Goldman Sachs

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Update: Jobs, Debt, Bank Reform

This has been a dull week for economic reporting with only dribs and drabs of news being released, and the Senate ploughing on through what seems like an endless pile of amendments to the basic Dodd bank reform bill. Nonetheless there are some small items to discus:

Jobs:

The weekly report on first time claims for unemployment assistance edged down once again, repeating the pattern of recent weeks. The decline was minimal at 4,000, and so does not signal a breakthrough in the jobs market. The weekly total of 444,000 is still way too high for us to relax and imagine that unemployment will come down quickly. Instead it marks another small step forward in what has become a war of attrition. We have to look over longer time spans to comprehend the improvement: this time last year the weekly claims were in the 600,000+ range, which means that we have improved about 30% over the last twelve months. That’s good progress, but insufficient, and the weekly gains have all but vanished: we have gained only 2.2% in the first third of 2010, which implies that the market has flattened out at an unacceptably high level. My own estimate is that we need the first time claims number to be somewhere in the mid 300,000 range before we will see dramatic changes in the unemployment rate. Until then we have to make do with these tiny weekly advances.

The more worrisome figure is the huge build up in long term unemployment. 4.63 million workers are now collecting long term unemployment benefits and more drop out weekly as they exhaust even the full 99 months now available. As I have mentioned before the existence of this huge number of long term unemployed has sparked a spirited debate in economics. The question being whether these workers represent ‘structural’ or ‘cyclical’ unemployment. This is an important distinction. If they are cyclically unemployed the implication is that they are still well skilled and that when jobs re-appear they will quickly find work. If, on the other hand, they are structurally unemployed, they are unlikely to find work quickly at all. This is either because their skills have atrophied due to prolonged unemployment, or that their skills do not match the requirements of the new jobs being generated. Clearly the policies put in place to fend off cyclical unemployment are very different from those needed to cure structural unemployment. In the case of cyclical job losses the focus should be on bolstering demand sufficiently to restore business activity to its pre-recessionary levels. Structural job losses are intractable to simple demand management: they need a longer term perspective and respond only to things such as retraining and relocation.

The resolution to this debate will have very large consequences for government policy during the upcoming year. Right now I think the answer seems to be that we have shed a great number of jobs that will never return. Which implies the need for aggressive retraining and career development support rather than simple demand management.

Debt:

The background chatter about our national debt continues. David Leonhardt in the New York Times did us all a disfavor this week by writing a long article comparing the US and Greek debt situations. Everywhere, it seems, commentators are asking whether we will go down the same road as the Greeks, and the big question has become: will the US default?

The short answer is no.

This, of course, seems like an evasion, especially when the Congressional Budget Office issued its assessment of the monthly budget deficit. On the surface the CBO report makes for ugly reading: the first seven months of the US fiscal year show an accumulated deficit of $800 billion, with April being much worse than the equivalent month last year. It was April’s poor figures that sparked quite a flurry of doomsaying: April 2010 saw a monthly deficit of $85 billion compared with April 2009’s $21 billion. The significance of April, of course, is that it tax month, and usually shows a net inflow of revenue for the government from all those tax receipts. In neither of the last two years did April show such an inflow, which means that the government has now suffered its longest ever run of deficit moths – the record run now stands at 19 consecutive loss making months. That’s awful. But entirely explicable. The big drop in this April’s revenue, when compared with last year’s, results simply from the massive drop in personal incomes being taxed. The biggest inflow each April comes from taxes on income that is not subject to withholding. Those taxes tend to be bunched up and paid at tax time. The problem this year is that the tax non-withholding incomes earned in 2009 dropped substantially over those of 2008. So, naturally, the amount of tax revenue dropped also. To get a better look at the trend in government revenues we need to look at the taxes being collected on incomes subject to withholding. Those are the incomes that are more immediately affected by the economy and the recovery. At that level of detail we find a significant improvement in tax revenues inflows. This supports the notion that the deficit will start to drop quickly as the economy generates more incomes on which taxes can be collected.

The outlook for the deficit is, in other words, improving, despite the flood of red ink.

But.

We still have an enormous budget problem that will not go away even when the economy is back to strong growth.

Not only are we burdened by the cost of the Bush tax cuts that contributed over half of the current deficit – the stimulus and the bailouts combined represent less than a third of the problem – but the long term trajectory of our costs is wrong: we are heading into an era of high costs. This is especially the case in health care, which is why I have been beating the drum of health care reform as a budget saving device. Even with the modest reform passed this spring we still have a long term gap in the budget that needs to be filled.

But the gap is nowhere near that of Greece. So the two situations cannot be compared. The American budget problem is far less difficult to deal with than the Greek problem. To deal with its crisis Greece will have to endure depression like reductions in aggregate demand, and an austerity program that will have to last for years. In contrast, the US has to lower its spending – increase its federal revenues – by about 6% of GDP. That’s still a big hole to fill, but it is not a crisis.

The number that people like Leonhardt obsess over is the accumulated national debt when compared with annual GDP. Right now the Greek debt stands at about 115% of GDP, and Leonhardt projects the US to hit somewhere around 140% when we reach the peak a couple of decades out.

This is nonsense.

First is is speculative. Second it assumes that tax and spending stays at their current levels. And, third, it fails to take into account the impact of rising inflation.

Speculation is inherent in any forecast, but it is entirely unreasonable to assume that tax policies remain unchanged. There will be tax hikes. There will also be spending cuts. I agree that politicians are notoriously incapable of imposing painful decisions on the voting public, but the current crisis and the global mess highlight the need for restrictive action. I think fiscal restraint will become the watchword, but only as the crisis, and the need for laxity, abates.

The two areas that are crying out for attention are defense and entitlements. The former is bloated by bureaucracy and outmoded thinking – the US military is awash with waste and duplication. I have advocated eliminating the Air Force entirely and handing its role back to the Army and Navy. The cost reduction by that move alone would be enormous. And we would lose no effectiveness. The litany of wasteful weapons programs and duplicative base locations is another perennial nut to crack. As for entitlements: we have to come to terms with the idea that those programs were put in place in an era when life spans were very different. they were never funded for the modern world. The idea that someone can retire at 65 and then live for another couple of decades is preposterous. The burden on the future taxpaying population is simply intolerable. It is this that has made the ‘unfunded’ liability explode. The mismatch between life expectancy and the amounts being set aside to cover the costs of those extended lifetimes is the source of the crippling outlook. So the answer is simple: current workers need to save more since they will have the benefit of longer lives; and we need to raise the age at which benefits can be collected. The notion of early retirement needs to be abolished. In any case, the concept of retirement is a modern post-industrial invention. We need to modify it to take into account medical advances.

Bank Reform:

Speaking of needed modification: the Senate’s slow crawl towards bank reform continues.

This last week we have been treated to a couple of stunning examples of bi-partisan cooperation. Senator Sanders from Vermont managed to get his amendment to create audits of the Federal Reserve Board passed by a 96 – 0 margin. While Senator Boxer’s amendment concerning the rules for winding up large banks and restricting the use of taxpayer money for bail-outs passed by a 96 – 1 margin. That audit of the Fed is highly restricted and does not apply to monetary policy decisions. The libertarians amongst you will be disappointed by that, but I think the maintenance of an independent monetary policy making body is worth a certain amount of obfuscation. I am glad, therefore, that Senator Sanders watered his amendment down even though he incurred, along the way, the wrath of Ron Paul and the more extreme anti-Fed evangelists.

Such is the hubris, willfulness, and incompetence of the banking industry that it has engendered this astonishing moment of cooperation in Congress. No one, it seems, wants to defend the banks too much.

Good.

But, there have been losses as well.

The Brown-Kaufman amendment to reduce the big banks in order to force an end to ‘too-big-to-fail’ was defeated by a healthy margin. Yet I think this aspect of the debate has opened up paths towards other ways of reining the banks in. So the efforts of Senators Brown and Kaufman will not go to waste.

Other issues being voted on concern the elimination of naked credit default swaps, and the introduction of a modicum of transparency into the derivatives market.

A naked CDS is one where a bank buys insurance against the failure of an asset that it doesn’t even own. This is an absurd practice and is akin to pure gambling. It allows Goldman, for instance, to purchase insurance against the failure of an asset owned by AIG. Not only is this a massive disconnect in the financial marketplace, but it encourages anti-social behavior. It decouples risk taking from risk management with the result that risk takers have no interest in limiting the damage on bad credit decisions. On the contrary they have vested interest in encouraging failure. This disincentive to manage risk has become pervasive and, I believe, contributes heavily to the destabilization of the credit market. When we remove the incentive to manage risk, because it is covered by a naked short position, we simultaneously remove the need for sound upfront credit policies and practices. The erosion in basic banking that the development of these pseudo-risk management products has wrought is astonishing and dangerous. So getting rid of the more egregious examples moves us in the right direction.

The Senate is continuing its deliberations. The current trend in the voting on the various amendments seems to be towards a more stringent final legislation than either Dodd or the Administration anticipated. I think this trend is welcome. My initial reaction to the Dodd proposal was that it was weak and meek. Hopefully Dodd’s lack of spine will be offset by the anger that seems to have taken hold of the Senate.

We can only hope.

Meanwhile, politics intrudes at every turn. The Senate is delaying a vote on the inclusion of the derivatives ruling from the Agriculture Committee until after the Arkansas Democratic primary. The reason? Blanche Lincoln is in danger and needs to present a populist success to her electorate. She runs the Agriculture Committee and is responsible for the more draconian rules agreed there. The Senate as a whole is likely to agree to a watered down version of those rules, so it is politic to allow the tough rules to appear dominant until Lincoln has weathered the vote.

And so it goes on.

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Goldman In Washington

Nothing else in the economy matters today, all eyes are firmly on the theatrics of the Senate hearings as Senator Levin’s committee grills various Goldman Sachs executives on the way in which that firm profited from the great crash that its own activities precipitated.

Anyone interested in the safety and soundness of our economy should take time to watch at least part of this hearing because it sets the entire crisis in context. The folks at Goldman, and I am sure at the other big banks, feel absolutely vindicated by their actions. They see no wrong. they feel no remorse. They affirm, when asked, that Goldman’s bonus structure is both fair and ethical. They see nothing untoward about trading against the deals they sell to others. And they have nothing to add to the question of regulation.

It is as if we are watching people from another planet.

My conclusion from today’s marathon session is that we will inevitably suffer more financial disasters in the years ahead. This is simply because the folks who inhabit the banking arena are not bankers. They are deal makers. That may sound like a nuanced argument, but I think it speaks volumes about the attitude and ethics on Wall Street.

None – not one – of the bankers on review could clearly articulate that they thought Goldman should have an ethical responsibility to its clients. Instead they all argued that they should ‘help’, ‘assist’, or ‘make markets’ for their clients.

This is not banking.

It is trading.

As one senator pointed out: it seems strange that Goldman makes more from its trading book than from its old fashioned investment banking book. The days of an investment bank being a reliable source of market data, and a facilitator to a client business is long gone. We have arrived at a more carnivorous era, where bankers actively take bets against the very assets they sell. And see nothing wrong in that activity. It is caveat emptor run amok.

There is far too much to discuss from the session, so I want to focus on a few salient points.

First: it is completely clear that Goldman has no problem in using the information it gleans from its client contacts in order to make profit for itself. Even if this means betting actively against those clients.

Time after time today we heard that Goldman is a ‘market maker’. This means that it acts passively when a client comes to it and asks to buy or sell assets. As a market maker Goldman is supposed to undertake the trade requested and quote the prices needed to accomplish that trade. Market makers have enormous access to the most important asset there is: information. Because of their constant conversation with clients they can glean what the amorphous market is thinking about the outlook. This enables a market maker to have more insight than other market players have. For instance, a pension company may be looking to buy assets of a certain maturity and comes to Goldman to execute that trade. Goldman gathers the prices and quotes them to the pension company, which has to decide whether to go ahead with the trade. The pension company’s decision will be based upon its own assessment of risk, and the suitability of the price quoted against that risk. Goldman has access to that information. More importantly, it has access to all the discussions surrounding that decision and to the risk appetite of its client. Goldman can add this to the information it gathers from other clients and so can establish a far more comprehensive view of the market than the pension company could.

This role as market maker is valuable to Goldman’s clients. And they trust Goldman to play that role as an unbiased facilitator. they also expect to be given some of the insight that Goldman possesses.

Obviously Goldman shares information.

But what comes across from today’s hearings is that it does not divulge everything. Rather, it appears to act neutrally as market maker, while simultaneously using the information it gathers to take its own position in the market.

So not only is Goldman a market maker, it is also an active market player.

Inevitably this leads conflicts of interest.

Except that Goldman denies that there is a conflict of interest. Instead it claims that it has every right to use whatever information it has for its own benefit, and that it does not have to reveal everything it knows or thinks about the market to its clients.

So when Goldman is aware that serious players are betting against a particular asset, and that it agrees with those players, it sees no ethical reason to disclose that fact to its clients who may have a different view.

This is indefensible.

A market maker has a privileged position. It has access to more information than other market players, most of whom are less frequent participants or whom are less privileged in the amount of information they can gather. Indeed, many of these less privileged players look to Goldman in order to get access to the necessary information they need.

So active players like hedge funds are less dependent on banks like Goldman, whereas less active players such as a pension fund or a municipality, are far more dependent.

Wall Street bankers seem to have forgotten this difference. Instead they hide behind the claim that pension funds etc are ‘sophisticated’ investors who are capable of making up their own minds about risk. This is true only up to a point. they key is that those sophisticated investors use the bankers input as a resource in their decision making. They are not immersed in the deal flow and therefore are less informed.

They are ripe for the picking.

It is clear that the two activities: market making and proprietary trading, if they are both under one roof, will lead to huge conflicts of interest and will disrupt the flow of information. Goldman’s successful short position against the mortgage market is now a classic example of this conflict.

Goldman did not see its role as advisor to investors who poured billions into securitized assets that Goldman was packaging for sale. It fulfilled the bare minimum responsibility to its clients. It sold assets that it knew were toxic, simply because it could find someone to buy those assets. It felt no obligation to warn anyone of its view or experience with those toxic assets. It left its clients to fend for themselves, while it quietly built trading positions to profit from the failure of the very stuff it was selling.

I don’t think this is illegal.

I do think it is unethical.

It certainly means that no one should trust Goldman’s view on anything. You just never know what they are not telling you.

A second observation I come away with from today’s hearing is simply that the accusation that ordinary people – mortgage borrowers – should be held accountable for the mess is far too simple.

The growth in the sub-prime mortgage market was stimulated in large part by the enormous appetite on Wall Street for assets to package and sell. Were it not for that demand it is highly likely that the bubble would have been far less dangerous and would certainly never have reached the excess it finally did. The bubble was created by Wall Street’s hunger for securitized assets. The flood of capital through Wall Street into these assets diverted billions from other uses – investing in factories for instance. The ruse used to set that diversion in motion was the apparent ability of Wall Street to convert rubbish loans – sub-prime mortgages that everyone knew were rotten – into pristine AAA investments.

There are very many investors whose in-house rules prohibit them from investing in low rated assets. Most pension companies fall into this category. Such investors need to be conservative because they hold a great responsibility to their customers – future retirees for instance. Such investors are always looking for a supply of very safe investments. And dealers like Goldman are always looking for a supply of safe assets to sell.

So the invention of the magic conversion of toxic into AAA opened up vistas of profit for the banks who could sell securitized assets by the boatload to pension companies and their like.

Once this nasty machine was in motion and the profits piled up, demand for the raw material shot up also.

Hence the sudden drop in underwriting standards, the explosion in sub-prime lending, and the run up in home prices.

The Wall Street hunger for profit drove the entire process.

But.

Having set the bubble on its way up, Wall Street, and Goldman in particular, saw no ethical problem with profiting from the bubble’s subsequent collapse.

Not only was the entire edifice based upon Wall Street’s incompetence – it horribly miscalculated its ability to perform magic – but it was amoral. That regular people were sucked into the bonus driven machine seems not to worry the bankers on display today. They were simply doing their jobs. That Wall Street’s greed drove mortgage lenders to induce people into borrowing that would never have occurred otherwise – because underwriting standards would have prohibited it – doesn’t enter their minds.

Instead they take great pride in their cleverness in seeing that there was a bubble – of their creation – and in being able to hedge against the implosion.

Heads they win.Tails you lose.

And we are supposed to acknowledge their genius. These are the same folks the banks ‘need’ to pay bonuses to in order that they can retain the ‘talent’. One of today’s participants made enough money that he was able to set up his own business. He expressed no remorse in his role in the mass destruction of the American households who were the fodder for his bonus claim.

Caveat emptor indeed.

One last observation: the culture gap between Wall Street and the rest of America is so large that I see no way to bridge it. These guys just don’t get it. They had no equity at risk, and yet caused the collapse of the dreams of millions of their fellow Americans. They just don’t comprehend that. To them everyone thinks the way they do. And if they don’t, they should. These are remorseless, hungry, smart and very dangerous people whose ethical framework is suspect to put it mildly. They see the world through the prism of short term profit. Nothing else matters.

When the real world failed to supply enough assets for them to meet their bonus goals they invented ‘synthetic’ assets. This was the final nail in the economy’s coffin. Once Wall Street had invented synthetic assets it could manufacture stuff to sell without regard to the number of mortgages in the country. A synthetic asset is one that has no real asset as its core. Instead it uses securitized and other processed assets as its ‘reference point’ for risk.

This would be like gambling with chips at a casino, but not actually paying for the chips. It would be like getting those chips on the basis of cash someone had used to buy another set of chips. Once the game is set up this way the players no longer are constrained by the amount of cash they have, but by the number of times the original amount of cash is ‘referenced’ when they need more chips. $10 can be used and re-used to justify the purchase of $100, or $1,000 or $1,000,000 worth of chips. All you need to do each time is to create a synthetic asset that refers back to the original cash. Wonderful if you can get away with it.

Wall Street did.

Not so wonderful when the original cash turns out to be rotten through. Then instead of that cash turning into a toxic asset, we are faced with multiples of the original amount. Many multiples.

What Wall Street did was to create and endless supply of chips with which to gamble. Those chips bore no relation to the actual size of the economy, to haw many houses there are, or even to how many loans were made. None of that ‘real world’ stuff mattered. What mattered was having an ever increasing supply of chips to gamble and make bonus quotas.

That the game destroyed the economy is nether here nor there.

As I sat watching the hearings I could but feel an intense fear for the economy. These bankers clearly failed to grasp what they had done. They ‘cared’ only so far as their ability to protect Goldman’s earnings. Their role in the epic recession was lost on them. They all profited from the run up and the run down. They are not unemployed. Nor are they impoverished. They are not even chastened.

It isn’t that they don’t care about America, its simply that they think America should be like them and make smart moves to enrich itself.

Welfare babies one and all. Yet self-regarding geniuses in their own minds.

And.

If the game doesn’t quite work out. There’s always someone there to bail you out and help you back on your well shod feet.

Isn’t that what taxpayers are for: to bail out Wall Street bankers so that they can keep on earning those bonuses?

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Bank Reform Monday

Well, here we are. The Senate is heading for a showdown today on bank reform. The odds are that the Republicans will vote against allowing a vote. That will trigger a pile of useless invective from both sides. Then, miraculously, a brokered solution will pop up and be allowed to the floor. Quite what that compromise will contain is anybody’s guess right now. Oh, and along the way the GOP is likely to introduce its own reform bill, one that has none of the nastier anti-Wall Street components and definitely doesn’t have any consumer protection in it.

So.

Are we there yet?

Not really.

The bigger issues remain to be solved.

One piece of good news is that the Democrats managed to coalesce around a decent regulatory framework for derivatives trading. Their proposal is based on the bill agreed to in the Agriculture committee last week. For those of you who are confused as to why the Agriculture committee plays such a prominent role in financial reform I should explain: derivatives used to be useful, many still are, and are used frequently by farmers to lock in the value of the crops they are producing in advance of harvest. Most agricultural products are bought and sold on futures markets, and options trading is very common in those markets. It is no accident that the center of gravity for exotic derivatives trading was Chicago, or that the Federal Reserve Board system has an excess of Midwest representation – there are more Federal Reserve Board districts in the Midwest than there are out west or in the south. It is a throw back to the agricultural era of American history that farming has an oversized say in American finance and politics, completely out of proportion to its contribution to GDP. One legacy of this antique past is that the Agriculture committees in Congress have oversight of, or at least a major say in, matters concerning derivatives.

Back to today.

The most likely outcome of today’s posturing will be a decision to vote later in the week on a hybrid bill. Unfortunately this hybrid is not going to solve our problems. I doubt whether it will include sufficient restrictions on the banks in terms of size or activities. Instead it will touch all the sensitive points lightly in order to look comprehensive. The big problem seems to be that Senator Dodd has yet to embrace the fact that Wall Street in its current guise is not performing its socially acceptable function – he appears to have become enamored of Wall Street’s self-image rather than its empirical impact.

Still the Dodd proposal is better than nothing and gives us a slight step up from the mayhem of the Reagan/Clinton/Bush deregulatory frenzy that allowed the banks to blow the economy up so easily.

Let me reprise the key features I see as essential to reform, but currently lacking in the most likely legislation:

  1. We need tough limits on bank size. This means breaking up the three or four largest banks, and setting such onerous penalties on them that they never cross the size boundary again.
  2. We need to break up functions in the style of the old Glass-Steagall Act. If bankers want to gamble they should do it with their own money and not ours. I am a big proponent of private banks where the partners are actual partners with their own net worth at risk.
  3. We need to eliminate via prohibition, any ‘synthetic’ derivatives. In order to fulfill their social purpose derivatives should be based on underlying assets, not on bundles of other derivatives.
  4. We need to eliminate the rating agencies in their current form – they were pernicious co-conspirators enabling the disaster. 93% of all AAA rated sub-prime based mortgage backed securities rated in 2006 have gone belly up. That is an extraordinary record of failure, and one that totally discredits the rating industry. Shut them down.
  5. We need to conform our legislation with international efforts to eliminate cross border regulatory arbitrage and to make the winding up of bankrupt banks both more speedy and less contentious.

For the record: I don’t see higher capital levels as a complete answer: many of the banks that ended up in trouble had decent capital ratios and their problems stemmed from liquidity, market, and management failures just as much as from a capital shortfall.

We should also all be clear: the outcome of good reform should be a larger number of banks, competing across reduced lines of business, and a return to the old divide between commercial and investment banking. The process will inevitably be messy, and no one ‘solution’ will deal with the systemic problems. To be effective reform has to be blunt, brutal, and straightforward. Trying to nuance and use clever wording to deal with the banks plays into their hands: they are extraordinarily good bureaucrats who know how to split hairs better than any other businesses. To combat them we need simple declarative statements and a very heavy hand.

Finally, as we await the events of this afternoon and evening, I should add that I am not concerned at all about Goldman Sachs profiting by betting against the mortgage market back in 2006 – 2009. The media has this one wrong. Short sales and other tricks designed to profit from a collapsing market are valuable tools in making markets work properly. Notice I didn’t say ‘work efficiently’ since I do not believe in efficient markets! Having said that: Goldman has every right to bet against the bubble. If they profit then so be it. The bubble itself was the problem, not the folks who profited from its implosion. My anti-Goldman rants are focused on its duplicity with respect to its clients. I find it abhorrent that they did not disclose their positions, and that they bet against products that they created and sold. Their problem is that they are now so large that if they want to be clever and bet against bubbles etc they will inevitably be betting against positions they themselves created. They are so large that they will keep on tripping over themselves. This size forces them into the kind of duplicity that I find deeply unethical. A defense based upon ‘clever customers know we are crooks’ is hardly one to be proud of. All of this gets eliminated when Goldman is broken into several parts and those parts then compete and bet against each other.

Meanwhile, keep an eye on the Senate. Bank reform is essential to our economic health. Let’s hope the new law isn’t too big of a fudge.

Or is that hoping for too much?

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Support “SAFE” Banking

The Brown-Kaufman proposal probably has little chance of success, so in my long standing tradition of supporting the underdog I want to throw my support behind it.

The reason is very clear: our biggest banks are too big. Not just too-big-to-fail, but too big to do anything properly. They are unmanageable in any real sense. Even an army of regulators has no chance of uncovering all the sly tricks being used to hide the absurd risks being taken. Internal risk management is buried under layers of hot-shot sales oriented bonus driven executives. Auditors, lawyers, accountants, and the rating agencies all buzz around feeding off the flow of deals and doing everything they can to obscure the truth in order to keep that flow surging. Boards of directors see only extremely redacted versions of the activities being sanctioned every day. And shareholders don’t give a hoot since they can off load their shares at the first sign of trouble, and will get bailed out in any case if the worst happens.

In other words every single aspect of control is perverted in order to maintain the orgy of cash that funds the extravagant lifestyles of those within the perimeter of the banking system. Everyone inside the system is to blame, and because of that no one can be blamed – we would have to replace everyone, and we simply are incapable of doing so.

The game is rigged against the public.

Every aspect of innovation is designed not to benefit customers, but to create new ways to gamble within the system. It is no accident that, as the banks return to profitability, their recovery is driven by trading – gambling – and not by lending or funding the real economy. It is as if the banks have become so huge that they operate in an economy all their own and are disengaged from the world around them.

Except of course that they suck in our savings and deposits in order to create the currency needed for their gambling games.

And when it all goes awry they expect us to fund and support their lavish lifestyles.

The urgency of cauterizing the banking system, perhaps sanitizing is a better word, is so high that I regard it as the make-or-break issue for our economy. Until we restore a banking system that is socially productive, one that actually is engaged in banking and not in proprietary trading, our ability to generate jobs and to maximize our wealth will be severely curtailed, if not eliminated.

The administration is only now arriving at this realization. The Republicans are of in some distant land in denial of the problem. And the banks are pouring money into their resistance – Goldman Sachs alone handed out more cash to Senators in March than in all of 2009. M ost went to GOP Senators who were opposing any reform at all.

It is this ability to distort and subvert democracy that ought to energize us all against the banks.

They are simply too big.

So in addition to that list of problems that bank size creates we should add their ability and willingness to distort politics.

And lest you imagine this is a local issue, watch the way in which the biggest banks lavish entertainment and attention at this week’s IMF meetings. The problem is not just here: it is worldwide.

Which is why I support Brown-Kaufman.

Putting in place a ‘resolution authority’ to enable the orderly liquidation of our largest banks is insufficient. They are all international. Resolution will get bogged down in a maze of international jurisdictional dogfights in which only the bank shareholders win. By becoming so complex and internationally entangled the banks hope to have avoided the law of any jurisdiction. They move profits around to lower taxes to bilk everyone. They move assets to the nation with the most lax regulation. And they hide both profits and assets along the way by playing one bureaucracy of against another.

These games are all legal.

They are all unethical.

They are all tolerated by politicians and exploited by the banks.

We should not be surprised by any of this behavior: the banks are simply gaming the system as best they can.

So we should change the system.

Radically.

By which I mean carve the banks apart. We should employ anti-trust style tactics and cut them down to reduce their individual power and to encourage competition. Divide and conquer. It is not enough to have clever laws on the books that can be deployed to break Citibank when it goes bust – still a high likelihood at sometime in the future. Why? Because at crunch time the political and economic calculus favors capitulation and bail-out. To avoid that end, we need to be blunt in our attack on the banks. They have demonstrated – copiously – they are oblivious to their role in the recession. Their continuing lack of self-control and now their imperious hubris in the face of the Goldman scandal, should be sufficient to motivate anyone with an objective interest in the safety of the economy.

The big banks must be reduced. If they suffer so be it. They have shown no remorse. Instead they have returned, after having been revived by our infusion of cash, to exactly the same path that led to the disaster. For this alone they deserve no sympathy.

Brown-Kaufman, augments the Dodd bill by placing hard limits on the size of a bank. In my opinion even Brown-Kaufman is being too lenient, but we have to start somewhere. We have to destroy the bank’s ability to connive their way back to immunity. That means reducing them from their lofty status and putting them back underfoot.

Dodd gives us resolution authority and consumer protection. Brown-Kaufman gives us size limitation. The Agricultural committee gave us derivative regulation. Sum these up and we have a good start on the long road back towards banking stability. We still need international coordination, but that will be more easily attained once we appear to be serious in our efforts to fix the crisis in American capitalism.

There has been much talk of the need to re-esatblish America’s good name in the world. That talk is usually in the context of the damage wrought by the Bush foreign policy. But just as damaging has been the collapse of the respect for our business acumen. Our banks have been exposed and along with them the seamy side of our economic model. Outright greed motivated the crash. Untrammeled hunger for profit led the banks to forget how to be banks. We need to replace that ethic with a more durable one that is not so relentlessly exploitive of the American and worldwide public. We need to save American capitalism from itself. That requires drastic and painful action. It means imposing our will on the banks.

After all our banks caused the recession. They ought to pay for its clean up. We need to make our banks safe again.

Support “SAFE” banking.

Addendum:

For those of you keeping score, there is another amendment floating about that deserves to make it into the final legislation: the Merkley-Levin proposal to enshrine the Volcker rule into law. This would force the separation of main street style banking from the casino style pseudo-banking so beloved of Goldman and the others. In effect it would re-institute the old Glass-Steagall Act that helped keep banking relatively stable for about seventy years.

Also: the White House and representatives from the House are urging Dodd not to compromise. They see the political virtue in forcing the GOP to come clean and decide whether it wants to support Main Street or Wall Street. The downside to this hard nosed position is that it opens up the possibility of a filibuster. That eventuality is receding quickly, though, as more and more GOP Senators run away from publicly supporting Wall Street.

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Bank Reform Kick Off … Sort Of

Here we go again.

Let the partisan sniping begin.

Despite protestations to the contrary the Republicans blocked debate on bank reform today. The reason? “This is not something that should be rushed”.

Ummmm.

The two parties have been engaged in close quarters combat for at least two months. Senators Dodd and Shelby have been virtually living together as they seek to thrash out a bi-partisan deal.

And.

The financial crisis hit us full force two years ago. That’s tons of time to reflect and get a response ready. Frankly, if the GOP hasn’t got any ideas together in the time since Lehman imploded and AIG was bailed out, both of which happened on George Bush’s watch – yes it was that long ago – then I doubt they will ever get any ideas together.

The problem for the Republicans is simple. They are the party of deregulation and free markets at a time when deregulation and free market theory has been debased and disproven by the actions of the big banks. They are on the wrong side of history. It is the obverse of their position back in the early Reagan days when anyone advocating deregulation and freeing up markets was hip and cool. Now they are passe and reactionary.

Getting from their deregulation trench to a better position is tough when that better position is well occupied by the Democrats.

Hence the brickbats.

And the hissy fits.

Last week was a great illustration of the political bind the GOP finds itself in.

Mid-week Mitch McConnell yelped about how he will oppose bank reform all the way. He looked like a man on a mission: no more bail-outs he yelled.

Within two days he was overwhelmed by the Goldman scandal and the obvious trickery of the big banks he had set out to defend. Goldman may or may not have committed fraud, but it sure looked unethical. Plus it announced enormous profits and ever increasing bonus pools for its already overpaid staff. This is probably not an organization a politician wants to expend too much time defending this fall in the elections. All of a sudden the GOP found itself about to be stranded on an island along with Wall Street. Not a good place to be when the public looks at Wall Street with such a jaundiced and angry eye.

So McConnell had to walk back his stridency within two days.

So his next trick was to claim that he had won the argument, and that he had forced the White House to concede some points on the proposed legislation. Specifically he pointed to the administration’s willingness to bargain away the bail-out tax on banks. Except that no one ion the Senate had suggested that bargain, and the current legislation still includes the very tax McConnell says he successfully rid it of.

Oh well.

After the Goldman scandal broke, a variety of GOP senators broke ranks and made it clear that they would not support a filibuster against the legislation. That seemed to clear the decks for debate. The bill is sitting on everyone’s desks for their edification. Discussions are ongoing about the details. Dodd and Shelby still cling to each other. Compromise is in the air.

Until later today when the GOP decided to go back to being the party of ‘no’.

So here we go again.

Health care redux.

Except that the Democrats seem to have learned not to waste time waiting for the likes of senators Collins and Snowe to decide whether they like the legislation. Instead they have announced that the vote is imminent – probably Monday.

All this huffing and puffing will undoubtedly take a few wrong turns before we actually get a vote. But it now looks likely that we will have bank reform fairly soon.

Is that good?

Well … it’s better than nothing.

The proposed legislation is a vast improvement over where we are today. Particularly when the bill that came out of the Senate Agricultural Committee is combined with it – that bill beefs up regulation over derivatives and will cause intense pain to the traders who benefit from doing deals in the murkiness of non-public and opaque corners of the erstwhile market. Nonetheless, we should all contain our enthusiasm. This legislation, even if it isn’t watered down by the bargaining now underway, is not sufficient to prevent another financial melt down. It is the beginning, not the end, of what I think will be long series of legislative efforts to put the financial genie back in its pre-deregulatory bottle.

The simple goal is to get banking to be socially responsible again. That means draining it of profit. Containing its excesses. Reducing our subsidy of it. Limiting the damage each bank can do. Cutting it down to size with respect to the economy. And above all else, stopping it sucking capital away from the ‘real’ economy. Don’t forget: banks are supposed to channel capital towards the best opportunity for profit. Not just for the traders, but for all of us. That means the banks need to get back to being banks, and get away from being deal makers, traders, and gamblers.

The old watchword for Goldman Sachs was that it should be ‘long term greedy’. That is to say it should be willing to sacrifice short term gain in order to secure the best long term profit. But banking, including Goldman, has become ‘short term greedy’. Banking should about building those long term relationships that create symbiotic profit opportunities both for the bank and its clients. It should not be about a dog-eat-dog brawl in which the only goal is today’s best deal. I realize this takes the macho gloss off Wall Street, but, hey, who said banking should be fun? It isn’t.

Bank reform needs to re-draw the financial map so that the industry is forced back to doing banking, and is severely – very severely – limited. The current legislation does too little to accomplish that. But at least we appear to be setting off on the journey.

It will be interesting to watch the Republicans as they adapt to this new world.

I hope they do. We need all the help we can get if we are to prevent another banking melt down.

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