Sunday, December 12, 2010

Once more into the breach.

The word is out. Wall Street is back. Houses in the Hamptons. High end cars. Manhattan condos. After two years of nervousness, excess may once again trump discretion, or shame.

Soon we will see Goldman CEO and former gold trader Lloyd Blankfein walking the halls of Congress once again, defending his industry's largesse and lucre—though perhaps this time he will have the good grace to forego his prior suggestion that they are doing “God’s work.”

Wall Street’s revival comes even as Citibank CEO Vikram Pandit took time out of the G-20 meetings in Korea to complain about how chilly the climate was for bankers in the U.S., in contrast to the warmth he felt ensconced among his global finance brethren.

Chilly indeed.

Could America conceivably be more accommodating to its major financial institutions, as they prepare to pay out record levels of bonus compensation in the coming weeks?

The myth continues that Wall Street was bailed out with the $700 billion of TARP money. Pushed through a recalcitrant Congress in the wanting months of the Bush administration by Hank Paulson and Ben Bernanke and disbursed over the months that ensued, TARP has become the iconic whipping boy of left, right and center alike.

Ironically, little of the TARP money was actually used to purchase bank “toxic assets,” as originally intended, as most banks refused to sell—fearing the losses that they would be forced to recognize. Instead, TARP funds were provided as equity infusions and asset guarantees that nursed the banks back from the brink of collapse.

Today, the details of the whole episode are receding into memory. Even as films and books have chronicled wide-ranging stupidity, fraud and incompetence, as a matter of public policy bad conduct was occasionally noted, but never pursued. We have moved on.

The boards of the banks remain intact. The CEOs that oversaw the debacle fly off to G-20 meetings in Geneva or Korea to bemoan their fate. To hear them talk, one would think that the banks were incidental to the financial crisis. And in their revision of history, the TARP money was forced upon them. They were doing just fine on their own.

Few recall Hank Paulson and Ben Bernanke viewing the American economy on the verge of collapse. Fewer still give credit to any of the participants—Bush, Paulson, Bernanke, Obama, Geithner—for having stabilized the financial system. That is now deep in the past.

The total cost of the orgy of greed that that surrounded the packaging and trading of complex derivatives and collateralized securities has yet to be fully tallied. Last year, the IMF projected total bank losses at over $4 trillion, with $2.7 trillion of those losses at U.S. banks. Federal Reserve Bank data shows household balance sheet losses from the market collapse reached $15 trillion in 2009—almost 24% of the total net worth of American families—before ebbing to $10 trillion as the equity markets rebounded.

What is lost in the fury over TARP is that it represents only a portion of the federal intervention to support the country’s leading banks, as well as the two largest investment banks, Goldman and Morgan Stanley, which converted into bank holding companies in order to gain access to Federal Reserve support.

The most far-reaching area of federal intervention has been the sustained injection of massive amounts of liquidity (i.e. money) into the banking system by leaving the critical Fed Funds Rate—the interest rate charged on interbank loans among members of the Fed system—at or close to zero.

The effects of a 0% Fed Funds Rate are profound. In a normal time, and in a normal, cyclical recession, lowering the Fed Funds Rate ripples through the economy as a lower cost of capital on prime business loans and other loans. In the current economy, however, little new business lending is taking place.

While Fed data indicates that little commercial banking (lending) is going on, banks are taking full advantage of the availability of zero interest loans, and have borrowed trillions from the Fed. Literally trillions. Goldman: $600 billion. Morgan Stanley: $2 trillion. Citi: $1.8 trillion. Bear Stearns (now J.P. Morgan): $1 trillion. Merrill Lynch (now Bank of America) $1.5 trillion.

The term trillion makes all of this somewhat hard to grasp. But what is easy to grasp is the notion that if someone lends you money at 0%—OK, 25 basis points if you want to be picky—reinvesting it at a positive spread is not hard to imagine. Most Americans would relish the thought of replenishing their depleted retirement savings with zero interest loans, and would find any number of ways to take advantage of the opportunity. Put the money in a bank. Buy treasuries. Buy bonds. Buy commodities. Buy gold. Buy almost anything.

For the banks, free money translates into huge trading profits with no trading risk if they stick to investing in treasuries, and more if the go farther afield. And that is the point. The Fed strategy of keeping the Fed Funds Rate at or near zero provides a back door way of recapitalizing the banks, of rebuilding the balance sheets of financial institutions that lost an estimated $3 trillion and were insolvent. $700 billion of TARP funds was nowhere near enough, and the banks bridled at the constraints on compensation that came as part of the deal. In contrast, the Fed strategy was clean, and for the most part invisible. It required no vote of Congress, no authorization or appropriation of federal funds. There was no public humiliation on Capitol Hill. The only downside—for the public at least—is that before those banking profits reach the bank balance sheets, 40% or so of the trading profits will be paid out as bonuses.

But the Fed strategy has come at a high price. While the zero Fed Funds Rate is great for the banks, it has been a killer for those living off of their savings and for the nation’s pension systems. Senior citizens whose income is derived from rolling over certificates of deposit have seen their interest income decline by as much as 95% as CD yields declined from the 3% to 5% range prior to the economic collapse to recent levels of ¼ to ½ of 1%, according to Fed data.

If much of this seems incomprehensible, the message is simple: The Federal Reserve policy of keeping its target rate near zero is intended to allow banks to recapitalize, but has the effect of taking money from the elderly and others living off their savings, and transferring that money to the banks.

Over the coming weeks, Wall Street banks will pay out an estimated $30 billion in bonuses. These bonuses come on the heels of the second year in a row of record trading profits. Those record profits are not a product of great market insight, but reflect what is possible when money is free.

So when you see Lloyd Blankfein walking the corridors of power on Capitol Hill, defending the trading profits of his industry and proclaiming once again that they are doing God’s work, give your mom a call, or your great aunt or your elderly neighbor living on a fixed income. Give them a hug, and thank them for their sacrifice for God and country. Apparently, their sacrifice is necessary to rebuild our banking system and our nation.

After all, someone has to pay the price, and God knows its not going to be the people who created the mess to begin with.

Friday, December 10, 2010

Passing moment.

Taken at their word, Tea Party acolytes had among their core message two principles: First, Congress should move quickly to end out of control deficit spending. Second, Congress should stop lying to the American people.

Well, so much for that election.

Over the past few weeks, in short order, Congress swept aside the recommendations of the President’s debt commission, ignored the parallel recommendations of the study committee led by Pete Domenici and Alice Rivlin, and moved to prevent the expiration of the Bush-era tax cuts that are set to expire at the end of this month.

Taken together, these actions reaffirm the principle that one ought to judge people on their actions rather than their words. For all of the words of praise directed at Erskine Bowles and Alan Simpson for putting a credible plan on the table—leading Bowles to foolishly intone that the era of deficit denial is over—Congress moved swiftly to assure jittery financial markets that such denial is still with us, and that any bold or courageous action by the 535 members of Congress to act on our long-term fiscal problems will not happen on their watch.

Or make that 534 members of Congress. Hats off to Kent Conrad, the sole member of the debt commission who will be in office in January who voted in favor of the debt commission recommendations.

To extend the Bush tax cuts is simply wrong.

Little if anything has been said in the public debate about why those tax cuts are set to expire: They expire to comply with the fiscal rules in place when the cuts were enacted into law. Back in 2001, tax legislation was required to meet a ten-year scoring rule, which required that the tax cuts be paid for over a ten-year horizon. The ten-year requirement itself was a liberalization of the earlier, less flexible, “Paygo” rules that required that changes be paid for on an ongoing basis.

These rules are not in the Constitution or some other founding document, but rather are rules Congress sets for itself, as if to guard the nation from Congress’ own penchant for reckless and inappropriate conduct. Congress does not have to approve balanced budgets—as we all know—but in the wake of Reagan-era deficits we saw the rise of legislation such as Gramm-Rudman-Hollings that sought to restrain Congress increasing disregard for fiscal prudence.

Simply stated, the Bush-era tax cut legislation provides for rates to return to the levels in effect in 2001 in order to pay for the largesse that was bestowed upon taxpayers over the ensuing years. Not just taxpayers who earn over $1 million, but all of us.

All those who are clamoring for tax rates to remain at the lower levels are giving the lie to the notion that Congress should be subject to any rules, or that such rules should be followed. The argument that tax rates should not be increased in the face of a recession is utterly disingenuous. Those arguing to gut the 2001 and 2003 tax bills now would be doing so regardless of our economic condition.

Look back at the historical record. Even as the tax cut legislation was being considered, Republican leaders assured their base that by 2010 the cuts would be made permanent, and that those who might seek to let the cuts expire would be attacked for raising taxes. That is to say, even at the moment of the original legislation, those who supported it eschewed any intention of adhering to the fiscal rules that Congress itself had imposed. At the time, the cynicism was breathtaking. But as political calculation, it was prescient.

Today, with the reversion to the pre-tax cut rates looming come January, few if any in Congress are prepared to stand on principle and remind their colleagues that those tax increase are the price that was to be paid for the prior years of reduced taxes. Instead, Congress can point to the economic situation as justification for their collective determination to undermine the fiscal rationale of the law that they are now seeking to upend.

The problem with the argument that this is not the time to “raise taxes” is that this was part of the deal. This was part of the rules—and a very limited set of rules at that—that were set in place to protect Congress from itself, and to protect the rest of the nation from Congress. And this will be no temporary action. By supporting a two-year extension, Republican strategists have made the sound bet that regardless of the financial condition two years from now, making those cuts permanent at that time will be an easy sell. After all, 2012 is an election year.

Perhaps further stimulus over the short-term is warranted, as the Domenici-Rivlin group specifically addressed. But ideally such actions would be targeted to have the greatest economic impact over the near term, while not undermining prospects for addressing the longer-term problems, such as providing a payroll tax holiday to boost domestic spending and addressing a corporate tax structure that inhibits the repatriation of foreign earnings and undermines domestic investment.

But the greatest irony is the support of eviscerating the Bush-era tax legislation coming from those who during the very same week supported the work—if not the specific recommendations—of the debt reduction commission. Both that commission and the Domenici-Rivlin group provided alternatives for balancing the short-term need for economic stimulus with long-term recommendations to address the nation’s fiscal situation. They provided our political leadership with the opportunity to stanch the momentum of a nation heading toward a fiscal train wreck. They provided a moment in which serious leaders could stand up and be counted.

How quickly that moment passed.

Representative Paul Ryan’s dissembling words in dismissing the work of the debt commission on which he served stand as evidence that for all the talk, most in Washington still do not believe that the problems we face warrant any serious consideration.

"I just don't think this thing (the work of the commission) has the ability to last in policy, and it simply buys us time. I'd rather fix the problem, with the Boomers starting to turn 65 this year, fix it once and for all so we can really get this thing fixed."

Ryan, the architect of his own fiscal reform plan, was simply unwilling to step forward and show the courage of his convictions. Imagine if he had said instead.

“I will support the Commission recommendations not because it is my preferred plan, but because it is the first step to forcing Congress—all of us who are charged to lead the American people—to make the hard choices necessary to chart a new course for our nation. I believe Congress must approve this plan. Then, those of us who believe there is a better way can propose changes to that plan that will improve our situation—bring down healthcare costs, further attack the problem of growing entitlement obligations at the federal and state level, increasing the pro-growth structure of our tax code.

“But all of those changes require first that we achieve balance—or something close to balance—and this plan does that. Those of us who believe further—and better—changes are necessary will make that case, to Congress and to the American people. But if this is the plan that gets is to a balanced starting point, we must all come together and support this as an essential first step.”

Almost 200 years ago, Alex deTocqueville commented that “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.” Paul Ryan, and most others in Congress, will vote soon to bribe Americans one more time, in pursuit of their own narrow political interests.

Shortly thereafter, these same politicians will clamor for deficit reduction and decry the fiscal situation of our nation—a situation that is a product of their own cynicism, self-interest and unwillingness to do the job for which they were elected.