Thursday, April 29, 2010

My humble comment to Yves Smiths's "Your Humble Blogger Discusses Financial Reform on PBS Newshour"

As you know, I read Yves Smith's excellent blog Naked Capitalism whenever I can. Here is my comment:

It was exciting to see you on PBS News Hour last night. Everyone with me saw your depth and breadth of knowledge. By the way, I had been reading the copy of ECONNED that I purchased earlier in the day at the Starbucks in my local Tucson Barnes & Noble. Thank you for writing it!!

I think it is likely that a bill will pass because the Republicans cannot be seen as being pro Wall Street thieves. It will happen quickly because the Democrats have been burned and educated by the Republican delay and vilify tactics on healthcare reform.

As a practical matter, the best that can be hoped for is that knowledgeable people such as Yves Smith, Brooksley Born, Elizabeth Warren, and perhaps certain States Attorneys General, draft and submit amendments to ensure implementation of effective oversight, regulation, and controls. Amendments to the bill should include administrative oversight guidelines for the relevant agencies.

The difficulty you raised of controlling international corporations is not insurmountable. Foreign governments will likely not comply with US requirements. However that is not a show stopper. An amendment can stipulate that what the bank does in its foreign operations must be in conformity with this bill, and must be transparent. Required reports on the activities of foreign branches or divisions to US agencies in the bill and the amendments should be no less frequent than quarterly. Potential penalties of losing their license for US operations is a big stick. Penalties involving the raising of reserve requirements in the US depending on foreign risk, as assessed by our oversight committees, is another big stick.

All off the books entities should be forbidden and called out as a prima facia proof of fraud and of the intent to defraud. Their mere existence should carry penalties that do not depend on proving any resulting fraud actually took place.

A sine qua non amendment repealing Senator Phil Gramm's infamous Repeal of the Glass-Seagall Act of 1933 should be inserted at the last minute.

As you said, exhaustive forensics would be very valuable and should continue long after a bill is passed. An amendment stating the intent of the bill that administrative agencies shall update their procedures and penalties as a result of ongoing Forensic investigation. It should provide a certain sum to fund this work for ten years, and should mandate which agencies must continue a level of forensic effort .

I agree with you that the use of CDOs should be limited. Their real value is in situations where the risk is stochastic, and not deterministic. In the case of adjustable rate, no documentation, subprime mortgages, involving the lack of documentation requirement, the use of ARMs, and the fact that these mortgagors were the last possible buyers at the extant prices, lead to an obvious, totally deterministic, easily modeled mechanism for any such mortgage failing to perform in 39 months of issue. Also, credit default swaps with entities holding similar mortgages in different regions were completely and predictably useless since all regions were using the same faulty application and review methods.

I should add that the tools developed and implemented to assess risk deal only with the stochastic parts of risk, and leave out totally the non-stochastic parts. An example of that can be seen in my assessment quite a while ago of the risk of the share value of Citigroup declining below the $40 price when I did my totally deterministic evaluations. Simply stated, given readily available data, it was easy to see that the model being used by banks and insurers was completely wrong.

Monday, April 26, 2010

Past Presidential Policies As Root Causes Of The Current US Economic Problems

Two people whose views are quire different, The Wizards of Paris, and Ed Friedman, have both pointed out to me that when considering the effects of previous United States Presidents and their administrations' policies on the current crisis in the US economy, President Reagan's policies and their effects must be included. Let's start with those and look for additional root causes in policies of other Presidents and their administrations.

President Reagan's administration did four main things that have had lasting economic effects that qualify as major causes of the current crisis. They are fundamental or root causes, not the immediate or proximate causes. We shall see that sometimes they merge.

What are those relevant and significant things the Reagan administration did?

1. It cut taxes.

2. It raised defense spending dramatically, leading to

(a.) a rapid rise in employment,

(b) a rise in the national debt, and,

(c) the intended collapse of the Soviet Union which realized it could not keep up with the Reagan defense spending levels.

3. Treasury Secretary "Tall Paul" Volker raised interest rates dramatically to reduce price increases inherited from the Carter administration. This added to the cost of doing business, which was offset by 1. and 2. above, i.e., the dramatic increase in Reagan's government spending and reduction in taxes, that also lead to a significant increase in the national debt.. That made it harder to deal with a future crisis, should it occur.

4. The Reagan administration accepted the views of the "freshwater economists" (Chicago School of Economics) that manufacturing jobs should be exported to countries with the lowest labor rates in the name of "efficiency." Where efficiency is unbelievably narrowly defined. Freshwater economists also believed in no taxation, so the companies that exported jobs picked up two quick and major advantages over those that still manufactured goods in this country:

(a) They paid no US taxes, and,

(b) they paid the world's lowest feasible labor rates.

Needless to say such corporations and the countries to which the transferred their manufacturing operations may have funded that school and hired it's professors as advisors! When I first heard the Chicago School's mantra that we should export manufacturing jobs, and I actually knew people who did export their own company's jobs to China, I said to myself. This will eliminate a major portion of jobs in the US and will ultimately and unavoidably lead to a very large US unemployment rate, possibly a collapse, and a decline in the power of the nation. It was obvious to me that there was no mechanism whereby jobs would be magically created as needed, I often say, by the tooth fairy, to pick up the slack. They said it would happen as needed. it was an article of faith, a religious dogma. I said they were mentally challenged. The disaster that would ultimately and inevitably follow was obvious.

It is very important to note that increasing government spending, as was done by Reagan, nowadays has less of a positive effect on US employment figures since so many goods purchased will be manufactured elsewhere. That needs to be change. That change is crucial.

The Clinton Administration pushed hard to implement actualize, and instantiate, the freshwater economist dogma. They said exporting manufacturing would increase US jobs and reduce unemployment. I said show me the mechanism. They said displaced US workers could be "retrained' to higher skill levels. I said to do what? When Vice President Al Gore came to MITRE and recommended that Barry Horowitz get rid of his "grey beards," my good friend and colleague Joe Cynamon said what do they want to retrain us to do? It was a funny line, since they never identified the new, and vastly superior skill set.

And what of the 50% of the people whose abilities are well suited to manufacturing work, and perhaps are not ready for or capable of a skill upgrade. Do we just throw them on the discard pile? Yes we do, we just raise the Core Unemployment number. Mission accomplished by academics! How brilliant a solution, and so elegant. No?

The Clinton administration was rescued by the rise in productivity due to the widespread introduction of personal computers into the business world. Skilled engineers could now do the work of secretaries, technical editors, and data entry technicians. So the number of employees shrank and skilled labor could now do much more menial tasks. There's a new skill set, right? Clinton's advisors felt the new personal computer industries would never export their jobs. Wasn't that a great assumption. Is there a single personal computer made in this country? (As of a few years ago there was one assembled here for gamers,) The freshwater group had obviously never sledded on a slippery slope when they were kids. An additional wonderful effect was the need for the economists to redefine the natural base level of core unemployment from less than 2 percent to 5 percent. They are now talking about 6 to 7 percent. Will it ever occur to them that exporting jobs leaves people unemployed or under employed? Hasn't occurred to them yet.

The Bush administration actuated a new national policy to eliminate all governmental oversight, regulation, and control of business and financial activity. That encouraged implementation of wild get rich quick schemes of the banking and energy industries which lead directly to the current collapse. We are approaching proximate causes.

Under Clinton and Bush, the internet bubble masked the decline of real wages, and the effects of rising core unemployment. Clinton exited just in time to avoid recognition for causing the reduction in real wages due to his push to export our manufacturing jobs. NAFTA for example.

A major root cause of the current disaster is the lack of oversight and regulation of the derivatives market under the Clinton and Bush administrations.

Regulation by the Commodity Futures Trading Commission (CFTC) was strenuously opposed by Federal Reserve chairman Alan Greenspan, Treasury Secretaries Robert Rubin and Lawrence Summers. On May 7, 1998, former SEC Chairman Arthur Levitt joined Rubin and Greenspan in objecting to the issuance of the brilliant and effective Brooksley Born's CFTC’s concept release. Their response dismissed Born's concerns out of hand and focused on the possibility that CFTC regulation of swaps and other OTC derivative instruments would increase legal uncertainty of such instruments, potentially creating turmoil in the markets, and reducing the value of the instruments.

Further concerns voiced were that the imposition of new regulatory costs would stifle innovation and push transactions offshore. Bur pushing jobs offshore where labor is cheaper was AND IS part of their religious mantra. So why not these jobs? Oh, yes of course, these were jobs in their own fields. Don't forget, this is an industry near and dear to these non-regulation minded Federal "regulators." Only MANUFACTURING JOBS should be pushed offshore! (Prior posts I address the feasibility of keeping design jobs Onshore when the manufacturing has gone Offshore. That's another one of the absurd freshwater economists' religious dogmas.

The Bush administration added a number of additional proximate causes to the present debacle. Its mantra of deregulation is a primary proximate cause. The repeal of Glass-Steagell was a major proximate cause. The repeal, engineered by Senator Phil Gramm, of the second Glass–Steagall Act (the Banking Act of 1933), see below, lead to the energy, housing, banking and derivative instrument "manufacturing" and trading bubbles that masked the decline in US real wages and GDI.

The lack of oversight and regulation of derivatives by the CTFC morphed into a proximate cause from it's original status of a root cause when AIG was revealed to be insolvent. The survival of the pension plan of a dear friend of mine, and many others I imagine, depends on the survival of AIG, which basically insured the crap they bought.

The Bush administration could no longer hide the decline of real wages, taking into account real, not "core," inflation. To deal with the drop in US gross domestic income, they encouraged the banking industry to engineer a rise in housing prices. That way, most people's apparent wealth and the GDI would appear to rise as along with the amazing rise in the "value" of their house.

This was supported and encouraged by Senator Barney Frank who saw it as a way for more people to realize the American dream. He was not an expert on deregulation effects. It is not clear that he could have anticipated the resulting, totally fraudulent securitization industry in which Henry Paulson and other bankers, mortgage initiators, and financial houses played a dominant role. That was another proximate cause.

The Bush administration apparently encouraged credit rating firms like Moodys, and Standard and Poors, to rank worthless securitization garbage as AAA. I often wondered about the seemingly inexhaustible supply of credit available to fund ill-considered (stupid?) mergers and acquisitions. Those sources of credit were in fact totally fictitious, non-existant, and fraudulent. Another proximate cause identified.

Ain't deregulation grand?

Note: I really should go back and add a list of bullets on the proximate cause of the collapse, and I may do that in a follow up post. However, my main purpose in writing this was to address a good friend's underlying assumptions of Reagan's role and effects. I loved Ronnie!!!! I have not addressed the positive effects of some of his ideas and style.

Interesting Note: April 21st: Moody's was slapped with a subpoena since the credit rating agency is not cooperating with Crisis Investigators

The panel created to investigate the roots of the financial crisis slapped credit rating agency Moody's Corp. with a subpoena Wednesday for failing to turn over key documents.

It's the first subpoena issued by the Financial Crisis Inquiry Commission to compel compliance, the panel's chairman, Phil Angelides, said during a conference call with reporters. The commission faces a December deadline to produce a report documenting and explaining the causes behind the worst financial crisis since the Great Depression.I am very pleased this committee's work.
A major root and proximate cause of the current disaster is the lack of oversight and regulation of the derivatives market.

Commodity Futures Trading Commission (CFTC) regulation was strenuously opposed by Federal Reserve chairman Alan Greenspan, Treasury Secretaries Robert Rubin and Lawrence Summers.[4] On May 7, 1998, former SEC Chairman Arthur Levitt joined Rubin and Greenspan in objecting to the issuance of the Brooksley Born's CFTC’s concept release. Their response dismissed Born's concerns out of hand and focused on the possibility that CFTC regulation of swaps and other OTC derivative instruments would increase legal uncertainty of such instruments, potentially creating turmoil in the markets, and reducing the value of the instruments. Further concerns voiced were that the imposition of new regulatory costs would stifle innovation and push transactions offshore.[7]

An economic and financial crisis affected US and world markets in 2008. As it gained momentum, newspapers began reporting on some of its possible causes, including the rejection of the CFTC's proposals and the adversarial relationship Greenspan, Rubin and Levitt had with Born.[8][4] The disagreement has been described not only as a classic Washington turf war,[6] but also as a war of ideologies as Greenspan and highly placed Clinton administration officials believed that, in large measure, the capital markets could be trusted to regulate themselves.[9]

Born declined to publicly comment on the unfolding 2008 crisis until March 2009 when she said: "The market grew so enormously, with so little oversight and regulation, that it made the financial crisis much deeper and more pervasive than it otherwise would have been."[6] She also lamented the influence of Wall Street lobbyists on the process and the refusal of regulators to discuss even modest reforms.[6]


The effects of repealing Glass-Steagall - One or More Proximate Causes
Shortly after George W. Bush was elected president, Congress and President Clinton were trying to pass a $384 billion omnibus spending bill, and while the debates swirled around the passage of this bill, Senator Phil Gramm clandestinely slipped a 262-page amendment into the omnibus appropriations bill titled: Commodity Futures Modernization Act. It is likely that few senators read this bill, if any. The essence of the act was the deregulation of derivatives trading (financial instruments whose value changes in response to the changes in underlying variables; the main use of derivatives is to reduce risk for one party). The legislation contained a provision -- lobbied for by Enron, a major campaign contributor to Gramm -- that exempted energy trading from regulatory oversight. Basically, it enabled the Enron debacle and ushered in the new era of unregulated securities. Interestingly enough, Gramm's wife, Wendy, had been part of the Enron board, and her salary and stock income brought in between $900,000 and $1.8 million to the Gramm household, prior to the passage of the Commodity Futures Modernization Act.

In 2003, Gramm left the Senate to join UBS, which had acquired investment house PaineWebber due to his deregulation bill. At UBS, Gramm lobbied Congress, the Fed and the Treasury Department. During Gramm's tenor at UBS and as a lobbyist, Congress passed the Responsible Lending Act, billed as an anti-predatory-lending measure, but was called the "Loan Shark Protection Act" by consumer advocates, as it was designed to preempt stronger state laws against anti-predatory lending. The Fed largely ignored the underlying and growing problems within the subprime mortgage/housing markets, as Bernanke famously acknowledged the housing market in April, 2007 as, "[showing] signs of softening," but said that a "sharp slowdown," is unlikely. Henry Paulson former head of Goldman Sachs became the Treasury Secretary in July, 2007, when, In 2005, Goldman [he] securitized $68 billion in residential mortgages and $23 billion in 'other assets' primarily related to CDOs," With such self-interest, and a lack of the nation's interest, we can see how this subprime mess was allowed to escalate to such great proportions.