Friday, July 31, 2009

Deepest year-over-year postwar slump

First four consecutive quarters of real GDP decline since 1947. This is probably pretty close to a bottom turning point, stabilization, if the pulse of the postwar economy has not stopped.  The next collapse, not yet visible over our one-year forecasting horizon, will probably take us into deeper depression, as we are not “liquidating” (charging off, making those who created the losses eat them) our bad debts, but piling them almost-dollar-for-bad-debt dollar onto the taxpayers, who are already staggering under a mountain of household, and state and federal government debt.  This is a prescription for collapse.  The “animal spirits” are still struggling upward and will do so even if unemployment goes to 12 percent.  This is unfortunate, as it will encourage the authorities to do nothing.  Unless there is a currency crisis that is in nobody’s interest to precipitate my models suggest the economy will expand on fiscal fumes until about 2013, plus or minus a couple of years, and then there will be a repeat debt-deflation and accompanying currency collapse.  If we experience another quarter of negative real GDP growth all bets are off.  The debt-deflation has gained sufficient momentum to overwhelm “animal spirits.”  The next “animal spirits” update will be next Friday or Saturday. 


For a discussion of how long it can take to deleverage on a national level, see Steve Keen’s discussion of the Australian case at .  h/t Yves

Thursday, July 30, 2009

Tarp banks award billions in bonuses

A million dollars is 20 years of a median family income.

Via:  FT 

By Greg Farrell in New York

Published: July 30 2009 18:18 | Last updated: July 30 2009 21:46

Citigroup and Merrill Lynch, which lost $55bn in 2008, between them paid 1,400 employees bonuses of $1m or more each, according to a New York state report, released on Thursday, on banks propped up with taxpayer funds.

  Bonus breakdown

  See details of Tarp recipients’ bonus payments click through

The study, compiled by Andrew Cuomo, New York attorney-general, showed that JPMorgan Chase and Goldman Sachs, which both finished in the black last year, paid the most million-dollar bonuses - 1,626 and 953, respectively.

However, the totals at a profitable bank such as Goldman were nearly matched by two of the year’s biggest losers on Wall Street. Citi, which suffered a $27.7bn loss, paid million-dollar bonuses to 738 employees. Merrill, which lost $27.6bn, paid 696 bonuses of $1m or more.

“There is no clear rhyme or reason to the way banks compensate and reward their employees,” Mr Cuomo said. “Compensation for bank employees has become unmoored from the banks’ financial performance.”

Republican Edolphus Towns, head of the House committee on government oversight and reform, pledged to hold hearings in September on the matter, suggesting the controversy over bankers’ bonuses is likely to continue later this year.

Earlier, Mr Cuomo had detailed the number of million-dollar bonus payments made at Merrill in the last days of 2008, before it was acquired by Bank of America. In his new report, sent to Mr Towns’ committee, Mr Cuomo detailed the number and size of bonuses at eight other banks that received billions from the federal troubled asset relief programme fund last October.

JPMorgan, which earned $5.6bn in 2008, set aside a total of $8.7bn for bonuses. The report shows that JPMorgan paid out bonuses in excess of $3m to more than 200 employees The bank received $25bn in Tarp funds last year and paid the money back last month.

At Goldman, the bonus pool last year was $4.8bn, more than twice the $2.3bn it earned for the year. Goldman paid $3m or more to 212 employees. The bank paid back $10bn in Tarp funds last month.

Citigroup set aside $5.3bn for its bonus pool, and paid bonuses of $3m or more to 124 employees. Like Bank of America, Citigroup received a total of $45bn in Tarp funds in 2008 and has recently converted some of that funding into common equity.

BofA paid bonuses of $3m to 28 employees and million-dollar bonuses to 172. The Charlotte, North Carolina, bank reported a profit of $4bn in 2008 and set aside $3.3bn for bonuses.

Morgan Stanley earned $1.7bn last year and set aside $4.5bn for bonus payments. The firm paid bonuses of $3m to 101 employees and million-dollar bonuses to 428. Morgan Stanley received $10bn in Tarp funds last year, and paid back the money in June.

Among the other banks in Mr Cuomo’s report, Bank of New York Mellon paid 74 million-dolllar bonuses, Wells Fargo paid 62 and State Street paid 44.

Wednesday, July 29, 2009

The coming squeeze on consumption: we ain’t seen nothin’ yet

Consumption spending has nowhere to go but down.


Average C/GDP is 64.7 percent.  In 2009Q1 the ratio was 70.5 percent—still over 70.0 percent on the fall in GDP despite about a 2 percent drop in consumption from it peak in third quarter 2007.  Consumer debt service as a percent of disposable personal income is up about 25 percent from 1980, to about 14 percent of disposable income.  One out of every six or seven dollars of the Americans family’s take-home pay goes to interest.  Using the more inclusive Financial Obligations Ratio, one out of every five dollars goes to financial payments.

The federal debt held by the public also increased dramatically from 1980, when the “supply side miracle” failed and the federal government taught Americans how to borrow heavily, with federal debt held by the public rising from 25 percent to now over 50 percent of GDP (data to 2009Q1), forecasted to rise to over 60 percent in coming quarters.



Increases in personal taxes to pay for bank bailouts and social programs will reduce disposable personal income.  Consumption spending hasn’t begun to revert toward mean values supported by income rather than debt, let alone adjusting for increased taxes.

Interest expense at the federal level will increase with the increasing debt, and over time, with increasing interest rates.  The average federal interest expense is 6.0 percent of GDP since 1939.  According to TreasuryDirect, the average interest rate on federal debt is now 3.5 percent.  A 1 percentage point increase across the yield curve would increase interest expense, cet. par., by over 25 percent, or about 1.5 percent of GDP.


And finally, don’t forget that the saving rate out of disposable income is expected to remain elevated as part of the new frugality, by four or five percentage points.

Adding it all up, a decline in consumption spending on the order of eight or ten percent doesn’t appear unlikely.




“The Federal Reserve Board has released revised data for the Household Debt Service Ratio from the first quarter 1980 to the present. According to the Federal Reserve Board, recent developments
in credit markets necessitated changing some of the sources used to calculate the ratio.
There are new sources for the distribution of loan types and for student loans, as well as updated
sources for loan maturities and interest rates. The change has shifted the level of the ratio down
but the movement has stayed roughly the same. The new release no longer shows consumer debt and
mortgage debt separately.”  The data is quarterly to 2009Q1.

Break up the Fed (then abolish it)

An op-ed in the WSJ of all places is saying pretty much what I wrote to my elected representatives in Fire Bernanke, Audit and Abolish the Fed.  Take actual banking regulation away from the eggheads and away from New York City.  Set up a bank examination agency somewhere in fly-over land and staff it with people who actually know banking.  The loans that were booked during the real estate bubble were laughable.   “Purchase money seconds”?  “Zero down”?  “Negative am”?  Please!  Any responsible banker of a generation or two ago would—and many did—gag on this crap.  It is encouraging that the article below appeared in the Wall Street Journal. 

The next step is to demolish B of A, Citi, JP Morgan, HSBC and Wells, all of whose balance sheets are probably jokes.  See Regulatory reports show 5 big banks face huge loss risk.  The “fortress balance sheet” of JPM is riddled with worthless derivatives, probably.  Time for a new sheriff who will take on the oligarchs and knock down their houses of cards.  These banks have been run like hedge funds and deserve to be dismantled and put under new leadership.  This is the kind of banking that Glass-Steagall and the other reform legislation of the early thirties sought to abolish, and that Larry Summers et al. brought back because “markets are self-regulating.”   

The sooner the President understands that the pitchforks aren’t just for the bankers, and gets rid of the Wall Street players who have ripped off the American public (Summers, Geithner, Bernanke for starters)—and embraces really radical financial reform and some pay-back of the banking bailouts, the better the President’s chances of political survival are.  Because asset values probably haven’t hit bottom, and the public won’t stomach any more bailouts, so more big losses are probably coming for the banks with lots of derivatives.

Via:  WSJ

Let’s Break up the Fed

The Federal Reserve has done a terrible job at financial regulation. Why give it more power?


The Obama administration’s plan to increase the powers of the Federal Reserve, says one critic, is like giving a teenager “a bigger, faster car right after he crashed the family station wagon.” Treasury Secretary Timothy Geithner disagrees. He argues that the Fed is “best positioned” to oversee key financial companies, and that the Obama plan would give the Fed only “modest additional authority.”

Mr. Geithner is right about one thing: The Fed’s power is already vast.But it wasn’t even well-positioned to supervise the likes of Citicorp. Broadening the Fed’s responsibilities won’t help. Instead, we should think of how best to dismantle an overextended Fed.

Though advanced economies like ours require organizations capable of taking on a wide range of activities, there are limits. As Frank Knight, the great Chicago economist, pointed out in his 1921 classic “Risk, Uncertainty, and Profit,” individuals who control large organizations have to delegate many decisions to subordinates. Entities like hedge funds, where individuals such as George Soros make most of the consequential choices, are exceptions.

Therefore, good judgments about people—picking the right subordinates, refereeing staff conflicts, evaluating performance, and so on—are crucial.

Good judgment requires experience, not just exceptional intelligence or raw ability. Although many lessons about managing people can be applied to different fields, good judgment also requires some specific expertise. You can’t manage plumbers without knowing something about plumbing.

Unfortunately no one can learn everything about everything. Yes, Lou Gerstner turned around IBM without any prior experience in the computer business. But he had decades of general management experience, was an exceptionally quick study, and had to come up to speed in just one industry. Individuals who can learn how to effectively lead conglomerates, especially during periods of transition, are exceedingly rare.

This mismatch between what even the most talented minds can learn and the challenges of controlling widely disparate businesses has helped bring our financial system to the brink of collapse. The great names in finance once had distinctive identities and capabilities: Salomon Brothers was the champion in bond trading; Merrill Lynch’s thundering herd was tops in retail brokerage; Morgan Stanley and J.P. Morgan’s white-shoe bankers built formidable blue-chip client lists; and Bear Stearns’s PSDs—poor, smart and driven staff—cultivated scrappy entrepreneurs. Willy-nilly diversification turned these focused outfits into highly leveraged, unwieldy agglomerations of unrelated fiefdoms.

Likewise, the Fed has been incapacitated by its transformation into an omnibus enterprise with responsibilities ranging from boots-on-the-ground regulation to high-level monetary policy. The Federal Reserve Act of 1913, which created the Federal Reserve System, did so to forestall financial panics rather than pursue macroeconomic policies. The gold standard defined monetary policy. The Fed was merely meant to “provide an elastic currency” by serving as lender of last resort in times of crisis. The Act also assigned the Fed routine responsibilities for maintaining and improving the financial system—examining banks, issuing currency notes, and helping clear checks.

The adoption of Keynesian and monetarist ideas by central bankers and elected officials subsequently cast the Fed in a proactive macroeconomic role. William McChesney Martin, who served as chairman from 1951 to 1970, said that the job of the Fed was “to take away the punch bowl just as the party gets going.” This might have been wise in theory, but it wasn’t mandated by the law. In 1977, an amendment to the 1913 Act explicitly charged the Fed with promoting “maximum” employment and “stable” prices. The Humphrey-Hawkins Full Employment Act that followed in 1978 mandated the Fed to promote “full” employment and while maintaining “reasonable” price stability.

Legislation also has increased the Fed’s responsibilities for overseeing the mechanics of the financial system. The Bank Holding Company Act of 1956 gave the Fed responsibility over holding companies designed to circumvent restrictions placed on individual banks. It was tasked with regulating the formation and acquisition of such companies.

Congress further tasked the Fed with enforcing consumer-protection and fair-lending rules. The Fed was made the primary regulator of the 1968 Truth in Lending Act that required proper disclosure of interest rates and terms. Similarly, the Community Reinvestment Act of 1977 forced the Fed to address discrimination against borrowers from poor neighborhoods.

The expansion of bank holding companies into activities such as investment banking and off-balance-sheet exposures to complex instruments such as credit-default swaps also required the Fed to increase the scope of its supervisory capabilities.

In principle, an exceptionally talented theorist might capably run a Fed focused just on monetary policy. Setting the discount rate and regulating the money supply are centralized, top-down activities that do not require much administrative capacity. But without deep managerial experience and considerable industry knowledge, effective chairmanship of a Fed that relies on far-flung staff to regulate financial institutions and practices is almost unimaginable. The vast territory the Fed covers would challenge the most exceptional and experienced executives.

As it happens, the Fed has been led for more than 20 years by chairmen who had no senior management experience. Prior to running the Fed, Alan Greenspan started a small consulting firm and Ben Bernanke was head of Princeton’s economics department. Given their understandable preoccupation with monetary and macroeconomic matters, how much attention could they be expected to devote to mastering and managing the plumbing side of the Fed? While the record of the Fed’s monetary policy has been mixed, its supervision of financial institutions has been a predictable and comprehensive failure.

The Fed’s excessively broad mandate also has thwarted accountability. The CEOs of Citibank, AIG, Bear Stearns, Lehman and Countrywide are all gone—albeit with too much delay and with no clawback of unmerited compensation. At the Fed, no high-level heads have rolled. Mr. Geithner was promoted to treasury secretary. Mr. Bernanke is treated with great deference as he solemnly testifies that if it weren’t for the Fed, the crisis would have been much worse. But then, how can anyone be held responsible for failing at a job no human could do?

At the very least we should split the monetary policy and regulatory functions of the Fed, as was done through the Maastricht Treaty that established the European Central Bank. What we need now is a debate about how to break up the Fed—and some of the sprawling financial institutions it supervises—in order to make both the regulator and the regulated more manageable and accountable.

Mr. Bhidé, a visiting scholar at Harvard, is the author of “The Venturesome Economy” (Princeton University Press, 2008). He is currently writing a book about the financial crisis.

Monday, July 27, 2009

The end of the end of the recession—the beginning of depression?

Great set of charts from Zero Hedge and David Rosenberg under Creative Commons license (nice!)>

The End of the End of the Recession

Note to Tyler and David (entered as comment at ZH):

by Anonymous
on Mon, 07/27/2009 - 09:42

It was so good until... you blew it:

"Reagan's lesson" was that you could use fake economics ("supply side" fairy tales) to justify more "government by greed"--lowering taxes on rich people.

You miss the point! The rich have manipulated the system from taxes to trading to clubby CEO compensation! AMERICA HAS FALLEN TO GOVERNMENT BY GREED AND MANIPULATION! THE SHARE AND SHARE ALIKE SOCIAL CONTRACT HAS BEEN DESTROYED! When you talk about "Reagan's lessons" you're siding with the bad guys! The libertarian solution at this point is totally heartless. You're still in love with your money.

Come up with a better plan. The rich in America need to give back a little. We need a new social contract. Read Strauss and Howe's The Fourth Turning for starters.

Fire Bernanke, Audit and Abolish the Fed

Thank you for using Mail System.

Message sent to the following recipients:
Representative XXXXXXXX
Message text follows:

Benign Brodwicz

July 27, 2009

[recipient address was inserted here]

[recipient name was inserted here],

The Fed has caused two depressions by excessive credit creation, and made
them worse by mismanagement.  The Fed has pulled off the most massive
expropriation of working taxpayers to the benefit of the rich in American

Abolish the Fed.  Take the regulation of the banking system away from the
Fed.  Establish an examination agency somewhere other than New York, say,
in Omaha.

Reverse the bailouts.  Raise marginal tax rates on the rich.  Stop America from
becoming a neo-feudal society.  It's already a banana republic.


Benign Brodwicz

Friday, July 24, 2009

States Forced to Cut Services to the Bone: The Opportunity Cost of the Bank Bailout

Via: Huffington Post  If you haven’t written and called your Congressional rep’s and your President, it’s past time to do so.  Arianna Huffington should like the Benign Brodwicz program for the economy.

Okay, the bailout of Wall Street isn't going to end up costing us $23.7 trillion dollars, the number that special inspector general Neil Barofsky fired off to call attention to the fact that banks are misusing the trillions we've given them, and are still hiding untold amounts of toxic assets off the books -- aided and abetted by the who-needs-transparency Treasury.

But we have pumped at least $4.7 trillion into the financial sector -- and the pumping isn't over. On Wednesday, Fed chair Ben Bernanke told the Senate Banking Committee that it "may be appropriate" for the government to guarantee the "mountains" of commercial real estate mortgage defaults the banks will likely be facing in the coming months.

At a certain point, these numbers are so huge it becomes hard to keep them in perspective, to be clear what $4,700,000,000,000 means in the real world. But reading about the effects of the massive budget cuts almost every state in the country is being forced to make puts the figure in perspective very fast.

And it reminds us, once again, how lopsided the "recovery" has been: with banks that received billions in taxpayer handouts now reporting massive profits and setting aside record amounts for executive bonuses, and the American people continuing to face 9.5 percent unemployment, 10,000 foreclosures a day, and vital services being cut.

So while Goldman Sachs crows about its $3.44 billion second-quarter profit, and Citigroup and Bank of America strut over the $3 billion and $2.4 billion they respectively earned, we are left to think about the opportunity cost of the trillions we have given to Wall Street -- to ponder what else we could have done with that money.

Consider: at least 39 states have imposed budget cuts that hurt families and reduce vital services to their most vulnerable residents. The litany of those affected includes children, the elderly, the disabled, the sick, the homeless, the mentally ill, as well as college students and faculty, and state government workers.

America's states are facing a projected cumulative budget gap of $166 billion for fiscal 2010. Even more budget gaps are expected for fiscal 2011. Total shortfalls through 2011 are estimated at $350 billion to $370 billion -- and could be even higher if unemployment continues to rise.

These are massive numbers. But when you remember that we spent $180 billion to bail out AIG ($12.9 billion of which went straight to Goldman), you realize that that alone would be more than enough to close the 2010 budget gap in every state in the union. Toss in the $45 billion we gave to now-making-a-profit Bank of America and the $45 billion we gave to now-making-a-profit Citigroup and we are well on the way to ensuring that no state's vital service are cut through 2011.

But instead that money has gone to the banks without any fundamental reform of the system, and without any strings attached about how much they had to turn around and lend to help the real economy recover. Or, indeed, without any strings attached about having to tell us what they did with our money. So all across the country the fiscal ax is falling.

According to a report by the Center on Budget and Policy Priorities, at least 21 states have made cuts to public health programs, 22 states have cut programs for the elderly and disabled, 24 states have cut aid to K-12 education, and 32 states have cut assistance to public colleges and universities.

The devastation is in the details:

In California, around 500,000 children face being denied health coverage due to cuts in a welfare-to-work program.

Minnesota has eliminated a program that provides health care to 29,500 low-income 21 to 64 year olds.

Rhode Island has eliminated health insurance for home-based childcare providers.

Maine has cut funding for homeless shelters.

Maryland has cut funding for a school breakfast program.

In Tennessee, an estimated 30,000 to 40,000 seriously ill people are expected to lose hospitalization and other needed medical services.

In Washington, between 7,000 and 17,000 residents will no longer qualify for a public health care plan for people living just above the poverty line.

Utah has cut Medicaid funding for physical therapy, occupational therapy, and speech and hearing services for adults.

Michigan, Nevada, California and Utah have dropped coverage of dental and/or vision services for Medicaid recipients.

Alabama has canceled services that allow 1,100 seniors to stay in their own homes and avoid being sent to nursing homes.

Georgia has cut back on programs that offer the elderly Alzheimer services, drug assistance, and elder support, and made a $112 million cut in an initiative designed to help close the gap in funding between wealthy and poor school districts.

Arizona has cut cash assistance grants for 38,500 low-income families.

Louisiana has made cuts that could keep mentally ill individuals from receiving the medication they need to manage their conditions.

Nevada will make it harder for low-income families to receive cash assistance and health insurance.

Virginia has decreased payments for people with mental retardation, mental health issues, and problems with substance abuse.

Illinois has cut funding for child welfare and youth services programs.

Connecticut has cut programs that help prevent child abuse and provide legal services for foster children.

Massachusetts has ordered cuts in geriatric mental health services, and prescription drug assistance, and made cuts in Head Start, universal pre-K programs, and services to help get special-needs children ready for school.

Keep in mind, all these services are being cut at a time when more and more people are finding themselves in need of them.

It's a perfect storm of suffering.

Looking at all the money that has gone to the banks -- and how well they seem to be doing, using it to bolster their bottom line (and even buy other banks) -- while the real economy is doing so poorly, proves just how wrong the government's approach to the recovery has been.

This approach was on full display during Bernanke's back-to-back testimony in front of the House on Tuesday and the Senate on Wednesday. He pointed to the bulls charging down Wall Street and the ballooning bottom line of the big banks as evidence that the steps taken by the Treasury and the Fed had helped avert a financial disaster. But he admitted that the prospects for increased employment or a decrease in home foreclosures wasn't likely for the next couple of years. And he admitted that "financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain."

But wasn't that the main reason for the bailout -- to get the banks lending again?

Launching into his questioning of Bernanke, Senate Banking Committee Chairman Chris Dodd said, "Americans who have lost, or are worried about losing, their jobs, their homes, or their retirement security have watched as others reap the benefits of our government's response.... When can [the American taxpayers] expect the recovery that they have funded? When will working families see their rally?"

Instead, they are seeing programs slashed, services cut, and state budgets balanced on their backs.

Something is very wrong with this picture.

Links 7/24

The middle way: reprise

Arianna Huffington got a naked capitalism citation for saying that a middle way reflecting neither all-Republican nor all-Democratic boilerplate positions is gaining ground in Washington (after >3 min I can’t find the link; sorry).

Here’s the problem I have with the libertarians: most of them don’t seem bothered by the financial catastrophe impending upon us (and yes, I will address that in the next “animal spirits” update).  From this I infer that they’re relatively well-off for the most part, traders and other rich folk who’d like to keep their taxes low and who don’t give much of a fig for the suffering of the unemployed.  Even Ron Paul has come out recently saying that it would be irresponsible not to provide health care for these folks.  He suggests paying for it by ending our wars.

Here’s the problem I have with the Keynesians like Paul Krugman:  they don’t look at the aggregate debt problem.  They’re advocating more debt to solve a problem of too much debt.  It will sink us.  It’s not just the ratio of federal debt to GDP; it’s the ratio of all nonfinancial debt to GDP that is at record levels of ~375 percent.  The Blue Dog Democrats share this concern.  My position is that we offer (1) health care and (2) a livable dole to the involuntarily unemployed.  These are the best stimulus dollars we can spend; they will be spent wisely.  Let the economy self-organize at the local level.  It’s going to take a long time to reconfigure the economy toward more saving and investment, away from consumption.  Also, helping people out will make them feel better about being Americans, rather than becoming radicalized.

Here’s the problem I have with the Monetarists:  see the above.  Ben Bernanke thinks that lowering interest rates, stimulating credit expansion, and adding to nonfinancial credit market debt is going to help!  When he and Alan (Not-Potty-Trained) Greenspan worried about deflation, didn’t they wonder why they were worrying about deflation?  Deflation happens when asset values get bid out of range by excessive credit creation, and people stop servicing the debt.  Banks reasonably tighten credit standards, and prices decline.  But no!  Greenspan and Bernanke think more credit creation is the answer.  Meanwhile, by keeping interest rates near zero (especially for well-connected borrowers like Goldman Sachs who not only get near-zero interest rates but FDIC guarantees on their debt) the Fed is creating a carry trade that will further distort asset prices and relative values.

Republicans exist to keep taxes low on rich people.  Democrats exist for much the same reason, because of the way elections are funded, but are willing to go a little higher on marginal tax rates on rich people.  It used to be that Democrats were the proven budget-busters, but after George W. Bush, that label no longer applies.  Most of Obama’s deficit is inherited.

The politicians need to come down off their ideological high horses and start taking care of the people. 

A simple outlines of my plan is here, in a letter I sent to my elected representatives:

Dear -----:

America already has more debt than it can handle.  The deficits will sink
the economy into a debt-deflation.

The stimulus, like the banking bailouts, is likely to go to the richest
Americans.  The government is broken.  The stimulus will not help the
people.  It is pork that will go to the well-connected.

America is a basket case.  Here's what we need:

1.  Health care for all, especially the unemployed, and a livable dole for
the unemployed to see them through the long crisis to come.  They will
spend the money taking care of their families and finding new jobs in time.

2.  Higher (much higher) marginal tax rates on the rich who have
manipulated the system to their advantage for so long.  I suggest 75%
rates on income over $1 million.  The rich need to learn to share, to give
back to the country that has treated them so well.

3.  An aggressive FDIC campaign to recognize and charge off bad debt in
the banking system.  Making rich investors whole on the taxpayers' backs
only exacerbates the debt-deflation, and risks turning America into a
neo-feudal society.  Reverse the banking bailouts.  Make Goldman Sachs pay
up—their profits were made with taxpayer money.

4.  Fiscal discipline.  The deficits need to be brought down under 5% of
GDP immediately, and to balance within 5 years.

America is a rich country.  The problem is not the amount of GDP, it's how
it's distributed.  America is now the greatest debtor country.  The
Keynesianism that worked in the thirties will sink us now. The government
is broken and can not be trusted to spend the public's money wisely.

These recommendations don't fit into either Republican or Democratic
molds.  As I used to tell my students, "make the adjustment."  A far worse
depression awaits us if we don't.

It's time for triage.  America is a basket case.

“Keep It Simple, Stupid” would seem to be a good way to go in the current environment.  So many mistakes were made during the Panic of 2008… and opportunistic Beltway insiders stand ready to spin every event to their own advantage.

Stop the bailouts.  Cut the pork.  Take care of the people.  Let the economy self-organize.

Thursday, July 23, 2009

Links 7/23

  • Detroit: The Post-Apocalyptic Future of American Cities? – Al Martin.  Blade Runner is now. 
  • Debt Man Walking – Michael White.  Trenchant analysis of the American consumer’s balance sheet from a mortgage broker, supportive of our theses that (1) the government can not afford to take on more debt, and (2) there are a lot of people in a lot of hurt.

On the failure of macroeconomics

There’s a lot of discussion of The Economist’s recent articles on the failure of economics.  I have commented on this previously in Screw the stimulus, shoot the macroeconomists.  Let me try to adopt a more conciliatory tone.  Like many Americans, I am experiencing a lot of frustration watching our dysfunctional government with the perspective of a Boomer’s life experience. So many mistakes, repeated so many times….

The political system is incapable of applying good macroeconomic models even if they exist.  Take for example the slope of the yield curve as a recession indicator, which I used in my model along with my “animal spirits” variable.  Introductory managerial finance texts teach that an inversion of the yield curve is a reliable signal of a recession arriving within about a year.  The Fed knows this, most financially astute people know this. 

The yield curve inverted in 2000 and again in 2006.  What was the policy response?  To pump up the money supply, credit and lending and debt expansion!  Why?  Because Alan Greenspan and Ben Bernanke both saw the potential for deflation.  Was this the right thing to do?  No!  The reason deflation was realistically in the outlook was because we had too much debt already! 

By pumping up credit, our exalted Fed chairmen thought they could save the economy, or perhaps at least not have it collapse on their watch.  Bernanke was publicly quoted many times in 2007 saying the economy was in good shape.

We live in a political economy.

So what should we do?  Take care of the people!  Make policy on moral grounds with minimal reliance on models.  When people become unemployed, help them.  My basic requirements for the stimulus as noted in the reference above are a poverty level dole for the unemployed, and universal health care.  It is truly barbaric that you lose your health care when you lose your job (or it becomes so expensive you can’t afford it).  The government can’t be trusted to spend our money wisely much beyond that.  Too much of the stimulus will be on wasteful projects.

I know this is way too reasonable for the professional economists to buy into.  I am a Ph.D. economist.  The academics are all riding their particular hobby horses, charging their favorite windmills. 

We are living with political economy they’ve helped to create, a mish-mash of broken theories that come in and out of vogue with the amount of money backing their political spokes-clowns.  Remember “supply-side economics”?  How about “real business cycle theory”?  Or “efficient markets theory”?  All these impressively mathematical theories were marshaled to support policies that had major distributional consequences.

Please!  Let’s try looking directly at who gets what out of these policies, and whether a majority of Americans think they’re fair.  It’s our money.

That’s my modest proposal.

Via:  The Jalopy Economy.  What central banking and modern macroeconomics (Keynesian or monetarist) have brought us.

All the fuss about “financial innovation” is largely about the illusory gains due to increasing indebtedness.  The rise in debt has fueled Wall Street’s compensation, asset bubbles, and has brought the U.S. to the brink of bankruptcy (and this doesn’t include the hidden indebtedness arising from social program promises).


Wednesday, July 22, 2009

Ron Paul: End wars to fund health care

Via:  Raw Story  Ron Paul scores again.  Do it, Congress!

Ron Paul: End wars to fund health care

By David Edwards and Daniel Tencer
Published: July 22, 2009
Updated 2 hours ago

House Rep. Ron Paul may be America’s most famous libertarian these days, but he’s making a surprising concession to progressives when it comes to the debate about public health care.

Though the house representative from the 14th District of Texas still insists that government should get out of the health care trade altogether, he told CNN’s Kiran Chetry on Wednesday that “you don’t want to cut under these [economic] conditions medical care from poor people who have been dependent, or the elderly.

“Even though I have my ideal system I would like to see, with the government out completely — because that would be a much better system — that’s not going to happen. I’m realistic.”

But, the House rep said, “one thing we shouldn’t do is pay for it with money out of thin air,” referring to the federal government’s ballooning deficit.

“So what i would do in a transition … is cut spending somewhere and take care of the people were talking about.”

And to finance health reform, Paul would like to see the US end its overseas military engagements. “I would cut from overseas spending, I would cut from these trillions and trillions of dollars that we have spent over the years and bring our troops home so that we can finance it [health care].”

Paul said that President Obama’s decision to cancel the F-22 fighter jet program was “a first very very minor step … and I applaud Obama for that. But we don’t need one [defense project] removed, we need to change our foreign policy, then we could afford the health care that is necessary to tide us over until we come to our senses and believe that freedom can deliver medical care much better than a bureaucracy.”


Paul continued his anti-war theme when CNN host Kiran Chetry asked him about (”We put the ‘love’ in revolution”), a dating website for Ron Paul followers.

“It sort of fits a famous slogan that I sort of liked, which says ‘Make love not war,’ so maybe that’s what they’re thinking about doing,” Paul said.

Click through link on headline for video at Raw Story.

Details Emerge of Atrocious California Budget Deal

Via:  Daily Kos  h/t Yves

This is disappointing.  The politicians have not honored the people’s wishes in the budget they have created.  Americans want some government services and are willing to pay for them.  The Republican/Libertarian position that “all government is bad” seems to me like (mostly) more of the same “keep taxes low on rich people who don’t need government services.”  The does not bode well for the the breakdown of American society that Ron Paul predicts in the previous post that is consistent with our overarching thesis from Strauss and Howe of a total breakdown of the American social contract in the next decade or so (see this for background).

by thereisnospoon

Mon Jul 20, 2009 at 09:33:54 PM PDT

Via the excellent crew at Calitics, a deal has been reached on the CA budget.  Diarist Richard Lyon posted about this earlier this evening, but his link to the Sacramento Bee's inadequate article was short on details.

The L.A. Times Mercury News has more details on this atrocious, all-cuts budget.  If a budget is indeed a moral document, it would seem from this budget that the state of California has the heart of a sociopath and an idiot.  It is all the more infuriating to know that such a document was crafted despite overwhelming Democratic majorities in the state legislature, and near universal ownership of statewide positions (with the exception of Governor and Insurance Commissioner).

Included in the budget, courtesy of our own tireless dday:

$15 billion in cuts, no new taxes, $11 billion in gimmicks and borrowing
$4-5 billion in local government raids
only an $800 million reserve (initially the talks were for a $4 billion one)
$6 billion in reductions to public schools, but an $11 billion dollar payment somewhere down the road though not in writing
yes, there's new offshore drilling in this deal, going around the Lands Commission, and without an oil severance tax for the producers
$1 billion assumed for the sale of the State Compensation Insurance Fund, which is not only unlikely but would really crush small businesses if sold
no suspension of Prop. 98
basically a reinvention of state government, more austere, and precisely when folks need the opposite.
...three furlough days a month for some state employees still in place for the rest of the year
$500 million in cuts to Cal Works
smiles all around from Dem leg. leaders as they cheer that "we did not eliminate the safety net for California."  Poking a big hole in it, apparently, qualifies as A-OK.
...we're also cutting $1.2 billion to corrections without releasing any prisoners, as per the actual politics as usual.  The only way you can do that is by cutting every treatment or rehabilitation program in the prisons, or eliminating overtime for corrections officers.  In other words, we're turning prisons into Public Storage units.

Also in the budget, according to John Myers' twitter feed:

$100 mil in money for Santa Barbara coast oil drilling project known as Tranquillon Ridge, say legis staff #cabudget

Legis staff: reforms to in-home health svcs (IHSS) incl. backgrnd checks for providers, fingerprinting of workers and most clients.#cabudget

Legis staff says much maligned Integrated Waste Mgmt Bd will be eliminated in January, a key issue of Guv.

Guv given OK in deficit deal to sell Orange County Fairgrounds, say legislative staff. No other "biggies" that were suggested.

Legis staff say some state parks will close, but 88% of funding restored. Says Guv's admin will choose which close, $8 mil savings#cabudget

Total local govt: abt $4.3 B. Borrow thru Prop 1A for $2 B, two year gas tax taking of $1B each year, $1.3 B from redevlp agencies#cabudget


I've given a few brief primers on the California budget situation before.  The key here is that majority Democrats in the legislature have no power to pass a budget, as Republicans have the power to block all budgets using the 2/3 rule, and to drive the state off a cliff.

Watching the state essentially go bankrupt is no problem for Republicans, who would see in it an opportunity to blame majority Democrats, as well as to break the backs of the public employee unions.  So it is left to Democrats to cave on everything the GOP wants, lest the GOP shoot the hostage.

There is still the possibility that progressive Democrats may balk at the budget deal, but this is unlikely: the deal isn't going to get better if the current one isn't passed.  Republicans in this state really are that extremist, and Arnold Scharwenegger has nothing to lose.

This is not an individual failing on the part of CA Democrats, except insofar as they have utterly failed to provide a consistent messaging structure to do away with GOP talking points, and inform the voters of the degree to which Republicans are destroying the state.

There is no compromise with these people, and this is not the sort of result the people of this progressive state want to see.  But it is what we're getting.  It is important to bear in mind what voters actually want to see in the state budget:

The vast majority of voters surveyed said the state should balance both spending cuts and tax increases to address the state budget shortfall. Revenue options supported by a strong majority of voters include:

Increasing taxes on alcoholic beverages (75% support)

Increasing taxes on tobacco (74% support)

Imposing an oil extraction tax on oil companies just like every other oil producing state (73% support)

Closing the loophole that allows corporations to avoid reassessment of the value of new property they purchase (63% support)

Increasing the top bracket of the state income tax from nine point three percent to 10 percent for families with taxable income over $272,000 a year and to eleven percent for families with taxable incomes over $544,000 a year (63% support)

Prohibiting corporations from using tax credits to offset more than fifty percent of the taxes they owe (59% support)

While voters strongly support these options to help California increase its revenue, voters are strongly against specific spending cuts proposed by Governor Schwarzenegger:

76% oppose cutting public school spending by $5.3 billion

73% oppose cutting funding for state colleges and universities by $1.2 billion

68% oppose cutting the state's funding for health care services by $1.1 billion

62% oppose cutting the state’s funding for homecare services by $494 million

Instead we get billions in corporate tax breaks, new oil drilling off the California Coast, and we remain the only state not to levy an oil extraction tax.

There are only two things that matter in California at this point: repeal of the 2/3 rule on budgets and revenue enhancements at the ballot box in 2010, and efforts toward a new Constitutional Convention.  This year's budget process has proven that politics as usual is no longer remotely acceptable in our once great State.

UPDATE: Just to be clear, the vote on the package will be on Thursday--but not much is likely to change about it in the intervening time.

Ron Paul on the breakdown of America

h/t ZH

Tuesday, July 21, 2009

How to spend stimulus dollars: unemployment insurance for all

Via: CNNMoney

Out of work, out of benefits, out of luck

By Julianne Pepitone, contributing writer
July 17, 2009: 09:53 AM EDT
The next bubble in the recession is about to burst.

More than 650,000 Americans will have used up all of their unemployment benefits by September, in what experts say could be the start of a looming crisis.

In the early days of the downturn, the government extended unemployment benefits beyond the standard 26 weeks to as many as 79 weeks in hopes of giving the jobless a longer lifeline. Officials predicted the economy worsening and businesses further contracting, resulting in fewer jobs for the newly unemployed to find.

With the recession now 18 months deep and the national unemployment rate standing at 9.5%, it appears that the effort wasn't robust enough for those in the crisis' first wave of layoffs.

"We need to get the issue attention now, because people are running out of benefits and there's just nothing for them," said Andrew Stettner, deputy director of the National Employment Law Project, an advocacy group that has calculated the number of people who will exhaust their unemployment benefits.

In fact, Stettner and the Labor Department are expecting the problem to accelerate. In the next few weeks, the victims of the mass layoffs that happened six months ago -- when the pace of layoffs was at its zenith -- will start running out of their basic benefits. A total of 4.4 million people are expected to face this fate -- or 65% of the entire filing population.

And while they may have up to another year of unemployment insurance benefits -- thanks to the confusing patchwork of extensions that were enacted last summer -- they will be soon be unaccounted for in government unemployment reports.

The Labor Department doesn't track anyone who has moved beyond 26 weeks of unemployment in its weekly data on continuing claims (the number of people who request benefits after their first week). And, said Stella Cromartie, spokeswoman for the Bureau of Labor Statistics, said the agency does not currently have plans to begin tracking this population.

As a result, by late summer the government may begin reporting significant declines in continuing filers. But it won't be cause for celebration. Instead of of indicating that the economy is on the rebound, it could mean that more people are falling off the radar.

"We will see a decline in continuing filers," said the NELP's Stettner. "People are falling out of these numbers, and the pace of more recent layoffs replacing them is not as steep."

"They're not included in these unemployment numbers we hear about every week," said the NELP's Stettner. "They're desperate, asking, 'What's going to happen to me?'"

That's the question facing Jay Ridinger, 54, of Baxter, Tenn. The self-proclaimed "road warrior" once worked for a contract management company, happily bouncing from city to city to complete federal projects.

Ridinger was accustomed to the stop-start schedule of a contractor, so he wasn't worried when his last stint ended in August. But he soon realized this stretch of unemployment was different: "I thought it was the status quo, and instead here I am, applying for food stamps. I just sat in the office and cried and cried."

When he was first laid off, Ridinger received the maximum $250 unemployment check per week -- at the time, Tennessee's standard benefits lasted 13 weeks. Revisions of laws allowed him to get additional weeks of benefits.

"Every time you run out of benefits, you think, 'What the heck am I gonna do?'" Ridinger said. "And then a month later, maybe a check will be in your mailbox -- maybe not. Even if you get one, it's like, 'Ain't that nice, after all that emotion?'"

In most states, the unemployed receive a maximum 26 weeks of state-funded benefits. Two extension programs may also be available for an extra 53 weeks of benefits. (Click here for further detail on unemployment benefits programs.)

The availability and duration of the programs depends on the state's unemployment rates and whether it agreed to participate in part or all of the federal programs. (View the map to see how many weeks of benefits your state offers.)

These extension programs are "difficult to understand, unprecedented and tough to administer," noted Heidi Shierholz, an economist at the Economic Policy Institute, a nonprofit think tank. "It surprised me how difficult it is to get data on this. I study labor markets all the time, and even I didn't know just how much of a behemoth it is."

But just because filers may not be counted in the weekly jobless claims data, it does not mean they don't impact the national unemployment rate. The Labor Department doesn't rely on unemployment-benefit claims to calculate the unemployment rate; instead the agency conducts interviews through a population survey and simply asks people if they have looked for work in the past four weeks. If they have, they're included in the rate.

So, if you have run through all of your benefits and say, "yes," you would still impact the unemployment rate. If you are unemployed and looking for work but aren't claiming benefits, you would be included as well.

Still, the weekly jobless claims number is a good indicator of the health and direction of the economy. And Edward Stuart, an employment economics expert from Northeastern Illinois University, believes the NELP's data may even be "conservative."

"The unemployment rate is going up, and the time spent unemployed is also going up," Stuart said. "Jobs are disappearing, and we aren't replacing them."

In the meantime, Ridinger waits -- checking about 80 Web sites daily and has applied for jobs all over the country in a variety of fields. After almost a year, he's had only one interview.

"This experience has hit me with every possible emotion," he said. "It's humiliating, degrading. I've changed my complete attitude toward the system. I just never expected to be a part of it."

Sunday, July 19, 2009

What to do with the Fed

Via:  FT

The Benign Brodwicz program, as of July 19, 2009 (short of dismantling the Fed and starting over again): 

  • No more too big to fail.  The Economist published a survey of banking a few years ago that cited research showing that size over about $30 billion in assets did not create economies.  Sparsely connected networks are more stable than densely connected one.  Reform the system to eliminate systemic risk.  We’ve supposedly had a systemic risk regulator since 1913—the Fed.
  • Reinstate Glass-Steagall.  Obvious.  The ancient argument against conglomerates applies.  There are no real economics, and no one knows how to run all these businesses (in fact conflicts of interest across lines cause extreme cognitive dissonance).
  • Separate bank examination from “monetary policy.”  If the bank examiners had held the banks to prudent lending standards, the mortgage crisis would not have happened, even if China as flooding us with cheap money.  The Fed, in the best tradition of fighting the last war, in this case Ben Bernanke implanted memories of deflation in the Great Depression, became concerned about deflation and created numerous asset bubbles to prevent it.  Did they ask why they were might be concerned about deflation?  Like maybe we have too much debt to handle?  No.  But if mortgages had stayed at 20 percent down, no “purchase money seconds,” and debt-to-income less than about 38 percent, the crisis wouldn’t have happened.  Of course, the rating agencies and their pimp, Wall Street, still might have sold the world a bill of goods to a lesser extent—but housing prices would not have entered a speculative bubble, and the overextension of credit would have been minimal.  If this were adopted, the eggheads running reserves would be able to do much less damage.  Beef up the FDIC, and extend its powers.  Let the people who actually understand banking do the hands-on regulation.
  • Cut the leverage in the system across the board!  Obvious.
  • Put all derivatives on fully disclosed exchanges.   Maybe kill off CDSs—at least require capital against them.
  • Eliminate “off balance sheet” accounting.  The accountants were major co-conspirators in this mess.  My accounting students in financial statement analysis used to take umbrage when I’d suggest that accountants might get “creative” with the books.  What happened goes well beyond creative into outright fraud, IMHO.

What to do with the Fed

by Willem Buiter
July 17, 2009 1:39am

The Fed is in trouble.  Obama administration proposals for enhancing the Fed’s supervisory and regulatory role and for  assigning it new macro-prudential responsibilities and powers - effectively turning it into the nation’s systemic risk regulator - are meeting with strong and vocal opposition.  The criticism is not just coming from the other agencies in the US financial sector regulatory and supervisory spaghetti bowl - agencies that would stand to lose power and influence or could be put out of business completely. The desire for stronger Congressional oversight of the Fed is no longer confined to a few libertarian fruitcakes, conspiracy theorists and old lefties.  It is a mainstream view that the Fed has failed to foresee and prevent the crisis, that it has managed it ineffectively since it started, and that it has allowed itself to be used as a quasi-fiscal instrument of the US Treasury, by-passing Congressional control. Are any or all of these criticisms justified? Let’s ponder a few of them.

The Fed did not see the crisis coming

This criticism is clearly correct.  The Fed’s failure to foresee the storm, even when it was imminent, represents an indictment of its competence at one of its key tasks: discerning developments likely to lead to systemic financial instability before the instability manifests itself, and taking preventive measures.

The Fed failed utterly in this task, but so did every other regulator, supervisor and government agency or official with even an indirect responsibility for financial stability.  Alan Greenspan did not see it coming during the almost 20 years (1987 till 2006) he spent at the Fed; neither did Ben Bernanke, a member of the Board of Governors of the Federal Reserve System from 2002 to 2005, Chairman of the President’s Council of Economic Advisers from June 2005 to January 2006 and Chairman of the Fed since February 1, 2006. Hank Paulson did not discern any financial crisis clouds on the horizon, either during his many years with Goldman Sachs (1974-2006), or during the first year of his tenure as Treasury Secretary (July 2006 - January 2009).  Likewise, Tim Geithner failed to foresee the crisis when he was Under Secretary of the Treasury for International Affairs(1998–2001) under Treasury Secretaries Bob Rubin and Larry Summers or as President of the New York Fed (2003 - 2009). Larry Summers was similarly blinded by the light during his years at the US Treasury (1993 -2001), including his years as Deputy Secretary under Bob Rubin (1995-1999) and his tenure as Treasury Secretary (1999-2001). There was not a Dicky Bird either from  Don Kohn or Bill Dudley.  So the list of dogs that did not bark is a long and distinguished one.

In fairness I should add that no academic scribbler, least of all I, foresaw the full force of what was about to descend upon us.  Academics are joined in the ranks of these who failed to foresee the financial cataclysm by gurus, pundits, economic and financial journalists, futurologists, urologists and other practitioners of cleromancy.

The Fed has actively contributed to the crisis, both through sins of omission and sins of commission

It is hard to disagree with this.  The Greenspan Fed kept the Federal Funds target rate too low for too long after June 2003.  This contributed to the oversupply of domestic and global liquidity that permitted the credit and asset market boom and bubble that ultimately brought us the crisis.  Ben Bernanke was a member of the Board of Governors through most of this period.  Tim Geithner was President of the New York Fed and Vice Chairman of the FOMC for virtually all of this period. Don Kohn was a member of the Board of Governors since August 2002.

Interest rate policy by the Fed since the crisis started has been competent, if we ignore the rather panicky out-of-phase and announced-out-of-normal-working-hours, 75 basis points cut in the Federal Funds target rate on January 21/22, 2008, following the Kerviel/Société Générale stock market blowout in Europe.  This instance of the ‘Fed put’ - aka excessive sensitivity of monetary policy to sharp declines in stock prices - mars an interest rate response to the crisis that was otherwise superior to what was produced in the Euro Area and the UK.

One aspect of interest rate policy where the Fed, along with the Bank of England and the ECB, has dropped the ball is the spread between the official policy rate and the rate banks earn on reserves held with the central bank.  The Fed, which started paying interest on reserves (both required reserves and excess reserves) only on October 9, 2008, initially set the rate on reserves as as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points.  As the Federal Funds target rate has moved down to zero (it currently hovers between 0 and 0.25%), the spread was reduced from 75 basis points to something between zero and 25 basis points, with the interest rate on reserves at zero.

It would obviously have been far superior to set the Federal Funds Target rate at zero and the interest rate on reserves at negative 75 basis points.  That way banks would be discouraged from taking advantage of the Fed’s wide range of liquidity-enhancing facilities only to redeposit the money with the Fed as excess reserves.  In mitigation it must be said that the Bank of England and the ECB are doing even worse as regards the levels of their official policy rates and the spreads over the interest rates on reserves (or deposit rate).  Bank rate in the UK still stands at 0.50 percent with the deposit rate 25 basis points lower. Again, a zero Bank rate and a deposit rate of -0.75 percent or lower would make a lot more sense.  The ECB does have a 75 basis point spread of its official policy rate over the deposit rate, but its official policy rate still stands at 1.00 percent, defying both logic and gravity.  With the recession in the Euro Area as deep as or deeper than in the US and the UK and with price inflation already in negative territory, a zero official policy rate and a deposit rate no higher than -0.75 percent is the only rate configuration that makes sense.

Of course the Fed hardly has the monopoly of actions that contributed to the crisis.  As Treasury Secretary, Larry Summers promoted and celebrated  the Gramm-Leach-Bliley Act of 1999, which repealed key provisions in the 1933 Glass-Steagall Act.  Some of his statements at the time must make uncomfortable reading the NEC Director: “Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century,” ….. “This historic legislation will better enable American companies to compete in the new economy.”[

After the departure of Arthur Levitt Jr. as Chairman of the SEC in 2001, that organisation played a central role in the mindless de-regulation and loss of oversight that characterised the subsequent years - the culmination of a process begun under the Clinton administration.  The nadir of this process was probably the repeal in 2004 of the net capital rule - the requirement that investment bank brokerages hold reserve capital that limited their leverage and risk exposure - after fierce lobbying by the large Wall Street investment banks.  Ironically, Hank Paulson, the future Treasury Secretary, played a leading role in this lobbying effort to repeal the net capital rule as Chairman and CEO of Goldman Sachs.  A few years later, as Treasury Secretary, he had to try to clean up the mess created in part by the abolition of that net capital rule.

Indeed, the whole mishmash of US financial regulation and supervision has long been viewed as a school book example of how not to structure such activities.  Fragmentation, balkanisation, overlap, turf battles and unproductive inter-agency rivalry and jealousy are the name of the game.  With federal commercial banking supervision split between the Fed, the FDIC and the Controller of the Currency (not counting the Office of Thrift Supervision for federal savings banks) and investment banks (not) supervised and regulated by the SEC, the US regulatory framework was an accident waiting to happen. Federal securities markets regulation and supervision is, for no good reason, split between the SEC and the Commodity Futures Trading Commission.  The SEC - discredited and without its investment bank constituency - is an organisation begging to be put out of its misery.

The reforms proposed by the Obama administration would merge the Office of Thrift Supervison into the Office of the Controller of the Currency.  It still leaves federal commercial banks with three regulators.

It is inconceivable but true that insurance continues to be regulated at the state level in the US.  Perhaps this should not be surprising, as the US legal profession too is balkanised at state level with only limited mutual recognition of bar membership among the states.

The Fed has expanded the size of its balance sheet quite massively since the crisis started in August 2007.  As of July 8, 2009, the size of the Fed’s balance sheet was just under 2 trillion US dollars, just over twice the size of a year earlier.  The monetary base increased over that same year from US$ 907bn to US$ 1722bn, almost all of it accounted for by a US$738bn increase in commercial bank deposits with the Fed.  Currency in circulation increased by only $77bn.

So as regards quantitative easing (expanding the size of the central bank balance sheet by purchasing government securities) and especially as regards qualitative easing or credit easing (expanding the amount of private sector securities or loans held on the central bank’s balance sheet, through outright purchases of private securities, by accepting private securities as collateral in repos (what the ECB calls enhanced credit support) or by lending unsecured to the private sector (something no central bank has done yet)) the Fed has held its own in the unconventional monetary policy stakes.  It cannot be faulted on the size of its operations.  It can be faulted on the terms of some of its operations and on its lack of openness about them.

The Fed has been actively contributing to the next crisis

Here indeed the Fed stands guilty as charged, although it is in good company.  The Fed, through its lender of last resort and market maker of last resort actions and through a wide range of quasi-fiscal support operations it has undertaken on behalf of  Wall Street and other segments of the US financial establishment (Fannie & Freddie, AIG), has made a major contribution to the creation of the biggest moral hazard machine ever seen in human history.

Probably the single most damaging  failure of the US Treasury, the US Congress and the US financial regulators was there inability/unwillingness to create a special resolution regime (SRR) with structured early intervention and prompt corrective action for all systemically important financial institutions (those too big, too complex, to interconnected, too international or too politically connected to fail in the ordinary Chapter 11 or Chapter 7 way).    An SRR is an ‘insolvency lite’ insolvency regime for banks and ohter systemically important financial institutions.  If early interventions fail, a bank that is judged (by a duly appointed administrator of the SRR, e.g. in  the FDIC in the case of insured deposit taking banks) to be at risk of becoming conventionally insolvent is instead rushed into a high-speed regulatory insolvency regime, the SRR.  There its balance sheet is restructured (typically existing equity is wiped out or diluted and unsecured creditors are turned into new equity holders).  The Administrator or Conservator has near-absolute powers to dispose of assets and to restructure liabilities.  Existing management, board and shareholders are disenfranchised for the duration of the institutions sojourn in the SRR.  The purpose of an SRR is that it wipes out a failing systemically important institution in a legal sense (by abrogating the property rights of shareholders, unsecured debt holders, mangement and board of directors) without wiping it out in the Army Corps of Engineers sense.  The bank (or insurance company) as a functioning organisation remains largely intact, and can continue to service existing contracts and commitments (at the discretion of the Adminstrator or Conservator of the SRR) and, most importantly, can engage in new lending, investment and funding activities, possibly with government support, including guarantees, for these new activity flows.

When the crisis started, an SRR existed for federally insured deposit-taking banks (administered by the FDIC), although the authorities did not have the nerve to put the largest insolvent institutions (such as Citi Group and Bank of America in it).  That SRR also did not apply to banking groups. There was an SRR for Fannie and Freddie, which was used effectively.  There was no SRR for investment banks.  There was no SRR for insurance companies like AIG.

The non-existence of an SRR for any systemically important institution amounts to a major policy failure of the executive and legistative branches of government.  The deafening silence of the Fed and the other regulators on the subject is a serious indictment of their competence.  After Bear Stearns went belly-up and was pushed into the terminal embrace of JP Morgan, it should have been clear even to the US authorities that either investment banks needed an SRR or that there ought to be no investment banks.  Yet we had to wait for the failure of Lehman and the forced acquisition of Merrill Lynch by Bank of America before the last two remaining large independent Wall Street investment banks, Goldman Sachs and Morgan Stanley, were ejected from the investment bank category and became bank holding companies.  This was not required  to give them access to the Fed’s discount window and other facilities.  If the Fed declares “unusual and exigent circumstances” to prevail, it can lend, against collateral of the Fed’s choosing, to individuals, partnerships and corporations (including non-financial corporations) , should it wish to.  It did, however, make it possible for these former investment banks to be put into an SRR.

If institutions are too systemically important to fail conventionally and if no SRR is available, they will have to bailed out at public expense should an emergency arise.  The regulators knew that.  The Treasury knew that.  The Congress knew that.  The banks knew that and their unsecured creditors knew that.   They permitted it to happen nevertheless.

The gradual creation and operation of this utterly disfunctional system of large, complex, interconnected and crossborder financial institutions and markets, which was both inefficient (real resource-wasting), distributionally unfair and regressive, and vulnerable to socially costly collapse unless bailed out by the tax payer, represents a form of crony capitalism without parallel in modern western economic history.  It is an interesting question, to which I don’t know the answer, whether those who presided over and contributed to the creation and operation were ignorant, cognitively captured or culturally by the financial interests for whom they created these fabulous opportunities for extracting rent, or captured in more direct and conventional ways.

At one level the answer does not matter much.  The system that was created was a corruption of a true market economy, because it relied for its existence and survival on soft budget constraints for the main players.  At most, the shareholders (that is, the owners of the tangible common equity) of these institutions were somewhat at risk.  The unsecured creditors, even the owners of subordinated bank debt, were subsidised by the tax payers’ free guarantee.

In the short run, the directly tax-payer-financed rescue operations like the TARP, and the indirectly tax-payer-financed but directly Fed-financed or FDIC-financed rescue operations for the defunct US banking and financial behemoths have prevented a comprehensive collapse of the financial system.  With a proper SRR in place for all systemically important financial institutions (anything highly leveraged and characterised by asset-liability mismatch in maturity, liquidity or currency denomination) systemic stability could have preserved without presenting the bill to the tax payer.  It would instead have been presented where it belongs in a market economy: to the unsecured creditors of these institutions.

Not only do the rules of the market economy dictate that the shareholders and the unsecured creditors of insolvent institutions pay the bill, both fairness and efficiency call for that assignment of the burden of insolvency.  The US Treasury, the Congress, the Fed and the other financial regulators have, through their behaviour since August 2007, confirmed and re-inforced the incentives for excessive risk taking by crossborder banks and any other financial institution deemed too systemically important to fail.   The groundwork for the next financial boom and bust cycle, worse than what we are just emerging from, have been put in place.

From this perspective, the failure of Lehman Brothers, although an unnecessary, preventable and costly event in a rationally structured world, is likely to turn out to be a medium- to long-term blessing, even though it contributed to the temporary cardiac arrest that afflicted global financial markets for a few months after September 15, 2008.  Clearly, I wouldn’t have started from where we were with Lehman on September 14, 2008 but given the choice, at that juncture, of bailing out Lehman with tax payer money or letting it go under, letting it go under was the lesser evil.  If Lehman too had been bailed out, the next financial boom and bubble would already have started.

The Fed has acted as an off-budget, off-balance-sheet special purpose vehicle of the US Treasury

When you look at the balance sheet of the Federal Reserve System, you find such items as the Net portfolio holdings of Maiden Lane I (US$ 25,958 mn on July 8, 2009), Net portfolio holdings of Maiden Lane II (US$ 15,744 mn) and Net portfolio holdings of Maiden Lane III (US$ 18,784 mn).  These are the legacies of the Fed’sinterventions in Bear Stearns (Maiden Lane I) and AIG (Maiden Lane II and III).  The Bear Stearns-related assets are likely to be rubbish.  Maiden Lane II and III I know less about.  I believe the US Treasury has guaranteed these Fed assets.  That’s nice for the Fed, but does not address the problem that through guarantees or indeminities, the US Treasury has engaged in off-budget and off-balance sheet financial operations that involve contingent commitments that have not been the subject of proper Congressional vetting, voting and oversight.

And there is more where this came from.  There is the Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility, worth US$ 7,998 mn; the Credit extended to American International
Group, worth US$ 43,026 mn; the Term Asset-Backed Securities Loan Facility, worth US$ 26,338mn; net portfolio holdings of the Commercial Paper  Funding Facility, worth US$ 112,360 mn; net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility and net portfolio holdings of Maiden Lane.  There is also just udnder US$ 112 bn worth of swap facilities with other central banks.

This is serious money.  Much of it is credit extended by the Fed on non-transparent terms to private counterparties.  Quasi-fiscal subsidies of unknown magnitudes are involved, especially when the Fed purchases illiquid private securities or accepts them as collateral at valuations based on procedures that remain private to the Fed.

Under the US Constitution, the use of financial resources by the state is supposed to be approved by and voted by the US Congress.  That constitutional nuisance has irked governments since the creation of the Republic.  The executive branch of government has found a variety of ways to end-run the US Congress.  In this crisis, the Fed has been the principal institutional vehicle through which the executive (the US Treasury and the NEC) has run circles around the Constitutional requirement that Congress has to vote appropriations before the executive can spend the money.  They have done this by using the full array of modern off-budget and off-balance sheet financing tricks developed mainly by the private sector over the past few decades, and that culminated in the Enron debacle and the creation of the shadow banking sector with its SIVs and other special purpose vehicles.

It permits the commitment of massive resources by the executive, through such quasi-independent government agencies as the Fed and the FDIC, without accountability to the Congress, the tax payer and the citizen. It subverts the US Constitution.

Elsewhere, I have written a length about the quasi-fiscal actions of the Fed up to the middle of 2008, through the TAF (the temporary term auction facility), the TSLS (term securities lending facility), the PDCF (the primary dealer credit facility), the Fed’s Bear Stearns support operation and its support for the Fannie and Freddie rescue operations.  Since then, the Fed has been deeply involved (some would say implicated) in the AIG rescue, the TALF (thus far rather unsuccessful on its own terms) the other programs whose imprint on the Fed’s current balance sheet I have just referred to, and the Public-Private Investment Partnership, much of which has by now died a death.  All these programmes involve commitments, sometimes contingent, of public financial resources without Congressional approval or oversight, and most of the time without accountability of any kind for the use of these resources. It is not surprising that Congress is chomping at the bit to remedy this flagrant abrogation of its Constitutional prerogatives by demanding greater oversight and control over the Fed.  I expect Congress will succeed in this objective.  Of course the US Congress tends to be ill-informed, populist and mightily beholden to special interests, so its greater grip on the future Fed is by no means an unambiguous blessing.  But the US Treasury and the Fed have really been asking for a vigorous Congressional response through the casual manner in which they have thumbed their noses at the concept of Congressional control of the public purse strings.

Who but the Fed could be the systemic risk regulator?

The Fed has weak qualifications for presiding over macro-prudential regulation and supervision of the US financial system, its institutions, instruments and players.  But however weak its past performance and credentials, they are rock-solid compared to those of the other candidate institutions.

The FDIC has no raison d’être. Neither has the Office of Thrift Supervision.  Deposit runs on the banking sector as a whole cannot be insured by the banking sector.  Deposit insurance should therefore be run from the US Treasury, which should of course try to recover, in the medium to long term, the cost of the scheme from the banks involved. The Office of the Controller of the Currency has no economic rationale and should be abolished. The SEC and the CFTC should at the very least be merged.  It makes sense to abolish both of them and replace them with a single macro-prudential regulator/supervisor for systemically important institutions, clusters of institutions, markets and instruments, a micro-prudential regulator/supervisor for individual institutions and a consumer protection agency for financial products.

Only the Fed can fulfill the macro-prudential regulator-supervisor role.  That is because it has the short-term deep pockets.  It is the source of the ultimate, unquestioned liquidity in the economy, through its monopoly of the issuance of base money.  Without the short-term deep pockets, a macro-prudential regulator/supervisor cannot act as lender of last resort, market maker of last resort or provider of enhanced credit support.  It would be a toothless old hag.

The problem with this solution of the macro-prudential regulator/supervisor problem is that it is incompatible with central bank operational independence as interpreted since 1989 or thereabouts.  Lender of last resort operations to provide illiquid institutions with funding liquidity, market maker of last resort operations to support systemically important markets for financial instruments that have become illiquid, and credit-enhancing operations of the kind engaged in by the Fed, the ECB and the Bank of England, merge smoothly and without discontinuities into solvency support operations, recapitaliser of last resort operations and other quasi-fiscal support operations by the central bank.

When the central bank plays a quasi-fiscal role, as the Fed has been doing on an unprecedented scale in the current crisis, the fullest possible degree of accountability to the Congress, the tax payer and the citizens is essential.  The Fed has no mandate to engage in quasi-fiscal operations, even when it is for a good cause.  Taxation without representation is incompatible with the American political tradition.

So the Fed as macro-prudential regulator will have to be subject to the close scrutiny of the GAO, and to much closer oversight by the Congress than it has been used to since the Treasury-Federal Reserve Accord of 1951.

Would changing the incumbents at the Fed help resolve the dilemma or would it amount to re-arranging the deckchairs on the Titanic (after it hit the iceberg)?  My view is that, despite everything I have just written, the current Federal Reserve Board is unlikely to be improved, as regard the quality of its pursuit of macroeconomic and financial stability, by any politically feasible change in the membership of the Board.  Only someone with macroeconomic stability and financial stability death wish would prefer a Federal Reserve Board with Larry Summers as Chairman instead of Ben Bernanke.

The kind of close Congressional and general political scrutiny and oversight that are absolutely essential in a healthy democracy when it comes to lender of last resort operations, market maker of last resort operations and other macro-prudential preventive and curative measures, are likely to lead to bad normal monetary policy (setting of the official policy rate) if past experience is anything to go by.  If the same institution, the central bank, has to be in charge of both normal monetary policy and systemic risk regulation (albeit jointly with the Treasury for the systemic risk role), there is no elegant, first-best solution.  Either monetary policy will be driven by politicians whose macroeconomics is limited to a partial understanding of the Keynesian cross and whose monetary policy views can be summarised by the proposition that the have never seen an official policy rate so low they would not want it even lower, or the central bank continues to act as an off-budget, off-balance sheet special purpose vehicle of the Treasury.

You pick.

Fiscal ruin of the Western world beckons

Via: Telegraph  What to do?  Take care of the unemployed with a livable extended dole and health benefits, chop pork and bailouts, rein in the deficit.  We have more debt than we can handle.  America is still a rich country.  The problem is the distribution, not the level of output.

For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state.

By Ambrose Evans-Pritchard
Published: 5:40PM BST 18 Jul 2009

Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

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Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland.

Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

"Something has to give," said Professor Colm McCarthy, the report's author. "We're borrowing €400m (£345m) a week at a penalty interest."

No doubt Ireland has been the victim of a savagely tight monetary policy e_SEmD given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.

As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a "penalty interest" on British Gilts, given the trajectory of UK national debt – now vaulting towards 100pc of GDP – and the scandalous refusal of this Government to map out any path back to solvency.

"The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever," said the Fund.

France and Italy have been less abject, but they began with higher borrowing needs. Italy's debt is expected to reach the danger level of 120pc next year, according to leaked Treasury documents. France's debt will near 90pc next year if President Nicolas Sarkozy goes ahead with his "Grand Emprunt", a fiscal blitz masquerading as investment.

There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's Lost Decade (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans e_SEmD famously building bridges to nowhere in Hokkaido e_SEmD has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240pc of GDP by 2014 e_SEmD beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up.

Error One was to permit a bubble in the 1980s. Error Two was to wait a decade before opting for monetary "shock and awe" through quantitative easing.

The US Federal Reserve has moved faster but already seems to think the job is done. "Quantitative tightening" has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of "exit strategies".

Is this a replay of mid-2008 when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2pc)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.

The Fed's doctrine – New Keynesian Synthesis – has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer.

The imperative for the debt-bloated West is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.

My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.