Single Regulators And The Fed

I think a single agency to regulate all banks makes a lot of sense. For all their carping about how every financial firm is different, the banks have certainly taken advantage of multiple regulators to pick and choose which one they want regulating them, leading to lenient rules and a lot of looking the other way as the regulators compete for their business.

The question, of course, is what form that single regulator would take. And vesting the Federal Reserve with some of these powers (though their role would be separate from the single bank regulator) gives me the willies:

They favor vesting the Federal Reserve with new powers as a systemic risk regulator, with broad responsibility for detecting threats to the financial system. The powers would include oversight of previously unregulated markets, such as the derivatives trade, and of market participants such as hedge funds.

Officials also favor the creation of a new agency to enforce laws protecting consumers of financial products such as mortgages and credit cards.

And they want to merge the Securities and Exchange Commission and the Commodity Futures Trading Commission, which share responsibility for protecting investors from fraud.

I like the Financial Products Safety Commission idea to protect consumers from mortgage flim-flammery and other banking products. But the Federal Reserve has acquired enormous power throughout this crisis. The Public-Private Investment Plan, which was supposed to buy up those toxic assets from the banks, looks almost dead, as the banks raised enough money and averted enough disaster to fashion themselves healthy and secure. It looks like there will be some modified buy-up of the assets (which the banks might be able to swap for one another's and game the system using taxpayer dollars), but no major clean-up. And that's because the Federal Reserve has become the 800 lb. gorilla in this crisis.

Recently, I asked an administration official which government program we'd remember as making the most difference in averting catastrophe. Where will the history books place the credit?

"It'll be the Federal Reserve," he replied. "It'll be their decision to increase the size of their balance sheet from whatever it was before the crisis to whatever it is now." The Fed's decisions, of course, have attracted relatively less press coverage, both because the Federal Reserve doesn't speak to the press as often as the Treasury Department and because new Federal Reserve policies don't spark tiffs with the Congress, or the Republican Party, or outside economists. As such, the Fed is a bit harder for reporters to write about. But there's some evidence that it will be Ben Bernanke, rather than Tim Geithner, who our children -- at least our nerdier children, the ones who study the recession of 2009 -- will read about.

But what will they read? The Fed releases no public information, just prints money in the trillions, making deals with absolutely no transparency, and basically keeping the financial world on life support. What we may all read is the difficulties of the Fed reeling back all these lifelines they handed out to the financial industry.

Lately, a steady stream of economic data has suggested that while the economy is still shrinking, the pace of the decline is slowing. That, in turn, has stoked fears that the Fed's efforts to steer the economy away from a 1930s-era depression would push the country toward '70s-style inflation.

Those fears center on the Fed's unprecedented efforts to revive the economy by creating more than $1 trillion in new money. Determining the best time to withdraw that money is a classic quandary for central bankers. The challenge of timing is even more daunting than usual this time because the Fed has become so integral to shoring up the financial system. As Fed leaders ponder their next move, analysts say they may have to choose between propping up credit markets today and fighting inflation tomorrow.

Yet this absolutely crucial policy decision has been literally vested in the hands of one man, Ben Bernanke, and an organization that has an unusually cozy relationship with the biggest banks who, after all, own them. The government ought to at least have some input and some transparency when it comes to these matters. Alan Grayson has put together a bill, H.R. 1207, that would allow the GAO to audit the Federal Reserve. This is overdue. We have no idea how many trillions the Fed has spent propping up the banks, and considering the importance and the thorny issues to come, we ought to know. This measure has attracted 181 sponsors from members of both parties. You can sponsor it here.

No viable political system can vest so much power in a closed loop and hope to survive. We need more information from the Fed.

Regulating Financial Products

Let's start with the agreement that the financial crisis, sated by trillions in government money, has eased. Those who understand LIBOR rates and TED spreads can explain that interbank lending and credit availability has increased. And banks have been able to raise capital, or at least most of them. GMAC wasn't so lucky, and so they're getting a $7.5 billion dollar bailout. And some top banks want to repay the government all of the TARP money.

But claiming that the system is healthy doesn't really pass the smell test. First of all, the program to buy toxic assets hasn't yet been implemented - Tim Geithner now says that will be ready around July. And Geithner's sloth in dealing with the multiplicity of issues has caused something of a crisis of confidence. Ultimately, the banks have been propped up, but the economy remains sick, CONSUMER lending doesn't seem to have bounced back, unemployment keeps rising, and some huge pitfalls, like a second foreclosure wave, remain out there.

We've lost this debate inside the White House - they will do whatever it takes to keep the banks afloat. However, the debate has shifted into what happens afterwards. How will the financial business be regulated to ensure no repeats of this crisis, and to reduce banks to their nominal function of helping capital flow? The White House is talking about moving regulatory power from the SEC to the Federal Reserve, which has a rearranging the deck chairs quality to it. The Fed missed the crisis, too, and are arguably even cozier with the big banks. However, this development would be truly welcome.

The Obama administration is actively discussing the creation of a regulatory commission that would have broad authority to protect consumers who use financial products as varied as mortgages, credit cards and mutual funds, according to several sources familiar with the matter.

The proposed commission would be one of the administration's most significant steps yet to overhaul the financial regulatory system. It would also be one of its first proposals to address causes of the financial crisis such as predatory mortgage lending.

Plans for a new body remain fluid, but it could be granted broad powers to make sure the terms and marketing of a wide range of loans and other financial products are in the interests of ordinary consumers, sources said.

Elizabeth Warren details this plan here - essentially, her argument is that toasters are regulated so that they won't explode in your house, so why not regulate mortgages that can explode with far more fury?

,"It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street," Warren wrote. "Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors?"

Warren proposed creating a new commission modeled on the Consumer Product Safety Commission, which protects buyers of products such as bicycles and baby cribs.

A Financial Products Safety Commission would have the power to protect consumers from shoddy financial instruments. For all the power of the banksters, they still had to go to people to get the mortgage-backed securities they needed to feed the beast of the surge of capital during the housing bubble. If the people were protected through regulations that barred the kinds of mortgages they were giving out, we have no crisis.

Simon Johnson has further thoughts coming out of a Congressional hearing on the subject, and he sounds positively giddy.

1. We need layers of protection against financial excess. Think about the financial system as a nuclear power plant, in which you need independent, redundant back-up systems - so if one “super-regulator” fails we don’t incur another 20-40 percentage points in government debt through direct and indirect bailouts. A consumer financial products protection agency should definitely be part of the package.

2. Congress will work on this. The intensity of feeling with regard to the need to re-regulate is striking, and there is much that resonates across the political spectrum.

3. In the end, much of banking is likely to become boring again. Special interests are convinced that they can fend off the regulatory challenge, but I find this increasingly unlikely. Enough people have seen through what they did, how they did it, and what they keep on doing. No doubt the outcomes will be messy and less than optimal, but at this point “less than optimal” is much preferable to “systemic meltdown”.

There is still much to argue about and, no doubt, there will be setbacks. We’ll get a better or a worse system, depending on how the debate goes. And if the external scrutiny slips away, so will point #3 above. But this was still by far the most encouraging hearing I’ve so far attended.

I'm not thrilled with the Administration's policies on the banks so far, but this would really be a step forward and Congress can lead it.

Banks Aren't Lending, Don't Have Enough Capital, Other Than That They're Fine

Tim Geithner showed up on Capitol Hill today, facing the Congressional Oversight Panel (whose leader got a brushback from the Beltway establishment and the right leading up to this hearing) to defend his plans for the financial industry.

Treasury Secretary Timothy Geithner defended the bank rescue program devised by the Obama administration Tuesday as the International Monetary Fund predicted U.S. financial institutions could lose $2.7 trillion from the global credit crisis [...]

Geithner said the new plan "strikes the right balance" by letting taxpayers share the risk with the private sector while at the same time letting private industry use competition to set market prices for the assets.

"If the government alone purchased these legacy assets from banks, it would assume the entire share of the losses and risk overpaying," Geithner said in his remarks. "Alternatively, if we simply hoped that banks would work off these assets over time, we would be prolonging the economic crisis, which in turn would cost more to the taxpayer over time."

Geithner said "the vast majority of banks" have more capital than they need to be considered well-capitalized. But he said the economic crisis and the bad assets have created uncertainty about the health of individual banks and reduced lending across the system.

I think the vast majority of banks are well-capitalized only if you mean "not the big ones." I mean, we have pretty hard evidence on this. The Treasury wouldn't play accounting games by converting preferred shares to common stock, which has the express purpose of reducing the liabilities on the banks' balance sheet and giving the impression that THEY ARE MORE WELL-CAPITALIZED, if the opposite was true. James Kwak pretty well takes apart the whole idea, so I won't comment further.

In addition, if the banks were so well-capitalized, they would actually lend instead of hoarding capital, which after all is the function of a bank.

Lending at the biggest U.S. banks has fallen more sharply than realized, despite government efforts to pump billions of dollars into the financial sector.

According to a Wall Street Journal analysis of Treasury Department data, the biggest recipients of taxpayer aid made or refinanced 23% less in new loans in February, the latest available data, than in October, the month the Treasury kicked off the Troubled Asset Relief Program.

The total dollar amount of new loans declined in three of the four months the government has reported this data. All but three of the 19 largest TARP recipients with comparable data originated fewer loans in February than they did at the time they received federal infusions.

Interestingly, the same banks that cut back the most on lending are the ones who have received the most money from the federal government, which suggests that the TARP funds might as well have been thrown down a well. But the banks want to return that TARP money (and I'm sure they'll get around to that any day now) while talking up their own earnings, which have been seen by the street as soft as tissue paper. To their credit, Treasury wants to put some limits on that return of TARP money, based on some amorphous idea of whether repayment is in the "national economic interest". But clearly, the banksters have never acted in that interest. This sad tale is sadly indicative:

Top officials at Chrysler Financial turned away a government loan because executives didn't want to abide by new federal limits on pay, according to new findings by a federal watchdog agency.

The government had offered a $750 million loan earlier this month as part of its efforts to prop up the ailing auto industry, including Chrysler, which is racing to avoid bankruptcy. Chrysler Financial is a major lender to Chrysler dealerships and customers.

In forgoing the loan, Chrysler Financial opted to use more expensive financing from private banks, adding to the burden on the already fragile automaker and its financing company.

They have always been more concerned with their personal fortunes than the health of the overall economy or even their own businesses. The greed here is astonishing.

Let's be honest here. Many banks are insolvent, and even the Administration admits that some will need more help. They don't want to sell the toxic assets because their essential insolvency will be too obvious to ignore. And they don't want the stress tests revealed for basically the same reason. At no point has the government appeared willing to end the stranglehold that the elites and the financial interests have over this economy.

I continue to worry that the Administration’s “wait-and-see” strategy is just increasing the ultimate costs - in terms of financial losses and unemployment. No government ever likes to tackle a severe banking crisis head on (mostly because that would greatly upset the financial elite), but it’s almost always the right thing to do.

I remain unconvinced by the Treasury’s line that “there is no alternative” to their approach. Or perhaps they are shifting towards the line that: “based on information that only the government has (and can have), it is our assessment that all other approaches would be more damaging.”

If that is now their position, we have built a financial system that is immune to democracy - today’s complexity and lack of transparency mean that it is easier than even to become too big to fail. The major banks now know this and will behave accordingly.

Oh, and by the way, the PPIP plan may be open to fraud and puts the taxpayer on the hook for close to $2 trillion.

It's their world, we just live in it.

More at TPM Muckraker.

The Nationalization Argument

In my earlier post I mentioned in passing that Obama offered a full response to critics on the left who think the banks have leveraged their power to prevent the necessary solutions to the financial crisis, like nationalization. Here it is:

On the other hand, there have been some who don’t dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it. They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear – the reason we have not taken this step has nothing to do with any ideological or political judgment we’ve made about government involvement in banks, and it’s certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.

Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm. So rest assured – we will do whatever is necessary to get credit flowing again, but we will do so in ways that minimize risks to taxpayers and to the broader economy. To that end, in addition to the program to provide capital to the banks, we have launched a plan that will pair government resources with private investment in order to clear away the old loans and securities – the so-called toxic assets – that are also preventing our banks from lending money.

Greg Sargent reads the tea leaves and thinks that Obama substantively responded by saying he wasn't ideologically opposed to nationalization. I think that's less important that his substantive disagreement, which is that nationalization would be more costly. Which is largely true - we saw in the IndyMac receivership that the cost totals were much larger than expected, and as Yglesias notes, nationalization would require up front money that Congress would be highly unlikely to appropriate. However, there's a bit of a false frame here. Lining up the PPIP against nationalization and saying that the PPIP is cheaper only makes sense if you think both have an equal potential of working. If, as I do, you think that the PPIP probably won't work, and that the problem is not one of liquidity but insolvency, then getting to nationalization quickly before throwing hundreds of billions more down a rathole would be significantly cheaper.

And evidence on my side of things, that the banks are insolvent, can be seen in the silly games some of them are playing to try and look profitable.

Goldman Sachs reported a profit of $1.8 billion in the first quarter, and plans to sell $5 billion in stock and get out of the government’s clutches, if it can.

How did it do that? One way was to hide a lot of losses in not-so-plain sight.

Goldman’s 2008 fiscal year ended Nov. 30. This year the company is switching to a calendar year. The leaves December as an orphan month, one that will be largely ignored. In Goldman’s earnings statement, and in most of the news reports, the quarter ended March 31 is compared to the quarter last year that ended in February.

The orphan month featured — surprise — lots of write-offs. The pretax loss was $1.3 billion, and the after-tax loss was $780 million.

Ingenious - dump all the write-downs into a missing month. Barry Ritholtz and James Kwak have more.

But when you scratch the surface of all this, you can plainly see that even the banks announcing record profits are hopelessly insolvent, and will continue to spiral downward as the economy remains stuck.

Wells Fargo & Co., the second- biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.

KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.

First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.

The $120 billion in "stress losses" kind of puts that whole $3 billion quarterly profit in perspective, don't it?

So while I agree that nationalization would be more expensive on a one-to-one basis, and I don't even totally fault Obama for, given the institutional constraints, giving some separate option the old college try, the inevitability of dealing with the insolvent banks argues for a quick remedy.

COP on the Beat

As we see today the life insurance industry set to get in on the bailout act and receive TARP money, the Congressional Oversight Panel, charged with actually overseeing the Treasury Department's TARP strategy, has released their latest report, which is unsparing. Elizabeth Warren, the chair of the COP, delivers a video introduction.



The report looks back at how these types of financial crises have been traditionally handled over time. Warren offers three choices to policymakers: liquidation (essentially what we did in S&L crisis), receivership (the Swedish option), and subsidization (what we're doing to keep zombie banks alive, like in Japan). As you can see above, Warren handles each of these options expertly, and finds four crucial actions needed to successfully resolve banking crises:

• Transparency. Swift action to ensure the integrity of bank accounting, particularly with respect to the ability of regulators and investors to ascertain the value of bank assets and hence assess bank solvency

• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2) shutting down those banks that are irreparably insolvent.

• Accountability. Willingness to hold management accountable by replacing – and, in cases of criminal conduct, prosecuting – failed managers.

• Clarity. Transparency in the government response with forthright measurement and reporting of all forms of assistance being provided and clearly explained criteria for the use of public sector funds.

Warren concludes that the TARP bailouts failed to provide transparency, accountability or clarity. The Geithner Treasury Department plans, including PPIP and increased transparency, still fall short. "Bottom line: Treasury's efforts to date could be enough, but we will continue to press Treasury about these four tests." Essentially, Warren gives a mixed review, and she thinks that the Treasury efforts are based on the idea that the problems are temporary and not systemic.

One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.

If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. Current prices may, in fact, prove not to be explainable without the liquidity factor. Even in areas of the country where home prices have declined precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even under-collateralized assets should not be trading at pennies on the dollar. Prices are being partially subjected to a downward self-reinforcing cycle. It is this notion of a liquidity discount that supports the potential of future gain for taxpayers and makes transactions under the CAP and the PPIP viable mechanisms for recovery of asset values while recouping a gain for taxpayers. On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.

I think Warren is being overly polite, but she's saying all the right things. And I think she's informing some of Congress' moves in this area. The House Oversight Committee is examining the "special purpose vehicles" allegedly used to skirt executive pay restrictions, which contain elements of accountability and clarity. Geithner and the Treasury Department are clearly acting assertively, but to what end? I think Warren's report is spot-on, and needs a wide audience.

Ptolemaic Bank-O-Centrism

Jeffrey Sachs has a primer on how banksters could game the PPIP and wind up rich at taxpayer expense:

Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

Noam Scheiber is unconcerned, calling this the good bank/bad bank scenario by different means (the bank gets recapitalized, the government gets stuck with the asset), but A.L. shows how he's missing the point.

Even if your plan is to do a good bank/bad bank model and have the government buy up all the bad assets, you still don't want the goverment to be paying the banks near face value for assets that are worth pennies on the dollar. The banks would make out like bandits under that scenario, all at the taxpayers' expense. No one thinks that the government should be buying these assets at those prices. All that would do is ensure that the taxpayers bear virtually all of the banks' losses.

At that point, there is no excuse for not nationalizing and at least taking a piece of the upside in addition to all of the downside.

I've seen this scenario half a dozen times since the PPIP was announced, and yet there has been no official response to the charge. Even if the rip-off artist doesn't wind up being one of the big banks, the potential for fraud is obvious, and there doesn't seem to be any safeguard to deal with it. Mike Lux says we need to "be helping to save the Obama team from themselves" in that case, but I see no instinct for self-preservation from these folks. They seem more like protectors of the banks than even protectors of their own legacy.

A series of recent meetings with members of Barack Obama's economic team (including running into Larry Summers on my way to an appointment in the West Wing, leading to a spirited back-and-forth that made me feel like I was back at Cambridge, debating the smartest kid in the class), left me with a pair of indelible impressions:

1) These are all good people, many of them brilliant, working incredibly hard with the best of intentions to solve the country's financial crisis.

2) They are operating on the basis of an outdated cosmology that places banks at the center of the economic universe.

Finance should serve industry, not master it. The banks and the financial system may make the rest of the economy run, but they should not set the rules and design the relay course. We're talking about $4 trillion in asset debt, which is only growing worse due to job loss and increased foreclosures. The banks cannot employ 5 million people and reverse the job trend, so they shouldn't be capturing ALL of the economic gain from the various bailout plans. The US economic outlook is worsening, IMO, because of this fundamentally skewed view of the world, where what's good for the banking elites equals what's good for the country to the exclusion of all else.

The Lesson

I don't know that I have much to say about the dysfunction in the Obama economic team that wouldn't just be a rewrite of Glenn Greenwald's piece, but it may be worth it to just disseminate the information. Here's the story so far:

Banks lost a ton of money by making terrible bets based on fanciful notions that housing prices would go up 20% year over year approximately forever. All the while the executives sat on each other's boards and handed out giant bonuses and compensation packages to each other while the financial sector grew essentially out of control. In the process, they used their money and power to effectively buy Capitol Hill and make sure their portion of the economy could keep growing, whether through usurious interest rates, a total lack of oversight (including by some of the same people now charged with overseeing the banks) or just massive wealth transfers. When everything came crashing down, the very last thing these banking interests wanted to do was admit defeat or give back any of their money and power. At the same time, the entire country was furious at them. So they set to work bribing who they knew would be top officials in the next government, people like Larry Summers, who honestly didn't even need to be bribed. And every time Congress or the executive branch threatened to end their party and put limits on their power, they found in Summers and other officials a willing partner in subverting the rules that would make them give back their bonuses and excessive compensation, which by the way the taxpayer is funding. We, the taxpayers, are told that this is necessary to ensure financial sector participation in the program to rid the banks of all of their bad assets at a potentially massive taxpayer expense. However, left unsaid is the fact that the same banks are planning to game the system by passing the same bad assets back and forth among each other at high prices, and using tricky accounting tactics to pretend that the assets on their books have value.

I think we can go to Greenwald now:

Rubin, Summers and Greenspan succeeded in inducing Congress -- funded, of course, by these same financial firms -- to enact legislation blocking the CFTC from regulating these derivative markets. More amazingly still, the CFTC, headed back then by Born, is now headed by Obama appointee Gary Gensler, a former Goldman Sachs executive (naturally) who was as instrumental as anyone in blocking any regulations of those derivative markets (and then enriched himself by feeding on those unregulated markets).

Just think about how this works. People like Rubin, Summers and Gensler shuffle back and forth from the public to the private sector and back again, repeatedly switching places with their GOP counterparts in this endless public/private sector looting. When in government, they ensure that the laws and regulations are written to redound directly to the benefit of a handful of Wall St. firms, literally abolishing all safeguards and allowing them to pillage and steal. Then, when out of government, they return to those very firms and collect millions upon millions of dollars, profits made possible by the laws and regulations they implemented when in government. Then, when their party returns to power, they return back to government, where they continue to use their influence to ensure that the oligarchical circle that rewards them so massively is protected and advanced. This corruption is so tawdry and transparent -- and it has fueled and continues to fuel a fraud so enormous and destructive as to be unprecedented in both size and audacity -- that it is mystifying that it is not provoking more mass public rage.

At the same time, the exact same banks which the government has propped up to the tune of trillions of dollars will not lift a finger to help out industries that produce tangible goods, further crumbling them and increasing the financial sector share of the economy.

And the lesson we have to learn here is that the financial sector bought government and has thus far gotten what they paid for.

I think I'll watch some basketball. Go Villanova! Your government is in control. You are free... to do as we tell you...

Set Up A Meeting With France, Mr. President

By now, Barack Obama has probably landed in London on the eve of the G20 summit, his first international conference as President. He has vowed to participate as a listener rather than just dictating terms. He should sit down with Nicolas Sarkozy:

Responding to a popular outcry, the French government issued a decree Monday banning stock options and limiting bonuses for bankers or auto executives who lay off workers after accepting government aid to weather the economic crisis.

Prime Minister François Fillon, announcing the measures, said France was the first European country to lay down such legal restrictions on executive pay. Although not retroactive, they will run through 2010, he said in a statement, and they could be extended.

"There is no question of some people escaping from the consequences of the crisis while others suffer unemployment or pay cuts," he added, pledging to monitor compliance with the decree carefully because "it is a question of justice."

Banks and auto companies were singled out because they have received extensive aid since the financial crisis broke out in September, leading to economic turmoil across the globe. President Nicolas Sarkozy allocated $14 billion in October to prevent France's six main banks from sinking and loaned $8 billion under favorable terms to the country's three main car companies.

I mean, this is almost a parallel situation. Societe Generale, one of the largest French banks, was a major AIG counter-party, and two weeks ago they admitted the granting of huge stock options to their executives. After public outrage, the French government, under duress, made the changes. And the Left in France remains dissatisfied.

The Socialist Party, France's main opposition group, criticized the decree as "perfectly insufficient," saying the ban should be retroactive and extend beyond banks and auto companies. In a statement, the party charged that Fillon chose to issue a decree instead of passing a law because he was afraid of a parliamentary debate on the government's efforts to address the crisis.

That is how an oppositional movement works. In America we have a few lonely cries in the wilderness, and Elizabeth Warren has been courageous in trying to get some accountability from the Treasury Department (alas, they have been stiffing her at every opportunity). But by and large most political leaders that would be seen as "on the Left" are supporting the Geithner plan, and the fury over the AIG bonuses has petered out. And people who should be giving out all their money on the street under threat of prison like Hank Paulson can whine about not getting more "credit" for saving the economy, and nobody bats an eyelash.

I know the political dynamic is easier in France, with the party on the left in opposition to the ruling party. Democrats are wary of criticizing Obama over the bank bailouts. But they must speak. We are at risk of >slipping into a Japanification (h/t Krugman), where we never do what's necessary to rescue the banks, and we slide along with zero growth and tied-up financial markets for a decade. Delay simply makes this problem worse, and makes the inevitable takeover and restructuring more expensive.

There is at least a possibility we can get out of this all right, if the PPIP becomes a prelude to determining solvency and nationalization. Perhaps the Congress needs to grant Treasury additional resolution authority to wind down units like AIG and nonbank financial institutions. But at the very least, the Administration can respond to public anger, as the political environment has shifted. People are not blaming the President for the economy right now, but at some point that will end. I appreciate their movement on many other fronts. But we have to rip off the band-aid and take the necessary steps to recapitalize the banks and ultimately tamp down the financial sector as a share of the overall economy.

Geithner Meets The Press

President Obama sat down with Bob Schieffer on Face the Nation today, but I was actually more interested in Timothy Geithner's back-to-back appearances on Meet The Press and This Week With George Stephanopoulos. These were his first two appearances on the Sunday shows, coming out of a week where he announced major initiatives to engage in a public-private partnership to buy up toxic assets, and to re-regulate the financial sector. Both interviews had some interesting moments.

On both shows, Geithner was asked about the potential flaw in the plan for toxic assets, that the banks simply won't sell at the prices set by private investors, because taking losses would reveal the banks to be insolvent. Geithner didn't have the best answer for this other than to urge the banks to "take risk again." Indeed, there is no mechanism to force the banks to sell. In addition, on the issue of counter-party payments from AIG, Geithner demurred at any potential efforts to recover money from Goldman Sachs and other banks who were paid out whole on their credit default swaps instead of being forced to negotiate, pivoting instead to the need for more tools to step in and take over a firm like AIG:

GEITHNER: George, we came into this crisis as a country without the tools necessary to contain the damage of a financial crisis like this. In a case of a large, complex institution like AIG, the government has no ability, had no meaningful ability to come in early to help contain the fire, contain the damage, prevent the spread of that fire. Restructure the firm, change contracts where necessary, and helped make sure that the financial system gets through this...

STEPHANOPOULOS: But it would have been the right thing to do, right?

GEITHNER: If we had the legal authority, that's what we would have done. But without that legal authority, we had no good choices. We were caught between these terrible choices of letting Lehman fail -- and you saw the catastrophic damage that caused to the financial system -- or coming in and putting huge amounts of taxpayer dollars at risk, like we did at AIG, to keep the thing going, unwind it slowly at less damage to the ultimate economy and taxpayer.

STEPHANOPOULOS: So how about now, Goldman Sachs is taking other government money. They got this $13 billion whole from AIG. Congressman Brad Sherman and others have said, they should give that $13 billion back.

GEITHNER: George, the important thing is, we have no legal ability now. That's why I went to Congress last week, to propose a broad change in resolution authority so that we have the capacity to do what we do with banks now.

I suspect that will be a less-than-satisfying answer to most people. Basically Geithner is trying to keep the past in the past, particularly with respect to AIG.

On some other fronts, however, Geithner displayed a definite concern to reel in the massive financial sector and build a broad-based economy that can better manage systemic risk. Here is an answer from Meet the Press on his regulatory proposals:

SEC'Y GEITHNER: Core thing is to make sure that the institutions at the center of our financial system are subject to much more conservative, much tougher requirements on capital and leverage that are applied more evenly and more effectively, frankly. We need to make sure that hedge funds and derivatives come within a framework of oversight so we protect the system from the risks they may present. And we need to make sure the government has the authority it needs to come in more quickly, to help contain the damage, restructure the system, so we can have a stronger system going forward [...] We need a better model. What we're proposing to do is use a model that exists for small banks that was designed by the Congress in the wake of the S&L crisis, build on that model and give the government a capacity to act more quickly, more effectively to contain the damage at least risk to the taxpayer and the economy as a whole.

Certainly, over-leveraging caused a good deal of this crisis; other countries where the banks are leveraged more conservatively are in better shape. Obviously, the devil is in the details - there are currently no capital requirements for hedge funds in the Geithner proposal, for example, and the real issue is whether the regulation will be strictly enforced. Our experience with bank regulators who are too cozy with the subjects they regulate recently suggest that the real problem is a lack of will.

But I thought Geithner's willingness to talk about the need to restructure the American economy, at the macro and the micro level, was interesting.

MR. GREGORY: Time magazine this week has its cover, and it's very interesting. I want to put it up on the screen for our viewers to see. "The End of Excess: Why the crisis is good for America." And there's a big red "reset" button. And everybody talks about reset. Obviously this is not a good crisis for America right now. But take a longer view. In the long run, is this crisis necessary for this economy?

SEC'Y GEITHNER: I think the adjustment to a period of excess is necessary. You never, you never want to have a crisis to remind people of the importance of living within your means, not borrowing too much or why regulation of the...(unintelligible)...is important. You never want to have a crisis that's damaging to make that point. But we're going to emerge stronger than this. When we get through this people are going to care less about what they make, more about what they do, what they achieve with what they make, and that will help make this country stronger.

MR. GREGORY: Will the economy be fundamentally different? Will people own fewer homes? I mean, home ownership, will that go down? Will consumption change? Will our lives change in a meaningful way?

SEC'Y GEITHNER: I think people will be living within their means more, which is helpful. We want to have, you know, a stronger, more sustainable recovery. Not a recovery based on a artificial boom that's not going to be sustained. We need to end this, this, this pattern of having booms and busts at the kind of frequency we've seen. That has to change. And that'll make the, that'll make this a better place to live and a more productive economy going forward.

Further, Geithner understands the importance of active engagement with the crisis, not to ease up on the pedal because of a few positive indicators. And he talks about the need for a broader segment of society to share in the benefits of recovery than the wide gap between the rich and poor we've seen explode in the past decade.

GEITHNER: Now, the important thing, though, is that we keep at it. You know, the big mistake governments make in recessions is they put the brakes on too early.

STEPHANOPOULOS: Is that what happened during the depression? Is that what Franklin Roosevelt did?

GEITHNER: That's one thing that happened in the depression. It's happened in Japan, too. It's happened in a lot of countries in the world. They see that first glimmer of light, and the impetus to policy fades and people are putting on the brakes, and we're not going to do that.

STEPHANOPOULOS: So income inequality goes down?

GEITHNER: It should go down. Again, you know, if you look at the record of performance in the '90s, you know, we had very strong productivity growth during a period of fiscal discipline, fiscal responsibility, strong private investment, and the gains were shared much more broadly.

We can do that as a country, but it requires getting this government to do a better job of doing things only governments can do. That's why I assume important we get better outcomes. That's why fixing our health care system and get costs growing more slowly is so important. That's why we need a better energy policy. And that's why infrastructure needs to be improved.

This mirrors what the President has been saying about sustainable growth rather than feeding into the same boom-and-bust cycles and propping up the same elites who took these tremendous gambles. Or in the words of Joe Biden - "We need to save markets from free marketeers."

Obviously, words are less important than actions. But this perspective can hopefully guide the Administration through this crisis, and provide the kind of investments needed to ensure that everyone has the opportunity to share in the recovery. I'm not convinced that Geithner is the best advocate for reducing inequality and stopping the casino on Wall Street, so from the outside the work continues to keep pushing for a newer, safer, more durable economy.

PPiPin'

You may have noticed that I am not an economist. I like to keep up with these matters, but at times it feels like, to quote one of my favorite authors, intellectual mountaintop air so rarified I have to constantly swallow to pop my ears. This adequately appropriates my experience with the Public-Private Investment Plan (PPiP) for toxic assets (or legacy assets, or whatever you want to call them). I can link to a bunch of very smart takes about whether or not it will work:

Simon Johnson and James Kwak, closest to my view, I think, say that the plan could work, but only if the banks agree to sell at reasonable prices, an unlikely scenario; and that ultimately, the problem is the outsized influence and power of the big banks.

Paul Krugman says - you know what he says.

Krugman, Johnson, Brad DeLong and Mark Thoma participated in a vigorous debate about the plan on the NYT blog. And there's another live discussion with DeLong, Thoma, Kwak and Felix Salmon.

Then there's Karl Denninger. And Noam Scheiber. And Martin Wolf. And Nouriel Roubini, who actually likes the plan. And Bo Lundgren, the guy who administered the Swedish model, who actually lines up pretty well with the Obama Administration's thinking, believe it or not:

"I'm a market liberal. My party that I used to lead, the Moderate Party, is the conservative party in Sweden and the parallel to the Republican Party in America," Lundgren said. "When I nationalized the banks, it wasn't because I wanted to: It was crisis management. Their owners had been wiped out, the banks were black holes, they had no equity left, and there was no alternative but to take them over." [...]

The Obama administration's initial plans have fallen short, Lundgren said, because they failed to reassure investors that the banking system was genuinely backed by the government and private sector.

"There are similarities [to Sweden's case]," Lundgren said. "There are three things any plan must do—the first is to maintain liquidity, that's taken care of by the Fed. The second thing is to restore confidence, and that hasn’t been done so far and obviously the first proposal to buy toxic assets wasn't enough. And then you need capital injections so banks can keep lending at the levels needed for the economy as a whole."

However, Lundgren said that Obama was correct in observing that a similar nationalization scheme might be more difficult given America's size and preeminent role in world finance compared to Sweden.

"With Japan and Sweden, the crises we had, even if it was a very long process with Japan, they were crises that we had on our own," Lundgren said. "The rest of the world economy managed to be not perfectly good but still reasonably good. This time it's worse; it's a kind of financial tsunami."

My point is that there are a lot of opinions here, all of them valid in one way or another, since so much of economics is based on modeling and theoreticals (cue the old "we'll assume a can opener" joke). So I'm going to put my thoughts into some bite-sized portions.

1) Getting a reasonable price for the assets seems to be the key. If Geithner manages to get authorization to wind down big firms like bank holding companies, that could be a powerful bargaining chip for eventual nationalization, which would incentivize the banks to sell.

2) Judging from Geithner's comments, I'm guessing that he saw nationalization as too costly and too risky, because the government would assume all the potential losses. There's some truth to this - the largest FDIC receivership of recent vintage, IndyMac, cost much more than the government expected, about 1/3 of its value. The range of options indeed are from bad to worse. But if you have to go back to receivership after this plan fails anyway, I don't see how it could be cheaper. Plus, the government is putting up 90% of the risk in this scenario, anyway. To quote Dean Baker, "It implies there are real big losses there, but those losses are there whether we take them over or not. It's very likely that we're looking at a larger hole than the administration has been acknowledging and to my mind that argues for a takeover strategy."

3) If Citi and BofA are indeed using TARP money to buy up their own bad assets while being subsidized on both sides by the US government, we have to have some criminal prosecutions at that point. There is substantial evidence that this is happening already. This is doubly weird considering that Bank of America's top analyst doesn't think the plan will work.

4) Chris Bowers' post on how and when we will know if these economic policies succeeded is worth a read.

5) Even in Roubini's (somewhat) positive account, he says that "The administration should be transparent in making clear that there is still a wealth transfer taking place here - from taxpayers to investors and banks." We were always going to pay dearly for this - the debate is on the margins of whether we pay a lot or a whole heckuva lot.

Anyway, if you want to join this maddening debate, the FDIC website has opened up a public comment section.

Goldman Will Shut It Down

As exasperated as I am with Congress, they do seem to know how to investigate, if they don't always get the follow-through right. And they seem to be looking in the right places. For instance, Elijah Cummings wants to know about the counter-party payments from AIG:

He's currently circulating (and I have obtained) a letter to colleagues, seeking their support for a TARP inspector general investigation into every aspect of the payments AIG made, with government money, to counterparties whose risky investments it had insured.

"Goldman Sachs claimed in September that they had no material exposure to AIG; however, after AIG released the counterparty information on March 15, we found out that Goldman Sachs received almost $13 billion in counterparty payments.

The Special Inspector General for the Troubled Assets Relief Program was created to ensure that transparency and accountability stay firmly rooted in the government's efforts to revive and sustain the American economy. This letter proposes that the Special Inspector General examine the nature of the counterparty payments - including the recipients, the process by which they were made whole, and the justification, if any, for that level of payment."

In addition, investigators for the House Oversight Committee are delving into Joseph Cassano, the former head of the AIG Financial Products unit and essentially Patient Zero of the global financial crisis.

Investigators for the House Oversight committee intend to interview Cassano about his role in the firm's collapse, and have already contacted his lawyer, a committee staffer told TPMmuckraker.

As CEO of AIG Financial Products, Cassano, based in the unit's London office, was the prime mover behind the credit default swaps, whose implosion brought the firm to its knees. He stepped down in March 2008, signing a $1 million-a-month "consulting" contract with the firm. (The contract was canceled last September.)

Federal investigators, as well as Britain's Serious Fraud Office, are also probing AIGFP. The Feds are reportedly focused in particular on whether Cassano and then-AIG CEO Martin Sullivan made false or misleading pubic statements about the company's potential exposure to losses on its credit default swaps. A December 2007 shareholder presentation the two men made is said to be of special interest.

The focus appears to be those counter-party payments from AIG, and how they made big international banks whole on their CDS bets. What worries me is that all roads lead to Goldman Sachs, which clearly has its tentacles around the Administration. Goldman vowed yesterday to return all the TARP money it received while neglecting to mention that they received even more government relief from AIG and other sources. And Goldman is a linchpin to the Geithner plan for toxic assets:

Tim Geithner suggested that Goldman Sachs could be one of five institutions helping to manage the public-private partnership program to buy up a bunch of toxic legacy assets from ailing banks.

Goldman has played a central role in this drama. As an institution, it's been extremely close to the Treasury department. And, as Josh noted, it's also about to pay off all of its TARP money (with the help, perhaps, of the other government money it received as an AIG counterparty) which will free it up to return to a status quo of paying enormous bonuses.

It's also, of course, one of the institutions that helped bring the financial system to its knees--it holds many of the toxic assets in question and may be well placed to bid them up and inflate their prices at auction. (How you manage the fund to rescue financial institutions with toxic assets while you yourself hold those same assets has yet to be sussed out by committee members.)

My point is that Goldman may be the eventual white whale for Congressional investigators, but the Treasury Department as currently structured will work overtime to shield them from any harm.

Sigh.

Let Us In

If the Administration needs help in sorting out all these toxic assets and getting them off the banks' balance sheets, why not enlist the American people and their wide purchasing power? In short, if the investing opportunity offers plenty of upside and no downside, why can't any individual participate?

If Geithner’s taxpayer subsidized toxic public/private plan goes forward, I think it would be fair if the federal government allow non-institutional investors to participate via a no-fee investment vehicle. I think if Americans had the option of investing in this program (without having to pay the egregious fees to the investment advisors/PE shops), it would be much easier to swallow since they would at least get the same deal the sharks are getting. There is probably more money on the sideline with individual investors than all these institutional investors. Maybe they could set up some ETF equivalent for it. I think the willingness of the administration to do such a thing would tell us a lot about whose for whose interest they are really looking out.

Via Kevin Drum, it looks like some of the institutional investors will offer the opportunity:

Two of the country's biggest money managers — Newport Beach-based Pacific Investment Management Co., known as Pimco, and New York-based BlackRock Inc. — say they may launch funds that would allow individuals to have a stake in some of the bad assets to be purchased from banks.

....Bill Gross, co-chief investment officer at Pimco, said his firm was looking into the idea of creating mutual funds that would tap into the program. BlackRock is doing the same, said Curtis Arledge, co-head of fixed income at the firm.

You may ask why individuals would want a share of toxic assets, and I'm not saying I'd call it a definite buy opportunity. But the principle is that a sweetheart deal for Wall Street could easily be turned into a sweetheart deal for everyone. Investors put up only 6 cents on the dollar, and yet they get to split the profits with the government 50/50. You don't find many deals like that every day. Opening the deal up would also reduce the suspicion that taxpayer money is just bailing out banks and enriching wealthy investors. It would enrich other investors, too! Now, there's still a dividing line between the investor class and the working class, but if pension funds could get involved, etc., at least some of this money would flow down to the worker.

A New Way Forward

My assumption about the favorable market reaction to Tim Geithner's plan to buy up Big Shitpile is that the Big Money Boyz got the answer they wanted to this question:

But some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group.

Some of them have told administration officials that they would participate only if the government guaranteed that it would not set compensation limits on the firms, according to people briefed on the conversations. The executives also expressed worries about whether disclosure and governance rules could be added retroactively to the program by Congress, these people said.

CNBC's latest Howard Beale for the overclass, Mark Haines, echoed these fears, as a paid echo is wont to do, despairing over how "scary" things are getting, what with Americans paying attention to the massive ripoff being undertaken at their expense and all.

HAINES: There were some scary stories in the paper over the weekend.

BURNETT: Mmm-hmm.

HAINES: About this kind of thing, regulating or somehow impacting executive pay, even among financial companies that didn’t take government money. It’s getting scary.

For the record, the bad asset (I'm sorry, "legacy asset". Bad framer!) plan could very plausibly fix the near-term problem while doing absolutely nothing for the long-term one. If the credit markets loosen and economic activity restarts as a result of this proposal (and I'm dubious), that would be wonderful. But if it restarts in the exact same fashion as the recent past, by allowing a small band of financial sector elites to make absurd profits, literally stolen from the taxpayer, and to keep their share of the overall economy unsustainably and unaccountably large, the long-term forecast on a host of fronts will be grim. Not only would it simply reinflate a bubble that could just as easily pop, but it would cement the viewpoint that corporate behemoths own government and took it over in a bloodless coup.

And contra Mr. Haines, what I heard this weekend were more stories of looting by the big banksters, as well as a growing impression that Goldman Sachs holds an unelected place inside the government.

Simon Johnson gets at the real problem.

The government feels that it cannot take over large banks, there is no bankruptcy-type procedure that would work, and only deference to the CEOs of major financial institutions can get us out of this mess. This is a conscious strategy decision from the very highest levels.

I’d like to say: OK, but this is absolutely the last time we will try for a solution to our banking problems involving a private sector-led approach. Of course this would not be credible and bank CEOs know this. Instead, I propose the following.

If Secretary Geithner’s scheme works, we draw the lesson that our banks became too big and we aim to make them smaller relative to the economy moving forward. The regulatory agenda currently in progress - including for discussion at the G20 next week - would do essentially nothing to reduce the political power of big banks. We need simple caps on bank size, leverage relative to the economy and - this is harder - measures of interconnected tail risk (i.e., is everyone making the same kind of crazy loans?). Design a system with this in mind: regulators get captured and super-regulators get super-captured.

If the scheme doesn’t work, we draw the exact same lesson. And, of course, we should expect Chairman Bernanke to move forward with his Plan B (or is it Plan Z?): inflation.

In any case, our top political leadership needs to really sell some version of the following message. We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%. We cannot afford to have the same problem again. We must break the power of banks before they break us all. And if you don’t think banks can do that much damage to economies, just look around outside the United States - the world is full of countries where growth is slowed or distorted by a financial system that becomes too powerful. This is not about tweaking the existing U.S. regulatory system; it is about complete change and - in many senses - turning back the clock to a financial system that was simpler, smaller, and much less dangerous.

This is the point missing from all the back and forth about the raw details of the Geithner plan. Under not even the rosiest of scenarios would it scale back the power and size of the financial sector relative to the economy, which in the end must be the ultimate solution for now and the future. The public fumes at scenarios that maintain a status quo that failed them and caused them undue pain, especially when they can conceive of a new way forward, where banks perform their core function under a regulatory microscope, and they never grow so large that they can possibly take down the entire economy.

Digby has been asking about the need for the left to assert itself. A group of very sharp organizers are putting together a mass series of demonstrations on April 11, calling itself A New Way Forward. Rallies are already being planned for 20 cities, and beyond just showing up in the streets, there is a careful effort to tie this into a greater movement, with a mission statement and a vision for a post-bailout, post-bubble economy.

NATIONALIZE: Experts agree on the means -- Insolvent banks that are too big to fail must incur a temporary FDIC intervention - no more blank check taxpayer handouts. (see Krugman on nationalization)

REORGANIZE: Current CEOs and board members must be removed and bonuses wiped out. The financial elite must share in the cost of what they have caused. (see Simon Johnson on reorganizing)

DECENTRALIZE: Banks must be broken up and sold back to the private market with new antitrust rules in place-- new banks, managed by new people. Any bank that's "too big to fail" means that it's too big for a free market to function. (see Mike Lux on decentralization)

Big bankers ruined our economy and now they are gaming the political system so they can profit even more off the crisis they caused. They must be stopped [...]

At the personal level, we know that the smart thing to do with our money right now is generally the less flashy thing. Paying off our debts and saving for the future protects us from the risks we can't afford to take in the current market. The same rules apply to the banks. This is a time for a level-headed government to step in and steer unhealthy banks away from more risky bets, and to help them stabilize in the name of economic security for America.

Nothing tells the bankers to keep on doing what they're doing more than an endless stream of free taxpayer money. The banks know that the government considers them too big to fail; if nationalization is off the table, what incentive do they have to act in the public interest?

In a basic sense, this is a fight against corruption. Not in the sense of a quid-pro-quo (though that may be there too), but in the sense of a corrupt ideology. For the most part, the world of economists, politicians and financiers is one elite web of influence. At some point, private profit took over as the only value to consider in building an economy, and it has never subsided. This is true of the thinking from both major parties.

Forget short-term thinking. We need a long-term rejection of the Masters of the Universe mentality and a full reorganization of the economy. I think A New Way Forward is on to something.