Fed Up

Alan Greenspan had an interesting change of heart today. He endorsed the Consumer Financial Protection Agency as an overseer of banks and lenders.

For Alan Greenspan, lapdog to Ayn Rand, perhaps the only person in America not to recognize the possibility of human greed in the financial markets, to come out for a federal body overseeing the Masters of the Universe, the same kind of consumer protections he opposed while chairing the Fed, is quite a turnaround indeed. But then Greenspan told us that he was rethinking his theories after the biggest financial collapse since the Depression.

Greenspan: I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms…

Waxman: In other words, you found that your view of the world, your ideology, was not right, it was not working.

Greenspan: Absolutely, precisely. You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.

In particular, Greenspan said that the Fed's current responsibilities are quite enough for the body to manage without the added layer of consumer protection. He might have gone a bit further and mentioned that, when faced with a choice between monetary policy and consumer protection, the Fed will always choose the former. They don't exist for the mere consumer. You can see this in the performance of Alan Greenspan's Federal Reserve during the housing bubble.

The visits had a ritual quality. Three times a year, a coalition of Chicago community groups met with the Federal Reserve and other banking regulators to warn about the growing prevalence of abusive mortgage lending [...]

The evidence eventually led Illinois to file suit against Wells Fargo in July for discrimination and other abuses.

But during the years of the housing boom, the pleas failed to move the Fed, the sole federal regulator with authority over the businesses. Under a policy quietly formalized in 1998, the Fed refused to police lenders' compliance with federal laws protecting borrowers, despite repeated urging by consumer advocates across the country and even by other government agencies.

The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates.

"In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision," former Fed Governor Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007. "It is like a city with a murder law, but no cops on the beat."

Binyamin Appelbaum's story is well worth reading. If the Federal Reserve were a rank-and-file employee, they would have been fired long ago.

I don't know if Greenspan is trying to atone for past sins or actually learn from past experience. But when you have Greenspan and the World Bank in agreement with the likes of Elizabeth Warren, that Fed powers have grown too strong and a separate entity needs to be charged with protecting people who enter into financial arrangements, there clearly is a growing consensus here.

Postscript: Barney Frank's interview with Ezra Klein has some excellent insights. Frank feels we must limit securitization - the idea that if you spread enough risk around you could sell literally anything. He wants higher capital requirements and less leverage for the big banks as well.

Shadow Government

If you want to know why weakening the Federal Reserve is gaining traction in Congress, take a look at this unbelievable report from Bloomberg:

The Federal Reserve Board has rejected a request by U.S. Treasury Secretary Timothy Geithner for a public review of the central bank’s structure and governance, three people familiar with the matter said.

The Obama administration proposed on June 17 a financial- regulatory overhaul including a “comprehensive review” of the Fed’s “ability to accomplish its existing and proposed functions” and the role of its regional banks. The Fed was to lead the study and enlist the Treasury and “a wide range of external experts.”

Some top central bank officials, after agreeing to the review, saw a potential threat to Fed independence after the Treasury released the proposal, two of the people said. The Obama plan said the Treasury would consider recommendations from the review and “propose any changes to the Fed’s governance and structure.”

Keep in mind that the Fed already has refused to disclose its assets, its balance sheet or its dealings with other banks and investment firms. Now the Treasury Department - the federal agency most directly in charge of the banking sector - asks for a review of the structure of the Fed, just simply how it organizes itself. And the Fed, whose chairman is chosen by the White House, said no.

Simply put, this is a runaway organization. We cannot expect it to be a credible partner on setting bank pay limits, for example, when it is intimately tied to the largest US banks, the CEOs of whom make several orders of magnitude more money than their global counterparts. Obviously those compensation limits will come up short, because a shadowy temple of an organization holds this tremendous, unaccountable power over the financial system.

Paul Krugman may think the Fed is now getting it - perhaps out of fealty to Ben Bernanke - but from where I sit, this is an unelected nation state with the arrogance of a dictator. They need to be brought to heel.

Michael Moore Smears Chris Dodd

I haven't seen Michael Moore's new movie, but Howie Klein has, and while he praises it he excoriates Moore for dredging up the discredited Chris Dodd Countrywide story, which has been picked over to death, with nobody finding any impropriety.

First, everyone who has seriously looked at the claims of a sweetheart deal has dismissed them: the Senate Ethics Committee; an independent compliance firm; the (not exactly Dodd-loving) Hartford Courant. And not once, but twice.

This is not the definition of the word "is." The man got a mortgage. He was told that he would get enhanced customer service, and assumed it was because of his good credit score. He got the exact same mortgage rate that anyone else buying a mortgage at the time would have gotten. He didn't know the CEO of Countrywide, nor anything about a Friends of the CEO program [...]

Why does this feel like, in the interest of being able to sit on Leno and say, "I went after Democrats too!," Moore passed up the real story here? It would have been really powerful if he made the connection between the bullshit allegations about Dodd and the banking industry desperately wanting to put the breaks on important housing and foreclosure legislation that Dodd was championing in the Senate at that very moment. Well, mission accomplished assholes, excuse me, the Sheriff is here to foreclose on my house (is it possible its the same one from Roger and Me? Oh, the irony) [...]

All in all, still love Moore, still want everyone to see the movie, but kind of wish he hadn't decided to jump ugly with one of the most progressive Senators in the Senate -- the guy responsible for the Family and Medical Leave Act, the Credit CARD Act, who voted for cramdown, worked to make that disaster of a bankruptcy bill better, then voted against it twice, voted for a 15% cap on interest rates, and is co-sponsoring another cap that is likely to come up again, is a leader on direct-student-loan reform, is in favor of a consumer financial protection agency and stripping the fed of some of its regulatory authority, and just last week introduced legislation to reign in the diabolical overdraft fee practice-- all stuff, if you are keeping score, which Moore clearly wasn't, that banks would rather paint a hammer and sickle on their walls than accept! I wish Moore hadn't got played like a three dollar harmonica. He should donate the 10 grand to Dodd's campaign.

It appears that the premise of Moore's film is that banking interests have taken over the government and prevented any meaningful regulation on the industry. Dodd's case can be an example of that, but not in the way Moore thinks. The banking lobby has consistently kneecapped him, with old charges that have a Whitewater quality to them, with all the same innuendo and the same lack of factual detail, right at the moments when Dodd was trying to get things passed to crack down on them. Dodd could have given away the Banking Committee Chair to completely-in-the-pocket Tim Johnson, but he didn't. And in the last few days, Dodd has introduced the aforementioned legislation to end the practice of banks charging overdraft fees on debit cards automatically, with 1000% interest, instead of giving customers the opportunity to have a transaction denied; introduced a plan for a single bank regulator that is at odds with the Obama Adminstration and his House counterpart Barney Frank, as well as being hated by the banking industry; and has taken the lead on weakening the power of the Fed, which is deeply desirable. In other words, despite the many slings and arrows, Dodd is basically doing the job Michael Moore would expect someone in his position to do, and doing it with gusto. He should be commended and not smeared.

You Mean People With No Money Aren't Spending?

Economists, living in their bubble, managed to be surprised by this.

U.S. consumer credit plunged more than five times as much as forecast in July as banks restricted lending terms and job losses made Americans reluctant to borrow.

Consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $15.5 billion in June, more than previously estimated. Credit fell for a sixth month, the longest series of declines since 1991.

The credit crunch, stagnant incomes and declines in household wealth are casting doubt on the strength of the economic recovery. The arrival of the government’s “cash for clunkers” program in late July wasn’t enough to keep credit that covers car loans from plummeting by a record amount, as consumers delayed other purchases [...]

Economists had forecast consumer credit would drop $4 billion in July, according to the median of 31 estimates in a Bloomberg News survey. Projections ranged from declines of $12 billion to no change from the previous month. The Fed initially said consumer credit decreased by $10.3 billion in June.

I'm guessing that cash for clunkers was the only thing bringing anyone out to purchase something on credit. Otherwise, people simply don't have the money after years of wage stagnation and record unemployment. People are learning the "new normal" of frugality out of complete necessity. In the long run, living within means is a good thing; in the short run, it's debilitating to the US economy.

And it's another example of how economists are not living in the real world with their models and charts. They don't see anything wrong with corporations making massive profits off the backs of consumers living on credit, or how that entire system could fold like a house of cards. They viewed capitalism as a shiny object and never saw its potential pitfalls in an unregulated form.

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

Of course, their salaries in part depend on them not knowing these facts, as the Federal Reserve has essentially bought off the profession and tilted it toward the principles of the unfettered free market. Ryan Grim's article is a must-read.

...the head of China's sovereign wealth fund: "Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”

Cramdown Returns

The Federal Reserve revealed survey results today showing the economy stabilizing throughout the country and the recession nearing an end. But without jobs, people won't feel that recession's end. As a result, even the Fed survey showed consumer spending "soft," and employment "weak" in all 12 Fed regions. And that will impact the still-unresolved sector of the economy that could easily relapse us into a double-dip recession, the housing market.

Although the ailing residential real-estate market is still weak, it also flashed signs of improvements. The Fed regions of Chicago, Richmond, Boston and San Francisco observed an "uptick in sales." Most regions said buyer demand remained stronger at the low end of the housing market, although Philadelphia did note an "upturn in sales at the high end of the market."

The Boston, Cleveland, Dallas, Kansas City, Richmond and New York regions credited the first-time home buyer tax incentive with spurring sales. Most regions reported downward pressure on home prices, although Dallas and New York said that prices were "firming."

That first-time homebuyers credit will soon expire, and this analysis fails to take into account the problems from those facing foreclosure, particularly those who got into adjustable-rate mortgages. The interest-only loan holders, in particular, could see a real disaster in the months and years to come when their rates reset.

Edward and Maria Moller are worried about losing their house — not now, but in 2013.

That is when the suburban San Diego schoolteachers will see their mortgage payments jump, most likely beyond their ability to pay.

Like millions of buyers during the boom, the Mollers leveraged their way into a house they could not otherwise afford by taking out a loan that required them to make only interest payments at first, putting off payments on the principal for several years [...]

With many of these homes under water — worth less than the loans against them — many interest-only mortgages will soon become unaffordable, as the homeowners have to actually start paying principal. Monthly payments can jump by as much as 75 percent.

The Mollers owe so much more than their house is worth, and have so few options, that they are already anticipating doom.

“I’m praying for another boom,” said Mr. Moller, 34. “Otherwise, we’ll have to walk.”

These people are going to lose their homes, with devastating consequences for the rest of the real estate market and the greater economy ($908 billion dollars are tied up in active interest-only loans). Even the Treasury Department expects millions more foreclosures in the same report that they tout their homeowner protection programs.

This is why it's good to see cramdown return. The provision, allowing bankruptcy judges to modify primary home loans unilaterally the way he would a vacation home or a yacht, would give those facing foreclosure a level playing field against lenders who have no incentive to change the terms of their loans.

House Financial Services Committee Chairman Barney Frank (D-Mass.) tells the Huffington Post he plans to revive the effort to give bankruptcy judges the authority to renegotiate home mortgages -- by making it part of this fall's much-anticipated financial regulatory reform bill.

Wall Street banks scored an overwhelming victory in April when they soundly defeated a cramdown measure in the Senate. Only 45 Democrats voted with homeowners, dealing the measure the kind of defeat that often sends legislation off into the wilderness for years, if not for good.

Frank and Senate Majority Whip Dick Durbin (D-Ill.), who led the bill in the upper chamber, both said after its defeat that it was finished. Frank was dismissive when, about a week after the vote, HuffPost asked if cramdown might come back. "Excuse me, what planet were you on last week? The vote was 45 to 51. Why would you ask that? Do I think there's a likelihood we could overturn 45-51? No," said Frank. "I wish it weren't the case."

But since then, foreclosures have continued unabated and the unemployment rate has continued to climb, increasing to 9.7 percent last month. Both forces feed on each other and create a drag on the economy.

The Obama administration had high hopes for the law Congress passed intended to encourage mortgage modifications. The law is all carrot, however, and no stick. Cramdown is the stick. If banks think they could get hit in bankruptcy court, they're more likely to bargain.

Because regulatory reform is a big bill with enough populist-friendly elements in it to be difficult to oppose, it could be a good vehicle for cramdown. Add that to the Consumer Financial Protection Agency and more credit card reform legislation, and that bill will be the subject of a huge fight, perhaps even bigger than the health care bill, at least in terms of lobbyist energy.

Auditing the Fed Coming To Pass?

I got a hold of some video of that infamous Barney Frank town hall meeting, where he asked the Larouchie holding the Obama-as-Hitler sign, "On what planet do you spend most of your time." Turns out that a not-nearly-as-crazy questioner asked Frank about HR 1207, the bill to audit the Federal Reserve, which has bailed out the banks for hundreds of billions of dollars under a virtual cover of secrecy. Frank said he supported the audit and promised to pass it by October. He also vowed to curtail the kind of lending power that allowed the Fed to float $80 billion dollars to AIG, and said that the Consumer Financial Protection Agency would curtail the Fed's power by taking the consumer protection elements of their mandate away from them.



There are now at least 282 co-sponsors to audit the Fed, on a bipartisan basis, mostly because people just want these world-historical interventions in the economy to come with some transparency. Frank, who talked about this effort to the Boston Globe the other day, appears sincere in meeting this goal. The economic powers in the Obama Administration really don't want any part of this, saying that "You want to keep politics out of monetary policy," but this isn't really about politics but about giving the public a sense of what they're paying for on a daily basis. The Federal Reserve just lost a lawsuit that will require more disclosure about the emergency deals they have cut. If Barney Frank and Ron Paul are getting together on this, I think the tide is turning.

Bernanke Is Back-y

The kid stays in the picture:

President Barack Obama will announce Tuesday that he is nominating Ben Bernanke for a second four-year term as chairman of the Federal Reserve, White House Chief of Staff Rahm Emanuel said.

Mr. Emanuel said Mr. Obama will make the announcement from Martha's Vineyard Tuesday. He said the president credits Mr. Bernanke for "pulling the economy back from the brink of depression."

Mr. Bernanke's term as Fed chairman expires in January. His renomination requires Senate confirmation.

Dean Baker said at Netroots Nation that he supported Bernanke's re-confirmation because "otherwise, Larry Summers would become the chair, and that would be awful."

Not exactly praiseworthy. But probably where we're at.

I'd say that, as a condition of Bernanke's re-appointment, we need a full audit of the Fed so we can figure out where the trillions of dollars that they used to staunch the bleeding in the financial markets has gone. But Senators may disagree with me.

Primarying The Federal Reserve

Much in the way that lawmakers can get pulled from the center to the left when primaried by a member of their own party, the Federal Reserve, facing the prospect of a Consumer Financial Protection Agency that would take away some of its power, is shifting to a more consumer-friendly position on lending practices, including getting rid of the dreaded yield spread premiums that incentivize lenders to screw their customers.

The Federal Reserve on Thursday unveiled a proposal to curb abusive lending practices by reining in compensation for mortgage brokers and by helping borrowers better understand the terms of loans available to them.

The plan, which builds on a similar effort adopted by the Fed last year, comes just as the central bank is trying to fend off a legislative initiative that would strip its consumer-protection role by creating an agency to oversee consumer financial products.

"It certainly doesn't hurt the Fed that they came out with mortgage lending rules that were tougher than most of the industry was expecting," said Jaret Seiberg, a policy analyst at Washington Research Group, a unit of Concept Capital.

The toughest part of the Fed's plan deals with compensation for mortgage brokers, who act as middlemen between borrowers and lenders. These brokers can be rewarded with extra fees for placing borrowers in higher-rate loans.

The proposal attempts to end this practice by barring lenders from offering extra compensation based on the terms of the loan, including the rate. Consumer advocates have long argued that incentive-based pay contributed to the subprime mortgage meltdown.

"This plan has got the potential to eliminate one of the worst practices in the mortgage market," said Michael Calhoun, president of the Center for Responsible Lending. "The devil will be in the details. Some of the worst actors in the industry have proven to be adept at exploiting weaknesses in rules. The final rule has to be tightly and carefully written."

However these things get into law is fine with me. Whether the threat of the CFPA entices the Federal Reserve to do its job, or whether a CFPA gets enacted and does it itself, ending the practice of paying off mortgage brokers for screwing their customers is a good thing.

Of course, these are forward-looking proposals. And however solid they may be, they do not deal with the current problem of people struggling to stay in their homes and stave off foreclosures, which is only growing. The current mortgage relief efforts are simply not working. I'm glad that Sheldon Whitehouse is signaling another look at cram-down, the idea of allowing bankruptcy judges to modify loan terms with the broker. You have to give the borrower some opportunity to dictate terms, or as we have seen the bank will not modify the loans.

But there is another option, and that's own to rent. Dean Baker has pushed this proposal prominently, and it's starting to get support on Capitol Hill.

There is a simple solution that requires no taxpayer dollars, requires no new bureaucracy and can immediately help millions of people facing foreclosure. Congress can simply temporarily alter the rules on foreclosure to allow homeowners facing foreclosures the right to stay in their home for a substantial period of time (e.g. seven to 10 years) as renters paying the market rent.

The lender would take ownership of the house and would be free to resell it, but the lease would carry over for the duration of the period designated by Congress, or until the former homeowner decided to move. In this period, normal landlord-tenant laws would apply, with the exception that the lender would not have the option to evict the former homeowner without due cause.

This rule change would provide homeowners with a large degree of housing security. If they like their current home, their neighborhood, their kids' schools, they would have the option to remain there for a substantial period of time. Furthermore, by making foreclosure a less attractive option for lenders, a right to rent law should give lenders much more incentive to pursue mortgage modifications as an alternative to foreclosure.

This change should also be beneficial for neighborhoods that are plagued by large numbers of foreclosures. Keeping former homeowners in their homes will keep homes occupied, preventing the blight that often comes from vacant homes that are not maintained.

The banks will fight this, but the overall housing market will likely rise from diminishing the glut of supply. The banks would get off the hook for a lot of the upkeep of blighted properties, the cycle of foreclosures could get stopped, and they would obtain consistent revenue streams in the form of rental payments, while still holding the potential equity of selling the home. I really, really like this idea.

...of course, the Fed's nods toward consumer protection won't be enough for people like William Greider, who think it ought to be dismantled. I think it's hard to argue with Greider, considering he knows as much about the Fed as any human being alive.

Where's My Pitchfork?

At a time when economic news, including today's report on retail sales, has dampened hopes of a recovery this year and raised the near-certainty of double-digit unemployment, we can all comfort ourselves with the great success of Goldman Sachs:

Comfortably beating analysts’ forecasts, Goldman Sachs earned second-quarter net profits of $3.44 billion, or $4.93 a share, the bank announced on Tuesday.

The results continue a robust turnaround for the firm since it rode out the final tumultuous months of last year with the aid of a federal rescue. They come just one month after it paid back its $10 billion in federal aid.

Goldman’s profit was lifted by record quarterly revenue of $6.8 billion in its fixed income, currency and commodities unit, where mortgage and other credit instruments are traded, the bank said in a statement. This business has performed well since the bank has taken on greater levels of risk since the end of last year.

Its equity underwriting business also generated record net revenue, worth $736 million in the second quarter, it said, as Goldman benefited among other things from a rush by other troubled banks to issue shares and raise their capital levels.

“We are performing well across the board,” said David A. Viniar, chief financial officer, who said the strong performance reflected “blocking and tackling every day” by Goldman’s employees.

Glenn Greenwald ably details the extraordinary actions taken on behalf of Goldman Sachs during the financial crisis right on through until today, so I need not repeat them. Even if they had not done so, Goldman would be in an excellent position to capitalize on the failures of other firms because of the implosion of Lehman Brothers and Bear Stearns - their competition has been euthanized, essentially. But that wasn't enough. They were allowed to change themselves into a bank holding company to qualify for Federal Reserve largesse. They received billions in federal money passed through AIG to pay off on their credit default swaps, putting them in a better position that any other US financial institution. They used their contacts throughout government to get favorable terms and handouts in virtually every program aimed at rescuing the financial system.

And to this day, the Treasury Department refuses to answer Congressional queries about accepting the recommendations of bailout auditors, nor will the Federal Reserve divulge the whereabouts of the trillions of dollars in funds they've let out since last September. I have a feeling that we'd throw an even bigger fit if we had more transparency. But what is already known, frankly, is enough.

In a related story, like everyone else I recommend Michael Lewis' article on AIG and Joseph Cassano in Vanity Fair. It focuses on understanding the past crisis rather than the credibility crisis we now face as a consequence of bailing out banks over people, but it's worth reading.

"Too Big To Fail" To Fail?

Over the weekend, the White House either released a new part of their regulatory plan or got the AP to bite at its larger intent - that they seek the end of "too big to fail" institutions that threaten to take down the entire economy.

They are the biggest of the big — the Citigroups, the Goldman Sachses, the AIGs and other financial behemoths. The Obama administration doesn't want so many around anymore.

Financial regulations proposed by the president would result in leaner and simpler institutions that don't carry the weight of the system on their marble columns [...]

So far, however, congressional debate has centered on the administration's plan to put the Federal Reserve in charge of these "systemically significant" companies. Less attention has focused on the potential effect on the institutions and the financial system's hierarchy.

Under the administration's proposal, companies such as Citi, Goldman Sachs and others in a broad top tier engaged in complex transactions would face stricter scrutiny and have to hold more assets and more cash as cushions against a downturn.

They also would have to anticipate their own demise, drafting detailed descriptions of how they could be dismantled quickly without causing damaging repercussions. Think of it as planning their own funerals — and burials.

Obama's plan, in short, aims to make it far less appealing to be so big. That was the middle ground the administration sought, a step short of an outright ban on systemically risky companies.

This sounds like a return to the behavioral economics mode that Obama wanted to push going into the White House - in effect, he wants to nudge big institutions from getting so large and interconnected that they must be kept on life support. The rules described here aren't entirely specific, but it sounds like the biggest companies will need to lower their leverage and increase their capital requirements as they grow.

Some believe that eliminating "too big to fail" is impractical. And those beliefs should be taken seriously. But even those critics believe that the way to do it is through capital requirements and leverage. So this is pretty much on the right track.

Now, if the White House takes this advice from the President of the New York Fed, we'd have something.

The Federal Reserve should break with past policy and try to identify and deflate asset bubbles before they can damage the U.S. economy, New York Federal Reserve President William C. Dudley said.

While interest-rate policy may not be the appropriate tool for popping bubbles, Fed officials have "other instruments in their toolbox," Dudley notes in the text of a speech scheduled for July 26 at the Bank for International Settlements in Basel, Switzerland. The New York Fed released his remarks yesterday.

The Fed's view has been that bubbles can be identified only in hindsight, and that all the central bank can do is prepare to clean up after they burst. The current crisis shows that policy is mistaken, Dudley said.

"Asset bubbles may not be that hard to identify," he said. "This crisis has demonstrated that the cost of waiting to clean up asset bubbles after they burst can be very high."

Dudley did not specify what tools the Fed should use. Analysts have suggested that central bankers might raise reserve requirements or amp up restrictions on margin lending.

Simon Johnson links approvingly but wonders if the Fed can actually meet this task.

Of course, if the Fed can’t get better at spotting bubbles, the implication is that no one can. Which means that “macroprudential regulator” is just a slogan – a nice piece of what Lenin liked to call “agitprop”.

And if macroprudentially regulating is an illusion, what does that imply? There will be bubbles and there will be busts. Next time, however, will there be financial institutions (banks, insurance companies, asset managers, you name it) who are – or are perceived to be – “too big to fail”?

You cannot stop the tide and you cannot prevent financial crises. But you can limit the cost of those crises if your biggest players are small enough to fail.

It really all goes back to that. Hopefully the Administration is on the right track.

The Financial Regulations

The President unveiled his regulatory overhaul today, refraining from leaving the details to Congress and instead putting together an extremely detailed document. The idea on the top line was to streamline the bureaucracy, as evidenced by the elimination of the Office of Thrift Supervision, a small regulatory agency which has become something of a scapegoat since they were the regulator for AIG. But Felix Salmon says that there is anything but streamlining in these rules:

Were you hoping that the present alphabet soup of regulators would get rationalized and downsized? I know that I was. But there’s only one place that’s going to happen: the OCC and the OTS are going to be folded into a new regulatory entity called the National Bank Supervisor (NBS), which (along with the Fed, natch) will oversee federally-chartered banks.

The National Bank Supervisor will not oversee state-chartered banks: those will remain under the umbrella of the FDIC, which is not being folded into the NBS. And the NBS will similarly not oversee credit unions: the NCUA will retain its independence and continue to regulate those itself.

Why perpetuate these distinctions between federally-chartered banks, state-chartered banks, and credit unions? I have no idea. But in order to get some measure of cohesion over all this, a second brand-new regulatory entity, the Financial Services Oversight Council, or FOSC, which will consist of the leadership of the NBS; the FDIC; the NCUA; the SEC and the CFTC (yes, they are remaining separate too); the FHFA (that, too, gets to remain independent for no obvious reason); the Treasury; the FOMC; and the brand-new Consumer Financial Protection Agency.

Or, to put it another way, FOSC = NBS + FDIC + NCUA + SEC + CFTC + FHFA + FOMC + CFPA + Treasury.

I know what you’re thinking — it can’t possibly be as simple as that. And you’d be right! There’s also a Financial Consumer Coordinating Council, which comprises the Consumer Financial Protection Agency, the Federal Trade Commission, and the SEC’s Investor Advisory Committee.

Oh, and I almost forgot, they’re also creating an Office of National Insurance.

It's so dense it requires a glossary of terms. And in addition, the Fed has kind of oversight provisions over the entire system, by becoming a systemic risk regulator (because they didn't miss the whole thing the first time around).

The streamlining matters less to me than whether or not this thing will actually work. And I think it has a chance. Rhetorically, its heart is in the right place (even Geithner and Summers' take). Obama means to base the regulation of banks on what they do and not what they say they are; seeks to end banks shopping around for their own regulator; and create a Consumer Financial Protection Agency to "protect consumers across the financial sector from unfair, deceptive, and abusive practices." There's also a fair bit on increasing international cooperation on these issues, which is crucial. This excerpt from an interview with Obama is a good look at his thinking on the subject:

Pres. OBAMA: No. I think that what we focused on was, number one, do we have the tools to prevent the kinds of risks that we saw back in September? And our conclusion was we didn't, and we had to make sure that we had a systemic risk regulator. So that is in place. We asked, do we have the resolution authority if an individual institution like an AIG breaks down, to quarantine them so that they're not bringing the whole system down? We didn't have that authority; we wanted to put that in place. Did we have a means of anticipating problems and properly regulating the nonbank sector of the financial system, which obviously has grown massively over the last decade? And we concluded we didn't have that power. So we got those things in place.

Were we sufficiently focused on consumers? And it turned out that consumer protection, investor protection was scattered among a whole bunch of different agency; we wanted to streamline, consolidate and give somebody line responsibility for that. So what we've started off with was identifying what were the biggest problems that we had, and are we putting in place the tools to prevent the kind of crises that we've seen from happening again?

HARWOOD: But you don't...

Pres. OBAMA: Now...

HARWOOD: ...have a single bank regulator, and some people have talked about judge shopping among banks for favorable regulation.

Pres. OBAMA: This is something that we've been concerned about in the past. What we do have, under our proposal, is that for tier one institutions, the big institutions who, if they fail, require us to shore them up, for those folks they are going to be under a single regulatory body. When it comes to some of the smaller banks, community banks, the FDIC has done a good job on that, and we feel confident that they can continue doing what they do. So our overall concept has been not to completely abandon those aspects of the system that worked, but rather focus on those aspects of the system that didn't, try to close gaps. Did, you know, any considerations of sort of politics play into it? We want to get this thing passed, and, you know, we think that speed is important. We want to do it right. We want to do it carefully. But we don't want to tilt at windmills, we want to make sure that we're getting the best possible regulatory framework in place so that we're not repeating the mistakes of the past.

I guess the best that can be said is that the banking lobby hates it. Unfortunately, they'll have another bite at the apple - Congress has to approve all this, and in so doing they could easily de-fang it.

Robert Reich has some good first principles that any financial regulation should include.

...Kevin Drum, er, doesn't like this much at all.

Single Regulators And The Fed

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

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

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

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

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

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

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

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

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

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

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

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

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

Supercop

President Obama reportedly wants to put the Federal Reserve in charge of managing systemic risk among "too big to fail" financial giants. And why not? They've certainly done a bang-up job so far.

Thrill to them throwing down the hammer on the biggest banks during the stress tests:

The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations [...]

At Fifth Third Bancorp, the Fed was preparing to tell the Cincinnati-based bank to find $2.6 billion in capital, but the final tally dropped to $1.1 billion. Fifth Third said the decline stemmed in part from regulators giving it credit for selling a part of a business line.

Citigroup's capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. Executives persuaded the Fed to include the future capital-boosting impacts of pending transactions.

Chill to the makeup of one of the Fed's branch boards:

The kerfuffle about current New York Federal Reserve Bank Chairman Stephen Friedman's purchase of some Goldman stock while the Fed was involved in reviewing major decisions about Goldman's future—well-covered by the Wall Street Journal here and here—raises a fundamental question about Wall Street's corruption [...]

So who selected Geithner back in 2003? Well, the Fed board created a select committee to pick the CEO. This committee included none other than Hank Greenberg, then the chairman of AIG; John Whitehead, a former chairman of Goldman Sachs; Walter Shipley, a former chairman of Chase Manhattan Bank, now JPMorgan Chase; and Pete Peterson, a former chairman of Lehman Bros. It was not a group of typical depositors worried about the security of their savings accounts but rather one whose interest was in preserving a capital structure and way of doing business that cried out for—but did not receive—harsh examination from the N.Y. Fed.

The composition of the New York Fed's board, which supervises the organization and current Chairman Friedman, is equally troubling. The board consists of nine individuals, three chosen by the N.Y. Fed member banks as their own representatives, three chosen by the member banks to represent the public, and three chosen by the national Fed Board of Governors to represent the public. In theory this sounds great: Six board members are "public" representatives.

So whom have the banks chosen to be the public representatives on the board during the past decade, as the crisis developed and unfolded? Dick Fuld, the former chairman of Lehman; Jeff Immelt, the chairman of GE; Gene McGrath, the chairman of Con Edison; Ronay Menschel, the chairwoman of Phipps Houses and also, not insignificantly, the wife of Richard Menschel, a former senior partner at Goldman. Whom did the Board of Governors choose as its public representatives? Steve Friedman, the former chairman of Goldman; Pete Peterson; Jerry Speyer, CEO of real estate giant Tishman Speyer; and Jerry Levin, the former chairman of Time Warner. These were the people who were supposedly representing our interests!

As Spitzer notes (and by the way, can we start blaming Eliot Spitzer's libido as among the causes of the financial crisis?), it's not necessarily corruption at the NY Fed, but a very cozy groupthink, where what's good for America and what's good for Wall Street are seen as equal. Whether you think the stress test portrayed a false picture of overall banking industry health or not, everybody basically agrees that stronger regulation and enforcement could avert the kind of crisis we've already seen. But the Federal Reserve acting as any kind of regulator for large banks and investment firms should invite peals of laughter. It reminds me of Bush hiring top industry lobbyists to regulate the industries for which they used to lobby.

Economic Tea Leaves (Not Tea Bags)

The Federal Reserve released a regional report showing some slight upticks in the economy in some regions and some sectors. Essentially they showed the economy falling at a slower rate. But they were alone among the spate of economic news over the past 48 hours.

Foreclosures went up 24% in March to its highest monthly total on record. Unemployment claims declined this week but are still at a very high level. And most startling, consumer prices fell for the first time since 1955 at the same time that local sales tax revenue fell dramatically. This is pretty common economics 101 - less demand, lower prices. But it risks a serious deflationary trap, despite the macroeconomic moves to print more money, which is typically inflationary. We are the opposite of a Weimar Republic right now.

The Labor Department said its closely watched Consumer Price Index fell 0.1 percent, after increasing 0.4 percent in February. Analysts polled by Reuters had forecast headline CPI rising 0.1 percent.

Core prices, which exclude food and energy items, rose 0.2 percent after rising by the same margin in February. That compared to analysts' prediction for a 0.1 percent increase. Core prices have risen by 0.2 percent for three months in a row. March core prices were lifted by increased costs for tobacco and vehicles.

On a year-over-year basis, consumer prices fell 0.4 percent in March, the first 12-month decline since August 1955, following a 0.2 percent increase the previous month. Core prices rose 1.8 percent year over year.

Since the entire world has built their export surplus on the banks of the American consumer, this severe drop in consumer spending has serious consequences for the world.

The facts are pretty straightforward. National economies rev up – or not – based on what business spends (known as investment), what households buy (consumption) and what is bought or sold between a country and the rest of the world.

The American household was the rock in all this [...]

Hence the delicately put, but nevertheless piercing, view from the European Central Bank, which would like to see a United States upturn as much as anyone in the world: “While households have been a powerful force in dampening the downturn in past recessions, the same may not be true in the current episode,” the central bank bulletin says.

It's not going to be the same, and the world will have to find new markets to make up for Americans living within their means, or live with lower growth. Of course, in the midst of this downturn, it could delay the bounce back for a long time.

More Regulatory Authority? How About Using What You've Got

At their joint hearing with the House Financial Services Committee, both Tim Geithner and Ben Bernanke advocated for regulatory authority over non-bank financial institutions. I'm trying to get a handle on this. First of all, the investment banks all went under this past fall, so Goldman Sachs, under current law, is a bank. JP Morgan is a bank. So is Merrill Lynch. AIG stands out as the exception to the rule, but regulating their PRODUCTS would seem to be the key, not granting emergency authority to seize them. What's more, states regulate insurance companies, and while I think there ought to be a federal overseeing authority, that could get messy. And as you'll read below, the financial products unit did have federal oversight. Then there are hedge funds and the like, but again, I see the regulatory needs in the product line and not necessarily the ability to seize. FWIW here's Bernanke's argument:

The decision by the Federal Reserve on September 16, 2008, with the full support of the Treasury, to lend up to $85 billion to AIG should be viewed with this background in mind. At that time, no federal entity could provide capital to stabilize AIG and no federal or state entity outside of a bankruptcy court could wind down AIG. Unfortunately, federal bankruptcy laws do not sufficiently protect the public's strong interest in ensuring the orderly resolution of nondepository financial institutions when a failure would pose substantial systemic risks, which is why I have called on the Congress to develop new emergency resolution procedures. However, the Federal Reserve did have the authority to lend on a fully secured basis, consistent with our emergency lending authority provided by the Congress and our responsibility as central bank to maintain financial stability. We took as collateral for our loan AIG's pledge of a substantial portion of its assets, including its ownership interests in its domestic and foreign insurance subsidiaries. This decision bought time for subsequent actions by the Congress, the Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve that have avoided further failures of systemically important institutions and have supported improvements in key credit markets.

Yves Smith sounds the right notes in her skepticism.

AIG, poster child of insufficient regulation, was overseen at the parent level (which is where the black hole creating Financial Products unit sat) by the Office of Thrift Supervision (no joke), which is an agency of the Treasury! So the Treasury is acting like it needs more authority to prevent future AIG's when its own agency was responsible for the doomsday machine part of AIG.

And the hedge fund supervision bit probably means less than meets the eye. Even if a lot of them have operations in Fairfield County or Manhattan, a lot are domiciled in the Caymans or Luxembourg. You do need to observe certain forms to make sure the designation sticks (have local counsel, have annual meeting there, etc.) but after the Bear Stearns hedge funds screwed up on that front (setting up funds there but not taking other steps consistent with having them domiciled offshore), other funds may have cleaned up their act [...] The problem is not regulatory authority, the problem is the lack of a special resolution regime of the sort the UK has for putting big complex financial firms into receivership. Merely giving Treasury authority is insufficient without putting in place needed bankruptcy type provisions [...] Given the lack of any mention of a special resolution regime, or intent to develop one, the point of this bill is NOT, appearances to the contrary, to be able to put more firms into receivership. It is to get broader authority to bail them out.

After the events of last week, Congress has little appetite for giving Treasury or the Fed more authority. Steny Hoyer shot it down today. Regulations are nice, but regulatory will appears to be what's lacking here, and giving the same people who want to bail out the whole sector with no strings attached more power doesn't seem advisable.

Will Regulations Save Us?

The supposed saving grace of the Geithner bank bailout is that at least regulations will be imposed that would eliminate the possibility for this to ever happen again. At least that's Europe's view, as well as Obama's long-term position:

But I think the most important thing that we can do is make sure that we put in a bunch of financial regulatory mechanisms to prevent companies like an AIG holding the rest of us hostage. Because that's -- that's the real problem.

The problem is not just what's happened over the last six months. The problem is what was happening for years, where people were able to take huge, excessive risks with other people's money, putting the entire financial system at risk -- and there were no checks, there were no balances, there was nobody overseeing the process.

Just enforcing the laws already on the books would represent an improvement over, say, the past thirty years. But any confidence that some kind of regulatory overhaul is imminent gets sapped by the first major "reform".

The Financial Accounting Standards Board, pressured by lawmakers to change the fair-value rule blamed for worsening the financial crisis, proposed permitting companies to use “significant judgment” in valuing assets [...]

Fair-value, also known as mark-to-market accounting, requires companies to set values on most securities every quarter based on market prices. Wells Fargo & Co. and other companies argue the rule doesn’t make sense when trading has dried up because it forces banks to write down assets to fire- sale prices.

What this boils down to is that the government will allow banks to pretend that their worthless assets are worth significantly more than what the market will pay for them. In other words, banks will rescue themselves from insolvency by using the magical power of bullshit.

You can't blame this one on the Bush Administration.

Meanwhile, the next regulatory move appears to be vesting more power in the Fed, which failed to regulate the banks the last time. I agree with a new authority to oversee massive financial industry risk and their exotic products, but not with an unaccountable and secretive board that won't even account for the trillions of dollars in hastily printed money they've spent on bank assets.

Regulators have plenty of authority right now. Their reticence to really challenge elites and risk a short-term loss in GDP to protect a larger meltdown reflects a lack of will.

Looking back with 20/20 hindsight the issue isn’t so much that we needed better “rules” as it is that we needed regulators we took seriously the idea that cracking down on private sector funny business is their job. Instead, we seem to have mostly had regulators who regarded the laws on the books as an unfortunate and anachronistic departure from a pure laissez faire ideal. So you got things like the SEC prosecuting celebrities on tenuous charges, but no real oversight of a mortgage sector run amok. When you look back at the trajectory leading up to the crisis, the problem of “deregulation” isn’t so much that there’s some particular rule that was removed during the Greenspan Era that could have saved us as it is that the mindset that drove the legislative agenda of deregulation ultimately proved paralyzing to policymakers.

Certainly, if anything would destroy the mindset of Randian laissez-faire capitalism, it would be the events of the past six months. But given the clear signs from this allegedly "socialist" Administration thus far, I'm not so sure.

Buying Off The Banksters

My college friends and I used to call anything this truly horrific a-good.

The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks.

The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.

To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.

I don't have to rehash the arguments against this idea, just link to them. Basically, the government will subsidize investors to overpay for bad assets, meaning that cash will simply flow from taxpayers to banks. Instead of shrinking the wealth and value of the financial sector relative to the greater economy, this plan would keep it in place. The White House clearly sees paying off the banksters as equal to saving the economy, making the solution far more expensive than the problem, especially considering that this probably won't work. John Cole sums it up:

The Illness- reckless and irresponsible betting led to huge losses
The Diagnosis- Insufficient gambling.
The Cure- a Trillion dollar stack of chips provided by the house.
The Prognosis- We are so screwed.

At this point, the only thing we should offer a significant class of banksters is a plea deal. Instead Geithner will preserve the institutions.

If you want to truly fill yourself with dread, consider that the Federal Reserve started buying mortgage-backed securities as early as August 2007, bought up a bunch more in January, and just announced the purchase of even more THIS WEEK. And yet Treasury needs to eat some of this crap as well. That's how many of these little buggers are out there.

OK, I'm going to go watch college basketball and slowly rock back and forth.

...Me again. James Kwak hits on something, connecting for me the Geithner plan to modify loan terms, thus reducing the value of mortgage-backed securities by definition, and this TALF plan, which would overpay for them well above their true value. The investors of the MBS could actually sue under the Takings clause of the Fifth Amendment, if structured improperly. What a fucking mess.

They Won't Have Us Follow The Money

The Politico writes a hit piece about Alan Grayson today (no link, they're trolling for one). They, and by proxy the Villagers and Republican concern trolls, are just horrified at his uncouth statements like calling Rush Limbaugh a "has-been hypocrite loser” who “was more lucid when he was a drug addict.” (I think Rush is a constituent, so good luck winning back his vote!)

What they're really mad about is that he hired a blogger, Matt Stoller, as his senior policy adviser, and he asked officials of the Federal Reserve what they're doing with nearly $2 trillion dollars of taxpayer money. This has become a feature of the financial meltdown - the utter lack of disclosure.

Banks like BofA will not disclose the timing of the bonuses Merrill Lynch handed out when they were on the verge of collapse, to the extent that people like Andrew Cuomo have to issue subpoenas to get some transparency. UBS will not disclose the names of thousands of Americans hiding their cash in Swiss bank accounts to dodge taxes, to the extent that Congress is attempting to rewrite the laws to crack down on offshore tax havens. AIG will not disclose the counterparties who are getting hundreds of billions of dollars in bailout money from the government, which is a major and evolving scandal that Josh Marshall and the TPM crew are trying to wrap their arms around. This in particular appears to be an unbelievable scheme, almost a black bag job, where the Fed drops money into an account and AIG picks it up so that everyone can maintain the fiction that it isn't a direct cash transfer. There's more here, including a description of how derivative counter-parties got away with murder in the 2005 bankruptcy bill, and how their taking all the equity if AIG went down would trigger a real and thoroughgoing collapse (as if one isn't imminent anyway).

But it's more than just AIG. The Fed won't release the names of any of the recipients of nearly $2 trillion in loans over the past two years. Bernie Sanders has legislation to force disclosure. CREW is filing a Freedom of Information Act request to find out. In fact, such requests have already been filed, by Bloomberg News and Fox News, only to be refused, despite being subject to FOIA.

As CREW explained in its request, the documents it seeks are essential to understanding and assessing the government's response to the devastating economic financial crisis our nation faces. CREW's Chief Counsel, Anne Weismann, put it like this:

Telling Americans that they are not entitled to know which banks are receiving 2.2 trillion dollars of taxpayer money is unacceptable under any terms. This administration has promised transparency and we expect it to deliver.

What is pretty clear is that a lot of this money is going to the banksters in backdoor bailouts that do nothing for the greater economy. Noriel Roubini writes:

“In the meantime, the massacre in financial markets and among financial firms is continuing. The debate on “bank nationalization” is borderline surreal, with the U.S. government having already committed–between guarantees, investment, recapitalization and liquidity provision–about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure).

Thus, the U.S. financial system is de facto nationalized, as the Federal Reserve has become the lender of first and only resort rather than the lender of last resort, and the U.S. Treasury is the spender and guarantor of first and only resort. The only issue is whether banks and financial institutions should also be nationalized de jure.

. . . AIG, which lost $62 billion in the fourth quarter and $99 billion in all of 2008 and is already 80% government-owned. With such staggering losses, it should be formally 100% government-owned. And now the Fed and Treasury commitments of public resources to the bailout of the shareholders and creditors of AIG have gone from $80 billion to $162 billion.

News and banks analysts’ reports suggested that Goldman Sachs got about $25 billion of the government bailout of AIG and that Merrill Lynch was the second largest benefactor of the government largesse. These are educated guesses, as the government is hiding the counter-party benefactors of the AIG bailout.”

The inability to disclose is intuitively linked to an inability to tell the truth - the banks are insolvent, the government already essentially owns them, and this inability to admit what's completely obvious is destined to cripple the economy permanently unless action is taken.

Here’s how the pattern works: first, administration officials, usually speaking off the record, float a plan for rescuing the banks in the press. This trial balloon is quickly shot down by informed commentators.

Then, a few weeks later, the administration floats a new plan. This plan is, however, just a thinly disguised version of the previous plan, a fact quickly realized by all concerned. And the cycle starts again.

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away [...]

So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.

This is why the establishment is mad at Alan Grayson. He's willing to say this kind of thing out loud.

Welcome To The ZIRP

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

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

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

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

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

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

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

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

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

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

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

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

Today In Economic Armageddon

The Federal Reserve joined forces with central banks across the world for a coordinated interest rate cut of 50 basis points. They're obviously throwing concerns about inflation out the window and trying to kickstart the credit markets, but Paul Krugman explains why that is not likely to work.

A quick illustration: in early July 2007, before the crisis, the target Fed funds rate was 5.25% and the rate on 30-day A2/P2 commercial paper — that is, CP issued by less-than-sterling borrowers — was 5.4%. On Monday of this week, the target Fed funds rate was 2%, down 325 basis points from pre-crisis levels, but the CP rate was 5.61% — up from pre-crisis levels.

So will this latest rate cut make any difference to borrowers? Maybe — but only to a few of them. We’re way past the point at which conventional monetary policy has much traction.

On top of this you have the Fed jumping into the commercial paper market, perhaps illegally, to get the rates they can't touch through monetary policy lowered. And they're starting to lend to private companies, putting more taxpayer dollars at risk.

These look like desperate attempts to stave off the inevitable, and nobody's really certain whether or not they'll work. What I think we have here is the policymakers in the White House trying to rescue their failed ideology and not the market. They want to use everything in their power (and a few things that aren't) to halt a slide to recession, as long as it doesn't look socialist and icky. What's more, they'd rather reward their friends on Wall Street than punish them, even though they have the opportunity to do either with the authority granted in the Paulson plan. The wiser move would be to follow Britain and just nationalize the banks already.

Britain’s largest banks are to be part-nationalised after the government took the momentous decision to pump tens of billions of pounds of public money into the sector to avert a banking collapse [...]

Under the UK bank rescue, the government is to put up to £250bn into the banking system in an effort to keep banks lending. It will also offer a guarantee to banks issuing medium term debt, which could mean backing a further £250bn of bank borrowings. But it is likely to demand dividend cuts and the end of big bonuses at the banks in return.

This is clearly what we should be doing here; a Swedish-style temporary nationalization with large equity stakes. It's cheaper and is more likely to be effective. And it looks like Emperor Paulson is slowly resigning himself to that reality:

Did anybody else notice that when Hank Paulson was describing in his press conference today what the Emergency Economic Stabilization Act enables Treasury to do, the first thing he listed was “to inject capital into financial institutions”?

That wasn’t how Treasury initially advertised its Troubled Asset Relief Program. It was sold as a way to get the market for mortgage securities moving (or, to use the jargon, liquid). Lots of academic economists objected that liquidity wasn’t the problem, it was insolvency. What Treasury needed to do was recapitalize financial institutions and take equity stakes in return […]

None of the people asking questions at the press conference really seemed to pick up on this, of course (&%%$# Washington journalists!). Along with Paulson’s affirmation that the FDIC was going to use its “systemic risk” powers to protect depositors and unsecured creditors “as appropriate,” I take it as one more sign that we’re headed toward a Swedish solution of our banking crisis—recapitalization and temporary nationalization of much of the banking system.

The second half of this needs to be a real stimulus bill for ordinary Americans which includes aid to state and local governments as well as infrastructure investment. And that's exactly what Nancy Pelosi is calling for.

DENVER - House Speaker Nancy Pelosi said Wednesday that a $150 billion economic stimulus plan is needed now because of the faltering economy and she may call the House into session after the election to pass it [...]

The Senate is expected to be back at work after Election Day to complete a public lands bill and perhaps deal with other matters, such as a measure to extend unemployment benefits. The House also could return to consider a stimulus plan and additional issues in a lame-duck session before the newly elected Congress takes over in January.

"We may have to go back into session before the next Congress," Pelosi said.

Pelosi said a stimulus package would create jobs by investing in public works, increasing food stamps benefits and extending unemployment insurance for the long-term jobless. She said lawmakers need to "hunker down" and look closely at the federal budget for possible savings, and reconsider whether the U.S. can afford to fight "a war without end" in Iraq.

Reality is intruding on the fantasy scenario that we can continue to prop up the financial system with funny money. The reckoning is going to be painful but we should at least start to head in the right direction.