Single Regulators And The Fed

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

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

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

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

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

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

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

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

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

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

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

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

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

Welcome To The ZIRP

The Federal Reserve cut their key interest rate as low as they can go - virtually to zero, although the bank rate is more like .5%. The investors loved it! Well, today they did, anyway. But this is the final tool in the shed for the Fed, and a zero interest rate policy (or ZIRP!) hasn't shown much success elsewhere in the world:

There's a bit of room left to go, since the rate isn't actually zero, but essentially, the Fed has run out of ability to use standard monetary policy. It's broken and it doesn't work anymore. Deflationary expectations have set in, and folks figure that a dollar a year from now will be worth more than dollar now, so even borrowing at zero or .5% doesn't seem like that good a deal.

As Bloomberg pointed out, the Bank of Japan kept rates at zero for five years, and it did squat. So the Fed has announced that it will use non-standard measures like buying up government backed housing bonds, and is considering buying long term treasuries, whose rates simply aren't dropping, even as people accept negative returns to buy short term securities. (They are doing so because the Fed was paying 1% interest on reserves, and treasuries can be used as reserves, which is why the Fed dropped the amount they pay on reserves to .25%.) [...]

Deflation can always be fixed, in the worst case scenario, the government could just send everyone a gift card for $50,000 which expires in 3 months and tell them to use it or lose it. But it can't be fixed by giving money to banks who won't lend it to the real economy, and even pushing down long bond rates really isn't going to matter as long as there are deflationary expectations.

So, expect the Fed to spend a LOT of money and get very little in return until someone uses some of the money to buy a clue. In the meantime, remember, you're probably going to have to pay this money back, no matter how little it does, unless the government manages to make itself go bankrupt. In theory the US need never go bankrupt, but a lot more of this, and it may turn out to be the lesser evil.

Paul Krugman calls it the liquidity trap - the Federal Reserve can't create a short-term shock to get the economy going at all, and the banks can't be prodded to lend, and the quantity of money is meaningless because bonds are worth essentially just as much. The Fed is also planning quantitative easing, basically increasing the money supply. But when money is the same as bonds, what's the difference? As Ian says, we're exploding the deficit and getting little in return.

The other worry is deflation; consumer prices fell at a record rate last month, which means that retailers can't sell enough to make a profit, which means they cut jobs, which means less people have money, and prices have to drop to sell anything, etc. Nasty business. While Kevin Drum notes that the drop in prices is entirely due to cheaper oil, taking that out of the equation there was virtually no change in inflation, which is unsustainable.

The textbook tells us to engage massive fiscal spending, as nobody is equipped to spend at all right now except for government. But Robert Reich is absolutely correct, IMO, that spending won't be enough.

Keynesianism is based on two highly-questionable assumptions in today's world. The first is that American consumers will eventually regain the purchasing power needed to keep the economy going full tilt. That seems doubtful. Median incomes dropped during the last recovery, adjusted for inflation, and even at the start weren't much higher than they were in the 1970s. Consumers kept spending by borrowing against their homes. But that's over. The second assumption seems even more doubtful: that, even if middle-class Americans had the money to continue the old pattern of spending, they could do so forever. Yet the social and environmental costs would soon overwhelm us. Even if climate change were not an imminent threat to the planet, the rest of the world will not allow American consumers to continue to use up a quarter of the planet's natural resources and generate an even larger share of its toxic wastes and pollutants.

The current deep recession is a nightmare for people who have lost their jobs, homes, and savings; and it's part of a continuing nightmare for the very poor. That's why we have to do all we can to get the economy back on track. But many other Americans are discovering they can exist surprisingly well buying fewer of the things they never really needed to begin with. What we most lack, or are in danger of losing, are the things we use in common -- clean air, clean water, public parks, good schools, and public transportation, as well as social safety nets to catch those of us who fall.

That's why it's not enough to spend, spend, spend, until the housing market comes back or everyone gets excited about the latest iGadget again. Indeed we need to create a new economy that is not based so heavily on unsustainable consumer spending. President-elect Obama has the right idea in talking about a green economy - not only would the money spent go into something of value, like the commons, but the emphasis on green technologies could spur innovation and perhaps generate something we can export for a change. Right now America is the number one exporter of raw materials in the world - we make precious little, give away our material wealth and do nothing but consume. When you strip away the CDOs and the CDSes and the subprime lenders, THAT's the problem. We're a bubble-based economy out of necessity. Without re-industrializing America, without making products the rest of the world wants, that will never change.

James Boyce has more, and believe me, I gave you the GOOD news.

The Meltdown

Inflation outpaced wages in June and consumer spending plummeted. Inflation, in fact, rose at its highest one-month level since 1981. That's going to go down somewhat in Juy, because gas prices have decreased. But we're still looking at stagnant wages, increasing unemployment, and no end in sight to the housing crisis. The economy is in the shitter.

Paul Krugman looks at this today.

The good news, I guess, is that we’ve been experiencing a sort of slow-motion meltdown, lacking in dramatic Black Fridays and such. The gradual way the crisis has unfolded has led to an angels-on-the-head-of-a-pin debate among economists about whether what we’re suffering really deserves to be called a recession.

Yet even a slo-mo crisis can do a lot of damage if it goes on for a year and counting.

Home prices are down about 16 percent over the past year, and show no sign of stabilizing. The pain from this bust is widely spread: there are millions of American families who didn’t buy mortgage-backed securities and haven’t lost their houses, but have nonetheless been impoverished by the destruction of much or all of their home equity.

Meanwhile, the job market has deteriorated even more than you’d guess from the jump in the headline unemployment rate. The broadest measure of unemployment, which takes into account the rapidly rising number of workers forced to take cuts in paid hours and wages, has risen from 8.3 percent to 10.3 percent over the past year, roughly matching its high point five years ago.

And there’s no end to the pain in sight.

While economists debate statistical analyses, people out in the country are hurting. In particular I worry about the underemployed, those part-time workers who can't string enough jobs together to survive. They're not traditionally counted in the employment statistics, and yet they're as much of a problem as the "underinsured" are in the health care crisis.

Krugman thinks another stimulus package may be in order, along the lines of what Barack Obama has proposed. But clearly, the sputtering economy has to become more of a focus of the campaign.

Incidentally, it’s surprising that the lousy economy hasn’t yet had more impact on the campaign. Mr. McCain essentially proposes continuing the policies of a president whose approval rating on economics is only 20 percent. So why isn’t Mr. Obama further ahead in the polls?

One answer may be that Mr. Obama, perhaps inhibited by his desire to transcend partisanship (and avoid praising the last Democratic president?), has been surprisingly diffident about attacking the Bush economic record. An illustration: if you go to the official Obama Web site and click on the economic issues page, what you see first isn’t a call for change — what you see is a long quote from the candidate extolling the wonders of the free market, which could just as easily have come from a speech by President Bush.

Obama actually stepped in the right direction on this today. He needs to realize he's in a fight instead of hovering above on some plane of post-partisanship.

Sunny Days For The Economy

While Bush and the Republican Party talk up how technically not horrible the economy is, Ben Bernanke spoke just like a whiner on Capitol Hill yesterday.

Warning of the risks of a further slowdown and higher inflation, Ben S. Bernanke, chairman of the Federal Reserve, offered a gloomy assessment of the economy on Tuesday as President Bush, speaking a few blocks away, urged Americans to have faith in the country’s financial foundation.

In testimony before the Senate Banking Committee, Mr. Bernanke avoided the word “recession” in characterizing the current economy, noting instead that consumer spending and exports were keeping growth “at a sluggish pace” while the housing sector “continues to weaken.”

He added that spending for personal goods had “advanced at a modest pace so far this year, generally holding up somewhat better than might have been expected given the array of forces weighing on household finances and attitudes.”

While the risks to the overall economy were still “skewed to the downside,” he said, inflation “seems likely to move temporarily higher in the near term.”

As if on cue, the consumer price index jumped up yesterday at the fastest rate in 17 years, mainly due to rising energy prices. And Bernanke didn't see any hope on that horizon, either:

In his testimony, he was especially pessimistic about any easing of energy prices, dismissing suggestions that they were being driven by speculation in futures markets. Instead, he said high energy costs reflected the markets’ recognition that demand was outstripping supplies.

“Over the past several years, the world economy has expanded at its fastest pace in decades, leading to substantial increases in the demand for oil,” Mr. Bernanke said. “On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years.”

I think there's a slight amount of speculation in the markets, but we're reaching a fundamental truth about oil, that production either is peaking or has peaked, and that we need an actual plan for getting off the carbon economy instead of cries of "Drill More!" for a product whose supply is diminishing.

The economy is basically everyone's #1 or #2 issue headed into the election. This NPR/Kaiser Foundation poll looking at economic issues in Ohio and Florida shows that 89% of residents in those two states think that the economy is "not so good" or "poor." Can 89% of the people be wrong? Sure, if they're all a bunch of whiners like Phil Gramm keeps saying. Of course, well over 89% of the country didn't buy the porn films he helped produce, so maybe he's just bitter.

The big picture is that the failed conservative policies of socializing risk and privatizing profit has caught up with them. They failed to react to bubbles in the housing market and practically forgot about regulation, and homeowners were screwed. They let insurance companies discriminate against their customers and saw 47 million Americans join the ranks of the uninsured. They sought bailouts for financial institutions who made bad decisions but not the homeowners who bore the greatest impact from them. They didn't respond to rising energy demand and sought only to raise profits for their oil company pals. They ran up huge deficits, borrowed for the future from China, and stratified inequality so much that it looks like a new Gilded Age. And now, they want to elect a man as President who will gladly carry out the same policies and further privatize the economy and tear at the social safety net.

(I'm glad that the DNC is taking on McCain on Social Security, by the way. Here's the video:)



It's time for a change.

Most Dangerous Trouble Spot In The World Update

Pakistan has seen yet another deadly attack today.

Bombs exploded at a federal police building and in a residential area of the eastern city of Lahore on Tuesday, killing at least 15 people and wounding many more, police said.

The Federal Investigation Agency in downtown Lahore was devastated by a bomb planted near an elevator, said Mirza Mohammed Yasin, an FIA official in the capital, Islamabad. At least a dozen people died, said Mohammed Afzal, a Lahore police official.

Three more died in a second bombing at a house in an upscale residential area, Afzal said. It was not immediately clear who lived there.

The militants engages in these attacks are trying to influence the country in a way they couldn't at the ballot box. It's doubtless that their numbers are being fed by increasing uneasiness and anxiety with the economic situation in the country. As the US recession inevitably goes global, this will become yet another obstacle to global stability, particularly with respect to food and energy prices. We're going to see global poverty spike on a massive scale. Relating specifically to Pakistan, this was more likely the cause of Pervez Musharraf's electoral failure than any widespread yearning for freedom or democracy. People vote with their pocketbooks.

With consumer prices for basic goods hitting new highs in Pakistan, anxieties about the country's economy are also on the rise. After seeing five years of strong gains under the government of President Pervez Musharraf, officials are scaling back expectations for growth in the face of wrenching food and energy shortages.

The crisis has taken a severe toll on Musharraf politically -- public frustration with rising prices helped the opposition win big in parliamentary elections last month. Now those parties, the Pakistan People's Party and a faction of the Pakistan Muslim League led by Nawaz Sharif, must confront the unpleasant task of managing the crisis. Economists here say a surge of foreign investment and export growth are needed.

It's the poor and the middle class being affected. Which has led to this weak position for Musharraf, one that will be exploited by the incoming government, which plans to join forces to reinstate judges over Musharraf's protests. When or if this will happen is another story.

It is up to Mr. Musharraf to convene Parliament. On Friday, at a time when agreement between the two parties seemed somewhat distant, the president said he would call the Parliament in 10 days “if there was peace in the country.”

And again we see the attacks inside Pakistan as something Musharraf needs to survive politically. Could this be why the US government, which is nominally backing Musharraf's continued hold on power, is funding tribal militias who have questionable allegiances?

The outpost's defenders belonged to Pakistan's Frontier Corps, an 85,000-member tribal militia that, according to the latest Pentagon budget, is set to receive up to $75 million in training and equipment this year, the first injection of what could be more than $400 million to be delivered over the next several years. Beyond this, little is known about the plan, the details of which remain classified. As reported by the New York Times, a 40-page secret document called "Plan for Training the Frontier Corps" is currently being circulated at the U.S. Central Command, awaiting final approval by its commander, Admiral William J. Fallon, and other senior defense officials. The use of the Frontier Corps in the fight against Taliban and Al Qaeda fighters in Afghanistan augurs a new approach to dealing with rising Islamic fundamentalism in Pakistan's tribal region. Like U.S. plans to fund it, the Frontier Corps has largely escaped scrutiny, but there are questions about its allegiances, competence, and suitability to the proposed mission. Support for tribal militias has become a centerpiece of the U.S. strategy in Iraq, one that carries with it inherent risks in terms of inadvertently backing potential enemies in the pursuit of short-term security goals. Supporting the Frontier Corps is similarly dicey.

My feeling is that trying to pursue an "Anbar Awakening" inside the frontier areas is simply, in the short term, pushing the Taliban/militant forces deeper inside Pakistan. Where they plot and carry out more attacks, giving Musharraf more of a reason to crack down and maybe impose martial law again. I could be wrong, but it does seem that Musharraf and the militants are mutually sustaining. In the long term, bolstering the Frontier Corps seems to be to be lunacy, ripe for blowback, and simply horrendous policy.

Becoming The Third-World Country We Seek

Apparently the fact that our money is worthless globally is now a plus:

The U.S. dollar's slump on world currency markets boosts sales prospects for U.S. exporters but could mean higher prices for American consumers already smarting from rising food and energy costs.

A weak dollar increases the chances of higher inflation. That could put the Federal Reserve in a tough position of having to choose between tolerating rising inflation or raising interest rates to curb it — even if that makes the emerging economic slowdown worse.

Cheap exports for the world, rising inflation, an enormous inequality gap - hey, when did we become Mexico?

Well, this is what you get when you have essentially unregulated capitalism driven by greed, and a systematic destruction of the federal agencies tasked with oversight. Massive deficits didn't help either; we've borrowed so much that our money has become worthless. The dollar has gone down because the Fed has been so concerned with keeping a lid on this mortgage crisis that interest rates have been cut. But when the dollar goes down, commodity prices go up, which means inflation as those rising prices are passed to the consumer.

There are, in short, a lot of pitfalls in this economy right now, and the options are simply poor.

UPDATE: This is funny.

So right after the Bear Stearns funds blew up, I had a thought: This is what happens when you lend money to poor people.

Don't get me wrong: I have nothing personally against the poor. To my knowledge, I have nothing personally to do with the poor at all. It's not personal when a guy cuts your grass: that's business. He does what you say, you pay him. But you don't pay him in advance: That would be finance. And finance is one thing you should never engage in with the poor. (By poor, I mean anyone who the SEC wouldn't allow to invest in my hedge fund.)