CTOBER 7, 2010, 8:40 PM
Make Wall Street Risk It All By WILLIAM D. COHAN
William D. Cohan on Wall Street and Main Street.
Tags:
incentives, investment bank, Wall Street
Two years after the near collapse of capitalism, we certainly have our fill of financial reforms. The 2,200-page Dodd-Frank Act, which President Obama signed this summer, creates an Orwellian alphabet soup of new agencies, oversight boards and offices intended to protect us from ourselves.
The problem is that since the incentives on Wall Street have not been changed one iota by the new laws — nor are they likely to be changed by any of the soon-to-be-written regulations of federal agencies — we’re no better protected from bankers’ potentially reckless behavior than we were before the latest round of reforms.
It’s not that Dodd-Frank ignored Wall Street’s past excesses. The law will ensure that some, but not all, derivatives will have to be traded on exchanges and that some, but not all, of the banks’ proprietary trading will be curbed and that some, but not all, of their private-equity and hedge funds will be shuttered or spun off. Dodd-Frank is also supposed to curtail Wall Street’s penchant for creating conflicts of interest, although how the law is going to do that is far from clear.
“In the end, our financial system only works — our market is only free — when there are clear rules and basic safeguards that prevent abuse, that check excess, that ensure that it is more profitable to play by the rules than to game the system,” President Obama said when he signed the bill into law. That rhetoric is fine, but unfortunately Dodd-Frank will do nothing to change the rules on Wall Street.
Nor, frankly, will the expected coming into force, in a couple of years, of the new Basel III capital rules, which will likely require banks to have common equity equal to 7 percent of the value of their assets.
Bankers and traders still have the same irresponsible, accountability-free incentives they have had for the past 40 years to generate as much revenue as they possibly can each year, regardless of the consequences. The change occurred when Wall Street firms stopped being partnerships, in which every partner put his full wealth on the line every day, and became corporations, which put the risks on their shareholders and creditors.
Dodd-Frank and Basel III both missed plum opportunities to change Wall Street’s incentive structure. Which is a shame, since it would not have been difficult. Human behavior is pretty simple actually. We do what we are rewarded to do. On Wall Street, people are hugely overcompensated for generating revenue, which they do by selling products (stocks, bonds, advice on mergers or investing) and by using their vast balance sheets to facilitate trades for clients and to take the risks others don’t want to take.
What’s made all this possible is the vast amounts of capital that Wall Street firms have amassed. Fifty years ago, Goldman Sachs had around $10 million of capital, which came from its partners; today Goldman has upward of $74 billion of capital, derived mostly from the generosity of its shareholders and the creditors who have bought Goldman’s public and private securities.
Over the past generation, this business model has worked well for one group in particular: the bankers, traders and honchos who work on Wall Street. These days on Wall Street, around 50 percent of every dollar of revenue generated is paid out to its employees in the form of compensation. What other business on earth does this? None.
And how would Dodd-Frank change this dynamic? It would give shareholders a nonbinding “say on pay” regarding the compensation of executives of public corporations. And even if a majority of shareholders expressed their displeasure, the companies would be free to ignore them. Yawn.
Regulators at the Securities and Exchange Commission will also have the mandate to explore whether a Wall Street firm’s compensation practices are contributing to excessive risk-taking and, if so, to try to do something about that, like making it easier for shareholders to oust directors. But that directive is an afterthought, too.
We already have definitive proof that Wall Street’s compensation practices lead to excessive risk-taking: witness the way Wall Street’s armies kept selling mortgage-backed securities filled with defaulting home mortgages long after the securities made any sense as an investment. Wall Street did the same thing in the 1980s with junk bonds, the same thing in the 1990s with Internet initial public offerings, and the same thing in the early 2000s with the debt of emerging telecommunications companies.
This sort of thing will happen again soon enough unless Wall Street’s senior executives have the clear economic incentive to closely monitor the risks their firms are taking and make it their business to ensure that the risks are prudent.
IN June 1987, Deputy Secretary of State John Whitehead, who had previously been Goldman’s co-senior partner, reflected on the insider trading scandals that were roiling one Wall Street firm after another.
“Anybody who alleges that Wall Street is rotten I just don’t think understands Wall Street,” Mr. Whitehead told Institutional Investor magazine. “I think it’s a remarkable system that still works effectively at the heart of our free-enterprise system. But if we are going to avoid sweeping government controls and regulations, then it is incumbent on the system to clean up its act.”
Of course, Wall Street did not follow his advice about cleaning up its own act. Rather, Wall Street went to the other extreme, pushing its friends in Washington for less and less regulation all through the 1990s and early 2000s. Let the market regulate Wall Street, we were told repeatedly. Now we face the “sweeping government controls and regulations” that Mr. Whitehead feared.
This did not have to happen. For example, Goldman Sachs seems to understand the power of creating internal incentives to monitor and to regulate the risks the firm is taking. When Goldman went public in 1999, unlike other firms it decided that a group of its 400 or so top executives would get paid not out of the firm’s revenues, but instead from the firm’s pretax profits. If the firm has no pretax profits in any given year, these executives get (only) their six-figure salaries, not the tens of millions in bonuses they count on.
As a result, the senior brass at Goldman is hyperfocused on making sure the firm is always profitable, and it always has been. This may very well be the precise reason that Goldman alone saw the brewing mortgage meltdown and did something about it.
When other firms were losing billions of dollars in 2007 as the mortgage market exploded, Goldman made $17.6 billion in pretax profits, one of its most profitable years ever, and its top three executives split around $200 million. You would think the rest of Wall Street would emulate Goldman’s approach to compensating its top executives. But it hasn’t.
SINCE neither Goldman’s example nor Dodd-Frank and Basel III will change Wall Street’s behavior, we have to find a new mechanism. To my mind, its central feature should be that each of the top 100 executives at Wall Street’s remaining “systemically important” firms be personally liable for the risks they take. Not just their unexercised stock options or restricted stock, but every asset they have in their possession: from their cars to their fancy homes to their bulging bank accounts.
The days of privatizing the profits for Wall Street and socializing the risks must end. As radical as this sounds, in truth it would be no different from when — before 1970 — Wall Street was a series of private partnerships.
We can’t turn back the clock: Wall Street’s big firms will never again be private partnerships. Instead, I propose that each large Wall Street firm create a new security that represents — and is secured by — the entire net worth of its 100 top executives. This security would be subordinated to all other creditors as well as to all preferred and common shareholders; in other words, if a firm goes bankrupt, this security is the first to be wiped out.
Had such a security existed at the time of the collapse of Lehman Brothers, the net worth of the top 100 Lehman executives — no doubt totaling several billion dollars — would have been collected after liquidating everything they owned and paid to Lehman creditors, who under the current system will be lucky if they get back 10 cents on the dollar.
Wall Street’s first reaction to this idea — aside from profanities — will be that it cannot possibly be done. Or that it would somehow threaten the sanctity of our capital markets.
But, in fact, it can and should be done. Indeed, Wall Street has all the intellectual capital it needs in its own archives to construct such a security: in the old partnership days every partner signed an agreement requiring him (and rarely her) to put his net worth on the line every day. Surely, clever Wall Street lawyers can draft a 21st-century version of the old partnership agreement.
What’s more, Wall Street should take the initiative to do this unprompted. As John Whitehead warned, the banks’ failure to show responsibility will only invite more government intervention.
If, however, the firms balk, the S.E.C. should require this sort of accountability from the senior managements as part of its new regulations governing Wall Street compensation. Or Congress should take advantage of the still-brewing outrage against Wall Street to force the creation of such a security.
Pretty harsh, right? Maybe, but Wall Street deserves no sympathy. Had this security, or something like it, been in place at every Wall Street firm five years ago, there would have been no mortgage bubble, no financial crisis, no deep and unsettling economic recession with nearly 10 percent unemployment, no need for the Troubled Asset Relief Program, and no need for Dodd-Frank or Basel III.
Why? Because human beings do what they are rewarded to do — especially on Wall Street — and if they are rewarded for taking prudent and sensible risks, that’s exactly what they will do.
This column appeared in print on October 8, 2010.
Showing posts with label Bailout. Show all posts
Showing posts with label Bailout. Show all posts
Friday, October 08, 2010
Thursday, May 06, 2010
Market Drop Fueled by a Crisis, Anxiety and an Error By FLOYD NORRIS
May 6, 2010
Market Drop Fueled by a Crisis, Anxiety and an Error By FLOYD NORRIS
Combine one part nervous traders, one part Greek crisis and one part trader error. Stir in one part central bank complacency. Bring to boil. Panic.
That combination produced one of the wildest days ever in financial markets, with the Dow Jones industrial average, at one point, down almost 1,000 points while the euro sank to its lowest level in more than a year. There were substantial declines in emerging markets, whose economies had seemed to be booming, and in developed markets fearful of renewed recessions.
Even though a substantial part of the worst plunge appeared to be linked to a trader error — one $40 stock fell for a time to one penny — prices had fallen around the world even before such mistakes began to happen.
It appears that investors are again growing more hesitant to own assets like stocks and bonds, particularly since many now cost far more than they did only a few months ago. Another sharp retrenchment by investors, consumers and businesses could threaten the current global recovery by choking off financing and new orders for companies.
For much of the last 14 months, the prices of risky assets around the world have been rising rapidly. That recovery, from lows reached in March 2009 amid talk of a new Great Depression, both reflected and encouraged a revival in economic activity. Manufacturers in most countries this week reported rapidly growing order books.
The most recent recession was made in the United States, and to a large extent it was unmade here as well. If it was the subprime mortgage market and other credit excesses that sent markets reeling, it was also a willingness of the American government, including the Federal Reserve Board, to plow in money when fears were at their highest that helped to bring those markets and economic activity back.
For the last several months, worries have been alternately rising and receding that the next crisis would be made in Europe, where Greece has faced the possibility of default. Europe and the International Monetary Fund have announced plans for a bailout, but there have also been riots in Greece amid anger over the steep budget cuts being forced on the country.
On Thursday, Jean-Claude Trichet, the president of the European Central Bank, said at a news conference that the bank’s governing council had not even discussed the possibility of buying government bonds. That was taken as a disappointment by some traders, who had hoped the central bank would follow the Fed’s lead in spreading liquidity around if conditions grew worse.
Instead, fears are growing that Europe, which is worried that the crisis in Greece could be followed ones in Portugal and Spain, will follow the pattern laid down by the United States government in 2007, when officials offered frequent reassurances that the subprime mortgage problem was “contained” but delayed taking the bold action that finally did stop the panic.
The height of panic on Thursday was reached shortly after lunchtime in the United States. First some currencies began to fall rapidly, with the euro suffering especially against the Japanese yen.
That could have been an indication that some large traders were unwinding positions. It has been popular to borrow yen at low interest rates and then use the money to speculate in higher yielding assets denominated in other currencies. Anyone unwinding such a trade would buy yen to repay the loan.
Then, within a few minutes, the United States stock market appeared to be collapsing. Some of the decline was real, but another part of it was simply trading gone awry.
Temporary plunges in the price of Procter & Gamble and 3M, the former Minnesota Mining, cost the Dow about 300 points, and appeared to be the result of errors, not intentional sell orders. Similarly, Accenture, a large consulting firm, fell from more than $40 a share to one penny.
By the close of the day, the Dow was down 347.80 points, or 3.2 percent, to 10,520.32.
There were also substantial declines in most major European and Asian indexes. In Greece, however, the stock market put on a small rebound after falling to a 13-month low on Wednesday.
Europe faces many obstacles in trying to deal with the growing crisis there. The European Central Bank, which handles monetary policy for the 16 countries in the euro zone, has fewer powers than the Fed does, and there is no Europe-wide government with powers to act quickly. Even now, after months of talking, the Greek bailout has not been approved by all whose approval is needed. The German parliament is expected to approve it on Friday.
Moreover, the American crisis developed before budget deficits spiraled upward. Coming up with cash now would be harder, a fact Mr. Trichet pointed to when he called on European governments to cut their budget deficits.
Spending large amounts of cash to bail out European governments is unlikely to be popular with voters in countries that are not in trouble, but a failure to do so could threaten many financial institutions around the continent.
A traditional way to reduce debt is to devalue currencies, which leaves the outstanding debt worth less. Countries in the euro zone cannot do that, which is one reason Greece is in such difficulty.
But some investors seem to expect that eventually worldwide inflation will form a significant part of the solution, enabling governments and other debtors to pay back loans with currencies worth less than when the loans were made. In the last three days, while the Standard & Poor’s 500-stock index has lost 6 percent of its value, the price of 30-year inflation-indexed Treasury security has risen by almost 4 percent.
There is no way to know whether this week’s jitters will be put aside as more good economic news is released, or whether Europe’s woes will create a repeat of the growing panic that engulfed American markets not that long ago.
In the second case, this could be another one of those times when markets move from one extreme to the other. In the fall of 2008, the collapse of Lehman Brothers sent investors fleeing. The following spring, hopes that the bailouts and stimulus plans were working helped to begin a strong bull market in nearly every asset category.
If this is another turning point, some of the winners will be those who, by luck or vision, managed to sell securities while the selling was easy. On Tuesday, Beazer Homes, a builder that was almost given up for dead in 2009 — when its shares traded for less than 25 cents — managed to raise $350 million selling new shares and new bonds. The money will go to refinance debt that otherwise could have forced the company into bankruptcy.
By the close on Thursday, investors who bought shares at that offering, paying $5.81, had lost almost 10 percent of their money as the stock closed at $5.25.
All this is taking place as the Senate debates financial reform amid considerable public hostility to banks. That no doubt will lead some on Wall Street to say that the markets are warning against making regulation too harsh, but the wild gyrations also serve as a reminder that the efficient markets hypothesis is not a very good model of what actually happens.
Markets turn out to be very bad at assessing values under some circumstances. They were far too optimistic is 2006, and ridiculously pessimistic in early 2009.
That is not a reason to get rid of markets, if only because any alternative, like letting judges and government officials set values, would likely be worse. But it does serve as a counterpoint to the infatuation with markets that led to the creation of a virtually unregulated shadow financial system. Those who believe in regulation will point to that, and say that if this wild ride continues, it will provide further evidence that markets need adult supervision.
Market Drop Fueled by a Crisis, Anxiety and an Error By FLOYD NORRIS
Combine one part nervous traders, one part Greek crisis and one part trader error. Stir in one part central bank complacency. Bring to boil. Panic.
That combination produced one of the wildest days ever in financial markets, with the Dow Jones industrial average, at one point, down almost 1,000 points while the euro sank to its lowest level in more than a year. There were substantial declines in emerging markets, whose economies had seemed to be booming, and in developed markets fearful of renewed recessions.
Even though a substantial part of the worst plunge appeared to be linked to a trader error — one $40 stock fell for a time to one penny — prices had fallen around the world even before such mistakes began to happen.
It appears that investors are again growing more hesitant to own assets like stocks and bonds, particularly since many now cost far more than they did only a few months ago. Another sharp retrenchment by investors, consumers and businesses could threaten the current global recovery by choking off financing and new orders for companies.
For much of the last 14 months, the prices of risky assets around the world have been rising rapidly. That recovery, from lows reached in March 2009 amid talk of a new Great Depression, both reflected and encouraged a revival in economic activity. Manufacturers in most countries this week reported rapidly growing order books.
The most recent recession was made in the United States, and to a large extent it was unmade here as well. If it was the subprime mortgage market and other credit excesses that sent markets reeling, it was also a willingness of the American government, including the Federal Reserve Board, to plow in money when fears were at their highest that helped to bring those markets and economic activity back.
For the last several months, worries have been alternately rising and receding that the next crisis would be made in Europe, where Greece has faced the possibility of default. Europe and the International Monetary Fund have announced plans for a bailout, but there have also been riots in Greece amid anger over the steep budget cuts being forced on the country.
On Thursday, Jean-Claude Trichet, the president of the European Central Bank, said at a news conference that the bank’s governing council had not even discussed the possibility of buying government bonds. That was taken as a disappointment by some traders, who had hoped the central bank would follow the Fed’s lead in spreading liquidity around if conditions grew worse.
Instead, fears are growing that Europe, which is worried that the crisis in Greece could be followed ones in Portugal and Spain, will follow the pattern laid down by the United States government in 2007, when officials offered frequent reassurances that the subprime mortgage problem was “contained” but delayed taking the bold action that finally did stop the panic.
The height of panic on Thursday was reached shortly after lunchtime in the United States. First some currencies began to fall rapidly, with the euro suffering especially against the Japanese yen.
That could have been an indication that some large traders were unwinding positions. It has been popular to borrow yen at low interest rates and then use the money to speculate in higher yielding assets denominated in other currencies. Anyone unwinding such a trade would buy yen to repay the loan.
Then, within a few minutes, the United States stock market appeared to be collapsing. Some of the decline was real, but another part of it was simply trading gone awry.
Temporary plunges in the price of Procter & Gamble and 3M, the former Minnesota Mining, cost the Dow about 300 points, and appeared to be the result of errors, not intentional sell orders. Similarly, Accenture, a large consulting firm, fell from more than $40 a share to one penny.
By the close of the day, the Dow was down 347.80 points, or 3.2 percent, to 10,520.32.
There were also substantial declines in most major European and Asian indexes. In Greece, however, the stock market put on a small rebound after falling to a 13-month low on Wednesday.
Europe faces many obstacles in trying to deal with the growing crisis there. The European Central Bank, which handles monetary policy for the 16 countries in the euro zone, has fewer powers than the Fed does, and there is no Europe-wide government with powers to act quickly. Even now, after months of talking, the Greek bailout has not been approved by all whose approval is needed. The German parliament is expected to approve it on Friday.
Moreover, the American crisis developed before budget deficits spiraled upward. Coming up with cash now would be harder, a fact Mr. Trichet pointed to when he called on European governments to cut their budget deficits.
Spending large amounts of cash to bail out European governments is unlikely to be popular with voters in countries that are not in trouble, but a failure to do so could threaten many financial institutions around the continent.
A traditional way to reduce debt is to devalue currencies, which leaves the outstanding debt worth less. Countries in the euro zone cannot do that, which is one reason Greece is in such difficulty.
But some investors seem to expect that eventually worldwide inflation will form a significant part of the solution, enabling governments and other debtors to pay back loans with currencies worth less than when the loans were made. In the last three days, while the Standard & Poor’s 500-stock index has lost 6 percent of its value, the price of 30-year inflation-indexed Treasury security has risen by almost 4 percent.
There is no way to know whether this week’s jitters will be put aside as more good economic news is released, or whether Europe’s woes will create a repeat of the growing panic that engulfed American markets not that long ago.
In the second case, this could be another one of those times when markets move from one extreme to the other. In the fall of 2008, the collapse of Lehman Brothers sent investors fleeing. The following spring, hopes that the bailouts and stimulus plans were working helped to begin a strong bull market in nearly every asset category.
If this is another turning point, some of the winners will be those who, by luck or vision, managed to sell securities while the selling was easy. On Tuesday, Beazer Homes, a builder that was almost given up for dead in 2009 — when its shares traded for less than 25 cents — managed to raise $350 million selling new shares and new bonds. The money will go to refinance debt that otherwise could have forced the company into bankruptcy.
By the close on Thursday, investors who bought shares at that offering, paying $5.81, had lost almost 10 percent of their money as the stock closed at $5.25.
All this is taking place as the Senate debates financial reform amid considerable public hostility to banks. That no doubt will lead some on Wall Street to say that the markets are warning against making regulation too harsh, but the wild gyrations also serve as a reminder that the efficient markets hypothesis is not a very good model of what actually happens.
Markets turn out to be very bad at assessing values under some circumstances. They were far too optimistic is 2006, and ridiculously pessimistic in early 2009.
That is not a reason to get rid of markets, if only because any alternative, like letting judges and government officials set values, would likely be worse. But it does serve as a counterpoint to the infatuation with markets that led to the creation of a virtually unregulated shadow financial system. Those who believe in regulation will point to that, and say that if this wild ride continues, it will provide further evidence that markets need adult supervision.
Tuesday, April 27, 2010
April 27, 2010 A Bank Tax as Insurance for Us All By DAVID LEONHARDT Washington The financial regulation bill before the Senate has the potential to
April 27, 2010
A Bank Tax as Insurance for Us All By DAVID LEONHARDT
Washington
The financial regulation bill before the Senate has the potential to do a lot of good. But it also has at least one major flaw: it would not do enough to prevent taxpayers from paying the bill for a future crisis.
What would? A tax on banks. The International Monetary Fund has started pushing for a bank tax, and a tax has also become part of the debate in Britain’s election campaign. In this country, however, the subject has taken a back seat to issues like derivatives regulation and the Goldman Sachs case. Those other issues are important, but they are not as central to minimizing the damage from the next crisis.
To understand why, let’s take a glimpse into the future. Imagine the year is 2020, and a major financial firm is collapsing.
The financial regulation bill that President Obama signed back in 2010 was meant to deal with just such a problem. It gave regulators something called “resolution authority.” They could seize a dying firm, wipe out its shareholders, fire its top executives and keep it operating until its surviving parts could be sold off in an orderly fashion. Now, in 2020, the regulators are preparing to use that authority for the first time.
But as they dig into the details, they realize they are facing a raft of problems. One of the biggest is that the firm has 70 percent of its assets abroad (roughly the share of Citicorp’s business that was overseas in 2009). Washington can’t simply seize assets held in London, Shanghai or Moscow.
So ultimately, the regulators are left with the same choice that arose in 2008: bankruptcy or bailout. Regulators can let the firm fall apart suddenly and risk the kind of collateral damage that the bankruptcy of Lehman Brothers caused. Or they can spend billions of taxpayer dollars propping up the firm, as was the case with A.I.G. It’s a miserable choice.
You also can be pretty sure which of the two options tomorrow’s policy makers will choose: bailout. History — in the form of the Great Depression and, more recently, Lehman — argues against the idea of liquidate, liquidate, liquidate, as Herbert Hoover’s Treasury secretary, Andrew Mellon, advocated. The downside, of course, is that taxpayers end up paying for Wall Street’s sins.
Obama administration officials insist that the reregulation plan will prevent this outcome. They note that both the Senate and House bills will give regulators more authority to monitor financial firms. Banks will also be required to hold more cash in reserve, which will give them a bigger cushion when some investments do go bad. The rules for resolution authority, meanwhile, will be written with international cooperation in mind.
And maybe time will prove the administration correct. But a good number of economists and banking experts are worried. They think the odds of a future bankruptcy-or-bailout dilemma will remain uncomfortably high even if reregulation passes.
For starters, there are the cross-border problems; in the midst of a crisis, governments may have trouble cooperating. Then there is the fact that the regulators have never before tried to shut down anything as complex as a multibillion-dollar financial firm. “It’s really hard — really hard,” says Robert Steel, who worked on the financial crisis in the Bush Treasury Department and later was chief executive of Wachovia. “Anyone who says they know exactly what we should do is overconfident.”
Another former top government official adds, bluntly, “Don’t kid yourself into thinking that if J. P. Morgan were on the rocks, it would disappear.”
Above all, no one knows what the next crisis will look like. So no one can be sure exactly how to prevent it. In all likelihood, Wall Street will eventually figure out ways around technocratic rules — and technocrats — and create trouble that today’s proposals don’t anticipate.
The beauty of a bank tax is that it acknowledges as much. Financial firms play a vital role in a market economy. But they also have a long record of causing crises, be it the South Sea bubble of 1720, the Panic of 1873, the Great Depression or our own Great Recession. A bank tax is akin to an insurance policy that taxpayers would require Wall Street to hold. The premiums on that policy would keep Wall Street from making big profits in good times while foisting its losses on society in bad.
The current Senate bill includes a kind of bank tax, but it has all kinds of problems. It would initially collect only $50 billion from firms and then set the money aside to pay the costs of future bailouts. Other crises have cost far more than $50 billion.
For this reason, the Obama administration prefers a postcrisis tax. The White House has proposed a so-called TARP tax, to raise at least $90 billion over the next decade and cover the costs of the 2008 bailout fund (the Troubled Asset Relief Program). But this idea has its own flaws. It does not leave any money for future busts. It assumes Washington will always be able to recoup those costs later, which doesn’t sound like a great bet.
The I.M.F. prefers a permanent tax, for the good reason that the risk of crises is permanent. “The challenge is to ensure that financial institutions bear the direct financial costs that any future failures or crises will impose — and maybe somewhat more, given all the other costs that bank failure can impose on the economy,” Carlo Cottarelli, the head of the I.M.F.’s fiscal affairs unit, wrote last weekend. The tax wouldn’t go into a dedicated bailout fund. Its purpose instead would be to discourage too much risk-taking and, over the long term, help offset any bailout costs.
Because the tax would be calculated based on a firm’s holdings, a small local bank or a larger bank with billions of dollars in safe consumer deposits might pay nothing. A leveraged investment bank would surely be taxed.
The TARP tax, in its technical design, would be similar. And Timothy Geithner, the Treasury secretary, told me recently that he was open to the idea of the tax’s becoming permanent. “There is a very good argument you should put a fee on finance, like a tax on pollution,” he said.
Yet the administration — nervous about upsetting the fragile support in Congress for financial reregulation — has been afraid of making the tax part of the broader bill. That strikes me as a mistake, given the tax’s importance. Obviously, though, if Congress passes a bank tax in a separate bill later this year, it will work out the same in the end.
There is some reason for optimism, too. Max Baucus, the chairman of the Senate Finance Committee, told Politico this week, “I don’t think there’s much doubt that there will be a bank tax.” Why? The tax is not just about punishing banks.
The federal government, remember, is facing a huge deficit. To pay it off, Washington will need to make spending cuts and raise taxes. Can you think of a better candidate for taxation than an industry that made huge profits during the boom and then helped cause the bust that has sent the deficit soaring?
A Bank Tax as Insurance for Us All By DAVID LEONHARDT
Washington
The financial regulation bill before the Senate has the potential to do a lot of good. But it also has at least one major flaw: it would not do enough to prevent taxpayers from paying the bill for a future crisis.
What would? A tax on banks. The International Monetary Fund has started pushing for a bank tax, and a tax has also become part of the debate in Britain’s election campaign. In this country, however, the subject has taken a back seat to issues like derivatives regulation and the Goldman Sachs case. Those other issues are important, but they are not as central to minimizing the damage from the next crisis.
To understand why, let’s take a glimpse into the future. Imagine the year is 2020, and a major financial firm is collapsing.
The financial regulation bill that President Obama signed back in 2010 was meant to deal with just such a problem. It gave regulators something called “resolution authority.” They could seize a dying firm, wipe out its shareholders, fire its top executives and keep it operating until its surviving parts could be sold off in an orderly fashion. Now, in 2020, the regulators are preparing to use that authority for the first time.
But as they dig into the details, they realize they are facing a raft of problems. One of the biggest is that the firm has 70 percent of its assets abroad (roughly the share of Citicorp’s business that was overseas in 2009). Washington can’t simply seize assets held in London, Shanghai or Moscow.
So ultimately, the regulators are left with the same choice that arose in 2008: bankruptcy or bailout. Regulators can let the firm fall apart suddenly and risk the kind of collateral damage that the bankruptcy of Lehman Brothers caused. Or they can spend billions of taxpayer dollars propping up the firm, as was the case with A.I.G. It’s a miserable choice.
You also can be pretty sure which of the two options tomorrow’s policy makers will choose: bailout. History — in the form of the Great Depression and, more recently, Lehman — argues against the idea of liquidate, liquidate, liquidate, as Herbert Hoover’s Treasury secretary, Andrew Mellon, advocated. The downside, of course, is that taxpayers end up paying for Wall Street’s sins.
Obama administration officials insist that the reregulation plan will prevent this outcome. They note that both the Senate and House bills will give regulators more authority to monitor financial firms. Banks will also be required to hold more cash in reserve, which will give them a bigger cushion when some investments do go bad. The rules for resolution authority, meanwhile, will be written with international cooperation in mind.
And maybe time will prove the administration correct. But a good number of economists and banking experts are worried. They think the odds of a future bankruptcy-or-bailout dilemma will remain uncomfortably high even if reregulation passes.
For starters, there are the cross-border problems; in the midst of a crisis, governments may have trouble cooperating. Then there is the fact that the regulators have never before tried to shut down anything as complex as a multibillion-dollar financial firm. “It’s really hard — really hard,” says Robert Steel, who worked on the financial crisis in the Bush Treasury Department and later was chief executive of Wachovia. “Anyone who says they know exactly what we should do is overconfident.”
Another former top government official adds, bluntly, “Don’t kid yourself into thinking that if J. P. Morgan were on the rocks, it would disappear.”
Above all, no one knows what the next crisis will look like. So no one can be sure exactly how to prevent it. In all likelihood, Wall Street will eventually figure out ways around technocratic rules — and technocrats — and create trouble that today’s proposals don’t anticipate.
The beauty of a bank tax is that it acknowledges as much. Financial firms play a vital role in a market economy. But they also have a long record of causing crises, be it the South Sea bubble of 1720, the Panic of 1873, the Great Depression or our own Great Recession. A bank tax is akin to an insurance policy that taxpayers would require Wall Street to hold. The premiums on that policy would keep Wall Street from making big profits in good times while foisting its losses on society in bad.
The current Senate bill includes a kind of bank tax, but it has all kinds of problems. It would initially collect only $50 billion from firms and then set the money aside to pay the costs of future bailouts. Other crises have cost far more than $50 billion.
For this reason, the Obama administration prefers a postcrisis tax. The White House has proposed a so-called TARP tax, to raise at least $90 billion over the next decade and cover the costs of the 2008 bailout fund (the Troubled Asset Relief Program). But this idea has its own flaws. It does not leave any money for future busts. It assumes Washington will always be able to recoup those costs later, which doesn’t sound like a great bet.
The I.M.F. prefers a permanent tax, for the good reason that the risk of crises is permanent. “The challenge is to ensure that financial institutions bear the direct financial costs that any future failures or crises will impose — and maybe somewhat more, given all the other costs that bank failure can impose on the economy,” Carlo Cottarelli, the head of the I.M.F.’s fiscal affairs unit, wrote last weekend. The tax wouldn’t go into a dedicated bailout fund. Its purpose instead would be to discourage too much risk-taking and, over the long term, help offset any bailout costs.
Because the tax would be calculated based on a firm’s holdings, a small local bank or a larger bank with billions of dollars in safe consumer deposits might pay nothing. A leveraged investment bank would surely be taxed.
The TARP tax, in its technical design, would be similar. And Timothy Geithner, the Treasury secretary, told me recently that he was open to the idea of the tax’s becoming permanent. “There is a very good argument you should put a fee on finance, like a tax on pollution,” he said.
Yet the administration — nervous about upsetting the fragile support in Congress for financial reregulation — has been afraid of making the tax part of the broader bill. That strikes me as a mistake, given the tax’s importance. Obviously, though, if Congress passes a bank tax in a separate bill later this year, it will work out the same in the end.
There is some reason for optimism, too. Max Baucus, the chairman of the Senate Finance Committee, told Politico this week, “I don’t think there’s much doubt that there will be a bank tax.” Why? The tax is not just about punishing banks.
The federal government, remember, is facing a huge deficit. To pay it off, Washington will need to make spending cuts and raise taxes. Can you think of a better candidate for taxation than an industry that made huge profits during the boom and then helped cause the bust that has sent the deficit soaring?
Friday, April 16, 2010
The Fire Next Time By PAUL KRUGMAN
April 16, 2010
Op-Ed Columnist
The Fire Next Time By PAUL KRUGMAN
On Tuesday, Mitch McConnell, the Senate minority leader, called for the abolition of municipal fire departments.
Firefighters, he declared, “won’t solve the problems that led to recent fires. They will make them worse.” The existence of fire departments, he went on, “not only allows for taxpayer-funded bailouts of burning buildings; it institutionalizes them.” He concluded, “The way to solve this problem is to let the people who make the mistakes that lead to fires pay for them. We won’t solve this problem until the biggest buildings are allowed to burn.”
O.K., I fibbed a bit. Mr. McConnell said almost everything I attributed to him, but he was talking about financial reform, not fire reform. In particular, he was objecting not to the existence of fire departments, but to legislation that would give the government the power to seize and restructure failing financial institutions.
But it amounts to the same thing.
Now, Mr. McConnell surely isn’t sincere; while pretending to oppose bank bailouts, he’s actually doing the bankers’ bidding. But before I get to that, let’s talk about why he’s wrong on substance.
In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?
The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.
So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.
Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.
So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?
Well, Mr. McConnell is trying. His talking points come straight out of a memo Frank Luntz, the Republican political consultant, circulated in January on how to oppose financial reform. “Frankly,” wrote Mr. Luntz, “the single best way to kill any legislation is to link it to the Big Bank Bailout.” And Mr. McConnell is following those stage directions.
It’s a truly shameless performance: Mr. McConnell is pretending to stand up for taxpayers against Wall Street while in fact doing just the opposite. In recent weeks, he and other Republican leaders have held meetings with Wall Street executives and lobbyists, in which the G.O.P. and the financial industry have sought to coordinate their political strategy.
And let me assure you, Wall Street isn’t lobbying to prevent future bank bailouts. If anything, it’s trying to ensure that there will be more bailouts. By depriving regulators of the tools they need to seize failing financial firms, financial lobbyists increase the chances that when the next crisis strikes, taxpayers will end up paying a ransom to stockholders and executives as the price of avoiding collapse.
Even more important, however, the financial industry wants to avoid serious regulation; it wants to be left free to engage in the same behavior that created this crisis. It’s worth remembering that between the 1930s and the 1980s, there weren’t any really big financial bailouts, because strong regulation kept most banks out of trouble. It was only with Reagan-era deregulation that big bank disasters re-emerged. In fact, relative to the size of the economy, the taxpayer costs of the savings and loan disaster, which unfolded in the Reagan years, were much higher than anything likely to happen under President Obama.
To understand what’s really at stake right now, watch the looming fight over derivatives, the complex financial instruments Warren Buffett famously described as “financial weapons of mass destruction.” The Obama administration wants tighter regulation of derivatives, while Republicans are opposed. And that tells you everything you need to know.
So don’t be fooled. When Mitch McConnell denounces big bank bailouts, what he’s really trying to do is give the bankers everything they want.
David Brooks is off today.
Op-Ed Columnist
The Fire Next Time By PAUL KRUGMAN
On Tuesday, Mitch McConnell, the Senate minority leader, called for the abolition of municipal fire departments.
Firefighters, he declared, “won’t solve the problems that led to recent fires. They will make them worse.” The existence of fire departments, he went on, “not only allows for taxpayer-funded bailouts of burning buildings; it institutionalizes them.” He concluded, “The way to solve this problem is to let the people who make the mistakes that lead to fires pay for them. We won’t solve this problem until the biggest buildings are allowed to burn.”
O.K., I fibbed a bit. Mr. McConnell said almost everything I attributed to him, but he was talking about financial reform, not fire reform. In particular, he was objecting not to the existence of fire departments, but to legislation that would give the government the power to seize and restructure failing financial institutions.
But it amounts to the same thing.
Now, Mr. McConnell surely isn’t sincere; while pretending to oppose bank bailouts, he’s actually doing the bankers’ bidding. But before I get to that, let’s talk about why he’s wrong on substance.
In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?
The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.
So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.
Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.
So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?
Well, Mr. McConnell is trying. His talking points come straight out of a memo Frank Luntz, the Republican political consultant, circulated in January on how to oppose financial reform. “Frankly,” wrote Mr. Luntz, “the single best way to kill any legislation is to link it to the Big Bank Bailout.” And Mr. McConnell is following those stage directions.
It’s a truly shameless performance: Mr. McConnell is pretending to stand up for taxpayers against Wall Street while in fact doing just the opposite. In recent weeks, he and other Republican leaders have held meetings with Wall Street executives and lobbyists, in which the G.O.P. and the financial industry have sought to coordinate their political strategy.
And let me assure you, Wall Street isn’t lobbying to prevent future bank bailouts. If anything, it’s trying to ensure that there will be more bailouts. By depriving regulators of the tools they need to seize failing financial firms, financial lobbyists increase the chances that when the next crisis strikes, taxpayers will end up paying a ransom to stockholders and executives as the price of avoiding collapse.
Even more important, however, the financial industry wants to avoid serious regulation; it wants to be left free to engage in the same behavior that created this crisis. It’s worth remembering that between the 1930s and the 1980s, there weren’t any really big financial bailouts, because strong regulation kept most banks out of trouble. It was only with Reagan-era deregulation that big bank disasters re-emerged. In fact, relative to the size of the economy, the taxpayer costs of the savings and loan disaster, which unfolded in the Reagan years, were much higher than anything likely to happen under President Obama.
To understand what’s really at stake right now, watch the looming fight over derivatives, the complex financial instruments Warren Buffett famously described as “financial weapons of mass destruction.” The Obama administration wants tighter regulation of derivatives, while Republicans are opposed. And that tells you everything you need to know.
So don’t be fooled. When Mitch McConnell denounces big bank bailouts, what he’s really trying to do is give the bankers everything they want.
David Brooks is off today.
Saturday, September 12, 2009
Lehman Had to Die So Global Finance Could Live By JOE NOCERA
September 12, 2009
Talking Business
Lehman Had to Die So Global Finance Could Live By JOE NOCERA
What if they’d saved Lehman Brothers?
What if, a year ago this weekend, the government and the banking industry had somehow found a way to keep Lehman from filing for bankruptcy? How might that have changed the course of the financial crisis?
We know, of course, what did happen; it is seared in our memory. On Monday, Sept. 15, 2008, when the news broke that, despite nonstop efforts that weekend, there would be no last-minute reprieve for Lehman, à la Bear Stearns, all hell broke loose.
The stock market tanked, dropping more than 500 points that day. The Reserve Primary Fund, a money market fund that held Lehman bonds, “broke the buck.” Shortly afterward, the American International Group nearly collapsed, and had to be bailed out with an extraordinary $85 billion loan from the government. Morgan Stanley was rumored to be next. Banks all over Europe were teetering. There were even fears about the stability of mighty Goldman Sachs. On Wall Street — indeed, in financial capitals all over the Western world — the panic was palpable.
Ever since that weekend, most people, including me, have viewed the decision by Henry Paulson Jr., the Treasury secretary at the time, and Ben Bernanke, the Federal Reserve chairman, to allow Lehman to go bust as the single biggest mistake of the crisis. Never mind that the two men have insisted ever since that they had no other option; surely, they could have created some options if they’d wanted to. Or so goes the conventional wisdom.
Christine Lagarde, France’s finance minister, for instance, called the decision “horrendous” and a “genuine mistake.” According to David Wessel, author of a book about the crisis, “In Fed We Trust,” the head of the European Central Bank, Jean-Claude Trichet, has said the same thing in private. He quotes one of Mr. Trichet’s aides as saying, “It never occurred to us that the Americans would let Lehman fail.” In speeches and articles, in books and television appearances, commentators of every political stripe have pointed to the Lehman bankruptcy as the event that turned the subprime crisis into a full-blown financial collapse.
As we approach this anniversary, though, I’ve begun to question that conventional wisdom. Yes, the fall of Lehman Brothers set off a contagion of panic. And I’m still convinced that Mr. Paulson and Mr. Bernanke could have found a way to save Lehman had they been so inclined (more on that in a moment). But I’ve become convinced that, if Lehman had been saved, the collapse would have occurred anyway.
John H. Makin, a visiting scholar at the American Enterprise Institute, wrote recently, “If the Lehman Brothers’ failure had not triggered the panic phase of the cycle, some other institutional failure would have done so.” I’ll go a step further: it is quite likely that the financial crisis would have been even worse had Lehman been rescued. Although nobody realized it at the time, Lehman Brothers had to die for the rest of Wall Street to live.
•
A week ago, a Reuters reporter traveled to Richard Fuld’s vacation home in Ketchum, Idaho, to see if the former Lehman chief executive would say anything about the anniversary. (When Mr. Fuld walked outside to meet her, he said, “You don’t have a gun; that’s good,” according to the reporter.)
Standing in his driveway, leading, as ever, with his chin, Mr. Fuld talked about the “pummeling” he had taken for presiding over the bankruptcy. “They’re looking for someone to dump on right now and that’s me,” he said. “The facts are out there. Nobody wants to hear it, especially not from me,” he added.
Mr. Fuld’s bitter remarks reflect the way many former Lehman executives feel, even now, about the fact that their firm was the only one to go under during the crisis. After all, they say, Lehman’s mistakes — too much leverage, an overreliance on shaky real estate assets, playing down the risks on its balance sheet — were the same mistakes just about every firm made. Bear Stearns made those mistakes — and was rescued. Citigroup made those mistakes — and was rescued.
What’s more, they say, in the months and weeks leading up to the September crisis, the firm, realizing that it might need a Plan B, proposed that it be allowed to become a bank holding company. It also asked for access to the Fed’s discount window, which is reserved for troubled banks. (What Lehman didn’t do, however, despite the repeated urging of Mr. Paulson, was find a partner with deep pockets or raise additional capital.) These are the “facts” Mr. Fuld was referring to when he spoke the Reuters reporter.
But Timothy Geithner, then New York Fed president, now Treasury secretary, didn’t like the idea of letting an investment bank become a bank holding company — so he said no. Immediately after the Lehman default, however, that is exactly what he allowed Morgan Stanley and Goldman Sachs to do, which helped stabilize both firms.
Of course, politics played a role, too. Congress had no stomach for another bailout on the heels of the takeover of Fannie Mae and Freddie Mac just a week before Lehman weekend. In his book, Mr. Wessel, the economics editor of The Wall Street Journal, quotes Mr. Paulson as saying in a conference call, “I’m being called Mr. Bailout. I can’t do it again.”
Although Mr. Paulson would later say that he had no legal authority to save Lehman Brothers, it seems pretty clear from Mr. Wessel’s account that he wasn’t really looking for any authority. He wanted to send a message. That Monday morning, in announcing the Lehman default, Mr. Paulson told the media: “I never once considered that it was appropriate to put taxpayers’ money on the line” to save Lehman Brothers.
For all of these reasons and more, former Lehman executives tend to feel that the process that led to the firm’s bankruptcy was profoundly unfair. I’ve heard the word “tragic” more than once. And I agree with them: it was unfair — and, certainly for the people who lost their jobs, even tragic. Lehman Brothers was simply in the wrong place at the wrong time. But for the sake of the financial system, it was also the luckiest thing that could have happened.
In the months between Bear Stearns and Lehman Brothers, Mr. Paulson and Mr. Bernanke had approached Congressional leaders about the need to pass legislation that would give them a handful of additional tools to help them deal with a larger crisis, should one ensue. But they quickly realized there was simply no political will to get anything done. After Lehman, however, Mr. Paulson and Mr. Bernanke were able to persuade Congress to pass a bill that gave the Treasury Department $700 billion in potential bailout money — which Mr. Paulson then used to shore up the system, and help ease the crisis. Even then, it wasn’t easy; it took two tries in the House to pass the legislation. Without the crisis prompted by the Lehman default, it would have been impossible to pass a bill like that.
That is one reason the Lehman default turned out to be a good thing. Here’s another: If Lehman had been sold to Bank of America, as originally planned, some other firm — no doubt bigger, and posing more danger to the global financial system — would have failed instead. By then, there was simply too much panic in the air. A crisis of some sort was inevitable.
Mr. Paulson, recall, wanted Wall Street to come up with its own solution for saving Lehman. But as the chief executives sat around the big conference table at the New York Fed all weekend, they kept worrying about who would be next. They talked openly about whether Merrill Lynch could last much longer. (Mr. Paulson bluntly told John Thain, Merrill’s chief executive, that he needed to find a buyer, which is why Bank of America turned its attention to Merrill and away from Lehman.) And there were rumblings that A.I.G. was in trouble. Why were they so reluctant to pitch in to save Lehman? They were worried that they might be next.
In truth, a Merrill or A.I.G. default would have created something akin to a financial nuclear bomb — much worse than Lehman’s filing for bankruptcy. Merrill was a much bigger firm, with deep roots on Main Street thanks to its “thundering herd.” A.I.G. was the world’s largest insurance company, whose credit-default swaps were propping up half of Europe’s banks. (By buying A.I.G.’s swaps, European banks could evade their capital requirements.) Lehman, by contrast, was a smaller firm, with practically no ties to Main Street. The risks it posed to the system were real — but smaller.
Almost everyone I’ve ever spoken to in Hank Paulson’s old Treasury Department agrees that without the immediate panic caused by the Lehman default, the government would never have agreed to make the loans needed to save A.I.G., a company it knew very little about. In effect, the Lehman bankruptcy caused the government to panic, which in turn caused it to save the firm it really had to save to prevent catastrophe. In retrospect, if you had to choose one firm to throw under the bus to save everyone else, you would choose Lehman.
It would be nice to be able to say that officials at Treasury and the Federal Reserve understood this at the time. But of course they didn’t. Throughout history, people have stumbled their way through crises, not fully understanding the potential consequences of their actions, hoping the choices they make turn out to be the right ones.
Mr. Bernanke is a well-known student of the Great Depression, which guided many of his actions during the crisis. Mr. Paulson showed immense tenacity once the crisis struck. History, I now believe, will praise their efforts in subduing the collapse. But the Lehman default?
You know the old saying: Sometimes, it’s better to be lucky than good. A year ago this weekend, it turns out, was one of those times.
Talking Business
Lehman Had to Die So Global Finance Could Live By JOE NOCERA
What if they’d saved Lehman Brothers?
What if, a year ago this weekend, the government and the banking industry had somehow found a way to keep Lehman from filing for bankruptcy? How might that have changed the course of the financial crisis?
We know, of course, what did happen; it is seared in our memory. On Monday, Sept. 15, 2008, when the news broke that, despite nonstop efforts that weekend, there would be no last-minute reprieve for Lehman, à la Bear Stearns, all hell broke loose.
The stock market tanked, dropping more than 500 points that day. The Reserve Primary Fund, a money market fund that held Lehman bonds, “broke the buck.” Shortly afterward, the American International Group nearly collapsed, and had to be bailed out with an extraordinary $85 billion loan from the government. Morgan Stanley was rumored to be next. Banks all over Europe were teetering. There were even fears about the stability of mighty Goldman Sachs. On Wall Street — indeed, in financial capitals all over the Western world — the panic was palpable.
Ever since that weekend, most people, including me, have viewed the decision by Henry Paulson Jr., the Treasury secretary at the time, and Ben Bernanke, the Federal Reserve chairman, to allow Lehman to go bust as the single biggest mistake of the crisis. Never mind that the two men have insisted ever since that they had no other option; surely, they could have created some options if they’d wanted to. Or so goes the conventional wisdom.
Christine Lagarde, France’s finance minister, for instance, called the decision “horrendous” and a “genuine mistake.” According to David Wessel, author of a book about the crisis, “In Fed We Trust,” the head of the European Central Bank, Jean-Claude Trichet, has said the same thing in private. He quotes one of Mr. Trichet’s aides as saying, “It never occurred to us that the Americans would let Lehman fail.” In speeches and articles, in books and television appearances, commentators of every political stripe have pointed to the Lehman bankruptcy as the event that turned the subprime crisis into a full-blown financial collapse.
As we approach this anniversary, though, I’ve begun to question that conventional wisdom. Yes, the fall of Lehman Brothers set off a contagion of panic. And I’m still convinced that Mr. Paulson and Mr. Bernanke could have found a way to save Lehman had they been so inclined (more on that in a moment). But I’ve become convinced that, if Lehman had been saved, the collapse would have occurred anyway.
John H. Makin, a visiting scholar at the American Enterprise Institute, wrote recently, “If the Lehman Brothers’ failure had not triggered the panic phase of the cycle, some other institutional failure would have done so.” I’ll go a step further: it is quite likely that the financial crisis would have been even worse had Lehman been rescued. Although nobody realized it at the time, Lehman Brothers had to die for the rest of Wall Street to live.
•
A week ago, a Reuters reporter traveled to Richard Fuld’s vacation home in Ketchum, Idaho, to see if the former Lehman chief executive would say anything about the anniversary. (When Mr. Fuld walked outside to meet her, he said, “You don’t have a gun; that’s good,” according to the reporter.)
Standing in his driveway, leading, as ever, with his chin, Mr. Fuld talked about the “pummeling” he had taken for presiding over the bankruptcy. “They’re looking for someone to dump on right now and that’s me,” he said. “The facts are out there. Nobody wants to hear it, especially not from me,” he added.
Mr. Fuld’s bitter remarks reflect the way many former Lehman executives feel, even now, about the fact that their firm was the only one to go under during the crisis. After all, they say, Lehman’s mistakes — too much leverage, an overreliance on shaky real estate assets, playing down the risks on its balance sheet — were the same mistakes just about every firm made. Bear Stearns made those mistakes — and was rescued. Citigroup made those mistakes — and was rescued.
What’s more, they say, in the months and weeks leading up to the September crisis, the firm, realizing that it might need a Plan B, proposed that it be allowed to become a bank holding company. It also asked for access to the Fed’s discount window, which is reserved for troubled banks. (What Lehman didn’t do, however, despite the repeated urging of Mr. Paulson, was find a partner with deep pockets or raise additional capital.) These are the “facts” Mr. Fuld was referring to when he spoke the Reuters reporter.
But Timothy Geithner, then New York Fed president, now Treasury secretary, didn’t like the idea of letting an investment bank become a bank holding company — so he said no. Immediately after the Lehman default, however, that is exactly what he allowed Morgan Stanley and Goldman Sachs to do, which helped stabilize both firms.
Of course, politics played a role, too. Congress had no stomach for another bailout on the heels of the takeover of Fannie Mae and Freddie Mac just a week before Lehman weekend. In his book, Mr. Wessel, the economics editor of The Wall Street Journal, quotes Mr. Paulson as saying in a conference call, “I’m being called Mr. Bailout. I can’t do it again.”
Although Mr. Paulson would later say that he had no legal authority to save Lehman Brothers, it seems pretty clear from Mr. Wessel’s account that he wasn’t really looking for any authority. He wanted to send a message. That Monday morning, in announcing the Lehman default, Mr. Paulson told the media: “I never once considered that it was appropriate to put taxpayers’ money on the line” to save Lehman Brothers.
For all of these reasons and more, former Lehman executives tend to feel that the process that led to the firm’s bankruptcy was profoundly unfair. I’ve heard the word “tragic” more than once. And I agree with them: it was unfair — and, certainly for the people who lost their jobs, even tragic. Lehman Brothers was simply in the wrong place at the wrong time. But for the sake of the financial system, it was also the luckiest thing that could have happened.
In the months between Bear Stearns and Lehman Brothers, Mr. Paulson and Mr. Bernanke had approached Congressional leaders about the need to pass legislation that would give them a handful of additional tools to help them deal with a larger crisis, should one ensue. But they quickly realized there was simply no political will to get anything done. After Lehman, however, Mr. Paulson and Mr. Bernanke were able to persuade Congress to pass a bill that gave the Treasury Department $700 billion in potential bailout money — which Mr. Paulson then used to shore up the system, and help ease the crisis. Even then, it wasn’t easy; it took two tries in the House to pass the legislation. Without the crisis prompted by the Lehman default, it would have been impossible to pass a bill like that.
That is one reason the Lehman default turned out to be a good thing. Here’s another: If Lehman had been sold to Bank of America, as originally planned, some other firm — no doubt bigger, and posing more danger to the global financial system — would have failed instead. By then, there was simply too much panic in the air. A crisis of some sort was inevitable.
Mr. Paulson, recall, wanted Wall Street to come up with its own solution for saving Lehman. But as the chief executives sat around the big conference table at the New York Fed all weekend, they kept worrying about who would be next. They talked openly about whether Merrill Lynch could last much longer. (Mr. Paulson bluntly told John Thain, Merrill’s chief executive, that he needed to find a buyer, which is why Bank of America turned its attention to Merrill and away from Lehman.) And there were rumblings that A.I.G. was in trouble. Why were they so reluctant to pitch in to save Lehman? They were worried that they might be next.
In truth, a Merrill or A.I.G. default would have created something akin to a financial nuclear bomb — much worse than Lehman’s filing for bankruptcy. Merrill was a much bigger firm, with deep roots on Main Street thanks to its “thundering herd.” A.I.G. was the world’s largest insurance company, whose credit-default swaps were propping up half of Europe’s banks. (By buying A.I.G.’s swaps, European banks could evade their capital requirements.) Lehman, by contrast, was a smaller firm, with practically no ties to Main Street. The risks it posed to the system were real — but smaller.
Almost everyone I’ve ever spoken to in Hank Paulson’s old Treasury Department agrees that without the immediate panic caused by the Lehman default, the government would never have agreed to make the loans needed to save A.I.G., a company it knew very little about. In effect, the Lehman bankruptcy caused the government to panic, which in turn caused it to save the firm it really had to save to prevent catastrophe. In retrospect, if you had to choose one firm to throw under the bus to save everyone else, you would choose Lehman.
It would be nice to be able to say that officials at Treasury and the Federal Reserve understood this at the time. But of course they didn’t. Throughout history, people have stumbled their way through crises, not fully understanding the potential consequences of their actions, hoping the choices they make turn out to be the right ones.
Mr. Bernanke is a well-known student of the Great Depression, which guided many of his actions during the crisis. Mr. Paulson showed immense tenacity once the crisis struck. History, I now believe, will praise their efforts in subduing the collapse. But the Lehman default?
You know the old saying: Sometimes, it’s better to be lucky than good. A year ago this weekend, it turns out, was one of those times.
Saturday, March 21, 2009
The Problem With Flogging A.I.G. By JOE NOCERA
March 21, 2009
Talking Business
The Problem With Flogging A.I.G. By JOE NOCERA
Can we all just calm down a little?
Yes, the $165 million in bonuses handed out to executives in the financial products division of American International Group was infuriating. Truly, it was. As many others have noted, this is the same unit whose shenanigans came perilously close to bringing the world's financial system to its knees. When the Federal Reserve chairman, Ben Bernanke, said recently that A.I.G.'s "irresponsible bets" had made him "more angry" than anything else about the financial crisis, he could have been speaking for most Americans.
But death threats? "All the executives and their families should be executed with piano wire — my greatest hope," wrote one person in an e-mail message to the company. Another suggested publishing a list of the "Yankee" bankers "so some good old southern boys can take care of them."
Or how about those efforts to publicize names of individual executives who received bonuses — efforts championed by Attorney General Andrew Cuomo of New York and Barney Frank, chairman of the House Financial Services Committee. To what end?
How does outing these executives fix skewed compensation incentives, which have created that unjustified sense of entitlement that pervades Wall Street? No, it's mostly about using subpoena power to satisfy the public's thirst for blood. (In light of the death threats, when Mr. Cuomo received the list of A.I.G. bonus recipients on Thursday, he promised to consider "individual security" and "privacy rights" in deciding whether to publicize the names.)
Then there was that awful Congressional hearing on Wednesday, in which A.I.G.'s newly installed chief executive, Edward Liddy, was forced to listen to one outraged member of Congress after another rail about bonuses — and obsess about when Treasury Secretary Timothy Geithner learned about them — while ignoring far more troubling problems surrounding the A.I.G. rescue.
Oh, and let's not forget the bill that was passed on Thursday by the House of Representatives. It would tax at a 90 percent rate bonus payments made to anyone who earned over $250,000 at any financial institution receiving significant bailout funds. Should it become law, it will affect tens of thousands of employees who had absolutely nothing to do with creating the crisis, and who are trying to help fix their companies.
Meanwhile, the real culprits — like Joseph J. Cassano, the former head of A.I.G.'s financial products division— are counting their money in "retirement." Nobody on Capitol Hill seems much interested in getting that money back. (And the bill does nothing about bonuses that were paid before 2009, meaning that most of those egregious Merrill Lynch bonuses, paid at the end of last year, will not be touched.)
By week's end, I was more depressed about the financial crisis than I've been since last September. Back then, the issue was the disintegration of the financial system, as the Lehman bankruptcy set off a terrible chain reaction. Now I'm worried that the political response is making the crisis worse. The Obama administration appears to have lost its grip on Congress, while the Treasury Department always seems caught off guard by bad news.
And Congress, with its howls of rage, its chaotic, episodic reaction to the crisis, and its shameless playing to the crowds, is out of control. This week, the body politic ran off the rails.
There are times when anger is cathartic. There are other times when anger makes a bad situation worse. "We need to stop committing economic arson," Bert Ely, a banking consultant, said to me this week. That is what Congress committed: economic arson.
How is the political reaction to the crisis making it worse? Let us count the ways.
IT IS DESTROYING VALUE During his testimony on Wednesday, Mr. Liddy pointed out that much of the money the government turned over to A.I.G. was a loan, not a gift. The company's goal, he kept saying, was to pay that money back. But how? Mr. Liddy's plan is to sell off the healthy insurance units — or, failing that, give them to the government to sell when they can muster a good price.
In other words, it is in the taxpayers' best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, "the indiscriminate pounding that A.I.G. is taking is destroying the value of the company." Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar.
IT IS, UNFORTUNATELY, BESIDE THE POINT Even on Wall Street this week, I didn't hear anyone condoning the A.I.G. bonuses. They should never have been granted, and Mr. Liddy should have been tougher about renegotiating them. (A rich irony here is that any nonfinancial company in A.I.G.'s straits would be in bankruptcy, and contracts would have to be renegotiated. The fact that the government is afraid to force A.I.G. into bankruptcy, despite its crippled state, is the main reason Mr. Liddy felt he couldn't try to redo the contracts.)
But there is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers' money has been funneled to A.I.G.'s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroup and every other company that bought credit-default swaps from A.I.G. should be made whole by the government? Why isn't it forcing them to take a haircut?
What's worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations?
The person who has made this point most forcefully is Eliot Spitzer, of all people. In his column for Slate.com, he wrote: "Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion cash infusion, and aren't they sitting on more than $100 billion in cash?" Mr. Spitzer told me that while "there is a legitimate sense of outrage over the bonuses, the larger outrage should be the use of A.I.G. funding as a second bailout for the large investment houses." Precisely.
IT IS DESTABILIZING How can you run a company when the rules keep changing, when you have to worry about being second-guessed by Congress? Who can do business under those circumstances?
Take, for instance, that new securitization program the government is trying to get off the ground, called the Term Asset-Backed Securities Loan Facility — or TALF. Although it is backed by large government loans, it requires people in the marketplace — Wall Street bankers! — to participate.
This program could help revive the consumer credit market. But at this point, most Wall Street bankers would rather be attacked by wild dogs than take part. They fear that they'll do something — make money perhaps? — that will arouse Congressional ire. Or that the rules will change. "The constant flip-flopping is terrible," said Simon Johnson, a banking expert who teaches at the M.I.T. Sloan School of Business.
A.I.G. offers another good example. Not all the employees who face the possibility of having their bonuses taxed out from under them work for the evil financial products division. Many of them work in insurance divisions. Very few of them pull down million-dollar bonuses, and none of them brought A.I.G. to its knees. (And employees who bought the company's stock are already hurting financially, having seen its value virtually wiped out.) They are the ones the company badly needs to keep if it hopes to sell those units at a healthy price. Taking away their bonuses — after they've already put the money in their bank accounts — hardly seems like the right way to motivate them. And demonizing them in Congressional hearings doesn't help either.
In previous columns, I have been an advocate of nationalizing big banks like Citigroup. But after watching Congress this week, I'm having second thoughts. If this is how Congress treats A.I.G., what would it do if it had a bank in its paws?
What the country really needs right now from Congress is facts instead of rhetoric. Instead of these "raise your hand if you took a private jet to get here" exercises of outraged populism, we need hearings that educate and illuminate. Hearings like the old Watergate hearings. Hearings in which knowledge is accumulated over time, and a record is established. Hearings that might actually help us get out of this crisis. It's happened before. In 1932, Congress established the Pecora committee, named for its chief counsel, Ferdinand Pecora. It was an intense, two-year inquiry, and its findings — executives shorting their own company's stock, for instance — shocked the country. It also led to the establishment of the Securities and Exchange Commission and other investor protections. One person who has been calling for a new Pecora committee is Senator Richard Shelby of Alabama, a Republican and key member of the Senate Banking Committee.
"As we restructure our regulatory system, we need to be thorough," he told me. "We need to understand what caused it. We shouldn't rush it."
Meanwhile, the House Financial Services Committee has scheduled a hearing on Tuesday featuring Mr. Bernanke and Mr. Geithner. The hearing has been called to find out only one thing: what did the two men know about the A.I.G. bonuses, and when did they know it?
Is that Nero I hear fiddling?
http://www.nytimes.com/2009/03/21/business/21nocera.html?sq=Joe%20Nocera%20Floggin%20A.I.G&st=cse&scp=1&pagewanted=print
http://snipurl.com/eakqp
Talking Business
The Problem With Flogging A.I.G. By JOE NOCERA
Can we all just calm down a little?
Yes, the $165 million in bonuses handed out to executives in the financial products division of American International Group was infuriating. Truly, it was. As many others have noted, this is the same unit whose shenanigans came perilously close to bringing the world's financial system to its knees. When the Federal Reserve chairman, Ben Bernanke, said recently that A.I.G.'s "irresponsible bets" had made him "more angry" than anything else about the financial crisis, he could have been speaking for most Americans.
But death threats? "All the executives and their families should be executed with piano wire — my greatest hope," wrote one person in an e-mail message to the company. Another suggested publishing a list of the "Yankee" bankers "so some good old southern boys can take care of them."
Or how about those efforts to publicize names of individual executives who received bonuses — efforts championed by Attorney General Andrew Cuomo of New York and Barney Frank, chairman of the House Financial Services Committee. To what end?
How does outing these executives fix skewed compensation incentives, which have created that unjustified sense of entitlement that pervades Wall Street? No, it's mostly about using subpoena power to satisfy the public's thirst for blood. (In light of the death threats, when Mr. Cuomo received the list of A.I.G. bonus recipients on Thursday, he promised to consider "individual security" and "privacy rights" in deciding whether to publicize the names.)
Then there was that awful Congressional hearing on Wednesday, in which A.I.G.'s newly installed chief executive, Edward Liddy, was forced to listen to one outraged member of Congress after another rail about bonuses — and obsess about when Treasury Secretary Timothy Geithner learned about them — while ignoring far more troubling problems surrounding the A.I.G. rescue.
Oh, and let's not forget the bill that was passed on Thursday by the House of Representatives. It would tax at a 90 percent rate bonus payments made to anyone who earned over $250,000 at any financial institution receiving significant bailout funds. Should it become law, it will affect tens of thousands of employees who had absolutely nothing to do with creating the crisis, and who are trying to help fix their companies.
Meanwhile, the real culprits — like Joseph J. Cassano, the former head of A.I.G.'s financial products division— are counting their money in "retirement." Nobody on Capitol Hill seems much interested in getting that money back. (And the bill does nothing about bonuses that were paid before 2009, meaning that most of those egregious Merrill Lynch bonuses, paid at the end of last year, will not be touched.)
By week's end, I was more depressed about the financial crisis than I've been since last September. Back then, the issue was the disintegration of the financial system, as the Lehman bankruptcy set off a terrible chain reaction. Now I'm worried that the political response is making the crisis worse. The Obama administration appears to have lost its grip on Congress, while the Treasury Department always seems caught off guard by bad news.
And Congress, with its howls of rage, its chaotic, episodic reaction to the crisis, and its shameless playing to the crowds, is out of control. This week, the body politic ran off the rails.
There are times when anger is cathartic. There are other times when anger makes a bad situation worse. "We need to stop committing economic arson," Bert Ely, a banking consultant, said to me this week. That is what Congress committed: economic arson.
How is the political reaction to the crisis making it worse? Let us count the ways.
IT IS DESTROYING VALUE During his testimony on Wednesday, Mr. Liddy pointed out that much of the money the government turned over to A.I.G. was a loan, not a gift. The company's goal, he kept saying, was to pay that money back. But how? Mr. Liddy's plan is to sell off the healthy insurance units — or, failing that, give them to the government to sell when they can muster a good price.
In other words, it is in the taxpayers' best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, "the indiscriminate pounding that A.I.G. is taking is destroying the value of the company." Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar.
IT IS, UNFORTUNATELY, BESIDE THE POINT Even on Wall Street this week, I didn't hear anyone condoning the A.I.G. bonuses. They should never have been granted, and Mr. Liddy should have been tougher about renegotiating them. (A rich irony here is that any nonfinancial company in A.I.G.'s straits would be in bankruptcy, and contracts would have to be renegotiated. The fact that the government is afraid to force A.I.G. into bankruptcy, despite its crippled state, is the main reason Mr. Liddy felt he couldn't try to redo the contracts.)
But there is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers' money has been funneled to A.I.G.'s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroup and every other company that bought credit-default swaps from A.I.G. should be made whole by the government? Why isn't it forcing them to take a haircut?
What's worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations?
The person who has made this point most forcefully is Eliot Spitzer, of all people. In his column for Slate.com, he wrote: "Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion cash infusion, and aren't they sitting on more than $100 billion in cash?" Mr. Spitzer told me that while "there is a legitimate sense of outrage over the bonuses, the larger outrage should be the use of A.I.G. funding as a second bailout for the large investment houses." Precisely.
IT IS DESTABILIZING How can you run a company when the rules keep changing, when you have to worry about being second-guessed by Congress? Who can do business under those circumstances?
Take, for instance, that new securitization program the government is trying to get off the ground, called the Term Asset-Backed Securities Loan Facility — or TALF. Although it is backed by large government loans, it requires people in the marketplace — Wall Street bankers! — to participate.
This program could help revive the consumer credit market. But at this point, most Wall Street bankers would rather be attacked by wild dogs than take part. They fear that they'll do something — make money perhaps? — that will arouse Congressional ire. Or that the rules will change. "The constant flip-flopping is terrible," said Simon Johnson, a banking expert who teaches at the M.I.T. Sloan School of Business.
A.I.G. offers another good example. Not all the employees who face the possibility of having their bonuses taxed out from under them work for the evil financial products division. Many of them work in insurance divisions. Very few of them pull down million-dollar bonuses, and none of them brought A.I.G. to its knees. (And employees who bought the company's stock are already hurting financially, having seen its value virtually wiped out.) They are the ones the company badly needs to keep if it hopes to sell those units at a healthy price. Taking away their bonuses — after they've already put the money in their bank accounts — hardly seems like the right way to motivate them. And demonizing them in Congressional hearings doesn't help either.
In previous columns, I have been an advocate of nationalizing big banks like Citigroup. But after watching Congress this week, I'm having second thoughts. If this is how Congress treats A.I.G., what would it do if it had a bank in its paws?
What the country really needs right now from Congress is facts instead of rhetoric. Instead of these "raise your hand if you took a private jet to get here" exercises of outraged populism, we need hearings that educate and illuminate. Hearings like the old Watergate hearings. Hearings in which knowledge is accumulated over time, and a record is established. Hearings that might actually help us get out of this crisis. It's happened before. In 1932, Congress established the Pecora committee, named for its chief counsel, Ferdinand Pecora. It was an intense, two-year inquiry, and its findings — executives shorting their own company's stock, for instance — shocked the country. It also led to the establishment of the Securities and Exchange Commission and other investor protections. One person who has been calling for a new Pecora committee is Senator Richard Shelby of Alabama, a Republican and key member of the Senate Banking Committee.
"As we restructure our regulatory system, we need to be thorough," he told me. "We need to understand what caused it. We shouldn't rush it."
Meanwhile, the House Financial Services Committee has scheduled a hearing on Tuesday featuring Mr. Bernanke and Mr. Geithner. The hearing has been called to find out only one thing: what did the two men know about the A.I.G. bonuses, and when did they know it?
Is that Nero I hear fiddling?
http://www.nytimes.com/2009/03/21/business/21nocera.html?sq=Joe%20Nocera%20Floggin%20A.I.G&st=cse&scp=1&pagewanted=print
http://snipurl.com/eakqp
Friday, March 20, 2009
Perverse Cosmic Myopia By DAVID BROOKS
March 20, 2009
Op-Ed Columnist
Perverse Cosmic Myopia By DAVID BROOKS
You'd think if some tiger were lunging at your neck, your attention would be riveted on the tiger. But that's apparently not how it works in the age of global A.D.D. As a tiger sinks its teeth into the world's neck, we focus on the dust bunnies under the bed and the floorboards that need replacing on the deck. We live in the world of Perverse Cosmic Myopia, an inability to focus attention on the most perilous matter at hand.
The tiger, of course, is the collapsing world financial system. Americans actually have a falsely mild view of this crisis because the economy is worse abroad. The U.N.'s International Labor Organization projects between 30 million and 50 million job losses worldwide. Central European countries are teetering; Japan's economy is horrifying; and the Chinese job creation machine is losing the race against its demographic pressures.
There have been riots in Greece and China as well as huge protest rallies in Dublin, Paris, London and beyond. So far, the protesters express anger without an agenda, but if the global economy continues to slide through 2010, they'll discover one. A predictable result is a series of beggar-thy-neighbor exchange-rate policies, followed by rising trade barriers and the degradation of the entire global system.
In times like these, you'd expect prudent leaders to prepare for the worst. After all, the pessimists have recently been vindicated by events. But that's apparently too painful to think about. In normal times, leaders like to focus on the short term at the expense of the long term. But now the short term is really confusing, so leaders take refuge in projects that are years or decades away.
The president of the United States has decided to address this crisis while simultaneously tackling the four most complicated problems facing the nation: health care, energy, immigration and education. Why he has not also decided to spend his evenings mastering quantum mechanics and discovering the origins of consciousness is beyond me.
The results of this overload are evident on Capitol Hill. The banking plan is incomplete, and there is zero political will to pay for it. The president's budget is being nibbled to death. The revenue ideas are dying one by one, while the spending ideas expand. By the latest estimate, the health care approach will cost $1.5 trillion over 10 years and the national debt will at least double, while the Chinese publicly complain about picking up the tab.
The Obama administration is at least distracted by important things. The Washington political class has spent the past week going into made-for-TV hysterics over $165 million in A.I.G. bonuses. We're in the middle of a multitrillion-dollar crisis, and our political masters — always willing to throw themselves into any issue that is understandable on cable television — have decided to risk destroying the entire bank-rescue plan because of bonuses that account for 0.001 percent of the annual G.D.P.
Even this is not the most idiotic of the distractions. For that, you have to look abroad.
This is a global crisis, and a core lesson of the Great Depression is that a global crisis calls for a global response. As such, Tim Geithner and Larry Summers are preparing for the upcoming G-20 summit with an agenda that has the merit of actually addressing the problem at hand: coordinate global stimulus, strengthen the International Monetary Fund, preserve open trade.
But the G-20 process is heading toward global impotence because the Europeans are dismissing this approach. Instead, they want to spend this moment of peril working on a long-term architecture to regulate global finance. The world is in flames and they want directorates and multilateral symposia and vague plans for a powerless "college of supervisors." This is what Marie Antoinette would be for if she were an annual Davos attendee.
Why are they taking this position? First, many European leaders think the answer to every problem is more global architecture. They've got Jean Monnet on the brain. Second, they prefer to free-ride on the stimulus packages that the Americans and Chinese are already paying for. Third, the fiscally responsible European countries can't commit to a policy that their debt-ridden partners can't live up to. Fourth, some reject the idea of using fiscal policy to end recessions.
Some of these reasons have merit, especially the last one. But one thing is for sure: The American agenda might work to ease the immediate crisis, but efforts to build a long-range global architecture certainly will not. After all the pious talk about post-Bush international cooperation, the current approach will lead to a big multilateral zero.
Many people used to wonder how the world's leaders could be so myopic at various points in history — like during the Versailles Treaty or the turmoil of the 1930s. We don't have to wonder any more. We get to watch the cosmic myopia replay itself in our own times.
http://www.nytimes.com/2009/03/20/opinion/20brooks.html?sq=Perverse%20Cosmic%20Myopia&st=cse&scp=1&pagewanted=print
http://snipurl.com/eakus
Op-Ed Columnist
Perverse Cosmic Myopia By DAVID BROOKS
You'd think if some tiger were lunging at your neck, your attention would be riveted on the tiger. But that's apparently not how it works in the age of global A.D.D. As a tiger sinks its teeth into the world's neck, we focus on the dust bunnies under the bed and the floorboards that need replacing on the deck. We live in the world of Perverse Cosmic Myopia, an inability to focus attention on the most perilous matter at hand.
The tiger, of course, is the collapsing world financial system. Americans actually have a falsely mild view of this crisis because the economy is worse abroad. The U.N.'s International Labor Organization projects between 30 million and 50 million job losses worldwide. Central European countries are teetering; Japan's economy is horrifying; and the Chinese job creation machine is losing the race against its demographic pressures.
There have been riots in Greece and China as well as huge protest rallies in Dublin, Paris, London and beyond. So far, the protesters express anger without an agenda, but if the global economy continues to slide through 2010, they'll discover one. A predictable result is a series of beggar-thy-neighbor exchange-rate policies, followed by rising trade barriers and the degradation of the entire global system.
In times like these, you'd expect prudent leaders to prepare for the worst. After all, the pessimists have recently been vindicated by events. But that's apparently too painful to think about. In normal times, leaders like to focus on the short term at the expense of the long term. But now the short term is really confusing, so leaders take refuge in projects that are years or decades away.
The president of the United States has decided to address this crisis while simultaneously tackling the four most complicated problems facing the nation: health care, energy, immigration and education. Why he has not also decided to spend his evenings mastering quantum mechanics and discovering the origins of consciousness is beyond me.
The results of this overload are evident on Capitol Hill. The banking plan is incomplete, and there is zero political will to pay for it. The president's budget is being nibbled to death. The revenue ideas are dying one by one, while the spending ideas expand. By the latest estimate, the health care approach will cost $1.5 trillion over 10 years and the national debt will at least double, while the Chinese publicly complain about picking up the tab.
The Obama administration is at least distracted by important things. The Washington political class has spent the past week going into made-for-TV hysterics over $165 million in A.I.G. bonuses. We're in the middle of a multitrillion-dollar crisis, and our political masters — always willing to throw themselves into any issue that is understandable on cable television — have decided to risk destroying the entire bank-rescue plan because of bonuses that account for 0.001 percent of the annual G.D.P.
Even this is not the most idiotic of the distractions. For that, you have to look abroad.
This is a global crisis, and a core lesson of the Great Depression is that a global crisis calls for a global response. As such, Tim Geithner and Larry Summers are preparing for the upcoming G-20 summit with an agenda that has the merit of actually addressing the problem at hand: coordinate global stimulus, strengthen the International Monetary Fund, preserve open trade.
But the G-20 process is heading toward global impotence because the Europeans are dismissing this approach. Instead, they want to spend this moment of peril working on a long-term architecture to regulate global finance. The world is in flames and they want directorates and multilateral symposia and vague plans for a powerless "college of supervisors." This is what Marie Antoinette would be for if she were an annual Davos attendee.
Why are they taking this position? First, many European leaders think the answer to every problem is more global architecture. They've got Jean Monnet on the brain. Second, they prefer to free-ride on the stimulus packages that the Americans and Chinese are already paying for. Third, the fiscally responsible European countries can't commit to a policy that their debt-ridden partners can't live up to. Fourth, some reject the idea of using fiscal policy to end recessions.
Some of these reasons have merit, especially the last one. But one thing is for sure: The American agenda might work to ease the immediate crisis, but efforts to build a long-range global architecture certainly will not. After all the pious talk about post-Bush international cooperation, the current approach will lead to a big multilateral zero.
Many people used to wonder how the world's leaders could be so myopic at various points in history — like during the Versailles Treaty or the turmoil of the 1930s. We don't have to wonder any more. We get to watch the cosmic myopia replay itself in our own times.
http://www.nytimes.com/2009/03/20/opinion/20brooks.html?sq=Perverse%20Cosmic%20Myopia&st=cse&scp=1&pagewanted=print
http://snipurl.com/eakus
Wednesday, March 11, 2009
The Looting of America’s Coffers By DAVID LEONHARDT
March 11, 2009
Economic Scene
The Looting of America’s Coffers By DAVID LEONHARDT
Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”
The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”
On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.
Now, it would have been nice if the Fed had shown some of this regulatory zeal before the worst financial crisis since the Great Depression. But that day has passed. So people are rightly starting to think about building a new, less vulnerable financial system.
And “Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.
Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.
But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.
Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.
He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.
•
The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.
This form of moral hazard — when profits are privatized and losses are socialized — certainly played a role in creating the current mess. But when I spoke with Mr. Romer on Tuesday, he was careful to make a distinction between classic moral hazard and looting. It’s an important distinction.
With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.
Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.
What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.
In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it.
I understand this chain of events sounds a bit like a conspiracy. And in some cases, it surely was. Some A.I.G. employees, to take one example, had to have understood what their credit derivative division in London was doing. But more innocent optimism probably played a role, too. The human mind has a tremendous ability to rationalize, and the possibility of making millions of dollars invites some hard-core rationalization.
Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”
Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.
But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.
Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.
Mr. Bernanke actually took a step in this direction on Tuesday. He said the government “needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm.” In layman’s terms, he was asking for a clearer legal path to nationalization.
At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.
Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s, when the economy was still suffering a hangover from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate for looting already seemed to be taking shape.
It was an obscure little market called credit derivatives.
Economic Scene
The Looting of America’s Coffers By DAVID LEONHARDT
Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”
The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”
On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.
Now, it would have been nice if the Fed had shown some of this regulatory zeal before the worst financial crisis since the Great Depression. But that day has passed. So people are rightly starting to think about building a new, less vulnerable financial system.
And “Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.
Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.
But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.
Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.
He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.
•
The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.
This form of moral hazard — when profits are privatized and losses are socialized — certainly played a role in creating the current mess. But when I spoke with Mr. Romer on Tuesday, he was careful to make a distinction between classic moral hazard and looting. It’s an important distinction.
With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.
Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.
What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.
In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it.
I understand this chain of events sounds a bit like a conspiracy. And in some cases, it surely was. Some A.I.G. employees, to take one example, had to have understood what their credit derivative division in London was doing. But more innocent optimism probably played a role, too. The human mind has a tremendous ability to rationalize, and the possibility of making millions of dollars invites some hard-core rationalization.
Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”
Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.
But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.
Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.
Mr. Bernanke actually took a step in this direction on Tuesday. He said the government “needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm.” In layman’s terms, he was asking for a clearer legal path to nationalization.
At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.
Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s, when the economy was still suffering a hangover from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate for looting already seemed to be taking shape.
It was an obscure little market called credit derivatives.
Friday, February 13, 2009
In Japan's Stagnant Decade, Cautionary Tales for America By HIROKO TABUCHI
February 13, 2009
In Japan's Stagnant Decade, Cautionary Tales for America By HIROKO TABUCHI
TOKYO — The Obama administration is committing huge sums of money to rescuing banks, but the veterans of Japan's banking crisis have three words for the Americans: more money, faster.
The Japanese have been here before. They endured a "lost decade" of economic stagnation in the 1990s as their banks labored under crippling debt, and successive governments wasted trillions of yen on half-measures.
Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail.
By then, Tokyo's main Nikkei stock index had lost almost three-quarters of its value. The country's public debt had grown to exceed its gross domestic product, and deflation stalked the land. In the end, real estate prices fell for 15 consecutive years.
More alarming? Some students of the Japanese debacle say they see a similar train wreck heading for the United States.
"I thought America had studied Japan's failures," said Hirofumi Gomi, a top official at Japan's Financial Services Agency during the crisis. "Why is it making the same mistakes?"
Many American critics of the plan unveiled Tuesday by Treasury Secretary Timothy F. Geithner said the plan lacked details. Experts on Japan found it timid — especially given the size of the banking crisis the administration faces.
"I think they know how big it is, but they don't want to say how big it is. It's so big they can't acknowledge it," said John H. Makin, an economist at the American Enterprise Institute, referring to administration officials. "The lesson from Japan in the 1990s was that they should have stepped up and nationalized the banks."
Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
One reason Japan's leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks.
A further lesson from Japan is that the bank rescue will determine the fate of the wider economy. While President Obama has prioritized his stimulus plan, no stimulus is likely to succeed unless the banking sector is repaired.
The Japanese crisis of the 1990s and early 2000s had roots similar to the American crisis: a real estate bubble that collapsed, leaving banks holding trillions of yen in loans that were virtually worthless.
Initially, Japan's leaders underestimated how badly the real estate collapse would hurt the country's banks. As in the United States, a policy of easy money had fueled both stock and real estate speculation, as well as reckless lending by banks.
Many in Japan thought that low interest rates and economic stimulus measures would help banks recover on their own. In late 1997, however, a string of bank failures set off a crippling credit crisis.
Prodded into action, the government injected 1.8 trillion yen into Japan's main banks. But the injections — too small, poorly planned and based on little understanding of the extent of the banking sector's woes — failed to stem the growing crisis.
Fearing more bad news if banks were forced to disclose their real losses, Japan's leaders allowed banks to keep loans to "zombie" companies on their balance sheets.
Japan, instead, experimented with a series of funds, in part privately financed, to relieve banks of their bad assets.
The funds brought limited results at best, says Takeo Hoshi, economics professor at the University of California, San Diego. For one thing, the funds were too small to make an impact. The depository for bad loans had no orderly way to sell them off. And the purchases that did take place failed to recapitalize banks because the bad assets were priced so low.
So far, the Obama administration's plan avoids the hardest decisions, like nationalizing banks, wiping out shareholders or allowing banks to collapse under the weight of their own bad debts. In the end, Japan had to do all those things.
Economists say these blunders meant Japan's financial system did not start to recover until late 2002, six years after the crisis broke. That year, the government of the reformist leader Junichiro Koizumi ordered a tough audit of the country's top banks.
Called the Takenaka Plan after Heizo Takenaka, who headed the government's financial reform efforts, the move finally brought the full extent of bad loans to light. Initially, banks lashed out at Mr. Takenaka. "The government can't order bank management to do this and that," Yoshifumi Nishikawa, president of the Sumitomo Mitsui Financial Group, complained to the press in October 2002. "It's absolutely absurd."
But Mr. Takenaka stood firm. His rallying cry, he said in an interview on Wednesday, was, "Don't cover up. Don't distort principles. Follow the rules."
"I told the banks clearly, 'I am in a position to supervise you,' " Mr. Takenaka said. "I told them I am not open to negotiation."
It took three more years to finally get the majority of bad loans off the banks' books. Resona Bank, which was found to have insufficient capital, was effectively nationalized.
From 1992 to 2005, Japanese banks wrote off about 96 trillion yen, or about 19 percent of the country's annual G.D.P. But Mr. Takenaka's toughness restored faith in the banks.
"That was a turning point in the banking crisis," said Mr. Gomi of the Financial Services Agency, who worked with Mr. Takenaka on the audits.
By then, other factors had fallen into place that aided economic recovery, including a boom in exports to the United States and China.
(Those very share holdings would come back to haunt banks, as the recent market sell-off batters their balance sheets. And as the economy worsens, bad loans are again on the rise, the Financial Services Agency said Tuesday.)
The United States will probably not be able to count on growing demand for its products, since the global economy is worsening.
"The way things are going right now," said Mr. Hoshi, "the U.S. taxpayers' burden will keep going up and up."
http://www.nytimes.com/2009/02/13/business/economy/13yen.html?sq=Tabuchi%20Hiroko&st=cse&scp=1&pagewanted=print
http://snipurl.com/by272
In Japan's Stagnant Decade, Cautionary Tales for America By HIROKO TABUCHI
TOKYO — The Obama administration is committing huge sums of money to rescuing banks, but the veterans of Japan's banking crisis have three words for the Americans: more money, faster.
The Japanese have been here before. They endured a "lost decade" of economic stagnation in the 1990s as their banks labored under crippling debt, and successive governments wasted trillions of yen on half-measures.
Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail.
By then, Tokyo's main Nikkei stock index had lost almost three-quarters of its value. The country's public debt had grown to exceed its gross domestic product, and deflation stalked the land. In the end, real estate prices fell for 15 consecutive years.
More alarming? Some students of the Japanese debacle say they see a similar train wreck heading for the United States.
"I thought America had studied Japan's failures," said Hirofumi Gomi, a top official at Japan's Financial Services Agency during the crisis. "Why is it making the same mistakes?"
Many American critics of the plan unveiled Tuesday by Treasury Secretary Timothy F. Geithner said the plan lacked details. Experts on Japan found it timid — especially given the size of the banking crisis the administration faces.
"I think they know how big it is, but they don't want to say how big it is. It's so big they can't acknowledge it," said John H. Makin, an economist at the American Enterprise Institute, referring to administration officials. "The lesson from Japan in the 1990s was that they should have stepped up and nationalized the banks."
Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
One reason Japan's leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks.
A further lesson from Japan is that the bank rescue will determine the fate of the wider economy. While President Obama has prioritized his stimulus plan, no stimulus is likely to succeed unless the banking sector is repaired.
The Japanese crisis of the 1990s and early 2000s had roots similar to the American crisis: a real estate bubble that collapsed, leaving banks holding trillions of yen in loans that were virtually worthless.
Initially, Japan's leaders underestimated how badly the real estate collapse would hurt the country's banks. As in the United States, a policy of easy money had fueled both stock and real estate speculation, as well as reckless lending by banks.
Many in Japan thought that low interest rates and economic stimulus measures would help banks recover on their own. In late 1997, however, a string of bank failures set off a crippling credit crisis.
Prodded into action, the government injected 1.8 trillion yen into Japan's main banks. But the injections — too small, poorly planned and based on little understanding of the extent of the banking sector's woes — failed to stem the growing crisis.
Fearing more bad news if banks were forced to disclose their real losses, Japan's leaders allowed banks to keep loans to "zombie" companies on their balance sheets.
Japan, instead, experimented with a series of funds, in part privately financed, to relieve banks of their bad assets.
The funds brought limited results at best, says Takeo Hoshi, economics professor at the University of California, San Diego. For one thing, the funds were too small to make an impact. The depository for bad loans had no orderly way to sell them off. And the purchases that did take place failed to recapitalize banks because the bad assets were priced so low.
So far, the Obama administration's plan avoids the hardest decisions, like nationalizing banks, wiping out shareholders or allowing banks to collapse under the weight of their own bad debts. In the end, Japan had to do all those things.
Economists say these blunders meant Japan's financial system did not start to recover until late 2002, six years after the crisis broke. That year, the government of the reformist leader Junichiro Koizumi ordered a tough audit of the country's top banks.
Called the Takenaka Plan after Heizo Takenaka, who headed the government's financial reform efforts, the move finally brought the full extent of bad loans to light. Initially, banks lashed out at Mr. Takenaka. "The government can't order bank management to do this and that," Yoshifumi Nishikawa, president of the Sumitomo Mitsui Financial Group, complained to the press in October 2002. "It's absolutely absurd."
But Mr. Takenaka stood firm. His rallying cry, he said in an interview on Wednesday, was, "Don't cover up. Don't distort principles. Follow the rules."
"I told the banks clearly, 'I am in a position to supervise you,' " Mr. Takenaka said. "I told them I am not open to negotiation."
It took three more years to finally get the majority of bad loans off the banks' books. Resona Bank, which was found to have insufficient capital, was effectively nationalized.
From 1992 to 2005, Japanese banks wrote off about 96 trillion yen, or about 19 percent of the country's annual G.D.P. But Mr. Takenaka's toughness restored faith in the banks.
"That was a turning point in the banking crisis," said Mr. Gomi of the Financial Services Agency, who worked with Mr. Takenaka on the audits.
By then, other factors had fallen into place that aided economic recovery, including a boom in exports to the United States and China.
(Those very share holdings would come back to haunt banks, as the recent market sell-off batters their balance sheets. And as the economy worsens, bad loans are again on the rise, the Financial Services Agency said Tuesday.)
The United States will probably not be able to count on growing demand for its products, since the global economy is worsening.
"The way things are going right now," said Mr. Hoshi, "the U.S. taxpayers' burden will keep going up and up."
http://www.nytimes.com/2009/02/13/business/economy/13yen.html?sq=Tabuchi%20Hiroko&st=cse&scp=1&pagewanted=print
http://snipurl.com/by272
Failure to Rise By PAUL KRUGMAN
February 13, 2009
Op-Ed Columnist
Failure to Rise By PAUL KRUGMAN
By any normal political standards, this week's Congressional agreement on an economic stimulus package was a great victory for President Obama. He got more or less what he asked for: almost $800 billion to rescue the economy, with most of the money allocated to spending rather than tax cuts. Break out the Champagne!
Or maybe not. These aren't normal times, so normal political standards don't apply: Mr. Obama's victory feels more than a bit like defeat. The stimulus bill looks helpful but inadequate, especially when combined with a disappointing plan for rescuing the banks. And the politics of the stimulus fight have made nonsense of Mr. Obama's postpartisan dreams.
Let's start with the politics.
One might have expected Republicans to act at least slightly chastened in these early days of the Obama administration, given both their drubbing in the last two elections and the economic debacle of the past eight years.
But it's now clear that the party's commitment to deep voodoo — enforced, in part, by pressure groups that stand ready to run primary challengers against heretics — is as strong as ever. In both the House and the Senate, the vast majority of Republicans rallied behind the idea that the appropriate response to the abject failure of the Bush administration's tax cuts is more Bush-style tax cuts.
And the rhetorical response of conservatives to the stimulus plan — which will, it's worth bearing in mind, cost substantially less than either the Bush administration's $2 trillion in tax cuts or the $1 trillion and counting spent in Iraq — has bordered on the deranged.
It's "generational theft," said Senator John McCain, just a few days after voting for tax cuts that would, over the next decade, have cost about four times as much.
It's "destroying my daughters' future. It is like sitting there watching my house ransacked by a gang of thugs," said Arnold Kling of the Cato Institute.
And the ugliness of the political debate matters because it raises doubts about the Obama administration's ability to come back for more if, as seems likely, the stimulus bill proves inadequate.
For while Mr. Obama got more or less what he asked for, he almost certainly didn't ask for enough. We're probably facing the worst slump since the Great Depression. The Congressional Budget Office, not usually given to hyperbole, predicts that over the next three years there will be a $2.9 trillion gap between what the economy could produce and what it will actually produce. And $800 billion, while it sounds like a lot of money, isn't nearly enough to bridge that chasm.
Officially, the administration insists that the plan is adequate to the economy's need. But few economists agree. And it's widely believed that political considerations led to a plan that was weaker and contains more tax cuts than it should have — that Mr. Obama compromised in advance in the hope of gaining broad bipartisan support. We've just seen how well that worked.
Now, the chances that the fiscal stimulus will prove adequate would be higher if it were accompanied by an effective financial rescue, one that would unfreeze the credit markets and get money moving again. But the long-awaited announcement of the Obama administration's plans on that front, which also came this week, landed with a dull thud.
The plan sketched out by Tim Geithner, the Treasury secretary, wasn't bad, exactly. What it was, instead, was vague. It left everyone trying to figure out where the administration was really going. Will those public-private partnerships end up being a covert way to bail out bankers at taxpayers' expense? Or will the required "stress test" act as a back-door route to temporary bank nationalization (the solution favored by a growing number of economists, myself included)? Nobody knows.
Over all, the effect was to kick the can down the road. And that's not good enough. So far the Obama administration's response to the economic crisis is all too reminiscent of Japan in the 1990s: a fiscal expansion large enough to avert the worst, but not enough to kick-start recovery; support for the banking system, but a reluctance to force banks to face up to their losses. It's early days yet, but we're falling behind the curve.
And I don't know about you, but I've got a sick feeling in the pit of my stomach — a feeling that America just isn't rising to the greatest economic challenge in 70 years. The best may not lack all conviction, but they seem alarmingly willing to settle for half-measures. And the worst are, as ever, full of passionate intensity, oblivious to the grotesque failure of their doctrine in practice.
There's still time to turn this around. But Mr. Obama has to be stronger looking forward. Otherwise, the verdict on this crisis might be that no, we can't.
http://www.nytimes.com/2009/02/13/opinion/13krugman.html?sq=&st=cse&%2334;Failure%20to%20Rise=&scp=1&%2334;%20Krugman=&pagewanted=print
http://snipurl.com/by22r
Op-Ed Columnist
Failure to Rise By PAUL KRUGMAN
By any normal political standards, this week's Congressional agreement on an economic stimulus package was a great victory for President Obama. He got more or less what he asked for: almost $800 billion to rescue the economy, with most of the money allocated to spending rather than tax cuts. Break out the Champagne!
Or maybe not. These aren't normal times, so normal political standards don't apply: Mr. Obama's victory feels more than a bit like defeat. The stimulus bill looks helpful but inadequate, especially when combined with a disappointing plan for rescuing the banks. And the politics of the stimulus fight have made nonsense of Mr. Obama's postpartisan dreams.
Let's start with the politics.
One might have expected Republicans to act at least slightly chastened in these early days of the Obama administration, given both their drubbing in the last two elections and the economic debacle of the past eight years.
But it's now clear that the party's commitment to deep voodoo — enforced, in part, by pressure groups that stand ready to run primary challengers against heretics — is as strong as ever. In both the House and the Senate, the vast majority of Republicans rallied behind the idea that the appropriate response to the abject failure of the Bush administration's tax cuts is more Bush-style tax cuts.
And the rhetorical response of conservatives to the stimulus plan — which will, it's worth bearing in mind, cost substantially less than either the Bush administration's $2 trillion in tax cuts or the $1 trillion and counting spent in Iraq — has bordered on the deranged.
It's "generational theft," said Senator John McCain, just a few days after voting for tax cuts that would, over the next decade, have cost about four times as much.
It's "destroying my daughters' future. It is like sitting there watching my house ransacked by a gang of thugs," said Arnold Kling of the Cato Institute.
And the ugliness of the political debate matters because it raises doubts about the Obama administration's ability to come back for more if, as seems likely, the stimulus bill proves inadequate.
For while Mr. Obama got more or less what he asked for, he almost certainly didn't ask for enough. We're probably facing the worst slump since the Great Depression. The Congressional Budget Office, not usually given to hyperbole, predicts that over the next three years there will be a $2.9 trillion gap between what the economy could produce and what it will actually produce. And $800 billion, while it sounds like a lot of money, isn't nearly enough to bridge that chasm.
Officially, the administration insists that the plan is adequate to the economy's need. But few economists agree. And it's widely believed that political considerations led to a plan that was weaker and contains more tax cuts than it should have — that Mr. Obama compromised in advance in the hope of gaining broad bipartisan support. We've just seen how well that worked.
Now, the chances that the fiscal stimulus will prove adequate would be higher if it were accompanied by an effective financial rescue, one that would unfreeze the credit markets and get money moving again. But the long-awaited announcement of the Obama administration's plans on that front, which also came this week, landed with a dull thud.
The plan sketched out by Tim Geithner, the Treasury secretary, wasn't bad, exactly. What it was, instead, was vague. It left everyone trying to figure out where the administration was really going. Will those public-private partnerships end up being a covert way to bail out bankers at taxpayers' expense? Or will the required "stress test" act as a back-door route to temporary bank nationalization (the solution favored by a growing number of economists, myself included)? Nobody knows.
Over all, the effect was to kick the can down the road. And that's not good enough. So far the Obama administration's response to the economic crisis is all too reminiscent of Japan in the 1990s: a fiscal expansion large enough to avert the worst, but not enough to kick-start recovery; support for the banking system, but a reluctance to force banks to face up to their losses. It's early days yet, but we're falling behind the curve.
And I don't know about you, but I've got a sick feeling in the pit of my stomach — a feeling that America just isn't rising to the greatest economic challenge in 70 years. The best may not lack all conviction, but they seem alarmingly willing to settle for half-measures. And the worst are, as ever, full of passionate intensity, oblivious to the grotesque failure of their doctrine in practice.
There's still time to turn this around. But Mr. Obama has to be stronger looking forward. Otherwise, the verdict on this crisis might be that no, we can't.
http://www.nytimes.com/2009/02/13/opinion/13krugman.html?sq=&st=cse&%2334;Failure%20to%20Rise=&scp=1&%2334;%20Krugman=&pagewanted=print
http://snipurl.com/by22r
The Worst-Case Scenario By DAVID BROOKS
February 13, 2009
Op-Ed Columnist
The Worst-Case Scenario By DAVID BROOKS
Between 1990 and 2007, the total mortgage debt held by Americans rose from $2.5 trillion to $10.5 trillion. This rise was part of a societal credit bubble that burst in 2008. To cushion the pain of that collapse, federal authorities decided to replace private debt with public debt.
In 2008, the Bush administration increased spending by about $1.7 trillion, and guaranteed loans, investments and deposits worth about $8 trillion. In 2009, the Obama administration spent $800 billion on a stimulus package, $1 trillion on a second round of bank bailouts and committed another trillion on health care reform and other bailout plans.
Americans generally welcomed the burst of public activism. In “Democracy in America,” Alexis de Tocqueville wrote about what happens to a people beset by anxiety: “The taste for public tranquility then becomes a blind passion, and the citizens are liable to conceive a most inordinate devotion to order.”
In normal times, Americans would have been skeptical of proposals to double or triple the size of federal programs, but amid the economic fear, that skepticism fell away. Wall Street traders hungered for a huge federal bailout replete with strings. Economists produced models that assumed that government could efficiently spend huge amounts of money, and these models were accepted.
The Obama administration was staffed with moderates who found that there was no reward for moderation. Liberals attacked them for being tepid. Republicans attacked them because it was enjoyable to see Democrats attacked. Over time, the administration drifted left and created what you might call Split Level Technocratic Liberalism.
President Obama defended spending initiatives in broad terms. He had enormous faith in the power of highly trained experts and based his arguments on models and projections. The actual legislation was cobbled together by Democratic committee chairmen, often acting beyond the administration’s control.
During 2010, the economic decline abated, but the recovery did not arrive. There were a few false dawns, and stagnation. The problem was this: The policy makers knew how to pull economic levers, but they did not know how to use those levers to affect social psychology.
The crisis was labeled an economic crisis, but it was really a psychological crisis. It was caused by a mood of fear and uncertainty, which led consumers to not spend, bankers to not lend and entrepreneurs to not risk. No amount of federal spending could change this psychology because uncertainty about the future remained acute.
Essentially, Americans had migrated from one society to another — from a society of high trust to a society of low trust, from a society of optimism to a society of foreboding, from a society in which certain financial habits applied to a society in which they did not. In the new world, investors had no basis from which to calculate risk. Families slowly deleveraged. Bankers had no way to measure the future value of assets.
Cognitive scientists distinguish between normal risk-assessment decisions, which activate the reward-prediction regions of the brain, and decisions made amid extreme uncertainty, which generate activity in the amygdala. These are different mental processes using different strategies and producing different results. Americans were suddenly forced to cope with this second category, extreme uncertainty.
Economists and policy makers had no way to peer into this darkness. Their methods were largely based on the assumption that people are rational, predictable and pretty much the same. Their models work best in times of equilibrium. But in this moment of disequilibrium, behavior was nonlinear, unpredictable, emergent and stubbornly resistant to Keynesian rationalism.
The failure to generate a recovery led to a collapse of public confidence. President Obama’s promises of 3.5 million jobs now seemed a sham and his former certainty a delusion. The political climate grew more polarized. That meant it was impossible to tackle entitlement debt. That and the economic climate meant it was impossible to raise taxes or cut spending or do anything to reduce the yawning deficits. Federal deficits were 15 percent of G.D.P. and growing.
Far from easing uncertainty, the exploding deficits led to more fear. The U.S. could not afford to respond to new emergencies, like hurricanes or foreign crises. Other nations sensed American overextension. Foreign debt-holders grew nervous. Interest rates rose. Congress indulged its worst instincts, erecting trade barriers, propping up doomed companies. Scholars began to talk about the American Disease, akin to the British Disease of the 1970s.
The nation had essentially bet its future on economic models with primitive views of human behavior. The government had tried to change social psychology using the equivalent of leeches and bleeding. Rather than blame themselves, Americans directed their anger toward policy makers and experts who based estimates of human psychology on mathematical equations.
Op-Ed Columnist
The Worst-Case Scenario By DAVID BROOKS
Between 1990 and 2007, the total mortgage debt held by Americans rose from $2.5 trillion to $10.5 trillion. This rise was part of a societal credit bubble that burst in 2008. To cushion the pain of that collapse, federal authorities decided to replace private debt with public debt.
In 2008, the Bush administration increased spending by about $1.7 trillion, and guaranteed loans, investments and deposits worth about $8 trillion. In 2009, the Obama administration spent $800 billion on a stimulus package, $1 trillion on a second round of bank bailouts and committed another trillion on health care reform and other bailout plans.
Americans generally welcomed the burst of public activism. In “Democracy in America,” Alexis de Tocqueville wrote about what happens to a people beset by anxiety: “The taste for public tranquility then becomes a blind passion, and the citizens are liable to conceive a most inordinate devotion to order.”
In normal times, Americans would have been skeptical of proposals to double or triple the size of federal programs, but amid the economic fear, that skepticism fell away. Wall Street traders hungered for a huge federal bailout replete with strings. Economists produced models that assumed that government could efficiently spend huge amounts of money, and these models were accepted.
The Obama administration was staffed with moderates who found that there was no reward for moderation. Liberals attacked them for being tepid. Republicans attacked them because it was enjoyable to see Democrats attacked. Over time, the administration drifted left and created what you might call Split Level Technocratic Liberalism.
President Obama defended spending initiatives in broad terms. He had enormous faith in the power of highly trained experts and based his arguments on models and projections. The actual legislation was cobbled together by Democratic committee chairmen, often acting beyond the administration’s control.
During 2010, the economic decline abated, but the recovery did not arrive. There were a few false dawns, and stagnation. The problem was this: The policy makers knew how to pull economic levers, but they did not know how to use those levers to affect social psychology.
The crisis was labeled an economic crisis, but it was really a psychological crisis. It was caused by a mood of fear and uncertainty, which led consumers to not spend, bankers to not lend and entrepreneurs to not risk. No amount of federal spending could change this psychology because uncertainty about the future remained acute.
Essentially, Americans had migrated from one society to another — from a society of high trust to a society of low trust, from a society of optimism to a society of foreboding, from a society in which certain financial habits applied to a society in which they did not. In the new world, investors had no basis from which to calculate risk. Families slowly deleveraged. Bankers had no way to measure the future value of assets.
Cognitive scientists distinguish between normal risk-assessment decisions, which activate the reward-prediction regions of the brain, and decisions made amid extreme uncertainty, which generate activity in the amygdala. These are different mental processes using different strategies and producing different results. Americans were suddenly forced to cope with this second category, extreme uncertainty.
Economists and policy makers had no way to peer into this darkness. Their methods were largely based on the assumption that people are rational, predictable and pretty much the same. Their models work best in times of equilibrium. But in this moment of disequilibrium, behavior was nonlinear, unpredictable, emergent and stubbornly resistant to Keynesian rationalism.
The failure to generate a recovery led to a collapse of public confidence. President Obama’s promises of 3.5 million jobs now seemed a sham and his former certainty a delusion. The political climate grew more polarized. That meant it was impossible to tackle entitlement debt. That and the economic climate meant it was impossible to raise taxes or cut spending or do anything to reduce the yawning deficits. Federal deficits were 15 percent of G.D.P. and growing.
Far from easing uncertainty, the exploding deficits led to more fear. The U.S. could not afford to respond to new emergencies, like hurricanes or foreign crises. Other nations sensed American overextension. Foreign debt-holders grew nervous. Interest rates rose. Congress indulged its worst instincts, erecting trade barriers, propping up doomed companies. Scholars began to talk about the American Disease, akin to the British Disease of the 1970s.
The nation had essentially bet its future on economic models with primitive views of human behavior. The government had tried to change social psychology using the equivalent of leeches and bleeding. Rather than blame themselves, Americans directed their anger toward policy makers and experts who based estimates of human psychology on mathematical equations.
Friday, January 30, 2009
A Global Credit Squeeze Is Felt Unevenly By FLOYD NORRIS
January 30, 2009
High & Low Finance
A Global Credit Squeeze Is Felt Unevenly By FLOYD NORRIS
DAVOS, Switzerland
Decoupling is last year's discredited theory.
It may also be tomorrow's reality. The world's efforts at economic recovery could well turn into a case of every country for itself. Call it "capital protectionism."
A year ago at the World Economic Forum, many chief executives and government officials hoped that an American recession, if one came, would be mild and would not spread overseas. The strength of world economic growth would enable Europe and Asia to "decouple" from the American economy.
What happened instead was the downside of globalization. Readily available and cheap capital played a crucial role in lifting growth around the world, and its absence for all but the safest borrowers is causing pain everywhere.
But what is not the same everywhere is the ability of governments to stimulate the economy. While the United States debates the details of how to spend a trillion dollars or more to bail out banks and stimulate the economy, the governments of some other countries find themselves caught in the credit squeeze.
In Latvia, the government got a bailout from the International Monetary Fund by agreeing to draconian measures that include wage cuts, spending reductions and tax increases. There were riots.
The president of Latvia, Valdis Zalters, was diplomatic when I asked him Thursday if he thought it was unfair that the United States could easily borrow when his country could not. "It's the way it is," he said. "The U.S. has a AAA rating. We had no choice."
The best positioned are those countries that have huge foreign currency reserves — think China — or printing presses for the international reserve currency — think the United States.
"The money is flowing out of all markets," said Ferit F. Sahenk, the chairman of Dogus Group, a Turkish conglomerate. This, he said, raised the risk of inadequate capital "not only for the banks but for private sector debtors as well."
That risk is only increased by what Steven Roach, the Morgan Stanley economist, called "the rising tide of economic nationalism." In both Europe and the United States there is pressure on bailed-out banks to increase lending — but not to just any borrowers.
"Some countries are encouraging their banks to invest mostly in domestic assets," Mr. Sahenk complained. "This is a new form of protectionism."
That worry is widespread. "Large economies are accessing international capital markets for themselves," said Trevor Manuel, the finance minister of South Africa.
He wants the big countries to share the borrowed wealth, but fears they will not.
Lord Adair Turner, the chairman of Britain's Financial Services Authority, voiced the same concern, calling it "the risk of a new mercantilism," centered on credit availability rather than trade. "It is not easy to avoid this," he added. "It could get out of hand."
The onset of credit protectionism, if it comes, will be the result of a drastic shift in the financial system. Private allocation of credit played a major role in the extraordinary world growth of the last quarter-century, but that system blew up when financial innovation led to a huge overextension of credit to borrowers with dubious ability to repay, whether they were subprime mortgage borrowers or highly leveraged companies.
With the banks crippled and shown to have taken what now look like foolish risks, it has fallen to governments to allocate credit, either indirectly by deciding which banks to bail out and on what terms, or even directly if, as some expect, many banks are eventually nationalized.
The pressures for nationalization come in part from worries that bank balance sheets are bottomless pits of toxic assets, and concern that it is unfair to taxpayers to let the benefits flow to the shareholders who stood by as the banks took too many risks.
Alan S. Blinder, a former vice chairman of the Federal Reserve and now an economics professor at Princeton, said he did not think nationalization would be the first or second choice of American policy makers, but that it could be the third or fourth.
And he added that the risk of credit protectionism would rise if the banks were nationalized.
It is hard to imagine that governments will do a particularly good job of allocating capital to its most productive uses, given the political pressures they will face. But there is no agreement on how to get the private banking system operating in an adequate fashion.
Pumping capital into the banks has not yet worked, even if it has stirred public outrage over high pay and perks for the bankers who got us into this mess. There is renewed interest in some kind of "bad bank" approach that would separate the toxic assets from the good ones, leaving the government with the bad stuff. But figuring out what to pay — assuming the banks have not been nationalized — is likely to be contentious.
At the same time, there is much talk about how to reform the regulatory systems around the world, and how to standardize regulation to avoid the "regulatory arbitrage" of seeking out jurisdictions with the least stringent rules.
"We allowed a series of near banks and shadow banks to grow without being regulated," said Lord Turner. In a new regime, he added, one rule must be, "If it looks like a bank and quacks like a bank, we have to regulate it like a bank." To do that, he would give regulators wide discretion to get information on how hedge funds and other institutions are operating, with the ability to impose regulation if they start to act too much like a bank.
Some economists fear that would stifle financial creativity, and even some who think far more regulation is needed question whether regulators can amass the expertise to make needed decisions promptly and wisely.
Mr. Roach predicts that this will be the first year since the Great Depression that the gross domestic product of the entire world declines. Fiscal stimulus plans may help to ease the pain, but it is hard to see how the world's economies can resume decent growth until the private financial system is operating much better than it is now.
"We've all been building this big, integrated financial system," said James Rosenfield, a co-founder of Cambridge Energy Research Associates. "We didn't consider what would happen when it disintegrated."
http://www.nytimes.com/2009/01/30/business/30norris.html?sq=Floyd%20Norris%20January%2030,%202009&st=cse&scp=1&pagewanted=print
http://snipurl.com/by50m
High & Low Finance
A Global Credit Squeeze Is Felt Unevenly By FLOYD NORRIS
DAVOS, Switzerland
Decoupling is last year's discredited theory.
It may also be tomorrow's reality. The world's efforts at economic recovery could well turn into a case of every country for itself. Call it "capital protectionism."
A year ago at the World Economic Forum, many chief executives and government officials hoped that an American recession, if one came, would be mild and would not spread overseas. The strength of world economic growth would enable Europe and Asia to "decouple" from the American economy.
What happened instead was the downside of globalization. Readily available and cheap capital played a crucial role in lifting growth around the world, and its absence for all but the safest borrowers is causing pain everywhere.
But what is not the same everywhere is the ability of governments to stimulate the economy. While the United States debates the details of how to spend a trillion dollars or more to bail out banks and stimulate the economy, the governments of some other countries find themselves caught in the credit squeeze.
In Latvia, the government got a bailout from the International Monetary Fund by agreeing to draconian measures that include wage cuts, spending reductions and tax increases. There were riots.
The president of Latvia, Valdis Zalters, was diplomatic when I asked him Thursday if he thought it was unfair that the United States could easily borrow when his country could not. "It's the way it is," he said. "The U.S. has a AAA rating. We had no choice."
The best positioned are those countries that have huge foreign currency reserves — think China — or printing presses for the international reserve currency — think the United States.
"The money is flowing out of all markets," said Ferit F. Sahenk, the chairman of Dogus Group, a Turkish conglomerate. This, he said, raised the risk of inadequate capital "not only for the banks but for private sector debtors as well."
That risk is only increased by what Steven Roach, the Morgan Stanley economist, called "the rising tide of economic nationalism." In both Europe and the United States there is pressure on bailed-out banks to increase lending — but not to just any borrowers.
"Some countries are encouraging their banks to invest mostly in domestic assets," Mr. Sahenk complained. "This is a new form of protectionism."
That worry is widespread. "Large economies are accessing international capital markets for themselves," said Trevor Manuel, the finance minister of South Africa.
He wants the big countries to share the borrowed wealth, but fears they will not.
Lord Adair Turner, the chairman of Britain's Financial Services Authority, voiced the same concern, calling it "the risk of a new mercantilism," centered on credit availability rather than trade. "It is not easy to avoid this," he added. "It could get out of hand."
The onset of credit protectionism, if it comes, will be the result of a drastic shift in the financial system. Private allocation of credit played a major role in the extraordinary world growth of the last quarter-century, but that system blew up when financial innovation led to a huge overextension of credit to borrowers with dubious ability to repay, whether they were subprime mortgage borrowers or highly leveraged companies.
With the banks crippled and shown to have taken what now look like foolish risks, it has fallen to governments to allocate credit, either indirectly by deciding which banks to bail out and on what terms, or even directly if, as some expect, many banks are eventually nationalized.
The pressures for nationalization come in part from worries that bank balance sheets are bottomless pits of toxic assets, and concern that it is unfair to taxpayers to let the benefits flow to the shareholders who stood by as the banks took too many risks.
Alan S. Blinder, a former vice chairman of the Federal Reserve and now an economics professor at Princeton, said he did not think nationalization would be the first or second choice of American policy makers, but that it could be the third or fourth.
And he added that the risk of credit protectionism would rise if the banks were nationalized.
It is hard to imagine that governments will do a particularly good job of allocating capital to its most productive uses, given the political pressures they will face. But there is no agreement on how to get the private banking system operating in an adequate fashion.
Pumping capital into the banks has not yet worked, even if it has stirred public outrage over high pay and perks for the bankers who got us into this mess. There is renewed interest in some kind of "bad bank" approach that would separate the toxic assets from the good ones, leaving the government with the bad stuff. But figuring out what to pay — assuming the banks have not been nationalized — is likely to be contentious.
At the same time, there is much talk about how to reform the regulatory systems around the world, and how to standardize regulation to avoid the "regulatory arbitrage" of seeking out jurisdictions with the least stringent rules.
"We allowed a series of near banks and shadow banks to grow without being regulated," said Lord Turner. In a new regime, he added, one rule must be, "If it looks like a bank and quacks like a bank, we have to regulate it like a bank." To do that, he would give regulators wide discretion to get information on how hedge funds and other institutions are operating, with the ability to impose regulation if they start to act too much like a bank.
Some economists fear that would stifle financial creativity, and even some who think far more regulation is needed question whether regulators can amass the expertise to make needed decisions promptly and wisely.
Mr. Roach predicts that this will be the first year since the Great Depression that the gross domestic product of the entire world declines. Fiscal stimulus plans may help to ease the pain, but it is hard to see how the world's economies can resume decent growth until the private financial system is operating much better than it is now.
"We've all been building this big, integrated financial system," said James Rosenfield, a co-founder of Cambridge Energy Research Associates. "We didn't consider what would happen when it disintegrated."
http://www.nytimes.com/2009/01/30/business/30norris.html?sq=Floyd%20Norris%20January%2030,%202009&st=cse&scp=1&pagewanted=print
http://snipurl.com/by50m
Wednesday, January 28, 2009
Wall Street's Socialist Jet-Setters By MAUREEN DOWD
January 28, 2009
Op-Ed Columnist
Wall Street's Socialist Jet-Setters By MAUREEN DOWD
WASHINGTON
As President Obama spreads his New Testament balm over the capital, I'm longing for a bit of Old Testament wrath.
Couldn't he throw down his BlackBerry tablet and smash it in anger over the feckless financiers, the gods of gold and their idols — in this case not a gilt calf but an $87,000 area rug, a cache of diamond Tiffany and Cartier watches and a French-made luxury corporate jet?
Now that we're nationalizing, couldn't we fire any obtuse bankers and auto executives who cling to perks and bonuses even as the economy is following John Thain down his antique commode?
How could Citigroup be so dumb as to go ahead with plans to get a new $50 million corporate jet, the exclusive Dassault Falcon 7X seating 12, after losing $28.5 billion in the past 15 months and receiving $345 billion in government investments and guarantees?
(Now I get why a $400 payment I recently sent to pay off my Citibank Visa was mistakenly applied to my sister-in-law's Citibank Mastercard account.)
The "Citiboobs" — as The New York Post, which broke the news, calls them — watched as the car chieftains got in trouble for flying their private jets to Washington to ask for bailouts, and the A.I.G. moguls got dragged before Congress for spending their bailout on California spa treatments. But the boobs still didn't get the message.
The former masters of the universe don't seem to fully comprehend that their universe has crumbled and, thanks to them, so has ours. Real people are losing real jobs at Caterpillar, Home Depot and Sprint Nextel; these and other companies announced on Monday that they would cut more than 75,000 jobs in the U.S. and around the world, as consumer confidence and home prices swan-dived.
Prodded by an appalled Senator Carl Levin, Tim Geithner — even as he was being confirmed as Treasury secretary — directed Treasury officials to call the Citiboobs and tell them the new jet would not fly.
"They woke up pretty quickly," says a Treasury official, adding that they protested for a bit. "Six months ago, they would have kept the plane and flown it to Washington."
Senator Levin said that the financiers will not be able to change their warped mentality, but will have to be reined in by Geithner's new leashes. "I have no confidence that they intend or desire to change," Levin told me. "These bankers got away with murder, and it's obscene that close to nothing is being asked of financial institutions. I get incensed at the thought that a bank that's getting billions of dollars in taxpayer money is out there buying fancy new airplanes."
New York's attorney general, Andrew Cuomo, always gratifying on the issue of clawing back money from the greedy creeps on Wall Street, on Tuesday subpoenaed Thain, the former Merrill Lynch chief executive, over $4 billion in bonuses he handed out as the failing firm was bought by Bank of America.
In an interview with Maria Bartiromo on CNBC, Thain used the specious, contemptible reasoning that other executives use to rationalize why they're keeping their bonuses as profits are plunging.
"If you don't pay your best people, you will destroy your franchise" and they'll go elsewhere, he said.
Hello? They destroyed the franchise. Let's call their bluff. Let's see what a great job market it is for the geniuses of capitalism who lost $15 billion in three months and helped usher in socialism.
Bartiromo also asked Thain to explain, when jobs and salaries were being cut at his firm, how he could justify spending $1 million to renovate his office. As The Daily Beast and CNBC reported, big-ticket items included curtains for $28,000, a pair of chairs for $87,000, fabric for a "Roman Shade" for $11,000, Regency chairs for $24,000, six wall sconces for $2,700, a $13,000 chandelier in the private dining room and six dining chairs for $37,000, a "custom coffee table" for $16,000, an antique commode "on legs" for $35,000, and a $1,400 "parchment waste can."
Does that mean you can only throw used parchment in it or is it made of parchment? It's psychopathic to spend a million redoing your office when the folks outside it are losing jobs, homes, pensions and savings.
Thain should never rise above the level of stocking the money in A.T.M.'s again. Just think: This guy could well have been Treasury secretary if John McCain had won.
Bartiromo pressed: What was wrong with the office of his predecessor, Stanley O'Neal?
"Well — his office was very different — than — the — the general décor of — Merrill's offices," Thain replied. "It really would have been — very difficult — for — me to use it in the form that it was in."
Did it have a desk and a phone?
How are these ruthless, careless ghouls who murdered the economy still walking around (not to mention that sociopathic sadist Bernie Madoff?) — and not as perps?
Bring on the shackles. Let the show trials begin.
http://www.nytimes.com/2009/01/28/opinion/28dowd.html?%2339;s%20Socialist%20Dowd=&sq=Wall%20Street&st=cse&scp=1&pagewanted=print
http://snipurl.com/by3d9
Op-Ed Columnist
Wall Street's Socialist Jet-Setters By MAUREEN DOWD
WASHINGTON
As President Obama spreads his New Testament balm over the capital, I'm longing for a bit of Old Testament wrath.
Couldn't he throw down his BlackBerry tablet and smash it in anger over the feckless financiers, the gods of gold and their idols — in this case not a gilt calf but an $87,000 area rug, a cache of diamond Tiffany and Cartier watches and a French-made luxury corporate jet?
Now that we're nationalizing, couldn't we fire any obtuse bankers and auto executives who cling to perks and bonuses even as the economy is following John Thain down his antique commode?
How could Citigroup be so dumb as to go ahead with plans to get a new $50 million corporate jet, the exclusive Dassault Falcon 7X seating 12, after losing $28.5 billion in the past 15 months and receiving $345 billion in government investments and guarantees?
(Now I get why a $400 payment I recently sent to pay off my Citibank Visa was mistakenly applied to my sister-in-law's Citibank Mastercard account.)
The "Citiboobs" — as The New York Post, which broke the news, calls them — watched as the car chieftains got in trouble for flying their private jets to Washington to ask for bailouts, and the A.I.G. moguls got dragged before Congress for spending their bailout on California spa treatments. But the boobs still didn't get the message.
The former masters of the universe don't seem to fully comprehend that their universe has crumbled and, thanks to them, so has ours. Real people are losing real jobs at Caterpillar, Home Depot and Sprint Nextel; these and other companies announced on Monday that they would cut more than 75,000 jobs in the U.S. and around the world, as consumer confidence and home prices swan-dived.
Prodded by an appalled Senator Carl Levin, Tim Geithner — even as he was being confirmed as Treasury secretary — directed Treasury officials to call the Citiboobs and tell them the new jet would not fly.
"They woke up pretty quickly," says a Treasury official, adding that they protested for a bit. "Six months ago, they would have kept the plane and flown it to Washington."
Senator Levin said that the financiers will not be able to change their warped mentality, but will have to be reined in by Geithner's new leashes. "I have no confidence that they intend or desire to change," Levin told me. "These bankers got away with murder, and it's obscene that close to nothing is being asked of financial institutions. I get incensed at the thought that a bank that's getting billions of dollars in taxpayer money is out there buying fancy new airplanes."
New York's attorney general, Andrew Cuomo, always gratifying on the issue of clawing back money from the greedy creeps on Wall Street, on Tuesday subpoenaed Thain, the former Merrill Lynch chief executive, over $4 billion in bonuses he handed out as the failing firm was bought by Bank of America.
In an interview with Maria Bartiromo on CNBC, Thain used the specious, contemptible reasoning that other executives use to rationalize why they're keeping their bonuses as profits are plunging.
"If you don't pay your best people, you will destroy your franchise" and they'll go elsewhere, he said.
Hello? They destroyed the franchise. Let's call their bluff. Let's see what a great job market it is for the geniuses of capitalism who lost $15 billion in three months and helped usher in socialism.
Bartiromo also asked Thain to explain, when jobs and salaries were being cut at his firm, how he could justify spending $1 million to renovate his office. As The Daily Beast and CNBC reported, big-ticket items included curtains for $28,000, a pair of chairs for $87,000, fabric for a "Roman Shade" for $11,000, Regency chairs for $24,000, six wall sconces for $2,700, a $13,000 chandelier in the private dining room and six dining chairs for $37,000, a "custom coffee table" for $16,000, an antique commode "on legs" for $35,000, and a $1,400 "parchment waste can."
Does that mean you can only throw used parchment in it or is it made of parchment? It's psychopathic to spend a million redoing your office when the folks outside it are losing jobs, homes, pensions and savings.
Thain should never rise above the level of stocking the money in A.T.M.'s again. Just think: This guy could well have been Treasury secretary if John McCain had won.
Bartiromo pressed: What was wrong with the office of his predecessor, Stanley O'Neal?
"Well — his office was very different — than — the — the general décor of — Merrill's offices," Thain replied. "It really would have been — very difficult — for — me to use it in the form that it was in."
Did it have a desk and a phone?
How are these ruthless, careless ghouls who murdered the economy still walking around (not to mention that sociopathic sadist Bernie Madoff?) — and not as perps?
Bring on the shackles. Let the show trials begin.
http://www.nytimes.com/2009/01/28/opinion/28dowd.html?%2339;s%20Socialist%20Dowd=&sq=Wall%20Street&st=cse&scp=1&pagewanted=print
http://snipurl.com/by3d9
Monday, January 26, 2009
Breakingviews.com How to Improve the Bank Rescue
January 26, 2009
Breakingviews.com How to Improve the Bank Rescue
The "bad bank" schemes being considered by President Obama's administration have a central flaw: they involve government-backed entities buying banks' dodgy assets, which in turn requires the immediate valuation of assets that trade at distressed prices, if at all. That increases the likelihood of error, risks rewarding obfuscation, and could leave taxpayers in a hole. There are better ways to structure bad banks.
To work properly, the incentives of all parties should be aligned as closely as possible. Bank rescues must distinguish between banks that are troubled but can be saved and those that should be allowed to die. As little as possible of the industry should be taken into public ownership. And taxpayers must be properly protected, so that the bad bank process does minimal damage to their economic interests.
There is a way to meet these objectives: allow banks to sell any assets they want, and have the government's bad bank acquire them on a consignment basis with no initial cash outlay. Banks would achieve a return on their consigned assets only as the bad bank sold them or allowed them to mature. This "consignment shop" structure removes the initial valuation challenge that bedeviled the original concept of the Treasury's Troubled Asset Relief Program.
One result of this approach, however, is that when banks remove assets from their balance sheets, it eats into capital. To replenish it, the government could hand the banks cash or, in a pinch, liquid Treasury bonds in exchange for preferred stock equal to the book value of the assets transferred, possibly with some warrants attached as well.
Meantime, the bad bank would act like the Resolution Trust Corporation, which gradually liquidated the assets consigned to it. Since it would have assets from many banks, it could combine them to help unscramble securitizations and maximize proceeds from sales. The bad bank could retain a modest commission, perhaps 5 percent, and return the net proceeds of asset sales to each bank.
The banks would then be required to use the proceeds to repurchase the government's preferred shares until its total investment had been repaid. After five years, any remaining preferred shares would convert to common shares.
By way of illustration, suppose the book value of a bank's assets is $100 billion. It consigns $60 billion of worrisome paper to the government's bad bank, leaving it with a $40 billion "good bank," which issues $60 billion of preferred stock to the government. Five years later, the government has sold all the bad assets, but managed to get only $25 billion for them. Meanwhile, though, the good bank has doubled in size.
So the good bank has $80 billion in book value, but the government still owns $35 billion of preferred stock. That then converts into common shares, and the good bank survives in public ownership with a government stake of 44 percent.
If, however, the good bank ends up worth less than the outstanding preferred stock, the government would take it over and begin an orderly liquidation, just as the Federal Deposit Insurance Corporation already does with failed banks. The worst banks would be eliminated from the market and survivors would have room to expand.
Under the consignment shop structure, banks would consign only assets with doubtful values. And banks that had not marked assets down enough would have to issue more preferred shares to the government, endangering their long-term survival or at least leaving them with higher levels of government ownership in the future.
Meanwhile, banks with assets that are not badly impaired could redeem the government preferred shares within five years, avoiding any government shareholding thereafter. And taxpayers would risk losses on bad assets only if a "good bank" ran out of capital completely, minimizing the potential cost and the risk of over-paying for assets.
Banks' share prices would, of course, remain uncertain while preferred shares were outstanding. But their standing as debtors would be much clearer, enabling them to raise private sector finance. This kind of structure, avoiding many of TARP's flaws, makes for a less bad "bad bank."
MARTIN HUTCHINSON
http://www.nytimes.com/2009/01/26/business/26views.html?sq=How%20to%20Improve%20the%20Bank%20Rescue%20Hutchison&st=cse&scp=1&pagewanted=print
http://snipurl.com/by3ki
Breakingviews.com How to Improve the Bank Rescue
The "bad bank" schemes being considered by President Obama's administration have a central flaw: they involve government-backed entities buying banks' dodgy assets, which in turn requires the immediate valuation of assets that trade at distressed prices, if at all. That increases the likelihood of error, risks rewarding obfuscation, and could leave taxpayers in a hole. There are better ways to structure bad banks.
To work properly, the incentives of all parties should be aligned as closely as possible. Bank rescues must distinguish between banks that are troubled but can be saved and those that should be allowed to die. As little as possible of the industry should be taken into public ownership. And taxpayers must be properly protected, so that the bad bank process does minimal damage to their economic interests.
There is a way to meet these objectives: allow banks to sell any assets they want, and have the government's bad bank acquire them on a consignment basis with no initial cash outlay. Banks would achieve a return on their consigned assets only as the bad bank sold them or allowed them to mature. This "consignment shop" structure removes the initial valuation challenge that bedeviled the original concept of the Treasury's Troubled Asset Relief Program.
One result of this approach, however, is that when banks remove assets from their balance sheets, it eats into capital. To replenish it, the government could hand the banks cash or, in a pinch, liquid Treasury bonds in exchange for preferred stock equal to the book value of the assets transferred, possibly with some warrants attached as well.
Meantime, the bad bank would act like the Resolution Trust Corporation, which gradually liquidated the assets consigned to it. Since it would have assets from many banks, it could combine them to help unscramble securitizations and maximize proceeds from sales. The bad bank could retain a modest commission, perhaps 5 percent, and return the net proceeds of asset sales to each bank.
The banks would then be required to use the proceeds to repurchase the government's preferred shares until its total investment had been repaid. After five years, any remaining preferred shares would convert to common shares.
By way of illustration, suppose the book value of a bank's assets is $100 billion. It consigns $60 billion of worrisome paper to the government's bad bank, leaving it with a $40 billion "good bank," which issues $60 billion of preferred stock to the government. Five years later, the government has sold all the bad assets, but managed to get only $25 billion for them. Meanwhile, though, the good bank has doubled in size.
So the good bank has $80 billion in book value, but the government still owns $35 billion of preferred stock. That then converts into common shares, and the good bank survives in public ownership with a government stake of 44 percent.
If, however, the good bank ends up worth less than the outstanding preferred stock, the government would take it over and begin an orderly liquidation, just as the Federal Deposit Insurance Corporation already does with failed banks. The worst banks would be eliminated from the market and survivors would have room to expand.
Under the consignment shop structure, banks would consign only assets with doubtful values. And banks that had not marked assets down enough would have to issue more preferred shares to the government, endangering their long-term survival or at least leaving them with higher levels of government ownership in the future.
Meanwhile, banks with assets that are not badly impaired could redeem the government preferred shares within five years, avoiding any government shareholding thereafter. And taxpayers would risk losses on bad assets only if a "good bank" ran out of capital completely, minimizing the potential cost and the risk of over-paying for assets.
Banks' share prices would, of course, remain uncertain while preferred shares were outstanding. But their standing as debtors would be much clearer, enabling them to raise private sector finance. This kind of structure, avoiding many of TARP's flaws, makes for a less bad "bad bank."
MARTIN HUTCHINSON
http://www.nytimes.com/2009/01/26/business/26views.html?sq=How%20to%20Improve%20the%20Bank%20Rescue%20Hutchison&st=cse&scp=1&pagewanted=print
http://snipurl.com/by3ki
Friday, January 16, 2009
An Economy of Faith and Trust By DAVID BROOKS
January 16, 2009
Op-Ed Columnist
An Economy of Faith and Trust By DAVID BROOKS
Once there was just Newtonian physics and the world seemed neat and mechanical. Then quantum physics came along and revealed that deep down things are much weirder than they seem. Something similar is now happening with public policy.
Once, classical economics dominated policy thinking. The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse. Sometimes people do stupid things, but generally the rider makes deliberative decisions, and the market rewards rational behavior.
Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models.
This view explains a lot, but not the current financial crisis — how so many people could be so stupid, incompetent and self-destructive all at once. The crisis has delivered a blow to classical economics and taken a body of psychological work that was at the edge of public policy thought and brought it front and center.
In this new body of thought, you get a very different picture of human nature. Reason is not like a rider atop a horse. Instead, each person's mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy. An irregular, idiosyncratic and largely unconscious process determines which of these internal players gets to control behavior at any instant. Context — which stimulus triggers which response — matters a lot.
This mental chaos explains how people can respond so quickly and intuitively to so many different circumstances. But it also entails a decision-making process that is more complicated and messy than previously thought.
For example, we don't perceive circumstances objectively. We pick out those bits of data that make us feel good because they confirm our prejudices. As Andrew Lo of M.I.T. has demonstrated, if stock traders make a series of apparently good picks, the dopamine released into their brains creates a stupor that causes them to underperceive danger ahead.
Biases abound. People who've been told to think of a high number will subsequently bid much more for an item than people who've been told to think of a low number. As Jonah Lehrer writes in his forthcoming book, "How We Decide," there are certain circumstances (often when there are many options) in which gut instincts lead to the best decisions, while there are other circumstances (sometimes when there are a few options) when calm deliberation is best.
Most important, people seek relationships more than money. If behaving a certain way helps a stock trader or a regulator fit in with his crowd, he's likely to keep doing it without too much rigorous self-examination.
A thousand mental shortcomings contributed to the financial meltdown. Republicans have tried to explain it by pointing to irresponsible policies at Fannie Mae. But that only explains a piece of what's happening.
This crisis represents a flaw in the classical economic model and its belief in efficient markets. Republicans haven't begun to grapple with the consequences.
For years, Republicans have been trying to create a large investor class with policies like private Social Security accounts, medical savings accounts and education vouchers. These policies were based on the belief that investors are careful, rational actors who make optimal decisions. There was little allowance made for the frailty of the decision-making process, let alone the mass delusions that led to the current crack-up.
Democrats also have an unfaced crisis. Democratic discussions of the stimulus package also rest on a mechanical, dehumanized view of the economy. You pump in a certain amount of money and "the economy" spits out a certain number of jobs. Democratic economists issue highly specific accounts of multiplier effects — whether a dollar of spending creates $1.20 or $1.40 of economic activity.
But an economy is a society of trust and faith. A recession is a mental event, and every recession has its own unique spirit. This recession was caused by deep imbalances and is propelled by a cascade of fundamental insecurities. You can pump hundreds of billions into the banks, but insecure bankers still won't lend. You can run up gigantic deficits, hire road builders and reduce the unemployment rate from 8 percent to 7 percent, but insecure people will still not spend and invest.
The economic spirit of a people cannot be manipulated in as simple-minded a fashion as the Keynesian mechanists imagine. Right now political and economic confidence levels are running in opposite directions. Politically, we're in a season of optimism, but despite a trillion spent and a trillion more about to be, the economic spirit cowers.
Mechanistic thinkers on the right and left pose as rigorous empiricists. But empiricism built on an inaccurate view of human nature is just a prison.
http://www.nytimes.com/2009/01/16/opinion/16brooks.html?sq=Brooks%20An%20Economy%20of%20Faith&st=cse&scp=1&pagewanted=print
http://snipurl.com/by4nm
Op-Ed Columnist
An Economy of Faith and Trust By DAVID BROOKS
Once there was just Newtonian physics and the world seemed neat and mechanical. Then quantum physics came along and revealed that deep down things are much weirder than they seem. Something similar is now happening with public policy.
Once, classical economics dominated policy thinking. The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse. Sometimes people do stupid things, but generally the rider makes deliberative decisions, and the market rewards rational behavior.
Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models.
This view explains a lot, but not the current financial crisis — how so many people could be so stupid, incompetent and self-destructive all at once. The crisis has delivered a blow to classical economics and taken a body of psychological work that was at the edge of public policy thought and brought it front and center.
In this new body of thought, you get a very different picture of human nature. Reason is not like a rider atop a horse. Instead, each person's mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy. An irregular, idiosyncratic and largely unconscious process determines which of these internal players gets to control behavior at any instant. Context — which stimulus triggers which response — matters a lot.
This mental chaos explains how people can respond so quickly and intuitively to so many different circumstances. But it also entails a decision-making process that is more complicated and messy than previously thought.
For example, we don't perceive circumstances objectively. We pick out those bits of data that make us feel good because they confirm our prejudices. As Andrew Lo of M.I.T. has demonstrated, if stock traders make a series of apparently good picks, the dopamine released into their brains creates a stupor that causes them to underperceive danger ahead.
Biases abound. People who've been told to think of a high number will subsequently bid much more for an item than people who've been told to think of a low number. As Jonah Lehrer writes in his forthcoming book, "How We Decide," there are certain circumstances (often when there are many options) in which gut instincts lead to the best decisions, while there are other circumstances (sometimes when there are a few options) when calm deliberation is best.
Most important, people seek relationships more than money. If behaving a certain way helps a stock trader or a regulator fit in with his crowd, he's likely to keep doing it without too much rigorous self-examination.
A thousand mental shortcomings contributed to the financial meltdown. Republicans have tried to explain it by pointing to irresponsible policies at Fannie Mae. But that only explains a piece of what's happening.
This crisis represents a flaw in the classical economic model and its belief in efficient markets. Republicans haven't begun to grapple with the consequences.
For years, Republicans have been trying to create a large investor class with policies like private Social Security accounts, medical savings accounts and education vouchers. These policies were based on the belief that investors are careful, rational actors who make optimal decisions. There was little allowance made for the frailty of the decision-making process, let alone the mass delusions that led to the current crack-up.
Democrats also have an unfaced crisis. Democratic discussions of the stimulus package also rest on a mechanical, dehumanized view of the economy. You pump in a certain amount of money and "the economy" spits out a certain number of jobs. Democratic economists issue highly specific accounts of multiplier effects — whether a dollar of spending creates $1.20 or $1.40 of economic activity.
But an economy is a society of trust and faith. A recession is a mental event, and every recession has its own unique spirit. This recession was caused by deep imbalances and is propelled by a cascade of fundamental insecurities. You can pump hundreds of billions into the banks, but insecure bankers still won't lend. You can run up gigantic deficits, hire road builders and reduce the unemployment rate from 8 percent to 7 percent, but insecure people will still not spend and invest.
The economic spirit of a people cannot be manipulated in as simple-minded a fashion as the Keynesian mechanists imagine. Right now political and economic confidence levels are running in opposite directions. Politically, we're in a season of optimism, but despite a trillion spent and a trillion more about to be, the economic spirit cowers.
Mechanistic thinkers on the right and left pose as rigorous empiricists. But empiricism built on an inaccurate view of human nature is just a prison.
http://www.nytimes.com/2009/01/16/opinion/16brooks.html?sq=Brooks%20An%20Economy%20of%20Faith&st=cse&scp=1&pagewanted=print
http://snipurl.com/by4nm
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