bailouts

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Nationalize California!

I ended my post on Friday last week with a tongue in cheek question: should we nationalize California? Given the turmoil that has erupted since the announcement of a budget compromise this morning, nationalization may now be a serious option.

“California is a true banana republic – it would be laughable were it not for the tragedy about to unfold.”

California has managed itself to the edge of oblivion, and like GM or Chrysler it deserves no sympathy at all from the rest of us. It has a convoluted and seriously damaged legislative system riddled through with anachronistic nonsense like the perverse ‘proposition’ process that allows any rich group of people to band together and collect enough support to pass legally binding single issue proposals. These propositions are a deep rooted part of the current malaise: they contort the budget process and prevent any form of holistic management of problems. They are an activists dream, but a managers curse.

Similarly the state’s constitution is plainly out of date with its insistence on super majority votes for tax increases.

These two ridiculous governance antiques, plus the states deeply divided voter base, have produced a level of incompetence that has now reached comic proportions.California is a true banana republic – it would be laughable were it not for the tragedy about to unfold.

Because the proposition system has blocked property tax revenue increases – it worse than that: it has generated a huge diversion of tax burden away from the wealthy and onto the poor – California relies disproportionately on income taxes for the bulk of its revenue. naturally in a time of job loss and wage cuts that implies a big fall in state income.

At the same time other propositions allocate money to things like education.

So the budgetary room for maneuver is minimal.

Throw in an electoral system rigged to ensure re-election of incumbents of both parties, and it is surprising that the state has not imploded before. There is no incentive for elected officials to be responsive to voters: they are generally assured re-election. So personal advancement comes from adopting ever more extreme partisan positions. The result is that the state’s legislature is populated by politicians on both sides of the aisle who have a near kamikaze desire to be seen as inflexible: there are no-tax absolutists, and no-spending cut absolutists, but precious few people trying to solve problems.

The place is a joke. And it is an exemplar of how not to construct a democracy. It is ‘me-ism’ run amok. No wonder it sent us Ronald Reagan: the ultimate ‘me-ist’.

Now the chickens come home to roost.

With revenues collapsed, no ability to raise revenues because of the ‘no-tax’ folks, and an unwillingness to trim spending because of the ‘no-cut’ folks, the state’s budget has spiraled out of control for months.

Today’s ‘compromise’ is a resounding defeat for the people of California: services will be slashed, tens of thousands of jobs will be lost, and the state’s debt will rise sharply. The school system is about to be thrown back decades. And the poor will suffer the loss of many basic safety net programs.

In other words this is a victory for the Hooverites.

So: the state’s recession is about to deepen. Those lost jobs are lost revenues for local business. The damaged schools system suggests an impaired competitive position down the road. Lost jobs also means lost tax revenues: thus adding to the very problem the job cuts are designed to solve. And the new borrowing adds to the state’s future tax bill.

Examples of the carnage: 20,000 teachers fired; there will be no music teaching, no art, and no physical education funded. Low income children, about 930,000 of them, will have their benefits cut. Cities and other municipalities will lose about $4.7 billion in state funding – so they will have to cut also. And $1.3 billion will be cut from low income health care generally. And oil drilling off the coast of Santa Barbara is to be given the go-ahead.

Quite what oil drilling will do to solve a near term crisis I don’t know, but it looks as if the right wingers won this one hands down. Their property taxes won’t go up, so those pockets of wealthy citizens are safe, and they’ve just assured a good supply of low educated cheap labor to mow their lawns in the future.

It makes me cringe to think that an economy as wealthy as California’s: it is huge by international standards can be so poorly managed.

Nonetheless that’s where the state now is.

Unable to pay its debts because its citizens presumably don’t care about either the quality of life or their fellow citizens enough to figure out a better way of government.

As I said: were this GM the credit markets and the world at large would be walking smartly away from the place. It would be on its knees begging for assistance. We would be discussing a bail-out and the terms to attach to it.

And the shame is this: because California is such a large part of the US it’s cutbacks are likely to make our recession harder to throw off. Those extreme moves the state is taking are Hooverite – they are exactly opposite to what is needed. The federal stimulus will be blunted by the idiocy at the state level.

So: should we just nationalize the place, write a check to balance its budget, and then enforce management and constitutional changes to make sure it doesn’t screw up again? That’s what we did to GM. Why not California?

Addendum, Tuesday, 10:45 p.m.:

Here’s the New York Times on the California debacle. The end of the California dream? Perhaps. Most of the so-called sun states live an illusion. They are full of people who want services for low cost. It is the state equivalent of a ponzi scheme: the only way they get away with it is constant growth to generate extra revenues, not from setting the taxes high enough to pay for things, but by getting more people in. Of course, like all ponzi schemes, when the music stops something has to give. All the sun states will have to confront this issue sometime: the need for infrastructure clashes with the population’s ‘dream’ of something for nothing. Then reality sets in and disillusionment follows.

Addendum 2:

This review in Washington Monthly of a book by Kevin Starr captures the sense of decline well. No one can eliminate the possibility that California can recover. It will. But the scars will also be deep and that fizz that made the state so compelling for thirty to forty years has clearly gone. Now it’s more like a brooding adolescent: petulant, confused, and totally lacking innocence. Too bad, but they all grow up sometime.

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End of the Week: Banks; Health Care; the Fed; and California

It seems that the entire week has drifted sideways: nothing of note occurred to suggest that the economy’s trajectory has changed. We are still declining, albeit at a slower rate. The problems remain the same: unemployment, high debt, and a very weak banking system. The next few weeks are crucial. If the recovery is to take hold later this year we must see definitive evidence of that change soon. In particular businesses have to stop contracting and restructuring, and consumers have to start spending. At the moment the only part of the economy preventing collapse is the government. But the cost is monumental: if other sectors don’t get involved soon our prospects dim markedly and next year will be grim.

“Let me leave you with one thought to ponder this weekend: should we nationalize California?”

Having said that most people, including myself, still think that the most likely course for GDP is a very modest improvement in the fourth quarter this year followed by slow to moderate growth throughout 2010.

Plenty of things could derail the recovery, but here I want to focus on the ‘big issues’ still facing us as we clean up our mess:

  • The banks. We now have three kinds of banks. Those that are dead in all but name. Those who are alive, but too small to be bailed out. And the behemoths who could destroy us all any time soon. Citibank and Bank of America are the obvious examples of ‘dead’ banks. They exist at the whim of the taxpayer. Neither is making much money, and both are very vulnerable to any sort of new credit default increase stemming from the economy’s intractable unemployment outlook. Both will remain effectively nationalized for some time: it was revealed only this week that B of A has been operating under Fed ‘Memorandum of Understanding’ [‘MoU’] for a while. An MoU is a very severe form of regulatory censure that essentially forces a bank to take steps to remedy problems – presumably the regulators thought the bank was moving too slowly to rectify its more glaring issues, like the inadequacy of its management. As for ‘poor old Citi’ – well enough said. The sooner they tear that place apart and make it manageable once again the better.
  • I feel bad for the medium sized financial firms. No cares about them anymore. We seem to have run out of both patience and money, so any smaller bank that gets itself into trouble will most likely have to go through bankruptcy. Ultimately I think that’s a healthy situation: the sooner banks have to behave sensibly and manage risks with a view to absorbing the consequences of failure, the better off we will all be. Banks are an essential part of a capitalist economy, but they cannot be allowed to exploit taxpayer fear of a banking system collapse to feather their own nests. They have to understand that our guarantees come with strings: like really intrusive regulation.
  • And I mean intrusive. Which gets us to the big question: is anyone going to rein in the behemoths? Right now it appears not. There is now a ‘big two’: Goldman Sachs and JP Morgan Chase, both of whom are taking full advantage or our largesse in order to lard their own pay. I find it astonishing that these two organizations are so socially insensitive that they announce record bonus awards while millions of regular Americans are being fired as a direct consequence of the ineptitude and greed of the big banks. And let’s be clear: the banks were right in the center of the collapse. Their folly and obscene risk taking was a root cause of our crisis. For these two banks to profiteer so openly and greedily at trough of public fiscal and bail out cash is a horror to watch. It simply reinforces my thought that bankers at these places are too arrogant to be trusted: they are willfully exploiting their status as ‘too-big-to-fail’ to game the system and privatize all the gains while shoveling the losses our way. It has to stop.
  • But it won’t. The reason these two behemoths survived as well as they did was not simply skill. They are also incredibly well connected politically. Both have their fingerprints all over the administration’s reactions to the financial crisis: Bear Stearns, and AIG are the prime examples.
  • The lesson? We will not achieve long term GDP stability with our current economic and regulatory framework – the big banks must be tamed, at whatever the cost. Otherwise they will have captured us in true ‘oligarch’ style. An example? The ‘Sovereign Credit Default Swap’ market. Sovereign CDS’s are a stupid concept: they are insurance policies against the default by a national government. They make sense only in emerging world economies. But the market that has ‘recovered’ is that for US and UK CDS’s. There can be nothing more indicative of the speculative nature and gambling tone of the big bank trading desks. My question is this: if the US government defaults on its debt – which what some of these traders are insuring against – which bank will be liquid enough to make good on the insurance? By the time the US government goes down the entire credit system is most likely gone before. The only reason to buy this rubbish is to gamble. This is just one example of the folly that pads the profits of the behemoths. They are taking huge bets, knowing we will clean up after them. As I said: this has to be stopped.
  • My suggestion? Enforce huge capital requirements against all derivatives. In some cases really marginal derivatives should carry a capital requirement of more than 100%. I am all for financial innovation, but these schoolyard yahoos are not innovating they are playing games with our money. So we should put a burden on them: innovate all you want, but some of these products are beyond the pale. Some should be publicly ‘non-guaranteed’ – meaning a failure in its market would not be seen as as reason for bail out. Or they should be covered by huge capital burdens. Preferably both. Only by deliberately withdrawing our guarantee of the gambling can we impose discipline on the children on those trading floors.
  • Now: health care. There has been a lot of discussion about the costs of reform. Most of the information I have seen quoted is simply right wing rhetoric. The Congressional Budget Office has now ‘scored’ the proposed legislation and come up with a cost of about $1 trillion over ten years. In my view that’s cheap. The Bush tax cuts cost us about $1.7 trillion. The difference between the two is not just that health care is cheap by comparison, but that we are actually getting something for our money! The Bush tax cuts went predominantly to the top 5% of taxpayers – a very small number of citizens – whilst the CBO estimates that about 35 million people will benefit from health care reform.
  • I have mentioned this before, but rationing is a red herring in the health care debate. We already ration health care. All we are discussing is how to alter the way in which we ration it. In this vein I highly recommend Peter Singer’s recent New York Times article on rationing. Singer is a philosopher who deals with ethics and all the complications associated with making ethicalchoices. His article cuts away the garbage from the ‘rationing’ canard.
  • Getting health care reformed is essential not just from a public policy perspective, but from a GDP perspective. We allocate way too much of our annual wealth to health care. In order to re-establish our competitive position and in order to be able to invest in future oriented and wealth generating assets like education, we need to disinvest in health care. So cutting costs is vital to our economic health. The first step towards cost cutting is to get a viable public option in place to break up the health insurance pricing cartels that exist in most states.
  • Finally in todays round-up: the Fed. Next week will provide a big moment in this crisis. Bernanke is going to testify before Congress about his plans to undo some of the massive and highly unconventional things the Fed was forced to do in order to stave off depression. Unwinding the Fed’s balance sheet is primary within that.
  • Under ‘normal’ circumstances the Fed has a very small balance sheet. This recession it was forced to ramp up its assets so it could pump reserves into the banking system. The problem is that these reserves could result in inflation once the economy gets going again – don’t forget that I don’t think there is any danger of inflation just yet because the economy is so far below capacity. At some point, hopefully not too far off, the economy will be growing and those extra reserves will need to be drained back out. Since the pumping-in process was so unconventional and unprecedented there is huge doubt about the Fed’s plans to reverse course: both from a timing and practical point of view. So Bernanke is scheduled to explain how he proposes to do that ‘draining’. But, and please mark my words, he will absolutely not be talking about when the draining will take place. I am sufficiently skeptical about the ability of the media to differentiate between the ‘how’ and ‘when’ questions that I expect a flurry of articles on Thursday next week expounding on disappointment or confusion about what Bernanke has just said. Right now all we sensible folk need to know is how he can roll back his monetary support. As long as he explains that we will be happy.
  • Lastly on the Fed: There is significant opposition brewing towards the administration’s plan to give the Fed a much larger role in the new financial regulatory set up. This opposition is led by people like Paul Volcker. I am on the side of the opposition in this one. One of the few inarguable facts to emerge from this crisis is that the Fed’s ability to analyze, let alone regulate, the big banks and financial markets was flawed. the analysts there are exceedingly bright people, but they are of the same mindset as those in the banks. They all believe that same economic theories and the technologies that rely upon those theories. Consequently there is no renegade view and no heterogeneity of opinion. Or not enough. In contrast the Fed gets very high marks for its monetary policy in the crisis itself. So my vote would go to a reform that reduces the Fed’s regulatory role and which leaves it to focus on monetary policy. This is not what the administration is pressing for. Like so much of what the Obama team proposes their reform is a ragbag of bureaucratic kluges. It is not reform. Let’s hope the opposition wins on this count.

Let me leave you with one thought to ponder this weekend: should we nationalize California? The parallels with GM are extraordinary. Years of bad management. Horrendous financial outlook. Total lack of willpower to resolve its own crisis. And now it has been forced to issue IOU’s to ‘pay’ its creditors. the place is a terrible mess. I have no idea about how we do this: but yes, we should nationalize California.

Enjoy the weekend everyone.

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    RIP CIT?

    Now that the government has refused to offer any form of bail out it looks as if CIT the medium sized small business lender will have to file for bankruptcy. This is a newsworthy event for a couple of reasons:

    “Poor old CIT was just ‘too-small-to-save’.”

    • It gives us all an indication of where the administration sees the ‘too big to fail’ line being drawn. CIT is obviously too small to pose ‘systemic risks, so everyone is comfortable with it going bust.
    • It highlights the problems that a business model built around wholesale sources of funding brings. The wholesale credit market is both volatile and highly risk averse right now so both the cost and availability of funds has become an issue to CIT and similar financial organizations – GE Capital and GMAC were both funded in the same way and are trying to diversify their sources of funds for these same reasons. Banks and finance companies with retail deposit taking ability – usually branches – are the ones who have a strong advantage in the near and medium terms if not also in the long run.
    • CIT used to be a middling performing and rather dull company specializing in various forms of lending and leasing to medium and small companies. Presumably its board of directors became bored with it since it hired a new CEO, Jeff Peek, in 2004 to change things up. Peek was an ex-Merrill Lynch investment banker who promptly launched CIT into new lines of business like sub-prime mortgage lending and student loans. No wonder he was passed over for the top job at Merrill – not that they did any better without him.
    • Once CIT goes into bankruptcy it will be the fourth largest in American history – quite an achievement for a middle of the road place.
    • Apparently there was a huge fight within the administration about whether CIT should be allowed to fail with the FDIC voting a resounding yes, and the Treasury and Federal Reserve Board wanting to help some more. Obviously the hard liners over at the FDIC won the day and the softies at Treasury have egg on their faces.

    I think it is the right decision.

    The taxpayers cannot provide unlimited guarantees to the entire system. There must be limits so that managers have some discipline. My beef about the big banks is that they have been exempted from any form of discipline: they are above regulatory control since they have the power to push back on reform; and they are above market power since they benefit from government bail out money. They cannot fail and, apparently, they cannot be hemmed in either.

    In contrast, poor old CIT was just ‘too-small-to-save’.

    RIP, CIT.

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    Uncertainty, Uncertainty, Uncertainty

    Well I think it’s safe to come out now. The threat of another depression has passed. Phew. Now comes the hard part. The odd thing about where we’ve just been is that in the depths of the last few months it was easier to act: thinking too far ahead was pointless and formulating proper reforms or corrective policies was just not appropriate. There was simply too much uncertainty.

    “Without a fix for the banks we will absolutely be headed back into dangerous gambling soon, but this time without the resources to fix it. That way lies the road to depression.”

    Now, from my point of view, uncertainty is the dominant theme in any economy. It is concern over the unknown that compels us to save and to form businesses that can undertake long term projects. Indeed from a theoretical perspective a business firm is simply a ‘hedge against uncertainty’ – as described by the economistBrian Loasby. Money is also such a hedge: we use money as a way to avoid having to barter and as a way to store value for future use. Money has no intrinsic value other than what it can be exchanged for, so keeping or setting aside a cash store in savings etc can be viewed either as a way to postpone current consumption for the future, or, alternatively, as a measure of the uncertainty we have about our ability to pay for future consumption.

    So everywhere we look uncertainty affects the way we construct our economic lives.

    I mention this because as we emerge from the storm of the past year one key factor seems to stand out: the dramatic drop in confidence, or conversely the dramatic increase in uncertainty, that has settled in on the economy.

    This might appear odd in the context of the revival of the credit markets which is one of the clear signals that the storm is abating. It is true that the financial world has lost much of the panic feeling that gripped it over that past few quarters. Banks have been able to issue equity; spreads are returning to more normal levels; bank profits are rising; and capital ratios are not declining, but are fairly stable. None of this implies that the system is repaired, but it is on its way to recovery. The banks are back to having fun. We are left to clear up their mess. Confidence is creeping back on Wall Street. That’s not our issue just yet.

    No. The uncertainty that has risen is on the consumer’s side of the economy. There has been an enormous shift in private savings. Looked at as the difference between private incomes and private expenditures, savings have gone through the roof. This implies an enormous contraction in consumption. And I mean enormous. Were it not for the extremely large increases in government spending we would most definitely be in the grips of a full depression at the moment. The contrast with the 1930’s is extraordinary: the rise in savings back then was less than our current shift. This means that we were on course for a worse depression than the Great Depression. It was, and still is, that bad.

    I say ‘still is’ because the shift towards savings, which has been advocated by many of us for a very long time, has been so sudden, and violent, that it risks completely dampening the recovery. There is no doubt that we need to unwind the overhang of debt that we gorged on over the past few decades. One of the reasons I regularly harangue the Reagan/Bush era is that the economy was encouraged to rush into indebtedness in order to mask underlying weaknesses. The moment Reagan filled the country’s imagination with hazy visions of yesteryear he led it away from fixing its issues. Those rose tinted glasses created an illusion that prevented a proper understanding of long term problems then emerging. And so a very imbalanced economy was created: loss of long term competitiveness and growing foreign oil dependency were ignored; stagnating wages and rising health care costs were glossed over; and the fact that many people had to borrow to stave off a declining standard of living was seen as a sign of optimism about the future, rather than a sign of something going badly wrong.

    The final nail in the Reagan/Bush coffin came when massive inflation in home prices was seen as a source of wealth rather than as a destabilizing social force. The prevailing, and hopelessly wrong, economic thinking that pervaded the whole Reagan/Bush era missed the danger of the real estate bubble precisely because it saw no bubble, just ‘exuberance’.

    The consequent implosion, which contrary to the opinions of many in the media, was foreseen by many of us, has now manifested itself in the shift towards savings I mentioned earlier.

    Uncertainty indeed abounds.

    Couple the huge blow to confidence that a 30% to 40% drop in home prices has dealt, with a bleak long term employment outlook and it easy to see why consumers are saving at the rate they are. Who knows what could happen next?

    The bad news is that the total debt level of the private sector is down only a couple of percentage points from its high back at the beginning of 2007. That implies we are likely to experience this rate of savings for a while longer as de-leveraging continues.

    The conclusion I come to from all this is that the recovery will be long and very slow. Unemployment will stay high, and most likely increase over the next few months.

    And the hard part is just beginning: we still have not dealt with the insanity of the banking system, which, if Goldman Sachs performance is anything to go by, is about to head straight back to the recent past and try to replicate its bad habits for huge private gains. There are no signs of lessons being learned there, just rampant opportunism safe in the knowledge that the taxpayers will pay the bill for the next catastrophe the banks heap on us all.

    Plus the epic fiscal effort we have had to make to stave off total disaster has left us with a Federal deficit problem that will need urgent attention in the medium term.

    Without a fix for the banks we will absolutely be headed back into dangerous gambling soon, but this time without the resources to fix it. That way lies the road to depression.

    As I said: uncertainty, uncertainty, uncertainty.

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    Banks To Repay TARP Money

    The Treasury Department has approved the plans of ten banks to repay the TARP money they received as part of last year’s bailout of the banking system. The total cash going back is $68 billion, which can either be lent out again if the need arises or simply be used to reduce the government’s need to borrow from somewhere else.

    In one way this is a good sign. Obviously the administration has more confidence in the banks than it did even a month or so ago. The names of the banks has not been released officially but reports suggest that JP Morgan Chase, Goldman Sachs, American Express, and Morgan Stanley are among them. Citigroup, Wells Fargo and Bank of America are not.

    The banks have wanted to repay the government since they all passed the stress tests performed a month or so ago. Continued use of TARP money meant that they were subject to restrictions on the way they conducted themselves. All the banks chaffed at the notion of government scrutiny of their activities, and in particular, at the limits placed on pay scales. Bankers like to pay themselves big bonuses, and while they were on the government dole political pressure and legal straight jackets stopped them from making significant payments to ‘key’ people.

    “The cost in cash and human misery that the bankers created is epic. They should pay for it.”

    The government was adamant that the banks demonstrate an ability to raise capital from private sources before it would allow repayment, hence the frenzy of debt and equity issuance by the healthier banks over the past month. Now that most have managed to restore their access to the capital markets the regulators are satisfied that this first group can be weaned off taxpayer assistance.

    But is this a good thing?

    I am not so sure.

    The banks who are now allowed to repay TARP cash all passed the stress tests. As you know I thought the stress tests were none too stressful. In fact I thought them to be easy. Not only that, but the banks all indulged in a period of negotiation subsequent to the tests, so the image created was not one of severe oversight but of indulgent cooperation. The regulators simply didn’t have the stomach to impose strong standards, and so the banks were required to rebuild themselves only up to fairly lenient levels of capital. And the ‘worst case scenario’ they all supposedly passed looks a lot like the most likely outcome for this year’s economy rather than a severe further downturn.

    Given this, I don’t think that we truly know just how healthy these supposedly healthy banks are. They are all still sitting on substantial portfolios of toxic assets of doubtful worth. They will no doubt need to keep raising capital just to offset future losses on those portfolios. Which means that the amount of capital available to be deployed as loans is still limited.

    So the flow of credit into the economy is by no mean assured even though we now have a slew of ‘healthy’ banks.

    Meanwhile we now have two types of banks: those who have repaid their TARP money, and those who are still tethered to the Treasury Department. Clearly the latter are now at a significant competitive disadvantage. The credit markets will differentiate even more strongly between the ‘strong’ banks and the ‘weak’ banks which implies higher interest rate costs for the weaker ones and possibly even more difficulty in their capital raising efforts. Private investors will take the repayment green light as a government ‘seal of approval’ and thus channel their investment into the strong banks and away from the weak ones. This will make it harder for the likes of Citi to rebuild itself to the point that it, too, can be allowed to repay TARP.

    The market has, of course, been drawing its own conclusions as to relative bank strengths, so all of this may not change the environment for capital raising very much. But it cannot be welcome news for shareholders of Citi, Wells, B. of A. etc that their organizations are still considered too weak to come off life support.

    In broader terms there are very clear signs that the credit markets have settled down from their crisis levels of last September and October. Risk spreads are much lower, funds are flowing, and investors are willing to lend to banks gain. So there is a semblance of normality slowly returning. The recent spate of better news in the ‘real’, i.e. non-financial, economy has helped lift the mood of investors too.

    But we should take great care not to declare the crisis over. The banking system remains very fragile and large losses on commercial real estate and credit card portfolios loom in the near future. Plus the banks are as opaque as ever in their activities. Nothing substantial has changed in the system except for the reduction in competitors and the new two tier system of good and weak banks that results from this TARP repayment. The biggest of our banks remain ‘too big to fail’ and can thus indulge in extravagant risk taking for the benefit of their bonus payouts knowing full well that the taxpayers will pick up the pieces.

    This privatization of profit and socialization of loss is an anathema to the long term health of the economy. It has to stop. Bankers have to be made accountable for the losses that their excessive risk taking produces. It was failed bank management, and, in particular, a cavalier approach to risk, that brought the nation’s economy to its knees. The cost in cash and human misery that the bankers created is epic. They should pay for it.

    This means radical and structural reform of the banking system.

    There are proposals already floating around as to how this should be done. So far none are adequate, although some regulators are agitating for strong action. The latest salvo to be fired came from Federal Reserve Board Governor Dan Tarullo just this week who focused especially hard on the banks considered to be ‘systemic risks’. He advocates a fairly hard line to restrict the damage that rotten bank management and failed bank business models can do to us in the future. As of now though the debate is only warming up, and time is slipping by.

    But for now the big banks will remain ‘too big to fail’ and thus we can expect them to retain control over public policy. This is the most important point we must confront. The banks have ‘captured’ the legislative process and thus can ensure that legislation is always modified in their favor. Even in these times of evident failure they have been able to push back against bankruptcy law changes that would have allowed easier mortgage payment modifications for borrowers. I am thus not expecting the administration to introduce the kind of stringent re-regulation I see as needed to prevent further banking mischief.

    The banks, even in their currently impoverished state, still flood the electoral system with cash and other forms of largesse. In any other nation on earth this flood would be called corruption. Here we call it free speech. It is the sort of free speech advocated by the Mafia. I doubt whether our doughty legislators will be able to resist the suggestions of their local bankers, let alone those of the big Wall Street banks and the various trade associations that inhabit the shadows of Washington.

    So while we applaud the repayment of TARP money, we may regret the continued power of the banks. They are not fixed yet. And the odds of getting them fixed, as in becoming socially acceptable and reliable institutions, is waning. As the immediacy of the crisis fades and the attention span of Congress shifts its focus somewhere else our window of opportunity for reform diminishes.

    I wonder whether we have lost the chance to restore balance to the economy even though the debate is only now beginning. I hope not.

    Addendum:

    Clearly the Congressional Oversight Panel [‘COP’], led by Elizabeth Warren of Harvard University, agrees with me about those stress tests. The panel’s June report contains a critique of the tests written by two Berkeley professors. They conclude that the tests are too lenient given where unemployment already is [the tests worst case assumed an unemployment rate of 8.9% as an average for 2009]; that they don’t extend far enough into the future, while much of the commercial loan losses will occur in 2011 and beyond; and that they have been deliberately obscured so that understanding how they were carried out is very difficult. The COP concludes that the stress tests should be run again to adjust for these problems.

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