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Guest Post: Anticipating Financial Instability - High Time for a Coherent Macroeconomics

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 15:34:50 -0700

Rob Parenteau, CFA, is sole proprietor of MacroStrategy Edge, editor of the Richebacher Letter, and a research associate with the Levy Economics Institute.

At a Brookings Institution session last March, while Bear Stearns was flaming out, Robert Rubin asserted "few, if any people anticipated the sort of meltdown that we are seeing in credit markets at present." Der Spiegel recently carried an insightful piece on one of the few, former central banker William White (http://www.spiegel.de/international/business/0,1518,635051,00.html). White and his protégés at the BIS – the central bank for central banks – like Claudio Borio repeatedly stuck their necks out to warn of the financial imbalances building in the global economic system. In contrast, most of their colleagues in central banks, backed by the prevailing mainstream macroeconomics, mistakenly asserted that inflation stability would insure both stability in economic growth and financial stability. Indeed, this was part of the narrative that central bankers like Chairman Bernanke took up with their Great Moderation story.

Similarly, Nassim Taleb has gained notoriety for his view that the recent episode of financial instability is an example of a Black Swan event – a type of "tail event" that will randomly disrupt human affairs because we tend to systematically clip off the extremes of the possible when examining the range of likely outcomes. Yet a recent paper by Dirk Bezemer at Groningen University, "No One Saw This Coming", however, documents that dissenting voices were there to be heard, if one was only willing to listen (http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf).

This in itself is not entirely surprising – after all, financial markets require bulls and bear if any trading is to actually occur, and there is always a contingent of knee jerk contrarians, misanthropes, and malcontents known as permabears willing to spin the doom and gloom narrative. However, what Bezemer uncovered is that an identifiable common thread ran across the dissenting views.

The dissenters, Bezemer found, shared an emphasis on a stock/flow coherent macroeconomics. That is, starting from what should be an uncontroversial, accounting based view that at the level of the economy as a whole, total income must equal total expenditures, and total assets must equal total liabilities, those who saw this coming were able to identify unsustainable sectoral cash flow and balance sheet developments. In advance, a stock/flow coherent macroeconomics revealed the reasons why the Great Moderation was bound, by construction, to eventually give way to the Great Disruption.

As Bezemer put it,

"Surveying these assessments and forecasts, there appears to be a set of interrelated elements central and common to the contrarians' thinking. This comprises a concern with financial assets as distinct from real sector assets, with the credit flows that finance both forms of wealth, with the debt growth accompanying growth in financial wealth, and with the accounting relation between the financial and real economy."

Having performed one such analysis for the Levy Economics Institute in 2006 (http://www.levy.org/vdoc.aspx?docid=866) and studied financial instability reports issued by the Levy Institute, the BIS, the IMF, and others prior to the recent financial crisis, we believe Bezemer has it largely correct. If policy makers are indeed serious about the "never again" pledge regarding a financial crises the size of the recent one, they will need to set aside the prevailing macroeconomic paradigm – one which has largely made itself irrelevant by approaching macro as little more than aggregated microeconomics. Instead, they will need to become familiar with a stock/flow coherent macroeconomics that highlights the way financial conditions can shape economic outcomes. This is an economics examined and utilized by J.M. Keynes, Irving Fisher, Hy Minsky, Wynne Godley, Kurt Richebacher, and others – it is an economics especially relevant to the world we actually inhabit.

When a plane crashes, investigators swarm over the site and retrieve the "black box" in order to determine the cause of the crash, with the aim of reducing the odds of future crashes. In that fashion, knowledge it built over time about what works and what does not work, and appropriate adjustment in technology or best practices can be made along the way.

Little in the way of such procedures appears to be set in motion following a financial crash. Given the ability of financial crises to disrupt the lives of more people than can fit on a plane, this should strike most people as somewhat cavalier, if not absurd.

Some, like Bill Black, have suggested nothing less than a modern version of the Pecora Commission should be launched (http://neweconomicperspectives.blogspot.com/2009/07/some-want-whole-truth-about-what-went_13.html). We are no fans of witch hunts, but we do believe ignoring useful frameworks for understanding financial instability, and leaving applied analysis based on these frameworks essentially ignored or marginalized, is unlikely to benefit anyone except those who gain the most from manufacturing and milking serial asset bubbles. Any attempt at an autopsy of the Great Disruption must go beyond cataloguing the inherent fragilities of the financial instruments and specific market structures themselves, as well as the flawed incentive structures and ample room for fraudulent practices, to a serious examination of the unsustainable macrofinancial dynamics that were either ignored or simply explained away.

If macroprudential supervision or any such related effort at reducing the odds of systemic economic crises unfolding from financial instability is to be successful, the core analytics will need to be built around a stock/flow coherent approach macroeconomics. The ground work in this area has been already been done by the likes of Claudio Borio, Wynne Godley, Levy Institute research associates, and others working in financial stability projects within various national and international institutions. Without paying attention to unsustainable sectoral cash flows and the resulting balance sheet leverage building up over time, financial vulnerabilities that can trip up the entire economy – indeed, as we have seen, the entire global economy - will remain largely invisible to investors, entrepreneurs, and policy makers. Perhaps that serves the interests of asset bubble perpetrators, but after recent events, it is high time to question whether those interests should remain paramount.

Bob Rubin is right – a few people did see an episode of financial instability brewing. Dirk Bezemer is also correct – these people tended to share a common approach to viewing economic and financial dynamics. That this framework is not being used to explicitly inform solutions to the current crisis is dumbfounding. That attempts to reduce the odds of future episodes of financial instability may not incorporate this framework, which after all is grounded in relatively straight forward and uncontroversial accounting, is senseless.

Is a Value Added Tax in Your Future?

yves@nakedcapitalism.com (Yves Smith) — Wed, 15 Jul 2009 09:39:23 -0700

I am prejudiced. The first time I every heard of value added taxes was in the early 1970s, and all the stuff I saw then said the VAT was a very bad tax, you raised as much from a sales tax with far lower administrative costs.

But many of our higher-tax OECD compatriots have VATs. If you ever have to contend with them, they are a huge pain for businesses (I had a wee taste with Australia's GST, ugh). And those economists of years past missed a few bureaucratic virtues of the VAT:

1. It appears to hide the tax, Dumb as that sounds, it appears to work. Not adding the tax at the till seems to go over better with the chump populace, This is not trivial. Jean Baptiste Colbert once said, "The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing"

2. VAT is a great tool for increased information capture. VAT leads to more frequent, and for some businesses, more detailed reporting Welcome to the total surveillance society.

VAT, like all sales taxes, is particularly regressive. And it should in theory reduce consumption. Given the duty assigned by China, to shop so as to keep their factories running, a VAT would not endear us to them.

However, Greg Mankiw is raising alarms about income taxes, with a 5.4% surtax proposed fpr "top earners", which his blog does not mention are defined as those earning over $1 million a year . Quelle horreur! Raise those marginal tax rates and everyone will give up and act just like the French and decide to have two and a half hour lunches.

Hhhm, Marginal tax rates are high in New York City (we even have city income taxes) and our sales tax is over 8% (atlthough this being a liberal enclave. food and clothing items below a certain price point are exempt) yet this is a famously workaholic town. Of course, you can only conclude so much from one data point, but it still suggests that high taxes are not necessarily a disincentive to income-earners.

In all seriousness, a VAT is a bad idea. Higher taxes are in our future, so we might as well get used to them. And the more visible the better, The more obvious it is how much we are taxed, the more the average guy is likely to demand a higher level of government services. Despite the often loudly trumpeted distaste for the European model, the Europeans I know do not seem unhappy about their taxes because they perceive that they are getting good value for their tax dolllar (before you think this to be too Pollyannish, they actually do complain less than Americans and even have the occasional nice word, In fact, the Germans and Austrians I know think our system is nuts. However, my sample excludes southern Europe). We've done the reverse here, taking as a given that low taxes (for an advanced economy) means we should reign ourselves to crappy service.

What is more than a tad distressing about this piece by Albert Hunt is that it show Bob Rubin still has a very influential role in policy, and appeasing the markets is seen as a major policy objective. That has the effect of putting considerable power in the hands of those who claim to know what it takes to ~~appease the gods~~ keep them happy.

From Bloomberg:

The Center for American Progress, run by former President Bill Clinton's one-time chief of staff John Podesta, serves as unofficial kitchen cabinet and idea catalyst for this administration.

The center had three recent private sessions of economic heavyweights, ranging from ex-Treasury chief Robert Rubin to liberal activist Bob Greenstein; one participant described the almost universal mood as "gloomy."

Podesta will soon unveil plans for a public forum in September laying out the daunting fiscal challenges, while trying to fashion a "progressive" agenda to deal with them. Any serious effort will almost certainly include substantive spending cutbacks.

The centerpiece might be moving to a consumption tax, which is fraught with political and economic implications...

Some nervous congressional Democrats, prominent liberal economists and Warren Buffett believe another stimulus injection may be necessary. That might not be achievable politically, however, unless the economy really tanks or it is done in conjunction within a more comprehensive strategy dealing with the long-term, mind-numbing budget shortfall.

Roger Altman, an investment banker, doesn't dispute the case for addressing economic sluggishness and only later turning to the looming fiscal crisis. He questions whether the public or the markets have such patience. Deficits don't usually resonate much with voters....

Compared to boosting taxes directly on middle-income earners or slashing domestic programs, a value-added tax as a partial replacement for income and possibly some payroll taxes may be a more attractive alternative, Altman believes. A growing number of Democrats, such as Senate Budget Committee Chairman Kent Conrad and Obama tax-reform adviser Paul Volcker, concur.

If so, it will cause a political bloodbath, particularly if it is a big net revenue-raiser. The "sales tax" label can be lethal. Consumption levies are usually regressive, hurting middle class and poorer people the most, and almost three decades later there remains a belief that espousing such a measure cost the former House Ways and Means Committee Chairman Al Ullman, now deceased, his supposedly safe seat in 1980....

The Obama administration would like to defer any major action on closing the budget gap, certainly until after Congress deals with health care.

Bair and Bernanke Back Size Disincentives For Banks

yves@nakedcapitalism.com (Yves Smith) — Wed, 15 Jul 2009 09:15:25 -0700

In an about-face, the Administration seems to be getting serous about trying to Do Something about the too-big-to-fail syndrome.

Or is it? The proposal comes from Shiela Bair, and does not have the support of the Treasury Department. Curiously, Bloomberg reports that Bernanke has endorsed the Bair plan, which unusually puts him in opposition with Geithner.

Is this move to bolster the Fed's bona fides as a systemic risk regulator? Probably not, since Bloomberg gives the impression that Bernanke is on board with Bair's proposal, when in fact the evidence is thin indeed. If you read the Bloomberg piece, its current headline, "Bair, Bernanke Push to Toughen Plan to Curb Biggest U.S. Banks " suggest that Bernanke and Bair are allied on this measure, while Bernanke has simply said restricting size is a "legitimate option."

The problem with the concept, however, is that it does not attack size and complexity per se, but goes back to trying to separate traditional banking from investment banking by slapping charges on depositaries who do more than traditional lending.

While this is better than nothing, Glass Steagall v. 2,0 would have a large impact on Citi, JP Morgan, and Bank of America. I'm not opposed to that, but this move has the effect of singling them out without doing anything to Morgan Stanley or the great (from a reregulation standpoint) untouchable. Goldman.

It would presumably lead these firms to separate their traditional banking businesses from their investment banking operations. That is not a bad move, but the benefits are probably overstated. The safety net has clearly been extended to what were investment banks. "No more Lehmans" is now official policy. So reducing complexity is a step in the right direction, but we still have the boys with the big trading operations with a de facto government guarantee, no charge for it (like FDIC insurance) and insufficient supervision given the guarantee.

I'm also leery of piecemeal approaches, It's easier for the industry to mobilize against initiatives launched separately, and single measures create the impression that the problem is being tackled, when any one measure will have limited effect.

A second problem is that trying to separate the two types of enterprise does not cut the links. Traditional bank lay off risks in the credit default swaps. market. And as we have learned, the investment banks have hedged their CDS risks for the most part by entering into offsetting contracts. That means the ultimate risk-taker sits elsewhere. So if the investment bank has done an adequate job of judging that the third party can absorb the risk, great, but if not, the IBank is exposed, and the obligor for the banking system risk. And as we saw with AIG and insurance-type guarantee like monoline guarantees, the investment banks didn't seem to do much due diligence on claims-paying ability of these guarantors (while CDS writers do post collateral, the CDS are subject to "jump to default" meaning a sharp rise in CDS price, and colletaral required at the time of default. An adequately collateralized positron can quickly change into something not well supported).

From Bloomberg:

Federal Deposit Insurance Corp. Chairman Sheila Bair, with support from Federal Reserve officials, is pushing for tougher measures to curb the size and risk-taking of the nation's largest financial firms.

The FDIC will propose slapping fees on the biggest bank holding companies to the extent that they carry on activities, such as proprietary trading, outside of traditional lending. The idea goes beyond the Obama administration's regulation-overhaul plan, which would have the Fed adjust capital and liquidity standards for the biggest firms, without any pre-set fees.

"What we have suggested is financial disincentives for size and complexity," Bair said in a July 9 interview. Fed Chairman Ben S. Bernanke told lawmakers last month that restricting size is a "legitimate" option.

Size limits would overturn decades of regulatory tradition that promoted the view that large, diversified institutions were more immune to risks when specific industries or regions slumped.

Bair's proposal is another chapter in the clashes she's had with Treasury Secretary Timothy Geithner and his department over dealing with banks and the financial crisis...

The fees would go to a reserve fund for rescues of bank holding companies, modeled on the FDIC's deposit-insurance fund. They would target risky assets, such as structured products, over-the-counter derivatives and assets kept off of balance sheets....

Minneapolis Fed President Gary Stern has also favored expanded FDIC powers to levy premiums on large, complex financial firms and tougher merger reviews where risks posed to the banking system are an "explicit consideration."

The Treasury's plan would tax financial firms only after bailouts occurred, reflecting concern that a pre-funded bailout reserve would worsen moral hazard, making the firms confident of a rescue in case their bets go wrong.....

House Financial Services Committee Chairman Barney Frank plans a hearing on the so-called too-big-to-fail issue later this month...

"There is nothing in the Treasury proposal designed to put creditors of large, systemically important financial institutions at risk of loss," Stern said in a July 9 speech in Helena, Montana. Bair also favors making explicit the losses for shareholders and creditors of firms that seek federal aid.

"A financial system characterized by a handful of giant institutions with global reach and a single regulator is making a huge bet that those few banks and their regulator over a long period of time will always make the right decisions," Bair told the Senate Banking Committee in May.

Links 7/15/09

yves@nakedcapitalism.com (Yves Smith) — Wed, 15 Jul 2009 09:41:26 -0700

Australia seeks new army robots BBC

Shaken Baby Baloney Independent Accountant

Managers doomed to repeat the mistakes of history John Kay, Financial Times. On the perils of running companies by the numbers, with McNamara and the Whiz Kids as object lessons.

How long will China finance America? Robert Peston

Calpers Sues Over Ratings of Securities New York Times (hat tip reader Scott)

China's Foreign-Exchange Reserves Top $2 Trillion Bloomberg

Insurers aghast at new accounting rules Eurointelligence

WaPo: Surveying the flaming wreckage John Quiggin.

Meet the Cast of the Sotomayor Hearings Adam Server, American Prospect

Coalition to attack plan for Fed powers Financial Times

June Retail Sales in Perspective EconomPic Data

Antidote du jour:

Guest Post: The Elephant in the Room?

yves@nakedcapitalism.com (Yves Smith) — Wed, 15 Jul 2009 09:58:34 -0700

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The Associated Press reports that the funding shortfall faced by the UK's defined benefit pension schemes broke back through the £200 billion barrier during June:

The deficit of the 7,400 defined benefit schemes, including final salary pensions, widened to £200.1 billion during the month, after dipping below the £200 billion mark for one month in May.

The current shortfall represents a dramatic turnaround from the collective £13 billion surplus the schemes had in June last year, according to pensions safety net the Pension Protection Fund.
Pension schemes have faced a double whammy of falling asset values and rising liabilities during the past year. The cost of their liabilities to members has soared by 21% during the past 12 months due to lower gilt yields.

At the same time, falling equity markets have slashed the value of the schemes' assets by 5.5%. A total of 6,461 pension schemes now face a funding shortfall, representing 88% of all defined benefit schemes.

The ongoing funding problems faced by many pension schemes is expected to lead to an increasing trend among companies to close their final salary pensions to existing staff, meaning they can no longer build up further benefits in them.
The majority of companies have already closed these schemes to new members, and
a recent report carried out by PricewaterhouseCoopers showed that 16% of ompanies have also frozen their schemes to existing ones.

A further 42% of employers said they planned to close their final salary schemes to future accruals in the near future, while 32% said they were considering doing so.

Professional Pensions reveals the exact figures of the widening U.K. pension crisis:

The aggregate funding position - total assets minus total liabilities - of defined benefit schemes has worsened during the last month, the Pension Protection Fund says.

The lifeboat fund said its PPF7800 index showed the aggregate deficit of UK schemes has grown to £200.1bn at the end of June from £179.3bn at the end of May. The PPF7800 index showed a surplus of £13bn at the end of June last year.

The PPF estimated the total deficit of schemes in deficit in June 2009 has worsened to £215.8bn from £196.8bn at the end of May. In June 2008, the aggregate deficit of all schemes in deficit stood at £60.3bn.

The total surpluses of schemes in surplus also worsened. It fell to £15.7bn from £17.5bn at the end of May 2009. In June 2008, the total surplus of all schemes in surplus stood at £73.3bn.

Alex Brummer writes this comment in the Daily Mail about a ballooning pensions crisis:

The rush out of defined-benefit pension schemes in recent months has become all too common. Britain's richest company BP has closed its scheme, regarded as one of the most generous, to new members.

And Barclays, seeking to conserve cash in a hostile climate for banking, has taken all but a handful of top executives out of its final salary scheme. Elsewhere at BT and British Airways the pension-fund deficit has become the elephant in the room.

BT may yet face delicate negotiations with the Pensions Regulator on its future obligations later this year as it completes its triennial actuarial valuation.

Just how bad life has become for defined-benefit schemes, which have more members than any others in the UK, isevident from the Pension Regulator's annual
report. It notes a sharp deterioration in the health of defined-benefit schemes.

At the end of March 2007, after a strong run for financial markets and efforts by companies to fill gaps, the surplus in defined benefit schemes reached £74.2billion. As the credit crunch drove down markets, the surplus was turned into a modest £5.1billion deficit by the end of March 2008, which ballooned to a £242billion shortfall by this March.

It has now narrowed to £200billion. Clearly, the end of the bull market and the sharp decline in equity prices played its part in this. Other factors have been increased mortality and the higher costs of running pension funds, with healthy retirement schemes now required to bail out of those of failed companies.

Except in a few brave companies, final-salary pensions look as dead as a dodo for new employees. What's worse, in the case of some quoted corporations, they could threaten dividend payouts and returns to investors as companies struggle to come to terms with their liabilities.

Given the deterioration in defined-benefit schemes, it is understandable that employers' group the CBI is among those campaigning for the government sector to face up to its pension obligations. Most recent estimates suggest a shortfall of £750billion in publicsector schemes. However, that may well be an underestimate.

But with private sector employers struggling under the weight of deficits, this is a problem that is not going to go away. It may have the surprising side-effect of rendering many quoted companies bid proof. But it is a defence that they would rather not have.

So are pension deficits the elephant in the room? As I have stated before, pension deficits will be the major global public policy issue of the next decade. That's why monetary authorities are desperately trying to reflate the global economy and avoid debt deflation at all costs.

The global pensions crisis will hit many hard working people in both the private and public sector. The latter are not immune to cuts in benefits and increased contribution rates. The only people laughing all the way to the bank are overpaid pension fund managers delivering mediocre results and ex-CEOs like Rick Wagoner.

CNN reports that the former General Motors CEO will receive $8.5 million over the next five years -- a reduction of about $12 million in his retirement package. I got a beter idea. Why doesn't Mr. Wagoner do the honorable thing and give his pension benefits to GM's underfunded pension fund?

Then again, honor is a rare commodity these days when everyone is looking to cut corners and profit on the backs of an ever restless working class wondering how they will safely retire without losing their dignity.

How globalisation led to universal banking in America

yves@nakedcapitalism.com (Yves Smith) — Mon, 13 Jul 2009 14:03:05 -0700

Submitted by Edward Harrison of Credit Writedowns.

Last week, I followed up Yves Smith's excellent post on "Why Big Capital Markets Players Are Unmanageable" with "More on why big capital markets players are unmanageable." I would like to extend the discussion beyond the U.S. border into a look at how the universal banking model abroad encroached on the U.S. banking system and created a response that made the repeal of Glass-Steagall an inevitability. I begin this post with the end of the Bretton Woods system and the beginning of deregulation. These event internationalised finance in way that made universal banking a desirable business model in the U.S. and ended Glass-Steagall.

I should note up front that I am not a market pundit that thinks the repeal of Glass-Steagall was a catalyst for the credit bubble and crash. Nor do I think regulatory reform should bring Glass-Steagall back as Paul Volcker seems to argue. Hopefully, this post will help explain why.

Bretton Woods

In July 1944, major nations met in Bretton Woods, New Hampshire to discuss reforms to the international monetary system. What came out of this conference was a system that had the U.S. dollar at its core with the dollar linked to Gold at a value of $35 an ounce. The system was stable only to the degree that the U.S. dollar maintained its value at this level. However, the U.S. started to inflate from the word go, with this inflation taking on greater measure in the 1960s under the"guns and butter" policy of Lyndon Johnson.

The French, under the charge of the sometimes anti-American leader Charles de Gaulle, were the first to balk at the inflation and they started to convert their U.S. dollar holdings to gold. Other nations followed. This led to the closing of the gold window in 1971, which was the formal recognition that the U.S. dollar was a depreciated currency due to money printing of the U.S. government.

Post Bretton Woods changes in American finance

After Bretton Woods ended, inflation soared globally, leading to disintermediation of the traditional banking system. Money market funds and the Eurodollar market came into existence immediately. Other forms of disintermediation for commercial banks followed including the development of the high yield bond market and securitization to name two. The market for oil and currencies took off as the removal of gold backing from the international monetary system introduced volatility into those markets. The net effect of these changes was a reduction in profits in traditional banking in America and a internationalization of the U.S. financial system.

In large part because of these changes, a focus on deregulation was seen as a fix. In academia, the laissez-faire movement had become dominant, with professors like Milton Friedman leading the way. Now, their ideas were moving into markets beginning with the deregulation of brokerage commissions in 1975 and the creative destruction this created. Over the short-term, deregulation was a killer for broker-dealers, upending the brokerage industry, decimating profits at many brokerages and leading to the rise of discount brokerages like Charles Schwab. This also allowed commissions to be low enough for middle class Americans to start participating in the markets and can thus be seen as a democratization of the markets.

But, overall the 1970s were unkind to the finance industry in America. Commercial banks were disintermediated. Broker-dealers were wiped out and large portions of the financial system moved offshore. The result was that American finance increasingly went abroad in search of profits.

The U.K. is next for major changes

Meanwhile the deregulation movement was gathering steam. The U.K. was considered the sick man of Europe in the 1970s and deregulation was seen as a fix. Eventually this led to changes in Britain that were similar to the changes in the U.S., the most significant of which was Big Bang in 1986 when fixed commissions were abolished. As in the U.S., the stockjobbers and stockbrokers were pummelled by deregulation and many went out of business. In my view, this marked the beginning of the global Universal banking model. Here's why?

The U.K. became a beach head for U.S. banks searching for profit abroad after the collapse of oil prices and the Latin America crisis in the early 1980s. This disintermediated traditional commercial bank lending in western Europe and reduced profits significantly for banks there. The U.K., as part of the European Union since 1973 and the locus of the Eurodollar market, also became the beach head for European universal banks now expanding internationally, in their own effort to increase profits. All of the major U.K. merchant banks were eventually gobbled up – most by foreign universal banks. Remember Barclays de Zoete Wedd, ING Barings, Dresdner Kleinwort Benson, SBC Warburg, Deutsche Moran Grenfell? Only one of these takeovers involved a U.K. domestic bank. In effect, the U.K. was becoming a de facto Universal banking market.

Back in America: New Competition

By the late 1980s and the 1990s, the deregulated atmosphere in the U.S. meant that commercial banks were seeing an erosion of margins in their traditional lines of business. They reached abroad and were burned (see article on ratings downgrades from 1988). So, they successfully lobbied to increase their ability to participate in investment banking (see 1987 NY Times article) and trading (not without problems: Bankers Trust was the most aggressive and trading irregularities were noted as far back as 1988).

By the 1990s, the now internationalised European universal banks were on the prowl in America too (I am ignoring Japan because its banks were forced into retreat during the lost decade). We saw Credit Suisse acquire First Boston, SBC acquire Dillon Read, and Deutsche Bank acquire Banker Trust. Now, we were seeing international universal bank behemoths that had huge balance sheets and huge investment banking and trading operations in America. The American companies felt at a disadvantage because of Glass-Steagall. And, in truth, they were. So, at this point, Glass-Steagall's repeal was inevitable because the climate in banking had changed. It was much more international and much more of a universal banking model.

Nevertheless, there was ample reason for alarm because deregulation and lack of oversight make for a dangerous combination. Had America moved to a universal banking model with strict oversight like one sees in Canada, perhaps many of the problems of the credit bubble could have been avoided. But, oversight was lax and the regulatory controls that even the Federal Reserve was granted over the mortgage market in 1994 were never used to stop excess in that market. All of this was predicted in 1999. Below is an excerpt from a New York Times story that ran after Glass-Steagall was repealed.Note how many of the lawmakers cited are the same ones in power today.

In the House debate, Mr. Leach said, ''This is a historic day. The landscape for delivery of financial services will now surely shift.''

But consumer groups and civil rights advocates criticized the legislation for being a sop to the nation's biggest financial institutions. They say that it fails to protect the privacy interests of consumers and community lending standards for the disadvantaged and that it will create more problems than it solves.

The opponents of the measure gloomily predicted that by unshackling banks and enabling them to move more freely into new kinds of financial activities, the new law could lead to an economic crisis down the road when the marketplace is no longer growing briskly.

''I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930's is true in 2010,'' said Senator Byron L. Dorgan, Democrat of North Dakota. ''I wasn't around during the 1930's or the debate over Glass-Steagall. But I was here in the early 1980's when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.''

Senator Paul Wellstone, Democrat of Minnesota, said that Congress had ''seemed determined to unlearn the lessons from our past mistakes.''

''Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,'' Mr. Wellstone said. ''Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.''

Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.

''The concerns that we will have a meltdown like 1929 are dramatically overblown,'' said Senator Bob Kerrey, Democrat of Nebraska.

Clearly Bob Kerrey was wrong and Paul Wellstone was right.

Post-Internet Bubble makes universal banking model complete

Just after this legislation was passed at the peak of the Tech Bubble, the bubble burst. I would argue that the bursting of the bubble was instrumental in completing the transformation in the U.S. to a universal banking model. If you think back to the mid-1990s, there were scores of boutique investment banks concentrating on the technology sector. The ‘Four Horsemen' of Alex.Brown, Montgomery Securities, Hambrecht and Quist, and Robertson Stephens were the principal actors. When the tech bubble burst, all of them disappeared, gobbled up by large commercial banks.

In effect, the disappearance of the Four Horsemen marked the end of the old Glass-Steagall model. It was only a matter of time before the likes of Morgan Stanley and Goldman Sachs were forced into the universal banking model.

U.S. Banking: Worse after the crisis than before

With the disaster at Lehman Brothers and Bear Stearns, the transformation became complete because Merrill was gobbled up by Bank of America and Goldman and Morgan became banks. Now, I failed to mention that another step commercial banks took to defend the economics of their business was to merge (list of large mergers here on Wikipedia). This, coupled with relaxation of interstate banking laws, has made the U.S. banking system very concentrated. Add in FDIC-enabled takeovers of WaMu and Wachovia and six too big to fail institutions control the roost: Citigroup, JPMorgan Chase, Wells Fargo, Bank of America, Goldman Sachs and Morgan Stanley.

So, ironically, the U.S. banking system is much more prone to systemic risk today than it was a year ago or a decade ago. Moreover, these institutions still have an enormous amount of so-called toxic assets on their balance sheet hidden in Level Three assets (see post "Level Three Assets: banks are hiding the ball on credit writedowns"). These assets have not been written down to reflect present market values. And, many more writedowns from commercial real estate and credit cards, leveraged loans and high yield bonds remain to be taken.

My conclusion, therefore, is that the likely technical recovery toward the end of this year or the beginning of 2010 is a fake recovery. Much underlying systemic weakness remains. Moreover, the U.S. banking system post-crisis is more concentrated and more vulnerable than ever before. Will bringing back Glass-Steagall solve this? No. This post demonstrates that there are forces in the global marketplace that make Glass-Steagall a relic of the 1930s. Nevertheless, a move away from the self-regulatory nonsense of the last generation is warranted. Enforcement of existing regulations, regulation of OTC derivatives and the shadow banking system are all important steps that need to be taken. However, above all, I am most concerned with the concentrated risk in our financial system. I see no other way to reduce this concentration than to break up too big to fail institutions. If you do see another way please feel free to comment.

Is Meredith Whitney bullish now?

yves@nakedcapitalism.com (Yves Smith) — Mon, 13 Jul 2009 16:43:18 -0700

Submitted by Edward Harrison of Credit Writedowns.

Just when I was wondering where Meredith Whitney had gone, she's back. But she has a whole new tone to her. In this interview on CNBC, she says she is expecting a monster number from Goldman (GS) tomorrow morning, in 2010 and in 2011. She is well above the street on Goldman. She even uses the word ‘cheap' when referring to the stock. Is Meredith Whitney a bull now? Have a listen – she also talks about other names and sees Bank of America (BAC) as the one to watch. I like her reference to ‘junk in the trunk' when talking about JPMorgan Chase (JPM) in the 2nd video below.

Her comments seem a far cry from the bearish Meredith Whitney of yore. What happened to that woman? Maybe she read my post "Marc Faber: "it's very tough for a forecaster who was ultra-bearish to stay bearish."

For a view of what Whitney sounded like just a few months ago, see my May post "Meredith Whitney seems onboard with the fake recovery" or my April post "Meredith Whitney: Regardless of stress tests, banks will still need more capital." She sounds very different today and is singing a tune I first got onboard with in April ("Wells profit forecast is a clear bullish sign"). But, given the huge run up in shares, I do question how much more upside there is to bank shares now despite what are likely to be very good earnings. Let's see how Goldman's earnings and shares do and that should be a good test.

You will notice that in the first video she suggests that the disappearance of the likes of Lehman and Bear are good for the surviving behemoths (which increases banking concentration, a point I just made).

UPDATE 1230ET: Whitney makes a point regarding loan modifications that I first made on May 26th ("How refinancing helps the likes of Bank of America and Wells Fargo") i.e. that the big banks are getting a HUGE incentive to do refis and this will goose their earnings short-term in three ways: a. they get a refinancing fee that goes straight to current income. b. they get an incentive fee due to rules the government made on May 21st, the subject of my May 26th post. c. the banks get to at least delay writedowns because past due mortgages become current and this will decrease their loan loss provisions over the short-term. Nevertheless, home mortgage default recidivism means that re-default likelihood is high and that the writedowns will eventually have to be taken. Whitney seems to be saying this makes banks a good trading play, not a good holding play.

Reader Notice

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 04:37:25 -0700

I am provisionally opening comments back up. Regulars may recall that I went to restricting them to people who had registered. Unfortunately, Blogger limits that to Open ID or people with Blogger accounts. I had hoped to be switched over to Wordpress an eternity ago, which allows for much more user friendly ways of registering, but that is on hold for now.

Please use a handle of some sort. And no nastiness, otherwise we go back to status quo ante, pronto.

Did Markit's Owners Trade CDS on Advance Access to Information?

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 05:47:37 -0700

We have a juicy tidbit on the wires tonight. The Department of Justice is conducting an investigation into whether Markit's clients traded on its research prior to its being made public,

As much as I would love to see the credit default swaps market reined in, or better yet, shut down, this move is puzzling. CDS are unregulated. Therefore there is no such thing (legally) as insider trading. Even in regulated commodities markets, there is no such thing as insider trading, since no one in theory had the advantaged position relative to the market in a commodity that corporate insiders do relative to a business.

So what legal theory is the DOJ operating on? Insider trading and front-running are SEC notions, and SEC regulations don't extend to CDS, save any registered securities that had embedded CDS. The letter came from the antitrust division, so the theory may be abuse of monopoly position (as in, relative to those contracts). But Markit is headquartered in London, which also raises jurisdictional issues.

Maybe I am missing something, but it that logic pertains there, why would it not extend to owners of an index, like the GSCI? Goldman famously reweighted it in 2007, and it is certain they positioned themselves to take advantage of that, But I don't recall the DOJ every going after actions like that.

I wonder if this is a shot across Wall Street's bow, to tell them if they do not clean up their act in CDS, they can expect much more of this sort of thing, or alternatively, a fishing expedition to collect 5x7 glossies that could be used if needed later.

I said in a post just a few days ago that credit default swaps were Public Enemy Number One. Guess I was more on target than I realized.

From Bloomberg:

The U.S. Justice Department is investigating the market for credit-default swaps, according to Markit Group Ltd., the data provider majority-owned by Wall Street's largest banks...

The antitrust division sent civil investigative notices this month to banks that own London-based Markit to determine if they have unfair access to price information, according to three people familiar with the matter...

Markit provides derivative and bond data to more than 1,500 customers. It owns the most actively traded credit swap indexes and pricing services in the market, which represents $28 trillion in underlying securities, according to the New York- based Depository Trust & Clearing Corp....

Justice Department investigators want to know if Markit's bank shareholders received advantages as owners and providers of prices and trading patterns for credit-default swaps, said two of the people. The data from the market's largest users is provided to more than 300 financial firms to set prices of the contracts in their portfolios, according to Markit's Web site.

The notices ask recipients to give the Justice Department details on the amount of their trading, exposure in the market, monthly value of their credit swaps and other information, said a person who read parts of the letter to Bloomberg News.

The letter also seeks the level of current bank ownership in Markit and whether the shareholders have tried to sell their stakes, the person said. Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley, all of New York, are among the owners of Markit.

End-of-day and real-time prices for credit swaps are available to Markit customers, the company says on its Web site. Real-time prices come from the Wall Street dealers that send that information to clients throughout the day.

A Bit of Goldman Schadenfreude

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 07:05:48 -0700

Wellie, we get a bit of cheery news of sorts to take the edge off the sting that Goldman, presumably alive today thanks to the many ministrations of the government, ultimately borne by chumps like you and me, is off again ~~looting~~ making money hand over fist.

It appears that quite a lot of Goldman employees sold stock when it was pretty depressed, between November and March. This is similar to what happened when the firm was still private, and had a very bad year in 1994. Many partners went limited. That did not mean they got to take their money and run; Goldman staged the withdrawals over many years. But it did mean the value of their partnership interest was set at that point in time. Why did that matter? If you expect equity to go down (the firm to lose money), you want your percentage interest applied to the level of equity pre the reduction, not post.

It was a massive vote of no confidence in the future of the firm (that was also the first time Goldman had ever had layoffs). A mini version of the same took place around the turn of the year. What a difference a few months makes.

That is a warning as well as an observation.

On the one hand, the MDs sold $700 million at comparatively low prices. On the other hand, cash was coming in from the TARP and in part going directly to these MDs. Insiders were also selling as the company was peddling shares to the public, Not a pretty fact set. So we will have a few days of fulminating and this too, like all misdeeds by Goldman, will soon pass. In particular, no one will care, since the stock has traded up and it looks like, for once, the chumps did well.

From the Financial Times:

Executives at Goldman Sachs sold almost $700m worth of stock following the collapse of Lehman Brothers last September....

Most of the sales occurred during the period in which the investment bank enjoyed the support of $10bn from the troubled asset relief programme...

The surge in selling among Goldman partners, at a time when the US government had thrown a lifeline to Wall Street, is likely to draw criticism from lawmakers on Capitol Hill. Having survived the crisis, the bank is expected to report strong second-quarter earnings on Tuesday on rebounding trading profits.

For the eight-month period for which figures are available, Goldman partners sold more than $691m in company stock, even as the firm expanded its public float from 395m to 503m shares in several capital raises.

For the comparable period between September 2007 and April 2008, when the average share price was substantially higher, Goldman partners sold about $438m in stock....

Some of the sales could have been motivated by margin calls, which are said to have afflicted a number of Goldman executives who used company stock as collateral for loans....

Goldman agreed to the unusual buy-backs last September to obviate the need for the two officers to sell stock on the open market, the company said in March. "Stock sales would easily have covered their requirements but, given the turbulent market conditions, we and they were concerned that such sales would be misconstrued by the market as indicating a lack of confidence in Goldman Sachs."

Employee ownership has been an important component of Goldman's "partnership" culture, a vestige of the investment bank's history as a privately held firm. It went public in 1999.

But Goldman's culture was severely tested last year. For the period during which executive sales were allowed, from September 17 to October 24, Goldman partners sold some $250m worth of stock.

A bigger wave of selling occurred during the window between December 2008, after Goldman reported its first quarterly loss as a public company, and mid-February. In that two-month period, when Goldman's share price sunk to near-historic lows, partners sold more than $280m worth of company stock.

Taleb (and Spitznagel) Call for Large-Scale Debt to Equity

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 06:38:49 -0700

Nicholas Nassim Taleb and Mark Spitznagel have a provocative comment up at the Financial Time today, In some way, it is isn't surprising for those familiar with his work on risk and uncertainty. On the other hand, it is an eye opener to see what an internally consistent, reasonably comprehensive solution to our mess looks like,

Taleb and Spitznagel, unlike most others, include real economy fragility in their calculus. The dependence on sophisticated computers networks and advanced communications creates more points of failure. Integrates supply chains and interdependence due to trade also creates more complexity. For the life of me, I never understood the vogue for outsourcing and offshoring, Every study ever done says the majority of companies are disappointed with the results. It seems to represent hope over experience. And from what little I have seen in the way of hard numbers says it does not yield impressive results. One IBM project, to send some work to China, showed that the labor cost savings were substantial, something like a 75% to 80% reducution. Yet the all-in cost savings projected were a mere 15% to 20%. And most projects do not live up to expectations. The gap between the two figures says the additonal coordination costs and delays were considerable.

That is a tremendous amount of rigidity and risk to introduce into one's operations for not much gain. Yet everyone went merrily down that path because it was what all right-minded modern companies were supposed to do.

The other big message of this piece is trying to prop up asset prices via more debt is a bad idea. He recommends restructuring via large-scale debt to equity conversions, plus arrangements that allow for partial equity conversions if borrowers go into arrears. A clever concept, but too hard to administer.

As much as Taleb and Spitznagel's message about the dangers of debt, and the need for a surgical remedy is clear, the odds of the right sort of action are zero unless things get much worse in short order.

From the Financial Times:

The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s....government policies worldwide are causing more instability rather than curing the trouble in the system. The only solution is the immediate, forcible and systematic conversion of debt to equity....

First, debt and leverage cause fragility; they leave less room for errors as the economic system loses its ability to withstand extreme variations in the prices of securities and goods. Equity, by contrast, is robust: the collapse of the technology bubble in 2000 did not have significant consequences because internet companies, while able to raise large amounts of equity, had no access to credit markets.

Second, the complexity created by globalisation and the internet causes economic and business values (such as company revenues, commodity prices or unemployment) to experience more extreme variations than ever before. Add to that the proliferation of systems that run more smoothly than before, but experience rare, but violent blow-ups.

Our ability to forecast suffers due to this complexity and the occurrence of the occasional extreme event, or "black swan". Such degradation in predictability should have made companies more conservative in their capital structure, not more aggressive – yet private equity, homeowners and others have been recklessly amassing debt. Such non-linearity makes the mathematics used by economists rather useless. Our research shows that economic papers that rely on mathematics are not scientifically valid. Not only do they underestimate the possibility of "black swans" but they are unaware that we do not have any ability to deal with the mathematics of extreme events. The same flaw found in risk models that helped cause the financial meltdown is present in economic models invoked by "experts". Anyone relying on these models for conclusions is deluded.

Third, debt has a nasty property: it is highly treacherous. A loan hides volatility as it does not vary outside of default, while an equity investment has volatility but its risks are visible. Yet both have similar risks. Thus debt is the province of both the overconfident borrower who underestimates large deviations, and of the investor who wants to be deluded by hiding risks. Then there are products such as complex derivatives, which in the name of "modern finance" make the system even more fragile.

Against this background, we have two options. The first is to deflate debt, the other is to inflate assets (or counter their deflation with a collection of stimulus packages.)

We believe that stimulus packages, in all their forms, make the same mistakes that got us here. They will lead to extreme overshooting or extreme undershooting. They lead to more borrowing, by socialising private debt. But running a government deficit is dangerous, as it is vulnerable to errors in projections of economic growth. These errors will be larger in the future, so central bank money creation will lead not to inflation but to hyper-inflation, as the system is set for bigger deviations than ever before.

Relying on standard models to build policies makes us all fragile and overconfident. Asking the economics establishment for guidance (particularly after its failure to see the risk in the economy) is akin to asking to be led by the blind – instead we need to rebuild the world to make it resistant to the economist's mystifications.

Invoking the pre-internet Great Depression as guidance for current events is irresponsible: errors in fiscal policy will be magnified by this kind of thinking. Monetary policy has always been dangerous.... Bubbles and fads are part of cultural life. We need to do the opposite to what Mr Greenspan did: make the economy's structure more robust to bubbles.

The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming "binary" – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from "hopers", hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialise in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.

Links 7/14/09

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 08:56:25 -0700

Sound effect: how cats exploit the human need to nurture Guardian

Sudden deaths of girl, 6, and GP raise fears over swine flu Times Online. Everyone is very nervous re swine flu, so this may be a false positive.

The Next Hacking Frontier: Your Brain? Wired

Molecule's constant efforts keep our memories intact ScienceBlogs

How McNamara Lost World War II Greg Palast

U.S. mulling mortgage aid for unemployed Reuters. Another trial balloon.

Japan's Robots Join Ranks Of Unemployed Michael Shedlock

Consumer Protection Elitists? Hardly Mark Thoma

Partial recovery will mean new lows for stocks Ed Harrison

Will Geithner Chicken Out On His Chance To Show Us His Bailouts Worked? Clusterstock. Notice how the ONLY concern here is the impact on financial players, not the real economy? We've had this backwards for a long time. Not that a bailout is the right or wrong remedy, but the priorities and metrics are stuffed up. Oooh, are we collectively screwed.

Shadow Banking: What It Is, How it Broke, and How to Fix It Atlantic

Insight: This crisis is not over Tim Lee, Financial Times

Book Review: The Myth of the Rational Market David Merkel

U.S. in Talks to Rescue CIT Wall Street Journal

Keeping Up Appearances: London Turns Eye to Empty Mansions Wall Street Journal

California Currency? A taste of things to come unless Percora II helps us leave discredited economic dogma behind Marshall Auerback, New Deal 2.0

SEC to create group to check rating agencies Financial Times

The Economy Is Even Worse Than You Think Mortimer Zuckerman, Wall Street Journal

Antidote du jour:

Guest Post: Chooching Pension Funds?

yves@nakedcapitalism.com (Yves Smith) — Tue, 14 Jul 2009 09:44:45 -0700

The NYT reports that President Obama's chief auto adviser, Steven Rattner, has stepped down:

Steven Rattner is quitting his post as President Obama's chief adviser on the roubled automobile industry at a time when an investigation into his former Wall Street firm's role in a scandal involving public pension funds has intensified.

Mr. Rattner, who has won plaudits for directing the rapid restructuring of General Motors and Chrysler, has been under a cloud since shortly after arriving in Washington in late February after it was disclosed that his firm, the Quadrangle Group, made payments to middlemen that helped it win state pension business.

It is unclear whether Mr. Rattner's departure is directly connected to the inquiry, or whether he felt that it was time to leave because Chrysler and G.M. effectively had emerged from bankruptcy. A person who has worked with him in Washington said he understood that Mr. Rattner had decided to leave because his role on the task force had come to its natural end. Mr. Rattner could not be reached for comment. A spokesman for Quadrangle declined to comment.

An investigation by New York Attorney General Andrew M. Cuomo has picked up in recent weeks, according to people briefed on the matter who did not want to be identified for fear of jeopardizing the inquiry. Quadrangle faces potential civil charges and is said to be eager to resolve the matter, according to these people, who said that Mr. Rattner has separate counsel from Quadrangle, and that discussions have accelerated among the various parties recently. Several other firms, including the Carlyle Group, a private equity firm, have paid fines and agreed to change their practices as a result of payments they made to get pension business.

A fine against Quadrangle could make it difficult for Mr. Rattner to remain in a position of authority in Washington, given his role in the matter. Mr. Rattner, according to people close to the investigation, arranged for his investment firm to pay $1.1 million to an agent who helped Quadrangle obtain New York pension business. The agent who received most of that money has been indicted and accused of selling access to the pension fund, but neither Mr. Rattner nor Quadrangle is expected to face criminal charges, according to people close to the matter. The Securities andExchange Commission is also investigating pension fund abuses.

The investigations in Quadrangle have raised questions about the political ambitions of Mr. Rattner. A major Democratic Party contributor, he backed Senator Hillary Rodham Clinton's presidential campaign, and some speculated that he would have been interested in a position in a Clinton administration, possibly as Treasury Secretary. His wife, Maureen White, was Mrs. Clinton's finance co-chairwoman. For years, Mr. Rattner has cultivated a reputation as a major player in New York's financial, political and charity circles. After working as a reporter for The New York Times, he became an investment banker, doing deals in the media and communications businesses for the likes of Lehman Brothers, Morgan Stanley and Lazard before co-founding Quadrangle in 2000.

Mr. Cuomo has been conducting a broad investigation of pension fund "pay-to-play" practices — allegations that investment firms had to pay politically connected middlemen to get pension funds to manage. Fees for managing pension funds can be very lucrative. While occupying a legal gray area, payments to intermediaries can be illegal if they amount to bribes or kickbacks made under the guise of being legitimate payments. In cases described in court filings, people who received payments for acting as intermediaries did no actual work, instead appearing simply to be collecting payoffs.

The attorney general's stated goal is to change industry practices to prevent futures abuses, and win fines for past violations. Carlyle, which is among the biggest and most politically connected private equity firms and paid a $20 million fine, has agreed to stop using intermediaries, known as placement agents, to win investment business from public pension funds. It also agreed to halt campaign contributions to public officials who oversee pension funds. Riverstone Holdings, another firm caught up in the case, paid a $30 million ettlement last month.

In a statement announcing Mr. Rattner's departure, the Obama administration made no mention of the pension scandal inquiry, but said Ron Bloom will take over the leadership of the task force.

In the past, the president has said he has full confidence in Mr. Rattner. Treasury Secretary Timothy F. Geithner praised his work turning around G.M. and Chrysler. The two carmakers completed their restructuring plans well ahead of schedule, taking little more than a month each.
"We are extremely grateful to Steve for his efforts in helping to strengthen G.M. and Chrysler, recapitalize GMAC, and support the American auto industry," Mr. Geithner said. "I hope that he takes another opportunity to bring his unique skills to government service in the future."

Investigators have been particularly focused on investment executives who arranged for payments to be made to further the production of "Chooch," a low-budget movie produced by the brother of David J. Loglisci, who was the chief investment officer of the New York State pension fund under Alan G. Hevesi, the former state comptroller. Investigators believe a number of executives, including Mr. Rattner, gave assistance to "Chooch" to win pension fund business.

Hey, at least Mr. Rattner wasn't appointed a pensions czar! I know of many rats (no pun intended) in the pension industry who I suspect took kickbacks and used fraudulent accounting to "juice up" their returns. There is an old Greek saying, "he who has honey on his fingers, can't help licking them."

Guest Post: There Will Be No Recovery

yves@nakedcapitalism.com (Yves Smith) — Sun, 12 Jul 2009 16:55:12 -0700

Submitted by Jesse of Le Café Américain

"The banks must be restrained, and the financial system reformed, and balance
restored to the economy, before there can be any sustained recovery."

Often a closing comment from our blog, essentially this is what Robert Reich is saying in his recent essay on the economy.

The median wage must generally increase for consumption to resume, and for this to happen the heavy taxes of the financial sector and the oligarchs on the real economy must be lowered significantly in proportion to its size.

There is reason for pessimism that this can happen voluntarily. I have come to the conclusion that there is a pathological drive in some small portion of the population to acquire and control and devour rather than consume, even to their own destruction.

The law sets limits on the speed on highways to protect the many from the reckless and willful behaviour of the few. That we ought not to set limits on the banking system is a remarkable bit of speciousness.

There are obvious questions of how to limit, and how to detect and prevent and prosecute violations, but few can argue that not regulating traffic is the best solution to the difficulty of the task. The comparison of highway regulation to economic commerce and financial transactions is more valid than obtuse. And there are many Wall Street bankers guilty of at least manslaughter in this most recent episode of reckless defiance of the common good for the sake of personal profits.

The comparison of this latest epidemic of bad economic behaviour is strikingly reminiscent of the Gilded Age at the end of the 19th century and the Roaring 20's. As you may recall both periods were followed by economic dislocation and a world in flames.

Why we allow this sort of bestial behaviour to ravage the many, in the mistaken support of 'free markets,' where nothing these people touch can remain free and effective and efficient for long, is truly an accomplishment of propaganda and those blinded by ideology.

Robert Reich
When Will The Recovery Begin? Never.
Thursday, July 09, 2009

The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. The reason is asset values at bottom are so low that investor confidence returns only gradually.

That's where the more sober U-shapers come in. They predict a more gradual recovery, as investors slowly tiptoe back into the market.

Personally, I don't buy into either camp. In a recession this deep, recovery doesn't depend on investors. It depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten home owners is under water -- owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.

Eventually consumers will replace cars and appliances and other stuff that wears out, but a recovery can't be built on replacements. Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. More on this to come.

A Grim Outlook for the Eurozone?

yves@nakedcapitalism.com (Yves Smith) — Mon, 13 Jul 2009 08:22:48 -0700

Ambrose Evans-Pritchard, who has been consistently alarmed about Europe (and often charged in comments of going overboard in general, and on this topic in particular) sounds a particularly loud alarm on Europe, based on the view that the ECB has not eased enough.

I have limited insight here. I have been told that German banks are clamping down hard even on very sound Mittelstand borrowers, and the Mittelstand companies are the German growth engine. I was also just in Europe in June, well before the peak of tourist season, in cities along the Rhine and Danube. I saw far fewer signs of visible distress than in New York, meaning no homeless (that may not be a valid indicator, between social services and policy possibly shooing them away) and no shuttered retail stores (while vacancies are pretty high throughout Manhattan). And the streets and stores all looked pretty busy, although I have no benchmark for what normal activity would be.

The one thing we may discount in our assessment of the responses of most European countries to the crisis is that they have far greater automatic stabilizers than we do, Germany, for instance, has generous unemployment programs. So with their high level of automatic stimulus, fewer discretionary measures are needed.

That does not speak to the adequacy of the overall effort, particularly on the monetary front, which Evans-Pritchard addresses.

From the Telegraph:

Without a radical change of strategy, the ECB risks pushing the weakest states into a debt-compound spiral that can only end in bond crises and/or the disintegration of Europe's monetary union – whichever comes first.

The International Monetary Fund says the eurozone will contract by 4.8pc this year, worse than the UK (-4.2pc) or the US (-2.6pc). The deepest damage will occur next year as Europe remains mired in slump, even as the rest of the world recovers. It is the length of recession that matters most for jobs, social stability, and public finances. I am not easily shocked any longer but I did sit up when Spain's budget chief Luis Espadas said the economic collapse could "easily" push Spanish public debt to 90pc of GDP by 2011. This is up from 36pc in 2007.

Nobody knows where the tipping point lies on public debt, though anything above 100pc of GDP in a currency union is courting fate. Some are already there. The European Commission says Italian debt will jump to 116pc in 2010. Greece is vaulting back to 109pc, Belgium to 101pc, France to 86pc.

Even German finances are falling apart.....Berlin says the deficit is heading for 6pc next year, taking debt to 82pc. This is happening all over the world, of course. But the ECB is compounding the effect, whether for reasons of politics, Bundesbank fetishism, or misjudgment. By refusing to join the US, Japan, Canada, Britain, and Switzerland in quantitative easing (QE) the ECB has allowed a contraction of private credit this summer. The M3 "broad" money supply has shrunk since February.

Ignore M3 at your peril. It flashed awarning signal in the US months before the collapse of Lehman Brothers last September; it is flashing the similar warning signals in Europe now.

Professor Tim Congdon from International Monetary Research said the eurozone money figures are "horrifying" and portend a serious crunch ahead. "My verdict is that the senior people in the ECB [and the Fed] have little organised understanding of the debt-deflationary processes initiated in late 2008," he said.

Ireland's M3 contracted at a 30pc annual rate last month, a death sentence for a hyper-indebted economy...

In Germany, the Mittlestand lobby (BVMW) says half its members are facing a liquidity squeeze, while the strutting finance minister, Peer Steinbrück, has assumed a ghostly pallor. "We must take seriously the threat of a credit crunch in the second half of this year," he said.

Mr Steinbrück has called for a suspension of the Basel II accounting rules in order to rescue banks, and even suggested that the German government undertake direct lending to boost credit. The regulator BaFin has already told us that bad debts are set to "blow like a grenade" this year. A leaked BaFin memo said "problematic" assets have reached €816bn (£700bn), led by Hypo Real with €268bn.

ECB experts think eurozone banks will have to write down a further €203bn by the end of next year. Yet ECB policy-makers seem unwilling to face the implications. Yes, they have injected €442bn in a one-year tender, but the money is not reaching the economy. Simon Ward from Henderson New Star said the ECB is repeating errors made in Japan when it first trifled with QE, relying on banks to pass on credit rather going for massive bond purchases.

Inevitably, Europe's politicians are taking matters into their own hands. They will not sit idly by as millions lose their jobs. If the ECB deflates, budgets must bear the strain, and that is exactly what Europe cannot afford with a birthrate of 1.53 per woman and the onset of demographic decline. The commission says the number of workers per pensioner over 65 will halve from four to two by 2040. Age-related costs will explode by 15pc of GDP in Greece, 9pc in Ireland, Spain and Holland. The populations of Germany and Italy will soon be shrinking.

Viewed strategically, Europe's mix of monetary deflation and rampant deficit spending by the states is nothing short of lunatic.
Needless to say, Britain faces it own colossal mess, but of a different kind. It is the Prime Minister who is taking the country over a cliff, not the Bank of the England. Voters will soon have the joy of sacking him. How do Europe's voters sack the ECB?