Shadow Government

If you want to know why weakening the Federal Reserve is gaining traction in Congress, take a look at this unbelievable report from Bloomberg:

The Federal Reserve Board has rejected a request by U.S. Treasury Secretary Timothy Geithner for a public review of the central bank’s structure and governance, three people familiar with the matter said.

The Obama administration proposed on June 17 a financial- regulatory overhaul including a “comprehensive review” of the Fed’s “ability to accomplish its existing and proposed functions” and the role of its regional banks. The Fed was to lead the study and enlist the Treasury and “a wide range of external experts.”

Some top central bank officials, after agreeing to the review, saw a potential threat to Fed independence after the Treasury released the proposal, two of the people said. The Obama plan said the Treasury would consider recommendations from the review and “propose any changes to the Fed’s governance and structure.”

Keep in mind that the Fed already has refused to disclose its assets, its balance sheet or its dealings with other banks and investment firms. Now the Treasury Department - the federal agency most directly in charge of the banking sector - asks for a review of the structure of the Fed, just simply how it organizes itself. And the Fed, whose chairman is chosen by the White House, said no.

Simply put, this is a runaway organization. We cannot expect it to be a credible partner on setting bank pay limits, for example, when it is intimately tied to the largest US banks, the CEOs of whom make several orders of magnitude more money than their global counterparts. Obviously those compensation limits will come up short, because a shadowy temple of an organization holds this tremendous, unaccountable power over the financial system.

Paul Krugman may think the Fed is now getting it - perhaps out of fealty to Ben Bernanke - but from where I sit, this is an unelected nation state with the arrogance of a dictator. They need to be brought to heel.

Where's My Pitchfork?

At a time when economic news, including today's report on retail sales, has dampened hopes of a recovery this year and raised the near-certainty of double-digit unemployment, we can all comfort ourselves with the great success of Goldman Sachs:

Comfortably beating analysts’ forecasts, Goldman Sachs earned second-quarter net profits of $3.44 billion, or $4.93 a share, the bank announced on Tuesday.

The results continue a robust turnaround for the firm since it rode out the final tumultuous months of last year with the aid of a federal rescue. They come just one month after it paid back its $10 billion in federal aid.

Goldman’s profit was lifted by record quarterly revenue of $6.8 billion in its fixed income, currency and commodities unit, where mortgage and other credit instruments are traded, the bank said in a statement. This business has performed well since the bank has taken on greater levels of risk since the end of last year.

Its equity underwriting business also generated record net revenue, worth $736 million in the second quarter, it said, as Goldman benefited among other things from a rush by other troubled banks to issue shares and raise their capital levels.

“We are performing well across the board,” said David A. Viniar, chief financial officer, who said the strong performance reflected “blocking and tackling every day” by Goldman’s employees.

Glenn Greenwald ably details the extraordinary actions taken on behalf of Goldman Sachs during the financial crisis right on through until today, so I need not repeat them. Even if they had not done so, Goldman would be in an excellent position to capitalize on the failures of other firms because of the implosion of Lehman Brothers and Bear Stearns - their competition has been euthanized, essentially. But that wasn't enough. They were allowed to change themselves into a bank holding company to qualify for Federal Reserve largesse. They received billions in federal money passed through AIG to pay off on their credit default swaps, putting them in a better position that any other US financial institution. They used their contacts throughout government to get favorable terms and handouts in virtually every program aimed at rescuing the financial system.

And to this day, the Treasury Department refuses to answer Congressional queries about accepting the recommendations of bailout auditors, nor will the Federal Reserve divulge the whereabouts of the trillions of dollars in funds they've let out since last September. I have a feeling that we'd throw an even bigger fit if we had more transparency. But what is already known, frankly, is enough.

In a related story, like everyone else I recommend Michael Lewis' article on AIG and Joseph Cassano in Vanity Fair. It focuses on understanding the past crisis rather than the credibility crisis we now face as a consequence of bailing out banks over people, but it's worth reading.

Actually, I Don't Want Your Bailout

I have about 30 posts I want to write about the developments of the past week and a half, but I want to try and alleviate the confusion over that Washington Post article stating that the Obama Administration spurned a request for aid for the state. Outside of Zoe Lofgren, a Congresswoman, nobody is named in this request, nor is the request defined. It refers late in the article to one letter from Bill Lockyer to Tim Geithner that appears to reference federal loan guarantees, which is, again, not a bailout. And the Governor has tried to rule out borrowing to deal with the cash crisis anyway. So I question whether anyone has discussed any kind of dollar transfer from the federal government to California at all. I think this article hangs on an extremely thin reed.

Now, I do think the government should consider offering loan guarantees, to stop the gouging of California going on from Wall Street. But I do not think that California progressives should WANT a "bailout" in the more traditional sense. It sounds like it would be a nice and tidy solution, and maybe the strings attached could make it easier for the state to get its business done. But that's very speculative, and so we have to consider who such a solution would bail out. Clearly, it would bail out the failed Democratic legislature for refusing to lead and take a long-term view on reforming the state governmental process to allow a return to stability. We know that, with revenues dropping like a rock, in six months the projections will fall short again. They have for about 15 straight months. Which means what, another bailout? That simply isn't a long-term, sustainable solution. Some may say that it would keep the poor from dying, but it seems to me it would only delay such an outcome. Heck, we know that California last issued IOUs during a budget crisis in 1992, during a MILD recession. The structure of state finances simply means that we will lurch from crisis to crisis forever without a permanent fix.

We have solutions and we know what they are; there's really no mystery, other than the fact that legislative Democrats refuse to dare speak their name. A federal band-aid would delay those solutions once again, as they have been delayed for 30 years. We simply will never fix this if we keep deferring the California dream and persuading others to mop up the mess caused by failed leadership.

More generally, a while back on Calitics (can't find it right now) I argued for a permanent federal fiscal stabilization fund that could be tapped if deficits hit a certain percentage. States could contribute with a federal match at 6:1 or something. We need to permanently end the paradox of state budget cuts during an economic downturn, and it should not be a stopgap fix. If people want the federal government to help, it should be mechanized and durable, and enhance economic recovery by kicking in when recovery is needed.

This may be a contrarian view, but I think a bailout would delay the changes desperately needed, nor would it even help the most vulnerable in society over the long-term or even the short-term. We need to deal with the problem at hand.

Myths and Falsehoods About The Backstop

When the traditional media followed the lead of the Hooverists on the right and started calling California's desire for federal loan guarantees to secure short-term borrowing a "bailout," which it isn't, support for the measure collapsed. But not only was California seeking a solution to being gouged by bankers and investors, but other localities would like the option as well, putting the lie to the notion that California seeks "preferential treatment." In fact, other localities want a simple payback to cover losses to their municipal bonds from the Lehman Brothers meltdown, which would cost far more to the Feds than a loan guarantee program. Moody's has downgraded the ENTIRE muni bond sector, not just California, so the costs have gone up across the board. Overall, there is an acknowledgement that the recession has made borrowing costs too exorbitant, and backing from the Feds could save municipalities billions at no cost to the government.

All of the proposals are meant to help struggling state and local governments that are facing a cash-flow squeeze. The economic downturn has eaten into their tax bases as local businesses shut, houses are lost to foreclosure and there is a resistance to raising taxes. The risk to the federal government is that it could lose money if things get worse for municipalities and states. Although backing debt with a guarantee does not require an immediate outlay of funds, the federal government could have to cover losses if there are defaults — which could be substantial if the economy weakens or states and municipalities cannot bring their budget deficits under control. Nonetheless, these overtures by state and local officials reflect a sense — perhaps just a hope — that municipalities suffering from a downturn in revenues and creditworthiness may find some relief in Washington beyond the stimulus money the federal government already is spending.

Emphasis there on "could." Those who know the market and understand it admit that California, and all the other states, would certainly repay the bondholders. The state has never missed a payment in its history, and bond repayment has a stronger priority in the California constitution than most other states. All the bond analysts I've seen say uniformly "California's not going to default." Not to mention the fact that the savings from being rescued from out-of-control interest rates would leave more money available to aovid cuts.

"There's simply no better stimulus than guaranteeing state and local bonds, particularly those that are being used to get through the crisis and avoid layoffs," said Rep. Brad Sherman, one of 15 Democrats in California's House delegation who signed a letter earlier this month asking for the federal loan guarantee.

Plus, supporters of the idea note that Washington stands to make a profit from loan fees as it did after bailing out New York City in 1975, a move that brought the city back from the brink of ruin [...]

"We are not asking for a bailout," said state Assembly Speaker Karen Bass, a Los Angeles Democrat. "We're asking for the federal government to step in where commercial banks can't this year because of the crisis within the financial industry."

In other words, the state didn't create the economic crisis, they didn't create the financial crisis, and they shouldn't be unable to secure normal short-term borrowing because of either.

Also contrary to the myths in the media, the federal government has NOT foreclosed this option whatsoever. The Treasury has been somewhat noncommital on the specifics, but agreed in broad terms that the municipal bond market needs to work better than it does today. In addition, Tim Geithner had this warning for the wordsmiths on the right and in the media:

But, according to a Bloomberg News account of the speech, Mr. Geithner cautioned: “I wouldn’t use the word bailout.”

The GM Bankruptcy

The offer to GM's bondholders was even punier than the offer to Chrysler's. And the bondholders predictably rejected the offer. So off we go into another bankruptcy. Under the terms of the deal, the government would take a much higher stake than they did with Chrysler.

The latest plan for the troubled automaker, which is expected to file for bankruptcy by Monday, calls for the Treasury Department to receive about 70 percent of a restructured G.M.

Including the more than $20 billion that has already been spent to prop up G.M., the government will provide G.M. at least $50 billion to get the company through Chapter 11, people with direct knowledge of the situation said Tuesday. By some estimates in Detroit, tens of billions beyond that amount may be required.

The United Automobile Workers, meanwhile, will hold up to 20 percent through its retiree health care fund, and bondholders and other parties will get the remaining share. Shareholders would be virtually wiped out.

Because of the publicly traded nature of the company, this will be a long and complex bankruptcy filing, unlike Chrysler, which appears to be moving right along. The government would be a silent partner, hoping to sell their shares as soon as the carmaker gets back on its feet.

Taxpayers will have invested around $50 billion into GM before this is over. I'm trying to understand how this makes sense. That's a lot of money to put into the hopes of the Chevy Volt. Maybe you can see this as an extension of the stimulus, saving another million or so jobs by keeping the architecture of the auto industry, and its suppliers, in place. That's about the only way I can stomach it.

The Backstop Is Not A Bailout

I heard a bunch of California Republicans yesterday talking about the effort to get the US Treasury to backstop state borrowing as a "bailout," and the media has fallen for it, using phrases like "California is too big to fail" and other snickering.

This is ridiculous.

Let me explain this fairly clearly. California will need to borrow billions of dollars to cover their cash flow issues, the same way they do every year. Traditionally, the money comes in at different times then the money goes out, necessitating short-term borrowing. Because of the state's miserable credit rating, the interest rates that investors charge for this borrowing are ridiculously high. Usually, banks guarantee those loans, but this year they are balking because of the severity of the state's fiscal picture. So the state has asked the Treasury to step in and guarantee the loans instead.

This would cost the Treasury Department approximately $0.00 dollars to perform. Providing loan guarantees simply means that you are insuring against default, which has never happened in the history of California. Not through the Depression or at any other time. What this would do is stop Wall Street from gouging the state with abnormally high interest rates, pure and simple.

Here are the words of an idiot:

Rep. Jerry Lewis (R-Redlands) predicted little sympathy for the Golden State on Capitol Hill. "I have the feeling that it's going to be a long time before Washington decides that they're going to ask Kansas or Wisconsin to help with California's funding problem," he said.

Nobody would be helping anybody. The federal government would guarantee loans that California would pay back. This is about lowering interest rates to make the price of short-term borrowing lower.

I understand that President Ford rejected these types of loan guarantees for New York City in the 1970s. But later he approved them. By the way, after that so-called "bailout," every single dollar was repaid by the city of New York. How on earth could this be characterized as a bailout?

The Ford Administration, under the direction of Treasury Secretary William Simon, imposed certain conditions on the loan guarantees (which will actually delivered directly by Treasury, so this is somewhat different). That could also happen here, and the Shock Doctrine possibilities are not pleasing. Still and all, this savings (which would only represent about $1 billion dollars in all, 1/20 of the current deficit) would not cost the federal government one red cent and thus shouldn't be used to cram down California in a punitive way. The possibility exists, but it's worth the risk.

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.

Stress Tests - Victory For The Oligarchs

Congratulations, everyone! We ended the banking crisis because the biggest banks only need $65 billion in new capital!

The findings, to be released Thursday by the Obama administration, suggest that the rescue money that Congress has already approved will be enough to fill the gaps. If so, the big bailouts for the banks may be over.

All of this assumes that the economy does not take another turn for the worse, which would result in even more losses at the banks — and the need for even more money to prop them up. But hopes that the tests will be a turning point in this financial crisis electrified Wall Street on Wednesday and some overseas markets the next day. Financial shares soared, lifting the broader American stock market to its highest level in four months. The Dow Jones industrial average rose 101.63, or 1.2 percent, to close at 8,512.28 Wednesday, while Japan's Nikkei index rose more than 4 percent by midday Thursday [...]

After news this week that Bank of America and Citigroup would be required to bolster their finances again, word came Wednesday that regulators had determined that Wells Fargo and GMAC, the deeply troubled financial arm of General Motors, would need to do so as well. But regulators decided that American Express, Capital One, Bank of New York Mellon, Goldman Sachs, JPMorgan Chase and MetLife would not need to take action. The official word is due at 5 p.m. Thursday.

So no great shakes, just $65 billion or so, which can easily be accomplished through the conversion of government preferred shares into common stock. And Bank of America, the bank in the biggest trouble, may only be in the situation they're in because they were forced to eat Merrill Lynch despite the negative impact on the firm. Good job on that one, Henry Paulson!

Kevin Drum is confused. It's not just that circumstances haven't changed, but hard data from economists around the world show the banks to be much worse off than the stress tests display.

All I can say at this point is that I'm baffled. If Geithner is right, then everything is fine and the banking system was never really in very big trouble. $65 billion is nothing. But if the IMF is right, American banks are nearly $300 billion short. If Nouriel Roubini is right, the shortfall might be even greater.

So who is right? I have no idea. "All Americans should be confident that these institutions are going to be viable institutions going forward," Geithner said tonight, and I sure hope that's the straight dope. But these discrepancies are simply too large to wave away. Somebody is way, way off base, and I'd sure like to know who it is.

We actually know this already. The stress tests were simply not that stressful. We can see that in the sentence in the Times beginning "All of this assumes that the economy does not take another turn for the worse." That's the POINT of a stress test! Regulators were supposed to look at how the banks would react to stress. Not to mention the fact that the banks lobbied for new results to the stress tests after the initial data were released.

Anyway, the Treasury announced that they would serve as a backstop for any bank that showed difficulty raising the necessary capital. So no stress! Simon Johnson and James Kwak argue that we've reached a place of co-dependency between the government and the banks.

Since February, however, the government has clearly communicated that it has no such intentions, for example in Geithner’s insistence that “the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.” Even as the capital shortfall numbers have leaked out over the past few days, the government has emphasized that no banks will actually be allowed to fail, or even be allowed to be put into a conservatorship; instead, they will first attempt to raise capital from the private sector, and failing that they can convert their TARP preferred stock into common stock. Even if this results in significant government ownership, there is no evidence that shareholders or creditors will be forced to take losses. As rfreud said in a comment here, “The stress tests results are confidence-building in that they signal the low likelihood of nationalization or seizure. Reform at the moment seems a distant prospect.”

In short, relationships between the government and the large banks have never been closer, with large amounts of money flowing in one direction, and complete co-dependency going in both directions. Those relationships are not entirely friendly, which is not surprising. In any crisis when public resources are called on to bail out the private sector, not all of the oligarchs will survive; Bear Stearns and Lehman have already vanished. But the winners - which should include Jamie Dimon of JPMorgan Chase and Lloyd Blankfein of Goldman - will emerge even more powerful and influential than before.

In rejecting “nationalization” (regulatory takeover and conservatorship), the government has not ensured a private, properly functioning banking system. Instead, it has muddled into a broken-down, undercapitalized system that is nominally in private hands, but is able to tap the state for apparently limitless support. And to date, that support has flowed on one-sided terms, with the taxpayer accepting downside risk but limited upside potential. No wonder bank shareholders are comfortable with this outcome.

Not only that, but the recent consolidation due to those banks and investment firms that failed has led to higher market shares for those that survived. All that cheap money from the government means higher profit margins on the back end. The banks are comfortable with this approach - they don't have to care about their overall health, they retain their power with the government, and they collect a nice bonus at the end of the year.

If that's success, well, I'd hate to see failure.

Why Don't You Just Make The Check Blank

It really has been comical to see the leaks of the stress tests trickle out, first with full confidence in the strength of the banks, then less, then less, and now a situation where Bank of America needs $34 billion dollars. Their total market capitalization right now is only $70 billion. The word "insolvent" comes to mind.

The government has told Bank of America it needs $33.9 billion in capital to withstand any worsening of the economic downturn, according to an executive at the bank.

If the bank is unable to raise the capital cushion by selling assets or stock, it would have to rely on the government, which has provided $45 billion in capital through the Troubled Asset Relief Program.

It could satisfy regulators’ demands simply by converting non-voting preferred shares it gave the government in return for the capital, into common stock.

But that would make the government one of the bank’s largest shareholders.

The company has certain assets they could sell, if anyone's in the market for a bank right now. But the most likely scenario makes the US government a near-controlling interest in Bank of America. Citigroup, which already has converted government preferred shares to common stock, needs an additional $10 billion or so, according to this report. It's not all that reassuring to hear BofA spokesmen claim that they'll be able to make $30 billion a year in income once the recession clears, which I think is more than Exxon.

Unfortunately, this is a fight that's already lost, Obama dinners with Paul Krugman aside. The banks will not be nationalized, and most likely they will be propped up until the crisis lifts. Geithner and Summers have their reasons for this, and the Administration doesn't see Congress playing along with anything that might damage the banksters too heavily (see cramdown) or allocating the money that would be needed for a restructuring. Mike Lux offers a couple post-TARP solutions that I think make sense:

The first is to really invest in long-term organizing and institutional building on the finance issue. While it is disappointing that Obama hasn't used this economic crisis and the populist anger it invoked to more fundamentally change the system that brought us to this pass, it's not like finance issues are going away or recede in importance in years to come. Now is the time to build institutions with the grassroots, political, and intellectual firepower to battle the banks in the years to come. We clearly have a stable of economists and business people who get what is going on, including George Soros, Joseph Stiglitz, Paul Krugman, Dean Baker, Rob Johnson, Simon Johnson, Leo Hindery, and others. What we need is long term institutional political power to build the constituency that will fight this fight effectively.

Just as importantly, we need to work constructively with the Obama administration to be prepared with a plan B if what they are doing begins to show significant weaknesses. If, as we restructuring advocates fear, the Geithner/Summers plan does not work to rebuild the economy, and/or the plan is gamed by the big banks to create other AIG bonus style scandals, Obama will be forced to turn to a plan B. If that happens, as I wrote a few weeks ago, progressives should avoid going into I-told-you-so mode, and instead be ready with a strong progressive plan that they can push with the administration. The economic thinkers listed above ought to be working together right now to come up with a strong plan B option. If we can keep a constructive dialogue going with the White House, and mobilize our friends in Congress and in the media, such a plan has a chance of being adopted.

I'll begin this new constructive arrangement by saying that I really like one aspect of the government's new plan - the idea that banks who want to return TARP money must cut themselves off from all the rest of the government largesse they receive to keep them afloat.

Banks that want to return Troubled Asset Relief Program funds will have to demonstrate their ability to wean themselves off another major federal program, according to senior government officials, making it less attractive for some banks to return the money.

The other program, a guarantee of debt issuance offered by the Federal Deposit Insurance Corp., allows firms to borrow money relatively inexpensively. Banks have $332.5 billion of debt outstanding under this program, which began last fall.

If you don't need assistance, prove it. Either you stay on the government dole or leap off. And either way, the government will regulate you in the future so you can't borrow using 30-1 leverage and take up half the national economy. If this is the result, I can basically live with it. But of course, this only applies to those few banks healthy enough to weather the storm. The Bank of Americas of the world? We're going to need a Plan B for them.

Stress'd

Arianna Huffington delivers the verdict on the Administration's stress tests before they come out later this week, and it's hard to argue with her:

For starters, why the holdup in releasing the results? It's been ten days since the Treasury Department and the Fed let the banks in on the preliminary results of the tests. So how come the public -- you know, the ones who keep bailing out the banks -- are still, ten days later, in the dark?

The reason is, the banks are using this time to negotiate how much information about their portfolios the hoi polloi will be privy to, and are trying to get the government to reconsider its analyses (which are already iffy, since they are based on the banks' own estimates and on assumptions about the economy - including unemployment rates, and cumulative real estate and credit card losses -- that are hardly stress-inducing). This is the equivalent of a teacher giving a student a look at his grades and allowing the student to try to cut a better deal before report cards are sent home to mom and dad [...]

And then there is the trouble with the assumptions at the heart of the stress tests. As Nouriel Roubini put it: "These are not stress tests but rather fudge tests... The results of the stress tests -- even before they are published -- are not worth the paper they are written on."

Nassim Taleb agreed: "This stress test is the equivalent of testing the Brooklyn Bridge by running a single heavy truck on it."

The ongoing horse-trading between the banks and the government has only exacerbated the mistrust, creating what the New York Times' Andrew Ross Sorkin, appearing on Charlie Rose, described as a lose-lose:

"Either you are going to be very realistic, perhaps even too realistic for many people, and you're going to suggest that some of these banks really are insolvent...or you're going to decide that the entire process is a whitewash and you're going to have no confidence in the test to begin with."

The fact that the releases, in absence of official information, have moved from all the banks being well-capitalized to now 10 of them requiring more funding simply destroys whatever positive spin will be overlaid on the eventual release. What some call "requires more capitalization" I call "insolvent," and needing a restructuring of their debt to flush out the toxic waste. Yet that option, as Arianna notes, has been taken off the table. Administration leaders insist that all capital requirements can be met through the private sector and no additional interventions from the government will be necessary. That may be the case on the surface, but considering that multiple government lending programs currently exist that save banks billions of dollars, it doesn't really mean anything. In fact, the web of government largesse outside of direct capital infusions going to the banks suggests a far too cozy relationship between the banksters and the policymakers:

The Federal Reserve Bank of New York shaped Washington's response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed's chairman, Stephen Friedman, sat on Goldman's board and had a large holding in Goldman stock, which because of Goldman's new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They've since risen $1.7 million in value.

Mr. Friedman also was overseeing the search for a new president of the New York Fed, an officer who has a critical role in setting monetary policy at the Federal Reserve. The choice was a former Goldman executive.

Of course, only the bankers understand the economy, so we should just shut up and let them raid the Treasury.

As Simon Johnson notes, this adds up to a major credibility problem for the Treasury Department.

In any case, this is a serious problem for Treasury’s optics. After long negotiations, the bank stress tests were set to show most banks are close to have their Goldilocks level of capital (i.e., just right) Given that we generally agree (and the President has long stressed) this is the biggest financial crisis since the Great Depression, we seemed to be on the the verge of a capital adequacy miracle.

But instead of this being seen as some combination of good luck and smart policy, ”everyone is basically fine” would look like the banks are running the show. My Treasury friends swear up and down this is not true, but that is now beside the point. Whatever the reality, it looks increasingly to everyone like the banks really are in charge. It’s a nasty rule of politics that you are damaged by where perceived blame lands, rather than by what you actually do.

Perhaps the normal ebb and flow of the business cycle will mask over this continued giveaway to Wall Street interests. But Obama has long said that the financial industry must shrink in size and prestige relative to the economy. I see no way for that to happen in the current environment, which means we'll still be chasing bubbles well into the future, at the expense of ordinary Americans.

...Roubini and Richardson in the WSJ:

The hope was that the stress tests would be the start of a process that would lead to a cleansing of the financial system. But using a market-based scenario in the stress tests would have given worse results than the adverse scenario chosen by the regulators. For example, the first quarter's unemployment rate of 8.1% is higher than the regulators' "worst case" scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year -- the stress test's worst possible scenario for 2010 [...]

Stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway.

I just feel like there's no political will to do this, however necessary it may be.

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.

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.

CA-32: My Calitics Interview With Emanuel Pleitez

The CA-32 race to replace Labor Secretary has less than six weeks to go until the primary. We know about the two major candidates; Board of Equalization member Judy Chu (not to be confused with Betty Chu, who will appear directly above her on the ballot and surely cause some errors among voters) and State Senator Gil Cedillo, whose extreme spending of campaign contributions on shopping, meals and lavish hotels made the LA Times this weekend and caused a stir.

Somewhat less remarked-upon has been the candidacy of Emanuel Pleitez, a product of East Los Angeles and Woodrow Wilson High School, who matriculated at Stanford, joined the advisory board of Voto Latino (a group that encourages voter registration and engagement for the Latino community), worked for Democratic lawmakers like Antonio Villaraigosa, Tom Daschle and Hillary Clinton, and worked on the Obama transition team at the Treasury Department. On Friday I had the opportunity to chat with Pleitez about his life experiences, the financial crisis, housing policy and a host of other issues. A paraphrase of that conversation follows.

(As a side note, this story about one of the volunteers on the campaign, who traveled all the way from Santiago, Chile to work on it, is pretty amazing.)

Calitics: Tell me about your experiences that have brought you to this run for Congress.

Emanuel Pleitez: You know, after college and working in the private sector at Goldman Sachs, I was able to travel a lot. And I think visiting 27 countries gave me a new perspective on what the challenges are out there in the world. When I would go to South Africa or India, China, Brazil, I would visit the universities, and the slums, and see their struggles, and it really made me think about the issues of global poverty. I even drove a taxicab in Myanmar! And what I took away from all that is that the best way to create change is to start in your own backyard. And that's what we're doing in this campaign.

Calitics: So how are things going?

EP: Well, we have 25 full-time staff working every day. And our main focus is door-to-door, face-to-face contact. We're out canvassing every day. A lot of people tell me that they think we're the only candidate in the race, because we're the only one they see. So we feel pretty good about our position.

Calitics: Now, you worked on the transition in the Treasury Department, and one central concern that a lot of people have had with Treasury is the lack of staffed positions at the undersecretary level, and the belief that Tim Geithner has basically had to go it alone over there. How should people look at the transition's performance in that respect?

EP: I agree with that criticism of Treasury. I had nothing to do with personnel, I worked in other departments. But there are many reasons for the lack of senior staff, and I wouldn't discount the ability and importance of the career civil servants working in the Department, who are doing a fantastic job.

Calitics: This week, the Congressional Oversight Panel released a preliminary report on the TARP program and Treasury's performance, and they were highly critical of the lack of transparency and clarity over some of these programs, as well as a lack of accountability for the big banks. How would you assess the various programs offered to this point?

EP: I don't have all the details of the COP report. My inclination is to defend Secretary Geithner, but I want people to be critical. I think what he's trying to do is return confidence to the markets and get credit flowing again, and we're seeing signs that the plans are starting to work.

Calitics: How would you approach the situation with the banks. Would you just recapitalize them forever, or seek a Swedish-style receivership or a liquidation of the insolvent firms?

EP: I would consider a receivership, but I wouldn't make that the first thing on the table because of the expense involved and the danger to the markets. But clearly, recapitalization alone won't work, that's just making capital disappear.

Calitics: What's the biggest problem in the economy that we're facing at this point?

EP: The biggest problem is the foreclosures right now. Some of them are in rural districts are suburbs and they're second, third and fourth homes, but for families in urban districts like mine, a foreclosure means the loss of everything you've got.

Calitics: Would you support bankruptcy judges being able to modify the terms of a primary loan for borrowers? Isn't there a problem with modifying securitized loans, in that the people holding the securities that have been modified can sue the loan servicers for illegally changing the terms of the security?

EP: That is a problem. But as I understand it, cram-down is more of a threat to incentivize loan modifications and keep people in their homes. Which is what we have to do. Investors will get hurt anyway if the loan forecloses. Somehow, the lenders and the investors and the home-owners have to come to an accommodation, and in that process the primary goal should be keeping people in their homes. I wasn't initially open to principal write-downs, but I am more so now, because we're seeing that the interest-only modifications are not working, and people are being forced into foreclosure just a few months later.

Calitics: What are some of the other challenges facing the economy that you want to deal with in Congress.

EP: Obviously, we still need major stimulus to save jobs and transition into a new economic future. A large part of my district is at or near the poverty rate, and we need help in these tough economic times. I expect another trillion dollars to be spent by the government. In my district, we need investments in public transportation and clean energy programs to reduce emissions and create manufacturing jobs. There's a program here called "La Gausa," which targets the high school dropout rate, and gets those kids into vocational programs for green jobs, whether it's solar panel installation or something like that, so that they can be prepared for the 21st century economy. We need more of that. And we need investment in education, because any dollars spent get the greatest return in education.

Calitics: Do you plan on joining any ideological caucus in Congress?

EP: I haven't really given it much thought, but I don't think so. I think all political is local, and I'd rather focus on helping my local community and responding to the concerns of my district. Maybe I'll join the Congressional Hispanic Caucus, that should be safe for me. (Laughs.)

Calitics: Well, thank you for talking to us today.

EP: Thank you.

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.

Stop The Legalized Theft

Alan Grayson has a controversial idea: rich corporate executives should stop stealing public money.

I introduced a bill - the 'Pay for Performance Act' - to put an end to this theft. It's on the House floor today. It bans unreasonable and excessive pay to employees of financial institutions that are running on taxpayer money. The bill is based on two simple concepts. One, no one has the right to get rich off taxpayer money. And two, no one should get rich off abject failure. If the government owns a chunk of a bank, that bank must pay its employees reasonably, and all bonuses must be performance-based.

But first, let's be clear about what has happened. The government owns stakes in many companies through the TARP program, and Congress tried to put executive compensation restrictions on those companies. Big banks, though, were able to carve out an exception for any contract signed before February. AIG executives drove a truck through that exception and stuffed their pockets with our money. This bill closes that loophole [...]

Everyone agrees that Congress must act to reign in these excesses. These bad banks have come close to destroying our economy. They did so to enrich the small group of employees who made horrible, and in some cases, illegal bets. Calling these bad banks "casinos" is a disservice to casinos, who must actually by law hold money to back all the bets they've taken in. Calling these con artists "bank robbers" is a disservice to bank robbers, who can only steal as much money as the bank holds at the time, without tapping into taxpayer funds, too.

It's time for action, and Congress is acting.

Jane Hamsher has the rundown of the conservative howling on the floor of the House. I believe there's a case to be made that the government shouldn't be setting compensation targets for private firms. But the sad truth is that none of these firms are private anymore. Many are almost completely reliant on public money, and so long as the government is a top shareholder, they ought to be able to set the rules to protect their investment.

London is overrun with protesters right now, with thousands of people demanding a change to the rules of global laissez-faire capitalism which have nearly destroyed this economy, and Republicans can go ahead and stick their fingers in their ears and choose not to hear it. I would not advise the Obama Administration to do the same, however. And there are some very disturbing signs. Picking as number two at Treasury the guy who wrote the law deregulating the banks, for example. And putting the taxpayer on the hook for several trillions of dollars solely to save the financial system, often in total secrecy, too. Joseph Stiglitz' op-ed today gets right to the point:

Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency [...]

Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan. After all, the F.D.I.C. has taken control of failing banks before, and done it well. It has even nationalized large institutions like Continental Illinois (taken over in 1984, back in private hands a few years later), and Washington Mutual (seized last September, and immediately resold).

What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.

So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.

But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.

Even if this thing works in the short term, we will have lost because the behemoth of the financial sector will be restored to its former glory. The need is to restructure and re-balance the economy.

...Grayson's bill, the Pay For Performance Act, passed the House by a vote of 247-171. Check out Grayson's floor speech. "We should not be paying arsonists to put out his own fire." Nice.

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.

More Regulatory Authority? How About Using What You've Got

At their joint hearing with the House Financial Services Committee, both Tim Geithner and Ben Bernanke advocated for regulatory authority over non-bank financial institutions. I'm trying to get a handle on this. First of all, the investment banks all went under this past fall, so Goldman Sachs, under current law, is a bank. JP Morgan is a bank. So is Merrill Lynch. AIG stands out as the exception to the rule, but regulating their PRODUCTS would seem to be the key, not granting emergency authority to seize them. What's more, states regulate insurance companies, and while I think there ought to be a federal overseeing authority, that could get messy. And as you'll read below, the financial products unit did have federal oversight. Then there are hedge funds and the like, but again, I see the regulatory needs in the product line and not necessarily the ability to seize. FWIW here's Bernanke's argument:

The decision by the Federal Reserve on September 16, 2008, with the full support of the Treasury, to lend up to $85 billion to AIG should be viewed with this background in mind. At that time, no federal entity could provide capital to stabilize AIG and no federal or state entity outside of a bankruptcy court could wind down AIG. Unfortunately, federal bankruptcy laws do not sufficiently protect the public's strong interest in ensuring the orderly resolution of nondepository financial institutions when a failure would pose substantial systemic risks, which is why I have called on the Congress to develop new emergency resolution procedures. However, the Federal Reserve did have the authority to lend on a fully secured basis, consistent with our emergency lending authority provided by the Congress and our responsibility as central bank to maintain financial stability. We took as collateral for our loan AIG's pledge of a substantial portion of its assets, including its ownership interests in its domestic and foreign insurance subsidiaries. This decision bought time for subsequent actions by the Congress, the Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve that have avoided further failures of systemically important institutions and have supported improvements in key credit markets.

Yves Smith sounds the right notes in her skepticism.

AIG, poster child of insufficient regulation, was overseen at the parent level (which is where the black hole creating Financial Products unit sat) by the Office of Thrift Supervision (no joke), which is an agency of the Treasury! So the Treasury is acting like it needs more authority to prevent future AIG's when its own agency was responsible for the doomsday machine part of AIG.

And the hedge fund supervision bit probably means less than meets the eye. Even if a lot of them have operations in Fairfield County or Manhattan, a lot are domiciled in the Caymans or Luxembourg. You do need to observe certain forms to make sure the designation sticks (have local counsel, have annual meeting there, etc.) but after the Bear Stearns hedge funds screwed up on that front (setting up funds there but not taking other steps consistent with having them domiciled offshore), other funds may have cleaned up their act [...] The problem is not regulatory authority, the problem is the lack of a special resolution regime of the sort the UK has for putting big complex financial firms into receivership. Merely giving Treasury authority is insufficient without putting in place needed bankruptcy type provisions [...] Given the lack of any mention of a special resolution regime, or intent to develop one, the point of this bill is NOT, appearances to the contrary, to be able to put more firms into receivership. It is to get broader authority to bail them out.

After the events of last week, Congress has little appetite for giving Treasury or the Fed more authority. Steny Hoyer shot it down today. Regulations are nice, but regulatory will appears to be what's lacking here, and giving the same people who want to bail out the whole sector with no strings attached more power doesn't seem advisable.

Regulatory Authority For Treasury

There's one theory that this public-private plan for bad assets was attractive to the Administration because it can be carried out without Congressional input. Clearly the environment in Congress would not necessarily generate legislation authorizing more money for the Treasury, and so structuring it as a loan, which the FDIC and the Fed already have the authorization for, makes a bit of sense.

It makes some political sense. Obviously, Obama thinks the big fight on the Hill will be the budget, and would rather not get distracted with months of a protracted battle over the banks. In the end, however, you can't hide from Congress. And if more statutory authority is required, maybe the Administration ought to go get it.

The Obama administration is considering asking Congress to give the Treasury secretary unprecedented powers to initiate the seizure of non-bank financial companies, such as large insurers, investment firms and hedge funds, whose collapse would damage the broader economy, according to an administration document.

The government at present has the authority to seize only banks.

Giving the Treasury secretary authority over a broader range of companies would mark a significant shift from the existing model of financial regulation, which relies on independent agencies that are shielded from the political process. The Treasury secretary, a member of the president's Cabinet, would exercise the new powers in consultation with the White House, the Federal Reserve and other regulators, according to the document [...]

The administration's proposal contains two pieces. First, it would empower a government agency to take on the new role of systemic risk regulator with broad oversight of any and all financial firms whose failure could disrupt the broader economy. The Federal Reserve is widely considered to be the leading candidate for this assignment. But some critics warn that this could conflict with the Fed's other responsibilities, particularly its control over monetary policy.

The government also would assume the authority to seize such firms if they totter toward failure.

I actually would vote against this, and I'll tell you why. The goal shouldn't be to seize companies engaging in what amounts to banking. It should be to end the shadow banking system, permanently. Similiarly, I like the systemic risk regulator idea, but instead of overseeing companies that are "too big to fail," we should probably just break them up, and put a ceiling on how much of the economy they can involve themselves in. We need to shrink the financial sector relative to the economy. I fail to see how these steps get us there. In fact, they perversely allow for a bigger role for the financial sector, because of the safeguards.

The Administration's on the right path here, but still not all the way down the mountain. Furthermore, everyone neglects the regulatory laws on the books already that just need to be enforced more broadly.

...Kevin Drum thinks this is another step to get the authority for nationalization, which is certainly possible.

Buying Off The Banksters

My college friends and I used to call anything this truly horrific a-good.

The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks.

The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.

To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.

I don't have to rehash the arguments against this idea, just link to them. Basically, the government will subsidize investors to overpay for bad assets, meaning that cash will simply flow from taxpayers to banks. Instead of shrinking the wealth and value of the financial sector relative to the greater economy, this plan would keep it in place. The White House clearly sees paying off the banksters as equal to saving the economy, making the solution far more expensive than the problem, especially considering that this probably won't work. John Cole sums it up:

The Illness- reckless and irresponsible betting led to huge losses
The Diagnosis- Insufficient gambling.
The Cure- a Trillion dollar stack of chips provided by the house.
The Prognosis- We are so screwed.

At this point, the only thing we should offer a significant class of banksters is a plea deal. Instead Geithner will preserve the institutions.

If you want to truly fill yourself with dread, consider that the Federal Reserve started buying mortgage-backed securities as early as August 2007, bought up a bunch more in January, and just announced the purchase of even more THIS WEEK. And yet Treasury needs to eat some of this crap as well. That's how many of these little buggers are out there.

OK, I'm going to go watch college basketball and slowly rock back and forth.

...Me again. James Kwak hits on something, connecting for me the Geithner plan to modify loan terms, thus reducing the value of mortgage-backed securities by definition, and this TALF plan, which would overpay for them well above their true value. The investors of the MBS could actually sue under the Takings clause of the Fifth Amendment, if structured improperly. What a fucking mess.

Dodd Was Pushed - Who Pushed Him?

Chris Dodd's "admission" that he was asked by unidentified Administration officials to take out the limits on executive compensation and bonuses from the stimulus package is being treated like a bombshell, for reasons which escape me. Let's start with his statement (via email):

“I’m the one who has led the fight against excessive executive compensation, often over the objections of many. I did not want to make any changes to my original Senate-passed amendment but I did so at the request of Administration officials, who gave us no indication that this was in any way related to AIG. Let me be clear – I was completely unaware of these AIG bonuses until I learned of them last week.

Reports that I changed my position on this issue are simply untrue. I answered a question by CNN last night regarding whether or not a specific date was aimed at protecting AIG. When I saw that my comments had been misconstrued, I felt it was important to set the record straight – that this had nothing to do with AIG.

Fortunately, we wrote this amendment in a way that allows the Treasury Department to go back and review these bonus contracts and seek to recover the money for taxpayers. Again, I have led the fight to curb excessive executive compensation, and will continue to do so.”

Dodd is classier than whatever Administration official tried to rat him out on this. But the fact remains that Dodd devised the amendment capping bankster salaries, authored it, got it passed through the Senate, and then someone in the White House asked him to nix part of it, which he did, reluctantly, while keeping in the forward-looking language. And by the way, this was all public knowledge in the run-up to the conference committee on the stimulus. I fail to understand how there could be a grand conspiracy on such a well-covered subject.

The only question that remains is: Who?Who asked Dodd to take out the amendment?

The anti-bonus provision has been the subject of several posts in the liberal blogosphere today, after an anonymous administration official was quoted in the New York Times Sunday appearing to place the blame on Dodd for the weakening of the language.

Jane Hamsher cites two contemporaneous articles on the stimulus that identify top administration opposing to Dodd's original, tougher language. This one from the Wall Street Journal reports that Timothy Geithner and Lawrence Summers "had called Sen. Dodd and asked him to reconsider."

And this one, from The Hill, says President Obama himself wanted changes in the provision.

If those reports -- both anonymously sourced -- are accurate, contacts with Dodd occurred well above the "staff level." Something tells us we'll be hearing more about this.

The reporters from the WSJ and The Hill who anonymously sourced their stories could actually shed the most light on this by simply giving up their sources, but of course that's not going to happen. So we wait. Tim Geithner or Larry Summers have an opportunity to clear their names as well.