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Friday, August 28, 2009

Marshall Auerback and the downside of more Bernanke

We may be the most anti among the Bernanke observers you've heard, but here is Marshall Auerback of New Deal 2.0, voicing his displeasure with this choice for most powerful unelected person in the World.

Woe and behold, more Ben Bernanke
Wednesday, 08/26/2009 - 1:09 pm by Marshall Auerback | Post a Comment

money-question-150The king of the Washington financial triumvirate gets to stay…to the detriment of the country and the economy. Roosevelt Institute Braintruster Marshall Auerback explains why the Bernanke reappointment is bad news, and what we really need to be doing to the banks — and to their shareholders.

Obama’s decision, announced yesterday, to reappoint Ben Bernanke to a second term as chairman of the Federal Reserve confirms what we already know and fear: This administration’s determination to save the big banks guarantees that we will emerge from this slump with an unreformed financial sector in the hands of the same people who produced the disaster in the first place.

Let’s be honest.It wasn’t Bernanke’s “bold” creative decisions that stemmed the onset of “Great Depression 2.0?; automatic fiscal stabilizers did the actual heavy lifting to stave off the depression — as they always have done since the onset of the New Deal.

Expanding lending to his member banks by progressively accepting more and more collateral helped but the liquidity crisis was caused by the Fed never having understood that requiring any collateral from member banks is both redundant and disruptive in the first place. Bernanke has yet to recognize this, as per his current discussions and policies.

He has also failed to recognize and articulate the essence of policy regarding bank capitalization, viz. TARP and related policies. This failure burned substantial political capital by presumably inflating the federal deficit (even though this was more accurately described as a Federal Reserve operation, rather than a Treasury purchase of real assets), when in fact it did nothing of the sort, and nothing that would not have been identically accomplished by the FDIC simply allowing the banks to operate with less regulatory capital under letters of understanding and penalties as desired by the regulators.

There has to be some serious restructuring in the financial and banking sector across the world. The worst thing about the current stimulus packages has been the way significant dollops of public money have gone to further the private interests of the top 1 percent of the population. In varying degrees this has happened in most countries, but Bernanke has been a key figure in championing and legitimising this regressive transfer of wealth.

My view is that if a bank cannot pay up it should be nationalised and the monetary capacity of the government then be used to guarantee deposits. Quantitative easing has done and does nothing more than lower longer term rates, which is more directly done by a reduction in Treasury bond issuance, something Bernanke has yet to articulate that he understands.

He has also come out repeatedly against budget deficits, contributing to the myths that keep us from using that avenue properly to restore aggregate demand proactively.

To be sure, the debt problem we face today is very serious, but the current concern for the federal deficit and its effect on the public debt is misplaced. Not only is the government debt low relative to the size of the economy, but also, as a matter of national accounting, deleveraging in the private sector cannot happen without an increase in the government’s deficit (the government’s deficit equals by identity the nongovernment’s surplus, so if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue; the only other possibility is that the rest of the world begins to dissave massively—letting the US run a current account surplus—but that is highly implausible). In addition, if the government deficit does not grow fast enough to meet the saving needs of the private domestic sector, national income will decline, and, given the size of the private sector’s debt problem, a full-blown debt-deflation process will emerge.

With Bernanke now firmly entrenched (and, apparently, about to get a huge increase in power as the country’s chief systemic regulator), it doesn’t take a prophet to see what’s coming, especially given the ongoing control of fiscal policy by Timothy Geithner and Lawrence Summers. While some bad assets will recover value, many will not, and losses will either go unrecognized or they will be transferred, via public-private partnerships, first off the balance sheets of the banks — and then when the mortgages default, to the taxpayer, via the non-recourse feature of the FDIC’s loans. We could assess the likelihood of this happening, if we chose, by the simple step of auditing the loan tapes underlying a fair sample of sub-prime securities, to determine the prevalence of missing documentation, misrepresentation and prima facie fraud, but fraud seems to be one of those concepts that remains anathema to America’s monetary and fiscal authorities (as well as a large chunk of the economics profession).

That we’re not getting to the bottom of this crisis and uncovering the bad behaviour that went on before means that we’re just setting up the banks for additional fraud. Given the increasingly parlous state of the bank’s hitherto unrecognized liabilities, coupled with a seemingly endless government guarantee, the current structure almost guarantees continued bad behaviour on the part of the banks. “Betting the bank” makes sense when you know that your institution is full of toxic junk, which is effectively underwritten by the taxpayer, enabling you to indulge in questionable accounting and pernicious compensation practices. That’s been the story of 2009 so far.

I and others have offered several answers to the “What should we do?” question, but here’s another idea: Banks’ shareholders need to be wiped out so that we can get rid of this horrible “too big to fail” structure once and for all, cut the banks down to size and minimize their pernicious influence in the government. The government should counteract that with additional fiscal policy, directed toward the needs of the productive economy — buying goods for the productive economy, for instance — and not toward a banker’s bottom line.

As Hyman Minsky argued, banks serve an important public purpose and thus are rewarded with access to the lender of last resort and to government guarantees. Those government guarantees provide cheap and virtually unlimited credit to banks in the form of insured deposits. Because there is no “market discipline” via bankruptcy that will be imposed on bank management, the banks themselves need to be regulated like utilities. Otherwise, the bank concerned can increase its profits on equity by raising the return on assets given a capital ratio, and by reducing the ratio of capital to assets (i.e., raising leverage). Each of these actions will increase the riskiness of banks—but can dramatically raise profitability for owners without increasing their capital at risk. Instead, it is the government insurer that absorbs any losses once the bank’s equity is destroyed by losses on bad assets. Bernanke, like Summers and Geithner, embraces this neo-liberal approach completely. The “market” has tried to downsize the financial sector, but Bernanke, Summers and Geithner only let market forces work their “magic” inside the bubble, not when it bursts.

All the programs championed by Bernanke, Geithner and Summers have failed to deal with the core issue at stake: many financial institutions are probably insolvent and need to be closed; assets must be analyzed carefully to figure out their profitability potential and the true financial state of financial institutions; an investigation must be open to determine responsibility among top managers. Even though financial markets have stabilized, they are still under heavy assistance by the government and we have not dealt with the solvency problems. Banks have been posting profit but, gains largely come from exceptional cash inflows (e.g., the sale of Smith Barney by Citi), they still need large government help to make those profits (Goldman Sach repaid $10 billion of Capital Purchase Program money to avoid the executive pay limit, but still got $12.9 billion from the help provided to AIG (Scheer 2009)), and suspicions of accounting manipulation (if not fraud) are surrounding the valuation of assets.

Yesterday, as usual, the “change” President simply perpetuated the status quo. Mind you, it could have been worse: Obama could have selected Larry Summers.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

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