Folks, I hate to tell you, these remedies fall so far short of what it would take as to constitute a complete joke. And I am cynical enough to believe that the industry is secretly delighted, its bitter howls to the contrary (now it admittedly may be a shocker to them that they might have to be a wee bit inconvenienced in the interests of appeasing the public). Remember the lesson of the Barney Frank derivatives bill: even that weak offering was watered down to nothing. The Kanjorski salvo is the first round, and the banks are going to get this cut back, substantially. And Kanjorski has unwittingly played into their hands. But the theater certainly is impressive. From Bloomberg:

Seven Wall Street lobbyists trooped to Capitol Hill on Nov. 9, hoping to convince Representative Paul Kanjorski’s staff that his plan to dismantle large financial firms was a bad idea.

They walked out with a sobering conclusion, according to the accounts of two attendees who requested anonymity because the meeting was private. Not only was Kanjorski serious, he planned to offer the legislation as early as next week — and it just might pass.

Today marks a decade to the day that President Bill Clinton signed the repeal of the Depression-era Glass-Steagall Act that split investment-banking from lending and deposit-taking. The repeal allowed the creation of Citigroup Inc., the financial colossus now propped up by $45 billion in taxpayer rescue funds. Financial firms are scrambling to prevent Congress from re- imposing the act.

“We’re playing with live ammo,” said Sam Geduldig, a lobbyist at Clark Lytle & Geduldig who represents financial- services firms and wasn’t at the Nov. 9 meeting. “The banking community is rightfully concerned.”

Now admittedly, the Kanjorski proposal would reinstitute Glass Steagall by splitting commercial banking operations from investment banking and thus lead to some pretty dramatic surgery at JP Morgan (hiving off Chase Manhattan), Citigroup, and Bank of America. But while that would affect the scope of operations (and thus the pay packages, since top level pay is correlated with asset size of the entity) of the highest ranks, it would have comparatively little impact at the business unit level.

This is a 1930s remedy for 21st century banking. The Kanjorski proposal does remarkably little to reduce TBTF risk. The real problem is not size, and this approach puts the focus on completely the wrong issue. So if this solution does come to pass, Congress will have spent a huge amount of political capital on a largely ineffective solution.

A little quiz: what exactly got bailed out in the crisis? Yes, we had to resolve some a few big sick banks, namely WaMu and Wachovia. But that happened pretty smoothly and was within traditional FDIC bounds.

The crisis bailed out the global capital markets. Look at where the Fed’s rescue the markets programs were directed. Once you got past the first, the Term Auction Facility, they were directed at credit markets that are the playground of a fairly small number of very influential capital markets firms (an indicative list: Goldman, JP Morgan, Citigroup, Morgan Stanley, the old Merrill part of BofA, plus the trading operations of major international banks like UBS, SocGen, Barclays, DeutscheBank). Simply splitting off capital markets businesses does absolutely nothing to reduce the risk they represent to taxpayers. A massive safety net has been thrown underneath them, and no one save Goldman’s PR department believes that they won’t be bailed out when one of them goes off a cliff again.

The Fed does require the granting of waivers for deposits to be used to support trading operations. I’ll confess I have not seen any data here, but my impression is that that is very limited (but one could argue that the big deposit base allows them to fund in the short-term borrowing markets more cheaply, which would benefit the trading operations. Eurobanks, by contrast, do permit deposits to be used to support the capital markets businesses, which does give them a funding advantage.

Remember, Bear Stearns, with a roughly $400 billion balance sheet, was too big to fail. We now have a comparatively small number of firms globally that are enmeshed via counterparty exposures in OTC trading markets. These products cannot be moved to exchanges (you need enough trading liquidity in the underlying instruments; there is a good reason that, for instance, corporate bonds, munis, and even Treasuries and FX are traded OTC). This is like pretending we are living in a world of mainframes, of isolated players, when the problem is an a network of distributed computers, where any one going down can and probably will bring the network down. And we can’t halt the network while we take it apart and rebuild it. You may not like my saying that, but these are design parameter problems.

How would you break up Bear Stearns? You can’t separate OTC derivatives from the related cash markets; that will cause havoc (you’d be putting the derivatives book in runoff mode while simultaneously making it monstrously difficult to hedge, and these books are dynamically hedged). The logical-looking ways of doing it (say having them separate equity markets businesses, which are exchange traded and did not require government support in the crisis, from the debt businesses) makes the firms smaller but still does not solve the TBTF problem, which is the OTC debt and related derivatives markets. Those have become crucial to credit intermediation.

Now there are a bunch of things the officialdom COULD do to reduce the size of the public’s exposure, and I see them nowhere on this list. One is to bar proprietary trading and monitor overnight positions to make sure banks don’t simply start taking significant (as opposed to short-term) directional bets on customer order flow desks. Second is to force any systemically important firm to get out of the commodities business. We have commodities exchanges that perform the socially useful function of commodities hedging for end users. There is no reason for governments to backstop that. Principal trading similarly not socially productive and should not be in firms that have recourse to the government checkbook. Capital markets players should also be prohibited from offering bridge loans to customers (that is consistent with the Glass Steagall idea).

So that is why the Kanjorski approach, despite the tough talk and possible disruption, is actually a big win, even if a somewhat extreme version (remarkably) were to pass.

The only viable solution to the misbranded TBTF problem is to require systemically important firms (one in the OTC debt businesses, which thanks to the development of “market based credit” is now essential to modern capitalism) to exit all activities that are not socially essential and therefore deserving of government support (pure fee businesses that pose no risk to the taxpayer would be allowed). The permitted activities are regulated intrusively, with tough rules on capital requirements, and product scope (new products would be subject to approval to make sure they were socially productive, that the regulators understood them, and they did not result in increased risk to taxpayers). In other words, an effective solution requires more extensive dismemberment than anyone plans right now, and still requires heavy regulation of the crucial bits that will inevitably be taxpayer backstopped.

I have written extensively on the fact that this is not a normal cyclical recession, and we’re not in the type of “jobless recovery” which we’ve had a couple of times in the last 50 years. Unemployment will continue rising in America for some time, which will make a real, sustainable recovery very difficult.

The heads of two Federal Reserve banks are now saying something similar:

Janet Yellen, president of the Federal Reserve Bank of San Francisco, and Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, warned that rising unemployment could crimp consumers, restraining the recovery. Consumer spending accounts for about 70 percent of economic activity.

But instead of doing anything to encourage a sustainable recovery in employment – such as rebuilding America’s manufacturing base, or breaking up the too big to fails so that the smaller banks have a chance to grow and lend more to individuals and small businesses (see this and this) – the government has simply thrown money at the banks.

Moreover – contrary to what you might have heard – PhD economist Dean Baker pointed out yesterday that America’s massive military spending on unnecessary and unpopular wars actually lowers economic growth and increases unemployment:

Defense spending means that the government is pulling away resources from the uses determined by the market and instead using them to buy weapons and supplies and to pay for soldiers and other military personnel. In standard economic models, defense spending is a direct drain on the economy, reducing efficiency, slowing growth and costing jobs.

A few years ago, the Center for Economic and Policy Research commissioned Global Insight, one of the leading economic modeling firms, to project the impact of a sustained increase in defense spending equal to 1.0 percentage point of GDP. This was roughly equal to the cost of the Iraq War.

Global Insight’s model projected that after 20 years the economy would be about 0.6 percentage points smaller as a result of the additional defense spending. Slower growth would imply a loss of almost 700,000 jobs compared to a situation in which defense spending had not been increased. Construction and manufacturing were especially big job losers in the projections, losing 210,000 and 90,000 jobs, respectively.

The scenario we asked Global Insight to model turned out to have vastly underestimated the increase in defense spending associated with current policy. In the most recent quarter, defense spending was equal to 5.6 percent of GDP. By comparison, before the September 11th attacks, the Congressional Budget Office projected that defense spending in 2009 would be equal to just 2.4 percent of GDP. Our post-September 11th build-up was equal to 3.2 percentage points of GDP compared to the pre-attack baseline. This means that the Global Insight projections of job loss are far too low…

The projected job loss from this increase in defense spending would be close to 2 million. In other words, the standard economic models that project job loss from efforts to stem global warming also project that the increase in defense spending since 2000 will cost the economy close to 2 million jobs in the long run.

Note 1: Global Insight is:

Recognized as the most consistently accurate forecasting company in the world.

Note 2: A paper published in 2007 by the The Political Economy Research Institute at the University of Massachusetts, Amherst entitled “The U.S. Employment Effects of Military and Domestic Spending Priorities” concludes:

We present in Table 1 our estimate of the relative effects of spending $1 billion on alternative uses, including military spending, health care, education, mass transit, and construction for home weatherization and infrastructure repair…

As we see, defense spending creates 8,555 total jobs with $1 billion in spending. This is the fewest number of jobs of any of the alternative uses that we present. Thus, personal consumption generates 10,779 jobs, 26.2 percent more than defense, health care generates 12,883 jobs, education generates 17,687, mass transit is at 19,795, and construction for weatherization/infrastructure is 12,804. From this list we see that with two of the categories, education and mass transit, the total number of jobs created with $1 billion in spending is more than twice as many as with defense.

Note 3: I honor the brave veterans and active-duty soldiers who have served our country. They are not responsible for the policies of the civilian leadership. Indeed, if you talk to soldiers, many will tell you they think we are involved in wars we shouldn’t be in.

Note 4: I am for a strong defense. That’s not what this is about.

But we got into the Iraq war based on the false linkage of Saddam and 9/11, and false claims that Saddam had WMDs. Nobel prize winning economist Joseph Stiglitz says that the Iraq war will cost $3-5 trillion dollars.

And experts say that the Iraq war has increased the threat of terrorism. See this, this, this, this, this and this.

(Incidentally, torture also reduces our national security).

I would be especially interested to hear the views of NC’s Asian readers on this post because Japan and China are usually considered antagonists with a long and sordid past.

Andy Xie thinks the Fed is on an inflationary path.  Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

If stagflation is the goal, why might central banks such as the Fed talk tough about inflation now? The purpose is to persuade bondholders to accept low bond yields. The Fed is effectively influencing mortgage interest rates by buying Fannie Mae bonds. This is the most important aspect of the Fed’s stimulus policy. It effectively limits Treasury yields, too. The Fed would be in no position to buy if all Treasury holders decide to sell, and high Treasury yields would push down the property market once again.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret.  There is really no other policy choice because the mountain of debt in the United States is immense.  And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do?  China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate?  Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

The point is that Japan has a strong and genuine case that favors more integration with East Asia. The United States is unlikely to recover soon and with enough strength to feed Japan’s export machine again. There is no more room for fiscal stimulus. Devaluing the yen to gain market share is not an option as long as Washington pursues a weak dollar policy. Without a new source of trade, Japan’s economy is doomed. Closer integration with East Asia is the only way out…

Five years ago, I wrote an op-ed piece for the Financial Times entitled China and Japan: Natural Partners. At the time, a prevailing sentiment was that China and Japan were antithetical: Both were still manufacturing export-led economies and could only gain at the other’s expense. I saw complementary demographics and capital: Japan had a declining labor force and China needed to employ tens of millions of youths migrating to cities from the countryside. China needed capital and Japan had surplus capital. And their trade relations indeed tightened, as Japan had increased the Chinese share of its overall trade to 17.4 percent in 2008 from 10.4 percent in ‘04.

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea.  Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

Bush rats fight back PhysOrg

Skunk’s Strategy Not Just Black and White PhysOrg. Maybe I can come back as a skunk. They have nice personalities and no one messes with them.

Mortgage Program Gathers Steam After Slow Start Wall Street Journal. Major disconnect between the opening paras and the money quote here, pure Orwellian reporting. The claim of success is based on 20% of eligible borrowers getting a trial mod. So what? As the story points out further on:

Whether the program will ultimately be judged a success will depend upon how many trial modifications become permanent. To receive a permanent fix, borrowers must be current on their payments in the trial program after three months and submit a hardship affidavit and other documents.

The administration won’t release figures on completed modifications until December, but so far it appears that very few trial modifications are becoming permanent, often because of a lack of documentation.

Willem Buiter Apparently Does Not LIke Gold, and Why Jesse. This was not one of Buiter’s finer moments.

How Banks View Loan Modifications Mandelman

Powerful interests are trying to control the market John Kay, Financial Times

Ambac may file bankruptcy soon Ed Harrison

Will rising oil prices derail the recovery? Jim Hamilton

On a New Form of Indentured Servitude The Confluence (hat tip reader John D)

Massive Defense Spending Leads to Job Loss Dean Baker (hat tip reader Gordon). Today’s must read.

Antidote du jour:

It seems odd that days after we were told by Goldman Sachs’s CEO, Lloyd Blankfein, that bankers are doing “God’s work”, we are still having active debates about how to regulate these selfless apostles of capitalism.

The latest foray into financial reform comes from the Senate. Senator Christopher Dodd will propose creating a single U.S. regulator that would strip the Federal Reserve and Federal Deposit Insurance Corp. of bank- supervision authority, according to a report from Bloomberg. Dodd, according to the Bloomberg report, has faulted the U.S. bank regulation system, saying “it encourages charter shopping and a ‘race to the bottom’ by agencies to win oversight roles.” Bloomberg notes that “his proposal goes further than proposals by President Barack Obama and House Financial Services Committee Chairman Barney Frank to merge the OTS and OCC.”

Certainly, almost anything is an improvement over the abomination that came out of Barney Frank’s committee. But we feel that the ‘race to the regulatory bottom’ could easily be solved via a simple mechanism: If you don’t fall in line with our regulatory requirements, you’re simply denied a banking license to operate in this country. Problem solved. The United States is the biggest banking market in the world. Do you think any major bank would willingly vacate this market?

And even if the “too big to fail” behemoths decided to transplant a bunch of their operations elsewhere, the country would still be left with thousands of community banks which could fill the void and better fulfill the public purpose described by Mr Blankfein: namely, to “help companies to grow by helping them to raise capital”, rather than extracting their pound of flesh via grotesquely high financial intermediary fees, as is the case today.

We have argued before on New Deal 2.0 that the FDIC is best suited to carry on the role of chief systemic regulator, given its role as deposit insurer. That regulator has the best institutional incentives to be concerned with systemic risk and to be a vigorous regulator. It should be the least subject to regulatory capture (a pervasive problem at the Fed, which is full of quant economists who have virtually no interaction with other Fed examiners).

But WHO controls the banks is ultimately less important than HOW we control the banks’ activities. Oversight is all very nice, but at times it pays to get back to first principles. What on earth is the public purpose of these things?

Banks are set up and supported by government for the further benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators. Newsflash: the public purpose of banking is NOT to provide profits per se to shareholders. Rather, the provision of the ability to earn profits is only a tool used to support the attendant public purpose. Banks should only be allowed to lend directly to borrowers, and then service and keep those loans on their own balance sheets. There is no further public purpose served by selling loans or other financial assets to third parties, but there are substantial real costs to government in regulating and supervising those activities. There are severe consequences for failure to adequately regulate and supervise those secondary market activities as well.

Banks should be prohibited from engaging in any secondary market activity because it serves no public purpose and may result in severe social costs in the case of regulatory and supervisory lapses. Some argue that these areas might be profitable for the banks, but this is not a reason to extend government sponsored enterprises into those areas. Therefore, banks should not be allowed to buy (or sell) credit default insurance. The public purpose of banking as a public/private partnership is to allow the private sector to price risk, rather than have the public sector pricing risk through publicly owned banks.

If a bank instead relies on credit default insurance, then it is transferring that pricing of risk to a third party, which is counter to the public purpose of the current public/private banking system. Banks should not be allowed to engage in proprietary trading or any profit-making ventures beyond basic lending. If the public sector wants to venture out of banking for some presumed public purpose it can be done through other outlets.

If the activities of the banks are not facilitating the production and movement of real goods and services what public purpose do they serve? It is clear they have made a small number of people fabulously wealthy. It is also clear that they have damaged the prospects for disadvantaged workers in many parts of the world.

It’s more obvious to all of us now that when the system comes unstuck through the complexity of these transactions and the impossibility of correctly pricing risk, the real economies across the globe suffer. The consequences have been devastating in terms of lost employment and income and lost wealth.

All governments should sign an agreement which would make all financial transactions that cannot be shown to facilitate funding for real goods and services illegal. Simple as that. When we keep these principles at the front of the argument, we can see that what Senator Dodd and Congressman Frank are arguing about is akin to how to rearrange the deck chairs on the Titanic.

Let’s review Benmosche’s impressive record of overweening contempt for the government, and therefore taxpayers that rescued AIG. To stress the obvious, AIG is nationalized from an economic standpoint. Like Freddie and Fannie, the only reason the government has not taken 100% ownership (aside from the fact that it might generate bad PR) is that the debt would need to be consolidated on the Federal balance sheet.

But even with the expedient fiction of 20% public ownership, do you think any CEO would dare pull the crap Benmosche has if, say, Warren Buffer held an 80% stake? Consider the record:
First, Benmosche started work….with a two week vacation. As we noted at the time:

I am cynical enough to believe that this signal, of having a CEO start his new job by going on holiday, is quite deliberate. We the great unwashed public are being given the message that we should not run Goldman operatives fine upstanding men like Edward Liddy out, because look what sort of commitment to the job we get now.

Second, Benmosche adopted the posture that he, and not his majority shareholder, was in charge. As we noted in our post, “AIG CEO Gives Uncle Sam (and Us) the Finger (Financial Services Industry Arrogance Watch)“:

Tim Duy pointed out this priceless remark from AIG’s new CEO, Robert Benmosch:

Benmosche told employees that he “had the luxury to say to the government, I’m not going to rush to do this. I’m appalled at how much pressure has been put on all of you to just sell it no matter what, because the Fed wants out, or the Treasury wants out. If they want out in a hurry, they shouldn’t have come in in the first place.”

For anyone who followed the rescue, this is a staggering bit of hubris and revisionist history. First, the idea that the government “came in” implies that this was some sort of normal investment process, as opposed to AIG begging the Federal government for a rescue, even though states, not the national government, are the main regulators of insurance business (the AIG Financial Products business was overseen, if you can call it that, by the Office of Thrift Supervision. AIG structured its operation so as to get them as supervisor precisely because they were guaranteed to do next to nothing).

Next, the original deal called for AIG to pay back the money in two years. That inconvenient fact has been airbrushed out of the story Benmosche tells us. AIG made great assurances that the operating units were worth a lot of money and paying back the loans would be no problem. They accepted a high rate of interest give the riskiness of the loans and the desire of the Federal government to keep the heat on AIG. This original deal in theory fit Bagehot’s rule: lend generously, at a penalty rate, against good collateral.

But AIG fooled itself, or maybe just everyone else. Those supposed crown jewels were worth a lot less than AIG thought.Once they had established they would not be permitted to fail, they started retrading the deal. When AIG realized it couldn’t sell some operating units, pronto, suddenly it started complaining the interest rate (I think Libor plus 8 1/2%, forgive me for working from memory) was too high. Oh, and they happened to need more money too, a wee oversight in their initial demand. So the deal was reworked to give them better terms, a bigger commitment, and NOTHING ADDITIONAL was obtained. This was a free concession, a very bad move in deal land.

The government owns 79.9% of AIG. Any private sector owner who had an overwhelming majority interest and got that kind of attitude from a CEO would fire him immediately. But no, we live in a world where arrogant members of the financial services industry engage in looting, dictate terms to the government, and try to rewrite history to make baldfaced lies seem plausible. Why shoudn’t the government pressure AIG? The idea that owners don’t pressure companies (the subtext of this remark) is an absurd misrepresentation. Go talk to the management of any underperforming company owned by a PE or venture capital firm. For the most part, they do not play nice, and would never tolerate Benmoshe’s posturing, and he knows that. He is simply playing the media and the public for fools.

Third, we have the retention bonus fiasco, in which AIG (under Liddy, not Benmosche) had said it needed to pay retention bonuses to certain staff members because they had specific expertise (both technical and knowledge of particular deals and portfolios) which meant it was worth paying them something extra to make sure they stayed at AIG during the unwind. That idea is no doubt offensive to some readers, but is selectively true.

But AIG abused this waiver, and handed out bonuses widely, including to clearly non-mission-critical support staff, which means it is certain they went to non-mission-critical managers too. And did we hear a peep of contrition from Benmosche? No, and it would be easy to look contrite here, since this didn’t happen on his watch.

Third, Benmosche had the temerity and poor judgment to lambaste Cuomo in a public forum, accusing him of things he never did. You do not pick a public fight with someone who has jurisdiction over you, let alone with a campaign of lies. From Bloomberg:

Robert Benmosche, chief executive officer of American International Group Inc., told employees that New York Attorney General Andrew Cuomo was “unbelievably wrong” for drawing attention to bonus recipients….Cuomo subpoenaed AIG in March during a national furor about $165 million in retention bonuses sent after the firm’s bailout and said those who returned the cash wouldn’t have their names published. That month, some employees received death threats and protesters visited the Connecticut homes of two AIG executives.

“What he did is so unbelievably wrong,” Benmosche said during the Aug. 11 remarks, according to a record obtained by Bloomberg. “He doesn’t deserve to be in government, and he surely shouldn’t be the attorney general of the state of New York. What he did is criminal. You don’t create lynch mobs to go out to people’s homes and do the things he did.”

After being approached by Bloomberg yesterday about the remarks, AIG said that Benmosche “regrets his comments regarding Mr. Cuomo and the tone of those comments” and said that Cuomo resisted pressure to release names.

Yves here. This is insufficient as an apology. AIG has still failed to recant the charge that Cuomo or his office leaked names, when frankly it is probably not hard (via public filings, interviews in industry magazines, etc.) to figure out the identities of at least some AIG top brass. And Cuomo has been proven correct in questioning the retention bonuses.

So predictably, this petulant child with serious impulse control problems has now thrown a huge tantrum. Per the Wall Street Journal:

Robert Benmosche has told the board of American International Group Inc. that he is considering stepping down as chief executive of the government-controlled insurer, just three months after taking the job, according to people familiar with the matter.

At a board meeting last week, the strong-willed industry executive told fellow AIG directors that he was “done” but agreed to think it over after other board members reacted with shock, according to the people.

The executive is chafing under constraints imposed by AIG’s government overseers, particularly a recent compensation review by the Obama administration’s pay czar, Kenneth Feinberg, according to the people. AIG, 80% government owned since a rescue last year, is one of the companies under Mr. Feinberg’s purview.

Last week, Mr. Benmosche and other AIG board members met with Mr. Feinberg in New York. During the three-hour meeting, board members discussed difficulties of complying with pay policies and retaining talent at the company. Mr. Benmosche’s frustrations “hit a crescendo,” said a person familiar with the matter. “Bob feels he is in an impossible situation,” the person added. Mr. Benmosche didn’t respond to a request for comment.

AIG has so far not appealed Mr. Feinberg’s decision for other AIG executives, according to a person familiar with the matter.

It isn’t clear whether Mr. Benmosche would actually resign. In his short tenure at AIG, he has developed a reputation for making provocative remarks and ruffling feathers as he seeks to achieve his goals.

He was said to be prepared to step down at least once before, in August, when his own pay package hadn’t yet been formally approved by Mr. Feinberg. His $10.5 million pay package, including cash salary of $3 million, was later finalized; it is the largest compensation package approved under the Treasury Department’s recent curbs on executive pay.

I cannot believe the intransigence here. If this had occurred in, say, the Johnson or Nixon administrations, someone from the officialdom would have read Benmosche the riot act a long time ago, pointing out he knew exactly what he was getting into and how it was far from prudent to cross someone much bigger than you are. But no one in Team Obama has any balls, Benmosche knows it, and is playing this for all it is worth.

A source on the Hill sent me the following summary of Senator Dodd’s proposed financial reform bill.

My source notes:

The summary leaves out Sections 1201-1204, which contain serious changes to the Federal Reserve bank structures, transparency elements, and restrictions on 13(3).

Comments and observations are always welcome. Dodd said at the press conference that this is a discussion draft, and that there will be room for comments and feedback in the next few weeks. The markup will begin in the first week of December.

This is a fluid process and I encourage you to speak out now on the process, with as much specificity as possible.

The full 1,136-page bill can be viewed at the bottom of this post.

I’m too busy to really read the summary, let alone the full bill.  Please help me figure out what is good, bad or just plain missing, and then let’s all phone our senators.

Here is the 11-page summary:

Senate Committee on Banking, Housing, and Urban Affairs, Chairman Chris Dodd (D-CT)

Contact: Kirstin Brost/Justine Sessions, 202-224-7391

Summary: Restoring American Financial Stability – Discussion Draft

Create a Sound Economic Foundation to Grow Jobs, Protect Consumers,

Rein in Wall Street, End Too Big to Fail, Prevent Another Financial Crisis

Over the past year, Americans have faced the worst financial crisis since the Great Depression. Millions have lost their jobs, businesses have failed, housing prices have dropped, and savings were wiped out.

The failures that led to this crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs.

HIGHLIGHTS OF THE DISCUSSION DRAFT

Consumer Financial Protection Agency: Creates an independent watchdog to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, while prohibiting hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail:

Prevents excessively large or complex financial companies from bringing down the economy by: creating a safe way to shut them down if they fail; imposing tough new capital and leverage requirements and requiring they write their own “funeral plans”; requiring industry to provide their own capital injections; updating the Fed’s lender of last resort authority to allow system-wide support but not prop up individual institutions; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Protects Against Systemic Risks: Creates an independent agency with a board of regulators to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the financial system. The agency could require companies that threaten the economy to divest some of their holdings.

Single Federal Bank Regulator: Eliminates the convoluted system of multiple federal bank regulators to increase accountability and end unnecessary overlap, conflicting regulation, and “charter shopping;” keeps in place the healthy dual banking system that governs community banks.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and director nominations.

Closes Loopholes in Regulation: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated – including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.

Protects Investors: Provides tough new rules for transparency and accountability from investment advisors, financial brokers and credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses. 2

INDEPENDENT CONSUMER FINANCIAL PROTECTION AGENCY

The Consumer Financial Protection Agency will have the sole job of protecting American consumers from fraud and abuse and will ensure people get the clear information they need on loans and other financial products from credit card companies, mortgage brokers, banks and others.

American consumers already have protections against faulty appliances, contaminated food, and dangerous toys.

With the creation of the Consumer Financial Protection Agency, they’ll finally have a watchdog to oversee financial products, giving Americans confidence that there is a system in place that works for them – not just big banks on Wall Street.

Why Change Is Needed: The economic crisis was driven by an across-the-board failure to protect consumers. When consumer protections are handled by regulators whose primary responsibility is to safeguard the profitability of the companies they regulate, consumer protections don’t get the attention they need. The result has been unfair, deceptive, and abusive practices being allowed to spread unchallenged, nearly bringing down the entire financial system.

The Federal Reserve is the primary consumer protection rule-writer, but it has repeatedly failed to act despite repeated demands from Congress. The Federal Trade Commission is responsible for consumer protections for non-bank finance companies, but lacks the authority and capacity to examine them.

The Consumer Financial

Protection Agency

• Consumer Protections in One Place: Consolidates consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, the Federal Reserve, the National Credit Union Administration, and the Federal Trade Commission.

• Independent: Led by a 5 member board with an independent director. The Chairman of the Financial Institutions Regulatory Administration will have a seat on the board.

• A Watchdog with Real Teeth: Unites rule-writing, supervision, and enforcement for consumer protection in a single, stand-alone agency with broad authority to investigate and react to abuses as they develop.

• Able to Act Fast: With this agency on the lookout for bad deals and schemes, consumers won’t have to wait for Congress to pass a law to be protected from bad business practices.

• Educates: Creates a new Office of Financial Literacy.

• Regulates Shadow Banking Industry: Levels the playing field for insured banks by regulating the shadow banking industry, such as mortgage brokers and payday lenders, for the 1st time and ensures that companies offering customers the same products receive the same regulatory treatment.

• Accountability: Makes one agency accountable for consumer protections. With many agencies sharing responsibility, it’s hard to know who is responsible for what, and easy for emerging problems that haven’t historically fallen under anyone’s purview, to fall through the cracks.

• Tougher State Laws: Allows states to pass tougher consumer protections that apply to all lenders, preventing federal regulations from preempting stronger state laws.

• Works with Bank Regulators: Coordinates with other regulators when examining banks to prevent undue regulatory burden.

• Bases Supervision on Risk: Focuses resources on companies that pose the biggest risk to consumers – mortgage bankers, brokers, finance companies and the largest institutions.

ADDRESSING SYSTEMIC RISKS: THE AGENCY FOR FINANCIAL STABILITY

One financial institution should never be capable of bringing down the entire American economy.

The newly created Agency for Financial Stability is an independent agency responsible for identifying, monitoring and addressing systemic risks posed by large, complex companies as well as products and activities that can spread risk across firms. It will discourage companies from getting too large by imposing burdens on them as they grow and give regulators the authority to break up large, complex companies if they pose a threat to the financial stability of the United States.

Why Change is Needed: The economic crisis introduced a new term to our national vocabulary – systemic risk.

In July, Federal Reserve Governor Daniel Tarullo, testified that “Financial institutions are systemically important if the failure of the firm to meet its obligations to creditors and customers would have significant adverse consequences for the financial system and the broader economy.”

In short, in an interconnected global economy, it’s easy for some people’s problems to become everybody’s problems. The failures that brought down giant financial institutions last year also devastated the economic security of millions of Americans who did nothing wrong – their jobs, homes, retirement security, gone overnight because of Wall Street greed and regulatory failures.

The Agency for Financial Stability

• Strong and Independent: Governed by an independent chairman, appointed by the President and confirmed by the Senate, to provide insulation from political manipulation. The board will have 9 members including the federal financial regulators and two independent members. The board members’ diverse areas of expertise will strengthen the board’s ability to identify and respond to emerging risks throughout the financial system.

• Tough to Get Too Big: Writes increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, imposing significant costs on companies that pose risks to the financial system.

• Break Up Large, Complex Companies: Gives the regulators the authority to break up large, complex companies if they pose a threat to the financial stability of the United States.

• Close Gaps in Regulation: Identifies unregulated financial companies that pose systemic risk and assigns them to a federal regulator for supervision.

• Lean and Mean: Expected to be staffed with a highly sophisticated staff of economists, accountants, lawyers, former supervisors, and other specialists. With just rule writing authority and no direct supervision, the agency can remain small but effective.

• Make Risks Transparent: Collects and analyzes data to identify and monitor emerging risks to the economy and make this information public in periodic reports and testimony to Congress twice a year.

• Oversight of Important Market Utilities: The Agency for Financial Stability will identify systemically important clearing, payments, and settlements systems to be regulated by the Federal Reserve.

4

ENDING TOO BIG TO FAIL

Preventing another crisis where American taxpayers are forced to bail out financial firms requires strengthening big companies to better withstand stress, putting a price on excessive growth that matches the risks they pose to the financial system, and creating a way to shutdown big companies that fail without threatening the economy.

Why Change is Needed: As long as giant firms (and their creditors) believe the government will prop them up if they get into trouble, they only have incentive to get larger and take bigger risks, believing they will reap any rewards and leave taxpayers to foot the bill if things go wrong.

Since the crisis began, a number of institutions previously considered “too big to fail” have only grown bigger by acquiring failing companies, leaving our country with the same vulnerabilities that led to last year’s bailouts.

Limiting Large, Complex Companies and Preventing Future Bailouts

• Discourage Excessive Growth: Imposes increasingly strict standards for companies as they grow larger, more complex, or more interconnected, including heightened capital, leverage, and liquidity requirements, that ensure these companies have greater resources to deal with financial shocks.

• Require Companies Provide Their Own Capital Injections: Requires institutions to issue long-term hybrid debt securities that will provide them with capital during a systemic crisis so failing institutions can provide their own life support.

• Funeral Plans: Requires large, complex companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and subject to restrictions on growth and activity as well as required divestment if they fail to submit acceptable plans. Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails. Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.

• Orderly Shutdown: Creates a mechanism for the FDIC to unwind failing systemically significant financial companies through receivership, but not open assistance. Costs of unwinding these companies will ultimately be charged to financial firms with assets of over $10 billion, not to the taxpayers.

• Limit Federal Reserve Lending: Updates the Federal Reserve’s 13(3) lender of last resort authority to allow system-wide support for healthy institutions or systemically important market utilities during a major destabilizing event, but not to prop up individual institutions.

5

CREATING A SINGLE FEDERAL BANK REGULATOR:

THE FINANCIAL INSTITUTIONS REGULATORY ADMINISTRATION

The Financial Institutions Regulatory Administration will eliminate the alphabet soup of multiple bank regulators that has led to weak, confusing regulation where it’s easy for problems to fall through the cracks and difficult to know who is responsible.

Why Change is Needed: Today, we have a convoluted system of bank regulators created by historical accident. There are 4 federal banking agencies that oversee national and state banks and federal and state thrifts. The result has been charter shopping, where firms look around for the regulator that will go easiest on them and fee-funded regulators go easy on those they regulate in order to keep their business, as well as a mess of overlaps, redundancies, and blurred lines of responsibility.

Experts agree that no one would have designed a system that looked like this. For over 60 years, administrations of both parties, members of Congress across the political spectrum, commissions and scholars have proposed streamlining this irrational system. The Financial Institutions Regulatory Administration will finally achieve that goal.

The Financial Institutions Regulatory Administration

• Independent: Headed by an independent chairman appointed by the President and confirmed by the Senate, a Vice Chairman experienced in state banking regulation, and a board including the chairmen of the FDIC and the Federal Reserve and two other independent members. It will be funded primarily by assessments on the industry.

• Single Focused Agency: Combines the functions of the Office of the Comptroller of the Currency and the Office of Thrift Savings, the state bank supervisory functions of the Federal Deposit Insurance Corporation and the Federal Reserve, and the bank holding company supervision authority from the Federal Reserve.

• Dual Banking System: Preserves the dual banking system, leaving in place the state banking system that governs most of our nation’s community banks.

• Separate Community Bank Division: Establishes a separate division within the new regulator to regulate community banks given the different supervisory issues they pose.

• Eliminates Charter Shopping: Stops financial institutions from choosing the easiest regulator, and stops fee-funded regulators from going easy on those they regulate to keep their business.

• Increases Accountability: Having a single regulator will mean an identifiable agency is held responsible for shortcomings in the banking system.

• Speeds Action, Increases Efficiency: Ends slow, cumbersome, coordinated rulemaking that creates extra red tape and inconsistent enforcement of the same rules by agencies. Overlaps impose unnecessary costs on regulated institutions and their customers.

• Focuses the FDIC and the Federal Reserve: The FDIC will focus on its jobs as deposit insurer and resolver of failed institutions, retaining backup examination authority over troubled banks and gaining additional authority to accompany the new agency on examinations of healthy banks and holding companies to ensure it has sufficient information to perform its insurance functions. The Federal Reserve will focus on monetary policy without being distracted by responsibilities for bank oversight and consumer protections. The Federal Reserve will continue to play a key role in assessing financial stability and have guaranteed access to financial institutions and any needed information.

6

ADDRESSING SYSTEMIC RISKS POSED BY DERIVATIVES

Common sense safeguards will protect taxpayers against the need for future bailouts and buffer the financial system from excessive risk-taking. Over-the-counter derivatives will be regulated by the SEC and the CFTC, more will be cleared through centralized clearing houses and traded on exchanges, un-cleared swaps will be subject to margin and capital requirements, and all trades will be reported so that regulators can monitor risks in this large, complex market.

Why Change is Needed: The over-the-counter derivatives market has exploded in the last decade – from $91 trillion in 1998 to $592 trillion in 2008. During last year’s financial crisis, concerns about the ability of companies to make good on these contracts and the lack of transparency about what risks existed caused credit markets to freeze.

Investors were afraid to trade as Bear Stearns, AIG, and Lehman Brothers failed because any new transaction could expose them to more risk.

Over-the-counter derivatives are supposed to be contracts that protect businesses from risks, but they became a way for companies to make enormous bets with no regulatory oversight or rules and therefore exacerbated risks. Because the derivatives market was considered too big and too interconnected to fail, taxpayers had to foot the bill for Wall Street’s bad bets.

Those bad bets linked thousands of traders, creating a web in which one default threatened to produce a chain of corporate and economic failures worldwide. These interconnected trades, coupled with the lack of transparency about who held what, made unwinding the “too big to fail” institutions more costly to taxpayers.

Bringing Transparency and Accountability to the Derivatives Market

• Closes Regulatory Gaps: Provides the SEC and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight. Uses the Administration’s outline for a joint rulemaking process with the Agency for Financial Stability stepping in if the two agencies can’t agree.

• Central Clearing and Exchange Trading: Requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared. Requires the SEC and the CFTC to pre-approve contracts before clearing houses can clear them.

• Safeguards for Un-Cleared Trades: Requires traders post margin and capital on un-cleared trades in order to offset the greater risk they pose to the financial system and encourage more trading to take place in transparent, regulated markets.

• Market Transparency: Requires data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.

7

HEDGE FUNDS

Hedge funds worth over $100 million will be required to register with the SEC as investment advisers and to disclose financial data needed to monitor systemic risk and protect investors.

Why Change is Needed:

Hedge funds are responsible for huge transfers of capital and risk, but generally operate outside the framework of the financial regulatory system, even as they have become increasingly interwoven with the rest of the country’s financial markets.

As a result, no regulator is currently able to collect information on the size and nature of these firms or calculate the risks they pose to the broader economy. The SEC is currently unable to examine private funds’ books and records or take sufficient action when it suspects fraud.

Raising Standards and Regulating Hedge Funds

• Fills Regulatory Gaps: Ends the “shadow” financial system in which hedge funds and other private pools of capital operate by requiring that they provide regulators with critical information.

• Register with the SEC: Requires hedge funds to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.

• Independent Custody of Client Assets: Requires investment advisers to use independent custodians for client assets to prevent Madoff-type frauds.

• Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $25 million to $100 million, a move expected to increase the number of advisors under state supervision by 28%. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.

INSURANCE

Office of National Insurance:

Creates a new office within the Treasury Department to monitor the insurance industry, coordinate international insurance issues, and requires a study on ways to modernize insurance regulation and provide Congress with recommendations.

Streamlines the regulation of surplus lines insurance and reinsurance through state-based reforms. 8

CREDIT RATING AGENCIES

Establishes a new Office of Credit Rating Agencies at the Securities and Exchange Commission to strengthen regulation of credit rating agencies. New rules for internal controls, independence, transparency and penalties for poor performance will address shortcomings and restore investor confidence in these ratings.

Why Change is Needed:

Rating agencies market themselves as providers of independent research and in-depth credit analysis. But in this crisis, instead of helping people better understand risk, they failed to warn people about risks hidden throughout layers of complex structures.

Flawed methodology, weak oversight by regulators, conflicts of interest, and a total lack of transparency contributed to a system in which AAA ratings were awarded to complex, unsafe asset-backed securities – adding to the housing bubble and magnifying the financial shock caused when the bubble burst. When investors no longer trusted these ratings during the credit crunch, they pulled back from lending money to municipalities and other borrowers.

New Requirements and Oversight of Credit Rating Agencies

• New Office, New Focus at SEC: Creates an Office of Credit Ratings at the SEC with its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public.

• Disclosure: Requires Nationally Recognized Statistical Ratings Organizations to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record.

• Independent Information: Requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible.

• Conflicts of Interest: Prohibits compliance officers from working on ratings, methodologies, or sales.

• Liability: Investors could bring private rights of action against ratings agencies for a knowing or reckless failure to investigate or to obtain analysis from an independent source.

• Right to Deregister: Gives the SEC the authority to deregister an agency for providing bad ratings over time.

• Education: Requires ratings analysts to pass qualifying exams and have continuing education.

9

EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE

Strengthening Shareholder Rights

Giving shareholders a say on pay and proxy access, ensuring the independence of compensation committees, and requiring public companies to set clawback policies to take back executive compensation based on inaccurate financial statements are important steps in reining in excessive executive pay and can help shift management’s focus from short-term profits to long-term growth and stability.

Why Change Is Needed: In this country, you are supposed to be rewarded for hard work.

But Wall Street has developed an out of control system of out of this world bonuses that rewards short term profits over the long term health and security of their firms.

Incentives for short-term gains likewise created incentives for executives to take big risks with excess leverage, threatening the stability of their companies and the economy as a whole.

Giving Shareholders a Say on Pay and Creating Greater Accountability

• Vote on Executive Pay and Golden Parachutes: Gives shareholders a say on pay with the right to a non-binding vote on executive pay and golden parachutes linked to corporate takeovers. This gives shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.

• Nominating Directors: Gives shareholders proxy access to nominate directors. Providing shareholders a greater role in choosing directors can help shift management’s focus from short-term profits to long-term growth and stability.

• Independent Compensation Committees: Standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.

• Clawbacks for Executives at Public Companies: Requires that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards.

• SEC Review: Directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.

10

SEC AND IMPROVING INVESTOR PROTECTIONS

Every investor – from a hardworking American contributing to a union pension to a day trader to a retiree living off of their 401(k) – deserves better protections for their investments. Investors in securities will be better protected by improving the competence of the SEC, creating uniform standards for those providing customers investment advice, and giving investors the right to sue those who commit securities fraud.

Why Change Is Needed: The Madoff scandal demonstrated just how desperately the SEC is in need of reform. The SEC has failed to perform aggressive oversight and is unable to understand the very companies it is supposed to regulate. And investors have been used and abused by the very people who are supposed to be providing them with financial advice.

SEC and Beefed Up Investor Protections

• SEC Reforms: Mandates an annual assessment of the SEC’s internal supervisory controls and a biannual GAO study of SEC management.

• Uniform Standards for Advisors: Mandates uniform standards for anyone providing customers investment advice, eliminating different standards for broker‐dealers and investment advisers. Small investors should have uniform protections regardless of the title of the financial professional advising them has.

• Best Interest of the Client: Brokers who give investment advice will be held to the same fiduciary standard as investment advisers – they will be required to act in their clients’ best interest.

• Aiding and Abetting: Investors will be able to sue persons who help commit securities fraud.

• New Advocates for Investors: Creates the Investment Advisory Committee, a committee of investors to advise the SEC on its regulatory priorities and practices as well as the Office of Investor Advocate in the SEC, to identify areas where investors have significant problems dealing with the SEC and FINRA and provide them assistance.

• Funding: The self-funded SEC will no longer be subject to the annual appropriations process.

SECURITIZATION

Companies that sell products like mortgage-backed securities are required to retain a portion of the risk to ensure they won’t sell garbage to investors, because they have to keep some of it for themselves.

Why Change Is Needed:

Companies made risky investments, such as selling mortgages to people they knew could not afford to pay them, and then packaged those investments together, called asset-backed securities, and sold them to investors who didn’t understand the risk they were taking. For the company that made, packaged and sold the loan, it wasn’t important if the loans were never repaid as long as they were able to sell the loan at a profit before problems started. This led to the subprime mortgage mess that helped to bring down the economy.

Reducing Risks Posed by Securities

• Skin in the Game: Requires companies that sell products like mortgage-backed securities to retain at least 10% of the credit risk. That way if the investment doesn’t pan out, the company that made, packaged and sold the investment would lose out right along with the people they sold it to.

• Better Disclosure: Requires issuers disclose more information about the underlying assets and to analyze the quality of the underlying assets.

11

MUNICIPAL SECURITIES

Municipal securities will have better oversight through the registration of municipal advisers and increased investor representation on the Municipal Securities Rulemaking Board.

Why Change is Needed:

Financial advisers to municipal securities issuers have been involved in “pay-to-play” scandals and have recommended unsuitable derivatives for small municipalities, among other inappropriate actions, and are not currently regulated.

Better Oversight of Municipal Securities

• Registers Advisors and Brokers: Requires SEC registration for financial advisers, swap advisers, and investment brokers – unregulated intermediaries who play key roles in the municipal bond market.

• Regulates Advisors and Brokers: Subjects financial advisers, swap advisers, and investment brokers to rules issued by the Municipal Securities Rulemaking Board and enforced by the SEC or a designee.

• Puts Investors First on the MSRB Board: Gives investor and public representatives a majority on the MSRB to better protect investors in the municipal securities market where there has been less transparency than in corporate debt markets.

CREATING A 21st CENTURY WORKFORCE FOR 21st CENTURY REGULATORS

This bill will take a look at a key hurdle for creating competent regulatory agencies: competent staff.

Why Change is Needed: The new proposals will create three new agencies – the Financial Institutions Regulatory Administration, the Agency for Financial Stability and the Consumer Financial Protection Agency – each posing staffing challenges that will determine the regulators’ success or failure.

A Better Work Environment to Attract Better Staff: The bill will set up a panel to look at the staffing needs of the three new agencies based on the successful panel that helped the IRS to improve their hiring practices. The advisory panel will last only three years to see that these agencies are able to attract, cultivate, and retain competent staff qualified to regulate complex, 21st century financial institutions.

Here is the full bill:

Sen. Chris Dodd’s Proposed Financial Overhaul Bill -

Murdoch could block Google searches entirely Guardian

Barclays’ Remarkable Bargain Andrew Ross Sorkin, New York Times

The Periodic Table of Bloggers Slope of Hope (hat tip Jim Bianco)

Pfizer abandons site of infamous Kelo eminent domain taking Washington Examiner (hat tip DoctoRx)

Flood initiative shows cross-border risk Gillian Tett, Financial Times

Hosanna!! Cassandra. Funny.

Antidote du jour:

The G-20 statement contained seven principles to guide policy during the balance of the crisis period. However, the agreed to policy principles juxtaposed with US trade data suggest that the G20 may be promoting the current recovery at the expense of contributing to a future crisis. The likely existence of this trade-off can be seen by reading the G20 statement (The executive summary is reproduced below.) and examining the behavior of the US trade deficit. The underlying politics also imply that probability of international economic and financial cooperation extending past the current stimulus packages is low to non-existent.

First, the executive summary of the G20 statement:

Executive Summary

The global economy has returned to positive growth following dramatic declines. The recovery is, however, uneven and not yet self-sustaining, notably in advanced economies. Financial conditions have continued to improve, but are still far from normal.

Exit strategies should pave the way for strong, sustained and balanced economic growth. The Principles below are intended to establish common ground for the design and implementation of policies during the exit from the extraordinary support measures taken during the crisis.

Principle 1. The timing of exits should depend on the state of the economy and the financial system, and should err on the side of further supporting demand and financial repair.

Principle 2. With some exceptions, fiscal consolidation should be a top policy priority. Monetary policy can adjust more flexibly when normalization is needed.

Principle 3. Fiscal exit strategies should be transparent, comprehensive, and communicated clearly now, with the goal of lowering public debt to prudent levels within a clearly-specified timeframe.

Principle 4. Stronger primary balances should be the key driving force of fiscal adjustment, beginning with actions to ensure that crisis-related fiscal stimulus measures remain temporary.

Principle 5. Unconventional monetary policy does not necessarily have to be unwound before conventional monetary policy is tightened.

Principle 6. Economic conditions, the stability of financial markets, and market-based mechanisms should determine when and how financial policy support is removed.

Principle 7. Making exit policies consistent will improve outcomes for all countries. Coordination does not necessarily imply synchronization, but lack of policy coordination could create adverse spillovers.

The seven principles all address domestic policies, monetary, fiscal and financial repair. The emphasis is on restoring sustainable growth. However, despite the call for balanced economic growth in the second sentence, there is no call for any country to take any steps to reduce global economic imbalances.

The US trade deficit since 1992:

The chart of the US trade deficit proves nothing. However, the underlying data is supportive of the argument that the US trade deficit was in large part not driven by exchange rates or excess savings in the rest of the world, but rather by income levels and the lack of savings in the US.

The juxtaposition of the G20’s seven principles, noting the absence of any effort to restore global balance, and the chart above should raise a number of questions.

Can we return to “balanced economic growth”, as per the executive summary, if the sole focus of policy is the restoration of economic growth? The behavior of the US trade deficit suggests stimulating economic growth in the US will lead to a re-widening of unsustainable international imbalances unless other steps are taken.

What does the total absence in the G20 statement of any reference to measures to reduce and prevent unsustainable global imbalances imply for the willingness and ability of policymakers to address the global imbalances?

Should not the exit strategy include steps to restore global balance if growth is to be sustainable?
Indentifying and implementing policies to prevent a return of wider trade deficits will be an economic, financial and political challenge. The effectiveness of Dollar adjustment to restore global balance is limited by the concentration of the US trade deficit and the willingness of some countries to peg the currencies to the Dollar. On the other hand, the Dollar must be part of the any adjustment process as the prices of US produced tradable goods must rise relative to the prices of US produced non tradables goods and services to incentivize resources to return the tradable goods sector. Additional adjustments will be required of the US, but adjustments by other countries will also be required to achieve an efficient and sustainable pattern of trade.

From a US geo-political perspective, there is another challenge. The US position is that other countries must make the adjustments (bear the costs) to reduce the imbalances. This turns the Washington consensus and years of precedent on their heads. In the past, when international imbalances generated problems, the costs and burden of policy and economic adjustments were borne by the deficit country(s) and not surplus countries. In this case however, the US position is exactly the opposite. The US position will not win it any friends.

Two statements this weekend, one by Geithner and the other by Chinese Premier Wen, reflect this problem. Geithner’s post-G20 statement indicates that US is still counting on cooperation from the rest of the world:

These are all global challenges. They are important to our national economic interest, but they cannot be addressed by the United States alone.

While Market Watch quoted Chinese premier Wen as saying:

I hope that as the largest economy in the world and an issuing country of a major reserve currency the United States will effectively discharge its responsibilities, …Most importantly, we hope the U.S. will keep its deficit at an appropriate size so that there will be basic stability in the exchange rate and that is conducive to the stability and recovery of the world economy.

The statements suggest that international cooperation on the trade front will no better than the international cooperation on carbon emissions has been.

The ongoing financial crisis will only worsen, if economic growth is not restored. However, it would be a Pyrrhic victory if the recovery simply set the stage for another economic or financial crisis.

First we have the absurd spectacle of bankers claiming that they are doing God’s work. Great! Then they should be willing to do it for free. I don’t recall the Bible discussing Jesus getting eight or nine figure compensation (or what passed for it back then), and the Gautama Buddha, born a prince, gave up all the trappings of wealth.

Now for those who follow the markets, we have the Ministry of Truth in action on the comment pages of the Financial Times, in the form of today’s offering, “Not all bubbles present a risk to the economy,” by Frederic Mishkin. Somehow, that headline strikes me as trying to make the case, “Nuclear wars don’t have to be bad for you.”

In other words, this appears to be yet another instance of Team Obama attempting policy by PR rather than (novel idea!) actually crafting sensible programs and sticking to them. The Fed has been operating fist in glove with the Treasury throughout the crisis; the idea that it is independent is a joke. The Fed is clearly involved in a concerted program to reflate distressed assets (most notably housing) that has spilled into just about every type of investment (and a few that have not traditionally been investments, namely commodities).

The Fed had been trying to argue that asset prices were irrationally depressed (funny how they had no problem with market prices when many fund managers saw they were wildly elevated, when risk spreads were absurdly low, and there was abundant evidence of froth in the credit markets). Now plenty of central bankers outside the US have been worrying out loud about the bubble in progress (they are framing it officially as a future problem, but reading between the lines, it isn’t hard to infer that they are concerned that it is already under way). And what has the Treasury and Fed said? Nothing beyond pointing out that they have tools for mopping up excessive liquidity.

So now we have former Fed governor Mishkin, curiously stepping up now to defend the officialdom. I was told by a well-connected reader after the bloggerfest at Treasury that Team Obama was in full court press mode, trying to curry goodwill with others to burnish the perception of its financial policies. It isn’t hard to imagine that Mishkin was asked to assist.

It was Mishkin who in January 2007, argued that:

that this concern about burst bubbles may be overstated. To begin with, the bursting of asset price bubbles often does not lead to financial instability…Japan’s experience is that the serious mistake for a central bank that is confronting a bubble is not failing to stop it but rather failing to respond fast enough after it has burst….

With a track record like that, should anyone take anything he says about bubbles seriously?

Mishkin also argued:

one must assume that a central bank can identify a bubble in progress. I find this assumption highly dubious because it is hard to believe that the central bank has such an informational advantage over private markets…

Yves here. We have the counterexample of Ian MacFarlane, governor of the Reserve Bank of Australia, who set out to combat Australia’s housing bubble. He did so by beating up on the banks, frequently pointing out that housing prices had risen too far, too fast and probably did not represent a great investment, plus a couple of judicious rate hikes. Australia is generally credited with having done a much better job of contending with its housing bubble than any other country in the same fix.

By definition, a bubble is a massive price distortion in certain types of assets. That is already not a good thing. If you believe in markets, you believe in the value of price mechanisms because they lead to efficient allocation of goods and services and help channel investment funds to productive uses. At a minimum, bubbles are bad because they suck capital into seriously suboptimal uses at the expense of better ones. So ANY defense of bubbles has to be regarded with considerable skepticism. Bubbles are bad even when they fall short of the standard of wrecking an economy, which appears to be the base line Mishkin is using in his FT piece. He contends that bubbles that are not fueled by credit are not really that pernicious:

The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.

Yves here. While narrowly true, this is all a bit slippery. The Fed was worried enough about the dot-com bust to drop rates WELL below the level indicated by its usual approach, the Taylor Rule, and held them there for an exceptionally long time. If this was such a benign bust, why did the Fed engineer and maintain negative real yields for so long?

The 1987 crash is a peculiar case. Even though equities had risen to bubble territory, the crash was worse than it should have been thanks to program trading. Moreover, Mishkin bizarrely omits that there WAS a credit component, namely LBO lending, which had been at high levels prior to the crash, picked up again in 1988 and was at high levels in 1989. The LBO bubble did help fuel the equity price rise (I recall a report in 1987 attributing 75% of the appreciation that year to takeover speculation, and a proposed measure to tax highly levered transactions was one of the proximate causes of the crash, see the Brady Report for details) but that did not unwind till the end of 1989. For some reason, the banking crisis of 1990-1991 is always depicted as an S&L crisis when non-S&Ls (including GE Capital) were big holders of really horrid takeover loans and took significant balance sheet hits.

And the commodities runup of the first half of 2008 would fit in Mishkin’s typology of “not so bad” bubbles. Jim Hamilton thinks, by contrast, that the rise in oil prices was the detonator for the credit contraction, that higher gas prices pushed overstretched consumers over the brink. And the agricultural commodities price spike led to riots over high soyabean and grain prices.

But Mishkin reverts to the same arguments he used in January 2007:

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Yves here. This is pure and simple willful blindness. And his argument, that policymakers are incapable of recognizing bubbles is silly. Investors and speculators (crudely speaking) have tougher stomachs than analysts (and presumably policy makers). You need to be willing to take losses and many people are not wired to do that. Being able and wiling to play in markets every day takes certain personal attributes that go beyond analytical ability. Bubbles are extreme events, they are less difficult to recognize than day-to-day investment picks.

Moreover, Mishkin offers a straw man: that the only way to stanch an asset bubble in a particular market is via monetary policy, which is a blunt instrument. Now it is true that the only tool readily available to the Fed now is monetary policy. But the Fed was lobbying to act as macroprudential regulator. It seems very peculiar that, in this post-bubble carnage, it has not done much of anything to generate thought (staff papers, for a starter) on the issue of what tools in addition to monetary policy authorities need to have at hand to be able to attack bubbles in specific, but significant, markets. For starters, you can restrict leverage, put limits on types of trading that might favor purely speculative momentum traders, etc (you’d need to look into particular mechanism peculiar to the relevant markets to devise a surgical intervention).

Mishkin’s arguments are absurd, except they reflect the Fed’s complete unwillingness to take on this task. It is much easier to offer the excuse that you are incapable (and talk yourself into it), than deal with the bigger issue: that pricking an asset bubble is unpopular. As Macfarlane noted:

Even if the central bank was confident that a destabilising bubble was forming, and that its bursting would be extremely damaging, the community would not necessarily know that this was in prospect, and could not know until the whole episode had been allowed to play itself out. If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not. If in the most favourable case, the central bank raised interest rates by a modest amount and prevented the bubble from expanding to a dangerous level, and it did so at a relatively small cost in terms of income and employment growth forgone, would it get any thanks? Almost certainly not…In all probability, the episode would be regarded by the public as an error of monetary policy because what might have happened could never be observed….

Yves again. What is truly disconcerting about Mishkin’s remarks is that, even though he is no longer at the Fed, they probably represent conventional wisdom there. And that means the officialdom has gained perilous little insight from this disaster. George Santayana warned about the consequences of failing to learn from history….