A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, July 30, 2009

TARP Congressional Oversight Panel Chair, Elizabeth Warren Testimony

Elizabeth Warren Testimony
emphasis added

Testimony of Professor Elizabeth Warren
Chair, Congressional Oversight Panel
before the
House Committee on Financial Services
Subcommittee on Oversight and Investigations
July 22, 2009


The Oversight Panel is one of three organizations to which the TARP legislation gives oversight responsibilities. We work closely with GAO and the Special Inspector General to ensure that all our oversight efforts complement, not duplicate, one another. We all want to make the whole of our work greater than the sum of its parts.


In late 2008, our economy faced an exceptional crisis. The stock market had plummeted. Credit markets had frozen. Our most important financial institutions were teetering on the brink of collapse, threatening to bring the whole economy down. In this challenging moment Congress created the TARP. Under this program Treasury pumped billions of dollars into banks, an emergency action meant to stabilize the financial system.

These actions imposed an enormous risk on taxpayers. If the TARP failed to stabilize the financial system, the entire economy could collapse. Even if the system stabilized after huge infusions of taxpayer funds, if some institutions were unable to recover, taxpayers could be saddled with debt for generations. While these risks were looming, then-Treasury Secretary Henry Paulson argued that TARP assistance could be used to rescue the economy as well as generate a profit for taxpayers. When Congress authorized the commitment of $700 billion to rescue the financial system, it decided that taxpayers should have the opportunity to share in a potential upside if the banks returned to profitability.

The opportunity to profit from TARP investments comes through special securities called warrants, which represent the right to buy shares of a company at a set price at some point in the future. Banks that received financial assistance under the TARP were required to give the government warrants for the future purchase of some of their common shares. Now that the markets have begun to show signs of recovery and many banks want to repay their TARP money, repurchase their warrants, and free themselves from the stigma and stipulations that accompany government bailouts, it is timely to consider the issues involved in the repayment of TARP assistance and the repurchase of warrants.

The Panel’s mandate is to examine Treasury’s choices, and in our July report we consider whether it makes sense to allow repayment now, and determine if taxpayers are receiving the maximum benefit possible from the TARP. Treasury recently chose to allow 10 of the nation’s largest banks, holding a third of the nation’s banking assets, to exit the TARP. These banks have repaid their government capital infusions, but Treasury still has the warrants that accompanied the TARP assistance. Because these warrants represent the only opportunity for the taxpayer to participate directly in the increase in the share prices of these banks, made possible by public money, the price at which Treasury sells these warrants is critical. We do not know what value Treasury has placed on the warrants it still holds, but the Panel’s July report presents an independent valuation to generate a baseline for comparison for when Treasury does sell its warrants, to help determine whether Treasury is in fact maximizing the return on taxpayers’ investments in these financial institutions.

The Panel’s July report presents a detailed technical valuation of Treasury’s warrants using the most widely-accepted mathematical model for warrant valuation. The assumptions employed in the use of any model are crucial, and the report offers a range of estimates based on high, low and best estimate assumptions for certain key variables, particularly the volatility of the underlying stock of the bank in question The Panel’s estimates for the value of the warrants Treasury held on July 6, 2009 range from $4.7 billion to $12.3 billion, with its best estimate being $8.1 billion.


As of the date of our report (July 10th) eleven small banks had repurchased their warrants from Treasury for a total amount of only 66 percent of the Panel’s best estimate of their value. If the warrants had been sold for the Panel’s estimation of market value, taxpayers would have recovered $10 million more. In these sales, liquidity discounts – applied to reflect the difficulty in trading securities of small institutions – have been a major factor in a way not likely to apply to the warrants of large, publicly-traded institutions. However, if Treasury continues to accept only 66 percent of the Panel’s estimated market value for the rest of warrants it holds, the shortfall to taxpayers could be as much as $2.7 billion.

It should be noted that Treasury is just beginning its warrant repurchase program. It is possible that policymakers may conclude that other objectives should override the goal of maximizing taxpayer returns. For example, Treasury has said that it wants to allow banks to operate again without TARP assistance as soon as they are strong enough to do so. The determination of whether they are in fact financially sound and able to repay their assistance remains critical, especially in light of ongoing concerns about the macroeconomic environment and the possibility of further credit losses down the road. As discussed in the Panel’s June report, the stress tests provide some comfort in this regard but the fact that the key economic assumptions used in those tests continue to deteriorate remains a cause for concern.

Banks have bought back only a fraction of one percent of all warrants issued, and the prices paid thus far may not be representative of what is to come. In fact, in the weeks since our report was published, Treasury seems to have begun conducting its warrant negotiations more aggressively. U.S. Bancorp, which recently paid back its $6.9 billion in TARP assistance, repurchased its warrants from Treasury for $139 million dollars. This figure was actually higher than that given by the Panel’s best estimate model – which would be good news for taxpayers if it is indicative of how future warrant negotiations with large institutions will play out. Additionally, as has been widely reported, banks like JPMorgan Chase and Goldman Sachs have thus far been unable to reach agreement with Treasury on a price for their warrants. Reports in the media also indicate that these two banks believe Treasury is asking too much for their warrants and that JPM Chase is urging Treasury to conduct an auction for them.

Treasury is obligated under the terms of the contracts it initially signed as part of the Capital Purchase Program to enter into negotiations with the banks to repurchase warrants once they have repaid their CPP investments. Only if the price ultimately negotiated is rejected by the bank in question can Treasury then move to an auction procedure to dispose of its warrants.

Nevertheless, because warrant valuation is a difficult task, the Panel explores the possibility that Treasury should leave it to the markets by selling the warrants in an open, public auction. This has the benefit of stopping any speculation about whether Treasury has been too tough or too easy on the banks that want to repurchase their own warrants. It also permits the banks to bid for their own warrants – in direct competition with outsiders.

As always, it is critical that Treasury make the process – the reason for its decisions, the way it arrives at its figures, and the exit strategy from or future use of the TARP – absolutely transparent. If it fails to do so, the credibility of the decisions it makes and its stewardship of the TARP will be in jeopardy.


Just yesterday, the Panel released a special report on farm credit and farm loan restructuring, as mandated by the Helping Families Save Their Homes Act of 2009. Farmers entered the recession in a historically strong position, and for many, balance sheets are in fairly good shape. But prosperity is not evenly spread across America. Today, more farmers are struggling. Net farm income is expected to fall 20 percent this year, and some sectors – especially dairy – are doing worse. Congress asked the Panel to consider whether three existing loan restructuring models – the USDA’s Farm Service Agency, the Farm Credit System, and the Making Home Affordable program for residential mortgages – could be used as a model for a farm loan restructuring mandate for TARP recipient banks.

The Panel found that a foreclosure plan that only works through a mandate on TARP recipient banks, no matter which model it followed, would have limited effect. Right now TARP recipient banks only hold about ten percent of farm real estate debt.
Treasury and Congress could consider other alternatives, such as setting aside a portion of remaining TARP funding for a farm mortgage foreclosure mitigation program, patterned on the incentive based program developed to protect homes, but focusing on bank participation beyond current TARP recipients. Another option would be to create within TARP a loan guarantee program for restructured farm loans. Both commercial banks and other lenders, like the Farm Credit System, report using government guaranteed loans to restructure trouble loans, but the availability of such loan guarantees is insufficient to meet the need. Finally, Congress has options outside of TARP to assist struggling farmers, such as commodity and price support programs. Such programs could allow assistance to be targeted to the specific sectors in need, like the dairy industry.

For August the Panel will turn to the topic of toxic assets. The precipitous drop in value of classes of assets linked (primarily) to residential real estate loans, produced the most serious financial crisis of the last 75 years. But government policy has not focused on those assets. Instead it has aimed to stabilize the financial institutions that hold them. What are the consequences, and more important, the risks of this approach to putting the financial sector into a position where the crisis cannot reignite?


Wednesday, July 29, 2009

Special Inspector General of TARP, Neil Barofsky, Testimony

Neil Barofsky Testimony

July 22, 2009

The Special Inspector General for the TARP program (SIGTARP) has made a variety or recommendations concerning the TARP program and has worked hard to advance the general understanding of the TARP. With respect to recommendations, one of SIGTARP’s most important oversight responsibilities is to provide recommendations to Treasury so that TARP programs can be designed or modified to facilitate effective oversight and transparency and to prevent fraud, waste, and abuse. SIGTARP’s reports detail these recommendations and provide updates on their implementation. Two categories of recommendations, however, are worth highlighting in particular:

Transparency in TARP Programs

Although Treasury has taken some steps towards improving transparency in TARP programs, it has repeatedly failed to adopt recommendations that SIGTARP believes are essential to providing basic transparency and fulfill Treasury’s stated commitment to implement TARP “with the highest degree of accountability and transparency possible.” SIGTARP’s July 21, 2009, Quarterly Report includes one new recommendation and there are several other additional unadopted recommendations from prior quarterly reports:
  • Use of Funds Generally: One of SIGTARP’s first recommendations was that Treasury require all TARP recipients to report on the actual use of TARP funds. Other than in a few agreements (with Citigroup, Bank of America, and AIG), Treasury has declined to adopt this recommendation, calling any such reporting “meaningless” in light of the inherent fungibility of money. SIGTARP continues to believe that banks can provide meaningful information about what they are doing with TARP funds — in particular what activities they would not have been able to do but for the infusion of TARP funds. That belief has been supported by SIGTARP’s first audit, in which nearly all banks were able to provide such information.
  • Valuation of the TARP Portfolio: SIGTARP has recommended that Treasury begin reporting on the values of its TARP portfolio so that taxpayers can get regular updates on the financial performance of their TARP investments. Notwithstanding that Treasury has now retained asset managers and is receiving such valuation data on a monthly basis, Treasury has not committed to providing such information except on the statutorily required annual basis.
  • Disclosure of TALF Borrowers Upon Surrender of Collateral: In TALF, the loans are non-recourse, that is, the lender (Federal Reserve Bank of New York) will have no recourse against the borrower beyond taking possession of the posted collateral (consisting of asset-backed securities (“ABS”)). Under the program, should such a collateral surrender occur, TARP funds will be used to purchase the surrendered collateral. In light of this use of TARP funds, SIGTARP has recommended that Treasury and the Federal Reserve disclose the identity of any TALF borrowers that fail to repay the TALF loan and must surrender the ABS collateral.
  • Regular Disclosure of PPIF Activity, Holdings, and Valuation: In the PPIP Legacy Securities Program, the taxpayer will be providing a substantial portion of the funds (contributing both equity and lending) that will be used to purchase toxic assets in the Public-Private Investment Funds (“PPIFs”). SIGTARP is recommending that all trading activity, holdings, and valuations of assets of the PPIFs be disclosed on a timely basis. Not only should this disclosure be required as a matter of basic transparency in light of the billions of taxpayer dollars at stake, but such disclosure would also serve well one of Treasury’s stated reasons for the program in the first instance: the promotion of “price discovery” in the illiquid market for MBS. Treasury has indicated that it will not require such disclosure.
Although SIGTARP understands Treasury’s need to balance the public’s transparency interests, on one hand, with the interests of the participants and the desire to have wide participation in the programs, on the other, Treasury’s default position should always be to require more disclosure rather than less and to provide the investors in TARP — the American taxpayers — as much information about what is being done with their money as possible. Unfortunately, in rejecting SIGTARP’s basic transparency recommendations, TARP has become a program in which taxpayers (i) are not being told what most of the TARP recipients are doing with their money, (ii) have still not been told how much their substantial investments are worth, and (iii) will not be told the full details of how their money is being invested. In SIGTARP’s view, the very credibility of TARP (and thus in large measure its chance of success) depends on whether Treasury will commit, in deed as in word, to operate TARP with the highest degree of transparency possible.

Imposition of Information Barriers, or “Walls,” in PPIP

In the April 21, 2009, Quarterly Report, SIGTARP noted that conflicts of interest and collusion vulnerabilities were inherent in the design of PPIP stemming from the fact that the PPIF managers will have significant power to set prices in a largely illiquid market. These vulnerabilities could result in PPIF managers having an incentive to overpay significantly for assets or otherwise using the valuable, proprietary PPIF trading information to benefit not the PPIF, but rather the manager’s non-PPIF business interests. As a result, SIGTARP made a series of recommendations in the April Quarterly Report, including that Treasury should impose strict conflicts of interest rules.

Since the April Quarterly Report, Treasury has worked with SIGTARP to address the vulnerabilities in PPIP, and SIGTARP made a series of specific recommendations, suggestions, and comments concerning the design of the program. Treasury adopted many of SIGTARP’s suggestions and has developed numerous provisions that make PPIP far better from a compliance and anti-fraud standpoint than when the program was initially announced.

However, Treasury has declined to adopt one of SIGTARP’s most fundamental recommendations — that Treasury should require imposition of an informational barrier or “wall” between the PPIF fund managers making investment decisions on behalf of the PPIF and those employees of the fund management company who manage non-PPIF funds. Treasury has decided not to impose such a wall in this instance, despite the fact that such walls have been imposed upon asset managers in similar contexts in other Government bailout-related programs, including by Treasury itself in other TARP-related activities, and despite the fact that three of the nine PPIF managers already must abide by similar walls in their work for those other programs.

If nothing else, the reputational risk that Treasury and the program could face if a PPIF manager should generate massive profits in its non-PPIF funds as a result of an unfair advantage, even if that advantage is not strictly against the rules, justifies the imposition of a wall. Failure to impose a wall, on the other hand, will leave Treasury vulnerable to an accusation that has already been leveled against it — that Treasury is using TARP to pick winners and losers and that, by granting certain firms the PPIF manager status, it is benefitting a chosen few at the expense of the dozens of firms that were rejected, of the market as a whole, and of the American taxpayer. This reputational risk is not one that can be readily measured in dollars and cents, but is rather a risk that could put in jeopardy the fragile trust the American people have in TARP and, by extension, their Government.

TARP in Context

During the last 36 hours there has been considerable media coverage and interest in section 3 of SIGTARP’s July Quarterly Report, which attempts to place the TARP into context in terms of how it has evolved and of the greater government-wide effort. TARP, as originally envisioned in the fall of 2008, would have involved the purchase, management, and sale of up to $700 billion of “toxic” assets, primarily troubled mortgages and mortgage-backed securities (“MBS”). That framework was soon shelved, however, and TARP funds are being used, or have been announced to be used, in connection with 12 separate programs that, as set forth in Table 1 below, involve a total (including TARP funds, loans and guarantees from other agencies, and private money) that could reach nearly $3 trillion. Through June 30, 2009, Treasury has announced the parameters of how $643.1 billion of the $700 billion would be spent through the 12 programs. Of the $643.1 billion that Treasury has committed, $441 billion has actually been spent.


As massive and as important as TARP is on its own, it is just one part of a much broader Federal Government effort to stabilize and support the financial system. Since the onset of the financial crisis in 2007, the Federal Government, through many agencies, has implemented dozens of programs that are broadly designed to support the economy and financial system. In our most recent quarterly report, we summarize these programs and the total potential support to the financial system as of 6/30/09, there is approximately $3.0 trillion outstanding, $4.7 trillion is the total support to date, including money that has been paid pack and programs that have ended. In total, the potential federal support through all of these programs is approximately $23.7 trillion.


SIGTARP is in the process of completing audit reports concerning executive compensation restriction compliance, controls over external influences on the CPP application process, selection of the first nine participants for funds under CPP (with a particular emphasis on Bank of America), AIG bonuses, and AIG counterparty payments. In addition, SIGTARP is undertaking a series of new audits, as follows:
  • Follow-up Assessment of Use of Funds by TARP Recipients: This audit will examine use of funds by recipients receiving extraordinary assistance under the Systemically Significant Failing Institutions program, the Automotive Industry Financing Program, as well as insurance companies receiving assistance under CPP.
  • Governance Issues Where U.S. Holds Large Ownership Interests: The audit, being conducted at the request of Senator Max Baucus, will examine governance issues when the U.S. Government has obtained a large ownership interest in a particular institution, including: (i) What is the extent of Government involvement in management of companies in which it has made sizeable investments, including direction and control over such elements as governance, compensation, spending, and other corporate decision making? (ii) To what extent are effective risk management, internal controls, and monitoring in place to protect and balance the Government’s interests and corporate needs? (iii) Are there performance measures in place that can be used to track progress against long-term goals and timeframes affecting the Government’s ability to wind down its investments and disengage from these companies? (iv) Is there adequate transparency to support decision making and to provide full disclosure to the Congress and the public?
  • Status of the Government’s Asset Guarantee Program with Citigroup: The audit examining the Government’s Asset Guarantee Program (“AGP”) with Citigroup, based upon a request by Representative Alan Grayson, will address a series of questions about the Government’s guarantee of certain Citigroup assets through the AGP such as: (i) How was the program for Citigroup developed? (ii) What are the current cash flows from the affected assets? and (iii) What are the potential for losses to Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve under the program?
  • Making Home Affordable Mortgage Modification Program: This audit will examine the Making Home Affordable mortgage modification program to assess the status of the program, the effectiveness of outreach efforts, capabilities of loan servicers to provide services to eligible recipients, and challenges confronting the program as it goes forward.

Tuesday, July 28, 2009

Charts and Persepctive on Employment

Plus "The End of the End of the Recession from Zero Hedge"

We did get the web site in some order this past weekend. The charts on economic performance by president are more complete, and we'll go into those in a moment. The forecast charts are now in order on the forecast page. The whole tangled empire is nearly in order.

After the charts we will come through with the promised perspective from last Saturday's podcast, which was left on the cutting room floor.

We hope you like the deep sky blue. It may work.


Employment and Unemployment

At one time our baseline scenario for employment and unemployment was significantly below that of other economists as represented by the Philadelphia Fed's survey of professional economists and the quarterly projections of the Federal Reserve Open Market Committee. (Although you will notice, the actual data tracked our forecast quite well.) Beginning in March, 2009, the consensus has tracked us more closely.


The unemployment rate cannot help but reflect the deteriorating economy, and particularly the collapse of consumer spending and state and local government revenues. Business earnings are positive only if those businesses have been very aggressive in cutting their workforces. This means further weakness down the road. Similarly, positive news in the form of an increase in the personal savings rate means less spending and a reduction in employment and consequently a reduction in savings down the road as more and more unemployed individuals must tap their rainy day funds to meet current expenses.


Demand Side expected George W. Bush to come within one million of being the first president in postwar history to preside over an economy that produced no -- zero -- net new jobs. Six months after his watch ended, the feat was accomplished.

Employment growth will lead the economy's true recovery, regardless of when that recovery occurs. An aggressive jobs-first program will produce the best outcomes. Unfortunately, private sector job growth is going to lag for years to come, and the growth which does occur will reflect the weak bargaining position of workers. That is, both the numbers and incomes connected with private sector new employment will lag for some time.

We're currently at work, as we threaten from time to time, on a second edition of Demand Side, the book.

Economic Performance by Party of the President is basically chapter 4 of Demand Side, the book.

Increase in Employment by Year again displays the "missing teeth" during Republican years and general stability and strength during years of Democratic presidents. Notice the relatively weak showing of George W. Bush in employment growth does not translate clearly to the chart below, the unemployment rate. The reasons for this are ambiguous.

Unemployment Rate.

The most striking element in this chart is the regular step down in the unemployment rate when Democrats have been in the White House. Only during the immediate postwar transition and in the year 1980 has there been any meaningful break in this pattern of downward steps.

Also with the exception of Carter and the year 1980, the unemployment rate has been significantly lower in the last year of a Democratic administration than in the first.

By President

Comparing these two charts we see that strength in employment growth does not translate clearly into lower unemployment rates. This is due to weaknesses in the methodology for calculating the official unemployment rate, which continues to count workers if they move from full-time to part-time and which reduces the denominator -- the workforce -- by so-called discouraged workers and by others.

By Presidential Term

These two charts confirm the pattern we have seen of employment growth being strong under Democrats, but not translating clearly into the unemployment rate. We observe here that both measures undercount the effect of weak employment. When employment growth is strong, wages also tend to be stronger, and vice versa. Incomes are the major source of demand, and they are doubly weak in a weak labor market.

In a moment we'll get to the longer-term perspective. But we did want to draw your attention to the excellent piece out of Zero Hedge by Tyler Durden, a 72-page presentation entitled, The End of the End of the Recession.


(embedded at the end of this post)

Introduced in part by this:

This presentation has been prepared in collaboration with the terrific work of
David Rosenberg, Chief Economist & Strategist, Gluskin Sheff + Associates

We believe an aggressive “fact-finding” investigation into the true depths of the
recession is critical due to increased pressure by members of the Mainstream
Media and conflicted Investment Banks to present a myopic, unjustified opinion
Furthermore, opinions based on overoptimistic projections and “hope” are the
primary reason the Credit Bubble persisted as long as it did

If the general population and regulatory authorities had approached rating agencies
about the optimism quotient in their faulty models, it is likely that the current
correction would have been nowhere near as severe

As there is an all too real threat of a relapse into the same kind of optimistic zeal
and the resultant formation of yet another asset bubble, Zero Hedge is
presenting the factual side of the story

We demand that readers question any and all assumptions

and elsewhere

The U.S. Consumer

Consumer deleveraging continues unabated despite all efforts by the Fed
and the administration

New credit card issuance has plunged 38% year to date, and the average
limit on new credit cards has declined by 3%

In May consumer credit contracted by $3.3 billion, the fourth decline in a
row: the longest declining period since 1991

Since Lehman collapse, consumer credit (excluding mortgages) has
contracted by $53 billion: an 11.5% annual rate, a record decline

Weekly bank lending through June show further shrinkage

This is a highly deflationary development: all the government can do is
cushion the blow

Former IMF Chief Economist Ken Rogoff: “The kind of deleveraging we
need to see takes six or eight years … The retrenching of the U.S.
consumer is a huge

Now a different form of perspective. The focus of the intelligent these days is on how to get out of the current economic mess. Our suggestion is that we begin to look at where we're going, because we cannot get back to where we came from, even if we wanted to. So, yes, Let's fix the hole in the boat caused by running it onto the rocks. But once we've done that, let's not pretend the job is done, because nothing good is going to come from sitting here on the beach.

That said, and at the risk of displaying a little less than perfect foresight, we'd like to read from Demand Side, the book, First Edition. This is only two years ago.

The point we make here is that everything was not going swimmingly prior to the crash and that going back there is not only not going back to the normal, it is not going back to the healthy or the possible. Setting a new course is the only way to keep the old outcomes from coming back.

The economic decline of the United States (written 2007)

The United States is in advanced stages of losing its manufacturing base. It clings to doomed technologies. Its infrastructure is aging and decrepit. Both government and citizens subsist on debt and borrowing. While the U.S. remains the richest nation, the free market ideology that directs federal policy comes with a curiously contradictory price tag in the form of enormous public borrowing by the Free Marketeers who direct fiscal policy. This borrowing and the resulting debt is then cited as proof of the regrettable profligacy of government.

We have doubled our mortgage debt within the past six years. ( Dean Baker, Dangerous Trends: The Growth of Debt in the U.S. Economy, September 2004.) Our aging population enters retirement with its Social Security made fragile by decades of borrowing to float general government operations. The free market advocates who now call for low taxes and high deficits have hidden from us as much as possible the financial facts. Borrowing does not reduce taxes, only postpones them to be paid back with interest.

Much of our debt is held by foreign central banks or individuals. They have financed our homes and durable goods. They will not be satisfied with payment in currency. Money is simply the medium of exchange. They will want goods and services. What will we give them? Where is the industrial plant or development plan to repay our debts?

Health care demands a sixth of our output, twice the proportion of other industrial nations. War demands people, treasure and effort that cannot be used to address our other problems.

Huge borrowing also bids up the value of the dollar. American-made products priced in expensive dollars must then compete with the manufactures of other countries. Standard economic theory has no explanation for trade deficits of hundreds of billions per year for decades. The inflated dollar and the trade deficit are inextricably linked, and result from the use of the dollar as reserve currency. The implications for instability and potentially excruciating correction are enormous if it should return to its role as simply a medium of exchange. Will the Federal Reserve, the central bank of the US, allow the dollar to collapse? Or will it pursue in futility the strength of the currency at the expense of a collapse in the economy?

Meanwhile workers and productive industry absorb the costs. Median incomes have stagnated since 1980, and wages have actually declined in real terms. Health care, energy, housing and education have consumed more of the family’s budget. And this richest nation also boasts the greatest disparity between its rich and poor. (Joshua Karliner, The Corporate Planet, Sierra Club Press, 1997.)

There is a way for the US to become a productive power again and for its government and citizens to operate in the black. The country can again trade goods and services in balance, rather than support itself on delusion and borrowing. That way will certainly not be found by running behind the Corporate Oligarchy and hoping for crumbs. The technologies and consumption patterns will not be the same in a rational world, but will provide for a fully engaged workforce and rising global economy that can convert the daunting challenges into opportunities. The United States, or its Corporate Oligarchy, may not dominate others economically, politically, or militarily, but we can be more prosperous, more secure, and allow our planet to survive as home for us all.

The End of the End of the Recession

Monday, July 27, 2009

Matt Taibbi, Rolling Stone, Inside the Great American Bubble Machine

In Rolling Stone Issue 1082-83, Matt Taibbi takes on "the Wall Street Bubble Mafia" — investment bank Goldman Sachs . Here are exerpts of that piece.

The piece has generated controversy, with Goldman Sachs firing back that Taibbi's piece is "an hysterical compilation of conspiracy theories" and a spokesman adding, "We reject the assertion that we are inflators of bubbles and profiteers in busts, and we are painfully conscious of the importance in being a force for good." Taibbi shot back: "Goldman has its alumni pushing its views from the pulpit of the U.S. Treasury, the NYSE, the World Bank, and numerous other important posts; it also has former players fronting major TV shows. They have the ear of the president if they want it."

Inside The Great American Bubble Machine
Posted Jul 02, 2009

The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

Any attempt to construct a narrative around all the former Goldmanites in influential positions quickly becomes an absurd and pointless exercise, like trying to make a list of everything. What you need to know is the big picture: If America is circling the drain, Goldman Sachs has found a way to be that drain — an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.

They achieve this using the same playbook over and over again. The formula is relatively simple: Goldman positions itself in the middle of a speculative bubble, selling investments they know are crap. Then they hoover up vast sums from the middle and lower floors of society with the aid of a crippled and corrupt state that allows it to rewrite the rules in exchange for the relative pennies the bank throws at political patronage. Finally, when it all goes bust, leaving millions of ordinary citizens broke and starving, they begin the entire process over again, riding in to rescue us all by lending us back our own money at interest, selling themselves as men above greed, just a bunch of really smart guys keeping the wheels greased. They've been pulling this same stunt over and over since the 1920s — and now they're preparing to do it again, creating what may be the biggest and most audacious bubble yet.

The basic scam in the Internet Age is pretty easy even for the financially illiterate to grasp. Companies that weren't much more than pot-fueled ideas scrawled on napkins by up-too-late bong-smokers were taken public via IPOs, hyped in the media and sold to the public for megamillions. It was as if banks like Goldman were wrapping ribbons around watermelons, tossing them out 50-story windows and opening the phones for bids. In this game you were a winner only if you took your money out before the melon hit the pavement.

It sounds obvious now, but what the average investor didn't know at the time was that the banks had changed the rules of the game, making the deals look better than they actually were. They did this by setting up what was, in reality, a two-tiered investment system — one for the insiders who knew the real numbers, and another for the lay investor who was invited to chase soaring prices the banks themselves knew were irrational. While Goldman's later pattern would be to capitalize on changes in the regulatory environment, its key innovation in the Internet years was to abandon its own industry's standards of quality control.

Goldman's role in the sweeping global disaster that was the housing bubble is not hard to trace. Here again, the basic trick was a decline in underwriting standards, although in this case the standards weren't in IPOs but in mortgages. By now almost everyone knows that for decades mortgage dealers insisted that home buyers be able to produce a down payment of 10 percent or more, show a steady income and good credit rating, and possess a real first and last name. Then, at the dawn of the new millennium, they suddenly threw all that shit out the window and started writing mortgages on the backs of napkins to cocktail waitresses and ex-cons carrying five bucks and a Snickers bar.

And what caused the huge spike in oil prices? Take a wild guess. Obviously Goldman had help — there were other players in the physical-commodities market — but the root cause had almost everything to do with the behavior of a few powerful actors determined to turn the once-solid market into a speculative casino. Goldman did it by persuading pension funds and other large institutional investors to invest in oil futures — agreeing to buy oil at a certain price on a fixed date. The push transformed oil from a physical commodity, rigidly subject to supply and demand, into something to bet on, like a stock. Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, an increase of 2,300 percent. By 2008, a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed.

The history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled-dry American empire, reads like a Who's Who of Goldman Sachs graduates. By now, most of us know the major players. As George Bush's last Treasury secretary, former Goldman CEO Henry Paulson was the architect of the bailout, a suspiciously self-serving plan to funnel trillions of Your Dollars to a handful of his old friends on Wall Street. Robert Rubin, Bill Clinton's former Treasury secretary, spent 26 years at Goldman before becoming chairman of Citigroup — which in turn got a $300 billion taxpayer bailout from Paulson. There's John Thain, the asshole chief of Merrill Lynch who bought an $87,000 area rug for his office as his company was imploding; a former Goldman banker, Thain enjoyed a multibillion-dollar handout from Paulson, who used billions in taxpayer funds to help Bank of America rescue Thain's sorry company. And Robert Steel, the former Goldmanite head of Wachovia, scored himself and his fellow executives $225 million in golden-parachute payments as his bank was self-destructing. There's Joshua Bolten, Bush's chief of staff during the bailout, and Mark Patterson, the current Treasury chief of staff, who was a Goldman lobbyist just a year ago, and Ed Liddy, the former Goldman director whom Paulson put in charge of bailed-out insurance giant AIG, which forked over $13 billion to Goldman after Liddy came on board. The heads of the Canadian and Italian national banks are Goldman alums, as is the head of the World Bank, the head of the New York Stock Exchange, the last two heads of the Federal Reserve Bank of New York — which, incidentally, is now in charge of overseeing Goldman.

But then, something happened. It's hard to say what it was exactly; it might have been the fact that Goldman's co-chairman in the early Nineties, Robert Rubin, followed Bill Clinton to the White House, where he directed the National Economic Council and eventually became Treasury secretary. While the American media fell in love with the story line of a pair of baby-boomer, Sixties-child, Fleetwood Mac yuppies nesting in the White House, it also nursed an undisguised crush on Rubin, who was hyped as without a doubt the smartest person ever to walk the face of the Earth, with Newton, Einstein, Mozart and Kant running far behind.

Rubin was the prototypical Goldman banker. He was probably born in a $4,000 suit, he had a face that seemed permanently frozen just short of an apology for being so much smarter than you, and he exuded a Spock-like, emotion-neutral exterior; the only human feeling you could imagine him experiencing was a nightmare about being forced to fly coach. It became almost a national cliché that whatever Rubin thought was best for the economy — a phenomenon that reached its apex in 1999, when Rubin appeared on the cover of Time with his Treasury deputy, Larry Summers, and Fed chief Alan Greenspan under the headline the committee to save the world. And "what Rubin thought," mostly, was that the American economy, and in particular the financial markets, were over-regulated and needed to be set free. During his tenure at Treasury, the Clinton White House made a series of moves that would have drastic consequences for the global economy — beginning with Rubin's complete and total failure to regulate his old firm during its first mad dash for obscene short-term profits.

After the oil bubble collapsed last fall, there was no new bubble to keep things humming — this time, the money seems to be really gone, like worldwide-depression gone. So the financial safari has moved elsewhere, and the big game in the hunt has become the only remaining pool of dumb, unguarded capital left to feed upon: taxpayer money. Here, in the biggest bailout in history, is where Goldman Sachs really started to flex its muscle.

It began in September of last year, when then-Treasury secretary Paulson made a momentous series of decisions. Although he had already engineered a rescue of Bear Stearns a few months before and helped bail out quasi-private lenders Fannie Mae and Freddie Mac, Paulson elected to let Lehman Brothers — one of Goldman's last real competitors — collapse without intervention. ("Goldman's superhero status was left intact," says market analyst Eric Salzman, "and an investment-banking competitor, Lehman, goes away.") The very next day, Paulson greenlighted a massive, $85 billion bailout of AIG, which promptly turned around and repaid $13 billion it owed to Goldman. Thanks to the rescue effort, the bank ended up getting paid in full for its bad bets: By contrast, retired auto workers awaiting the Chrysler bailout will be lucky to receive 50 cents for every dollar they are owed.

Immediately after the AIG bailout, Paulson announced his federal bailout for the financial industry, a $700 billion plan called the Troubled Asset Relief Program, and put a heretofore unknown 35-year-old Goldman banker named Neel Kashkari in charge of administering the funds. In order to qualify for bailout monies, Goldman announced that it would convert from an investment bank to a bank-holding company, a move that allows it access not only to $10 billion in TARP funds, but to a whole galaxy of less conspicuous, publicly backed funding — most notably, lending from the discount window of the Federal Reserve. By the end of March, the Fed will have lent or guaranteed at least $8.7 trillion under a series of new bailout programs — and thanks to an obscure law allowing the Fed to block most congressional audits, both the amounts and the recipients of the monies remain almost entirely secret.

Converting to a bank-holding company has other benefits as well: Goldman's primary supervisor is now the New York Fed, whose chairman at the time of its announcement was Stephen Friedman, a former co-chairman of Goldman Sachs. Friedman was technically in violation of Federal Reserve policy by remaining on the board of Goldman even as he was supposedly regulating the bank; in order to rectify the problem, he applied for, and got, a conflict-of-interest waiver from the government. Friedman was also supposed to divest himself of his Goldman stock after Goldman became a bank-holding company, but thanks to the waiver, he was allowed to go out and buy 52,000 additional shares in his old bank, leaving him $3 million richer. Friedman stepped down in May, but the man now in charge of supervising Goldman — New York Fed president William Dudley — is yet another former Goldmanite.

The collective message of all of this — the AIG bailout, the swift approval for its bank-holding conversion, the TARP funds — is that when it comes to Goldman Sachs, there isn't a free market at all. The government might let other players on the market die, but it simply will not allow Goldman to fail under any circumstances. Its edge in the market has suddenly become an open declaration of supreme privilege. "In the past it was an implicit advantage," says Simon Johnson, an economics professor at MIT and former official at the International Monetary Fund, who compares the bailout to the crony capitalism he has seen in Third World countries. "Now it's more of an explicit advantage."

Fast-forward to today. It's early June in Washington, D.C. Barack Obama, a popular young politician whose leading private campaign donor was an investment bank called Goldman Sachs — its employees paid some $981,000 to his campaign — sits in the White House. Having seamlessly navigated the political minefield of the bailout era, Goldman is once again back to its old business, scouting out loopholes in a new government-created market with the aid of a new set of alumni occupying key government jobs.

Gone are Hank Paulson and Neel Kashkari; in their place are Treasury chief of staff Mark Patterson and CFTC chief Gary Gensler, both former Goldmanites. (Gensler was the firm's co-head of finance.) And instead of credit derivatives or oil futures or mortgage-backed CDOs, the new game in town, the next bubble, is in carbon credits — a booming trillion- dollar market that barely even exists yet, but will if the Democratic Party that it gave $4,452,585 to in the last election manages to push into existence a groundbreaking new commodities bubble, disguised as an "environmental plan," called cap-and-trade. The new carbon-credit market is a virtual repeat of the commodities-market casino that's been kind to Goldman, except it has one delicious new wrinkle: If the plan goes forward as expected, the rise in prices will be government-mandated. Goldman won't even have to rig the game. It will be rigged in advance.

Sunday, July 26, 2009

Charles Duhigg, NYT, on High Frequency Trading, with update on action from Sen. Charles Schumer

Goldman Sachs employs the best talent. Their ex-Enron traders to do what they do best, game the system. High frequency trading (HFT) is gaming the system. The market is corrupted completely when the conditions of purchase and sale are compromised like this.

Goldman was the subject of a Rolling Stone we will put up tomorrow. At the end of the Times piece is legislative response from Charles Schumer.

There is a word for people who enable high rollers to get away with cheating and contribute their money to the crime. "Suckers."

Stock Traders Find Speed Pays, in Milliseconds
New York Times
Published: July 23, 2009

It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.

Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The Securities and Exchange Commission says it is examining certain aspects of the strategy.

“This is where all the money is getting made,” said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. “If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”

For most of Wall Street’s history, stock trading was fairly straightforward: buyers and sellers gathered on exchange floors and dickered until they struck a deal. Then, in 1998, the Securities and Exchange Commission authorized electronic exchanges to compete with marketplaces like the New York Stock Exchange. The intent was to open markets to anyone with a desktop computer and a fresh idea.

But as new marketplaces have emerged, PCs have been unable to compete with Wall Street’s computers. Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.

High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits — and then disappear before anyone even knows they were there.

High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders — typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.

“It’s become a technological arms race, and what separates winners and losers is how fast they can move,” said Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange. “Markets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell.”

The rise of high-frequency trading helps explain why activity on the nation’s stock exchanges has exploded. Average daily volume has soared by 164 percent since 2005, according to data from NYSE. Although precise figures are elusive, stock exchanges say that a handful of high-frequency traders now account for a more than half of all trades. To understand this high-speed world, consider what happened when slow-moving traders went up against high-frequency robots earlier this month, and ended up handing spoils to lightning-fast computers.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Multiply such trades across thousands of stocks a day, and the profits are substantial. High-frequency traders generated about $21 billion in profits last year, the Tabb Group, a research firm, estimates.

“You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient,” said Andrew M. Brooks, head of United States equity trading at T. Rowe Price, a mutual fund and investment company that often competes with and uses high-frequency techniques. “But we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity.”

Here is some late response from Senator Charles Schumer
Schumer Presses SEC for Ban on ‘Unfair’ High-Frequency Trades
July 25 (Bloomberg)
By Edgar Ortega and Eric Martin

Charles Schumer, the third-ranking Democrat in the U.S. Senate, asked the Securities and Exchange Commission to ban so-called flash orders for stocks, saying they give high-speed traders an unfair advantage.

Schumer’s letter to SEC Chairman Mary Schapiro yesterday raised the stakes in a debate over the practice offered by Nasdaq OMX Group Inc., Bats Global Markets and Direct Edge Holdings LLC, which handle more than two-thirds of the shares traded in the U.S. With flash orders, exchanges wait up to half a second before they publish bids and offers on competing platforms, giving their own customers an opportunity to gauge demand before other traders.

“This kind of unfair access seriously compromises the integrity of our markets and creates a two-tiered system, where a privileged group of insiders receives preferential treatment,” Schumer wrote in the letter.

Flash orders make up less than 4 percent of U.S. stock trading, according to Direct Edge and Bats. They have drawn criticism from the Securities Industry and Financial Markets Association, which is Wall Street’s main lobbying group, and Getco LLC, one of the biggest firms that uses high-frequency trading strategies to make markets in stocks and options. NYSE Euronext, owner of the world’s largest exchange by the value of companies it lists, told the SEC in May that the technique results in investors getting worse prices.

Schumer, a member of the Senate Banking Committee, said he will introduce legislation to ban flash orders if the SEC doesn’t act on his request.

‘Deeper Conversation’

“This practice has been going on for three years and didn’t get much attention until the New York Stock Exchange” started complaining, said Sang Lee, managing partner at financial- services consultant Aite Group LLC in Boston. “Someone like Chuck Schumer getting involved in the process will create a deeper conversation about where the whole market is headed.”

Brian Fallon, a spokesman at Schumer’s office in Washington, confirmed Schumer sent the letter. Erik Hotmire, an SEC spokesman, declined to comment. Nasdaq’s Robert Madden, Randy Williams of Bats and Ray Pellecchia of NYSE Euronext also didn’t respond. Nasdaq and NYSE are based in New York. Bats has its headquarters in Kansas City, Missouri.

Direct Edge, based in Jersey City, New Jersey, handles the most flash trades through its three-year-old Enhanced Liquidity Provider program. Chief Executive Officer William O’Brien said in an interview yesterday that it’s available to any brokerage and that investors choose to have their orders held to make it more likely they will be executed.

‘Better Position’

“Anybody can be part of it,” he said. “This is something that warrants a debate, and when you have so many competing interests, we think the SEC is in a better position to fulfill that.”

The Schumer letter follows concerns expressed by investors and traders that computer-driven strategies executing hundreds of trades a minute make stock prices more volatile and boost costs. NYSE Euronext, operator of the New York Stock Exchange, estimates that about 46 percent of daily volume is executed through high-frequency strategies.

For the past decade, U.S. equity markets have sought to draw more business from high-frequency traders by offering rebates on transaction fees. Exchanges rent space in their data centers to brokerages so they can cut the distance information must travel and reduce transaction times to eke out an edge over the competition.

‘Not Good’

“You have all this activity going on that in one way or another is preferencing one part of the investing group over another,” said Michael Panzner, author of “The New Laws of the Stock Market Jungle” and a Wall Street trader for a quarter century. “That’s not good.”

More than 75 percent of money managers use computer-driven strategies because they reduce costs, according to a survey this month conducted by Greenwich Associates, a consulting firm in Stamford, Connecticut. For those transactions, they rely on some of Wall Street’s largest brokerages, which account for two- fifths of high-frequency trading, NYSE estimates.

Traders including David Lutz say automated brokerages are helpful because they boost liquidity, increasing the likelihood that buyers and sellers will agree on a price. Competition has driven bids and offers for stocks including Microsoft Corp., Citigroup Inc. and General Electric Co. to 1 cent in the U.S., according to data compiled by Bloomberg.

“When high-frequency traders are in the stocks I’m trying to execute, it helps me find the best execution,” said Lutz, a managing director of equity trading at Stifel Nicolaus & Co. in Baltimore. “It’s completely benign to me.”

Saturday, July 25, 2009

Podcast Transcript 07.25.09 Audio perspective -- Martin Wolf, Eliot Spitzer, Dylan Ratigan

Plus Idiot of the Week with Robert Eisenbeis.

Today a little bit of audio and some perspective

Eliot Spitzer and Dylan Ratigan explain the garbage on the Fed's balance sheet and why we paid real money for it. Or maybe they just point out that we paid real money for garbage and take the Fed to task. Stay tuned.

Before that we have Idiot of the week with Robert Eisenbeis. We have Martin Wolf speaking directly to the bad economics of the past thirty years.

First this note, following our podcast relay of a House subcommittee's hearing on High Speed Rail, we hear from The Transport Politic website:

The House Okays Additional $4 Billion for High-Speed Rail

24 July 2009

This Budget provision, if approved by Senate, will increase federal allocations for rail to $12 billion in this year alone.

Yesterday, the U.S. House passed its housing and transportation bill, which will provide funds for fiscal year 2010. Approved mostly by members of the majority Democratic party, the bill would allocate $4 billion to high-speed rail programs — if the Senate’s version, likely to be considered after the August recess, includes the same provision.


.. The President’s Budget released earlier this year asked the Congress to devote $1 billion for the next five years for high-speed rail, in addition to the $8 billion already marked for the program under the stimulus bill. The House’s decision to increase that number to $4 billion is a direct reaction to the huge response from states and the private sphere for stimulus-based federal rail grants. The FRA revealed that forty states had applied for more than $103 billion.

Iowa Congressman Tom Latham (R) attempted to block the inclusion of so much money for rail, arguing that the government shouldn’t embark on what he argued would be a $100 billion endeavor. Yet his amendment was put down by a vote of 136-284, with 40 Republicans voting against his measure — compared to the only 16 members of the GOP voting for the bill as a whole. This indicates strong bipartisan support in Congress for high-speed rail investment and bodes well for similar action in the more conservative Senate.


Demand Side is cheering. The sooner and more aggressive the construction of high speed rail, the cheaper and more productive will be the investment.

Now, On to

Idiot of the Week,

With Robert Eisenbeis, former research director at the Atlanta Fed, talking on the idea of stimulus.


Clearly, once again, proximity to money does not mean competence in economics. We've already had the tax cuts fail twice, not to mention the huge debt hole they drilled in the one time surplus. The consumption function is much more substantial when you add stimulus in the form of a new job than in the form of an additional hundred dollars of discretionary income. The discrete these days save. We'll take up the savings rate in the next podcast.

Elsewhere in this interview with Tom Keene, Eisenbeis quotes the P.T. Barnum of economics, Milton Friedman, as saying, "Monetary policy acts with long and variable lags." Which, I think, speaks to the vagaries of monetary policy. The truth is it is far easier to stall an economy with monetary policy than it is to get one going again. We think you are witnessing that in the current experiment of history.

But, Robert Eisenbeis, Idiot of the Week.

Many of our idiots are fairly competent if they don't stray too far from their base of competence. Here is, for example, Eisenbeis in a clip earlier in that Bloomberg interview.


Let's use this comment on the Fed's balance sheet as a segue into Eliot Spitzer and Dylan Ratigan taking on the blather of the Fed with regard to what they've taken on. I hope the schtick translates to audio. It appeared on Ratigan's MSNBC "Morning Meeting" this week.


Enough of that.

Now to finish the podcast, Financial Times chief economist Martin Wolf gave the best interview of the past week, again on Bloomberg on the Economy with Tom Keene. Wouldn't it be nice to have an audio link capacity? Be that as it may, here is what he had to say with regard to the economic paradigm of the past thirty years.


I never bought it. I never believed in the so-called New Classical Economics, which essentially says "Demand is not a problem. The Market always clears. We're always at full employment. And we don't need to worry at all about the sorts of problems that worried John Maynard Keynes in the Thirties and, indded, worried Milton Friedman. I would argue that that sort of view in economics, which was the dominant paradigm for thirty years, that essentially the economy is in equilibrium all the time. The financial system is always in equilibrium. That seems to me to have been a mistake. A mistake made by brilliant people, but a mistake.

And we're going to ahve to go back to the sort of thinking about macroeconomics there was in the middle of the 20th Century. Yes. There's a big job of intellectual reconstruction to be done.

I must say I'm a bit pessimistic about this. What has struck me most forceably in this crisis is how everybody pretty well, with a few exceptions, have gone back to economic thinkers of the middle of the 20th century. Not new thinkers. Certainly not new, new thinkers. Maybe it's because this crisis has come as a terrible shock. It was not something very many people expected, and so there hasn't been the time for economists to think about what it means

But the truth is .... that we are going to have to go back to the drawing board, and ask ourselves "Is the model of the economy of enlighted rational individuals maximizing their wealth as they see it, one which is consistent with equilibrium, full employment all the time. And it seems to me pretty clear that it isn't, because people make absolutely fundamental and systematic errors. If we have the right macroeconomic environment, or the wrong one, which is what we have been discussing...

So yes, I think this is a matter of starting afresh, and I think that starting afresh has hardly started.

Martin Wolf

One thing, this should cause despair among those who toiled in the field of rational expectations. You grew only thorns. On the other hand, young economists should feel some encouragement. You didn't have to learn the wrong stuff and now with a good, direct view, you can be far more competent -- notice I did not say employable, only competent -- than peers with much more experience.

That brings up the thought. Why not a reading list? Yes. Robert Lekachman's The Age of Keynes, maybe forty years old, is very good as a start. I'll pick some others for the next edition of the podcast.

Thursday, July 23, 2009

Nouriel Roubini and the Threat of Long-Term Joblessness

Others, like Brad DeLong (The Jobless Recovery Has Begun) have announced the imminent onset of the jobless recovery.


You cannot send people from the plant to the McDonald's and call it a recovery. You cannot generate a few more dollars and call it a recovery. Employment and wages and incomes to the median are the real measure of the health of the economy.

Even granting that a "Recovery" is upward movement, not a return to prosperity, such a word needs to be associated with a broad-based upward movement. Jobs must be part of that base.

We first made this point after the first Bush recession, when economic activity picked up, but the lot of the workforce trailed. The following recovery was hailed by the financial industry, but the entire experiment only papered over a weak economy with a housing and debt bubble. Had we been operating policy from the jobs perspective, we would not have been so blindsided by the ultimate crash.

The Joblessness Threat
by Nouriel Roubini
July 23, 2009
Project Syndicate

NEW YORK – Recent data suggest that job market conditions are not improving in the United States and other advanced economies. In the US, the unemployment rate, currently at 9.5%, is poised to rise above 10% by the fall. It should peak at 11% some time in 2010 and remain well above 10% for a long time. The unemployment rate will peak above 10% in most other advanced economies, too.

These raw figures on job losses, bad as they are, actually understate the weakness in world labor markets. If you include partially employed workers and discouraged workers who left the US labor force, for example, the unemployment rate is already 16.5%. Monetary and fiscal stimulus in most countries has done little to slow down the rate of job losses. As a result, total labor income – the product of jobs times hours worked times average hourly wages – has fallen dramatically.

Moreover, many employers, seeking to share the pain of recession and slow down layoffs, are now asking workers to accept cuts in both hours and hourly wages. British Airways, for example, has asked workers to work for an entire month without pay. Thus, the total effect of the recession on labor income of jobs, hours and wage reductions is much larger.

A sharp contraction in jobs and labor income has many negative consequences on both the economy and financial markets. First, falling labor income implies falling consumption for households, which have already been hard hit by a massive loss of wealth (as the value of equities and homes has fallen) and a sharp rise in their debt ratios. With consumption accounting for 70% of US GDP in the US, and a similarly high percent in other advanced economies, this implies that the recession will last longer, and that economic recovery next year will be anemic (less than 1% growth in the US and even lower growth rates in Europe and Japan).

Second, job losses will lead to a more protracted and severe housing recession, as joblessness and falling income are key factors in determining delinquencies on mortgages and foreclosure. By the end of this year about 8.4 million US individuals with mortgages will be unemployed and unable to service their mortgages.

Third, if you plug an unemployment rate of 10% to 11% into any model of loan defaults, you get ugly figures not just for residential mortgages (both prime and subprime), but also for commercial real estate, credit cards, student loans, auto loans, etc. Thus, banks losses on their toxic assets and their capital needs will be much larger than recently estimated, which will worsen the credit crunch.

Fourth, rising job losses lead to greater demands for protectionist measures, as governments are pressured to save domestic jobs. This threatens to aggravate the damaging contraction of global trade.

Fifth, the higher the unemployment rate goes, the wider budget deficits will become, as automatic stabilizers reduce revenue and increase spending (for example, on unemployment benefits). Thus, an already unsustainable US fiscal path, with budget deficits above 10% of GDP and public debt expected to double as a share of GDP by 2014, becomes even worse.

This leads to a policy dilemma: rising unemployment rates are forcing politicians in the US and other countries to consider additional fiscal stimulus programs to boost sagging demand and falling employment. But, despite persistent deflationary pressure through 2010, rising budget deficits, high financial-sector bailout costs, continued monetization of deficits, and eventually unsustainable levels of public debt will ultimately lead to higher expected inflation – and thus to higher interest rates, which would stifle the recovery of private demand.

So, while further fiscal stimulus seems necessary to avoid a more protracted recession, governments around the world can ill afford it: they are damned if they do and damned if they don’t. If, like Japan in the late 1990’s and the US in 1937, they take the threat of large deficits seriously and raise taxes and cut spending too much too soon, their economies could fall back into recession. But recession could also result if deficits are allowed to fester, or are increased with additional stimulus to boost jobs and growth, because bond-market vigilantes might push borrowing costs higher.

Thus, even as mounting job losses undermine consumption, housing prices, banks’ balance sheets, support for free trade, and public finances, the room for further policy stimulus is becoming narrower. Indeed, not only are governments running out of fiscal bullets as debt surges, but monetary policy is having little short-run traction in economies suffering insolvency – not just liquidity – problems. Worse still, in the medium turn the monetary overhang may lead to significant inflationary risks.

Little wonder, then, that we are now witnessing a significant correction in equity, credit, and commodities markets. The irrational exuberance that drove a three-month bear-market rally in the spring is now giving way to a sober realization among investors that the global recession will not be over until year end, that the recovery will be weak and well below trend, and that the risks of a double-dip W-shaped recession are rising.

Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University, and Chairman of RGE Monitor

Copyright: Project Syndicate, 2009.

Wednesday, July 22, 2009

Elizabeth Warren on the Consumer Financial Protection Agency

A consumer financial products protection agency is a non-intrusive, non-audit driven, way of managing financial markets. It is actually managing a market, rather than dealing with market participants. The market being the sale and purchase of a good or service.

Absent assurances that your toaster will not burst into flame, would you buy it? Even if it came with a factory-certified schematic drawing, i.e., complete disclosure? Why not have a balance between buyer and seller in terms of financial expertise?

So-called financial innovation has been similar to making the car go faster by removing the weight of the steering mechanism. Combined with a return to market discipline which is lost as soon as firms are "too big to fail," and the market could work again. Glass-Steagall like reductions in the allowable size of participants (not intrustive descriptions or audits) and this analysis of financial products is the low-bureaucracy way to healthy markets.

Elizabeth Warren, the director of the TARP oversight commission, is outstanding.

Three Myths about the Consumer Financial Protection Agency
Elizabeth Warren

This guest post was contributed by Elizabeth Warren, chair of the Congressional Oversight Panel and the Leo Gottlieb Professor of Law at Harvard University. (Update: more on the case for a CFPA in her YouTube video, released yesterday.)

I’ve written a lot about the creation of a new Consumer Financial Protection Agency (CFPA), starting with an article I wrote in the Democracy Journal in the summer of 2007. My writing has helped me work through the idea and has advanced a conversation about what kind of changes in financial products would be most effective. A couple of weeks ago, I testified before the House Financial Services Committee about why I think a new consumer agency is so important, and I’ve argued the case many times.

Today, though, I’d like to post specifically about some of the push back that has developed on this issue. In particular, I’d like to focus on three big myths – myths designed to protect the same status quo that triggered the economic crisis.

MYTH #1: CFPA Will Limit Consumer Choice and Hinder Innovation

At a recent hearing on the CFPA, Rep. Brad Miller challenged an industry representative to identify one consumer who chose double-cycle billing to be included within the terms and conditions of his or her credit card contract. It was a great moment. If the status quo is about choice, then explain why half of those with subprime mortgages chose high-risk, high-cost loans when they qualified for prime mortgages. If the status quo is about choice, then explain why Citibank declared itself consumer friendly, dropped universal default, then quietly picked it up again the following year because they said consumers couldn’t tell whether they had the term or not.

The truth, of course, is that no consumer “chooses” to accept the tricks and traps buried within the legalese of financial products. Rather, consumers must choose among various products with one feature in common: dozens of pages of incomprehensible fine print.

The CFPA will not limit consumer choice. Instead, it will focus on putting consumers in a position to make choices for themselves by streamlining regulations, making disclosures smarter, and making financial products easier to understand and compare. The Agency will promote plain vanilla contracts—short, easy to read mortgages and credit card agreements. The key principle behind the new agency is that disclosure that runs on for pages is not real disclosure—it’s just a way to hide more tricks. Real disclosure means that a lender has to be able to explain what it is selling so that the customer can read it and understand it. Once consumers can understand the risk and costs of various products – and can compare those products quickly and cheaply – the market will innovate around their preferences.

Daniel Carpenter, a Professor of Government at Harvard University, has written a great deal about the modern pharmaceutical industry. While anyone with a bathtub and some chemicals could be a drug manufacturer a century ago, Carpenter points out that drug companies were willing to invest far more in research and development to bring good drugs to the market once FDA regulations drove out bad drugs and useless drugs. Good regulations support product innovation.

MYTH #2: The CFPA Will Add Another Layer of Regulation and Increase Regulatory Burden

Current regulations in the consumer financial area are layered on like pancakes—see a problem and fry up a regulation, but don’t integrate it with the earlier regulation. Today, seven different federal agencies have some form of regulations dealing with consumer credit. The result is a complicated, fragmented, expensive, and ineffective system. With consolidated and coherent authority, the CFPA can harmonize and streamline the regulatory system—while making it more effective.

But the real regulatory break-through for the CFPA would be the promotion of “plain vanilla” contracts that would likely meet the needs of about 95% of consumers. These contracts would have a regulatory safe harbor. By using an off-the-shelf template for a plain vanilla contracts and filling in the blanks for interest rates, penalty rates and a few other key terms, a financial institution can legally satisfy all its federal regulatory requirements—no need to do more.

Of course, some banks would want to offer more complicated products. For many, they could file-and-use, so long as they met the same regulatory standards of adequately disclosing risks and explaining costs—briefly enough and clearly enough for people to understand them.

A streamlined new regulatory regime would have a serious impact on the credit industry. Today’s complicated disclosure system favors big lenders that can hire a legion of lawyers to navigate the rules—and spread the costs among millions of customers. Those complex rules fall much harder on a smaller institution that must navigate the same regulatory twists and turns, but with far smaller administrative staffs. Plain vanilla contracts will be particularly beneficial for community banks and credit unions that will be able to divert fewer resources toward regulatory compliance and more toward customer service and innovation.

MYTH #3: Prudential and Consumer Regulation Cannot Be Separated

Make no mistake: This is a fancy claim for the status quo. If the CFPA can be left with the current bank regulators, then it can be smothered in the crib. For decades, the Federal Reserve and the bank regulators (the OCC and the OTS) have had the legal authority to protect consumers. They have brought us to this crisis by consistently refusing to exercise that authority.

The agencies’ well-documented failures – discussed in detail by Travis Plunkett and Ed Mierzwinski and by Professor Patricia McCoy — are largely the result of two structural flaws. The first is that financial institutions can now choose their own regulators. By changing from a bank charter to a thrift charter, for example, a financial institution can change from one regulator to another. The regulators’ budget comes in large part from the institutions they regulate. If a big financial institution leaves one regulator, the agency will face a budget shortfall and the agency will likely shrink. Knowing this, financial institutions can shop around for the regulator that provides the most lax oversight, and regulators can compete by offering to regulate less. Regulatory arbitrage triggered a race to the bottom among prudential regulators and blocked any hope of real consumer protection.

The second structural reason that prudential regulators failed to exercise their authority to protect consumers is a cultural one: consumer protection staff at existing agencies find themselves at the bottom of the pecking order because these agencies are designed to focus on other matters. At the Federal Reserve, senior officers and staff wake up every morning thinking about monetary policy. At the OCC and OTS, agency heads wake up thinking about capital adequacy requirements and safety and soundness. Consumer protection issues are—at best—an afterthought. The CFPA would create a home in Washington for people who wake up each morning thinking about whether American families are playing on a level field when they buy financial products. By bringing economic experts who care about consumer financial issues under one roof, CFPA can develop as a smart agency that develops real expertise.

A single consumer agency would also be able to make sure that the same products face the same regulations. Today, mortgages are regulated differently depending on whether they are issued by a bank, a nationally-chartered thrift, a nationally-chartered credit union, and so on. Imagine for a moment if toasters or toys had different safety standards depending on who manufactured them. Or, even worse, imagine if some manufacturers could bypass safety standards almost in entirety – as is now the case for non-depository financial institutions. It is time for one Agency to regulate financial products in a consistent manner across the board.

In 2001, Canada created an independent agency much like the proposed CFPA. I recently spoke with some Canadian economists, and they not only said the system works, they also expressed bewilderment about the idea that prudential and consumer regulation would be combined. As one said, they “have different ways of thinking about the world.”

At the end of the day, industry lobbyists try hard to invent myths and make things sound confusing to intimidate the public and to keep policymakers from acting. But this issue is simple: keeping safety and soundness and consumer protection together has not ensured safety and soundness, has not protected consumers, has not fostered choice and innovation, and has not minimized regulatory burden. In fact, the current regulatory structure that combines consumer protection with other bank oversight responsibilities has led to the kind of bad regulatory oversight that has led us to this crisis. The CFPA would put someone in Washington—someone with real power—who cares about customers. That’s good for families, good for market competition, and good for our economy.

By Elizabeth Warren

Robert Kuttner wonders where a recovery is going to come from

A jobless recovery sounds a lot to us like bouncing along the bottom of a crashed economy. There needs to be an engine of growth. We've argued for rebuilding America. Here is Robert Kuttner on the subject:
Smoking the Green Shoots
by Robert Kuttner
July 19, 2009

Question for the day: Where is the economic recovery going to come from?

We are still at the stage of the recession where economic downdrafts are producing more downdrafts. Reduced purchasing power leads to fewer retail and factory sales and more layoffs, further reducing consumer demand. The Obama stimulus package, about 2.5 percent of GDP for each of two years, doesn't make up enough of the difference. But the federal deficit, caused mainly by falling revenues and not by increased public spending, is alarming the budget hawks. The administration worries, correctly, that deficits will be high for several years to come and wonders who will keep lending Uncle Sam the money. Yet cutting back spending before recovery comes would be suicidal.

In addition, the financial sector has not yet returned to health, despite outsized profits (and bonuses) reported by the likes of Goldman Sachs. This is the kind of purely financial engineering that caused the collapse. The fevered activity at Goldman is a sign of lingering economic illness, not economic health. The rest of the economy, which depends on the financial sector for real investment capital, is still deeply depressed.

Louis Uchitelle's piece in Sunday's New York Times provides some instructive numbers.

Every major sector that reflects the purely private economy has been losing jobs, the only exception being energy extraction plus a tiny increase in computer systems design and management consulting. All of the other expanding sectors that are actually adding jobs reflect government spending - education, health, general government. But the declines in the workhorse parts of the private economy such as manufacturing, construction, and retailing are huge.

With purchasing power still declining and unemployment still rising, where will the recovery come from? White House economic chief Lawrence Summers, in a major speech at the Peterson Institute July 17, emphasized the good news.

"We were at the brink of catastrophe at the beginning of the year but we have walked some substantial distance back from the abyss," he said. And, ever the empiricist, Summers reported that a Google search revealed that "hits for economic depression have returned to baseline levels." That's nice, but what Summers did not forecast was a robust recovery.

And if we stay on the present path, recovery will not come for a long time. Federal deficits will be large enough to raise questions about who will keep lending us the money - but not large enough to power a real recovery that increases real incomes and provides good jobs. The last time we had a massive financial meltdown like this, it took the hyper-stimulus of a war - World War II - to recapitalize industry and re-employ workers.

What, then, is the moral equivalent of war for the 21st century? Let's think way, way outside the box.

We might begin with a serious strategy for rebuilding American manufacturing. American corporations and politicians have been cavalier about just letting manufacturing go. Uniquely among advanced and developing nations, we have no national strategy for nurturing manufacturing at home. There's even an office in the Commerce Department that helps companies outsource.

As a result, even a modest uptick in purchasing power will not produce enough American jobs because there are so many things that America no longer makes.

We could start with clean energy, and move on to mass transit, and reclaim America's capacity to make things. Right now, even if we massively shifted to wind and solar energy, other nations would get most of the production jobs because most solar panels and wind turbines are not made here, while Americans would just get the temporary installation jobs.

We could also get serious about insisting that other trading nations not coerce or bribe our manufactures to locate facilities overseas as a condition of doing business - a flagrant violation of trade law. We could start having a real industrial policy for commercial industry in the way that we have long had a tacit industrial policy for products deemed essential to the military.

The administration is confused about how to reconcile industrial goals with trade law. It had to do a lot of backing and filling so that tens of billions of taxpayer dollars to modernize the auto industry didn't end up subsidizing more outsourcing of jobs to China. If trade law interferes with our ability to revive American manufacturing, then there's something wrong with trade law and let's change it.

For a fine summary on how to revive domestic manufacturing, take a look at the new book, Manufacturing a Better Future for America, edited by Richard McCormack and written by some of America's best experts on reviving manufacturing.

The book is published by the Alliance for American Manufacturing.

After manufacturing, we need to get serious about investing in a new generation of public infrastructure - everything from smart-grid electrical systems to broadband and modern water and sewer and transportation systems. That will produce lots of good jobs, and make for a more efficient and productive economy.

As far as the deficit is concerned, it will probably need to get bigger before it gets smaller. During World War II, when the nation was a lot poorer and nearly half of our national output went to defeat the Axis powers, my parents and grandparents and tens of millions of Americans like them bought war bonds.

We didn't depend on foreign borrowing, even though the deficits were far larger. Today, the government should create Recovery Bonds and market them to Americans, so that we can finance our own social investment and cease to be financial wards of foreign dictatorships.

The good people at Goldman Sachs can demonstrate their patriotism - not by offering to make money as financial middlemen - but by buying the first issue of these bonds as an investment. The government needs no investment bankers to market these bonds. It can sell them directly to citizens

Gentle reader, we are in a national economic emergency. This is not just about talking up the economy by emphasizing good news. The administration needs to stop smoking its own green shoots and offer strategies equal to the magnitude of the crisis.

Robert Kuttner is co-editor of The American Prospect, and a Senior Fellow at Demos. His latest book is Obama's Challenge.