Keep An Eye On This

As much of the content of the traditional media rankles many of us, the editorial decisions should as well. Dozens of potentially game-changing stories go unreported while the Umbrage Brigade on cable talk about what Joe Wilson said about Jimmy Carter or whether Michelle Obama is overstepping her boundaries by talking about health care (I caught that one today). Meanwhile, the biggest financial crisis in 70 years just happened, and even people who consider themselves well-informed don't understand the entire story. The Congress enacted the Financial Crisis Inquiry Commission (some are calling it the new Pecora Commission, given its similarity to the Depression-era commission of that name led by chief investigator Ferdinand Pecora), headed by former California Treasurer and gubernatorial candidate Phil Angelides, and they held their first public session yesterday. The meeting was introductory in nature, but Tim Fernholz came away with a few thoughts.

• Given the membership [PDF], I worried that the committee would be beset with partisan bickering and/or clashing ideologies, like the Congressional Oversight Panel. The COP, appointed by Congress to provide oversight of the bank rescues, is regularly undermined by dissents from Representative Jeb Hensarling, whose deeply conservative economic views preclude almost any reasonable discussion about regulation and finance. But though some tensions showed, I though the conservative New Pecora commissioners seemed open-minded; former Bush administration economic official Keith Hennessey and McCain economic adviser Douglas Holtz-Eakin made productive comments, though Peter Wallison, a more doctrinaire conservative than either of the other two, seemed to have his mind made up about the financial crisis, essentially blaming Fannie Mae and Freddie Mac right from the outset. He may be the poison pill on this committee.

• Most surprising was Vice-Chairman Bill Thomas, a former Republican Congressman and Committee Chair. Thomas seemed to agree broadly with Chairman Phil Angelides goals of non-partisan fact-finding, and went out of his way to compliment the views of every member of the commission. He even singled out Commissioner Brooksley Born, who strongly advocated regulating derivatives during the Clinton administration, telling her that the crisis would have been much more manageable had her advice been acted on. Later, asked by a reporter if the issue of regulating markets would divide the committee, Thomas stepped forward to say that he thought regulatory reform was inevitable and that making it work correctly was critical. Though it is easy for him to say that now, Thomas' early impressions are much less doctrinaire than had been anticipated.

• One concern: There is no liberal economist on the committee, while there are three conservative economic thinkers in Hennessey, Holtz-Eakin and Wallison. The Democratic appointees have regulatory, legal, political and private business experience, but no specific economic expertise.

• Early in the week, the New Pecora Commission announced the appointment of Thomas Greene as its Executive Director. Greene, a lawyer, has done complex investigatory work both in Washington, D.C. and in California, coordinating anti-trust and securities investigations in a variety of venues. The appointment is critical; recall that the Pecora Commission was named after it's executive director, Ferdinand Pecora, not the members of congress who constituted the actual committee. And more talent is coming: As Greene hung around after the hearing, several different people, including several lawyers, approached him about working for the commission.

The FCIC will hold hearings and issue regular reports between now and December 2010. This needs to be watched. We all have a sense that the banksters turned Wall Street into their private gambling hall and took huge risks, secure in the knowledge that they could get the government to bail them out if things went awry. Currently there have been no prosecutions of the major players in the scandal, no accountability to any degree, and a year later, Wall Street appears to be going back to their same old ways, entirely at our expense. Michael Hirsh believes that this commission offers one last chance to make the record public, and use it as a lever to change the system. He's not optimistic, however. The ideological shadings of the commission and Angelides' wariness of using the subpoena power he's been given worry him (I actually think Angelides can be a lot tougher than Hirsh or anyone gives him credit for). But he offers a glimmer of hope.

Still, Angelides and his team may yet surprise us. It's happened before. The history of "blue ribbon" commissions like this one is rich and storied in Washington; one of them, in 1942, was led by an obscure senator from Missouri who was also seen as a political hack at the time. His name was Harry Truman, and he turned his commission on defense malfeasance into a ticket into the White House and the history books [...]

What we do need, however, is a parade of witnesses who will provide what's been missing so far in this crisis—a prominent outlet for public outrage. In the last nine months, the Obama administration and the grandees in Congress have been designing solutions without much input from the outside, often using experts from Wall Street (especially "Government Sachs"). It's pretty much been a closed system. Even Paul Volcker, considered perhaps the greatest Federal Reserve chairman in history (now that the Alan Greenspan era looks much worse retrospectively), has been all but ignored by the president he is advising. Volcker has been making a series of speeches around the country calling for sensible changes to the structure of Wall Street that the administration and Congress are not yet considering. He wants federally guaranteed bank deposits to be cordoned off from heavy risk-taking and proprietary trading. Volcker wants banks, in other words, to be barred from behaving like hedge funds. "Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking," Volcker told a corporate group Wednesday in Los Angeles. He should be invited to Washington to say the same thing.

I can remember a time when commissions like these, from the Pecora Commission to the Truman Commission to Watergate to Iran-Contra to even the 9-11 Commission, were major public news, followed intensely by the media. You'd think that a similarly designed commission tasked with uncovering the greatest loss of wealth in world history would generated more than a few words on the cable news crawl. But we have to make this important, too. The FCIC may fall into partisan bickering, or it may create some powerful narratives about the criminal enterprise on Wall Street. But none of it will matter if nobody pays any attention.

Imagining The Paul Volcker Treasury Department

Paul Volcker was pretty heavily involved with the Obama transition team, and certainly had the ear of the Administration at some point. I don't know the status of that now. But hopefully they pick up on this article in the Wall Street Journal:

Former Federal Reserve Chairman Paul Volcker on Wednesday said banks should operate in a much less risky fashion, including not making trading bets with their own capital, comments that could provoke intensified debates over the future of financial regulation.

Mr. Volcker, who currently is chairman of the White House's Economic Recovery Advisory Board, suggested banks should be restricted to trading on their client's behalf instead of making bets with their own money through internal units that often act like hedge funds.

"Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking," he said in a speech to the Association for Corporate Growth in Los Angeles [...]

Mr. Volcker said banks should be banned from "sponsoring and capitalizing" hedge funds and private-equity firms, which are largely unregulated. He also said "particularly strict supervision, with strong capital and collateral requirements, should be directed toward limiting proprietary securities and derivatives trading."

He also said collateral and leverage restrictions against the largest nonbank financial institutions "may be needed."

That's because it isn't, it's just become a growth center for banks that can operate like a casino and get the government to bail them out if things go wrong.

Volcker is basically advocating a similar version of the reforms that came out of the Great Depression. Then, banks were separated into commercial and investment entities under the Glass-Steagall Act, and bank holding companies could not own other financial firms. That came out of the Pecora Commission recommendations, which dug up so much of Wall Street's corrupt practices that the necessity of reform could not be refuted.

In a Volcker Treasury Department, instead of Tim Geithner, we would have a chance to make these the starting points for reform, and invigorate the modern-day Financial Crisis Inquiry Commission, or Angelides Commission, to dig deep and look into what the financial firms did to nearly destroy the economy. The banksters would be fending off the cries for reform instead of using their lobbying arms to channel them in business-friendly ways.

Now wouldn't that be nice?

...Matt Taibbi says that Volcker was basically beached after the campaign along with a lot of the other more progressively minded economic advisers. It sounds pretty right.

More Evidence Of Goldman Sachs' Blood Funnel

I saw Bill Maher offer Matt Taibbi some pushback last night about his Rolling Stone piece on Goldman Sachs. Maher wasn't willing to believe that Goldman has been uniquely positioned to profit from the breakdown of the financial system and the various bubbles created. Maher offered the predictable "why just Goldman" response, and Taibbi decided to talk about the many Goldman officials in high positions in the government. He could have just pointed to this story that leaped from Zero Hedge to the New York Times yesterday.

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 [...]

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.”

They literally place their super-fast computers physically close to the machines that govern NYSE trades, to get the jump on competitors and make enough pennies off of the brief ups and downs of stocks to rake in mounds of cash. And in some cases, investors can buy access to buy and sell order information on certain exchanges that can be used to make these quick orders. When Chuck Schumer is calling for an investigation of Wall Street, you know something has gone horribly wrong.

No, Goldman Sachs is not the only organization profiting from this scheme, or any of the numerous others. But their name keeps surfacing among those that are, in pretty much every case. I don't know how much evidence it takes to understand their role in all of this. Taibbi may not have gotten every single solitary thing right in his very long piece, but he got enough right to make some very powerful people nervous. And rightly so.

We need to go further in determining what caused this financial crisis and what pitfalls remain. The new iteration of the Pecora Commission, a Depression-era panel that uncovered the origins of that crisis, can lead the way.

We, the undersigned, call on you to fulfill the responsibilities of your position by joining together in non-partisan cooperation to investigate the origins of the financial crisis in ways that lead to a full understanding of the institutions, people and practices that are responsible for our economic collapse.

In particular, we encourage the adoption of three guidelines that history has taught us are essential to an effective inquiry:

Appoint a single investigator. This individual must have a proven record of exposing fraudulent elites and institutions, and must provide a professional, non-political spirit to the investigation.

Afford no special treatment. No one is off-limits or gets special protection in the investigation.

Provide the tools to do the job. The investigator must be given ample budget and time, full subpoena authority, and the ability to hire and fire staff.

These principles were applied in the 1930s when Congress launched a formal inquiry into the causes of the Great Depression. That commission - led by Ferdinand Pecora - was willing to reach into the highest levels of Wall Street and finance to determine the causes of the economic collapse of 1929. The courage with which the commission greeted its task - and the revelations that courage ensured - inspired the sweeping banking and financial reforms that were the bedrock of our financial system for decades.

Building a new financial foundation requires us to begin on solid ground - the truth. It is only by illuminating the mistakes of the past that we will be able to meet the great challenges of the future.

And they can start by photocopying Matt Taibbi's notes.

Angelides On Pecora II

Tim Fernholz talks with Phil Angelides, the new chairman of the Financial Crisis Inquiry Commission, a modern-day analogue to the Pecora Commission of the 1930s, charged with finding out the origins of the financial crisis, who we should hold responsible, and how we can ensure it never happens again. There are some interesting tidbits in the interview. First, we can be sure that Angelides has an understanding of the problem.

Why is this commission important?

The magnitude of what's happened in this country is astounding. Millions of people have lost their homes, millions of people have lost their life savings, millions of Americans have seen their pensions disappear. We have seen over a trillion dollars in taxpayer money go to prop up a dying financial system. This is a cataclysm. My view is that there is a real hunger in this country to have a pursuit of the truth, to find out what happened and why it happened, so hopefully, instead of sweeping it under the rug, it will not happen again in our lifetimes. This is an important commission with a critical role of serving the nation's best interests because we are called on to look into something that has been fundamentally important to this country: The very foundations of our financial system have been shaken [...]

Do you believe we already have a broad understanding of what led to this crisis, or do you feel there are a lot of questions still unanswered?

All of us come with our personal views. I'll start by saying that in the early part of this decade, as early as 2002, I was concerned about what was happening the marketplace. I was deeply concerned about executive compensation so I mobilize shareholders across the country to push back on executive compensation. I was concerned about lax enforcement at the SEC. ... I was part of a movement of activist shareholders in an effort to bring some common sense to the market place. In the wake of the Enron and Worldcom, we had some momentum, but the economy recovered and the regulators took their foot off the brakes. We all come in with our own viewpoints, but our job is to look at this fresh.

Next, he's willing to give his Republican colleagues on the committee some input, but he's setting ground rules and he thinks he can get the others on the commission to play ball:

The commission has the ability to subpoena information, but only if at least one of the Republican appointees supports the decision. Are you at all concerned about disagreement within the committee hurting its ability to gather information?

When the Speaker and the Majority Leader asked me to serve as chair, [I knew] this would be a hard and difficult road. I'm starting on the assumption that other commissioners, like myself, are interested in getting to the facts and the root causes. If we have to issue subpoenas, I hope we can do that. Hopefully people [with information] will cooperate, but if not, we were given the tools to get the facts. I would want to start on the basis that no commissioner would want to deprive us of information to make a good judgment on behalf of the American people. The commission is interesting because it really focuses on the inquiry, rather than the policy and political implications. I think that gives us a better chance of coming up with a nonpartisan, bipartisan findings of facts.

And finally, he seems to recognize something that a lot of people don't - the regulators probably had the capacity to stop at least the most egregious criminality happening in the markets, but they didn't use the authority they had. What the Financial Crisis Inquiry Commission can offer is, in Angelides' words, "a road map" and "a guidebook" to the next generation of regulators, so they know what to look for and where to go.

Now, Zachary Roth has a long piece about Bill Thomas and the other Republicans on the FCIC, or Pecora II, and how they are partisan enough to resist a real inquiry. The provision that one Republican must vote with Democrats in order to issue subpoenas could allow anyone Republicans don't want testifying to be able to do so; and all of the Republicans appear, to Roth, to be candidates to hang together:

None of the three rank-and-file Republican appointees seem like good candidates to break ranks. Peter Wallison is a fellow at the American Enterprise Institute, who has been a prominent advocate of the favored conservative notion that Fannie Mae and Freddie Mac are the true culprits in the crisis, and who argued this week in the Washington Post against creating a consumer protection commission for financial products -- an idea seen by many as a cornerstone of any effort to reform the financial regulatory system. Doug Holtz-Eakin, for his part, was John McCain's top economic adviser at the time when the GOP presidential nominee declared the fundamentals of the economy strong. And Keith Hennessey is a former economic adviser to President Bush and a former aide to Sen. Trent Lott.

But it's the identity of the Republican-appointed vice chair -- whose support is required by law for the commission to perform several other key functions, like hiring staff -- that's the really ominous sign. That's Bill Thomas, the Republican former congressman from California, who earlier this decade chaired the House Ways and Means committee.

During his years in Congress, Thomas, who now works for a major DC lobbying firm, acquired a reputation as a smart, highly-skilled and acutely partisan supporter of big business, who once tried to have Democrats forcibly ousted from a capitol meeting room, and was accused of being literally in bed with a corporate lobbyist.

I'd agree that Wallison and probably Hennessey and Thomas are useless, but Holtz-Eakin, a former head of the CBO, has at least displayed flashes of intellectual honesty when he wasn't in charge of a Presidential campaign's economic policies. He has acknowledged the need for higher taxes. He has called for the Bush tax cuts to expire. He's definitely conservative and he sometimes says some boneheaded things, but I don't see him as a hardcore partisan, actually. And if Angelides structures this as a just the facts inquiry, there's at least the promise of a legitimate investigation.

Phil Angelides To Chair Financial Crisis Inquiry Commission

As part of an earlier bill, Congress initiated the modern-day analogue to the Pecora Commission of the 1930s, named after its chief counsel Ferdinand Pecora. That commission detailed the origins of the financial crisis that caused the Great Depression, and led to the passage of several banking reforms, including the Glass-Steagall Act, which separated investment banks and commercial banks. The Pecora Commission was credited for the reforms that stabilized the financial system after a 19th century full of depressions. After decades of neglect and deregulation, we needed a new Pecora Commission to examine the breakdowns in the financial system and recommend best practices to ensure it never happens again. And the man who will head this commission is Phil Angelides.

House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid today announced six appointments to the 10-member Financial Crisis Inquiry Commission, established by Congress to examine the domestic and global causes of the financial crisis.

Speaker Pelosi and Majority Leader Reid appointed Phil Angelides as chairman of the Commission. The statute requires the House Speaker and the Senate Majority Leader to jointly appoint a commission chair. Mr. Angelides, one of Speaker Pelosi’s three appointments to the commission, served with distinction as the elected California State Treasurer from 1999 to 2007. He has earned national recognition as an effective public and private sector leader with broad expertise and accomplishments in the fields of investor protection, housing, finance, and corporate and financial market reform.

The Commission will conduct a comprehensive examination of, and hold hearings on, more than 20 specific areas of inquiry related to the financial crisis, including the role of fraud and abuse in the financial sector; state and federal regulatory enforcement; tax treatment of financial products; credit rating agencies; lending practices and securitization; unregulated financial products and practices; and corporate governance and executive compensation. The Commission will also examine the causes of major financial institutions that failed or were likely to fail had they not received exceptional government assistance. The Commission will provide its findings and conclusions in a final report due to Congress on December 15, 2010.

Obviously this takes Angelides out of the running for any political races in the 2010 cycle. But he'll actually have a far more influential position - determining the causes of the financial crisis and how to fully reform the system. I'm pleased that Speaker Pelosi and Senator Reid went outside of Washington for this task, not to any of the typical high priests of bipartisanship. I hope Angelides can get this job done, and it seems to fit with his skills.

The rest of the Democrats on the commission, including Clinton-era official Brooksley Born (who wanted to regulate derivates in the late 1990s) and former Florida Sen. Bob Graham, can be found at the release.

...The Republicans added a vice-chairman with a California connection: former House Ways and Means Chairman Bill Thomas.

Scalia Throws A Curve

While there's no question the Supreme Court has tilted significantly to the right, in one case at the end of this session, they squeaked through a very damaging policy for the banking lobby. And believe it or not, it took Antonin Scalia to do it - I guess he's the new "swing vote":

In a rebuke of the Bush administration, the Supreme Court ruled Monday that a federal bank regulator erred in quashing efforts by New York state to combat the kind of predatory mortgage lending that triggered the nation's financial crisis.

The 5-4 ruling by the high court was unusual. Justice Antonin Scalia, arguably the most conservative jurist, wrote the majority's opinion and was joined by the court's four liberal judges.

The five justices held that contrary to what the Bush administration had argued, states can enforce their own laws on matters such as discrimination and predatory lending, even if that crosses into areas under federal regulation [...]

The ruling angered many in the financial sector, who fear it'll lead to a patchwork of state laws that'll make it harder for banks and other financial firms to take a national approach to the marketplace.

"We are worried about the effect that this ruling could have on the markets," said Rich Whiting, general counsel for the Financial Services Roundtable, a trade group representing the nation's 100 largest financial firms, in a statement. The decision "hinders the ability of financial services firms from conducting business in the United States. Even worse, it will cause confusion for consumers, especially those who move from state to state."

If there's one thing I love seeing in print, it's the words "the ruling angered many in the financial sector."

The near-term practical effect of this is that the states can resume looking into the lending practices of the banks in their regions, and potentially take them to court. Andrew Cuomo, the winner in this lawsuit, has been doing some of the best work in the country fighting the banks, and now he's empowered to continue.

These kinds of rules preventing pre-emption of the state laws when it comes to financial services are one key element of the creation of the new Consumer Financial Protection Agency, which the banks also can't stand, because it would consolidate consumer protection laws and enforce rigid standards for mortgages, credit cards, payday lending and consumer credit. Cue the whining:

"We have the view that the market, left to its own devices, isn't always going to lead to an optimal outcome for consumers," Michael Barr, the assistant treasury secretary for financial institutions, said in a news briefing.

Financial institutions said the move went beyond a step back to regulation.

"This is going in headfirst," said Scott Talbott, the senior vice president of government affairs for the Financial Services Roundtable, the lobby for the nation's biggest financial firms. "This could take us back to the 1950s."

While denying that the legislation is heavy-handed, Barr acknowledged that it would open a new era of financial regulation.

"I don't think it's a surprise that big banks and institutions that benefited from the status quo want to keep it that way. It's unacceptable to us," he said.

Now, if we actually can get this modern-day Pecora Commission off the ground, we'll at least have a multi-pronged approach to going after those who caused the financial crisis and continue to rip off their customers. I'm not all that optimistic, given the fact that the banksters own the place. But at least we have a chance.

That Glorious Transparency

Big Tent Democrat flags this line in Obama's national security speech:

Funniest line of the speech - "I ran for President promising transparency, and I meant what I said. That is why, whenever possible, we will make information available to the American people so that they can make informed judgments and hold us accountable." Hell, Bush and Cheney could have said that.

Another thing Bush and Cheney could have done - in fact, would have done - is pre-empt accountability for the financial crisis by adding a singing statement to the bill authorizing an independent commission gutting their ability to collect data:

Section 5(d) of the Act requires every department, agency, bureau, board, commission, office, independent establishment, or instrumentality of the United States to furnish to the Financial Crisis Inquiry Commission, a legislative entity, any information related to any Commission inquiry. As my Administration communicated to the Congress during the legislative process, the executive branch will construe this subsection of the bill not to abrogate any constitutional privilege.

The Hill explains that Obama is basically threatening to withhold data and cite executive privilege if he chooses. When Darrell Issa, fercryinoutloud, can rail against your deceptiveness - and be right - you've really sunk.

Congress supported the commission idea in broad, bipartisan fashion, although a group of roughly 50 conservative Republicans opposed it in the House. On Wednesday, the main Republican supporter of the commission, Rep. Darrell Issa (Calif.), lashed out at the signing statement.

“Why is a president who talked so much about transparency now threatening to back away from it? If critical information is withheld from the inquiry on the financial crisis, its conclusions won’t have the credibility of the 9/11 Commission report,” Issa said in a statement to The Hill.

It pains me to say that Issa raises a good question, and it's not enough to say that Obama would only withhold the "proper" kind of information and release the rest. It makes a total mockery about the claims to transparency.

Piercing Pecora

In addition to the credit card bill, before Memorial Day the President will in all likelihood sign a bill giving the federal government more tools to fight financial fraud. It cleared the House yesterday after having cleared the Senate. But the financial fraud tools matter less to me than the provision in the bill authorizing an investigation into the causes of the financial crisis, which has the potential to turn into a modern-day Pecora Commission, offering evidence and recommndations on fixing the economic system. One catch, however:

The Senate passed the same version of the bill last week, and the President is expected to sign it short order. During deliberations between House and Senate leaders to resolve differences between the bills, negotiators made one potentially important change to the commission's guidelines, which now require that at least one member appointed by the Senate or House Minority Leader assent to the issuance of subpoenas, should they be necessary to compel testimony or other evidence. Whether that impacts the functioning of the commission will depend, I suppose, on how many subpoenas turn out to be necessary, and how much the Republican appointees resemble their appointers in Congress.

How many people expect the House minority to select wise moderate appointees who want to engage in a dogged, uncompromising investigation?

Oh well, it was a good idea...

Only 539,000?

The news that businesses laid off "only" 539,000 jobs in April is supposed to be positive, and yet the February and March numbers revised upwards, and most important, the jobless rate increased at basically the same rate as previous months, to 8.9%. Despite less jobs lost, nobody is creating jobs in any meaningful way to re-employ those people.

I know employment is a lagging indicator, but if this is the good news, I don't want to see the bad.

But the Obama Administration has clearly taken the message from the green shoots they're reading through the tea leaves: the banks can "earn their way" out of the crisis (Geithner even said that today. Wow), and then they can capitalize everything else. We know the stress tests lightened up on their adverse assessment to paint as pretty a picture as possible for the banks' economic outlook. "If this picture proves to be wrong, then it means that we will have unnecessarily delayed the clean-up of the financial system," as Dean Baker says.

Paul Krugman has more, noting that while the banks will "make it" through the recession, and lending through the government's other programs may fill in the gap for weak banks, lots could go wrong.

It’s not at all clear that credit from the Fed, Fannie and Freddie can fully substitute for a healthy banking system. If it can’t, the muddle-through strategy will turn out to be a recipe for a prolonged, Japanese-style era of high unemployment and weak growth.

Actually, a multiyear period of economic weakness looks likely in any case. The economy may no longer be plunging, but it’s very hard to see where a real recovery will come from. And if the economy does stay depressed for a long time, banks will be in much bigger trouble than the stress tests — which looked only two years ahead — are able to capture.

Finally, given the possibility of bigger losses in the future, the government’s evident unwillingness either to own banks or let them fail creates a heads-they-win-tails-we-lose situation. If all goes well, the bankers will win big. If the current strategy fails, taxpayers will be forced to pay for another bailout.

But what worries me most about the way policy is going isn’t any of these things. It’s my sense that the prospects for fundamental financial reform are fading.

This is why I'm stressing the importance of the modern-day Pecora Commission. Revealing the true rot at the heart of Wall Street is key to forcing regulatory reform down the throats of the banksters.

Happy Stress Test Day

Well, huzzah, the stress tests are here, and good news, everything's OK, just a matter of $75 billion dollars and we're ready to roll, just a rounding error, really. I can see why everyone's so excited. After all, if you can come up with a solution to a capitalization problem that involves "get(ting) the government to pay them more than three times the market value of their stock," I don't think you'd have anything to worry about either. And of course, the more that investors consider the banks to be healthy, the more healthy they quantitatively are, in a sense.

So my best guess is that this is a quite deliberate effort (there are credible reports of active efforts to squeeze short sellers) to pump up the bank stocks to facilitate their fundraising. John Dizard had urged central banks sponsoring road shows nearly a year ago to help them raise the needed equity. I'd prefer an open sales effort to this mingling of hucksterism with supposed regulatory policy. And they have clearly been intermingled. Note how the prime objective of the stress tests has been above all to restore confidence. Huh? The most important aim should be to assess their condition so as to determine what if anything needs to be done. To subordinate proper regulatory action to reassuring "the markets" is backwards. If the public had faith in the integrity of the process, the need for a confidence exercise would vanish.

One problem for the banksters: the outliers. Several bigger banks do need a good degree of capital, and at least in the case of GMAC, a lot more capital, comparatively speaking.

The federal government has ordered the financing arm of General Motors to raise $13.1 billion in new capital to ensure the firm's stability in the face of heavy losses in mortgage and auto lending and costs related to taking over new loans for Chrysler dealers and customers, said sources familiar with talks between government and industry officials.

The sum is among the biggest required for any U.S. financial institution, and could prove difficult for GMAC to raise because of the limited nature of its business and poor quality of its loans. The firm has struggled in the past to raise money from private investors and has already received $5 billion in federal assistance. It is likely that the federal government would end up providing much, if not all, of the needed capital, but it remained unclear where that money would come from.

About $4 billion of the total would be needed to cover the cost of assuming Chrysler Financial's dealer and retail auto loans, said one senior financial industry executive.

As James Kwak notes, this means that GMAC has negative capital at the moment, which, um, means insolvency.

Some smart people at the Times' Room for Debate series give their thoughts. I basically consider this a sham based on rosy scenarios and grade-grubbed by the subjects, but as has been said, we lost the debate inside the White House, and they're going to do what they must to keep the banks afloat. I think we have to focus on this Pecora Commission idea that's passed both houses of Congress (some helpful background here), which can lay the groundwork for major regulatory reform, through investigation of what happened to create the crisis. Obviously this comes out of Congress, so who knows what kind of teeth it will have, and historically blue-ribbon panels don't have much of a track record, but take a look at the potential of this thing:

The Financial Markets Inquiry Commission is empowered to hold hearings and to issue subpoenas either for witness testimony or documents and will have more than twenty substantive areas of focus, including:

the role of fraud and abuse in the financial sector
state and Federal regulatory enforcement
tax treatment of financial products
credit rating agencies
lending practices and securitization
corporate governance and executive compensation
Federal housing policy
derivatives
GSEs
short-selling

Additionally, the bill requires the commission to examine the role of fraud and abuse towards consumers in the mortgage sector, examine the extent to which the legal and regulatory structure governing financial institutions creates the opportunity for financial institutions to engage in regulatory arbitrage, examine the role of credit default swaps and the impact of financial institutions that are “too big to fail” on market expectations, and examine the causes of major financial institutions that failed or were likely to fail without government assistance. The Commission will report their findings and conclusions to Congress by December 15, 2010 and is required to refer any person who may have violated U.S. law in relation to the financial crisis to the Attorney General (AG) or state AGs.

We can put people in jail. We can set the future. We can shrink the financial sector. And we can do it through this panel. Let's push for a real commission.

Too Big, Period.

What will post-recession Wall Street look like? The President talks about a smaller financial sector as a function of a stronger economy.

And so I wonder if you would be willing to describe a little bit of your learning curve about finance, and what you envision finance being in tomorrow’s economy: Does it need to be smaller? Will it inevitably be smaller?

THE PRESIDENT: Well, first of all, I think that we should distinguish between finance as the lifeblood of our economy and finance as a significant industry where we have a comparative advantage — right? So in terms of just growing our economy, we’ve got to have enough credit out there to fund businesses, large and small, to allow consumers the flexibility to make long-term purchases like cars or homes. So that’s not going to change. And I would be concerned if our credit market shrunk in ways that did not allow for the financing of long-term growth.

What that means is not only do we have to have a healthy banking sector, but we’re going to have to figure out what we do with the nonbanking sector that was providing almost half of our credit out there. And we’re going to have to determine whether or not as a consequence of some of the steps that the Fed has been taking, the Treasury has been taking, that we see the market for securitized products restored.

I’m optimistic that ultimately we’re going to be able to get that part of the financial sector going again, but it could take some time to regain confidence and trust.

What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade. That I think will change. And so part of that has to do with the effects of regulation that will inhibit some of the massive leveraging and the massive risk-taking that had become so common.

Now, in some ways, I think it’s important to understand that some of that wealth was illusory in the first place.

So we won’t miss it?

THE PRESIDENT: We will miss it in the sense that as a consequence of 25-year-olds getting million-dollar bonuses, they were willing to pay $100 for a steak dinner and that waiter was getting the kinds of tips that would make a college professor envious. And so some of the dynamic of the financial sector will have some trickle-down effects, particularly in a place like Manhattan.

But I actually think that there was always an unsustainable feel about what had happened on Wall Street over the last 10, 15 years, and it’s not that different from the unsustainable nature of what was happening during the dot-com boom, where people in Silicon Valley could make enormous sums of money, even though what they were peddling never really had any signs it would ever make a profit.

That doesn’t mean, though, that Silicon Valley is still not a huge, critical, important part of our economy, and Wall Street will remain a big, important part of our economy, just as it was in the ’70s and the ’80s. It just won’t be half of our economy. And that means that more talent, more resources will be going to other sectors of the economy. And I actually think that’s healthy. We don’t want every single college grad with mathematical aptitude to become a derivatives trader. We want some of them to go into engineering, and we want some of them to be going into computer design.

Rhetorically this is very right, but as I've said the policies being undertaken don't fit the rhetoric at all. They seem far more designed to reinflate the financial sector and allow them no consequence for their bad decisions. Maybe this comes later, with regulatory reform. That certainly seems to be the signal from the President.

Let's try to define the problem and work backwards. Clearly, the growth of finance in terms of salary and proportion of the overall economy has gone completely out of balance. The power of Wall Street financiers provides one reason for this, but so does the newfangled structure of the economy which rewards such behavior.

This wasn’t the first time that something like this had happened. There have been three big banking booms in modern U.S. history. The first began in the late nineteenth century, during the Second Industrial Revolution, when bankers like J. P. Morgan funded the creation of industrial giants like U.S. Steel and International Harvester. The second wave came in the twenties, as electrification transformed manufacturing, and the modern consumer economy took hold. The third wave accompanied the information-technology revolution. Each wave, Philippon shows, was propelled by the need to fund new businesses, and each left finance significantly bigger than before. In all these cases, it wasn’t so much that the bankers had changed; the world had.

The same can’t be said, though, of the boom of the past decade. The housing bubble was unique, and uniquely awful. Each of the previous waves had come in response to a profound shift in the real economy. With the housing bubble, by contrast, there was no meaningful development in the real economy that could explain why homes were suddenly so much more attractive or valuable. The only thing that had changed, really, was that banks were flinging cheap money at would-be homeowners, essentially conjuring up profits out of nowhere. And while previous booms (at least, those of the twenties and the nineties) did end in tears, along the way they made the economy more productive and more innovative in a lasting way. That’s not true of the past decade. Banking grew bigger and more profitable. But all we got in exchange was acres of empty houses in Phoenix.

The giant pool of money, the large chunk of investment capital from around the world, had to park itself somewhere, and suddenly US home sales became the preferred bet. And then mortgage securitization led to a complete rewriting of the rules for who qualified for loans, and you know the rest.

How can we counteract this? Well, making the financial sector operate without the massive amounts of leverage that encourage bad bets would be a start. Suroweicki thinks we can hope for Wall Street to "recognize that its proper role is, as it has been in the past, to follow the real economy, rather than trying to drive it." I just don't find that realistic, given their power and their mindset. And so we need the independent Pecora Commission that will apparently be chaired to have some real power to make real recommendations that would rein in Wall Street and ensure their growth gets stunted. And forgive me for quoting John Ashcroft, but we need some real accountability and charges filed against any companies that may have broken the law. Interestingly, Ashcroft doesn't believe in the same kind of accountability for torture.

The government must hold accountable any individuals who acted illegally in this financial meltdown, while preserving the viability of the companies that received bailout funds or stimulus money. Certainly, we should demand justice. But we must all remember that justice is a value, the adherence to which includes seeking the best outcome for the American people. In some cases it will be the punishing of bad actors. In other cases it may involve heavy corporate fines or operating under a carefully tailored agreement.

(Do you think the editorial page editors of the Times openly snickered when they accepted this op-ed, and were all too happy to give Ashcroft the rope to hang himself?)

Banks need to understand their core function of providing the swift flow of capital, not to create wealth markets for themselves. That can be achieved through responsible regulation.

Grading On A Curve

The news leaking out from the stress tests just got worse and worse. First all the banks would be fine, then one would need more capital, then "at least" one, then six. So the banks did the responsible thing - they sought a delay while begging for a second opinion.

Citigroup Inc. may need to raise as much as $10 billion in new capital, according to people familiar with the matter, as the government continues negotiations with banks over the results of its so-called stress tests.

The bank, like many others, is negotiating with the Federal Reserve and may need less if regulators accept the bank's arguments about its financial health, these people said. In a best-case scenario, Citigroup could wind up having a roughly $500 million cushion above what the government is requiring.

The discussions stem from the tests being run by the Fed and the Treasury to assess the health of the country's 19 largest banks. Those results will be released Thursday, later than initially planned.

It's amazing that the banks are somehow allowed to negotiate the test results, like a slacker tenth-grader trying to pass calculus. This undermines the whole credibility of the tests, effectively making them useless. And this is a direct result of the Treasury Department structuring these tests in such a way that assured the banks nobody would fail, and all of them would get whatever funds were necessary, whether through private capital or a virtual government guarantee. It seems to me that the stress tests could have been used as leverage for negotiating Administration priorities. Instead, the opposite is the case.

It's hard to discern at a remove how much of the peevishness is the discovery by banks that they have little to lose in behaving like utter pigs. We saw it today with the failure of the bankruptcy mod bill in the Senate (even after concessions had been offered). Admittedly, Chrysler was a partial exception, since the Treasury made considerable economic concessions, but finally drew the line and put the company into bankruptcy. However. Team Obama wanted to make a show to prevent even worse shenanigans with GM (but the New York Times points out that the pre-pack could take as long as four months, hardly a quick in and out, and some bankruptcy lawyers have pointed out that other deals expected to be fast track have taken a year).

But let's face it, in a real test, you don't get to score it yourself and then argue the grade. The banks fundamentally don't seem to accept that they are regulated entities and expect to be treated as equal partners. Given the likely decay in employment given the weakening fundamentals, all the Treasury is doing is getting the banks to face the music perhaps six months ahead of time, which is something they should be doing on their own.

The Administration had something of real value, namely information, and they failed to use it. As a result, cramdown dies, thanks to the Mortgage Bankers Association. Foreign banks with substantial ties to the US can refuse to give up tax information on their offshore customers with impunity. And they'll be sure to go after the credit card reform bill in the Senate next week.

With respect to Chrysler, I keep hearing that Obama won a game of chicken with the hedge funds, and granted Cerberus ended up with nothing while Perella Weinberg accepted the government offer at the last minute. But Chrysler sits in bankruptcy, and nothing there is assured except that some of the fund managers will get their CDS paid off.

Geithner decided not to use the tools at his disposal. And I don't think he did that by accident. At this point, I'll have to believe this talk about a new Pecora Commission when I see it.

Pecora Percolating

A little-known financial fraud bill in the Senate could be the vehicle to a wide-ranging Congressional commission to study the financial crisis and make recommendations for regulation.

The Senate signaled a willingness late Wednesday to create a select committee to investigate causes of the nation’s financial crises.

In an amendment accompanying other legislation on financial fraud, senators agreed in a voice vote to consider creation of a special commission that would delve into the roots of the collapse.

The amendment had bipartisan support from Senators Kent Conrad, Democrat of North Dakota, and Johnny Isakson, Republican of Georgia, as well as Senators John McCain, Republican of Arizona, and John Dorgan (it's Byron -ed.), Democrat of North Dakota. In a statement, Senator Dorgan’s office said the select committee would have full subpoena power and would not only hear testimony, but make recommendations for reforms to try to prevent future downturns of this type.

However, that vote contrasts with a separate commission voted through on the same bill, which would make the commission independent of Congress.

The Senate passed an amendment to an anti-fraud bill yesterday that would create an independent outside commission, complete with subpoena power, to investigate the causes of the crisis on Wall Street. The amendment was written by Sen. Johnny Isakson (R-GA), but was cosponsored by, among others, Sen. Chris Dodd (D-CT) [...]

These developments comes amid high level discussions among Congressional Democrats about the creation of an internal commission--modeled on the Pecora investigation into the 1929 collapse--to investigate the key events that preceded today's financial crisis. Dodd's staff has been largely silent on the idea of an internal commission, noting that his committee has already laid the groundwork for a thoroughgoing investigation. (Interestingly, the Pecora commission was conducted under the auspices of the Senate Banking Committee, which Dodd currently chairs.)

If the bill passes both the House and Senate with both amendments in tact, then the two commission will move forward, one outside the direct control of Congress. Democratic leaders agree that an investigation of some kind is in order have indicated some flexibility as to the exact specifications of such a commissions. Among the chief concerns are whether an external commission would enjoy subpoena power (though that concern might now be allayed) and that it could be stacked with people who lack either accountability or the incentive to investigate the issue thoroughly. One could, of course, raise similar concerns about an internal commission.

Barney Frank is already pulling back legislation on regulation, presumably until this commission business is straightened out. And I think that's somewhat wise. We're only going to get one shot at decent regulations, so we'd better array all the evidence and show all the fraud in the system before we set up the new rules of the road.

Pecora Talk

Interesting...

House Speaker Nancy Pelosi will meet with Sen. Majority Leader Harry Reid tonight--a weekly meeting--and will discuss the creation of a congressional panel to investigate the causes of the financial crisis and worsening recession, Hill sources say.

In 1933, a Sicilian-born American lawyer named Ferdinand Pecora became the chief counsel to the Senate Banking Committee, and conducted a wide-ranging investigation on the causes of the financial crisis that prefigured the Great Depression. Today, Pelosi says she wants Congress to take a similar look into the collapse on Wall Street.

Reid spokesman Jim Manley says that the majority leader is broadly sympathetic to the idea of congressional action, but notes that a panel could be figured in a number of different ways.

A Pecora Commission with broad powers and the ability to convert those powers into action would be very powerful. To be a fly on the wall of that conversation...

Banksters Losing Their Grip?

With all the talk of torture and wiretapping and tea parties, I have neglected that little story about how the banks have the economy by the cojones and won't let go. While more banksters release earnings reports completely tarnished by the creative accounting and cheap bailout money (as well as conveniently forgetting major write-downs that would show a loss), they are continuing to tell everyone they're just about to repay the government, a fact somewhat sullied by the fact that they have no money:

Former Treasury Secretary Paul O'Neill noted that at the start of the TARP program, the heads of the major U.S. banks were summoned to Washington and told they were required to take the money so that those who needed it would not be stigmatized.

"So they all took the money. Stop and think about that. What was the purpose of this policy? To deceive the people so that the public would not know which banks were in danger of failing? Why didn't any of the CEO's, claiming not to need the money, have the courage to refuse?" O'Neill said in an e-mail to ABC News. "If banks now claim they want to return the money because they don't need it, why do they have to raise new capital to replace the money from we the people in order to repay the government?"

O'Neill said that unfortunately the government is permitted to practice a policy of deception for the greater good of the society.

"Is the public ever going to have clear facts regarding any of the individual institutions?" he said. "For months I have been calling for a public disclosure of all bank assets by rating class, along with facts showing the face value of so-called toxic assets along with the associated current book keeping value and associated reserve account. The public and members of Congress seem to be accepting of the idea that a handful of people in the administration and the Fed should do all of this in secret."

The banksters clearly want to return the money to get out from under executive pay restrictions. They care more about their own salaries than they do the greater economy. But of course, if a bank like Goldman Sachs does manage to return TARP money, they are still a ward of the state given all the special treatment it has gotten from special-purpose vehicles and cheap money from the Fed, without which they would be in the toilet right now. Oh, and the creative accounting and counter-party payments from AIG, too.

Now, the Treasury Department has actually pushed back on this a bit. They oppose the banks repaying the TARP funds. They replaced Neel Kashkari as head of the TARP. And they will now release the stress test results, and they claimed that Goldman's desire to repay the TARP money was a factor.

The administration’s hand may have been forced in part by the investment firm Goldman Sachs, which successfully sold $5 billion in new stock on Tuesday and declared that it would use the proceeds and other private capital to repay the $10 billion it accepted from the government in October.

That money came from the Troubled Asset Relief Program, or TARP, and Goldman’s action was seen as a way of predisclosing to the markets the company’s confidence that it would pass its stress test with flying colors.

Goldman’s action has put pressure on other financial institutions to do the same or risk being judged in far worse shape by investors. The administration feared that details on healthier banks would inevitably leak out, leaving weaker banks exposed to speculation and damaging market rumors, possibly making any further bailouts more costly.

The Goldman move also puts pressure on the administration to decide what conditions will apply to institutions that return their bailout funds. It is unclear if Goldman, for example, will continue to be allowed to benefit from an indirect subsidy effectively worth billions of dollars from a federal government guarantee on its debt, a program the Federal Deposit Insurance Corporation adopted last fall when the credit markets froze and it was virtually impossible for companies to raise cash.

“The purpose of this program is to prevent panics, not cause them,” said one senior official involved in the stress tests who declined to speak on the record because the extent of the disclosures were still being debated. “And it’s becoming clearer that we and the banks are going to have to explain clearly where each bank falls in the spectrum.”

Yves Smith thinks that this information was leaked specifically to blame Goldman for releases that would possibly result in receivership or worse for the most struggling banks. And Emptywheel hones in on those FDIC subsidies:

Shorter Anonymous Senior Official: "Goddamn it Goldman, you risk starting a panic here! And as punishment, we're going to reconsider the terms of that FDIC backing." [...]

Goldman Sachs, you see (and Bank of America, and JP Morgan Chase, and Citi, and Morgan Stanley, and Wells Fargo) have been benefiting from higher credit ratings than they themselves merit because the FDIC has been backing their loans to the tune of billions of dollars [...]

Now, frankly I'm most interested in this from the same perspective that Yves is. These two stories, taken together, appear to be a welcome new tactic from the Administration, to start laying out all the value the government has given the banksters. It's time to make these banks squirm with the recognition that they're deadbeats for a change.

There are plenty of tactics available to the regulators here, and if they get sufficiently pissed off, I'll bet they have no problem using them. Significantly raising capital requirements, for example, or calling in the antitrust division of the Justice Department to investigate the market share of leading banks, or even letting Nancy Pelosi loose with her (very noble) idea for a 21st-century Pecora Commission:

Democratic House Speaker Nancy Pelosi, saying that the American people are demanding "discipline and accountability" after the multibillion-dollar federal bailouts, promised Wednesday to create a legislative commission with broad oversight to investigate the causes of Wall Street irregularities and their full costs to taxpayers.

Pelosi, speaking to the Commonwealth Club of California, said she wants the panel to be modeled after the Pecora Commission, a bipartisan investigative body established by the U.S. Senate in 1932 to examine the causes and abuses of the Wall Street crash of 1929 and to prevent a repeat.

"They investigated what happened in the markets," including conflicts of interests and irregularities that set off such devastating effects on the U.S. economy, she said. When the commission issued its findings during the administration of President Franklin Delano Roosevelt, "they had tangible recommendations," she said, which helped generate widespread public support for major banking system reforms and new securities laws.

Liberals are cheering this move by Pelosi and the Congress because it could result in the same kind of systemic reform we saw after the Depression. And with even the teabaggers angry about the bailouts, Republican leaders would be in little position to mount a defense.

Anyway, I don't know where this will lead, but it seems to me that the banksters have a slightly weaker hand than they did a couple weeks ago. They still have the power to overrun the country, but the anger is rising and Treasury has a few tools in the toolkit; and what's more, they might actually use them.