the political economy behind current travails. Years after finding no place in public policy ‘debates,’ versions that preserve the political economy that brought the West to current circumstance are all that exist. Another way to put this is to repeat—under the policies of a Democratic President and ‘liberal’ Federal Reserve Chairman the fortunes of the economic malefactors responsible for current economic travails were revived while those of the overwhelming majority of the citizens of the West continue to decline.
The reason why the early neo-Keynesian recommendations would have been beneficial was they would have restructured economic relations in constructive ways. For instance, a government jobs program that provided jobs for all seekers would provide three benefits. In the first, it would provide all of the benefits of employment—incomes, government revenue through taxes and the capacity to buy the goods and services produced by others. In the second, it would put a lie to the ideological improbability of ‘frictionless’ labor markets. The neo-Victorians would have seen, just as they did in the 1930s, the reason people don’t work is because there are no jobs, not because of personal psychological / moral failings. Finally, a government jobs program would provide competition for private employers whose gargantuan profits, the highest in modern history, derive in large measure from their ability to systematically underpay labor.
This last point is the central reason why government jobs programs were never seriously considered while neo-Keynesian monetary policies that benefit the wealthy through financial asset price inflation were implemented early on and persist to this day in the form of QE (Quantitative Easing). The ‘private’ market employers who own the political system don’t want competition for employees. To be clear, there have been no real objections from either political party in Washington to the support the Federal government and Federal Reserve have provided to Wall Street, ‘private’ corporations and financial asset investors (a/k/a plutocrats). These policies benefit the existing political economy—the product of decades of historical development. The objection to government ‘interference’ in the economy only arises when it weakens the economic power of those who have so arranged current circumstance to their own liking.
The ‘economic stabilizers’ that have indeed lessened the impact of the Lesser Depression are premised on short cyclical recessions managed (caused) by the Federal Reserve. A short cyclical recession is not what the West is currently experiencing. This gives different meaning both economically and in the political sociology of capitalism to these automatic stabilizers (unemployment benefits, increased transfer payments). The powers that looted public and private pensions and healthcare plans are using the same rationales and methods to de-legitimize all residual government spending that undermines the transfer of social resources to the ruling plutocracy. Having good ideas just isn’t enough. A change in the political economy that allows them to be implemented is first necessary.
Rob Urie is an artist and political economist in New York
by JackRiddler » Sat Jan 05, 2013 6:12 pm
Weekend Edition December 28-30, 2012
How Today’s Fiscal Austerity is Reminiscent of World War I’s Economic Misunderstandings
America’s Deceptive 2012 Fiscal Cliff
by MICHAEL HUDSON
When World War I broke out in August 1914, economists on both sides forecast that hostilities could not last more than about six months. Wars had grown so expensive that governments quickly would run out of money. It seemed that if Germany could not defeat France by springtime, the Allied and Central Powers would run out of savings and reach what today is called a fiscal cliff and be forced to negotiate a peace agreement.
But the Great War dragged on for four destructive years. European governments did what the United States had done after the Civil War broke out in 1861 when the Treasury printed greenbacks. They paid for more fighting simply by printing their own money. Their economies did not buckle and there was no major inflation. That would happen only after the war ended, as a result of Germany trying to pay reparations in foreign currency. This is what caused its exchange rate to plunge, raising import prices and hence domestic prices. The culprit was not government spending on the war itself (much less on social programs).
But history is written by the victors, and the past generation has seen the banks and financial sector emerge victorious. Holding the bottom 99% in debt, the top 1% are now in the process of subsidizing a deceptive economic theory to persuade voters to pursue policies that benefit the financial sector at the expense of labor, industry, and democratic government as we know it.
Wall Street lobbyists blame unemployment and the loss of industrial competitiveness on government spending and budget deficits – especially on social programs – and labor’s demand to share in the economy’s rising productivity. The myth (perhaps we should call it junk economics) is that (1) governments should not run deficits (at least, not by printing their own money), because (2) public money creation and high taxes (at lest on the wealthy) cause prices to rise. The cure for economic malaise (which they themselves have caused), is said to be less public spending, along with more tax cuts for the wealthy, who euphemize themselves as “job creators.” Demanding budget surpluses, bank lobbyists promise that banks can provide the economy with enough purchasing power to grow. Then, when this ends in crisis, they insist that austerity can squeeze out enough income to enable private-sector debts to be paid.
The reality is that when banks load the economy down with debt, this leaves less to spend on domestic goods and services while driving up housing prices (and hence the cost of living) with reckless credit creation on looser lending terms. Yet on top of this debt deflation, bank lobbyists urge fiscal deflation: budget surpluses rather than pump-priming deficits. The effect is to further reduce private-sector market demand, shrinking markets and employment. Governments fall deeper into distress, and are told to sell off land and natural resources, public enterprises, and other assets. This creates a lucrative market for bank loans to finance privatization on credit. This explains why financial lobbyists back the new buyers’ right to raise the prices they charge for basic needs, creating a united front to endorse rent extraction. The effect is to enrich the financial sector owned by the 1% in ways that indebt and privatize the economy at large – individuals, business and the government itself.
This policy was exposed as destructive in the late 1920s and early 1930s when John Maynard Keynes, Harold Moulton and a few others countered the claims of Jacques Rueff and Bertil Ohlin that debts of any magnitude could be paid if governments would impose deep enough austerity and suffering. This is the doctrine adopted by the International Monetary
Fund to impose on Third World debtors since the 1960s, and by European neoliberals defending creditors imposing austerity on Ireland, Greece, Spain and Portugal.
This pro-austerity mythology aims to distract the public from asking why peacetime governments can’t simply print the money they need. Given the option of printing money instead of levying taxes, why do politicians only create new spending power for the purpose of waging war and destroying property, not to build or repair bridges, roads and other public infrastructure? Why should the government tax employees for future retirement payouts, but not Wall Street for similar user fees and financial insurance to build up a fund to pay for future bank over-lending crises? For that matter, why doesn’t the U.S. Government print the money to pay for Social Security and medical care, just as it created new debt for the $13 trillion post-2008 bank bailout? (I will return to this question below.)
The answer to these questions has little to do with markets, or with monetary and tax theory. Bankers claim that if they have to pay more user fees to pre-fund future bad-loan claims and deposit insurance to save the Treasury or taxpayers from being stuck with the bill, they will have to charge customers more – despite their current record profits, which seem to grab everything they can get. But they support a double standard when it comes to taxing labor.
Shifting the tax burden onto labor and industry is achieved most easily by cutting back public spending on the 99%. That is the root of the December 2012 showdown over whether to impose the anti-deficit policies proposed by the Bowles-Simpson commission of budget cutters whom President Obama appointed in 2010. Shedding crocodile tears over the government’s failure to balance the budget, banks insist that today’s 15.3% FICA wage withholding be raised – as if this will not raise the break-even cost of living and drain the consumer economy of purchasing power. Employers and their work force are told to save in advance for Social Security or other public programs. This is a disguised income tax on the bottom 99%, whose proceeds are used to reduce the budget deficit so that taxes can be cut on finance and the 1%. To paraphrase Leona Helmsley’s quip that “Only the little people pay taxes,” the post-2008 motto is that only the 99% have to suffer losses, not the 1% as debt deflation plunges real estate and stock market prices to inaugurate a Negative Equity economy while unemployment rates soar.
There is no more need to save in advance for Social Security than there is to save in advance to pay for war. Selling Treasury bonds to pay for retirees has the identical monetary and fiscal effect of selling newly printed securities. It is a charade – to shift the tax burden onto labor and industry. Governments need to provide the economy with money and credit to expand markets and employment. They do this by running budget deficits, and this can be done by creating their own money. That is what banks oppose, accusing it of leading to hyperinflation rather than help economies grow.
Their motivation for this wrong accusation is self-serving and their logic is deceptive. Bankers always have fought to block government from creating its own money – at least under normal peacetime conditions. For many centuries, government bonds were the largest and most secure investment for the financial elites that hold most savings. Investment bankers and brokers monopolized public finance, at substantial underwriting commissions. The market for stocks and corporate bonds was rife with fraud, dominated by insiders for the railroads and great trusts being organized by Wall Street, and the canal ventures organized by French and British stockbrokers.
However, there was little alternative to governments creating their own money when the costs of waging an international war far exceeded the volume of national savings or tax revenue available. This obvious need quieted the usual opposition mounted by bankers to limit the public monetary option. It shows that governments can do more under force majeur emergencies than under normal conditions. And the September 2008 financial crisis provided an opportunity for the U.S. and European governments to create new debt for bank bailouts. This turned out to be as expensive as waging a war. It was indeed a financial war. Banks already had captured the regulatory agencies to engage in reckless lending and a wave of fraud and corruption not seen since the 1920s. And now they were holding economies hostage to a break in the chain of payments if they were not bailed out for their speculative gambles, junk mortgages and fraudulent loan packaging.
Their first victory was to disable the ability – or at least the willingness – of the Treasury, Federal Reserve and Comptroller of the Currency to regulate the financial sector. Goldman Sachs, Citicorp and their fellow Wall Street giants hold veto power the appointment of key administrators at these agencies. They used this beachhead to weed out nominees who might not favor their interests, preferring ideological deregulators in the stripe of Alan Greenspan and Tim Geithner. As John Kenneth Galbraith quipped, a precondition for obtaining a central bank post is tunnel vision when it comes to understanding that governments can create their credit as readily as banks can. What is necessary is for one’s political loyalties to lie with the banks.
In the post-2008 financial wreckage it took only a series of computer keystrokes for the U.S. Government to create $13 trillion in debt to save banks from suffering losses on their reckless real estate loans (which computer models pretended would make banks so rich that they could pay their managers enormous salaries, bonuses and stock options), insurance bets gone bad (underpricing risk to win business to pay their managers enormous salaries and bonuses), arbitrage gambles and outright fraud (to give the illusion of earnings justifying enormous salaries, bonuses and stock options). The $800 billion Troubled Asset Relief Program (TARP) and $2 trillion of Federal Reserve “cash for trash” swaps enabled the banks to continue their remuneration of executives and bondholders with hardly a hiccup – while incomes and wealth plunged for the remaining 99% of Americans.
A new term, Casino Capitalism, was coined to describe the transformation that finance capitalism was undergoing in the post-1980 era of deregulation that opened the gates for banks to do what governments hitherto did in time of war: create money and new public debt simply by “printing it” – in this case, electronically on their computer keyboards.
Taking the insolvent Fannie Mae and Freddie Mac mortgage financing agencies onto the public balance sheet for $5.2 trillion accounted for over a third of the $13 trillion bailout. This saved their bondholders from having to suffer losses from the fraudulent appraisals on the junk mortgages with which Countrywide, Bank of America, Citibank and other “too big to fail” banks had stuck them. This enormous debt increase was done without raising taxes. In fact, the Bush administration cut taxes, giving the largest cuts to the highest income and wealth brackets who were its major campaign contributors. Special tax privileges were given to banks so that they could “earn their way out of debt” (and indeed, out of negative equity).[1] The Federal Reserve gave a free line of credit (Quantitative Easing) to the banking system at only 0.25% annual interest by 2011 – that is, one quarter of a percentage point, with no questions asked about the quality of the junk mortgages and other securities pledged as collateral at their full face value, which was far above market price.
This $13 trillion debt creation to save banks from having to suffer a loss was not accused of threatening economic stability. It enabled them to resume paying exorbitant salaries and bonuses, dividends to bondholders and also to pay counterparties on casino-capitalist arbitrage bets. These payments have helped the 1% receive a reported 93% of the gains in income since 2008. The bailout thus polarized the economy, giving the financial sector more power over labor and consumers, industry and the government than has been the case since the late 19th-century Gilded Age.
All this makes today’s financial war much like the aftermath of World War I and countless earlier wars. The effect is to impoverish the losers, appropriate hitherto public assets for the victors, and impose debt service and taxes much like levying tribute. “The financial crisis has been as economically devastating as a world war and may still be a burden on ‘our grandchildren,’” Bank of England official Andrew Haldane recently observed. “‘In terms of the loss of incomes and outputs, this is as bad as a world war.’ he said. The rise in government debt has prompted calls for austerity – on the part of those who did not receive the giveaway. ‘It would be astonishing if people weren’t asking big questions about where finance has gone wrong.’”[2]
But as long as the financial sector is winning its war against the economy at large, it prefers that people believe that There Is No Alternative. Having captured mainstream economics as well as government policy, finance seeks to deter students, voters and the media from questioning whether the financial system really needs to be organized in the way it is. Once such a line of questioning is pursued, people may realize that banking, pension and Social Security systems and public deficit financing do not have to be organized in the way they are. There are better alternatives to today’s road to austerity and debt peonage.
To be continued.
Notes.
[1] No such benefits were given to homeowners whose real estate fell into negative equity. For the few who received debt write-downs to current market value, the credit was treated as normal income and taxed!
[2] Philip Aldrick, “Loss of income caused by banks as bad as a ‘world war’, says BoE’s Andrew Haldane,” The Telegraph, December 3, 2012. Mr. Haldane is the Bank’s executive director for financial stability.
--- Part Two ---
This copy is for your personal, non-commercial use only.
December 31, 2012
America’s Deceptive Fiscal Cliff
The Financial War Against the Economy at Large
by MICHAEL HUDSON
Today’s economic warfare is not the kind waged a century ago between labor and its industrial employers. Finance has moved to capture the economy at large, industry and mining, public infrastructure (via privatization) and now even the educational system. (At over $1 trillion, U.S. student loan debt came to exceed credit-card debt in 2012.) The weapon in this financial warfare is no longer military force. The tactic is to load economies (governments, companies and families) with debt, siphon off their income as debt service and then foreclose when debtors lack the means to pay. Indebting government gives creditors a lever to pry away land, public infrastructure and other property in the public domain. Indebting companies enables creditors to seize employee pension savings. And Indebting labor means that it no longer is necessary to hire strikebreakers to attack union organizers and strikers.
Workers have become so deeply indebted on their home mortgages, credit cards and other bank debt that they fear to strike or even to complain about working conditions. Losing work means missing payments on their monthly bills, enabling banks to jack up interest rates to levels that used to be deemed usurious. So debt peonage and unemployment loom on top of the wage slavery that was the main focus of class warfare a century ago. And to cap matters, credit-card bank lobbyists have rewritten the bankruptcy laws to curtail debtor rights, and the referees appointed to adjudicate disputes brought by debtors and consumers are subject to veto from the banks and businesses that are mainly responsible for inflicting injury.
The aim of financial warfare is not merely to acquire land, natural resources and key infrastructure rents as in military warfare; it is to centralize creditor control over society. In contrast to the promise of democratic reform nurturing a middle class a century ago, we are witnessing a regression to a world of special privilege in which one must inherit wealth in order to avoid debt and job dependency.
The emerging financial oligarchy seeks to shift taxes off banks and their major customers (real estate, natural resources and monopolies) onto labor. Given the need to win voter acquiescence, this aim is best achieved by rolling back everyone’s taxes. The easiest way to do this is to shrink government spending, headed by Social Security, Medicare and Medicaid. Yet these are the programs that enjoy the strongest voter support. This fact has inspired what may be called the Big Lie of our epoch: the pretense that governments can only create money to pay the financial sector, and that the beneficiaries of social programs should be entirely responsible for paying for Social Security, Medicare and Medicaid, not the wealthy. This Big Lie is used to reverse the concept of progressive taxation, turning the tax system into a ploy of the financial sector to levy tribute on the economy at large.
Financial lobbyists quickly discovered that the easiest ploy to shift the cost of social programs onto labor is to conceal new taxes as user fees, using the proceeds to cut taxes for the elite 1%. This fiscal sleight-of-hand was the aim of the 1983 Greenspan Commission. It confused people into thinking that government budgets are like family budgets, concealing the fact that governments can finance their spending by creating their own money. They do not have to borrow, or even to tax (at least, not tax mainly the 99%).
The Greenspan tax shift played on the fact that most people see the need to save for their own retirement. The carefully crafted and well-subsidized deception at work is that Social Security requires a similar pre-funding – by raising wage withholding. The trick is to convince wage earners it is fair to tax them more to pay for government social spending, yet not also to ask the banking sector to pay similar a user fee to pre-save for the next time it itself will need bailouts to cover its losses. Also asymmetrical is the fact that nobody suggests that the government set up a fund to pay for future wars, so that future adventures such as Iraq or Afghanistan will not “run a deficit” to burden the budget. So the first deception is to treat only Social Security and medical care as user fees. The second is to aggravate matters by insisting that such fees be paid long in advance, by pre-saving.
There is no inherent need to single out any particular area of public spending as causing a budget deficit if it is not pre-funded. It is a travesty of progressive tax policy to only oblige workers whose wages are less than (at present) $105,000 to pay this FICA wage withholding, exempting higher earnings, capital gains, rental income and profits. The raison d’être for taxing the 99% for Social Security and Medicare is simply to avoid taxing wealth, by falling on low wage income at a much higher rate than that of the wealthy. This is not how the original U.S. income tax was created at its inception in 1913. During its early years only the wealthiest 1% of the population had to file a return. There were few loopholes, and capital gains were taxed at the same rate as earned income.
The government’s seashore insurance program, for instance, recently incurred a $1 trillion liability to rebuild the private beaches and homes that Hurricane Sandy washed out. Why should this insurance subsidy at below-commercial rates for the wealthy minority who live in this scenic high-risk property be treated as normal spending, but not Social Security? Why save in advance by a special wage tax to pay for these programs that benefit the general population, but not levy a similar “user fee” tax to pay for flood insurance for beachfront homes or war? And while we are at it, why not save another $13 trillion in advance to pay for the next bailout of Wall Street when debt deflation causes another crisis to drain the budget?
But on whom should we levy these taxes? To impose user fees for the beachfront reconstruction would require a tax falling mainly on the wealthy owners of such properties. Their dominant role in funding the election campaigns of the Congressmen and Senators who draw up the tax code suggests why they are able to avoid prepaying for the cost of rebuilding their seashore property. Such taxation is only for wage earners on their retirement income, not the 1% on their own vacation and retirement homes.
By not raising taxes on the wealthy or using the central bank to monetize spending on anything except bailing out the banks and subsidizing the financial sector, the government follows a pro-creditor policy. Tax favoritism for the wealthy deepens the budget deficit, forcing governments to borrow more. Paying interest on this debt diverts revenue from being spent on goods and services. This fiscal austerity shrinks markets, reducing tax revenue to the brink of default. This enables bondholders to treat the government in the same way that banks treat a bankrupt family, forcing the debtor to sell off assets – in this case the public domain as if it were the family silver, as Britain’s Prime Minister Harold MacMillan characterized Margaret Thatcher’s privatization sell-offs.
In an Orwellian doublethink twist this privatization is done in the name of free markets, despite being imposed by global financial institutions whose administrators are not democratically elected. The International Monetary Fund (IMF), European Central Bank (ECB) and EU bureaucracy treat governments like banks treat homeowners unable to pay their mortgage: by foreclosing. Greece, for example, has been told to start selling off prime tourist sites, ports, islands, offshore gas rights, water and sewer systems, roads and other property.
Sovereign governments are, in principle, free of such pressure. That is what makes them sovereign. They are not obliged to settle public debts and budget deficits by asset selloffs. They do not need to borrow more domestic currency; they can create it. This self-financing keeps the national patrimony in public hands rather than turning assets over to private buyers, or having to borrow from banks and bondholders.
To be continued.
--- Part Three ---
This copy is for your personal, non-commercial use only.
January 02, 2013
America's Deceptive Fiscal Cliff
Why the Fiscal Squeeze Imposes Needless Austerity
by MICHAEL HUDSON
The financial sector promises that privatizing roads and ports, water and sewer systems, bus and railroad lines (on credit, of course) is more efficient and will lower the prices charged for their services. The reality is that the new buyers put up rent-extracting tollbooths on the infrastructure being sold. Their break-even costs include the high salaries and bonuses they pay themselves, as well as interest and dividends to their creditors and backers, spending on stock buy-backs and political lobbying.
Public borrowing creates a dependency that shifts economic planning to Wall Street and other financial centers. When voters resist, it is time to replace democracy with oligarchy. “Technocratic” rule replaces that of elected officials. In Europe the IMF, ECB and EU troika insists that all debts must be paid, even at the cost of austerity, depression, unemployment, emigration and bankruptcy. This is to be done without violence where possible, but with police-state practices when grabbers find it necessary to quell popular opposition.
Financializing the economy is depicted as a natural way to gain wealth – by taking on more debt. Yet it is hard to think of a more highly politicized policy, shaped as it is by tax rules that favor bankers. It also is self-terminating, because when public debt grows to the point where investors (“the market”) no longer believe that it can be repaid, creditors mount a raid (the military analogy is appropriate) by “going on strike” and not rolling over existing bonds as they fall due. Bond prices fall, yielding higher interest rates, until governments agree to balance the budget by voluntary pre-bankruptcy privatizations.
Selling Saved-up Treasury Bonds to Fund Public Programs is Like New Deficit Borrowing
If the aim of America’s military spending around the world is to prepare for future warfare, why not aim at saving up a fund of $10 trillion or even $30 trillion in advance, as with Social Security, so that we will have the money to pay for it?
The answer is that selling saved-up Treasury bills to finance Social Security, military spending or any other program has the same monetary and price effect as issuing new Treasury bills. The impact on financial markets – and on the private sector’s holding of government debt – by paying Social Security out of past savings – that is, by selling the Treasury securities in which Social Security funds are invested – is much like borrowing by selling new securities. It makes little difference whether the Treasury sells newly printed IOUs, or sells bonds that it has been accumulating in a special fund. The effect is to increase public debt owed to the financial sector.
If the savings are to be invested in Treasury bonds (as is the case with Social Security), will this pay for tax cuts elsewhere in the budget? If so, will these cuts be for the wealthy 1% or the 99%? Or, will the savings be invested in infrastructure, or turned over to states and cities to help balance their budget shortfalls and underfunded pension plans?
Another problem concerns who should pay for this pre-saving. The taxes needed to pre-fund a savings build-up siphon off income from somewhere in the economy. How much will the economy shrink by diverting income from being spent on goods and services? And whose income will taxed? These questions illustrate how politically self-interested it is to single out taxing wages to save for Social Security in contrast to war-making and beach-house rebuilding.
Government budgets usually are designed to be in balance under normal peacetime conditions, so most public debt has been brought into being by war (prior to today’s financial war of slashing taxes on the wealthy). Adam Smith’s Wealth of Nations (Book V) traced how each new British bond issue to raise funds for a military action had a dedicated tax to pay its interest charges. The accumulation of such war debts thus raised the cost of living and hence the break-even price of labor. To prevent this from undercutting of British competitiveness, Smith urged that wars be waged on a pay-as-you-go basis – by full taxation rather than by borrowing and entailing interest payments and taxes (as the debt itself rarely was amortized). Smith thought that populations should feel the cost of war directly and immediately, presumably leading them to be vigilant in checking grandiose projects of empire.
The United States issued fiat greenback currency to pay for much of its Civil War, but also issued bonds. In analyzing this war finance the Canadian-American astronomer and monetary theorist Simon Newcomb pointed out that all wars must be paid for in the form of tangible material and lives by the generation that fights them. Paying for the war by borrowing from bondholders, he explained, involved levying taxes to pay the interest. The effect was to transfer income from the Western states (taxpayers) to bondholders in the East.
In the case of Social Security today the beneficiary of government debt is still the financial sector. The economy must provide the housing, food, health care, transportation and clothing to enable retirees to live normal lives. This economic surplus can be paid for either out of taxation, new money creation or borrowing. But instead of “the West,” the major payers of the Social Security tax are wage earners across the nation. Taxing labor shrinks markets and forces the economy into austerity.
Quantitative Easing as Free Money Creation – To Subsidize the Big Banks
The Federal Reserve’s three waves of Quantitative Easing since 2008 show how easy it is to create free money. Yet this has been provided only to the largest banks, not to strapped homeowners or industry. An immediate $2 trillion in “cash for trash” took the form of the Fed creating new bank-reserve credit in exchange for mortgage-backed securities valued far above market prices. QE2 provided another $800 billion in 2011-12. The banks used this injection of credit for interest rate arbitrage and exchange rate speculation on the currencies of Brazil, Australia and other high-interest-rate economies. So nearly all the Fed’s new money went abroad rather than being lent out for investment or employment at home.
U.S. Government debt was run up mainly to re-inflate prices for packaged bank mortgages, and hence real estate prices. Instead of alleviating private-sector debt by writing down mortgages in line with the homeowners’ ability to pay, the Federal Reserve and Treasury
created money to support property prices – to push the banking system’s balance sheets back above negative net worth. The Fed’s QE3 program in 2012-13 created money to buy mortgage-backed securities each month, to provide banks with money to lend to new property buyers.
For the economy at large, the debts were left in place. Yet commentators focused only on government debt. In a double standard, they accused budget deficits of inflating wages and consumer prices, yet the explicit aim of quantitative easing was to support asset prices. Inflating asset prices on credit is deemed to be good for the economy, despite loading it down with debt. But public spending into the “real” economy, raising employment levels and sustaining consumer spending, is deemed bad – except when this is financed by personal borrowing from the banks. So in each case, increasing bank profits is the standard by which fiscal policy is to be judged!
The result is a policy asymmetry that is opposite from what most epochs have deemed fair or helpful to economic growth. Bankers and bondholders insist that the public sector borrow from them, blocking the government’s power to self-finance its operations – with one glaring exception. That exception occurs when the banks themselves need free money creation. The Fed provided nearly free credit to the banks under QE2, and Chairman Ben Bernanke promised to continue this policy until such time as the unemployment rate drops to 6.5%. The pretense is that low interest rates spur employment, but the most pressing aim is to provide easy credit to revive borrowing and bid asset prices back up.
Fiscal Deflation on Top of Debt Deflation
The main financial problem with funding war occurs after the return to normalcy, when creditors press for budget surpluses to roll back the public debt that has been run up. This imposes fiscal austerity, reducing wages and commodity prices relative to the debts that are owed. Consumer spending shrinks and prices decline as governments spend less, while higher taxes withdraw revenue. This is what is occurring in today’s financial war, much as it has in past military postwar returns to peace.
Governments have the power to resist this deflationary policy. Like commercial banks, they can create money on their computer keyboards. Indeed, since 2008 the government has created debt to support the Finance, Insurance and Real Estate (FIRE) sector more than the “real” production and consumption economy.
In contrast to public spending for goods and services (or social programs that increase market demand), most of the bank credit that led to the 2008 financial collapse was created to finance the purchase property already in place, stocks and bonds already issued, or companies already in existence. The effect has been to load down the economy with mortgages, bonds and bank debt whose carrying charges eat into spending on current output. The $13 trillion bank subsidy since 2008 (to enable banks to earn their way out of negative equity) brings us back to the question of why taxes should be levied on the 99% to pre-save for Social Security and Medicare, but not for the bank bailout.
Current tax policy encourages financial and rent extraction that has become the major economic problem of our epoch. Industrial productivity continues to rise, but debt is growing even more inexorably. Instead of fueling economic growth, this of credit/debt threatens to absorb the economic surplus, plunging the economy into austerity, debt deflation and negative equity.
So despite the fact that the financial system is broken, it has gained control over public policy to sustain and even obtain tax favoritism for a dysfunctional overgrowth of bank credit. Unlike the progress of science and technology, this debt is not part of nature. It is a social construct. The financial sector has politicized it by pressing to privatize economic rent rather than collect it as the tax base. This financialization of rent-extracting opportunities does not reflect a natural or inevitable evolution of “the market.” It is a capture of market structures and fiscal policy. Bank lobbyists have campaigned to shift the economic arena to the political sphere of lawmaking and tax policy, with side battlegrounds in the mass media and universities to capture the hearts and minds of voters to believe that the quickest and most efficient way to build up wealth is by bank credit and debt leverage.
Budget Deficits as an Antidote to Austerity
Public debts everywhere are growing, as taxes only cover part of public spending. The least costly way to finance this expenditure is to issue money – the paper currency and coins we carry in our pockets. Holders of this currency technically are creditors to the government – and to society, which accepts this money in payment. Yet despite being nominally a form of public debt, this money serves as public capital inasmuch as it is not normally expected to be repaid. This government money does not bear interest, and may be thought of as “equity capital” or “equity money,” and hence part of the economy’s net worth.
If taxes did fully cover government spending, there would be no budget deficit – or new public money creation. Government budget deficits pump money into the economy. Conversely, running a budget surplus retires the public debt or currency outstanding. This deflationary effect occurred in the late 19th-century, causing monetary deflation that plunged the U.S. economy into depression. Likewise when President Bill Clinton ran a budget surplus late in his administration, the economy relied on commercial banks to supply credit to use as the means of payment, charging interest for this service. As Stephanie Kelton summarizes this historical experience:
The federal government has achieved fiscal balance (even surpluses) in just seven periods since 1776, bringing in enough revenue to cover all of its spending during 1817-21, 1823-36, 1852-57, 1867-73, 1880-93, 1920-30 and 1998-2001. We have also experienced six depressions. They began in 1819, 1837, 1857, 1873, 1893 and 1929.
Do you see the correlation? The one exception to this pattern occurred in the late 1990s and early 2000s, when the dot-com and housing bubbles fueled a consumption binge that delayed the harmful effects of the Clinton surpluses until the Great Recession of 2007-09.
When taxpayers pay more to the government than the economy receives in public spending, the effect is like paying banks more than they provide in new credit. The debt volume is reduced (increasing the reported savings rate). The resulting austerity is favorable to the financial sector but harmful to the rest of the economy.
Most people think of money as a pure asset (like a coin or a $10 dollar bill), not as being simultaneously a public debt. But to an accountant, a balance sheet always balances: Assets = Liabilities + Net Worth. This liability-side ambivalence is confusing to most people. It takes some time to think in terms of offsetting assets and liabilities as mirror images of each other. Much as cosmologists assume that the universe is symmetrical – with positively charged matter having an anti-matter counterpart somewhere at the other end – so accountants view the money in our pocket as being created by the government’s deficit spending. Holders of the Federal Reserve’s paper currency technically can redeem it, but they will simply get paid in other denominations of the same currency.
The word “redeem” comes from settling debts. This was the purpose for which money first came into being. Governments redeem money by accepting it for tax payment. In addition to issuing paper currency, the Federal Reserve injects money into the economy by writing checks electronically. The recipients (usually banks selling Treasury bonds or, more recently, packages of mortgage loans) gain a deposit at the central bank. This is the kind of deposit that was created by the above-mentioned $13 trillion in new debt that the government turned over to Wall Street after the September 2008 crisis. The price impact was felt in financial asset markets, not in prices for goods and services or labor’s wages.
This Federal Reserve and Treasury credit was not counted as part of the government’s operating deficit. Yet it increased public debt, without being spent on “real” GDP. The banks used this money mainly to gamble on foreign exchange and interest-rate arbitrage as noted above, to buy smaller banks (helping make themselves Too Big To Fail), and to keep paying their managers high salaries and bonuses.
This monetization of debt shows how different government budgets are from family budgets. Individuals must save to pay for retirement or other spending. They cannot print their own money, or tax others. But governments do not need to “save” (or tax) to pay for their spending. Their ability to create money means that they do not need to save in advance to pay for wars, Social Security or other needs.
Keynesian Deficit Spending vs. Bailing out Wall Street to Keep the Debt Overhead in Place
There are two kinds of markets: hiring labor to produce goods and services in the “real” economy, and transactions in financial assets and property claims in the FIRE sector. Governments can run budget deficits by financing either of these two spheres. Since President Franklin Roosevelt’s WPA programs in the 1930s, along with his public infrastructure investment in roads, dams and other construction – and military arms spending after World War II broke out – “Keynesian” spending on goods and services has been used to hire labor or pay for social programs. This pumps money into the economy via the GDP-type transactions that appear in the National Income and Product Accounts. It is not inflationary when unemployment exists.
However, the debt that characterized the Paulson-Geithner bailout of Wall Street was created not to spend on goods and services, but to buy (or take liability for) mortgages and bank loans, insurance default bets and arbitrage gambles. The aim was to subsidize financial losses while keeping the debt overhead in place, so that banks and other financial institutions could “earn their way” out of negative net worth, at the economy’s expense. The idea was that they could start lending again to prevent real estate prices from falling further, saving them from having to write down their debt claims to bring levels back down within the ability to be paid.
Michael Hudson’s book summarizing his economic theories, “The Bubble and Beyond,” is available on Amazon. His latest book is Finance Capitalism and Its Discontents. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, published by AK Press. He can be reached via his website, mh@michael-hudson.com
by JackRiddler » Sat Jan 05, 2013 9:53 pm
http://www.guardian.co.uk/commentisfree ... harrington
The Joris Luyendijk banking blog
Anthropologist and journalist Joris Luyendijk ventures into the world of finance to find out how it works
'The rating agencies have been the all-purpose bogeymen for the crisis'
William J Harrington was a senior analyst at Moody's. Whether you're an insider yourself or just want to know more after reading this rare interview, he's here to answer your questions
Joris Luyendijk
guardian.co.uk, Monday 17 December 2012 10.00 EST
A board in Tokyo tracks the Japanese yen's exchange rate against the US dollar after a downgrade of Spain's credit rating by Moody's. Photograph: Toru Hanai/Reuters
When the banking blog asks insiders who they blame for the financial crisis, most say: the rating agencies. It was the rating agencies that assigned super safe ("triple A") ratings to complex financial instruments. When these blew up, the agencies accepted no responsibility, claiming they had merely been expressing "opinions".
William J Harrington was a senior analyst at rating agency Moody's between 1999 and 2010 in New York. Since then he has been campaigning for reform and drawing attention to ongoing problems with ratings. Bill is coming into the comment threads below to answer your questions and discuss his views.
It's really worth reading his testimony in full here.
Some of Bill's quotes hint in one sentence at a whole universe of dysfunction: "In my days it was individual managers [at Moody's] who set the rules on how to interact with the bankers: for instance whether we could scream back at them (we could not)." And: "I knew rating agencies were seen in the industry as losers and 'also-rans'. I didn't care. I didn't go to conferences, to industry parties… The reality is rating agencies attract rather different kinds of people."
The most shocking thing, at least for me, was this:
"The CEO of Moody's in the runup to the fiasco in 2008 is now… still the CEO of Moody's. Last year his compensation was $6m, in line with his five-year average. Moody's has never had a losing quarter. This is why analysts who follow Moody's for investors really like Moody's. Moody's always makes a profit."
Bill says he has asked people at Moody's why those responsible weren't fired. "That would be an admission of liability, I was told. Worse, precisely the managers responsible for the instruments that blew up have been rewarded and promoted. I don't believe in conspiracies but here you really have a small cabal of people doing this."
Free market theory predicts that when market players perform as badly as the rating agencies have, new companies will see an opportunity. This has hardly happened with the market for rating agencies. Bill: "Rating agencies form an oligopoly, with Moody's, Fitch and S&P controlling 97% of the market between them. If there were many significant rating agencies of varying sizes and ownership structures rather than three indistinguishable large ones, then if a few changed their approach it would be hard for the rest to simply continue to go along for the ride. Currently, this is not a self-correcting system."
But why don't other players in finance demand better rating agencies? After two decades at the top of his profession, Bill offers this bleak assessment:
"The rating agencies are such small entities in such a huge industry. They are like the Panama canal. Crucial but very small. Worldwide, the nine big registered rating agencies have less than 4,000 junior and senior analysts working for them, combined across all activities. JP Morgan alone employs a quarter of a million people. This state of affairs seems to suit the big players well. The rating agencies are one moving piece in the machine that they can push around.
"The rating agencies have been the all-purpose bogeymen for the crisis. They bear a heavy responsibility, absolutely, but this exclusive focus obscures how the problems are embedded in the whole system: the big banks, accountancy firms, financial law firms, investment firms, regulators, the financial press… The rating agencies have done us a disservice by allowing so much of the blame to rest on them. They are effectively protecting these other players – who seem quite happy with this arrangement. Meanwhile people at rating agencies go: "just blame us, we're used to it."
It's very rare for a former rating agency employee to speak out like Bill does: "I didn't take 'a package'. If I had I might have gotten a year's salary – but I'd have to sign a 'non-disparagement' clause which meant that I'd remain silent about what I saw."
There is much more good stuff in the full interview, about how the rating process actually works, how rating agencies reward their employees in a fundamentally different way from other areas in finance, and what it's been like for Bill to be gay in finance.
Especially if you're considering leaving a comment below, please read the full text first. As for those comments, it would be really great if other (former) rating agency employees would come forward. Equally interesting would be to hear from insiders across the financial industry about their experiences with the rating agencies. At the end of the full text Bill makes two alarming points about ongoing problems with ABSs. What do other insiders think?
As for financial outsiders: this is your chance. Bill had a ring seat during the buildup, climax and aftermath of the 2008 financial crisis. A firm believer in disseminating information and insight about finance to as large an audience as possible, he is eager to take your questions, also those about finance generally.
• This banking blog features interviews with insiders across the industry. Here is a guide to help you find your way.
One other rating agency employee has spoken to the blog: "Every time I read about a new financial product, I think: 'Uh-oh'."
Another voice in finance who is gay: "When I came out, my boss was really supportive and so were my colleagues. There has been only one idiot so far."
[full statement]
http://www.guardian.co.uk/commentisfree ... gton/print
Ex-Moody's analyst: 'By 2006 it was toxic everywhere'
William J Harrington talks to Joris about what he loved and hated about the rating agency, and why the system broke down
Joris Luyendijk
guardian.co.uk, Monday 17 December 2012 10.00 EST
William J Harrington was a senior analyst at the rating agency Moody's between 1999 and 2010 in New York. Since then he has been campaigning for reform and drawing attention to ongoing problems with ratings. Bill is coming into the comment threads here to answer your questions and discuss his views.
"The rating agencies have been the all-purpose bogeymen for the crisis. They bear a heavy responsibility, absolutely, but this exclusive focus obscures how the problems are embedded in the whole system: the big banks, accountancy firms, financial law firms, investment firms, regulators, the financial press. The rating agencies have done us a disservice by allowing so much of the blame to rest on them. They are effectively protecting these other players – who seem quite happy with this arrangement. Meanwhile, people at rating agencies say: 'Just blame us, we're used to it.'
"The rating agencies are such small entities in such a huge industry. They are like the Panama canal. Crucial but very small. Worldwide the nine big registered rating agencies have less than 4,000 junior and senior analysts working for them, combined across all activities. JP Morgan alone employs a quarter of a million people. Again, this state of affairs seems to suit the big players well. The rating agencies are one moving piece in the machine that they can push around.
"An added problem is that rating agencies form an oligopoly, with Moody's, Fitch and S&P [Standard and Poor's] controlling 97% of the market between them. If there were many significant rating agencies of varying sizes and ownership structures rather than three indistinguishable large ones, then if a few changed their approach it would be hard for the rest to simply continue to go along for the ride. Currently, this is not a self-correcting system.
"The CEO of Moody's in the run-up to the fiasco in 2008 is now … still the CEO of Moody's. Last year his compensation was $6m, in line with his five-year average. Rating agencies make so much money … Moody's has never had a losing quarter. This is why analysts who follow Moody's for investors really like Moody's. Moody's always makes a profit.
"I have asked people at Moody's: why didn't you fire those responsible? But that would be an admission of liability, I was told. Worse, precisely the managers responsible for the instruments that blew up have been rewarded and promoted. I don't believe in conspiracies but here you really have a small cabal of people doing this.
"The cliched idea about rating agencies seems to go like this: a deal to rate a complex financial instrument came in, we stamped it triple A and collected our check. This is a canard. People were working all day on these things, and in the end there would be a committee vote on whether to extend a triple A rating.
"How it works: you have junior analysts, senior analysts and management. Together we work through the instrument, running our models and finding out exactly how it is designed. It is a constant collaborative process between junior and senior analysts and management at Moody's, plus the bankers. At the end there would be a committee meeting on the basis of one man, one vote: juniors, seniors and management were ostensibly all equal. I loved that system, to go into committee and cast your vote. My family is from New England, where the town hall meeting was invented. It's a beautiful tradition to stand before your peers and express yourself in this way.
"Rating agencies are powerful. Without that AAA rating the bank cannot sell the instrument. Even if we'd delay our rating by a few days because of further questions, the bank would look bad, having to explain the delay to their clients. So the goal was for bankers to improve the instrument in such a way that our models would record AAA results and we could proceed to committee to vote.
"Over time this system broke down. Management began to promote those analysts who kept the machine running, who didn't push back against bankers. At the same time they hired more and more junior analysts who were cheaper. These junior analysts were impressive in their own right, just probably too inexperienced by, say, 10 years.
"More and more it was the bankers who drove the process. They became bolder, as they discovered that they'd get their rating without having to improve an instrument. In 2004 you could still talk back and stop a deal. That was gone by 2006. It became: work your tail off, and at some point management would say, 'Time's up, let's convene in a committee and we'll all vote "yes"'. Issues brought up by analysts in committee would be dismissed, or management would park them, saying 'Let's make a note of that'. Or: 'I am glad you're raising it' – nothing would happen. You knew that while management talked the talk in the committees and big group meetings, they would have agreed to other things with the bankers earlier. Again, it was never rubber-stamping. Most analysts did not go on autopilot. It was more subtle.
"By 2006, I concluded that the committee process for these complex instruments had irredeemably broken down. I moved full time to a derivative sub-sector where I still felt it was possible to make committees work.
This is why it's easy for me to talk about all this. Also, when I walked out in 2010 after having wound down my responsibilities I didn't take a "package". If I had I might have gotten a year's salary – but I'd have to sign a 'non-disparagement' clause which meant that I'd remain silent about what I saw. By the way, everything I am writing about now, and everything I am telling you, I raised all of that when at Moody's. I never leaked anything to the Wall Street Journal. I could have. But I never did.
"In my days it was individual managers who set the rules of how to interact with the bankers: for instance whether we could scream back at them (we could not). Management is the big problem, bankers or no bankers. And there is no way to get around management. There is no structure, no attempt to evaluate committee proceedings based on analyst contribution over time. Moreover, managers have great discretion to reverse committee outcomes by essentially calling a foul and insisting on a do-over.
"In response to the crisis Moody's has changed its committee format somewhat. These days junior rating analysts vote first, to prevent them from taking their cues from their superiors. This looks like a solution. But senior managers can send all sorts of non-verbal signals. Junior and senior analysts take their lead from managers who oversee them both in committee and in all other matters as well, for instance compensation and promotion. If management makes it clear there is no downside for letting something go, for overlooking potential problems in an instrument … To be sure, every analyst is individually responsible for their votes no matter how toxic the environment. No one is forced to work at Moody's.
"Rating agencies work differently from banks, law and accountancy firms. These are often solo practices where small groups of people form teams which work on the premise that you eat what you kill – bring in a lot of business and you make a lot of money. Then within the team there's a star system where some players get far more than others.
"Moody's is different. Our department's revenues fed into one big pot, together with those from other activities – Moody's rates corporations, countries, derivatives and many other things. Moody's Corp, the ultimate parent, earned profit margins of 90% from our group.
Another difference with law, investment banks and accountancy is that teams there are often poached wholesale by competitors. That would never happen in rating agencies. You just wouldn't jump ship and join Fitch. By the way, our management would always make fun of Fitch, as in: that Mickey Mouse shop, they'll rate anything.
"I trained as an economist and worked for Merrill Lynch but I knew that was a training ground. A rating agency suited me much better. I liked being able to turn off work at night. I liked working with lots of different banks, and was happy to argue with bankers. I liked the systemic thinking that rating requires, looking at lots of variables, and I am comfortable telling people when there's something I don't understand. I never sought a management role, I didn't like the way they threw their weight around in committee.
"I knew rating agencies were seen in the industry as losers and also-rans. I didn't care. I didn't go to conferences, to industry parties. The reality is they attract rather different kinds of people. Junior and senior analysts alike were exceptionally intelligent, many with PhDs.
"Even when the environment turned toxic in 2006, I stayed and accepted that I might be fired for doing so or that I might feel obligated to resign – by then it was toxic everywhere. I expected the financial system to fall apart, it was inevitable.
"In investment banks people always seem to want more, more, more. The reward system is just so … straight. You see people get old before their time because their primary concern seems to be find the next deal. They seem to lose everything that makes them unique. And they have this enormous sense of self-importance. Moody's really suited me, it clicked.
"In cross-industry surveys Moody's has received a 100% score as a good place for gay people to work. People would sometimes ask, coming into Moody's: 'Why is it so gay here?'
"I suppose that once a place establishes itself as gay-friendly, others will gravitate towards it. I do suspect some of the most toxic managers at Moody's liked to hire beaten-up people who may have felt they had few options – getting people indebted to them by not being homophobic.
"Being gay in finance has left an important stamp on my life. I remember when I was interning at Salomon Brothers – in those days a venerable firm. They offered me a job and I went around introducing myself to people on the trading floor, as was the protocol. At one point a trader looked at me and said: "Salomon Brothers is great. Unless you're a faggot. I hate faggots."
"I had trained myself not to flinch since I was 10, so I didn't. It was horrible. This was 1991. Nobody was out on the floor and I wanted to come out at my own speed without having to lie. I never went along to a strip club, never pretended to have a girlfriend. I believe discrimination blocked me at Merrill as well although I started coming out anyway and some people responded positively. Being openly gay was not an issue at Moody's.
"I don't want to reveal my pay at Moody's; these things are private. I will say that I was one of the two top analyst earners worldwide by 2004-2005. But I made less in salary and bonus than Goldman Sachs whistleblower Greg Smith's $500,000. Typically compensation was 60% salary, 40% bonus – with that bonus calculated primarily on the basis of the whole firm's performance and secondarily on our own department's.
"One misunderstanding is that the problems that caused the crisis are no longer with us. But banks post complex financial instruments as collateral to central banks. These still follow the ratings to assess the value of these instruments. This means that re-evaluating those ratings and downgrading them will have serious knock-on effects on the capital base and hence the financial health of banks.
"Another misunderstanding is that we can start assigning triple A-rated asset-backed securities (ABS) again. There are problems baked into ABSs, in particular the derivative contracts underpinning them. The problem is what happens with the ABS when the bank counter-party for a derivative hedge becomes insolvent. Last, rating agencies make bailouts more likely by factoring open-ended taxpayer support into bank ratings.
"I will be happy to explain in more detail in the comments section."
© 2013 Guardian News and Media Limited or its affiliated companies. All rights reserved.
by JackRiddler » Sat Jan 05, 2013 10:12 pm
Did you catch this gem from Hudson in the latest super-long update set I've been posting today wrote:
The federal government has achieved fiscal balance (even surpluses) in just seven periods since 1776, bringing in enough revenue to cover all of its spending during 1817-21, 1823-36, 1852-57, 1867-73, 1880-93, 1920-30 and 1998-2001. We have also experienced six depressions. They began in 1819, 1837, 1857, 1873, 1893 and 1929.
Do you see the correlation? The one exception to this pattern occurred in the late 1990s and early 2000s, when the dot-com and housing bubbles fueled a consumption binge that delayed the harmful effects of the Clinton surpluses until the Great Recession of 2007-09.
http://www.counterpunch.org/2012/12/19/ ... bate/print
December 19, 2012
The History of Budget Deficits and Economic Growth in Relation to Taxes and Unemployment
The Fact-Free Fiscal Cliff Debate
by NEWK MINDSHAFTGAP
Those who cannot remember the past are condemned to repeat it
— George Santanyana
Over the course of the last few years, there has been much propaganda from politicians of all persuasions on what factors are conducive to economic growth and/or the emergence of budget deficits or surpluses. Regardless of the political viewpoint being represented, these claims have usually been supported by essentially no facts, and this absence of facts implies a lack of analysis in a political debate that has displaced by competing ideologies. The breakdown of reason is taking on great importance as the so-called fiscal cliff approaches, and with it, the increasing possibility of a full-blown constitutional crisis. My aim is to identify factors that have been associated with budget surpluses and/or solid economic growth (as measured by annual growth in the gross domestic product (GDP) in fiscal year (FY) 1931 through FY 2012 and to relate them to the emotionally-charged question of taxes.
Before proceeding further, it is important to list several caveats. First and foremost, what follows is an historical analysis, not an economic analysis. For example:
* It does not address the very different nature of federal debt from private debt in creating burden on the economic growth, not to mention the way deficits are accounted for in the National Income and Product Accounts.
* It does not discuss the comparative impact of different types of taxes and different types of government or private spending on the economy.
* It treats inflation-adjusted GDP growth as a simplistic measure of overall economic advancement. In reality, it is also relevant to consider whether GDP growth is broadly shared or narrowly concentrated in one small segment of the population. Similarly, GDP growth treats a billion dollars of activity X as being equivalent to a billion dollars of activity Y, even if X and Y have far different effects on the lives of ordinary people.
* There is no attempt to identify causative relationships between various contributing factors (tax rates, government spending patterns, etc) and political/economic results (budget surplus, strong economic growth). In fact, correlation does not automatically imply causation, but a statistically strong correlation between A and B could plausibly be construed as meaning that A at least contributes to B if there is no credible mechanism for B to cause A and no obvious underlying cause for both A and B at the same time.
Finally, and most importantly, this analysis is not prescriptive. It is simply a description of some basic historical patterns that have evolved in our contemporary political economy.
Keeping these crucial caveats in mind, the following sections present some first cut correlations between deficits, economic growth, employment, and tax rates. The correlations described below suggest that many of the ‘assumptions’ shaping the debate of the so-called fiscal cliff are disconnected from reality. Unless these basic misconceptions are corrected, any resulting grand bargain may well worsen the deficit by impeding employment and economic growth, assuming the inertia of past patterns of correlation continue into the future.
Factors Correlated with Federal Surpluses or Deficits
Unemployment rate: During the 82-year base period, the factor most strongly correlated, by far, with having a federal surplus is the unemployment rate. Out of these 82 years, 41 had an average unemployment rate of 5.6% or higher and 41 had an average unemployment rate of 5.5% or less. To place this in context, the current unemployment rate is 7.9%, and the average rate for 2012 will probably be slightly over 8%. Of the 41 years with low unemployment, three occurred during the World War II spending spree of FY 1943 through FY 1945, when no credible level of revenue could have produced a balanced budget. I have excluded these years from the table below.
There was a federal deficit in 100% of the years with an unemployment rate of 5.6% or higher. The highest unemployment rate during a year with a surplus was 5.5%, during one year of the Eisenhower administration. In 28 non-WWII years with unemployment rates of 4.6% to 5.5%, there were 6 surpluses and 22 deficits. In 10 non-WWII years with unemployment rates of 4.5% or less, there were 6 surpluses and only 4 deficits. Such low unemployment rates are almost always the result of several consecutive years of rapid GDP growth. In other words, a robust economy seems to be an absolute prerequisite for having a federal government surplus.
Overall federal taxes: Assertions about the impact of “high taxes overall” are easily tested, as good information is available about federal taxes as a percentage of GDP, federal deficits/surpluses, and economic growth, is available for every year during the 82-year basis period. The median value for federal taxes (including Social Security, Medicare, individual income taxes, corporate income taxes, etc.) during this period was 17.6% of GDP, with 40 years of 17.5% or less and 42 years of 17.6% or more. By comparison, the values for 2009 through 2012 were all in the 15.1% to 15.8% range. This was the first time during the post-WWII period that taxes were under 16% of GDP for more than two consecutive years, and the first time since the Truman administration that taxes were under 16.2% of GDP at all.
The table below shows a strong correlation between higher than average overall federal taxes and federal surpluses or smaller than average deficits, although the correlation is not as strong as is the case with unemployment rate. In addition, the last budget surplus when federal taxes were under 17.5% of GDP occurred in the Truman administration, more than 60 years ago. At that time Medicare did not exist, and the fraction of the populace eligible for Social Security was far smaller than it is today.
Federal taxes on the very wealthy: Assertions about the impact of “high taxes on the wealthy” are more difficult to test. Information about the maximum tax rate on the wealthy is available for the entire base period, but there are complicating factors:
* The point at which the maximum tax rate goes into effect has varied wildly over the last 80 years. The maximum tax bracket has affected anywhere from several percent of the population down to less than one person per thousand. Currently, the maximum tax rate on ordinary income affects slightly over 1% of the population.
* It is not trivial to combine the maximum tax rate on ordinary income with the maximum tax rate on capital gains in a consistently meaningful manner. There have been several years when the maximum tax rate on capital gains was the same as the maximum tax rate on ordinary income, and years in which the maximum tax rate on ordinary income was up to five times higher than the maximum tax rate on capital gains.
* The tax rate on capital gains has often been constant, without regard for the amount of capital gains, but has often had multiple tax brackets for varying amounts of capital gains.
* For most people, “ordinary income” is the dominant factor. By contrast, the richest 0.1% of the population (over $2.9 million per household, according to the Washington Post (Nov 28, 2012)) mostly derive more income from capital gains than from ordinary income, but the exact ratio of capital gains to ordinary income varies widely within the fortunate few.
* Dividends have sometimes been treated as ordinary income and sometimes as capital gains.
At the expense of being simplistic, I will use the maximum tax rate as the metric for taxes on the wealthy, and I will define the “maximum effective tax rate” as being 0.6*(maximum tax rate for capital gains) + 0.4*(maximum tax rate for ordinary income). This is based on the assumption that the “average rich person” derives 60% of his/her income from capital gains and dividends and 40% from ordinary income.
The average value for “maximum effective tax rate” for the base period is 40.9%, and the median value is 44.8%, compared to a mere 23% today (35% on ordinary income and 15% on capital gains, with dividends treated as capital gains). The current “maximum effective tax rate” is the lowest it has been since 1931. I occasionally see claims that taxes on the wealthy (or overall taxes) were lower in the Reagan-Bush41 era than they are today. The maximum tax rate on ordinary income was in the 28% to 31% range 1988 through 1992, compared to 35% today, but dividends and capital gains were taxed at up to 28% to 28.9% then, yielding a “maximum effective tax rate” of 28% to 29.7%. Moreover, overall federal taxes never dropped below 17.3% during the Reagan era. The real Reagan was much more of a tax-and-spend kind of guy than modern Tea Party adherents realize or acknowledge.
There has been a strong positive correlation between a higher than average “maximum effective tax rate” and budget surpluses or smaller than average deficits, as shown in the table below. Moreover, there has NEVER (within the last 82 years) been a surplus in a year when the “maximum effective tax rate” was under 27.5%, compared to 23% today.
Factors Correlated with GDP Growth
Overall federal taxes: As stated above, the median value for federal taxes during this period was 17.6% of GDP, with 40 years of 17.5% or less and 42 years of 17.6% or more. By comparison, the values for 2009 through 2012 were all in the 15.1% to 15.8% range. This was the first time during the post-WWII period that taxes were under 16% of GDP for more than two consecutive years, and the first time since the middle of the Korean War that taxes were under 16.2% of GDP at all. The table below shows a moderate correlation between lower than average overall federal taxes and stronger than average GDP growth, although there was extremely wide variation within both the “high tax years” and the “low tax years.” For example, three of the five worst years during the 82-year base period were “low tax years.”
Federal taxes on the very wealthy: All of the caveats and complications from the discussion above still apply here. The situation here is radically different than it is with regard to the overall federal tax burden. There is a significant positive correlation between higher than average taxes on the very wealthy and higher than average economic growth, as shown in the table below. That is, high taxes on the wealthy have usually been associated with good economic growth (although I make no claim regarding causation here).
Moreover, the results from the table are NOT sensitive to the manner in which taxes on ordinary income and taxes on capital gains are combined to create the maximum effective tax rate. The same conclusions would result if the table focused only on capital gains, or only on ordinary income. For example, the median value for the maximum tax on capital gains was 25% in 1931-2012. In years when the maximum tax rate on capital gains was 25% or higher, annual GDP growth had mean and median values of 4.2% and 3.7%, respectively. In years when the maximum tax rate on capital gains was under 25%, annual GDP growth had mean and median values of 1.4% and 2.7%, respectively.
The results in the table above are so contradictory to much of the modern political dogma that I decided to delve into the period from 1965 through 2012 in more detail. I divided this era into 6 periods of 4 or more consecutive years, based on keeping years with a similar “maximum effective tax rate” together. I omitted 1981 and 1986-1987, because these years did not fit naturally into any period of 4 or more consecutive years with similar tax rates. The table below shows the average rate of GDP growth during each of the 6 periods. The 3 periods with below-average taxes on the wealthy finished 3rd, 5th, and 6th (last) in GDP, and the period with the highest taxes on the wealthy finished tied for 1st. Clearly, many other factors influenced the rate of economic growth during these 6 periods of time, so the table does not prove that high taxes on the wealthy are good for the economy. Nevertheless, the table strongly indicates that high taxes on the wealthy are fully compatible with rapid economic growth. Hence, the burden of proof should be on people who claim that any increase in taxes on the wealthy would drive the economy into the toilet, not on people who advocate a modestly higher maximum tax bracket.
Corporate taxes: Any such analysis is quite difficult, starting with the choice of metric(s) to be used. The maximum bracket for US corporate income taxes is 35%, for profits exceeding $18.3 million. This is one of the highest rates in the world, and higher than average by US historical standards. On the other hand, the United States has innumerable deductions-exemptions-loopholes for corporate income taxes, so that corporate incomes taxes in recent years have constituted a lower percentage of GDP than the historical average. Moreover, several corporations had profits exceeding $1 billion in 2010, while paying less than 1% of their profits in corporate income taxes.
I investigated two candidate metrics: corporate income taxes as a percentage of GDP and corporate income taxes as a percentage of total US corporate profits. I was unable to find enough data on the second metric, so I settled on corporate income taxes as a percentage of GDP. This metric has at least one significant flaw. Since corporate taxes are based on corporate profits, not total corporate income, these taxes automatically decline during a recession that leads to a major reduction in overall corporate profits and automatically rise greatly during an economic boom. Hence, this metric does not fully capture any “drag effect” that this tax might have on the economy.
The Results: Corporate taxes exceeded 2% of GDP every year from 1946 through 1980, and averaged above 3% of GDP. From 1981 through 2009, corporate income taxes never reached 3% of GDP, seldom exceeded 2% of GDP, and averaged about 1.5% of GDP. The value of about 0.95% in 2009 was the lowest on record (since 1946). GDP growth averaged 3.2% per year in 1946-1980 and 2.8% per year in 1981-2009, which shows that higher levels of corporate taxes are compatible with good economic growth. Modestly higher corporate taxes could, however, reduce the deficit.
Federal spending: From 1931 through 2012, federal spending was at or above 19.5% of GDP in half of the years. This figure has grown over time: it had a median value of 17.6% in FY 1931 through 1971, compared to a median of 21% and a minimum of 18.2% in FY 1972 through 2012. The table below shows that there has been a weak inverse correlation between high federal spending and strong GDP growth, but there has been extremely wide variation within both high-spending years and low-spending years. In fact, the worst year on record was a low-spending year as were three of the worst four years. The only high-spending year among the four worst years was in FY 1946, during the de-mobilization from World War II, and GDP shrinkage during that drastic transition was virtually inevitable.
The situation with regard to federal spending is far more complex than the table can express. Federal spending is not some uniform blob that expands and contracts – the composition of federal spending today is far different from what is was 50 to 80 years ago, and there is no reason to think that expenditures on military procurement, infrastructure upgrades, research on science and technology, education, Social Security, Medicare, Medicaid, and unemployment compensation would all have a similar effect per trillion dollars spent. Sorting out the impact of separate types of spending on the economy would be a major undertaking.
A final relevant point is that some types of federal expenditures – Medicaid, food stamps, unemployment compensation – rise automatically during a recession and contract automatically during an economic boom. Moreover, expenditures on Medicare and Social Security rise automatically when the fraction of the populace over the age of 65 grows. It would be necessary to exclude these types of expenditures from the table to get a more meaningful idea on whether discretionary federal spending is good for the economy.
Conclusions
Several of the tables above conceal extremely wide variation within groups. In such a case, a moderate difference between two groups is of little relevance, due to the large range of variation in the data. Historical data does, however, support two conclusions that strongly contradict Republican orthodoxy and the views of so-called fiscal hawks. These are:
* The key to having a manageable deficit is to have a robust economy. Thus, discussions within the government should focus primarily on reducing unemployment by generating broadly shared GDP growth, without generating excessively inflationary pressure when the economy is near to full employment (which is not the case today). Therefore, measures aimed directly at deficit reduction should be focused on items that clearly pose little risk to employment and/or economic growth.
* The only policy change that could achieve measurable deficit reduction with almost no risk to economic growth is higher taxes on the very wealthy and on corporate profits. High taxes on the very wealthy have been associated with both strong GDP growth and budget surpluses in the past. A credible initial step to keep from falling off the fiscal cliff might consist of modest tax increases for individuals/families making between about $250,000 per year and $1,000,000 per year, and large tax increases for individuals or families making over $1,000,000 per year. Reducing or eliminating the gap between the maximum tax bracket for ordinary income and the maximum tax brackets for dividends and capital gains could also generate significant additional revenue with little risk to the economy.
On the other hand, these historical patterns imply a grand bargain based on cuts in Social Security, Medicare, Medicaid, infrastructure upgrades, education, and research on S&T, while maintaining today’s absurdly low taxes on the wealthy, is likely to push the economy back into full-scale recession, undermine US economic competitiveness well into the 2020s, cause enormous suffering for a significant fraction of the populace, and actually increase the deficit.
Newk Mindshaftgap is the a nom de plume of a man with long experience in the Federal Government and he has three degrees in physics.
by JackRiddler » Thu Jan 10, 2013 8:21 pm
http://www.counterpunch.org/2013/01/04/ ... licy/print
Weekend Edition January 4-6, 2013
America's Deceptive Fiscal Cliff
The Ideological Crisis Underlying Today’s Tax and Financial Policy
by MICHAEL HUDSON
From antiquity and for thousands of years, land, natural resources and monopolies, seaports and roads were kept in the public domain. In more recent times railroads, subway lines, airlines, and gas and electric utilities were made public. The aim was to provide their basic services at cost or at subsidized prices rather than letting them be privatized into rent-extracting opportunities. The Progressive Era capped this transition to a more equitable economy by enacting progressive income and wealth taxes.
Economies were liberating themselves from the special privileges that European feudalism and colonialism had granted to favored insiders. The aim of ending these privileges – or taxing away economic rent where it occurs naturally, as in the land’s site value and natural resource rent – was to lower the costs of living and doing business. This was expected to make progressive economies more competitive, obliging other countries to follow suit or be rendered obsolete. The era of what was considered to be socialism in one form or another seemed to be at hand – rising role of the public sector as part and parcel of the evolution of technology and prosperity.
But the landowning and financial classes fought back, seeking to expunge the central policy conclusion of classical economics: the doctrine that free-lunch economic rent should serve as the tax base for economies seeking to be most efficient and fair. Imbued with academic legitimacy by the University of Chicago (which Upton Sinclair aptly named the University of Standard Oil) the new post-classical economics has adopted Milton Friedman’s motto: “There Is No Such Thing As A Free Lunch” (TINSTAAFL). If it is not seen, it has less likelihood of being taxed.
The political problem faced by rentiers – the “idle rich” siphoning off most of the economy’s gains for themselves – is to convince voters to agree that labor and consumers should be taxed rather than the financial gains of the wealthiest 1%. How long can they defer people from seeing that making interest tax-exempt pushes the government’s budget further into deficit? To free financial wealth and asset-price gains from taxes – while blocking the government from financing its deficits by its own public option for money creation – the academics sponsored by financial lobbyists hijacked monetary theory, fiscal policy and economic theory in general. On seeming grounds of efficiency they claimed that government no longer should regulate Wall Street and its corporate clients. Instead of criticizing rent seeking as in earlier centuries, they depicted government as an oppressive Leviathan for using its power to protect markets from monopolies, crooked drug companies, health insurance companies and predatory finance.
This idea that a “free market” is one free for Wall Street to act without regulation can be popularized only by censoring the history of economic thought. It would not do for people to read what Adam Smith and subsequent economists actually taught about rent, taxes and the need for regulation or public ownership. Academic economics is turned into an Orwellian exercise in doublethink, designed to convince the population that the bottom 99% should pay taxes rather than the 1% that obtain most interest, dividends and capital gains. By denying that a free lunch exists, and by confusing the relationship between money and taxes, they have turned the economics discipline and much political discourse into a lobbying effort for the 1%.
Lobbyists for the 1% frame the fiscal question in terms of “How can we make the 99% pay for their own social programs?” The implicit follow-up is, “so that we (the 1%) don’t have to pay?” This is how the Social Security system came to be “funded” and then “underfunded.” The most regressive tax of all is the FICA payroll tax at 15.3% of wages up to about $105,000. Above that, the rich don’t have to contribute. This payroll tax exceeds the income tax paid by many blue-collar families. The pretense is that not taxing these free lunchers will make economies more competitive and pull them out of depression. The reality is the opposite: Instead of taxing the wealthy on their free lunch, the tax burden raises the cost of living and doing business. This is a major reason why the U.S. economy is being de-industrialized today.
The key question is what the 1% do with their revenue “freed” from taxes. The answer is that they lend it out to indebt the 99%. This polarizes the economy between creditors and debtors. Over the past generation the wealthiest 1% have rewritten the tax laws to a point where they now receive an estimated 66% – two thirds – of all returns to wealth (interest, dividends, rents and capital gains), and a reported 93% of all income gains since the Wall Street bailout of September 2008.
They have used this money to finance the election campaigns of politicians committed to shifting taxes onto the 99%. They also have bought control of the major news media that shape peoples’ understanding of what is happening. And as Thorstein Veblen described nearly a century ago, businessmen have become the heads most universities and directed their curriculum along “business friendly” lines.
The clearest way to analyze any financial system is to ask Who/Whom. That is because financial systems are basically a set of debts owed to creditors. In today’s neo-rentier economy the bottom 99% (labor and consumers) owe the 1% (bondholders, stockholders and property owners). Corporate business and government bodies also are indebted to this 1%. The degree of financial polarization has sharply accelerated as the 1% are making their move to indebt the 99% – along with industry, state, local and federal government – to the point where the entire economic surplus is owed as debt service. The aim is to monopolize the economy, above all the money-creating privilege of supplying the credit that the economy needs to grow and transact business, enabling them to extract interest and other fees for this privilege.
The top 1% have nearly succeeded in siphoning off the entire surplus for themselves, receiving 93% of U.S. income growth since September 2008. Their control over the political process has enabled them to use each new financial crisis to strengthen their position by forcing companies, states and localities to relinquish property to creditors and financial investors. So after monopolizing the economic surplus, they now are seeking to transfer to themselves the economic infrastructure, land and natural resources, and any other asset on which a rent-extracting tollbooth can be placed.
The situation is akin to that of medieval Europe in the wake of the Nordic invasions. The supra-national force of Rome in feudal times is now situated in Washington, with Christianity replaced by the Washington Consensus wielded via the IMF, World Bank, WTO and its satellite institutions such as the European Central Bank, backed by the moral and ideological role academic economists rather than the Church. And on the new financial battlefield, Wall Street underwriters have used the crisis as an opportunity to press for privatization. Chicago’s strong Democratic political machine sold rights to install parking meters on its sidewalks, and has tried to turn its public roads into privatized toll roads. And the city’s Mayor Rahm Emanuel has used privatization of its airport services to break labor unionization, Thatcher-style. The class war is back in business, with financial tactics playing a leading role barely anticipated a century ago.
This monopolization of property is what Europe’s medieval military conquests sought to achieve, and what its colonization of foreign continents replicated. But whereas it achieved this originally by military conquest of the land, today’s 1% do it l by financializing the economy (although the military arm of force is not absent, to be sure, as the world saw in Chile after 1973).
The financial quandary confronting us
The economy’s debt overhead has grown so large that not everyone can be paid. Rising default rates pose the question age-old question of Who/Whom. The answer almost always is that big fish eat little fish. Big banks (too big to fail) are eating little banks, while the 1% try to take the lion’s share for themselves by annulling public and corporate debts owed to the 99%. Their plan is to downgrade Social Security and Medicare savings to “entitlements,” as if it is a matter of sound fiscal choice not to pay low-income payers whilerentiers at the top re-christen themselves “job creators,” as if they have made their gains by helping wage-earners rather than waging war against them.
The problem is not Social Security, which can be paid out of normal tax revenue, as in Germany’s pay-as-you-go system. This fiscal problem – untaxing real estate, oil and gas, natural resources, monopolies and the banks – has been depicted as financial – as if one needs to save in advance by a special tax to lend to the government to cut taxes on the 99%.
The real pension cliff is with corporate, state and local pension plans, which are being underfunded and looted by financial managers. The shortfall is getting worse as the downturn reduces local tax revenues, leaving states and cities unable to fund their programs, to invest in new public infrastructure, or even to maintain and repair existing investments. Public transportation in particular is suffering, raising user fees to riders in order to pay bondholders. But it is mainly retirees who are being told to sacrifice. (The sanctimonious verb is “share” in the sacrifice, although this evidently does not apply to the 1%.)
The bank lobby would like the economy to keep trying to borrow its way out of debt and thus dig itself deeper into a financial hole that puts yet more private and public property at risk of default and foreclosure. The idea is for the government to “stabilize” the financial system by bailing out the banks – that is, doing for them what it has not been willing to do for recipients of Social Security and Medicare, or for states and localities no longer receiving revenue sharing, or for homeowners in negative equity suffering from exploding interest rates even while bank borrowing costs from the Fed have plunged. The dream is that the happy Greenspan financial bubble can be recovered, making everyone rich again, if only they will debt-leverage to bid up real estate, stock and bond prices and create new capital gains.
Realizing this dream is the only way that pension funds can pay retirees. They will be insolvent if they cannot make their scheduled 8+%, giving new meaning to the term “fictitious capital.” And in the real estate market, prices will not soar again until speculators jump back in as they did prior to 2008. If student loans are not annulled, graduates face a lifetime of indentured servitude. But that is how much of colonial America was settled, after all – working off the price of their liberty, only to be plunged into the cauldron of vast real estate speculations and fortunes-by-theft on which the Republic was founded (or at least the greatest American fortunes). It was imagined that such bondage belonged only to a bygone era, not to the future of the West. But we may now look back to that era for a snapshot of our future.
The financial plan is for the government is to supply nearly free credit to the banks, so that they can to lend debtors enough – at the widest interest-rate markups in recent memory (what banks charge borrowers and credit-card users over their less-than-1% borrowing costs) – to pay down the debts that were run up before 2008.
This is not a program to increase market demand for the products of labor. It is not the kind of circular flow that economists have described as the essence of industrial capitalism. It is a financial rake-off of a magnitude such as has not existed since medieval European times, and the last stifling days of the oligarchic Roman Empire two thousand years ago.
Imagining that an economy can be grounded on these policies will further destabilize the economy rather than alleviate today’s debt deflation. But if the economy is saved, the banks cannot be. This is why the Obama Administration has chosen to save the banks, not the economy. The Fed’s prime directive is to keep interest rates low – to revive lending not to finance new business investment to produce more, but simply to inflate the asset prices that back the bank loans that constitute bank reserves. It is the convoluted dream of a new Bubble Economy – or more accurately a new Great Giveaway.
Here’s the quandary: If the Fed keeps interest rates low, how are corporate, state and local pension plans to make the 8+% returns needed to pay their scheduled pensions? Are they to gamble more with hedge funds playing Casino Capitalism?
On the other hand, if interest rates rise, this will reduce the capitalization multiple at which banks lend against current rental income and profits. Higher interest rates will lower prices for real estate, corporate stocks and bonds, pushing the banks (and pension funds) even deeper into negative equity.
So something has to give. Either way, the financial system cannot continue along its present path. Only debt write-offs will “free” markets to resume spending on goods and services. And only a shift of taxes onto rent-yielding property and tollbooths, finance and monopolies will save prices from being loaded down with extractive overhead charges and refocus lending to finance production and employment. Unless this is done, there is no way the U.S. economy can become competitive in international markets, except of course for military hardware and intellectual property rights for escapist cultural artifacts.
The solution for Social Security, Medicare and Medicaid is to de-financialize them. Treat them like government programs for military spending, beachfront rebuilding and bank subsidies, and pay their costs out of current tax revenue and new money creation by central banks doing what they were founded to do.
Politicians shy away from confronting this solution mainly because the financial sector has sponsored a tunnel vision that ignores the role of debt, money, and the phenomena of economic rent, debt leverage and asset-price inflation that have become the defining characteristics of today’s financial crisis. Government policy has been captured to try and save – or at least subsidize – a financial system that cannot be saved more than temporarily. It is being kept on life support at the cost of shrinking the economy – while true medical spending for real life support is being cut back for much of the population.
The economy is dying from a financial respiratory disease, or what the Physiocrats would have called a circulatory disorder. Instead of freeing the economy from debt, income is being diverted to pay credit card debt and mortgage debts. Students without jobs remain burdened with over $1 trillion of student debt, with the time-honored safety valve of bankruptcy closed off to them. Many graduates must live with their parents as marriage rates and family formation (and hence, new house-buying) decline. The economy is dying. That is what neoliberalism does.
Now that the debt build-up has run its course, the banking sector has put its hope in gambling on mathematical probabilities via hedge fund capitalism. This Casino Capitalist has become the stage of finance capitalism following Pension Fund capitalism – and preceding the insolvency stage of austerity and property seizures.
The open question now is whether neofeudalism will be the end stage. Austerity deepens rather than cures public budget deficits. Unlike past centuries, these deficits are not being incurred to wage war, but to pay a financial system that has become predatory on the “real” economy of production and consumption. The collapse of this system is what caused today’s budget deficit. Instead of recognizing this, the Obama Administration is trying to make labor pay. Pushing wage-earners over the “fiscal cliff” to make them pay for Wall Street’s financial bailout (sanctimoniously calling their taxes “user fees”) can only shrink of market more, pushing the economy into a fatal combination of tax-ridden and debt-ridden fiscal and financial austerity.
The whistling in the intellectual dark that central bankers call by the technocratic term “deleveraging” (paying off the debts that have been run up) means diverting yet more income to pay the financial sector. This is antithetical to resuming economic growth and restoring employment levels. The recent lesson of European experience is that despite austerity, debt has risen from 381% of GDP in mid-2007 to 417% in mid—2012. That is what happens when economies shrink: debts mount up at arrears (and with stiff financial penalties).
But even as economies shrink, the financial sector enriches itself by turning its debt claims – what 19th-century economists called “fictitious capital” before it was called finance capital – into a property grab. This makes an unrealistic debt overhead – unrealistic because there is no way that it can be paid under existing property relations and income distribution – into a living nightmare. That is what is happening in Europe, and it is the aim of Obama Administration of Tim Geithner, Ben Bernanke, Erik Holder et al. They would make America look like Europe, wracked by rising unemployment, falling markets and the related syndrome of adverse social and political consequences of the financial warfare waged against labor, industry and government together. The alternative to the road to serfdom – governments strong enough to protect populations against predatory finance – turns out to be a detour along the road to debt peonage and neofeudalism.
So we are experiencing the end of a myth, or at least the end of an Orwellian rhetorical patter talk about what free markets really are. They are not free if they are to pay rent-extractors rather than producers to cover the actual costs of production. Financial markets are not free if fraudsters are not punished for writing fictitious junk mortgages and paying ratings agencies to sell “opinions” that their clients’ predatory finance is sound wealth creation. A free market needs to be regulated from fraud and from rent seeking.
The other myth is that it is inflationary for central banks to monetize public spending. What increases prices is building interest and debt service, economic rent and financial charges into the cost of living and doing business. Debt-leveraging the price of housing, education and health care to make wage-earners pay over two-thirds of their income to the FIRE sector, FICA wage withholding and other taxes falling on labor are responsible for de-industrializing the economy and making it uncompetitive.
Central bank money creation is not inflationary if it funds new production and employment. But that is not what is happening today. Monetary policy has been hijacked to inflate asset prices, or at least to stem their decline, or simply to give to the banks to gamble. “The economy” is less and less the sphere of production, consumption and employment; it is more and more a sphere of credit creation to buy assets, turning profits and income into interest payments until the entire economic surplus and repertory of property is pledged for debt service.
To celebrate this as a “postindustrial society” as if it is a new kind of universe in which everyone can get rich on debt leveraging is a deception. The road leading into this trap has been baited with billions of dollars of subsidized junk economics to entice voters to act against their interests. The post-classical pro-rentier financial narrative is false – intentionally so. The purpose of its economic model is to make people see the world and act (or invest their money) in a way so that its backers can make money off the people who follow the illusion being subsidized. It remains the task of a new economics to revive the classical distinction between wealth and overhead, earned and unearned income, profit and rentier income – and ultimately between capitalism and feudalism.
This is the fourth and final installment of Michael Hudson’s ground-breaking report on the state of the economy. [See above for first three parts.]
Michael Hudson’s book summarizing his economic theories, “The Bubble and Beyond,” is available on Amazon. His latest book is Finance Capitalism and Its Discontents. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, published by AK Press. He can be reached via his website, mh@michael-hudson.com
by JackRiddler » Thu Jan 10, 2013 8:25 pm
http://www.counterpunch.org/2013/01/08/ ... liff/print
January 08, 2013
Will the New Government Put an End to Austerity?
Japan and the Fiscal Cliff
by DEAN BAKER
An event that has received far too little attention in the United States was the election of a new prime minister in Japan. Last month the people of Japan voted overwhelmingly to throw out the governing party and to support the return of the Liberal Democrats headed by Shinzo Abe.
Electing Liberal Democrats is not new in Japan; they have held power for most of the period since World War II. Even putting in Abe as prime minister is not new. He had earlier served a brief stint in this position from 2006-2007. Abe is a well-connected party boss who has worked his way to the top ranks of the party in the same way as other party leaders.
What is new is Abe’s stated agenda. Abe wants to get Japan off its two-decade-long path of near stagnation, promising a policy of vigorous stimulus. There are two main parts to this policy. First, he promises to embark on another round of infrastructure spending, with the goal being the direct creation of tens of thousands of jobs.
Perhaps more importantly, he wants Japan’s central bank to explicitly target a higher rate of inflation. If they follow Abe’s recipe, the central bank will commit itself to raising the inflation rate to 2.0 percent, buying as many Japanese government bonds or other assets as necessary to bring about this result. The goal is to reduce the real interest rate: the difference between the nominal interest rate that people actually pay on borrowed money and the rate of inflation.
Given the weakness of the Japanese economy it would be desirable to have a negative real interest rate; however, nominal interest rates will never fall below zero. People will not pay banks to hold their money. Since Japan was actually seeing modest rates of deflation, this meant that the real interest rate still remained considerably higher than would be desired.
However, if people actually come to expect the 2.0 percent inflation targeted by the central bank then it will mean that the real interest will turn negative. Firms that are able to borrow at near zero interest rates will have more incentive to invest when they expect that the items they are producing will sell for 6 percent more money in three years or 10 percent more money in five years.
The idea of deliberately targeting a higher rate of inflation was first put forward by Paul Krugman in a famous 1998 paper. While many prominent economists, including Federal Reserve Board chairman Ben Bernanke, endorsed Krugman’s position, no central bank has had the courage to actually test the theory by making it explicit policy. Inflation-phobic central banks found it impossible to accept the idea that ahigher rate of inflation could actually be a desirable policy goal.
This is why Abe’s agenda is so impressive. While Japan does have an independent central bank, Abe has made it clear that he will use his control of parliament to take away this independence if the central bank does not agree to carry out his inflation-promoting agenda. Unless he is derailed in this effort, we will be able to see a clear test of this prescription.
It is also worth noting one other way in which Japan is already a model. The deficit chicken hawks that dominate Washington policy debates are warning us that financial markets will panic if we don’t soon get our debt under control, with investors fleeing the dollar and interest rates soaring. Japan’s ratio of debt to GDP of 240 percent is more than twice that of the United States, yet the interest rate on long-term government bonds is hovering near 1.0 percent and the government’s main concern is that the yen is over-valued.
If Abe is allowed to carry through his policy and it proves successful, it will provide a great example for the United States, Europe, and other regions still suffering the effects of the economic collapse in 2008. Of course these countries have not always been able or willing to learn lessons from other experiments.
The eurozone countries proved that deficit reduction in the middle of a downturn leads to recessions and higher unemployment, just as textbook Keynesianism predicted. The United Kingdom provided an even better proof of the Keynesian model since it did it to itself in the context of a country with its economy that was not suffering from a crisis of confidence.
In spite of the overwhelming evidence that these examples provide of the foolishness of deficit reduction in the middle of downturn, austerity remains very much in fashion in elite Washington circles. If our leaders can’t learn from other countries’ failures, there is still the hope that they make be able to learn from success.
If Abe carries through his Keynesian agenda and manages to restore Japan to a healthy growth path perhaps it will put an end to austerity economics in the United States. As President Bush always used to say, “is our leaders learning?”
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.
This article originally appeared on Al Jazeera.
http://www.counterpunch.org/2013/01/08/ ... line/print
January 08, 2013
Social Darwinism and Fundamentalist Economics
Deficit, Debt and Decline
by MICHAEL BRENNER
Washington’s foreign policy establishment is wringing its hands over the deficit. They voice fears that America’s dominant position in the world will be jeopardized by tight budgets and lingering austerity that lowers its influence on all manner of global economic matters. That could mean a smaller military, less aggressive financial diplomacy, and weakened hand in trying to pressure countries like Iran. We are warned that curtailed power will have dire effects on our national security.
A retreat from global engagement hovers ominously on the horizon – or so we are told. One senior State Department diplomat quoted in last Friday’s New York Times darkly raised the spectre of a revived isolationism as the long-term debt problems may become an “excuse to turn our backs on the Middle East and trim our sails on the new focus on Asia.” This Cassandra does not spell out what exactly “turning our backs” or “trimming our sails” amounts to in practical terms. What strategic conceptions underlie these assessments? What hard American interests are visualized as being at risk? Is it correct to correlate foreign policy effectiveness with the availability of expensive tangible assets – abundant, all-purpose military forces above all? How credible are the financial assumptions themselves – re. debt burdens that are exaggerated; deficits due mainly to the prolonged recession, the Bush tax giveaways to the rich and near rich, Pentagon budgets that in fact will continue to rise in real terms, and the calculations of corporations to off-shore profitable operations with the encouragement of strong IRS incentives?
The emerging conventional wisdom on a deficit driven decline in the United States’ international position too easily can slip into group think that features dubious premises, doubtful logic and questionable arithmetic. We have seen this phenomenon at work constantly since 9/11 with devastatingly bad results for national well-being.
So here is a close look at what lies behind the frantic waving of distress flags. Most crucial is the firm conviction that the United States must be in a position to exercise controlling influence on the international affairs of every global region. In military terms, it is summed up by the Pentagon’s dedication to establishing “full spectrum dominance“ everywhere. Simply put, the doctrine proclaims that we should be able to prevail in any conflict at whatever level of intensity and scope. That audacious idea justifies the building of a far-flung network of bases across Southwest and Central Asia far from traditional zones of American strategic concern. It is mutually reinforced by the open-ended “war on terror.” Using the current loose definition of the terrorist threat, defending America has come to encompass everything from chasing ghosts of terrorism past across the wastes of the Sahara and fomenting acts of terror in Iranian Baluchistan to the foredoomed and vastly expensive expeditions aimed at remaking Iraq and Afghanistan according to our specifications. As an add-on, Special Force missions are slashing through the jungles of Honduras and Columbia on the pretense that the country’s drug addiction problem is rooted there rather than in the homes and on the streets of American communities.
Special Forces number close to 60,000. Organized as the United States Special Operations Command (USSOCOM), this army within an army is deployed in scores of countries performing an array of secret and semi-secret missions. (By comparison, the total deployable troops in the British army numbers roughly 75,000). Their very availability inescapably influences judgments as to where national interests require their engagement. Expensive, highly trained elite units are not easily reconciled to spending their time doing one-armed push-ups while watching the military channel.
Full spectrum dominance also entails the build-up of more conventional forces equipped with ultra-high tech weaponry in Asia to thwart any Chinese design to exercise the kind of influence around its periphery that we exercise in Latin America and Europe – as if a replay of Victory at Sea in the Pacific was in the offing. It includes as well an explicit commitment to maintaining military hegemony in the Persian Gulf and the entire Middle East. There, we are bent on denying an antagonistic Iran any role in the strategic affairs of the region they inhabit; and, there, we are working at full throttle to block the rise of Islamic fundamentalists with jihadist tendencies even as we work to undercut the regimes that have held them in check.
All of this demands enormous resources. The waste and duplication that have become the hallmark of the bloated, contractor ridden military/intelligence establishment adds a hefty premium to the trillion dollar sum. The bigger question, though, is whether the all-embracing strategic design and audacious goals that animate our security obsessed actions, and our foreign policy generally, make sense. Does it serve us well? The answers are taken for granted by the American foreign policy elite. This despite a decade of frustration and failure, despite a progressive militarization of foreign policy that is manifestly counter-productive, despite the abundant evidence that the country is less secure now than it was ten years ago, and despite the warping of American society in egregious ways that is doing irreparable harm to the American “brand” around the globe.
In the Middle East, we are trying to superimpose the simple logic of power politics on a turbulent political reality of unique complexity and complication. Talk of perpetuating a presumed American hegemony is out of touch with the times. It doesn’t fit either conditions or our skills and capability in the region post Iraq/Afghanistan debacles, post-collapse of American moral standing, post-Arab Spring and the exhibition of Washington’s hypocrisy, post the relative decline of American liquid capital to lend or invest, post rise of the Muslim Brotherhood & Assoc., post sectarian passions playing out in country after country. Continuing to follow this simplistic model of yesteryear promises only more sorrow – for ourselves and for peoples of the Greater Middle East. A whiff of fresh thinking is desperately needed in Washington’s stale and smug corridors of power. That is the true deficit that we should be worrying about.
The loss of esteem in the world that we are experiencing does not stem mainly from the admittedly absurd machinations of the Republican Congress and a timid White House – however unseemly they are. Rather, it is the steady impoverishment of salaried workers; it is the sub-par health care that places us at the bottom of the standings among developed countries; it is denying the old the means for a decent existence; it is the gross culture of greed that permeates our elites and rules our politics; it is the national infatuation with violence – this is what has tarnished both the image and reality of America. It is not the lack of political will to squeeze the vulnerable even more than we already are doing.
Hence, those who truly worry about the United States’ place and influence in the world should refocus their attention. Abandon fanciful notions of American global dominion. Let go of the ambition to reach somehow the nirvana of a world where there is zero threat to Americans’ security. Learn the diplomatic arts of accommodation. Liberate oneself from the proven fallacies of discredited doctrines of market fundamentalist economics and Social Darwinism. And regain the belief in a humane society that does not posit false trade-offs pitting the basic welfare of its citizens against the vain pursuit of a dream of world domination that is as unworthy as it is improbable.
Michael Brenner is a Professor of International Affairs at the University of Pittsburgh.
by JackRiddler » Thu Jan 10, 2013 8:30 pm
JackRiddler wrote:.
I have a chance to meet this guy tomorrow (Harrington) at the Alt.Banking meeting of Occupy, but probably won't make it. See the perks of living in New York? Thrills! Chills!
Nevertheless, the preparatory reading has been interesting. He is a former Moody's analyst...
by JackRiddler » Tue Jan 22, 2013 11:42 am
http://dallasfed.org/news/speeches/fish ... 130116.cfm
Research & Data Banking Community Development Economic Education Globalization Institute Publications
FRB Dallas Home » Dallas News »Speeches » Fisher » 2013 »
Ending 'Too Big to Fail':
A Proposal for Reform Before It's Too Late
(With Reference to Patrick Henry, Complexity and Reality)
Remarks before the Committee for the Republic
Washington, D.C. · January 16, 2013
It is an honor to be introduced by my college classmate, John Henry. John is a descendant of the iconic patriot, Patrick Henry. Most of John’s ancestors were prominent colonial Virginians and many were anti-crown. Patrick, however, was the most outspoken. Ask John why this was so, and he will answer: “Patrick was poor.”
However poor he may have been, Patrick Henry was a rich orator. In one of his greatest speeches, he said: “Different men often see the same subject in different lights; and therefore, I hope that it will not be thought disrespectful to those gentlemen if, entertaining as I do, opinions of a character very opposite to theirs, I shall speak forth my sentiments freely, and without reserve. This is no time for ceremony … [it] is one of awful moment to this country.”
Patrick Henry was addressing the repression of the American colonies by the British crown. Tonight, I wish to speak to a different kind of repression—the injustice of being held hostage to large financial institutions considered “too big to fail,” or TBTF for short.
I submit that these institutions, as a result of their privileged status, exact an unfair tax upon the American people. Moreover, they interfere with the transmission of monetary policy and inhibit the advancement of our nation’s economic prosperity.
I have spoken of this for several years, beginning with a speech on the “Pathology of Too-Big-to-Fail” in July 2009.[1] My colleague, Harvey Rosenblum—a highly respected economist and the Dallas Fed’s director of research—and I and our staff have written about it extensively. Tomorrow, we will issue a special report that further elucidates our proposal for dealing with the pathology of TBTF. It also addresses the superior relative performance of community banks during the recent crisis and how they are being victimized by excessive regulation that stems from responses to the sins of their behemoth counterparts. I urge all of you to read that report.[2]
Now, Federal Reserve convention requires that I issue a disclaimer here: I speak only for the Federal Reserve Bank of Dallas, not for others associated with our central bank. That is usually abundantly clear. In many matters, my staff and I entertain opinions that are very different from those of many of our esteemed colleagues elsewhere in the Federal Reserve System. Today, I “speak forth my sentiments freely and without reserve” on the issue of TBTF, while meaning no disrespect to others who may hold different views.
The Problem of TBTF
Everyone and their sister knows that financial institutions deemed too big to fail were at the epicenter of the 2007–09 financial crisis. Previously thought of as islands of safety in a sea of risk, they became the enablers of a financial tsunami. Now that the storm has subsided, we submit that they are a key reason accommodative monetary policy and government policies have failed to adequately affect the economic recovery. Harvey Rosenblum and I first wrote about this in an article published in the Wall Street Journal in September 2009, “The Blob That Ate Monetary Policy.”[3] Put simply, sick banks don’t lend. Sick—seriously undercapitalized—megabanks stopped their lending and capital market activities during the crisis and economic recovery. They brought economic growth to a standstill and spread their sickness to the rest of the banking system.
Congress thought it would address the issue of TBTF through the Dodd–Frank Wall Street Reform and Consumer Protection Act. Preventing TBTF from ever occurring again is in the very preamble of the act. We contend that Dodd–Frank has not done enough to corral TBTF banks and that, on balance, the act has made things worse, not better. We submit that, in the short run, parts of Dodd–Frank have exacerbated weak economic growth by increasing regulatory uncertainty in key sectors of the U.S. economy. It has clearly benefited many lawyers and created new layers of bureaucracy. Despite its good intention, it has been counterproductive, working against solving the core problem it seeks to address.
Defining TBTF
Let me define what we mean when we speak of TBTF. The Dallas Fed’s definition is financial firms whose owners, managers and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction. Such firms capture the financial upside of their actions but largely avoid payment—bankruptcy and closure—for actions gone wrong, in violation of one of the basic tenets of market capitalism (at least as it is supposed to be practiced in the United States). Such firms enjoy subsidies relative to their non-TBTF competitors. They are thus more likely to take greater risks in search of profits, protected by the presumption that bankruptcy is a highly unlikely outcome.
The phenomenon of TBTF is the result of an implicit but widely taken-for-granted government-sanctioned policy of coming to the aid of the owners, managers and creditors of a financial institution deemed to be so large, interconnected and/or complex that its failure could substantially damage the financial system. By reducing a TBTF firm’s exposure to losses from excessive risk taking, such policies undermine the discipline that market forces normally assert on management decisionmaking.
The reduction of market discipline has been further eroded by implicit extensions of the federal safety net beyond commercial banks to their nonbank affiliates. Moreover, industry consolidation, fostered by subsidized growth (and during the crisis, encouraged by the federal government in the acquisitions of Merrill Lynch, Bear Stearns, Washington Mutual and Wachovia), has perpetuated and enlarged the weight of financial firms deemed TBTF. This reduces competition in lending.
Dodd–Frank does not do enough to constrain the behemoth banks’ advantages. Indeed, given its complexity, it unwittingly exacerbates them.
Complexity Bites
Andrew Haldane, the highly respected member of the Financial Policy Committee of the Bank of England, addressed this at last summer’s Jackson Hole, Wyo., policymakers’ meeting in witty remarks titled, “The Dog and the Frisbee.”[4] Here are some choice passages from that noteworthy speech.
Haldane notes that regulators’ “… efforts to catch the crisis Frisbee have continued to escalate. Casual empiricism reveals an ever-growing number of regulators … Ever-larger litters have not, however, obviously improved the watchdogs’ Frisbee-catching abilities. [After all,] no regulator had the foresight to predict the financial crisis, although some have since exhibited supernatural powers of hindsight.
“So what is the secret of the watchdogs’ failure? The answer is simple. Or rather, it is complexity … complex regulation … might not just be costly and cumbersome but sub-optimal. … In financial regulation, less may be more.”
One is reminded of the comment French Prime Minister Clemenceau made about President Wilson’s 14 points: “Why 14?” he asked. “God did it in 10.”
Were that we only had 14 points of financial regulation to contend with today. Haldane notes that Dodd–Frank comes against a background of ever-greater escalation of financial regulation. He points out that nationally chartered banks began to file the antecedents of “call reports” after the formation of the Office of the Comptroller of the Currency in 1863. The Federal Reserve Act of 1913 required state-chartered member banks to do the same, having them submitted to the Federal Reserve starting in 1917. They were short forms; in 1930, Haldane noted, these reports numbered 80 entries. “In 1986, [the ‘call reports’ submitted by bank holding companies] covered 547 columns in Excel, by 1999, 1,208 columns. By 2011 … 2,271 columns.” “Fortunately,” he adds wryly, “Excel had expanded sufficiently to capture the increase.”
Though this growingly complex reporting failed to prevent detection of the seeds of the debacle of 2007–09, Dodd–Frank has layered on copious amounts of new complexity. The legislation has 16 titles and runs 848 pages. It spawns litter upon litter of regulations: More than 8,800 pages of regulations have already been proposed, and the process is not yet done. In his speech, Haldane noted—conservatively, in my view—that a survey of the Federal Register showed that complying with these new rules would require 2,260,631 labor hours each year. He added: “Of course, the costs of this regulatory edifice would be considered small if they delivered even modest improvements to regulators’ ability to avert future crises.” He then goes on to argue the wick is not worth the candle. And he concludes: “Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. [The situation] requires a regulatory response grounded in simplicity, not complexity. Delivering that would require an about-turn.”
The Dallas Fed’s Proposal: A Reasonable ‘About-Turn’
The Dallas Fed’s proposal offers an “about-turn” and a way to mend the flaws in Dodd–Frank. It fights unnecessary complexity with simplicity where appropriate. It eliminates much of the mumbo-jumbo, ineffective, costly complexity of Dodd–Frank. Of note, it would be especially helpful to non-TBTF banks that do not pose systemic or broad risk to the economy or the financial system. Our proposal would relieve small banks of some unnecessary burdens arising from Dodd–Frank that unfairly penalize them. Our proposal would effectively level the playing field for all banking organizations in the country and provide the best protection for taxpaying citizens.
In a nutshell, we recommend that TBTF financial institutions be restructured into multiple business entities. Only the resulting downsized commercial banking operations—and not shadow banking affiliates or the parent company—would benefit from the safety net of federal deposit insurance and access to the Federal Reserve’s discount window.
Defining the Landscape
It is important to have an accurate view of the landscape of banking today in order to understand the impact of this proposal.
As of third quarter 2012, there were approximately 5,600 commercial banking organizations in the U.S. The bulk of these—roughly 5,500—were community banks with assets of less than $10 billion. These community-focused organizations accounted for 98.6 percent of all banks but only 12 percent of total industry assets. Another group numbering nearly 70 banking organizations—with assets of between $10 billion and $250 billion—accounted for 1.2 percent of banks, while controlling 19 percent of industry assets. The remaining group, the megabanks—with assets of between $250 billion and $2.3 trillion—was made up of a mere 12 institutions. These dozen behemoths accounted for roughly 0.2 percent of all banks, but they held 69 percent of industry assets.
NOTES: Percentages reflect share of industry assets. Asset size is based on the total assets of a U.S. banking organization (holding company, when applicable) as of Sept. 30, 2012.
SOURCES: Call reports (Federal Financial Institutions Examination Council); FR Y-9C filers (National Information Center, Federal Reserve System).
The 12 institutions that presently account for 69 percent of total industry assets are candidates to be considered TBTF because of the threat they could pose to the financial system and the economy should one or more of them get into trouble. By contrast, should any of the other 99.8 percent of banking institutions get into trouble, the matter most likely would be settled with private-sector ownership changes and minimal governmental intervention.
How and why does this work for 99.8 percent but not the other 0.2 percent?
To answer this question, it helps to consider the sources of regulatory and market discipline imposed on each of the three groups of banks.
Let’s look at two dimensions of regulatory discipline: Potential closure of the institution and the effectiveness of supervisory pressure on bank management practices.
Do the owners and managers of a banking institution operate with the belief that their institution is subject to a bankruptcy process that works reasonably quickly to transfer ownership and control to another banking entity or entities? Is there a group of interested and involved shareholders that can exert a restraining force on franchise-threatening risk taking by the bank’s top management team? Can management be replaced and ownership value wiped out? Is the firm controlled de facto by its owners, or instead effectively management-controlled?[5] In addition, we ask: To what extent do uninsured creditors of the banking entity impose risk-management discipline on management?
This analytical framework is summarized in the following slide:
SOURCE: Federal Reserve Bank of Dallas.
Looking across line 1, it is clear that community banks are subject to considerable regulatory and shareholder discipline. They can and do fail. In the last few years, the Federal Deposit Insurance Corp. (FDIC) has built a reputation for regulators carrying out Joseph Schumpeter’s concept of “creative destruction” by taking over small banks on a Friday evening and reopening them on Monday morning under new ownership. “In on Friday, out by Monday” is the mantra of this process.
Knowing the power of banking supervisors to close the institution, owners and managers of community banks heed supervisory suggestions to limit risk. Community banks often have a few significant shareholders who have a considerable portion of their wealth tied to the fate of the bank. Consequently, they exert substantial control over the behavior of management because risk and potential closure matter to them. Since community banks derive the bulk of their funding from federally insured deposits, they are simple rather than complex in their capital structure and rarely have uninsured and unsecured creditors. “Market discipline” over management practices is primarily exerted through shareholders.
Of the three groups, the 70 regional and moderate-sized banking organizations depicted in line 2 are subject to a broader range of market discipline. Like community banks, these institutions are not exempt from the bankruptcy process; they can and do fail. But given their size, complexity and generally larger geographic footprint, the failure resolution and ownership transfer processes cannot always be accomplished over a weekend. In practice, owners and managers of mid-sized institutions are nonetheless aware of the downside consequences of the risks taken by the institution. Uninsured depositors and unsecured creditors are also aware of their unprotected status in the event the institution experiences financial difficulties. Mid-sized banking institutions receive a good dose of external discipline from both supervisors and market-based signals.
TBTF megabanks, depicted in line 3, receive far too little regulatory and market discipline. This is unfortunate because their failure, if it were allowed, could disrupt financial markets and the economy. For all intents and purposes, we believe that TBTF banks have not been allowed to fail outright.[6] Knowing this, the management of TBTF banks can, to a large extent, choose to resist the advice and guidance of their bank supervisors’ efforts to impose regulatory discipline. And for TBTF banks, the forces of market discipline from shareholders and unsecured creditors are limited.
Let’s first consider discipline from shareholders. Having millions of stockholders has diluted shareholders’ ability to prevent the management of TBTF banks from pursuing corporate strategies that are profitable for management, though not necessarily for shareholders.
As we learned during the crisis, adverse information on poor financial performance often is available too late for shareholder reaction or credit default swap (CDS) spreads to have any impact on management behavior. For example, during the financial crisis, shares in two of the largest bank holding companies (BHCs) declined more than 95 percent from their prior peak prices and their CDS spreads went haywire.[7] The ratings agencies eventually reacted, in keeping with their tendency to be reactive rather than proactive. But the damage from excessive risk taking had already been done. And after the crisis? Judging from the behavior of many of the largest BHCs, with limited exception, efforts by shareholders of these institutions to meaningfully influence management compensation practices have been slow in coming. So much for shareholder discipline as a check on TBTF banks.
Unfortunately, TBTF banks also do not face much external discipline from unsecured creditors. An important facet of TBTF is that the funding sources for megabanks extend far beyond insured deposits, as referenced by my mention of CDS spreads. The largest banks, not just the TBTF banks, fund themselves with a wide range of liabilities. These include large, negotiable CDs, which often exceed the FDIC insurance limit; federal funds purchased from other banks, all of which are uninsured, and subordinated notes and bonds, generally unsecured. It is not unusual for such uninsured/unsecured liabilities to account for well over half the liabilities of TBTF institutions. If market discipline were to be imposed on TBTF institutions, one would expect it to come from uninsured/unsecured depositors, creditors and debt holders. But TBTF status exerts perverse market discipline on the risk-taking activities of these banks. Unsecured creditors recognize the implicit government guarantee of TBTF banks’ liabilities. As a result, unsecured depositors and creditors offer their funds at a lower cost to TBTF banks than to mid-sized and regional banks that face the risk of failure.
This TBTF subsidy is quite large and has risen following the financial crisis. Recent estimates by the Bank for International Settlements, for example, suggest that the implicit government guarantee provides the largest U.S. BHCs with an average credit rating uplift of more than two notches, thereby lowering average funding costs a full percentage point relative to their smaller competitors.[8] Our aforementioned friend from the Bank of England, Andrew Haldane, estimates the current implicit TBTF global subsidy to be roughly $300 billion per year for the 29 global institutions identified by the Financial Stability Board (2011) as “systemically important.”[9] To put that $300 billion estimated annual subsidy in perspective, all the U.S. BHCs summed together reported 2011 earnings of $108 billion.
Add to that the burdens stemming from the complexity of TBTF banks. Here is the basic organization diagram for a typical complex financial holding company:
NOTE: FHCs largely share the same legal and regulatory framework as BHCs.
SOURCE: Federal Reserve Bank of Dallas.
To simplify a complex issue, one might consider all the operations other than the commercial banking operation as shadow banking affiliates, including any special investment vehicles—or SIVs—of the commercial bank [10].
Now, consider this table. It gives you a sense of the size and scope of some of the five largest BHCs, noting their nondeposit liabilities in billions of dollars and their number of total subsidiaries and countries of operation (according to the Financial Stability Oversight Council):
SOURCES: "Which Banks Could Face Cap on Size?" by Victoria McGrane, Wall Street Journal, Oct. 11, 2012; Financial Stability Oversight Council.
For perspective, consider the sad case of Lehman Brothers. More than four years later, the Lehman bankruptcy is still not completely resolved. As of its 10-K regulatory filing in 2007, Lehman operated a mere 209 subsidiaries across only 21 countries and had total liabilities of $619 billion. By these metrics, Lehman was a small player compared with any of the Big Five. If Lehman Brothers was too big for a private-sector solution while still a going concern, what can we infer about the Big Five in the table?
Correcting for the Drawbacks of Dodd–Frank
Dodd–Frank addresses this concern. Under the Orderly Liquidation Authority provisions of Dodd–Frank, a systemically important financial institution would receive debtor-in-possession financing from the U.S. Treasury over the period its operations needed to be stabilized. This is quasi-nationalization, just in a new, and untested, format. In Dallas, we consider government ownership of our financial institutions, even on a “temporary” basis, to be a clear distortion of our capitalist principles. Of course, an alternative would be to have another systemically important financial institution acquire the failing institution. We have been down that road already. All it does is compound the problem, expanding the risk posed by the even larger surviving behemoth organizations. In addition, perpetuating the practice of arranging shotgun marriages between giants at taxpayer expense worsens the funding disadvantage faced by the 99.8 percent remaining—small and regional banks. Merging large institutions is a form of discrimination that favors the unwieldy and dangerous TBTF banks over more focused, fit and disciplined banks.
The approach of the Dallas Fed neither expands the reach of government nor further handicaps the 99.8 percent of community and regional banks. Nor does it fight complexity with complexity.
It calls for reshaping TBTF banking institutions into smaller, less-complex institutions that are: economically viable; profitable; competitively able to attract financial capital and talent; and of a size, complexity and scope that allows both regulatory and market discipline to restrain excessive risk taking.
Our proposal is simple and easy to understand. It can be accomplished with minimal statutory modification and implemented with as little government intervention as possible. It calls first for rolling back the federal safety net to apply only to basic, traditional commercial banking. Second, it calls for clarifying, through simple, understandable disclosures, that the federal safety net applies only to the commercial bank and its customers and never ever to the customers of any other affiliated subsidiary or the holding company. The shadow banking activities of financial institutions must not receive taxpayer support.
We recognize that undoing customer inertia and management habits at TBTF banking institutions may take many years. During such a period, TBTF banks could possibly sow the seeds for another financial crisis. For these reasons, additional action may be necessary. The TBTF BHCs may need to be downsized and restructured so that the safety-net-supported commercial banking part of the holding company can be effectively disciplined by regulators and market forces. And there will likely have to be additional restrictions (or possibly prohibitions) on the ability to move assets or liabilities from a shadow banking affiliate to a banking affiliate within the holding company.[11]
To illustrate how the first two points in our plan would work, I come back to the hypothetical structure of a complex financial holding company. Recall that this type of holding company has a commercial bank subsidiary and several subsidiaries that are not traditional commercial banks: insurance, securities underwriting and brokerage, finance company and others, many with a vast geographic reach.
Where the Government Safety Net Would Begin and End
Under our proposal, only the commercial bank would have access to deposit insurance provided by the FDIC and discount window loans provided by the Federal Reserve. These two features of the safety net would explicitly, by statute, become unavailable to any shadow banking affiliate, special investment vehicle of the commercial bank or any obligations of the parent holding company. This is largely the current case—but in theory, not in practice. And consistent enforcement is viewed as unlikely.
SOURCE: Federal Reserve Bank of Dallas.
Reinforced by a New Covenant
To reinforce the statute and its credibility, every customer, creditor and counterparty of every shadow banking affiliate and of the senior holding company would be required to agree to and sign a new covenant, a simple disclosure statement that acknowledges their unprotected status. A sample disclosure need be no more complex than this:
This two-part step should begin to remove the implicit TBTF subsidy provided to BHCs and their shadow banking operations. Entities other than commercial banks have inappropriately benefited from an implicit safety net. Our proposal promotes competition in light of market and regulatory discipline, replacing the status quo of subsidized and perverse incentives to take excessive risk.
As indicated earlier, some government intervention may be necessary to accelerate the imposition of effective market discipline. We believe that market forces should be relied upon as much as practicable. However, entrenched oligopoly forces, in combination with customer inertia, will likely only be overcome through government-sanctioned reorganization and restructuring of the TBTF BHCs. A subsidy once given is nearly impossible to take away. Thus, it appears we may need a push, using as little government intervention as possible to realign incentives, reestablish a competitive landscape and level the playing field.
Why Protect the 0.2 Percent?
My team at the Dallas Fed and I are confident this simple treatment to the complex problem and risks posed by TBTF institutions would be the most effective treatment. Think about it this way: At present, 99.8 percent of the banking organizations in America are subject to sufficient regulatory or shareholder/market discipline to contain the risk of misbehavior that could threaten the stability of the financial system. Zero-point-two percent are not. Their very existence threatens both economic and financial stability. Furthermore, to contain that risk, regulators and many small banks are tied up in regulatory and legal knots at an enormous direct cost to them and a large indirect cost to our economy. Zero-point-two percent. If the administration and the Congress could agree as recently as two weeks ago on legislation that affects 1 percent of taxpayers, surely it can process a solution that affects 0.2 percent of the nation’s banks and is less complex and far more effective than Dodd–Frank.
Making a Time of ‘Awful Moment’ a Time of Promise
The time has come to change the decisionmaking paradigm. There should be more than the present two solutions: bailout or the end-of-the-economic-world-as-we-have-known-it. Both choices are unacceptable. The next financial crisis could cost more than two years of economic output, borne by millions of U.S. taxpayers. That horrendous cost must be weighed against the supposed benefits of maintaining the TBTF status quo. To us, the remedy is obvious: end TBTF now. End TBTF by reintroducing market forces instead of complex rules, and in so doing, level the playing field for all banking institutions.
I return to Patrick Henry. He noted that “it is natural to man to indulge in the illusions of hope. We are apt to shut our eyes against a painful truth, and listen to the song of that siren till she transforms us.” We labor under the siren song of Dodd–Frank and the recent run-up in the pricing of TBTF bank stocks and credit, indulging in the illusion of hope that this complex legislation will end too big to fail and right the banking system. We shut our eyes to the painful truth that TBTF represents an ongoing danger not just to financial stability, but also to fair competition.
The Dallas Fed offers a modest but, we believe, far more effective fix to Dodd–Frank. This plan is not without its costs. But it is less costly than all the alternatives put forward and it seriously reduces the likelihood of another horrendous and costly financial crisis.
This need not be a time of “awful moment.” It should instead be a time of promise. Treating the pathology of TBTF now would be a big step toward a more stable and prosperous economic system, one that relies on fundamental principles of capitalism rather than regulatory complexity and increasing government intervention.
Thank you.
Notes
1. The views expressed by the author do not necessarily reflect official positions of the Federal Reserve System.
2. See “Two Areas of Present Concern: the Economic Outlook and the Pathology of Too-Big-to-Fail (With Reference to Errol Flynn, Johnny Mercer, Gary Stern and Voltaire),” speech by Richard W. Fisher, July 23, 2009, and “Paradise Lost: Addressing ‘Too Big to Fail’ (With Reference to John Milton and Irving Kristol), speech by Richard W. Fisher, Nov. 19, 2009.
3. See “Financial Stability: Traditional Banks Pave the Way,” Federal Reserve Bank of Dallas Special Report, January 2013, http://www.dallasfed.org (note: the report will be available online at 9 a.m. Eastern time on Jan. 17).
4. See “The Blob That Ate Monetary Policy,” by Richard W. Fisher and Harvey Rosenblum, Wall Street Journal, Sept. 27, 2009.
5. See “The Dog and the Frisbee,” by Andrew G. Haldane and Vasileios Madouros, Bank of England, paper presented at “The Changing Policy Landscape” symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyo., Aug. 30–Sept. 1, 2012.
6. For a distinction between owner-controlled and management-controlled firms, see The Modern Corporation and Private Property, by Adolf A. Berle and Gardiner C. Means, New York: Macmillan, 1932.
7. Several of the nation’s largest banking companies received massive and extraordinary government assistance in 2008–09 but were never listed as failures in the FDIC database nor included on the list of “problem banks.” Discipline without teeth probably leads the management of such institutions to “turn a deaf ear” to their supervisors. Rod Stewart said it well in his song “Young Turks”: “But there ain’t no point in talking, when there’s nobody listening.”
8. See “Regulatory and Monetary Policies Meet ‘Too Big to Fail’,” by Harvey Rosenblum, Jessica J. Renier and Richard Alm, Federal Reserve Bank of Dallas Economic Letter, vol. 5, no. 3, 2010, Chart 1, p. 6. More specifically, Citigroup and BankAmerica Corp. experienced peak-to-trough declines in their common stock prices of over 96 percent.
Bank for International Settlements 2011/2012 Annual Report, June 24, 2012, pp. 75–6.
9. See “On Being the Right Size,” speech by Andrew Haldane, Bank of England, at the 2012 Beesley Lectures, Institute of Economic Affairs’ 22nd Annual Series, London, Oct. 25, 2012.
10. For a review of shadow banking, see “Understanding the Risks Inherent in Shadow Banking: A Primer and Practical Lessons Learned,” by David Luttrell, Harvey Rosenblum and Jackson Thies, Federal Reserve Bank of Dallas Staff Papers, no. 18, 2012.
11. As an example, Sen. David Vitter and Sen. Sherrod Brown cite in their letter to the Government Accountability Office on Jan. 1, 2013, that “Bank of America moved $15 trillion in derivatives contracts from its broker-dealer, Merrill Lynch, to its insured depository institution affiliate in response to a credit downgrade. ... This move reportedly saved the bank $3.3 billion in additional collateral payments.”
About the Author
Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.
Federal Reserve Bank of Dallas
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