Comments on the ever-irascible Paul Krugman’s column, “Reagan Did It,” which blames the 1982 Garn-St. Germain Depository Institutions Act for all our current problems.
Here Paul lets his deep hatred of Republicans cloud his judgment, as usual.
I was teaching macroeconomics in 1982 and joked with my students that Reagan was going to ruin the economy for decades to come. All of us junior faculty saw “supply side economics” for what it was—a ruse to lower taxes on rich people—and we knew that once supply side economics failed that Congress would fail to have the discipline to balance the budget. Cutting taxes wins elections, raising taxes loses them. So Walter Mondale’s campaign in 1984 was proof of concept. The poor man at least managed to carry one state, his home state of Minnesota, the exemplar of northern European style socialism in North America. So the fiscal disaster was easy to see coming even back then.
The insolvency of the S&Ls was not as easy to spot from the vantage point of academia (something I know very well now, as a practitioner), but wiser heads like William Seidman did indeed sound the alarm before the sector went bankrupt.
But Paul Krugman turns a blind eye to the very manifest sins of the liberal mafia currently making policy, especially Robert Rubin and his colleagues Larry Summers and Tim Geithner. It is widely agreed that it was the deregulation of the Gramm-Leach-Bliley Act in 1999 that repealed the parts of the Glass-Steagall Act which had not already been repealed, that in large part produced the greatest and most fraud-riddled asset bubble in history, the American real estate bubble of the Oh-Oh Decade that is currently unwinding.
Unfortunately, the pursuit of economic policy seems to have become somewhat “personal,” as the monetary and fiscal authorities, acting well beyond their knowledge or statutory authority, seem to have adopted an underworld style of enforcement. Although I find Independent Accountant’s frequent bigotry offensive and wrong, I do credit his (and Yves Smith’s and Zero Hedge’s) coverage of the backstories of the current chaos, our drift toward financial fascism. Here is his take on recent events:
"The [Fed] directed at least seven of the nation's biggest banks to bolster their capital levels by $65 billion while effectively blessing the stability of six others, marking for the first time a bold line between some of the nation's stronger and weaker banks. ... By contrast, regulators have told Bank of America Corp. it must take steps to address a roughly $34 billion capital shortfall, the biggest gap among its peers. Wells Fargo & Co. needs to find $13 billion to $15 billion; GMAC LLC, $11.5 billion; Citigroup Inc., $5 billion; and Morgan Stanley, $1.5 billion. ... Financial markets seemed to shrug off news of the capital shortfalls. ... Some investors said the news was less negative than many had feared. Others held out the idea that many banks would be able to boost their capital without having to seek fresh government funds. The stress tests--designed to examine individual banks' ability to withstand future losses--helped alleviate the near-panic that investors felt at the beginning of the year as many worried some banks might have to be nationalized. ... 'I think this will be a confidence-instilling announcement,' [FDIC] Chairman Shelia Bair told a Senate panel Wednesday. 'There will be additional needs for capital buffers for some institutions, but I think there will be mechanism to do that within the next six months.' ... Now, some of the stronger banks will be permitted to repay funds borrowed from the government under its [TARP] and escape the related restrictions on compensation and dividend payments. ... Banks are being told to boost their capital not because they are in trouble, but because regulators think they don't have a big enough buffer to continue lending if the economy worsens in the coming months", my emphasis, Deborah Solomon, David Enrich and Damian Paletta (SE&P) at the WSJ, 7 May 2009.
"For nearly three months, more than 150 federal employees have been scrutinizing bank books, questioning bankers' projections and comparing each bank's expectations. The government now knows more about the 19 banks, which represent about two-thirds of all US bank assets, than anyone", my emphasis, David Wessel (DW) at the WSJ, 7 May 2009.
"BofA needs to boost common equity by about $35 billion following the tests. Conveniently, it has about $33 billion of private preferred shares. ... True, forcing a conversion solely on private investors could make it hard for banks to sell preferred into private markets for years to come. ... Meanwhile, amid the euphoria, it is important to remember that switching preferred for common is just juggling capital, not raising new money", Peter Eavis at the WSJ, 7 May 2009.
"A shareholder revolt cost Ken Lewis, [BofA's] chief executive, his title as chairman of the board last week, but yesterday's news that BofA will probably need to raise $34bn in new capital could cost him the other part of his job. ... Jeffrey Sonnenfeld of the Yale School of Management said the latest revelations about BofA's financial condition were grounds for Mr. Lewis' dismissal. ... He added that BofA's acquisition of Countrywide Financial and Merrill Lynch in the past year were handled poorly, especially because Mr. Lewis did not inform BofA's shareholders about the size of Merrill's losses prior to the vote on approving the deal: 'Ken Lewis way overpaid on two acquisitions, and failed to inform his true owners of the status of the purchases he was going to make'," my emphasis, Greg Farell at the FT, 7 May 2009.
"The federal government projected that 19 of the nation's largest banks could suffer losses of up to $599 billion through the end of next year if the economy performs worse than expected and ordered 10 of them to raise a combined $74.6 billion in capital to cushion themselves. The much-anticipated stress-test results unleashed a scramble by the weakest banks to find money and a push by the strongest ones to escape the government shadow of taxpayer-funded rescues. ... But questions remain about the stress tests' rigor, in part since the Fed scaled back some projected losses in the face of pressure from banks. ... The information provided by the stress tests will 'make is easier for banks to raise new equity from private sources,' Mr. [Tim] Geithner said. ... Nine of the stress-tested banks--including titans like JP Morgan Chase & Co. and ... [GSG] as well as several regional institutions--have adequate capital. That finding essentially represents a seal of approval from the Fed. ... The test results were vigorously contested by some banks, which argued they were superficial and didn't reflect significant differences in the health of various banks' loan portfolios", my emphasis, David Enrich, Robin Sidel and Deborah Solomon at the WSJ, 9 May 2009.
"Why did the stress tests treat [GSG] better than Morgan Stanley [MS]? ... As a result of Thursday's stress test, [MS] raised $4 billion in common stock. That shareholder dilution mightn't have been needed if the authorities had come up with stronger earnings generation for [MS]. Were the stress tests' assumptions 'stacked in [GSG's] favor?' asks Michael Hecht at JMP Securities. ... The government documents don't give enough detail to explain the gap. ... Few would argue that [GSG] isn't the stronger of the two, and the government may have its [GSG] projections right. But the numbers appear to bake in the idea that [GSG] is savvier at making money from taking risk. The US had better be right", Peter Eavis at the WSJ, 9 May 2009.
"The [Fed] significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of bargaining. In addition, according to bank and government officials, the Fed used a different measure of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits. ... Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests' rigor. ... [BofA] was 'shocked' when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations. ... At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as 'asinine,' were particularly heated, according to people familar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings. ... With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets. But if they were too soft, the tests could have lost their credibility, defeating their basic confidence-building purpose", my emphasis, David Enrich, Dan Fitzpatrick and Marshall Eckblad (EF&E) at the WSJ, 9 May 2009.
"I've been thinking about stresses. Actually I've been thinking about Treasury Secretary Geithner's stress tests, rosy scenarios, the missing laugh track, the classes of 2009, households, and the automotive giants. ... You see an army of 200 federal examiners had gone over the books and calculated the impact of growing unemployment, asset (particularly real estate portfolio lending) deterioration, potential exposure on other investments, and various personal-credit/ loan write-offs. The unstated goal was to re-assure the general public that our banking behemoths were on solid ground and that there was no reason to fear any 1930's type meltdown. ... It was set up from the get go to advance all of them to the next grade level in the spirit of 'no child (or mega bank) left behind.' Well, guess what? THAT is exactly what happened! ... The worst case scenarios (of what can go wrong, will go wrong) for the coming two years suggested a 'further potential exposure' of a mere $599 BILLION in losses (roughly 5.1% of total assets)", Fred Cederholm (FC) Financial Sense, 11 May 2009, link: http://www.financialsense.com/editorials/cederholm/2009/0511.html.
"Are America's banks: a) healthy, b) insolvent, or c) being kept alive by the government but delighted to pretend otherwise? ... That any bank can sell equity is one big benefit of the stress test. By producing a credible estimate of losses over the next two years--$600 billion--officials have restored some confidence in the banks' word. ... But investors can now buy a bank's shares and be confident that its books are not being cooked flagrantly and that it is not about to be nationalised", my emphasis, Economist, 14 May 2009, link: http://www.economist.com/finance/PrinterFriendly.cfm?story_id=13665327.
"Finally, a stimulus plan Wall Street can get behind. ... But thanks to the government's stress tests, Wall Street is being flooded with fees. A number of the stress-tested 19 financial institutions, whether told by the [Fed] to raise money or to boost their capital cushions or not, are rushing to sell new shares. The 10 that have been told to plug a capital hole have a month to submit a capital-raising plan and than six months to raise the cash. ... What does that mean for Wall Street? Plenty of underwriting fees. ... Add to those offerings [GSG's] sale of $5 billion in common stock last month, and the fees that were generated from TARP bank follow-on deals in the past two months stand at more than $670 million. The big winners? The investment banks of [GSG], [MS], JPMorgan Chase, Barclays, and Wells Fargo and its Wachovia unit, which will share in this fee party, according to Dealogic", Stephen Grocer at the WSJ, 14 May 2009.
"Federal officials have pressured [BofA] to revamp its board by bringing in directors with more banking experience, as regulators place the bank under increasingly heavy government scrutiny. The move represents unusual influence by the federal government over the workings of a financial institution in which it doesn't own a stake. It's particularly significant because many of the bank's woes stem from its purchase of Merrill Lynch & Co.--an acquisition that was completed after heavy prodding by federal regulators. The Merrill deliberations were the beginning of regulators' deepening involvement in the Charlotte, NC, lender's day-to-day operations. ... Prior to those moves, federal banking regulators--the [Fed] and the Office of the Comptroller of the Currency--had signalled to the bank's leadership that such steps would be well received by the federal government. Government officials also suggested that the task of reshuffling the board be led by independent directors, and that the board needed more members with banking expertise", my emphasis, Dan Fitzpatrick and Damian Paletta at the WSJ, 15 May 2009.
Come on SE&P, you can do better than this. How do you know what Zimbabwe Ben (ZB) thinks? Would ZB make a confidence shattering announcement? What do we learn from this? Ken Lewis "rats out" ZB and Hank Paulson, the BofA gets dinged for $34 billion. GSG wants to return its TARP funds, it's fine. How can anyone take these tests seriously? Is the BofA worse off than Citigroup? I have no idea what these tests consisted of. ZB said on television they were not solvency tests. What then?
DW, are you serious? I'll "audit" you comment. Assume 175 of ZB's "finest" worked 50 hours a week for 11 weeks. Further, if they were Big 87654 drones, they would be billed at a $325 per hour weighted average. By the magic of multiplication I get: 175 x 11 x 50 x $325 = $31.3 million. This is my "shadow" Big 87654 stress test price. Last year KPMG billed Citi $98 million, PWC billed BofA $83 million, that's $181 million already! What did the "stress testers" do? My surmise: a whole lotta nuttin'. The Big 87654 should be furious with DW for suggesting ZB & Co. know more about these banks than the Big 87654. On the other hand ...
Has Eavis ever got this right.
Is Sonnenfeld working for ZB?
Beware round numbers. I surmise ZB decided the stress tests' minimum future losses were $600 billion to still have "market cred". Starting with $600 billion, the stress testers job was: allocate losses to favored and disfavored banks, like GSG and BofA respectively. If a bank's losses exceed ZB's projections, can its stockholders sue the Fed as if it was a CPA firm rendering an opinion? Seal of approval? Is the Fed now an underwriter?
Quoted without comment.
Did EF&E read their article? Who wants a Fed which is "responsive to industry feedback"? Isn't that partially responsible for "the crisis"? I'd welcome Wells Fargo's lawsuit. Who knows what discovery might reveal? Regulators "risked angering their constituents". Who are? TBTF bank managements, or the members of Pat Buchanan's pitchfork brigade? The tests were a "confidence-building" measure. The Fed could have saved plenty. It could have asked the DOJ to let Bernie Madoiff run the stress tests in return for a reduced sentence. How about it ZB and Eric Holder? Bernie needs something to do with his time.
Well said FC. FC is an Illinois CPA who is an S&L crisis veteran.
Does the Economist realize it indicted the: Big 87654, SEC, OCC and PCAOB all at once? Ye who favor more regulation, think about this.
It's good to see GSG will get something out of this.
Who does the Fed want added to BofA's board? Vikram Pandit? Lloyd Blankfein? That this is retaliation for Ken Lewis violating the Fed's "omerta" becomes more obvious every day.
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