Between a ‘Derm and a Donkey

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2010.01.14  MEA CULPA – The following entry was based on a news report that mislabeled bank assets (loans, credit) as liabilities (deposits, capital). That’s a common mistake — most people would tend to think of money that someone else put into their care as an “asset”. After reading the FT’s front page story on the proposed bank levy, we note that it’s designed to be applied to exactly the kinds of assets that helped to precipitate the financial crisis. We therefore apologize for calling it a joke, and for the other aspersions we cast in its direction (see below). Our initial assessment was obviously wrong. It might not be a bad idea, and perhaps the Obama administration has taken the position that it will be easier to administer than tighter capital requirements; or perhaps the threat of the tax is being used as leverage in tightening long term capital requirements.  However…

(1) A fifteen basis point haircut on typical investment bank returns, especially if nothing is done about the leverage that can be employed, is awfully skimpy;  

(2) There are still risks in who will actually bear the cost;

(3) the activities of investment banks actually do some social good, believe it or not;

(4) The President and Congress are still more like Herbert Hoover than FDR/JFK/RR; and

(5) We’re still stuck between ‘Derms and Dems for the foreseeable future.

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In our latest Idle Speculator, we asserted that in the years ahead, the U.S. economy was likely to remain stuck between a pachyderm and a donkey. If today’s events are any indication, it’s a good call. President Obama called for a punitive tax on large banks, and the only Republican response we’ve heard so far is from a Congresswoman who mostly railed against public spending. In our view, both sides continue to make little if any sense. 

President Obama’s bank tax would apply only to institutions with $50B or more in assets, and the rate would be 15 basis points (0.15%). However, the levy would not be on bank income, but rather on banks’ liabilities, i.e., deposits. What does this mean? We’d need to take a closer look once legislation is drafted, but based on what’s been said, here’s our initial impression:

First, the large banks aren’t going to pay a damn thing. Depositors (savers) are simply going to take a 0.15% haircut on the interest rate they receive, all else equal. Essentially, this will just act as an additional tax on people who deposit funds with large banks, and/or as a marginal incentive to deposit funds with other institutions.

Second, it won’t do anything to prevent the systemic leverage and boneheaded risk taking that got us into this mess. Systemic fragility arises when banks create too many assets (by extending credit) relative to their liabilities and capital. If the government wanted to prevent this through taxation rather than regulation (probably a bad idea to begin with), then it should be taxing bank assets. Of course, even then, it would simply mean that debtors’ interest rates would go up by the amount of the tax…which means the banks still wouldn’t pay a damn thing (refer back to point one).

In his remarks, the President said:

“My determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people who have not been made whole, and who continue to face real hardship in this recession…”

As in his recent comments on the jobs situation, the President shot well wide of the mark. While it’s reportedly an attempt to marshall populist support by attacking a particulary unpopular industry, the approach is a joke (as supporting evidence, we’d point out that Financials are the third best performing sector in the S&P 500 today, and that Money Center and Regional Banks are among the best performing industries within it). 

We can only infer that of late, the President has been listening to the very worst strategists in his Cabinet, folks who would recommend Herbert Hoover’s approach to economic crisis and recovery over FDR’s (or JFK’s or Reagan’s if you prefer) at a time when the latter’s is far more appropriate. Obama’s current hawkishness is evident in the AP article:

Obama said he was determined that every dollar spent from the $700 billion Troubled Asset Relief Program to rescue Wall Street firms, auto companies and mortgage holders is either repaid or paid for in some fashion.

His party’s hawkishness is also evident in the continuing failure to extend the COBRA subsidy under ARRA (a cynic might infer that this is intended to garner more support for heath care reform, but it’s a hawkish action either way). Thus, despite all the talk on the right and among tea party goers about “tax and spend liberals”, the reality looks quite different to us. The American electorate continues to be presented with only two choices — revenue hawks and budget hawks, i.e., higher taxes or lower spending – and those are essentially flip sides of the same coin.

In any case, forcing depositors to take a haircut, forcing debtors to pay marginally higher interest rates, or recovering every single dollar issued under TARP will do nothing to remedy the real hardships being faced by the American people in this recession. It also does nothing to prevent another financial crisis. If the President really wants to accomplish something on those counts, here are a few suggestions:

• Push hard for focused, meaningful financial regulatory reforms that will prevent excessive systemic fragility.
• Use the federal government’s creditworthiness and risk taking capacity to provide more direct assistance (i.e., employment) to the underemployed. 
• Stop being so terrified of budget deficits. Thinking about structural deficits is OK, but acting now to solve them could actually make the problem worse (ask Japan).
• Let private sector intermediaries (banks) use a historically steep yield curve to continue repairing their balance sheets by financing public deficits.
• If you insist on attacking TARP recipients, target the agents who control them (e.g., executive compensation or bonuses above a certain level), not owners, depositors, and borrowers.
• Enact policy measures that lower uncertainty, raise optimism, and thus increase the private demand for credit and investment.

You might also demand some accountability from whichever advisors had the most influence over today’s statement and last Friday’s…

URLs:

http://symmetrycapital.net/idlespeculation/20100112.pdf

http://news.yahoo.com/s/ap/20100114/ap_on_bi_ge/us_obama_bank_fees

http://biz.yahoo.com/p/

http://biz.yahoo.com/p/4conameu.html

http://www.dol.gov/ebsa/faqs/faq-cobra-arra.html

http://www.ft.com/cms/s/0/a025fd26-00ad-11df-ae8d-00144feabdc0.html

http://ftalphaville.ft.com/blog/2010/01/14/126481/the-back-of-the-envelope-bank-levy/

Auerback: Deficit Hawking

Good piece from Marshall Auerback on the risk of premature public sector tightening, as manifest in a proposed ‘deficit commission’.

…President Obama has voiced support for such a plan, as have 35 Democratic and Republican senators, who have signed on to legislation that would create a bipartisan commission with broad power to force painful spending cuts and tax increases through Congress….Even before its official inception, the proposed commission is starting with remarkably partisan assumptions about debt and entitlement programs. What is so inherently “unsustainable” about our current levels of government debt? In the early Victorian period, for example, the British government debt to GDP ratio was nearly 200 per cent and almost reached that level again in the early 1920s.  The historian Lord Macaulay noted that at every stage of debt increase, “it was seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever.”

The ideas which underlie this new commission also display fundamental ignorance about double-entry bookkeeping principles which have been in existence for over 7 centuries.

In truth, today’s deficit hawks are nothing more than zealots — poised again to preach their nonsensical theology that government deficits are dangerous and need to be cut, without honestly explaining the full consequences of their recommendations. If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then private sector incomes and real output will decline absent an increase in government spending. The danger of premature fiscal tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of Social Security taxes helped push the US back into recession when recovery from the Great Depression was far from complete.

I’m becoming a rather lonely wingnut, but we strongly suspect that Auerback and his ilk are right, and that the spending phobes and deficit hawks are wrong. If so, and if the Administration and Congress tighten prematurely, with or without the Fed, then the 1937 and 1990s Japan scenarios remain firmly in play. Time will tell.

URLs:

http://www.newdeal20.org/?p=7241

http://symmetrycapital.net/idlespeculation/2007110701.pdf

Rubin to the Rescue?

In Newsweek, former Goldman Sachs CEO, Clinton Treasury Secretary, and Citigroup bigwig Robert Rubin offers his analysis of the Great Recession and proposed nostrums for preventing another:

Given my views as to the causes of the crisis, I would recommend the following:

• There should be greatly increased capital and margin requirements for derivatives and other instruments of financial engineering to create a greater cushion when trouble develops and to reduce risk exposure. I developed this view during my many years of working with derivatives before entering government, as described in my 2003 book, In an Uncertain World.
• Standard derivative contracts should trade on an exchange to increase transparency. Transactions that are custom designed would not be exchange traded but would be subject to the same capital and margin requirements as listed transactions. Disclosure requirements could be considered for customized transactions, to provide private counterparties and regulators with the transparency to understand the risks.
• There should be two sets of more stringent leverage limitations for systemically significant institutions, one defined by risk-based models and the second by much simpler measures, since mathematical models can’t capture the full range of real-world possibilities.
• There should be significant constraints on off-balance-sheet financing; for example, institutions must retain ownership of a portion of off-balance-sheet assets.
• We need a change in accounting systems to avoid the artificial effects of mark-to-market accounting for illiquid assets on balance sheets and on markets. There are other accounting approaches that would better reflect long-run values for these assets.
• We should also provide effective mechanisms for dealing with systemically important nonbank financial institutions—including bank holding companies—that get into trouble, to mitigate “too big to fail” concerns, but practical ways to do this need to be developed.
• There should be greatly increased protections, both to safeguard consumers and to reduce systemic risk. The elements should include readily understandable disclosure, suitability requirements, prohibition of practices or instruments inherently susceptible to abuse, and, if some practical way can be found, personalized advice for the most vulnerable consumers.

Fair enough, mostly no brainers, but is Rubin being disingenuous? As we’ve previously written, there seem to be growing threats to to the man’s political capital, particularly within the Democratic party. And judging by this piece from Marshall Auerback, those threats still exist, and have intensified since 2006:

As one of the people whose policies threw the global economy off the rails, Rubin may be uniquely qualified to provide solutions as to how to get the economy back on track. But that would presuppose that the man actually acknowledged mistakes (as some of his other Goldman Sachs/Clinton Administration colleagues, such as Gary Gensler, have done) and displayed at least a marginal understanding of where he went wrong.

No such luck. We get the usual self-serving “nobody could have possibly predicted a crisis of this magnitude” right at the start…

Auerback cites a damning interview with the former head of the CFTC, Brooksley Born (a position now held by the aforementioned Gary Gensler):

…as analysts sort out the origins of what has become the worst financial crisis since the Great Depression, Born has emerged as a sort of modern-day Cassandra. Some people believe the debacle could have been averted or muted had Greenspan and others followed her advice.As chairperson of the CFTC, Born advocated reining in the huge and growing market for financial derivatives.

According to Auerback:

Rubin now suggests that Born’s problem was one of style, rather than substance: she, being “too confrontational”, risked aborting any politically feasible reform of OTC derivatives. That’s certainly an interesting reinterpretation of Rubin’s actual role as Treasury Secretary, during which he laid the groundwork for today’s crisis through an aggressive championing of financial deregulation. It’s hard to think of one instance where the former Goldman Sachs CEO actually came down hard on his former Wall Street colleagues. Had he at least acknowledged some remorse or recognition of error, he would be more appropriately suited for an advisory role on how to fix the global economy, much as a reformed criminal often has useful insights on penal reform.No such luck here. If being one of the worst Treasury Secretaries ever wasn’t enough, Rubin left another unfortunate legacy at Citigroup, where he was a senior advisor after he quit the Treasury. He left Citi just before its near collapse amidst criticism of his performance. A distinguishing moment of his tenure was when Rubin got hold of Peter Fisher in the US Treasury Department to try to put pressure on the bond-rating agencies to avoid downgrading Enron’ debt which was a debtor of Citigroup…

Letting him publicly expound on getting the global economy back on track is akin to providing Kim Il Jong-il a public platform on human rights. Unlike Greenspan, who at least admitted mistakes, Rubin expects to be taken seriously as a policy maker despite acknowledging zero responsibility for the debacle that threw millions of Americans into unemployment. People around the world have lost their jobs, savings, and more largely thanks to the policies championed by this misguided deficit warrior.

Ouch.

We’ll pile on by reminding people that as Treasury Secretary, Rubin presided over implementation of the “strong dollar” policy designed by his predecessor, Lloyd Bentsen, which had damaging effects on many developing nations’ economies. He’s also featured prominently in a recent list at Motley Fool of “The 10 Dumbest Banker Quotes of All Time”. And we agree with Auerback that a sincere mea culpa for past errors, whether at Treasury or Citigroup, would buy the man some badly needed goodwill. We think he should also expand his bullet points to include the following: 

• Let’s not repeat the mistake of believing that experts always know best.
• Let’s agree that optimal outcomes often require more than just unbridled private actors.
• Let’s resolve not to get caught up in any more cults of personality, whether adorer or adoree.

Update 01/07/2010 (via Mark Thoma) – Larry Summers, who is currently President Obama’s National Economic Council chief, and was Robert Rubin’s protege and eventual successor at the Clinton Treasury, also finds his political capital under attack from both the left and the right.   

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URLs:

http://www.newsweek.com/id/225623/page/2

http://www.amazon.com/gp/product/0375757309?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0375757309

http://www.newdeal20.org/?p=7270

http://www.stanfordalumni.org/news/magazine/2009/marapr/features/born.html

http://www.fool.com/investing/general/2009/11/25/the-10-dumbest-banker-quotes-of-all-time.aspx

http://www.economicprincipals.com/issues/2010.01.03/880.html

http://capitalgainsandgames.com/blog/bruce-bartlett/1373/summers-out

Kotok’s Scathing Indictment

We recently expressed our misgivings about Treasury Secretary Geithner; David Kotok of Cumberland Advisors let him — and the new Administration — have it with both barrels. This is an important read, whether one agrees with him or not (we do):

…Geithner (on page 81 and again on page 95) answered: “President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency. President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China’s currency practices.”

“Manipulation?”  “Aggressively?“  This is strong language.  Geithner did not do this on his own authority.  These are prepared answers.  He is citing the new President, not once but twice.

…the dollar [is] likely to get stronger.  Right now it is the default choice of the world.  We have currency strength not because we are so desirable but because we are currently better than the others…

So what do we do within 72 hours of launching the Obama administration that says it is seeking “change?”  We fire the first public salvo in what could easily become a trade war or a threat to global financial integration.

What makes us so credible?  Is it our proven record of regulatory oversight of our financial markets, as demonstrated by the Madoff scandal and the SEC?  Is it the way our rating agencies work so diligently to place a coveted “AAA” on paper that was peddled to the rest of the world and was found out to be highly toxic?  Is it the way we honor the promises of federal agencies by having tier-one-eligible Fannie and Freddie preferred held in the US and abroad by institutions, and then essentially cause a structural default on that preferred (actually, dividend suspension)?  Or is it the way the actions of Treasury and the Federal Reserve allowed a primary dealer (Lehman) to fail, thus triggering a global contagion?

C’mon?  Where is the plan to restore confidence and credibility and transparency and consistent policy for the United States?  And how does the Obama administration believe that launching a fight with China is beneficial?

In the 1930s the severe recession of 1929-1931 was turned into the depression of 1931-1933 because of protectionism.  Every historian knows that.  Every economist learns it in school.  This is well-known by Geithner and even better-known by Larry Summers and Paul Volcker.  They are the three members of the Obama economic troika.

The statement Geithner repeated twice was certainly known to them in advance.  Why did they not temper it?  What is the plan?  Do they want to threaten and see if China backs down?  This, too, is dangerous.  Do they intend to pursue the Schumer tariff scheme?  There are more questions than answers.

Lastly, Larry Summers was going to attend the World Economic Forum in Davos, Switzerland.  He has cancelled.  Why?  Was it because he did not want to have to face the private conversations that would follow such statements as have been made by Geithner in the name of the President?

Watch Davos closely.  And remember that the absence of statements is as revealing, if not more so, than the presence of them.  Not one mention of trade openness appears in our reading of the 100 pages of answers to the Senate.  Maybe someone else can find an affirmation of free and open trade.  I cannot.

We fear protectionism.  It starts with rhetoric. We now have that threat.  If it is pursued, it ends badly for everyone.  No one wins.

Cumberland also posted Geithner’s written Q and A responses on its website.

http://www.symmetrycapital.net/newsandviews/newsandviews/2009012240.html

http://www.cumber.com/special/geithnerquestions2009.pdf