After The Love Is Gone…

Andrew Ross Sorkin at Dealbook at NYT:

Daniel S. Loeb, the hedge fund manager, was one of Barack Obama’s biggest backers in the 2008 presidential campaign.

A registered Democrat, Mr. Loeb has given and raised hundreds of thousands of dollars for Democrats. Less than a year ago, he was considered to be among the Wall Street elite still close enough to the White House to be invited to a speech in Lower Manhattan, where President Obama outlined the need for a financial regulatory overhaul.

So it came as quite a surprise on Friday, when Mr. Loeb sent a letter to his investors that sounded as if he were preparing to join Glenn Beck in Washington over the weekend.

“As every student of American history knows, this country’s core founding principles included nonpunitive taxation, constitutionally guaranteed protections against persecution of the minority and an inexorable right of self-determination,” he wrote. “Washington has taken actions over the past months, like the Goldman suit that seem designed to fracture the populace by pulling capital and power from the hands of some and putting it in the hands of others.”

Over the weekend, the letter, with quotations from Thomas Jefferson, Ronald Reagan and President Obama, was forwarded around the circles of the moneyed elite, from the Hamptons to Silicon Valley. Mr. Loeb’s jeremiad illustrates how some of the president’s former friends on Wall Street and in business now feel about Washington.

Mr. Loeb isn’t the first Wall Streeter to turn on the president. Steven A. Cohen, founder of the hedge fund SAC Capital Advisors and a supporter of the Obama campaign, recently held a meeting with Republican candidates in his home in Greenwich, Conn., to strategize about the midterm elections, according to Absolute Return magazine.

Other onetime supporters, like Jamie Dimon, chief executive of JPMorgan Chase, also feel burned by the Obama administration, people close to him say.

That the honeymoon between Washington and Wall Street has turned to bitter recriminations is not news, given that the administration had long pledged to revamp Wall Street regulation in the wake of a crisis that rattled the global financial system.

Less than two years ago, Democrats received 70 percent of the donations from Wall Street; since June, when the financial regulation bill was nearing passage, Republicans were receiving 68 percent of the donations, according to an analysis by the Center for Responsive Politics, a nonpartisan research group.

But what is surprising is that some of the president’s biggest supporters have so publicly derided his policies, even at the risk of hurting their ability to influence the party in the future. Issues like the carry-interest tax on private equity or the Volcker Rule have become personal.

Why so personal? The prevailing view is that bankers, hedge fund mangers and traders supported the Obama candidacy because he appealed to their egos.

Mr. Obama was viewed as a member of the elite, an Ivy League graduate (Columbia, class of ’83, the same as Mr. Loeb), president of The Harvard Law Review — he was supposed to be just like them. President Obama was the “intelligent” choice, the same way they felt about themselves. They say that they knew he would seek higher taxes and tighter regulation; that was O.K. What they say they did not realize was that they were going to be painted as villains.

Paul Krugman:

I talked to some financial-industry backers of Obama back during primary season; they really didn’t know or care much about policy issues, but were in love with Obama over his style — and also over the prospect of being in his inner circle, something they knew wouldn’t happen with Hillary. Now they’re mad because they don’t feel that they’re getting enough stroking.

And you have to bear in mind that this comes after Obama has made immense efforts to placate the financial industry. There were no bank nationalizations; there were hardly any strings attached to bailouts; the financial reform bill was by no means draconian given the scale of the disaster. But Wall Street is furious that Obama might even hint that they caused the crisis — which he does, now and then, because, well, they did.

And as far as I can tell, hardly any of the new anti-Obamanites is thinking at all about what will really happen once John Boehner is speaker.

You know, one might have thought that having all the money in the world would make people less petty, less concerned about whether they feel that they’re in the in-group. But nooooo [/Belushi]

Daniel Indiviglio at The Atlantic:

In fact, most of those who I know on Wall Street aren’t particularly politically principled. They basically have the view that the government can do its thing, and they can do theirs. More regulation? They’ll just shrug and find loopholes or new ways to make money. Higher taxes? They have accountants with sophisticated income recognition strategies that handle that sort of nuisance. Their involvement in politics essentially consists of donating money to important politicians so that they can be relatively sure that government will generally leave them alone, or lend them a helping hand in case of emergency.

And that’s what they expected from President Obama. Instead, he adopted the popular narrative that Wall Street was the villain. This was a shock, because these bankers don’t share that view. As far as they’re concerned, a very small portion of them actually were responsible for the problems that led to the financial crisis. Indeed, many of them suffered disproportionally, as they had a year or two where their bonuses were far below what was anticipated, even though their individual performance hadn’t declined. They felt that they were in many ways victims of the housing bubble as well, even if their consequence wasn’t foreclosure or long-term unemployment like so many Americans.

That’s not to say people — or even President Obama — should necessarily by sympathetic to their bruised egos. This is just the explanation. If these Wall Street bankers and traders had analyzed President Obama and his base’s politics on a deeper level, then they would have seen precisely the treatment they got. Frankly, it could have been worse if the far-left progressive wing got their way. Of course he would vilify Wall Street after a credit crunch nearly caused another depression. After all, politicians need someone to blame in such situations. What other outcome could they have reasonably expected?

Naked Capitalism:

Please. Are you going to seriously tell me big financial players are up in arms because Team Obama occasionally calls them bad names? That explanation is so obviously bogus as to call for a look for the real reason. There’s a much more straightforward explanation, and it’s called “follow the money.”The key omission from this story is the name Rahm Emanuel. Rahm, a former partner at Wasserstein Perella, was particularly effective at fundraising from private equity funds and hedge funds.

So re-read this key phrase: ” They say that they knew he would seek higher taxes and tighter regulation; that was O.K.” But what the article buries in plain sight is the fact that the plans to tax hedge and PE funds carried interest at ordinary income tax rates, rather than a preferential capital gains tax rates, has the 2 and 20 crowd seeing red. And in case you had any doubts, there was no justification for this special treatment in the first place. Loren Steffy of the Houston Chronicle noted (hat tip Independent Accountant) provides a deft skewering:

Dear IRS: Please note that beginning this year, I am no longer earning an income. From now on, I am compensated through what I like to call column interest. It isn’t pay. It’s a capital gain that I receive in exchange for providing about 2,000 words a week to this newspaper. Please lower my tax rate accordingly. hey, you can’t blame me for trying. After all, a similar strategy has worked for years for money managers at hedge funds and private equity firms. … The private investment community is decrying the move as a massive tax increase, is if oblivious to the fact that it’s enjoyed an unfair tax break for years. … Let’s set aside the rather silly notion of private equity as an engine of job creation–most buyouts result in big job cuts–and focus on the inequality. Private equity managers typically collect a 2 percent annual fee on assets in the fund, which is taxed as income. They also scoop up 20 percent of their funds’ annual profits, which is known as carried interest. … Profit-sharing plans for just about everyone else are taxed as income. … Tax law is a murky world, but one basic principle of our tax code is that people who perform similar jobs for similar pay should receive similar tax treatment. That’s not the case in the investment world.

Sorkin does mention Steve Schwarzman’s infamous outburst (”likened the administration’s plan for taxes on private equity to ‘when Hitler invaded Poland in 1939.’”) but does not indicate the fact that this is the major reason for the falling out among Obama’s former backers. It’s one thing to raise taxes generally, the big boys can stomach that. But it’s quite another to raise taxes in a way that targets them. (And note, by the way, that this measure failed, but the industry was still deeply offended at this show of disloyalty).

Similarly, Sorkin later argues for the reasonableness of the revolting businessmen:

Mr. Loeb’s views, irrespective of their validity, point to a bigger problem for the economy: If business leaders have a such a distrust of government, they won’t invest in the country. And perception is becoming reality.

Just last week, Paul S. Otellini, chief executive of Intel, said at a dinner at the Aspen Forum of the Technology Policy Institute that “the next big thing will not be invented here. Jobs will not be created here.”

Yves here. This is patently ridiculous and disingenuous. First, Sorkin chooses to overlook that Otellini’s comments about inventions and jobs is based on his throwing in his weight with the venture capital industry, which was one of the groups that fought the proposed taxes on carried interest. The argument, implicitly is that the VC industry would shrink or disappear were there no carried interest tax break, and that we’d therefore see much less new business formation.

Both those ideas are questionable. Yes, the VC business as it is currently constituted might shrink, but a lot of angel investors do deals as principals or with small syndicates. One can as easily argue with so many people now possessing Wall Street experience, we’d likely see capital move through new channels to small ventures.

But more important, the idea that VC is critical to new business growth is complete urban legend. Amar Bhide, in the first systematic study of successful new ventures, determined that VC contributes very little to the funding of new businesses, even the most successful ones (his proxy was the Inc. 500).

Second, the line that Sorkin parrots from big businesses, “Be nice to us or we’ll quit investing,” is also bunk. Guess what? As we’ve indicated, big businesses were net disinvesting even during the corporate-friendly Bush Administration. And to the extent they are leery of investing now, far and away the biggest reason is macro uncertainty. It’s awfully hard to plan if you aren’t sure whether the outlook is for inflation or deflation. But businesses will cavil like crazy about government intervention because it is one of the few variables they might be able to influence.

And it’s also remarkable that Sorkin can treat the self-serving and misleading canard, “We’re mad that Obama is treating us like bad guys” seriously. For anyone at the TBTF firms, it’s patent rubbish. The firms got overt and back door bailouts so they could shore up their equity capital, and what do they do? Pay a big chunk of government-provided largesse out to themselves in record 2009 bonuses. It’s one of the most blatant acts of looting on record, and the industry deserves every bit of scorn the authorities can muster dumped on its head.

Felix Salmon:

Now Sorkin and Dealbook are the exemplars, at the NYT, when it comes to the journalistic virtue of putting primary documents online. Their Scribd account has over 100,000 subscribers and has had over 2 million visits; it’s much more active than the parallel documents.nytimes.com format used by much of the rest of the paper.

But anybody reading Sorkin’s column today simply has to take him at his word when he says that Loeb’s letter “sounded as if he were preparing to join Glenn Beck in Washington over the weekend.”

If I wanted, I could paint I different picture of the letter. I could point out that there are no fewer than three quotes from Barack Obama on its first page, talking about the importance of helping others and spreading wealth across the whole American population. I could note that Loeb is just as harsh on capitalists as he is on the government.

Many people see the collapse of the sub-prime markets, along with the failure and subsequent rescue of many banks, as failures of capitalism rather than a result of a vile stew of inept management, unaccountable boards of directors, and overmatched regulators not just asleep, but comatose, at the proverbial switch.

And he also sees new government rules being helpful on this front:

Many of the boards we have come across are populated by individuals who rely on the stipends they receive from numerous corporate boards and thus appear motivated primarily to ensure continuing board fees, first-class air travel and accommodations, and a steady diet of free corned beef sandwiches until they reach their mandatory retirement age. We are therefore encouraged by the recently finalized proxy rules, which will ease the nomination and election of directors by shareholders.

He’s even pulling with the government when it comes to cracking down on sleazy for-profit colleges:

Our perspective on the government’s increased willingness to use its regulatory muscle enhanced our short positions in the for-profit education space. Indeed, this summer certain government actions taken regarding these companies served to accelerate the unfolding of our thesis on these names.

So, who has the more accurate view of Loeb’s letter, me or Sorkin? The answer is Sorkin: I’ve been quoting very selectively. But in one crucial respect I’m being much more open and transparent about the letter than he is: I’m linking to it. He’s not.

There’s no legal or journalistic reason why Sorkin shouldn’t link prominently to the letter. When I spoke to Richard Samson, the NYT’s top lawyer on such matters, he was clear that although there are copyright reasons why the NYT might not post the letter itself, there’s absolutely nothing to stop the paper from linking to where the letter is posted elsewhere. And in general, Sorkin’s Dealbook blog is pretty good when it comes to external links.

I see a few possible reasons why Sorkin might not link to the letter, none of them good.

First, he might be moving Dealbook away from the blog concept (and it was always more of an email newsletter than a blog to begin with) to something much more self-contained. Dealbook has been hiring aggressively, and is clearly setting itself up in opposition to, and in competition with, other online sources of financial news. Maybe that makes Sorkin more hesitant to link out than he was in the past.

Alternatively, maybe Sorkin is happy to link out in theory, but he has problems linking specifically to the relatively juvenile and tabloid Dealbreaker. I don’t think that’s true: Dealbook does link to Deabreaker on a semi-regular basis.

There’s a couple of other possibilities, too, which are more worrying. Perhaps Sorkin got the letter directly from Loeb himself, on the condition that he not publish it, and he felt that linking to it would violate the spirit of that agreement. Or maybe there was no formal agreement at all, but Sorkin just felt that linking to the letter would annoy Loeb, and therefore decided not to do so in order to help maintain his relations with a source.

Or maybe it was just an oversight, further evidence that linking to primary sources simply isn’t very important at the NYT.

James Kwak at The Baseline Scenario:

I’ve criticized the Obama administration in many more words than Daniel Loeb. But putting the blame on certain categories of people does not somehow absolve “capitalism.” Our capitalist system–which until recently we considered the best, most pure version in the world–allowed incompetent people to become executives (and to run hedge funds), allowed incompetent people to become directors and to avoid any responsibility for their actions, and allowed companies to swamp regulators with battalions of high-priced lawyers and lobbyists.

This is a basic category error. Capitalism is an economic system; managers, directors, and regulators are people. They are not mutually exclusive. If you want to say that capitalism necessarily means universally good managers, responsible directors, and effective regulators, then that’s an argument you have to make (and good luck making it).

Just because you make a lot of money doesn’t mean you know what you’re talking about. Unfortunately, in this country if you make a lot of money, a lot of people listen to you.

(Here’s the full letter. Along the way, Loeb says that the current decline in confidence and economic activity is due to the SEC’s lawsuit against Goldman.)

Timmy And Lizzy, Having A Tizzy

John Hudson at The Atlantic with the round-up

Shahien Nasiripour at The Huffington Post:

Treasury Secretary Timothy Geithner has expressed opposition to the possible nomination of Elizabeth Warren to head the Consumer Financial Protection Bureau, according to a source with knowledge of Geithner’s views.

The financial reform bill passed by the Senate on Thursday mandates the creation of a new federal entity charged with protecting consumers from predatory lenders.

But if Geithner has his way, the most prominent advocate for creating the agency may not be picked to lead it.

Warren, a professor at Harvard Law School whose 2007 journal article advocating the creation of such an agency inspired policymakers to enact it into law, has rocketed to prominence since the onset of the financial crisis as one of the leading reform advocates fighting on behalf of American taxpayers.

Warren has been an aggressive proponent for the bureau in public and behind the scenes, working regularly with President Barack Obama’s top advisers and the Democratic leadership in Congress. Since 2008, she has overseen the Congressional Oversight Panel, a bailout watchdog created to keep tabs on how two administrations spent hundreds of billions of taxpayer dollars to bail out Wall Street while struggling to keep distressed homeowners out of foreclosure and small businesses from collapsing.

Yet while her work on behalf of a federal unit designed solely to protect borrowers from abusive lenders has been embraced by the administration, Warren’s role as a bailout watchdog led to strained relations with the agency her panel has taken to task with brutal reports every month since Obama took office: Geithner’s Treasury Department.

It’s no secret the watchdog and the Treasury Secretary have had a tenuous relationship. Geithner’s critics have enjoyed watching Warren question him during his four appearances before her panel. Her tough, probing questions on the Wall Street bailout and his role in it — often delivered with a smile — are featured on YouTube. One video is headlined “Elizabeth Warren Makes Timmy Geithner Squirm.”

Simon Johnson at Baseline Scenario:

With his track record of survival, Geithner and his team apparently feel they can push hard against Elizabeth Warren and give the new consumer protection job to someone closer to their philosophy – which is much more sympathetic to the banking industry.

This would be a bad mistake – trying the patience of already exasperated Congressional Democrats.  If the Obama administration can’t even complete the deal they implicitly agreed with Senators over the past months, this will set of a firestorm of protest within the party (and with anyone else who is paying attention).

Financial “reform” is already very weak.  If Secretary Geithner gets his way on consumers protection, pretty much all of the Democrats efforts vis-à-vis the financial sector’s treatment of customers have been for naught.

Tim Geithner is sometimes compared to Talleyrand, the French statesman who served the Revolution, Napoleon, and the restored Bourbons – opportunistic and distrusted, but often useful and a great survivor with a brilliant personal career.  In the end, of course, no one – including Talleyrand – proves indispensible.  And everyone of this sort eventually pushes their luck too far.

If the Democratic leadership really wants to win in the November elections, they should think very hard about the further consequences of Mr. Geithner.

Dean Baker at TPM:

Undoubtedly her actions made many people in positions of power uncomfortable. But, that is exactly what we need in order for the new consumer protection agency to be effective.

The Federal Reserve Board already had the power and the responsibility to do the job that the new consumer board has been assigned. The problem was that Ben Bernanke, Alan Greenspan, and their colleagues on the Fed board (with some notable exceptions) never took this responsibility seriously. As a result, consumer protection was a joke.

Shifting the responsibility to a new board does not by itself guarantee that consumer protection in financial matters will now be treated seriously. Just ask the folks at the Mineral and Management Service about their oversight of deep-sea drilling.

Ensuring that the new board carries through its responsibilities in the way that is intended will require a leader with integrity, intelligence and independence. Elizabeth Warren clearly fits that description. Selecting anyone else will be an insult not only to her, but to all the individuals and organizations who worked so hard to bring the Consumer Financial Protection Board into existence.

Felix Salmon:

Shahien Nasiripour says, plausibly enough, that Tim Geithner is opposed to tapping Elizabeth Warren for the job, despite the fact that she’s the obvious choice. I hope he doesn’t get his way. The bureau would never have come into being without Warren pushing it hard; it’s only fair she gets a chance to run it at inception, and shape the way it does business. Even if she has been harsh in her public questioning of Geithner.

David Dayen at Firedoglake:

Boy, and bloggers are called the immature ones. Geithner gets his fee-fees hurt because Warren dares to tell the truth about the Wall Street cartel and the woefully inadequate job Treasury has done, particularly on the foreclosure crisis, and so that makes her unacceptable for a position she literally dreamed up. I think it’s time to end the fiction that the Treasury Department is in any way interested in fundamentally changing the balance of power between Wall Street and consumers. If this report is correct, Geithner is using his power to block someone who would actually make Wall Street nervous from having a position of authority.

At least one progressive group is already fighting back. The Progressive Change Campaign Committee has blasted an email to their supporters demanding that Warren be named the head of the CFPB.

As a Harvard professor, her credentials are impeccable. And she was the one who came up with the idea for the Consumer Financial Protection Bureau — perhaps the best piece of this bill — in the first place.

In short, Warren is perfect for the position and most financial insiders have just assumed she would get it. That’s why it’s so outrageous that Geithner — a longtime Wall Street insider — would attempt to sabotage her appointment.

I will be in a position to gather more information about this in the near future, not only from Treasury, but from Elizabeth Warren. It turns out I’m on a panel with her next week at Netroots Nation. We’ll talk about the Forgotten Foreclosure Crisis along with Sen. Jeff Merkley and the Huffington Post’s Ryan Grim. So if you’re in Vegas, please come out as I speak with the next head of the Consumer Financial Protection Bureau – unless Timmeh has something to say about it.

Matthew Yglesias:

I wouldn’t put a ton of stock in a story based on “a source with knowledge of Geithner’s views” but the two of them have clashed in the past so this could be the case. For example, speaking on the record earlier today Assistant Treasury Secretary for Financial Institutions Michael Barr said Narisipour’s report was wrong, and that he and Geithner both regard her as “exceptionally well-qualified.”

I’m firmly of the view that nobody is indispensable ever, and Warren is no exception to that, but there’s a good prima facie case for her. That’s because good agencies not only need good people at the top, they need good people in the middle and the bottom too. Once an agency’s been up and running for a while, this is largely a question of lock-in. Effective, high-prestige public agencies (the United States Navy, the Federal Reserve) attract a lot of motivated applicants and thus get on a self-reenforcing path of effective personnel and high prestige. But when you start something new, everything is wide open. Launching the agency with someone like Warren—a reasonably well-known high-status individual whose status among people interested in consumer financial protection is very high—will draw other committed people into the new bureau.

Paul Krugman:

There’s also a political aspect. The Obama administration suffers from the perception that it’s been too much in the pocket of Wall Street — partly because there’s at least a grain of truth to the accusation. Appointing a prominent pro-consumer crusader would have to help repair the image, while appointing somebody unknown to the public, especially when expectations are running high, would hurt.

And bear in mind that Warren really is a pioneering expert on household debt and financial distress, who has also shown an ability to work effectively in an official position. Against that, whatever personal quarrels she may or may not have had shouldn’t count at all.

Brian Beutler at TPM:

On a conference call with reporters this afternoon, President Obama’s top political adviser David Axelrod sought to calm the waters. “Elizabeth is certainly a candidate to lead it,” he said.

That sentiment was echoed this morning by Michael Barr, Assistant Treasury Secretary for Financial Institutions. “I don’t know where that came from,” he said on a conference call. “She’s been working closely with me and Secretary Geithner for a year and half to push for this consumer protection bureau. I believe and Secretary Geithner believes that she’s exceptionally well-qualified to run it.”

Geithner and Warren haven’t exactly had a warm public relationship, so the news that he has reservations, and may be trying to block her, is no surprise. Just ask Sheila Bair. But this puts the White House in a tricky spot now if it turns out Obama does not nominate her.

More Simon Johnson at Baseline Scenario:

It’s one thing to block Elizabeth Warren from heading the new Consumer Financial Protection Bureau.

It’s quite another thing to deny in public, for the record, that any such blocking is going on (e.g., see this report; Michael Barr apparently said something quite similar today).

There is a strong groundswell of opinion on this issue from the left – see the BoldProgressives petition.  But the center also feels strongly that, given everything Treasury has said and done over the past few months, it would be a complete travesty not to put the strongest possible regulator in change of protecting consumers.  (See Ted Kaufman on the NYT’s DealBook, giving appropriate credit to the SEC, and apply the same points to broader customer issues going forward.)

This can now go only one of two ways.

1. Elizabeth Warren gets the job.  Bridges are mended and the White House regains some political capital.  Secretary Geithner is weakened slightly but he’ll recover.
2. Someone else gets the job, despite Treasury’s claims that Elizabeth Warren was not blocked.  The deception in this scenario would be nauseating – and completely blatant.  “Everyone was considered on their merits” and “the best candidate won” will convince who exactly?

Despite the growing public reaction, outcome #2 is the most likely and the White House needs to understand this, plain and clear – there will be complete and utter revulsion at its handling of financial regulatory reform both on this specific issue and much more broadly.  The administration’s position in this area is already weak, its achievements remain minimal, its speaking points are lame, and the patience of even well-inclined people is wearing thin.

Failing to appoint Elizabeth Warren would be the straw that breaks the camel’s back.  It will go down in the history books as a turning point – downwards – for this administration.

UPDATE: John Talbott at HuffPo

Jim Newell at Gawker

UPDATE #2: Jonathan Karl and Matthew Jaffe at ABC News

Felix Salmon

Mike Konczal

Joseph Lawler at The American Spectator

UPDATE #3: Pat Garofalo at Think Progress

UPDATE #4: Noam Scheiber at TNR

FinReg Brings Us Back To Waterloo, Yet Again

Simon Johnson at Baseline Scenario:

The bank lobbyists have the champagne out – the Brown-Kaufman amendment, which would have capped the size and leverage of our largest banks – was defeated in the Senate last night, 33-61.  Feeling ascendant, the big banks swarm forward to take on their next foe – the Kanjorski amendment (that would greatly strengthen the power of regulators to break up megabanks), which they plan to gut in the backrooms.

This is overconfidence – because the consensus against them is beginning to shift significantly.  Partly this is the result of great efforts by Senator Ted Kaufman, Senator Sherrod Brown, and their colleagues over recent months and weeks.  Partly this is due to all the people who came on board and pushed hard.

But, as in many such cases, it is also a question of luck – and timing.

The European sovereign debt crisis is deepening.  And the picture that is worth many thousands of words is the NYT’s graph of interlocking debt within the eurozone.

As far as anyone can ascertain, this is almost all debt held by banks (often then “repo-ing”, or borrowing against it as collateral, at the European Central Bank.)

In other words, the European megabanks – lauded by Senators Dodd, Corker, Warner and others as a model for us to follow – are up to the eyeballs in bad debt.  Their governance has completely failed.  Their regulatory systems have been gutted – on their way to being turned into ash.

None of this would matter, of course, if the eurozone policy elite had its act together and could terminate its current position with minimal losses.  But it cannot – the deer are in the headlights.

[…]

To the victors last night in the Senate: congratulations – your opponents have fallen back.  Your generals are known to be invincible, your forces are the best, and your resources are without limit.

And so we wait for you again, on a gentle slope and behind a ridge – appropriately enough with our backs to Brussels.  Welcome to Waterloo.

Jane Hamsher at Firedoglake:

The Kaufman “break up the banks” bill got drubbed tonight because it was perceived as a Democratic bill and the banks could work through the GOP to kill it, which gave the ConservaDems cover for opposing it too.

But nobody got on the floor of the Senate today to speak against Audit the Fed.  They were all scared shitless.  The left/right coalition supporting the bill  includes everyone from Richard Trumka, Bill Black, Andy Stern and Jamie Galbraith to Grover Norquist, the Campaign for Liberty and Freedomworks on the right.   We worked hard to put that coalition together for the past year, and it was transpartisan by design.  If you stood against Audit the Fed, you were  just a  shill for the banks.  There’s no justification.  It made the dividing lines extremely clear: populism vs. corporatism, with no ability to take refuge in the safe crannies of partisanship.

It took a lot of courage for the people involved in that coalition to join together and say “enough.” Party hacks on both sides launched endless personal attacks against those involved, accusing them of “consorting with the enemy” in a desperate attempt to restore a disfunctional chess board.  But everyone stood their ground, and when all else failed, the White House put the squeeze on Bernie Sanders.

David Dayen at Firedoglake:

Only, outside of a couple upstart groups like A New Way Forward, the progressive movement determined it not a cause worth fighting for. It’s just a plain fact that breaking up the mega-banks would have 10,000 times the impact of the public option – or auditing the Fed, for that matter – and absolutely nobody in the progressive coalition cared. There’s no doubt that something this transformative was a tough road – the White House didn’t go totally on the record but they weren’t exactly for it, with the Treasury Department’s Neal Wollin saying in a press event yesterday that “What’s really key about this is that the institutions be less risky, that they not pose threats to the broader system.  Size is one attribute with respect to risk, but there are other attributes.” Given the political capture of our governmental system by Wall Street, something of this magnitude was always a high climb.

And yet it got three more Republican votes than the public option ever got in its history. Yesterday, at the Financial Crisis Inquiry Commission, Henry Paulson – Henry Paulson! – came out for it, saying “we should not move ourselves back to a system of consolidated, monolithic commercial banks.” Alan Greenspan – Alan Greenspan! – said in March that Federal Reserve data showed no positive effect from economies of scale for anything but a mid-sized banking institution, pinpointed at only around $100 billion in assets (some of our banks are over a trillion right now). Conservative academics supported it. Republicans in the Senate made the argument for everyone, saying that the current bill didn’t stop too big to fail.

But practically nobody on the progressive side foresaw its power, its simplicity, preferred to look at other priorities, and Wall Street won big in a time when their political influence is at a low ebb. That 28 Democrats will get off the hook with this vote, because nobody bothered to look into it, is astonishing, given those facts.

This is a failure of the progressive movement. You fight the fights worth fighting for, and nothing – nothing – has been more worth fighting for, which got a vote on the floor of the Senate during the Obama Presidency, than this. Nothing at all. It’s a viciously cruel irony that a coalition called Mobilize For Our Economy just formed on the DAY that the Safe Banking Act went down to defeat.

Jane claims that “the Kaufman “break up the banks” bill got drubbed tonight because it was perceived as a Democratic bill and the banks could work through the GOP to kill it, which gave the ConservaDems cover for opposing it too.” If this were true, there was never any reason to spend six months on a public option campaign, because Safe Banking was far more bipartisan and far more transformational. It may not have had bright shiny poll numbers that could be touted, but that would be because nobody ever tried to force it into the national conversation. We have a problem with financial behemoths that cannot be regulated. It’s at the root of everything we’ve seen in the economy in the last decade. If you’re not willing to fight that fight you’re not really willing to change anything.

On that midday press conference, Kaufman referenced the big drop of the stock market and said, “The idea that there’s not going to be another financial crisis is a victory of hope over reality.” The idea that progressives were either blindsided, completely unaware or too preoccupied with whatever other nonsense to whip this vote is a victory of cynicism over hope.

Reihan Salam:

My guess is that Dayen and I disagree on many things, but my sense is that while the Safe Banking Amendment was far from flawless — I’m still not convinced that size is as centrally important as the bill’s sponsors, and its intellectual architects Simon Johnson and James Kwak, believe — it did include a variety of other measures that would really would alleviate the TBTF problem, thus making it a pretty decent second best option. The fact that it attracted the support of three reliably conservative senators — Shelby, Ensign, and Coburn — suggests that this was a lost opportunity for the right. Now that the bulk of the Republican caucus has coalesced around the Dodd bill, plus trivial tweaks, Senate Republicans have left close observers scratching their heads: if this is the endgame, why fight back at all?

Tim Fernholz at Tapped:

There won’t be any votes today or Monday, but there was one more positive development yesterday: A compromise has been reached on Sen. Bernie Sanders’ bill to audit the Fed, which will apparently allow for more transparency while protecting independent monetary policy. That means the White House and Senate leaders are supporting the amendment. If progressive economist Dean Baker thinks the deal is a win for reformers, it probably is.

Dean Baker at Talking Points Memo:

The effort to audit the Fed got a big boost last night when Senator Bernie Sanders reached an agreement with Chris Dodd, the chair of the banking committee. Under the deal, the Government Accountability Office (GAO) would undertake a full audit of the special facilities created by the Fed since December of 2007. GAO would make the findings from its audit available to the Congressional leadership. It would also make most of the details of the Fed’s transactions available to the public.

To cope with the economic crisis, the Fed created 13 different special lending facilities. At their peak last year, these facilities had lent out more than $2 trillion. The Fed has only disclosed aggregate data about these facilities, telling us how much each one lent out month by month. It has refused to disclose any information about the specific loans and beneficiaries. This means that we have no way of knowing how much Citigroup, Goldman Sachs or anyone else benefited from these facilities.

Under the terms of the deal, by December 1 of this year the Fed will have posted on its website all the loans that were part of these facilities. Any interested journalist, academic, blogger or generic snoop can read through the data and find exactly how much money Goldman Sachs got, at what interest rate, with what collateral and when they paid it back. This is a big victory.

More Dayen, on Baker:

Yes it is, and as I have come to understand, the entire point of conducting an audit of the Fed was to get at these special lending facilities. “What have you done with our money” was the key question, which will be answered under the terms of this deal (which still has to go through a conference committee and a final vote, mind you).

Now I know Ron Paul and some libertarians are angered by this deal. But understand that Ron Paul doesn’t want an audit of the Federal Reserve. He wants to end the Federal Reserve. The best-selling book “End the Fed” that he wrote tipped me off to this. He wants to go back to hard-money policies and a return to the gold standard. Now, you can argue that this would end the cartel of central bankers scheming with their monetary policy, or that it would turn US monetary policy into the inflation-uber-alles laissez-faire mess we’re seeing in Europe that is threatening a global depression. The consequences for Paul’s favored end-state would be catastrophic if implemented in real time. This Fed is failing in different ways – and their actions should draw more scrutiny – but eliminating it would return us to the Stone Age.

And so you should probably know who you’re dealing with. There’s no good reason for the restrictions on this particular audit, but in its streamlined form, it seeks to answer one question – what did the Fed do on an emergency basis with two trillion dollars in taxpayer money. Not only does the Sanders amendment force an answer to that question, it opens it up to public scrutiny in ways that Paul-Grayson didn’t. As Baker says, this is a beginning and not an ending for transparency and accountability.

David Vitter may offer the original proposal for a vote and more power to him. But an audit really is just an audit. Ron Paul wanted to use an audit as a tool to destroy the Fed.

Meanwhile I think there’s some needed perspective here. Fed transparency is important but it pales in comparison to the very real efforts to force fundamental changes to how Wall Street operates, changes that have thus far been batted down without people batting an eyelash. That has been the ongoing failure of this debate, sidetracked over an issue (however important) about opening up the books rather than ones that would actually legitimately constrain the runaway finance sector.

Ezra Klein:

As the FinReg process has pushed forward, controversy has centered around two amendments: Bernie Sanders’s proposal to audit the Federal Reserve and a proposal by Sherrod Brown (pictured) and Ted Kaufman to break up large banks. Grouping the two of these together has been a little bit weird; one transforms Wall Street while the other directs a government agency to keep us abreast of what they’re doing with our money.

But the Federal Reserve has fought the effort for transparency as if it were an effort to break them apart. Ben Bernanke’s letter on the subject sounds alarmed, to say the least. But because the Fed was never able to make a very good case that their new powers shouldn’t result in somewhat more transparency, they’ve lost. Now, a modified version of Sanders’s amendment seems sure to pass.

Conversely, the Brown-Kaufman proposal to break up the banks failed last night, 61 to 33. In some way, I’d say you’re seeing the fundamentals of these policies assert themselves. Audit the Fed is not a radical bill and it’s actually a bit hard to argue against it. Breaking up the banks makes a fair amount of sense, but it’s substantively a lot more radical than anything else in the legislation.

Banks Play Hide The Rancid Salami In The Hudson Castle

Kate Kelly, Tom McGinty and Dan Fitzpatrick at WSJ

Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York.

A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.

Excessive borrowing by banks was one of the major causes of the financial crisis, leading to catastrophic bank runs in 2008 at firms including Bear Stearns Cos. and Lehman Brothers. Since then, banks have become more sensitive about showing high levels of debt and risk, worried that their stocks and credit ratings could be punished.

That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.

Andrew Ross Sorkin at Dealbook at NYT:

“You want your leverage to look better at quarter-end than it actually was during the quarter, to suggest that you’re taking less risk,” William Tanona, a former Goldman analyst and head of financial research in the United States at Collins Stewart, told The Journal.

The newspaper suggests this practice is a symptom of the 2008 crisis in which banks were harmed by their high levels of debt and risk. The worry is that a bank displaying too much risk might see its stocks and credit ratings suffer.

There is nothing illegal about the practice, though it means that much of the time investors can have little idea of the risks the any bank is really taking.

Michael Scherer at Swampland at Time:

Some advice* for you the next time you need a loan: Before you go to the bank, move about 42 percent of your existing debts “off balance sheet,” so you don’t have to report them. That pesky credit card bill you will never be able to pay off–hide it. Those car payments you probably won’t be able to make–make ’em disappear, if only for a few days.

Even if your banker eventually finds out that you fooled him, you won’t have to sweat it. After all, banks make it a policy to hide their debt from the public, as the Wall Street Journal explains today in a story that you should not miss.

[…]

* I am joking. Do not take this advice. It is illegal for you to lie to your bank. But of course, it is perfectly legal for the bank to misrepresent its own level of risk before making public reports. Why the disparity? When you run the casino, you play by different rules. And the bonuses are really good.

Jennifer Taub at Baseline Scenario:

These revelations by Martin Kelly, Lehman’s controller, and Marie Stewart, the global head of accounting policy, invited many questions.

First, how reliable are they? Recall that Kelly is the first addressee listed on the May 2008 letter from Lehman whistleblower, Matthew Lee. Second, how could they know what the practices were at the competitor CSEs (CSE was the regulatory designation from 2004 – 2008 of the five large independent investment banks – Bear, Lehman, Merrill, Morgan Stanley and Goldman)? Third, if there was no legal change at that time, what was the magic of 2007? In other words, if the examiner, Anton Valukas, is correct in suggesting the “repo 105” practice was actionable, are these other investment banks vulnerable to litigation for pre-2007 practices? Fourth, was it possible that the other investment banks had been hiding billions of dollars of debt off balance sheet? Fifth, what was the connection between these practices and the financial crisis? Sixth, was this still going on at the firms?

Prior to finding the answers to these questions, I noticed that the SEC had posted a sample letter that it sent to “certain public companies requesting information about repurchase agreements, securities lending transactions, or other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets.” The illustrative letter was signed by the Senior Assistant Chief Accountant. Pleased that the SEC was on the job, I turned my attention to other matters, until this morning.

It is hard to predict what will happen next. However, it is quite possible, that the Valukas Report will be the global financial crisis analog to the Pecora Hearings, helping to energize robust regulatory reform. At the very least, this reinforces the need that all debt and all transactions that have the economic effect of debt or leverage must be on balance sheet. Only time will tell.

Annie Lowrey at The Washington Independent:

The Securities and Exchange Commission — in the wake of the revelation last month that Lehman Brothers used such transactions to park billions of debt off its balance sheet shortly before its collapse — is investigating banks’ use of the tactic. In my mind, there is one dead simple way to preclude banks from skewing their debt and leverage levels using repo transactions (which are, I should note, common, important and perfectly legal): Require banks to report not just their debt levels at the time the reports come out, but their quarterly average debt levels, thus removing the incentive to alter them.

Naked Capitalism:

The fact that the existence of widespread fraud is finally being addressed in polite company is a good first step.

But where are the prosecutions?

Neither happy talk nor propaganda will fix the economy. The governments of the world have spent trillions trying to wallpaper over the fraud, and have become insolvent doing so.

But it’s not working. Indeed, polls show that people no longer trust our economic “leaders”. See this and this.

Only honest talk – and holding the people who committed fraud accountable – will stabilize the economy.

Barry Ritholtz at The Big Picture

Louise Story and Eric Dash in NYT:

It was like a hidden passage on Wall Street, a secret channel that enabled billions of dollars to flow through Lehman Brothers.

In the years before its collapse, Lehman used a small company — its “alter ego,” in the words of a former Lehman trader — to shift investments off its books.

The firm, called Hudson Castle, played a crucial, behind-the-scenes role at Lehman, according to an internal Lehman document and interviews with former employees. The relationship raises new questions about the extent to which Lehman obscured its financial condition before it plunged into bankruptcy.

While Hudson Castle appeared to be an independent business, it was deeply entwined with Lehman. For years, its board was controlled by Lehman, which owned a quarter of the firm. It was also stocked with former Lehman employees.

None of this was disclosed by Lehman, however.

Felix Salmon:

This is all, obviously, extremely complicated. Hudson Castle was borrowing short and then lending that money out to banks like Lehman, which would post securities as collateral. (That’s the first thing that doesn’t make sense: since when are repo rates higher than CP rates?)

But obviously Hudson was lending unsecured as well, or else its security interest wasn’t well structured, because now it’s a major Lehman creditor.

Yet at the same time Hudson — or its Fenway subsidiary — borrowed $3 billion from Lehman. And those notes “were used to back a loan from Fenway to a Lehman subsidiary” — this is the point where I completely fail to understand what’s going on. And that loan from Fenway to Lehman was also secured by another loan, to a California property developer — so now it was secured twice? And the Fenway notes were used as security twice over, as well, since besides being pledged back to Fenway they were also pledged to JP Morgan?

Certainly there was some very crazy stuff going on around Hudson Castle — and knowing what we know about Lehman, it’s entirely plausible that the crazy stuff was all designed “to shift investments off its books”. But the main reason I have to believe that story that is that I trust the NYT. If I read this story on a blog somewhere, I’d dismiss it as borderline-incomprehensible conspiracy-theory rambling; but since I saw it featured prominently in the NYT, I know that some highly respected and respectable journalists and editors really believe there’s a story here.

I just wish they’d done a better job of showing us what Lehman was doing, rather than just telling us — and then trying to support their assertions with a series of details which really doesn’t make any sense.

John Cole:

Look- I know I’m just a layman, but this sounds like EXACTLY what Andrew Fastow, the Chief Financial Officer at Enron, did for years before Enron finally crashed and burned. He’s in jail.

But these guys raped everyone, walked away with millions, and are probably thick as thieves with a new crowd in some other organization where we are told it would be Stalinesque to tax their bonuses.

John Lounsbury at Seeking Alpha:

The next item reminds me of the child’s argument: “But Mom, everybody does it. It must be okay.”

Last week Kate Kelly, Tom MCGinty and Dan Fitzpatrick had a report in The Wall Street Journal showing how all banks manipulate their balance sheet to accommodate the accounting cycle. In this case, banks use repos to raise cash for trading during the quarter and then close out the positions in time for the quarterly accounting date.

According to the WSJ article, the total of repos in banks averages 42% higher at the highest point in the quarter compared to the accounting date. The following graph shows the total repo activity by banks, plotted weekly.

(Click to enlarge)

It’s Okay Mom, It’s Not Illegal

There is apparently nothing illegal about all of this. If that is the case, then the term “a nation of laws” is itself a deception. It should not be legal to hide assest off the books by maneuvers such as Repo 105. It should not be legal to hide the fact that excess leverage is used every month for trading, hidden from the official balance sheet.

Disclosure: No positions

Greasing The Wheels For The Skid

Peter Boone and Simon Johnson at Baseline Scenario:

There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties.  The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment.

At the end of 2001, Argentina’s public debt GDP ratio was 62%, while at end 2009 Greece’s was 114%.  Argentina’s public deficit reached 6.4% GDP in 2001, while Greece’s was 12.7% GDP (or 16% on a cash basis) in 2009.  Both countries locked themselves into currency regimes which made it extremely painful to exit:  Greece has the euro, while Argentina created a variant of a currency board system tied to the US dollar.  And both countries had seen their competitiveness, as measured by the “real exchange rate” (which reflects differential inflation relative to competitors) worsen by 20% over the previous decade, helping price themselves out of export markets – and boosting their consumption of imports.  In 2009 Greece had a current account deficit equal to 11.2% of GDP, while Argentina’s 2002 current account deficit was a much smaller 1.7% GDP.

The solution to such crises is rarely gradual.  Once financial market confidence is lost, yields on government debt soar, private capital flees, and sharp recessions occur.  The IMF ended up drawing tough conclusions from its Argentine experience – the Fund should have walked away from weak government policy programs earlier in the 1990s.  Most importantly, IMF experts argued that from the start the IMF should have prepared a Plan B, which included restructuring of debts and termination of the currency board regime, since they needed a backstop in case the whole program failed.  By providing more funds, the IMF just kicked the can a short distance down the road, and likely made Argentina’s final collapse even more traumatic than it would otherwise have been.

Sadly, the Greeks are today in a similar situation: the government’s macroeconomic program is not nearly enough to calm markets, or put Greece’s debt on a sustainable path.  By 2012 we estimate Greece’s debt/GDP ratio will rise from 114% of GDP to over 150%.  The interest payments alone on this would amount to 9% of Greek’s incomes at current rates, and almost all those funds are transferred to the German, French, and Swiss debt holders.

Greece’s 2010 “austerity” program is striking only for its lack of credibility. Under that program Greece, even in 2010, does not pay the interest on its debt – instead the government plans to raise 52bn euros in credit markets to refinance all its interest while at the same time it borrows 4% of GDP more.  A country’s “primary budget” position measures the budget without interest expenses — at the very least, the Greeks need to move from a 4% of GDP primary budget deficit to a 9% of GDP primary surplus – totalling 13% of GDP further fiscal adjustment, in the midst of what will be a massive recession, just to have enough funds to pay annual interest on their 2012 debt.  This is under the rather conservative assumption that interest rates would settle near 6% per year, where they stand today.  The message from these calculations is simple: Greece needs to be far more bold if its austerity program is to have a serious chance of success.

How did Greece manage to get into such a terrible situation?  Local politics that lead to profligate spending is one answer.  But remember that someone needs to supply the money that allows such profligacy.  In this case it was the European Central Bank that handed Greece the keys to the safe.

Megan McArdle:

Greece’s fiscal problems are turning into one of those endless sagas, the kind we watch unfold at Thanksgiving every year.  Aunt Daphne is going to leave Uncle John!  No, they’re in counseling! Wait, now Aunt Daphne is breaking up with the counselor, too!  The rumors are starting to take on a toxic life of their own, driving up the yields demanded on Greek debt–which in turn, makes it less likely that they’ll be able to finesse the crisis with a moderate infusion of outside cash.

Paradoxically, that seems to be good news for us, pushing our debt yields lower; we are the proverbial “any port in a storm”. This phenomenon is what makes it so difficult to assess the risk of US fiscal trouble.  On the one hand, the US budget is clearly on a completely unsustainable path, and frankly, our household budgets don’t look so much better.  This should make investors nervous about our bonds.

And as far as I can tell, they are.  But they’re even more nervous about bonds everywhere else . . . because everywhere else has worse demographic problems, and a less impressive history of economic growth.  So they aren’t signalling their nerves the way we’d expect, by slowly and steadily pushing up bond yields.

But that in itself is a vulnerability.  If at any point we are not seen as the safest game in town, we will take a gigantic–the better word might be “catastrophic”–hit on our bond interest.  If there’s somewhere safer to park our money, suddenly we lose the premium we currently enjoy for having bonds considered the “risk free” rate.  So while our super-sterling credit rating may delay the onset of a fiscal crisis, if we ever let it get to that point, the onset may be even more sudden and disasstrous than these things usually are.  All the more reason to start getting our fiscal house in order now.

Paul Krugman at NYT:

The debt crisis in Greece is approaching the point of no return. As prospects for a rescue plan seem to be fading, largely thanks to German obduracy, nervous investors have driven interest rates on Greek government bonds sky-high, sharply raising the country’s borrowing costs. This will push Greece even deeper into debt, further undermining confidence. At this point it’s hard to see how the nation can escape from this death spiral into default.

t’s a terrible story, and clearly an object lesson for the rest of us. But an object lesson in what, exactly?

Yes, Greece is paying the price for past fiscal irresponsibility. Yet that’s by no means the whole story. The Greek tragedy also illustrates the extreme danger posed by a deflationary monetary policy. And that’s a lesson one hopes American policy makers will take to heart.

The key thing to understand about Greece’s predicament is that it’s not just a matter of excessive debt. Greece’s public debt, at 113 percent of G.D.P., is indeed high, but other countries have dealt with similar levels of debt without crisis. For example, in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed. And debt as a percentage of G.D.P. continued to fall in the decades that followed, hitting a low of 33 percent in 1981.

So how did the U.S. government manage to pay off its wartime debt? Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation, with both real G.D.P. and the overall level of prices rising about 40 percent from 1946 to 1956.

Unfortunately, Greece can’t expect a similar performance. Why? Because of the euro.

Until recently, being a member of the euro zone seemed like a good thing for Greece, bringing with it cheap loans and large inflows of capital. But those capital inflows also led to inflation — and when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies. Over time, Greek prices will have to come back down. And that means that unlike postwar America, which inflated away part of its debt, Greece will see its debt burden worsened by deflation.

Arnold Kling:

What Krugman never mentions in his column is the fact that defense spending fell dramatically as a share of GDP in the United States after World War II. In fact, even as late as the 1990’s, the fiscal outlook in the United States appeared to be improving because defense spending’s share of GDP was falling. As of now, defense spending is already too low relative to GDP for further cuts to make a meaningful difference.

According to the Committee on the Fiscal Future of the United States, by 2030, U.S. debt will be 117.6 percent of GDP, roughly the same as that of Greece today. And that is with total non-interest, non-entitlement spending of only 8.5 percent of GDP. (The report pre-dates the Obama Administration, which has substantially increased the path for both debt and spending.)

I have said this before, but the Left’s favorite solution to this, which is bending the health care cost curve between now and 2080, is whistling past the graveyard. We will not get to 2080. Instead, the crisis will come before 2030. If you have not done so already, stare at the table.

Several years ago, I wrote that the future will be a Great Race between technological progress and Medicare–a contest between the technological Singularity and a fiscal Singularity, if you will. Back then, I thought that the technological singularity had a better chance of winning than I do now.

The next time the United States hits a debt-to-GDP ratio of 100 percent or more, we will look much more like Greece in 2010 than the United States in 1945. That is, our government will be in a state of paralysis, the public-sector unions and pensioners will be in a state of hysteria, and defense spending will be only a few percentage points of GDP. Like Greece, we will be devoid of options. At that point, “inflating away the debt” will not be some mild, harmless act–it will require a virulent inflation and/or capital levy that wipes out the savings of everyone except those who have found safe havens overseas.

Have a nice day.

Matthew Continetti at The Weekly Standard

Tom Maguire:

First, the notion of hyper-inflation followed by default probably takes its inspiration from Weimar Germany and Latin America.  However, neither example is useful since they (like Greece, but unlike the US) were dealing with debt denominated in something other than their own currency.  In fact, as Krugman notes in the passage above, inflation is probably a substitute for formal repudiation of our debt.

However, Japan’s Lost Decade provides a more relevant example – a long, grinding deflation could push the US into an untenable financial position.  And that might happen despite a sustained Fed policy of low interest rates and easy money.  Imagine that China maintains its link of the yuan to the dollar, so that easy dollars simply result in easy yuan, thereby stimulating employment and production in China (actually, that is pretty easy to imagine, since it has been the story of the last several years, although China’s policy may change.)  The Fed will never achieve either inflation or robust growth here, since China swallows it up by buying dollars and selling yuan, and the US might be pushed to the brink.

But to the brink of what?  What might a US default look like?  Since we control our own printing presses, it is not that easy to picture logical scenarios in which we default on our debt rather than spinning the presses and printing the legal tender needed to pay off our bills, notes and bonds.  But we are talking about Washington, so why rely on logic?

Matt Welch in Reason

Felix Salmon:

There are two outcomes which no one wants in Greece but which are still becoming increasingly likely: default and devaluation. Argentina did both in 2001. But these aren’t binary things: both can be relatively mild or extremely severe. In Greece’s case, they would surely be much more modest than they were in the Argentine.

The first option is default. If it happens, it’ll happen, as Thomas says, in the form of a debt restructuring, where holders of Greek debt would end up getting new bonds with new terms — lower interest payments, lower principal amounts, that kind of thing. Debt restructurings are messy and unpleasant things at the best of times, but what we’re really talking about here is the sovereign equivalent of a loan modification which, if it goes according to plan, makes both the borrower and the lender better off.

What we’re most emphatically not talking about here is an Argentina-style default, where the country simply unilaterally stops paying any interest on its debt, and then takes years to address the issue, trying to drive the hardest bargain it can all the while.

Then there’s devaluation. If Greece leaves the euro, that would allow it to devalue its currency. If it redenominated its debt from euros into drachmas, that alone would constitute a default, even without a bond exchange. But again, in the event that Greece did leave the euro, it wouldn’t see its currency plunge overnight to a third of its previous value, as Argentina did.

This is where being a member of the EU really does help — not least because of the large exposure that many European banks have to Greece. Even if Germany insists on a hardline refusal to bail Greece out, it equally doesn’t want a Greek failure to be the just the first of the PIIGS dominos to fall, in a series of sovereign collapses which would make the 1998 Asian crisis look positively tractable in comparison. As a result, even in the worst-case scenario, the EU and IMF are at least likely to step in somewhere to cushion the blow and to try to isolate Greece’s problems. What happens in Athens must stay in Athens: if it spreads to Rome and Lisbon and Dublin and Madrid, London would probably be next, and at that point we’d have a major global financial crisis at least as severe as the one we just went through.

So while it’s true that, as Mohamed El-Erian says, things will likely get worse for Greece before they get better, it’s worth being a little bit realistic here about just how much worse they could possibly get. For the time being, everybody’s still hoping that Greece will somehow manage to get through this crisis — and Greece’s debt spreads, while wide, aren’t yet trading at distressed levels. That’s grounds for hope. And it’s also an indication that traders see much less downside here than there was in Argentina.

Robert Wielaard at Huffington Post:

Trying again to halt a debt crisis that has hammered the euro, fellow eurozone governments tossed struggling Greece a financial lifeline Sunday, saying they would make euro30 billion in loans available this year alone – if Athens asks for the money.

The International Monetary Fund stands ready to chip in another euro10 billion, said Olli Rehn, the EU monetary affairs chief.

The promise – filling in details of a March 25 pledge of joint eurozone-IMF help – was another attempt to calm markets that have been selling off Greek bonds in recent days.

Markets viewed the March pledge as too vague and carrying such tough restrictions that Greece could not easily get the money. As a result, investors demanded high rates to loan to the government as it struggles to avoid default – rates the government says it can’t go on paying. Greece has some euro54 billion in debt coming due this year and a huge budget deficit.

In an emergency video conference, the finance ministers of the 16-eurozone nations agreed on a complex three-year financing formula that generates an interest rate of “around 5 percent.”

EARLIER: A Scattering Of Blog Posts Concerning Greece, Germany, And EMF

Beware Goldman Sachs Bearing Gifts

The Autopsy Report Shows Repo 105 In The Soul

Michael J. de la Merced and Andrew Ross Sorkin in NYT:

It is the Wall Street equivalent of a coroner’s report — a 2,200-page document that lays out, in new and startling detail, how Lehman Brothers used accounting sleight of hand to conceal the bad investments that led to its undoing.

The report, compiled by an examiner for the bank, now bankrupt, hit Wall Street with a thud late Thursday. The 158-year-old company, it concluded, died from multiple causes. Among them were bad mortgage holdings and, less directly, demands by rivals like JPMorgan Chase and Citigroup, that the foundering bank post collateral against loans it desperately needed.

But the examiner, Anton R. Valukas, also for the first time, laid out what the report characterized as “materially misleading” accounting gimmicks that Lehman used to mask the perilous state of its finances. The bank’s bankruptcy, the largest in American history, shook the financial world. Fears that other banks might topple in a cascade of failures eventually led Washington to arrange a sweeping rescue for the nation’s financial system.

According to the report, Lehman used what amounted to financial engineering to temporarily shuffle $50 billion of assets off its books in the months before its collapse in September 2008 to conceal its dependence on leverage, or borrowed money. Senior Lehman executives, as well as the bank’s accountants at Ernst & Young, were aware of the moves, according to Mr. Valukas, the chairman of the law firm Jenner & Block and a former federal prosecutor, who filed the report in connection with Lehman’s bankruptcy case.

Naked Capitalism:

Well, it is folks, as a newly-released examiner’s report by Anton Valukas in connection with the Lehman bankruptcy makes clear. The unraveling isn’t merely implicating Fuld and his recent succession of CFOs, or its accounting firm, Ernst & Young, as might be expected. It also emerges that the NY Fed, and thus Timothy Geithner, were at a minimum massively derelict in the performance of their duties, and may well be culpable in aiding and abetting Lehman in accounting fraud and Sarbox violations.

We need to demand an immediate release of the e-mails, phone records, and meeting notes from the NY Fed and key Lehman principals regarding the NY Fed’s review of Lehman’s solvency. If, as things appear now, Lehman was allowed by the Fed’s inaction to remain in business, when the Fed should have insisted on a wind-down (and the failed Barclay’s said this was not infeasible: even an orderly bankruptcy would have been preferrable, as Harvey Miller, who handled the Lehman BK filing has made clear; a good bank/bad bank structure, with a Fed backstop of the bad bank, would have been an option if the Fed’s justification for inaction was systemic risk), the NY Fed at a minimum helped perpetuate a fraud on investors and counterparties.

This pattern further suggests the Fed, which by its charter is tasked to promote the safety and soundness of the banking system, instead, via its collusion with Lehman management, operated to protect particular actors to the detriment of the public at large.

And most important, it says that the NY Fed, and likely Geithner himself, undermined, perhaps even violated, laws designed to protect investors and markets. If so, he is not fit to be Treasury secretary or hold any office related to financial supervision and should resign immediately.

I am reading the report, and will provide an update later, but here are the key bits (hat tip reader John M). As much as Karl Denninger has done some terrific initial reporting, he does not go far enough as far as the wider implications are concerned.

Tim Cavanaugh in Reason:

But in his brief appearances in the 336-page report, Geithner’s main concern seems to be with preventing a panic over the diseased state of Lehman. Geithner not only acknowledges his efforts at concealment, but seems to believe they were the right thing to do:

In addition to the losses Lehman would incur by selling “sticky” assets at firesale prices, deleveraging also raised the additional problems of market perception and valuation.3187 As Secretary Timothy Geithner explained to the Examiner, selling “sticky” assets at discounts could hurt Lehman by revealing to the market that Lehman “had a lot of air in [its] marks” and thereby further draining confidence in the valuation of the assets that remained on Lehman’s balance sheet.3188

The first sentence is drawn from a November interview between Geithner and Valukas, the second from “Reducing Systemic Risk In A Dynamic Financial System,” a speech Geithner delivered in June 2008. To say dressing up Lehman’s bleeding sores was wrong, you need to acknowledge that a central bank should not engage in the suppression of information, and I’m pretty sure we lost that argument a long time ago.

Smith suspects (not without reason) that this mission to regulate the market’s feelings toward Lehman led Geithner to connive at what certainly looks to have been a fraud: the erroneous counting of “501 Repos” — assets Lehman sold with an agreement to repurchase — as straightforward sales. That is, the outside world thought these toxic assets were gone from Lehman’s books, when in fact they were merely festering. Smith has some interesting words about whether, and why, Lehman counterparties went along with this charade. (Likeliest answer: They were all betting on the come like the rest of America.)

Tyler Durden at Zero Hedge:

That this scam was going unsupervised (just who the hell were the counterparties?) for many years, and that many banks are likely using it right now to fool investors, regulators, rating agencies, and the idiots at the FRBNY (who certainly also know about this), is beyond criminal. Yet that nobody will go to jail for this is as certain as the market going up another 10% tomorrow. A full investigation has to be conducted immediately into whether existing Wall Street firms, and in particular those who use Ernst & Young as auditors, are currently abusing public confidence via such transactions.

Stephen Gandel at Curious Capitalist at Time:

This seems like fraud to me. The examiner calls it “actionable” and he says the moves open Lehman and its executives up to suits from shareholders who could claim, it appears rightly so, that they were mislead. Still I am not convinced accounting played as big a role in this crisis as past ones. Here’s why:

Yes, Lehman does seem to have hid some of its loans. And that means other banks were probably using this trick as well. But how much did the trick distort Lehman’s books. Not much. In fact, even if Lehman had made all of its loans available for everyone to see it’s not clear that any investors would have cared, or the NY Fed would have spent one more minute thinking about the firm’s solvency.

That’s because the vast majority of its loans and illiquid investments were out there for all to see. In fact, if you add back in the $50 billion the firm was hiding the firm’s net leverage ratio moves from 12.1 to a whopping 13.8. Merrill Lynch had a leverage ration of more than three times that.

What the moves did do was to shield the firm from criticism from the likes of short-sellers like David Einhorn who claimed the situation at Lehman was getting worse, but couldn’t prove it. On the margin, Lehman’s accounting trick made it look like its leverage ratio was either stable or improving. Nonetheless, people like Einhorn didn’t need another reason to short Lehman Brothers. They already knew something smelled at Lehman. They just didn’t know what they were smelling was slightly worse than they thought.

Perhaps the biggest takeaway from this is that Sarbanes-Oxley has again proven useless in preventing corporate fraud. Accounting fraud is exactly the type of thing Sarbox was supposed to stop by beefing up corporate boards and imposing new accounting oversight all the way up to the board level. But the Lehman examiner’s report says the investment bank’s executives were able to keep its board in the dark. The examiner says board members appear to have had no knowledge of the “Repo 105” accounting trick. Just another sign that the true failing that caused the financial crisis was at its heart a regulatory one.

Larry Doyle at Wall Street Pit:

Reports that Lehman was effectively ‘cooking its books’ prior to its ultimate demise are not a surprise.

Reports that Dick Fuld, then CEO of Lehman, was not aware of the nature of this cooking are both ridiculous and pathetic.

The lifeblood of every financial institution on Wall Street is access to financing for its operations. That financing very often comes in the form of repurchase agreements (repo financing), in which the institution borrows funds while pledging assets. These short term loans, often overnight loans, are unwound at a preset date and preset prices. The rates borrowers have to pay for funds borrowed depend on the credit quality of the borrower itself and the quality of the assets pledged.

UPDATE: Mike Konczal at Rortybomb

James Kwak at Baseline Scenario

Naked Capitalism

Kevin Drum

Felix Salmon

Jon Stewart

A Scattering Of Blog Posts Concerning Greece, Germany, And EMF

Anne Applebaum in Slate:

The Germans are fed up with paying Europe’s bills. They don’t want to bail out the feckless Greeks with their flagrantly inaccurate official statistics; they resent being Europe’s banker of last resort; they object to the universal demand that they plug the vast holes in the Greek budget deficit in the name of “European unity”; and for the first time in a long time they are saying it out loud. Not only are tabloids demanding the sale of the Acropolis, Frankfurter Allgemeine Zeitung, Germany’s deeply serious paper of record, has pointed out that while the Greeks are out protesting the raising of the pension age from 61 to 63, Germany recently raised its pension age from 65 to 67: “Does that mean that the Germans should in future extend the working age from 67 to 69, so that Greeks can enjoy their retirement?’

With an unerringly poor sense of timing, the Greeks have, in response, chosen precisely this moment to flaunt their own set of resentments. One Greek minister complained to the BBC that the Nazis “took away the Greek gold that was in the Bank of Greece, they took away the Greek money and they never gave it back.” The mayor of Athens has demanded 70 billion euros for the ruins the Nazis left behind after the war. The Greek consumer organization, not exactly thankful for the German bailout or Europe’s demands for Greek budget cuts, has called for a boycott of German products. Officially, the Germans have described these comments as “not helpful.” Unofficially, the German press is foaming at the mouth (see above), for once reflecting accurately the views of both German politicians and German voters.

More curious is the question of why this is happening at this particular moment: After all, the Germans have been paying for European unity—not just the currency but the farming subsidies, the assistance to poorer regions, the highways in Spain and Ireland—for decades without ever complaining much. In Warsaw, one sees children’s playgrounds proudly bearing signs declaring that they have been “built with European money,” most of which presumably comes from German taxpayers. So why are those German taxpayers suddenly complaining about the Greeks?

Tyler Cowen:

Say that Portugal, Italy, and Greece were more like Germany, economically speaking that is.  Toss in Albania to make the contrast starker.  They would have higher productivity and higher output.  They would export more.  But with their higher wealth, they would import more too.  That includes more imports from Germany, most likely.  German *net exports* might well decline, as Germans buy more olive oil and high-powered computer software from Albania.  But German exports need not decline *on net* (over a longer run of continuing global growth they certainly will not decline) and that should prove good enough for the German model to sustain itself.

No economist thinks that being wealthy is a zero-sum game.  “Being like Germany” isn’t exactly the same as being wealthy, but the German model succeeds (in large part) because of its high absolute level of exports.  “Net exports” is a zero-sum game at any single point in time, but when it comes to secular growth that’s also not the variable which matters.

The bottom line is that people are blaming Germany (and China) a bit too much here.

The Prudent Investor at Seeking Alpha:

Word has probably spread that the European Union is now attempting to solve the debt crisis with the creation of a European Monetary Fund (EMF). This shows one more time the fierce commitment of the EU to fight debt with new debt – which has never worked in history – instead of developing a radical banking reform that would curb derivatives and impose strict rules on off-balance sheet risks while tackling soaring budget deficits aggressively.

As with most “important” announcements these days – of which most are vaporizing overnight in a EU where governments begin to mutually shoot broadsides against their Pan-European fellows – the EMF “plan”, initiated by German Finance Minister Wolfgang Schaeuble, is maybe a headline-grabber, but lacks among all details the most important one: Where will the money come from?

While EMF may sound trustworthily as a word game on the IMF (International Monetary Fund), this blogger wonders which Eurozone member could fund this monetary fund. As all Eurozone countries except micro-sized Luxemburg are currently confronted with a massive expansion of budget deficits that precede higher debt-to-GDP ratios in 2010 and 2011, there are simply no funds around that could go into the proposed EMF unless Eurozone members kiss goodbye another part of what is left of their gold reserves. In comparison, the IMF sits on a hoard of 3,000 metric tons (of which close to 200 tons are earmarked for sale this year). Unfortunately, as they kept selling the best performing asset of the last decade – gold – central banks and the governments behind them will not be very keen to continue this foolish course of giving away gold, the only money (not currency) that has never lost its value.

Free Exchange at The Economist:

OVER the past few days, several economists, both in America and Europe, have weighed in on Daniel Gros and Thomas Mayer’s proposal for a European Monetary Fund (EMF). They have raised questions both about the need for an EMF in principle, and about its feasibility and usefulness in the present context, i.e. Greece’s troubles. I think it’s fair to say that Messrs Gros and Mayer’s ideas came in for a good deal of criticism from our invited experts on all these counts.

The guest piece argued that:

The difficulties facing Greece and other European borrowers expose two big failures of discipline at the heart of the euro zone. The first is a failure to encourage member governments to maintain control of their finances. The second, and more overlooked, is a failure to allow for an orderly sovereign default.

Our commenters were by and large unconvinced that that there was a need for a new institution to do what existing institutions were already doing bits of. This applied particularly strongly to the idea of the EMF as a way to enforce fiscal discipline.

Desmond Lachman wrote:

“What is even less clear is why Gros and Mayer would want to reinvent the wheel by creating a European Monetary Fund, when one has the International Monetary Fund that already has the expertise to impose the appropriate conditionality on lending to wayward countries like Greece”

But maybe the EMF would do a better job than the IMF? Edwin Truman was sceptical, saying that “if the EMF were tougher than the IMF is on average in terms of its economic and financial conditions, then Euro area countries would prefer to go to the IMF for assistance”.

Tyler Cowen argued that the “underlying problems of European multilateral governance” are unlikely to “be solved by creating an entirely new and different institution”. He would rather the ECB were reformed by broadening its focus beyond price stability, than an EMF set up. Carmen Reinhart worried about the ECB and the EMF (if one were indeed to be set up) butting heads.

Simon Johnson at Baseline Scenario:

By the end of 2011 Greece’s debt will around 150% of GDP (the numbers here are based on the 2009 IMF Article IV assessment; we make some adjustments for the worsening economy and the restating of numbers since that time – for example, the fiscal deficit in 2009 will likely turn out to be about 8 percent, which is double what the IMF expected until recently).  About 80 percent of this debt is foreign owned, and a large part of this is thought held by residents of France and Germany.  Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of GDP abroad to those bondholders.

What if Greek interest rates rise to, say, 10% – a modest premium for a country which has the highest external public debt/GDP ratio in the world, which continues (under the so-called “austerity” program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, and which is struggling to establish any sustained backing from the rest of Europe?  Greece would need to send at total of 12% of GDP abroad per year, once they rollover the existing stock of debt to these new rates (nearly half of Greek debt will roll over within 3 years).

This is simply impossible and unheard of for any long period of history.  German reparation payments were 2.4 percent of GNP during 1925-32, and in the years immediately after 1982, the net transfer of resources from Latin America was 3.5 percent of GDP (a fifth of its export earnings).  Neither of these were good experiences.

On top of all this Greece’s debt, even under the IMF’s mild assumptions, is on a non-convergent path even with the perceived “austerity” measures.  Bubble math is easy.  Hide all the names and just look at the numbers.  If debt looks like it will explode as a percent of GDP, then a spectacular collapse is in the cards.

Seen in this comparative perspective, Greece is bankrupt today without a great deal more European assistance or without a much more drastic austerity program. Probably they need both.

Given there’s a definite bubble in Greek debt, should we expect European politicians to help deflate this gradually?  Definitely not – in fact, it is their misleading statements, supported in recent days (astonishingly) by the head of the International Monetary Fund, that keep the debt bubble going and set us all up for a greater crash later.

The French and Germans are apparently actually encouraging banks, pension funds, and individuals to buy these bonds – despite the fact senior politicians must surely know this is a Ponzi scheme, i.e., people can get out of Greek bonds only to the extent that new investors come in.  At best, this does nothing more than postpone the crisis – in the business, it is known as “kicking the can down the road.”  At worst, it encourages less informed people (including perhaps pension funds) to buy bonds as smarter people (and big banks, surely) take the opportunity to exit.

While the French and German leadership makes a great spectacle of wanting to end speculation, in fact they are instead encouraging it.  The hypocrisy is horrifying – Mr. Sarkozy and Ms. Merkel are helping realistic speculators make money on the backs of those who take seriously misleading statements by European politicians.  This is irresponsible.

Paul Krugman:

So how is that possible? Suppose that Greece had as much credibility as Germany, and could borrow at a real interest rate of 2 percent. Then stabilizing the real value of its debt, even with a debt ratio of 150 percent, would require a primary surplus of only 3 percent of GDP. That’s certainly possible for some countries, although maybe not for Greece.

Boone and Johnson assume, however, that Greece would have to pay 10 percent nominal, say 8 percent real. Servicing that would require a primary surplus of 12 percent of GDP, probably impossible for almost anyone.

So this suggests that optimism or pessimism about future default can, to at least some degree, be a self-fulfilling prophecy. Not a new insight, I know, but it looks increasingly important for thinking about where we are now.

UPDATE: Henry Farrell

Ryan Avent at Free Exchange at The Economist

Matthew Yglesias

Petting The Fat Cats

Julianna Goldman and Ian Katz at Bloomberg:

President Barack Obama said he doesn’t “begrudge” the $17 million bonus awarded to JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon or the $9 million issued to Goldman Sachs Group Inc. CEO Lloyd Blankfein, noting that some athletes take home more pay.

The president, speaking in an interview, said in response to a question that while $17 million is “an extraordinary amount of money” for Main Street, “there are some baseball players who are making more than that and don’t get to the World Series either, so I’m shocked by that as well.”

“I know both those guys; they are very savvy businessmen,” Obama said in the interview yesterday in the Oval Office with Bloomberg BusinessWeek, which will appear on newsstands Friday. “I, like most of the American people, don’t begrudge people success or wealth. That is part of the free- market system.”

Obama sought to combat perceptions that his administration is anti-business and trumpeted the influence corporate leaders have had on his economic policies. He plans to reiterate that message when he speaks to the Business Roundtable, which represents the heads of many of the biggest U.S. companies, on Feb. 24 in Washington.

Greg Sargent:

The White House is making a transcript of the interview available to anyone who asks, and the comments seem a bit more nuanced than the headlines suggest:

QUESTION: Let’s talk bonuses for a minute: Lloyd Blankfein, $9 million; Jamie Dimon, $17 million. Now, granted, those were in stock and less than what some had expected. But are those numbers okay?

THE PRESIDENT: Well, look, first of all, I know both those guys. They’re very savvy businessmen. And I, like most of the American people, don’t begrudge people success or wealth. That’s part of the free market system. I do think that the compensation packages that we’ve seen over the last decade at least have not matched up always to performance. I think that shareholders oftentimes have not had any significant say in the pay structures for CEOs.

QUESTION: Seventeen million dollars is a lot for Main Street to stomach.

THE PRESIDENT: Listen, $17 million is an extraordinary amount of money. Of course, there are some baseball players who are making more than that who don’t get to the World Series either. So I’m shocked by that as well. I guess the main principle we want to promote is a simple principle of “say on pay,” that shareholders have a chance to actually scrutinize what CEOs are getting paid. And I think that serves as a restraint and helps align performance with pay.

The other thing we do think is the more that pay comes in the form of stock that requires proven performance over a certain period of time as opposed to quarterly earnings is a fairer way of measuring CEOs’ success and ultimately will make the performance of American businesses better.

It seems like there’s a bit more of an emphasis here than the initial story suggested on his support for specific measures to check the long-term trend of inflated bonuses, and the thrust of his comments seem aimed at combating the perception that such policies are anti-business.

That said, that substance was bound to be overshadowed by Obama’s praise for the businessmen as “savvy,” his general unwillingness to “begrudge” wealth, and his discussion of their outsized bonuses in the context of the “free market system,” which seems off key, given the massive taxpayer bailouts of the financial industry.

Simon Johnson at Baseline Scenario:

Does the president truly not understand that Dimon and Blankfein run banks that are regarded by policymakers and hence by credit markets as “too big to fail”?

This is the antithesis of a free-market system.  Not only were their banks saved by government action in 2008-09 but the overly generous nature of this bailout (details here) means that the playing field is now massively tilted in favor of these banks.  (I put this to Gerry Corrigan of Goldman and Barry Zubrow of JP Morgan when we appeared before the Senate Banking Committee last week; there was no effective rejoinder.)

Not only that, but the incentives for the people running these megabanks is now to take on reckless amounts of risk.  They get the upside (for example, in these compensation packages) and – when the downside materializes – this is belongs to taxpayers and everyone who loses a job.  (See my testimony to the Senate Budget Committee yesterday; there was no disagreement among the witnesses or even across the aisle between Senators on this point.)

Being nice to the biggest banks will not save the midterm elections for the Democrats.  The banks’ campaign contributions will flow increasingly to the Republicans and against any Democrats (and there are precious few) who have fought for real reform.

The president’s only political chance is to take on the too big to fail banks directly and clearly.  He needs to explain where they came from (answer: the Reagan Revolution, gone wrong), how the problem became much worse during the last administration, and how – in credible detail – he will end their reign.

James Kwak at Baseline Scenario:

More generally, Obama is trying to strike a balance: put pressure on Wall Street while not appearing to be wielding a pitchfork himself. This is why he felt compelled to say, “I, like most of the American people, don’t begrudge people success or wealth. That is part of the free- market system.” At the same time he feels compelled to advocate for relatively mild reforms, such as paying bonuses in stock instead of cash, which is at best a partial solution. (Top Wall Street executives were already paid overwhelmingly in stock rather than cash before the financial crisis.)

I’m not sure why he needs to strike that balance. CEOs are overpaid, bankers are overpaid, and bank CEOs are overpaid.  Why not just say it plainly?

Paul Krugman:

Oh. My. God.

We’re doomed.

First of all, to my knowledge, irresponsible behavior by baseball players hasn’t brought the world economy to the brink of collapse and cost millions of innocent Americans their jobs and/or houses.

And more specifically, not only has the financial industry has been bailed out with taxpayer commitments; it continues to rely on a taxpayer backstop for its stability. Don’t take it from me, take it from the rating agencies:

The planned overhaul of US financial rules prompted Standard & Poor’s to warn on Tuesday it might downgrade the credit ratings of Citigroup and Bank of America on concerns that the shake-up would make it less likely that the banks would be bailed out by US taxpayers if they ran into trouble again.

The point is that these bank executives are not free agents who are earning big bucks in fair competition; they run companies that are essentially wards of the state. There’s good reason to feel outraged at the growing appearance that we’re running a system of lemon socialism, in which losses are public but gains are private. And at the very least, you would think that Obama would understand the importance of acknowledging public anger over what’s happening.

But no. If the Bloomberg story is to be believed, Obama thinks his key to electoral success is to trumpet “the influence corporate leaders have had on his economic policies.”

Michael Scherer at Swampland at Time

Digby:

He’s not a stupid man. The only thing you can conclude is that this is a matter of principle for him and that he truly believes that these people are worth that kind of money despite the fact that they nearly destroyed the world financial system and are benefiting from its chaos and failure.

And it clarifies once and for all that he doesn’t understand the very real angst out in the country and the desperate need to hold someone, somewhere, accountable for what’s gone wrong. Evidently, he’s perfectly content to allow the government to take the blame for the whole sorry mess.

Daniel Foster at The Corner:

On the subject of the latest round of Wall Street bonuses, President Obama recently told Business Week that he, “like most of the American people, [doesn’t] begrudge people success or wealth.”

“That is part of the free-market system,” the president said.

Perhaps the president’s softening toward capitalism has something to do with the fact that fewer Wall Street CEOs are flocking to his $30,000-a-head steak and lobster dinners ever since the phrase “fat cat” gained currency in Washington. But in any event, the president’s praise of the free market is about as bland and uncontroversial as it gets, and even so, the White House is already starting to walk them back.

But the ever-understated Paul Krugman, responding to the Obama interview on his blog, is not pleased. Borrowing the mantle of our own John Derbyshire, he says: “Oh. My. God. . . . We’re doomed.”

A Has-Ben?

David Dayen at Firedoglake:

No, health care was the first casualty. But Roll Call has an incredible article up, reporting from the Senate that Ben Bernanke’s nomination for a second term at the Fed is in real trouble.

Ben Bernanke’s nomination to serve a second term as chairman of the Federal Reserve appears to be in peril. Bernanke is up for a second term at the Fed; his current term expires in 10 days on Jan. 31. A handful of Senators had previously threatened to filibuster the nomination, but this week the number of opposing lawmakers appeared to grow, further dimming his prospects for installment.

“I think it’s worthy of a review,” said Sen. Bob Casey (D-Pa.), who is undecided.

Majority Leader Harry Reid (D-Nev.) met with Bernanke on Thursday, one day after Democrats voiced concerns during their weekly policy luncheon about the nomination. In a statement after his meeting with the Fed chairman, Reid was coy, saying the two met “to discuss the best ways to strengthen and stabilize our economy.” […]

At Wednesday’s Democratic caucus meeting, according to Senators, liberals spoke out against confirming Bernanke for a second term. Those liberals tried to make the case that the White House needs to put in place fresh economic advisers to focus on “Main Street” issues like unemployment rather than Wall Street concerns. Moderates were more reserved, Senators said, but have similarly withheld their support for Bernanke.

Wow, wow, wow. We knew that today’s announcement – you could call it Glass-Steagall II – that “no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit” was a big real, and represented the triumph of Paul Volcker over the more slave-to-Wall Street elements in the White House. The picture here says it all about who appears to be winning and losing, at least today, in the White House. And I hope more is on the way.

But Bernanke is a different matter. The nomination was thought to be all but done. There were a few on the right and a few on the left in the Senate against it, but despite the multiple holds it looked like Bernanke had the requisite 60 votes to overcome them. But that’s completely in doubt now. Earlier this week we saw Bernanke making concessions. He asked GAO for an audit of the AIG bailout. This was clearly a move to try and make Senators more comfortable with voting for him. As of today, it doesn’t appear to be working.

Mark Tapscott at Washington Examiner:

Federal Reserve Board Chairman Ben Bernanke’s confirmation vote by the Senate for a second four-year term has been delayed, pending receipt by the committee of documents concerning the Fed’s role in the massive bailouts of the U.S. financial industry in 2008 during the economic meltdown.

Three Republican senators – all members of the Senate Banking Committee – are pushing for release of all documents concerning the Fed’s role in the bailouts, especially that of the crippled insurance giant AIG before the confirmation vote is taken.

“This was the right decision to delay the vote on the Bernanke nomination, because the Fed continues to stonewall Congress and the public,” said Sen. Jim DeMint, R-SC. “We cannot rush ahead with the Bernanke nomination while examinations by Congress and the GAO of the Fed’s AIG bailout are ongoing.

“Senators should not be put in a position to vote before they know the full story behind Chairman Bernanke’s role in the bailout and financial meltdown, what the Fed knew and when, and how severe the losses for the taxpayers will be. Chairman Bernanke and the Fed could speed this process up by opening up the Fed to a full audit,” DeMint said.

Similarly, Sen. David Vitter, R-LA, said the vote should be delayed until all requested documents have been provided by the Fed.

“As I Stressed to Chairman Dodd before the committee vote on Bernanke, it is vitally important that Congress has the ability and time to adequately review the Federal Reserve’s bailout of AIG,” said Vitter. “Although some of our offices have had time to review some of the documents, not all are available at this time and Congress should wait until GAO’s review before proceeding with his nomination vote.”

Simon Johnson at Baseline Scenario:

There are three specific questions that Bernanke must answer, in some convincing detail, if he is to shore up his weakening cause in the Senate.

1. Does he support the President’s proposed emphasis on limiting the scope and scale of big banks?
2. With regard to the key detail, is it his view that the size of big banks can be capped “as is” or – more reasonably – should we require these banks to contract or divest so as to return to the profile of system risk that prevailed say 15 or 20 years ago?
3. If Congress cannot act in the short-term, because of opposition from Republicans and some Democrats, does he see the Fed’s role as taking the initiative in this arena – or will he wait passively for the legislature to act?

As running hard against the “too big to fail” banks is now a major theme of 2010 and beyond for the Democrats, how can any Democratic Senators feel comfortable voting for Ben Bernanke unless they know exactly what his position is on all of these points?

And given what we know about Bernanke’s record and positions relative to these questions, absent new information it is not a surprise to see his support dwindling.

Doug Mataconis at Below The Beltway

Joe Weisenthal at Clusterstock:

FireDogLake points to a gated article at Capitol Hill publication Roll Call about the growing Democratic revolt against Bernanke.

The bottom line: There’s a growing chorus of Democrats who aren’t so keen on re-appointing Bernanke just yet. The latest is Pennsylvania Senator Bob Casey.

If Ben Bernanke is tossed the market will go into a tizzy that will make yesterday seem like child’s play. Even Warren Buffett recently told CNBC that if Ben Bernanke isn’t going to get re-confirmed he wants to know a day in advance (so he can sell stocks).

It still seems likely that Bernanke will get re-appointed, but the winds are definitely blowing against him. He’s much more in league with Geithner and Summers (ideologically) than he is with current White House hero Paul Volcker.

Eric Zimmermann at The Hill:

Sen. Barbara Boxer (D-Calif.) has become the latest lawmaker to announce her opposition to Ben Bernanke’s second term as Fed chairman.

In a statement released to the Huffington Post, Boxer said that while she respects Bernanke, it is “time for a change.”

“Dr. Bernanke played a lead role in crafting the Bush administration’s economic policies, which led to the current economic crisis,” said Boxer. “Our next Federal Reserve Chairman must represent a clean break from the failed policies of the past.”

Boxer’s statement comes just hours after another liberal Democrat, Sen. Russ Feingold (D-Wisc.) announced his opposition to Bernanke.

UPDATE: Lots of posts on Bernanke, we’ll just give you a few:

Brad DeLong

Matthew Yglesias

Kevin Drum

Paul Krugman

Calculated Risk

Noam Scheiber at TNR

Stan Collender

Bruce Bartlett

Peter Suderman at Reason

Ride Of The Volcker-ies

Simon Johnson at Baseline Scenario:

Paul Volcker, legendary central banker turned radical reformer of our financial system, has won an important round.  The WSJ is now reporting:

President Barack Obama on Thursday is expected to propose new limits on the size and risk taken by the country’s biggest banks, marking the administration’s latest assault on Wall Street in what could mark a return — at least in spirit — to some of the curbs on finance put in place during the Great Depression.

This is an important change of course that, while still far from complete, represents a major victory for Volcker – who has been pushing firmly for exactly this.

Thursday’s announcement should be assessed on three issues.

1. Does the president provide a clear statement of why we need these new limits on banks?  The administration’s narrative on what caused the crisis of 2008-09 has been lame and completely unconvincing so far.  The president must take it to the banks directly – tracing the origins of our “too big to fail” vulnerabilities to the excessive deregulation of banks following the Reagan Revolution and emphasizing how much worse these problems became during the Bush years.
2. Are the proposed limits on the total size (e.g., assets) of banks, or just on part of their operations – such as proprietary trading?  The limits need to be on everything that banks do, if they are to be meaningful at all.  This is not a moment for technocratic niceties; the banks must be reined in, simply and directly.
3. Is there a clear strategy for (a) taking concrete workable proposals directly to Congress, and (b) win, lose, or draw in the Senate, running hard with this issue to the midterm elections?

Push every Republican to take a public stand on this question, and you will be amazed at what you hear (if they stick to what they have been saying behind closed doors on Capitol Hill.)

The spin from the White House is that the president and his advisers have been discussing this move for months.  The less time spent  on such nonsense tomorrow the better.  The record speaks for itself, including public statements and private briefings as recently as last week – this is a major policy change and a good idea.

Tyler Cowen:

Obama proposes a new banking plan and everyone is commenting for instance here is Simon Johnson.  The plan seems to involve limits on bank size and limits on proprietary trading.  Some time ago I decided not to “chase around” all the different banking plans on tap.  First, it would make me dizzy, and second it is hard to evaluate the plans in their early forms.  But here are some general questions you should ask about any plan:

1. Do its restrictions apply to subsidaries, affiliates, and holding companies in a meaningful way?  Can they apply?

2. How do the restrictions apply to off-balance sheet activities, if at all?  Keep in mind the various lessons about the construction of synthetic asset positions.

3. How will Congressional oversight committees apply and interpret the plan?  This is a big one.

4. Can a financial institution avoid or sidestep the restrictions by changing its status as a commercial bank, legally speaking?

5. If you cap bank size, are the new and smaller banks still “too big to fail” by prevailing standards?

6. How does the proposal treat bank leverage, including implicit forms of leverage through off-balance sheet activities?  Does leverage get redistributed elsewhere?

7. How does it affect the political economy of bank lobbying?

I don’t pretend to know the answers to these questions for the new Obama plan nor do I expect such answers to be announced on day one.

Edmund Andrews:

The politics of this are obvious enough: after the Massachusetts disaster, which has dealt a major blow to the prospects for passing even a weak health care reform, Obama is reaching for something — anything! — to change the subject.   With the big bailed-out banks reporting hefty profits and ginormous bonuses this week, at the same time that they fight off regulation and a modest new tax, what better time than this to bash the banks.

At this writing, we don’t know any details about what Obama will propose.  They appear to echo ideas that Paul Volcker, the former Fed chairman, has been pushing in vain at least a year now.

Despite the whiff of desperation and cynicism surrounding this new push, the White House has good reasons to get tougher with the big banks.

The financial industry has been shameless about taking bailouts without taking responsibility for the reckless lending that gave us the crisis of the century.  The banks have spent millions fighting the proposed Consumer Financial Protection Agency, even though outrageous mortgages were at the heart of of the  meltdown.  They have managed to dilute House legislation that would require financial derivatives to be traded on exchanges or through clearing houses (because, Lordy, that would force them to put up margin payments to secure the trades).   And they got House lawmakers to limit the ability of state regulators to impose tougher rules than the Feds  (recall that Federal regulators fought all the way to the Supreme Court to prevent states like New York and North Carolina from getting out in front on abusive mortgages).

We shouldn’t use regulation as a form of punishment or for pandering to populist fury on both the right and the left.  But there are good reasons to limit the size and operational range of financial institutions.

Naked Capitalism:

This all sounds well and good, in fact, I’ve advocated prohibiting prop trading (you’d need pretty active monitoring of overnight positions to make sure it has not simply been moved back to order flow desks). It is not a socially productive activity and has no place in firms enjoying government backstops.

But how do you “limit” prop trading in firms that have international operations? Without the famed “harmonisation” with the UK and EU, I’m curious as to how this can be implemented as to not be circumvented (the UK bonus tax fiasco is an embarrassing reminder of blood-minded the industry is about preserving its perquisites).

This is going to be very difficult to implement at this juncture, unless Team Obama has a purely regulatory solution. This should have been implemented months ago, when the banks were on the ropes and beholden to Washington. They are now emboldened and will fight tooth and nail. And the report at the Financial Times says the plan will require new legislation. Given how derivatives reform was gutted and health care reform was botched, what do you think the odds are that something with teeth will be voted in? Pretty close to zero.

Arnold Kling:

In principle, I am against attempts by government to structure industries. But I take the view that the political economy of small banks is better than that of large banks. Large banks find it easy to persuade regulators that they are doing wonderful things and find it easy to persuade politicians that they need to be bailed out. Maybe small banks would find this task somewhat harder.

Felix Salmon:

The banks of course will scream blue murder, while at the same time trying to say that those kind of walls exist already. But they can’t have it both ways. I’m also fascinated by the fact that Paul Volcker’s fingerprints are all over this announcement, while the names of Larry Summers and Tim Geithner are nowhere to be seen. Has Volcker done some kind of an end-run round Summers while no one noticed? I guess that things will come into more focus tomorrow. I, for one, can’t wait.

UPDATE: Megan McArdle

Jim Manzi at The American Scene