But wait, didn’t Ben save us all from a Great Depression? Didn’t his inspired and bold action opening taps and taking an axe to hogsheads of money down at the Fed preserve our very way of life? No. He preserved Wall Street’s way of life. He saved the banks, not their depositors. In fact, he used the depositor’s money (our money and that of our children and grandchildren) to not save the depositors, which I find particularly ironic.

We had a real estate crisis that precipitated a banking crisis, but Ben only fixed the banks, and not all that well, either.

And Grandma? She wrote a check, lots of checks, to her kids and grandkids helping them keep their homes. There is right now a charitable transfer of wealth happening from the oldest Americans to their middle-aged children that is, in many cases, the only thing keeping the latter in their homes.

Funny nobody talks about this.

Sometimes, only sometimes, the financial community comes up with an apt metaphor.  One that struck me recently from a Wall Street Journal conference on lessons learned from the Great Crisis of 2008 is that large banks should have “Living Wills.”

If you don’t personally have a Living Will, you should probably think about getting one.  A Living Will gives clear directions in case you are incapacitated.  Revive me, don’t revive me if I will be a vegetable, and so on.  And it names the people who will execute these powers.  I have my beloved Dr. Weld, my retired cardiologist.

If a bank had a Living Will, it would go through the same procedures.  In case of systemic failure — the financial equivalent of a heart attack — here’s what should happen.  If a bank prepares a living will in times of tranquility when there is time to thrash through all the possibilities that would be an excellent idea, especially if all the banks did it, and the information was checked with regulators and lawyers.

Mario Draghi, governor of the Bank of Italy, said, “We want to be in a position where we are free to let fail any institution without paying the exorbitant price we are paying.  Therefore, the most important point is to have a mechanism that gives power, ability and funding to allow whichever authority steps in to continue preseerving the core function of the failed institution.”

The public appetite for throwing money at big banks and having taxpayers pick up the bills is nil.  Wall Street firms kept alive by the taxpayers are getting ready to hand out enormous bonuses: what’s fair about that?

Living wills can be modified or tweaked as you go along.  But having a living will for a bank — and getting it done now — is not only a good metaphor but a sound idea.

When I was at your house on Sunday, you said the stimulus was not going to be enough, and faulted Bernanke for not backing additional stimulus.

But additional stimulus would have to be voted by the Congress.  And all the political folk say there is “no political will” for more stimulus.  Furthermore I mentioned the Bernanke confirmation hearings, which are surprising in the intensity of their vitriol, Senators attacking th Fed chairman.

These Senators and Congresspeople are just reflecting what their folks at home are saying.  The constituents are feeling ripped off.  Their own standard of living is going down, but as taxpayers they bailed out the banks and investment banks because the “systemic risk” was so great, and now the partners and officers of those banks are about to get billions in bonuses.  No wonder there is no “political will” for more stimulus.

So we come back to these questions:

1) The economic heart attack last fall was a product of, among other things, excessive leverage — debt.  What has been done about that?

2) The peddlers of the mortgages now known as “toxic waste” were aided aided by the rating agencies, Standard & Poor’s, Moody’s, Fitch.  These rating agencies were worthless.  What is being done about the rating agencies?  They gave AAA ratings to the “toxic waste” because they get their fees — their livelihoods — from the people they are rating.  That’s a huge flaw in the system. They should either be nationalized and be an agency like the FDIC or be totally independent and get their fees from a broad-based assessment of all the partipants. They should not be paid for delivering AAA ratings.

3) The big banks were bailed-out because of “systemic risk,” because they were “too big to fail.”  Yet now, through attrition, forced mergers and the bailout, the big banks have gotten even bigger.  We can’t continue to have “too big to fail” institutions keep growing, and have the government guarantee them, and pay their leaders billions in bonuses. What is being done about “too big to fail?”

I could go on, but the point is, until people get the feeling that real reforms have been instituted, that the morass has been cleaned up, there isn’t going to be the”political will” to support an optimum strategy.  We will have an economy that slides as the stimulus wanes.

Don’t you agree that the financial sector needs a “New Deal?”

j

“All politics is local,” said Tip O’Neill, and it is true. Even politicians on the national stage are dependent on local or regional voters to return them to office. And so despite the national or international rhetoric, local values and concerns always have to be met in the end, something we are likely to see ahead in the way our economy is managed.

Out of the bubble years, you see, we’re now embracing slow growth as our national mantra. Pay as we go. This new norm means slower U.S. growth from a lower base with higher unemployment and lower U.S. living standards.  The U.S. is setting itself up for a weak new-norm recovery in 2010 as capital continues shifting abroad.

Only it won’t work. This slow-growth outlook cannot be sustained very long because too many states, cities and companies will be below breakeven. The new norm growth rate built into the bond market is below the stall speed for the economy.

In the end, Washington will have to change economic policy in reaction to slow growth and high unemployment.  We’re seeing this a bit already in the statements of Treasury Secretary Timothy Geithner supporting a strong dollar even though his agency is not yet doing anything to make the dollar strong.

Inevitably the state and local governments will come begging and rightly so. It is unclear whether that points to another ratchet up in federal spending, a tax cut, protectionism, regulatory relief from the small-business credit crunch, a departure from Washington’s weak-dollar policy in order to draw capital back to the U.S., or something else.

Whatever the solution the Obama Administration attempts to apply, it will mean the quick end of slow growth as local politics again holds sway.

My wife is a real estate agent in Charleston, SC and last month she actually sold a house. “Hooray, the housing crisis is finally ending!” she said. But that’s not likely. In fact housing is probably going to get worse, or at least that’s the conclusion of a pretty grim but convincing white paper on the subject from Amherst Securities Group LP, a leading dealer and market maker in mortgage-backed securities.

Home prices are being buoyed somewhat right now by the $8,000 first-time homeowner tax credit, but there are only so many first-time homeowners available to buy houses, say the boys and girls from Amherst. What happens when every first-timer who can afford a house owns a house? Trouble.

Home prices have also been buoyed by the simple fact that more people tend to buy homes in the spring and summer and those are the numbers we’ve been seeing – numbers that will seasonally drop in the fall and winter. We tend to annualized these seasonal numbers, too, making them look bigger, even though we know they are likely to drop.

Federal programs to help homeowners avoid foreclosure: forget about them, according to Amherst. The number of mortgages that will actually be saved by this supposed $75 billion program won’t even amount to a rounding error, they claim. And sure enough, it is easy to look through recent claims by the Obama Administration and see the awful truth: with 7 million mortgages in default right now averaging six months from liquidation, the idea that the Administration will modify (and thereby “save”) four million of those mortgages over the next two years, well that’s laughable. By the time the paperwork is finished for the 25 percent who MAY qualify for modification (that’s 1.75 million – nowhere close to four million) most of those homes will have been auctioned, IF buyers can even be found.

If there is a positive side to this I suppose it’s that the full $75 billion won’t have been spent.  Or is that a negative, given the outcome?

Another positive (a very negative positive at that), is that foreclosures will go slower than they historically have simply because the banks won’t be able to get rid of the extra houses – about SEVEN MILLION extra houses, Amherst estimates.

The number of mortgages in trouble is increasing faster than homes can be foreclosed or mortgages can be modified. That’s 300,000 homes per month — homes we haven’t even talked about — or worried about to this point — going under. Starting soon this shadow excess inventory of seven million homes – 1.35 times the number of homes that are usually for sale – will push prices back down in many communities. That’s a true inventory of almost 13 million homes for sale in a market that can, in a good year, handle a little over five million.

When supply goes up, prices go down. And supply is about to go dramatically up.

But this bubble, too, will decline in time, though to make it do so may require further federal effort. There’s little political stomach for a second bailout, but with the government having an equity position in so many banks there may be the moral suasion to change bankers – at least for awhile – into landlords. Because just are there are seven million families losing their homes, so too there are seven million families looking for places to rent.

It has been only a year since we suffered a national economic heart attack, the nitroglycerin in this case having been hundreds of billions in cash pumped through the financial system to avoid a fatal event. There were no heroes in this story, although Ben Bernanke, having done his scholarly work on The Great Depression, knew how to stave one off at that moment, more a paramedic than a cardiologist. And now, just a year later, we are back to our old bad habits.

The last man standing who has any integrity, in my view, is Tall Paul Volcker. When he was Fed Chairman, he got death threats. Builders facing interest rates of 18 percent and 20 percent mailed in two by fours with impolite language to express their unhappiness. But Volcker broke the back of inflation and gave Greenspan an economy he could coast on for a while.

When Volcker talks, we should all listen. And he talked recently, this time to Congress. What to do about the financial system? Here are some points from Tall Paul’s testimony, available here.

“What all this amounts to is an unintended and unanticipated extension of the official ‘safety net,’ an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will by encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises — even greater crises — will increase.”

Our heart attack came from RISK and DEBT, from leverage gone wild.

One major Volcker point is to reinstate Glass-Steagall. That New Deal effort said the commercial banks had to stick to lending, and could not trade, like investment banks. But Glass-Steagall got blown away in 1999. Banks, as public companies, wanted to show earnings growing quarterly, and so took on more and more debt, and more risk. In effect, they became hedge funds with a window into the Fed, so instead of borrowing 7 to 1 or even 10 to 1, they could go to 30 to 1. They took the risks, pocketed the profits, and now the taxpayers have bailed them out.

So Tall Paul’s top point is to get the banks out of the casino. We should also, he says:

– regulate derivatives as a typical financial product

– encourage more prudent compensation practices

– register and establish reporting requirements for hedge funds and private equity

I can’t see a thing wrong with any of this. Derivatives are not going to go away, but they could be transparent and traded transparently. Leading up to the national heart attack, the derivatives got so complex that probably not a single bank CEO could explain some of his products. We taxpayers spent $180 billion — that’s billion with a “b” — to prop up AIG, and the whole AIG mess was done with complex derivatives (and large dollops of greed and stupidity).

As for “prudent compensation practices,” let’s not get hung up on the numbers. The basic idea, to me, is that when you run up risk and leverage and pocket the immediate profits where is the “clawback” when your firm goes so busted the taxpayers have to bail it out? Those AIG people KEPT THE MONEY. So did the Merrill people who lost $27 billion in a single quarter, and were given BONUSES of $3.5 billion. Some of them got a hundred million dollars for the worst disaster in Merrill’s history. That’s essentially our money. They KEPT THE MONEY, too.

In his testimony, Volcker said we have to coordinate with other countries to work on a global approach for oversight. Well, of course that’s not going to be easy.

We find ourselves saying, “of course, of course, why hasn’t this already happened?”

Where Volcker will have a harder time is in his arguments about “moral hazard.” Where is the punishment for the sinners? Did we have to let Lehman go to make sure some investment banks got the message? Will that message stick?

Tall Paul of course took the opportunity to underline the sanctity of the independence of The Federal Reserve, a passionate concern of his.

Here is Volcker doing some pen-to-yellow-pad thinking:

We threw all of this money at the banking system because of systemic risk. Your dry cleaner or your gas station can go four paws up in the air, but we have to float Citi — and AIG — because they present “systemic risk.” They are “too big to fail.” That just offends Tall Paul’s sense of how to run a financial system. Instead of throwing trillions at self-wounded entities, we should instead appoint a special “Conservator” to take control of a bank that’s clearly going to default. The Conservator would do just what Paulson and Bernanke did under such high pressure — arrange mergers or sales, or orderly liquidation, or negotiate debt for new stock. But can’t you hear the screams from the Limbaugh radio fans now? The government is already too big? Who’s to say what is a systemic risk? This works for me as long as I imagine Volcker as The Conservator. But this is what we had to do last year, and we improvised it.

We can’t go back to 2008. That was too close.

Tall Paul is not actually in the government. He is listed as an advisor, and I am sure some people will listen, just as some Congresspeople will. But for each item he has suggested, there is a militant constituency opposed, so it can keep its pockets full.

We ignore Tall Paul at our peril.

Actually, the first country to use the concept, to my knowledge, is the small Himalayan kingdom of Bhutan, tucked up between China and India.  In 1972, King Jigme Singye Wangchuck coined the term “gross national happiness” and ordered his administration to construct such an index.  I have not attempted to run down the 72 variables in the Bhutanese GNH (gross national happiness), but Bhutan has universal healthcare coverage, high literacy rates, the purest air in the world and, according to a Belgian correspondent of the Financial Times, no Blackberry coverage at all.

]]> http://www.adamsmithsays.com/2009/10/gross-national-happiness/feed/ http://www.adamsmithsays.com/2009/10/hear-tall-paul/ http://www.adamsmithsays.com/2009/10/hear-tall-paul/#comments Mon, 05 Oct 2009 16:41:18 +0000 Adam Smith http://www.adamsmithsays.com/?p=157 To me, Tall Paul Volcker ought to get a permanent lifetime achievement award for integrity.  He didn’t flinch when he got death threats for raising interest rates to 15 percent in the early 80s to break the back of a virulent inflation.  When he says the way things ought to be, I pay him heed because I know he has no agenda but the public good.  (Revelation of possible conflict:  Paul used to be on the board of my television company, where he restricted his role to advising who might or might not be a good guest, and sometimes his secretary, Anka, would supply a phone number.  Also, my office mate, Craig Drill, and Paul have occasional  weight losing contests.  Paul is six-eight and Craig close to six-seven and they have both been known to hit 300 pounds, so the contest is to see who can get to 275, loser to buy dinner).

You would think, after the disaster we had in the nation’s financial system last year, that everyone should pay rapt attention, then, to Volcker.  Paul says a bank should be a bank, loaning money to clients.  It should not be making bets with units that act like hedge funds.  ”Extensive participation in the impersonal, transaction-oriented capital market,” Paul said in a speech in Los Angeles, “does not seem to me an intrinsic part of commercial banking.”  In that speech, which I am sure he will repeat before Congress when asked, he said banks should be banned from “sponsoring and capitalizing” hedge funds and private equity firms.  Further, strict supervision “with strong capital and collateral requirements should be directed toward limiting proprietary securities and derivatives trading.”  Paul is chair of the White House’s Economic Recovery Advisory Board, and he was asked, in Los Angeles, whether his comments were a break with the administration.  ”Nothing I said should be a surprise,” he said.

Considering the depths of gloom just a year ago, and how the Fed and the Treasury had to bail out the banks, and how the head of the British banking authority says that a year ago the entire world was less than 24 hours from a slide into a Great Depression, you would think that Paul’s statements border on the obvious.

What is eerie is how quickly people forget, and how eager they are to pretend that nothing really happened.   Derivatives never went away, big bets are back, hundred million dollar paychecks are hatching, and what is worse, there seems be the implicit assumption that the government will bail out  the system again if there is systemic risk.

I would say if you want to take your own money and borrow 40 to 1 against it, fine.  But a public, or even quasi public,  institution has no business doing  anything remotely like that, because it’s easy to make big bets if you can socialize the risk. That is, if you can hand the bill to the taxpayers and walk off to play again.

The financial press has been hung up on executive compensation, where one bill has passed the House.  And of course, investment banks that would have died, like Goldman Sachs, are now commercial banks, where they have access to the Fed, but can only borrow at 12 to 1 instead of 35 or 40 to 1.

The Group of 20 met in Pittsburgh and said yes, they needed some international rules.

But derivatives, the instruments of leverage, are still unregulated.  Sheila Bair, the chair of the Federal Deposit Insurance Corporation, says “the off exchange derivates market is still the Wild West.”  She, and other regulators, want to see derivatives traded openly, on an exchange.  That would mean that banks could not hide money losing positions, and would have to put up more money if the bets moved against them.  Some banks oppose open derivatives trading because it might cut their profits by making pricing more visible and competitive.  So nothing has happened.  And some people who see the big picture fear that, as the crisis fades, so will the momentum to do something.  Robert Shiller, the Yale economics professor who predicted the housing bust, says “people will accept change at a time of crisis, but we haven’t managed to do much.  Maybe complacency is coming back.”

The government had to put up $180 billion of our tax money to save one firm, AIG.  That’s a lot of schools and roads.  (And while General Motors is not a bank, the government owns it, too.)

Nassim Taleb, who wrote “The Black Swan” about long-odds events happening, thinks the possibility of an even bigger bust could be in the making because people believe the government will bail out the risk takers.  Sheila Bair says investors in financial institutions must believe they will lose their money if the institutions fail.  ”You need to send a very strong, clear signal to restore market discipline,”  she says.

All of this scares me.  Not for this year.  I suppose Congresspeople will say, well, if we are going to change it, we have to get it right.

But will we waste the opportunity, and learn nothing from the experience of 2008?

This began as a mortgage crisis.  Lenders dropped their standards on loans, giving them to people who shouldn’t have qualified, driving housing prices up in a bubble that eventually popped and here we are with eight percent of all mortgaged houses in foreclosure and home prices down 30-40 percent over two years ago.  The technique our government used to deal with this was to prop-up the bankers, not the borrowers.

Why?

That’s a question I have been asking all over and the smart money answer generally comes down to: 1) that’s the way the system is set-up; 2) that’s the way we’ve always done it, and; 3) it would be too complex to deal with individuals — better to deal, instead, with a few dozen banks.

Why?

The system was widely perverted to deal with the current crisis; it wasn’t “business as usual” at all.  Companies that weren’t (and still aren’t) bank holding companies were declared to be so and got money from the Fed and Treasury as a result.  Same for insurance companies and brokerage firms that remained as they were but got money still, through sleight-of-hand by Fed chairman Bernanke.

Doing things “the way we’ve always done it” is what got us into this mess.

And the miracle of information technology makes it just as easy to send money to people as it is to take it from them in the form of taxes.  Saying that a bank has to be in the middle makes no sense at all.

We could have taken a completely different approach to the problem and simply treated the symptom, inserting what computer jocks call a “wait state” in the mortgage system so panic could subside, adjustments could be made, and life could be eased back to normal.

Remember that economies are cyclical and a lot of good financial planning is simply leaving enough reserves to survive until things get better.  That could have been our major economic tactic in dealing with the crisis in 2008. Instead of pumping $700 billion to $1.3 trillion (nobody knows the real number) into economic stimulus, the U.S. government could have simply paid everyone’s mortgage — EVERYONE’S — for six months.

There are 51 million mortgages in America and the average mortgage payment in 2006 was $1686, so paying everyone’s mortgage for six months would have cost $516 billion — hundreds of billions less than the Bush/Paulson/Obama/Geithner/Bernanke plan.

The money people would otherwise have used to make their mortgage payments could have gone for other things, making it effectively a huge economic stimulus in its own right.  With mortgages paid in full there would have been no foreclosures OR bank failures.  Yes, there would still have been problems with the banking system that needed  correction, but there would have been six months to do the correcting.

Lehman Brothers would still be in business, Bear Stearns, too.  Merrill Lynch would be independent. AIG would not have failed. Even Bernie Madoff would probably still be in business — at least for awhile.

So why didn’t we do it that way?  Because it would have been putting women and children first.

I need a drink.