Geithner

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Cheer Up Obama

The fine line between economics and politics has frayed this last week in the aftermath of the Massachusetts election result. I never thought the line was substantial anyway, but that only served to place me on the edge of economics rather than invalidate what I thought. After all for the first hundred and fifty years of its existence the study we know simply call ‘economics’ was called ‘political economy’. The greats of the 1800’s – Ricardo, Marx, Bentham, Malthus, and John Stuart Mill – would all have thought of themselves as working within political economy. Indeed their primary motivation was to place economic thinking at the service of the burgeoning industrial societies of the western world. This began to end in 1870 with the beginnings of neo-classical economics and its founders – Jevons, Menger, and Walras – who conceived of economics as a science and dropped the political attachment to emphasize that point.

And what’s this to do with Obama?

Simple: the message, to the extent there is a coherent message, he should have received is that it is the ‘economy stupid’.

Fancy words and strategies in Iraq, Afghanistan, and anywhere else simply don’t count. People want jobs. Period. Survey after survey. Poll after poll, say the same thing: the number one issue in the minds of voters is the economy and its continued deplorable state. Foreign policy and even security is a minor side show by comparison.

And let’s get reasonable: Obama’s ratings are still very strong. He outpaces both Reagan and Clinton by good margins in his popularity. He is not about to collapse. If my memory serves me correctly both those gentlemen emerged as two term presidents. I expect Obama will as well.

So cheer up Obama.

There is one thing to focus on. Which makes life simple. Indeed the politics of the next year is uncomplicated.

Economic policy is the only battleground that the voters want to see energy expended on. So get to it.

The damage from that election is not all that great. Health care reform can still get done, albeit in roundabout ways. Indeed the loss of a seat may focus the Democratic leadership on being more inventive than they have been. A big ‘if’ I realize. Especially with the level of mistrust that has emerged between the House and Senate Democratic caucuses. All the Democrats have to do is copy the way in which George Bush forced through legislation. Use all the rules to your own advantage and marginalize the minority.

Simple.

Now about the economy …

Let’s begin by harnessing all that popular anger at the banks. Get out in front of it. Stop being seen as stooge of the banks. Too many of the administration’s key players are seen as bank insiders – Geithner in particular. His unfortunate comments after Obama’s speech last week introducing the ‘Volcker Rule’ as policy shows that he doesn’t get it. The days of playing nice with the banks are over. The public wants blood, they should get some. The key is to deliver what the public wants without ruining economic policy. My view is that the public is right on this one: the banks screwed up, they have shown no ability to self reform, and they continue to spit in the face of regular people. The banking industry has not cleaned up its act at all. None of the senior managers who oversaw the implosion have been fired. The only leadership change has been at Bank of America, and there it is only skin deep.

When banks lose billions the entire executive team needs replacing. Even the blameless get thrown out.

Obama pulled the plug on GM’s febrile leadership, why not on Citibank’s? Especially since the social cost of Citbank’s failure is far greater than that of GM’s.

By failing to deal with the banks Obama has cast himself as an insider insensitive to the hardship that the greed of Wall Street flooded the country with.

Being a Wall Street insider is not a popular place these days. Hence the quick pivot on economic policy and the Volcker Rule.

But.

Words are easy. Sometimes too easy for Obama. Now he needs to force some action.

He needs to change his economic team to get it into line with popular demands. Geithner must go. So too must Summers.

The case for getting rid of Summers is even more clear in my mind than that for Geithner. Summers is tainted by his years as an advocate of banking deregulation under Clinton. His conversion to regulation appears skin deep. Plus his advocacy of caution last year when the stimulus was being put together was a major error: that failure alone has caused much of the political pain the administration is now feeling. A larger stimulus would have eased the unemployment situation. Instead we are now caught in no man’s land, with a new stimulus ruled out for political reasons – although I would like to see that tested – and the jobs market stuck.

Lastly we need honesty. The economic recovery will be slow. Let’s be straightforward about that. Voters know how tough it is. They want to make sure that the toughness is not focused on them while others make off with scarcely a scratch. But more than that the voters need to hear that all this pain will not be pointless. The adjustment in the economy that we are going through is to make a long term improvement: less debt reliance and less finance. More basic industry and investment in the future. Less trickery and more service. Less marketing hype and more useful stuff that people both understand and want.

And they need to be told that the economy cannot support all the things we want simultaneously. We cannot afford expansive foreign policies and an unreformed health care system. Offense Defense spending needs to be reined in and made more cost effective.

The middle class has been squeezed over the last two decades: health care, education, and housing costs have all escalated way more than wages. The stress of maintaining a decent standard of living showed up in those ludicrous real estate loans, and in ever increasing credit card debts.

One little noticed comparison in the current crisis is how similar education and health care costs are: both are driven up by industries in which normal incentives of cost control do not work. Both are essential to a middle class way of life, but both are impervious to change. As a result both are corroding the American dream.

Economic policy needs to address the realities that voters feel. Those realities extend beyond the short term erosion of work stability and jobs. It reaches into the destruction of the employment contract by employers who protect short term rather than nurture long term profit – the result being a more volatile work experience and heightened risk for average workers. This volatility came right at the time health care and education costs exploded without any real increase in service. The shift in the economy was asymmetric: workers were forced to absorb all the risks without getting any of the rewards. It is no accident that the only economic measure to match historic growth rates during the last decades was corporate profit. Shareholders offloaded risk onto the workforce who got nothing but short shrift.

A natural consequence was that voters turned increasingly towards self destructive pattern of behavior: voting for tax cuts that scarcely affected them yet bled the Treasury dry; attacks on government services that were badly conceived and delivered instead of seeking to improve them; a reliance on debt rather than equity; a mistrust of the soundness of safety net inherited from the New Deal; and an uninformed reliance on market magic as the salve for all ills. In short the Reagan illusion. People kept voting for policies that heaped responsibility on the individual, but which also stripped those same individuals of the power to compete. It was a doomed enterprise. They were doomed to drown as those with privilege raced ahead. The result is a return to pre-New Deal levels of inequality and an attack on the middle class. The voters forgot that the New Deal was the foundation upon which the post war middle class was built, and that free markets are vicious places for the relatively weak.

Obama now has the task of turning back that tide.

He can begin by harnessing the popular, and justified, anger at the banks and starting the long road toward re-establishing a better balance between regulation and laissez faire.

He is helped by the fact that his opposition is embedded deeply in the Reagan world: the GOP has no economic policy other than that we just saw implode. They should be easy targets. As long as Obama frees himself from Wall Street.

This was never going to be an easy year: all the evidence pointed to a jobless recovery. That Summers and Geithner failed to respond with strong action and preferred the safety of the trade methods tells me that they misjudged the depth of the problem. They want to tinker, when we need reform.

So three things will save the day. Three actions. Three steps and Obama is assured of two terms.

One: get a jobs program now.

Two: go after the banks. Reform them and cut them down to size.

Three: replace Geithner and Summers.

It’s the economy stupid. It always is.

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Obama and The Banks: Part 2

Well Obama came out swinging. Not quite hard enough for my taste – I remain a hard liner when it comes to the banks – but at least there was a hint of anger and a suggestion of a willingness to fight. That is a pleasant change from the insipid and muddled approach we had to suffer through on health care. The immediate downward plunge in bank stock prices was an accurate reaction from the markets. It could be, I stress that word ‘could’, that the days of bank rent seeking are over.

Let’s hope anyway.

The really good news, and I must admit it was both a great boost and surprise, was that Paul Volcker seems suddenly to have gone from forgotten periphery figure to central actor. Almost overnight the so-called ‘Volcker Rule’ has become a major component of the administration’s attempt to re-regulate the banking industry. Since I have always had a soft spot for Paul Volcker, I have to voice my pleasure at this turn of events.

The basic themes of the new proposal are to place limits on bank size and to separate investment banking from commercial banking in the manner of the old, and much lamented, Glass-Steagall Act. The banks took decades of lobbying to get rid of Glass-Steagall and only one decade to abuse their new powers sufficiently to warrant its return. If that isn’t a lesson for economists I don’t know what is.

For those of you whose eyes glaze over whenever bank reform is mentioned please pay attention: in my opinion – and I am by no means alone – getting the banking system back onto a sound footing is the most important single structural domestic issue facing America today. Balancing the Federal budget is a distant second. Fixing health care is part of the budget balancing process and so is subsumed in that second priority. You will notice that I was careful to say ‘structural’ issue because I view getting the employment situation as a cyclical or short term issue. The difference, of course, is that structural issues are those that need permanent or long term attention.

The banking system is broken. It is being exploited by ruthless individuals at the big banks to pad their own wealth. It has veered into unsafe territory because those individuals are willing to take vast risks with other people’s money safe in the knowledge that if they screw up they will be bailed out by the taxpayers. This sounds too simple to be true, but it is the essence of our problem. The big banks have gone on an orgy of risk taking that they scarcely understood and failed to manage. Traditional banking skills like relationship building and tending were thrown overboard and new skills introduced: ‘deal making’ became the norm. So perverse did the banking culture become that deal making was seen as a new form of relationship building. Goldman Sachs exploited its relationships to broker deals and saw itself as the epitome of a relationship bank.

But relationships in banking are not asymmetrical in the way Goldman sees them: they are mutual. Both sides should benefit. I read and hear far too many complaints from Goldman customers that the information they hand over on the course of one deal is then exploited relentlessly by Goldman for its own profit in unconnected deals. It might not be against the law, but it is corrosive to long term mutual benefits if the bank can endlessly take information and use it for its own book without compensating the customer in some way.

As I mentioned yesterday one reason I advocate breaking up the banks – rather than simply restricting their size – is to induce competition. The relationship exploitation I just referred to is one form of anti-social behavior that extra competition would control or eliminate. Right now Goldman and the others can run roughshod over their own customers because those customers have little choice about where to go to get their banking needs met.

I have said it hear repeatedly: the benefits of capitalism – which are abundant – are only ever delivered in real terms when competition exists. The heart of capitalism is competition, not profit making. The allure of profits generates competition. Competition drives innovation. Innovation drives cost cutting and lower prices. The end result is that customers end up paying less for better products. they are wealthier as a result. Along the way capitalists can make short term profits but not long term profits. The only way, in theory, that a capitalist can make long term profits is to innovate endlessly.

Defenders of banking argue that we have seen enormous innovation from the big banks. That is a shallow and failed argument. Innovation is not the creation of even more obscure legalese and fine print. Nor is it the creation of products that only exist to pad out bonus pools. The banking system is supposed to allocate capital effectively through the economy, and to provide a low cost and sound payment system so we can save and get cash reliably when we need to. As Volcker has said, the last big innovation in banking was the ATM machine. The plethora of murky and dubious securitized ‘products’ don’t count: they are simply variations on an old theme.

But, back to Obama.

The proposals have the right thrust. Capping bank size at 10% of the nation’s deposit base is a good start. There are a host of details yet to work out, and I imagine that the armies of lawyers Wall Street employ are already devising sinister schemes to dodge any new rules. Similarly putting a stop to ‘proprietary’ trading will be enormously difficult in practical terms since identifying such trading and separating it from trading undertaken on behalf of a customer is sometimes very difficult. [Proprietary trading is that done by a bank for its own profit rather than being done to satisfy a client need]. Besides, there is little evidence that proprietary trading contributed excessively to the banking melt down. The really big errors were made in securitization and the failure to understand elementary risks of things like sub-prime mortgages and commercial real estate loans. A final objection to a ban on proprietary trading is that banks use such positions to hedge their risks: do regulators really want to expose banks to excessive risk?

So the details will determine the success of the proposals. My approach as you know is much more blunt for exactly the reason that banks are very good at cheating and getting around rules. I know. I helped devise such schemes. Since I believe that creative bankers, lawyers, and accountants will always find ways to cheat – the financial incentive is too powerful for them not to try – then we need to accept that fact and act accordingly. We need to assume cheating and therefore insulate ourselves against the result.

The only way to do that is to limit our exposure to the banks.

To do this we need to force banks to play with their own money and not ours. One way to do this is to increase capital requirements way beyond where they are now. Entering the last crisis most of our banks met or exceeded current capital requirements so we know that such rules are not a solution by themselves. They do, however, limit the taxpayer involvement in a crisis. So start there.

Next we need to limit our insurance exposure. Some bank activities should be made clearly uninsured. Proprietary trading is a good example. We can do this by hiving off that form of banking into uninsured private banks – like the old time investment banks – and thus restricting our insurance to commercial or main street banks. We can limit the size of banks so that each bank failure does less damage. And we can raise the fees we charge banks for the insurance, so as to price properly for the privilege of using our insurance backstop. Naturally banks will raise prices to customers for any increase in insurance costs, but that will have the positive effect of dampening demand for bank services and slowing the industry down, which is not a bad thing at all.

The Obama proposals, based as they are on the Volcker recommendations, aim along these lines. As such they are a major step forward.

Are they enough? No. But they are a much better set of ides than the pablum being put forward by the Treasury Department or the Federal Reserve Board.

Which brings me to the politics of the proposals.

It is quite apparent that a shift in power within Obama’s advisory circles led to yesterday’s announcements. The ludicrous capitulation of the Democrats in Massachusetts obviously contributed to the hasty timing, but the infighting over bank reform had been going on much longer. Obama had originally asked for reform proposals on his desk by year end 2009. That didn’t happen and so he switched to plan ‘B’. I have already said that the winner of the switch is undeniably Volcker, and to a lesser degree Goolsbee at the NEC, the big losers are Geithner and Bernanke. Geithner because he fumbled getting a reform package organized last year, and Bernanke because he represents so much of the status quo.

Indeed the first victim of Obama’s shift in focus could well be Bernanke whose confirmation is now in the balance. As the Democrats try to reframe the political debate in reaction to the loss on Massachusetts and obvious and vulnerable target will be the banking industry and all those who apologize for its anti-social antics. Bernanke is front and foremost in that line. His recent defense of the Fed was all about limited action and new obscure rules to empower the Fed. A quiescent Congress might well have gone along with him. A chastened and newly populist Congress might not.

Geithner too is in trouble. He has openly opposed the Volcker style fix for banking, and has argued for incremental and more bureaucratic approaches. While he stood on the podium yesterday as the president made his statement, he was unusually pushed to the back behind the towering figure of Volcker.

So a shift for the better has taken place. There is an opportunity to get banking back in a box where it cannot do the damage it did. I was pleasantly surprised by the content of Obama’s announcement. I was particularly pleased by the evident influence Volcker has had. Now comes the tricky bit: getting the details worked out. But this time at least we are working from a strong position. The odds are much better that we will get something meaningful.

That’s change progress we can believe in.

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Obama and Banking: Another Bust?

The cynic in me wants to begin by asking: will he screw this one up as well?

But, I should think more positively and at least attempt to be pleased with the gruel the White House keeps packaging as gourmet food.

We cannot get into a discussion of the latest rumors about finance reform without at least commenting on the ridiculous election result in Massachusetts. So allow me to go there first with a rant – I promise I will keep it short!

It is frankly astonishing that the Democrats could be astonished. They screwed themselves royally. Their candidate was a complete twit and committed the full allowance of electoral mistakes. Her campaign should henceforth be held up as how to not to defend a safe seat. The irony is so vast: the Democrats and Obama screwed up health care reform by losing Teddy Kennedy’s seat. This would be the same Ted Kennedy who devoted his life to health care reform. Nice one Obama.

But the blame extends everywhere: the insipid performance of the Senate majority as it wandered through its self-absorbed and delusional debate over health care reform was both an insult to the people of America and a fiasco of political suicide. I have never been so aghast at politicians. The ridiculous and foolhardy outreach to Republican,s who had absolutely no intention of compromise, was a scene straight from a comic book: the president and his fellow travelers deluded themselves into believing that folks like Snowe and Lieberman were actually worth reaching out to. For what? They did not support health care reform in any shape, form, or way. They wanted to kill it from day one. So we were all condemned to watching the Obama frog be boiled. Apparently the only person unaware of his fate was Obama himself. His obsession with bi-partisanship will destroy him. Someone needs to tell him the simple rule: it takes two to compromise.

Maybe the truth is more simple: he doesn’t have any beliefs. He certainly was quick to give up on reform. Too quick in my book. There was no fire. No anger. No heavy leaning on waverers. No attempt to shape debate. All we got was a pallid and soft ‘reality checked’ view that we have to ‘reach out’ and water down so as to ‘get something’ done. Having sold us on the watered down version, the least Obama could do was get that Massachusetts win and assure that even the weak reform was passed. Instead he failed to be energized by the prospect of that loss. I have to conclude he wasn’t committed to reform in the first place.

Those who argue he had no choice are part of the problem too. Look what his vision has brought us: a diminished party presence, a diminished opportunity, and a diminished nation. Some change we can believe in.

Now what? having run away from all the big fights in 2009, what capitulation can we expect in 2010?

Well: finance reform.

Which ends my rant and begins the commentary.

The Wall Street Journal is reporting that Obama is going to announce, later today, measures that will significantly restrict the big banks. Notice that wording: ‘restrict’ not ‘reduce’.

In other words: here we go again.

Obama is congenitally unable to be tough. So instead of starting in a strong position and then working back to the middle compromise, he anticipates where the end will be and starts there. The obvious result is that he has to compromise from there and ends up giving into the opposition. That was the fate of health care and it could be the fate of bank reform.

We need smaller banks for two major reasons: one is that we simply cannot afford to bail out big banks anymore. The biggest banks are now so large that to bail them out would bankrupt the US Treasury. If not bankrupt, the damage would be so great that we would be severely limited in our fiscal policy options were we in another recession. Don’t forget that this last crisis began as a result of banking stupidity. The limited fiscal response – the weak stimulus – was conditioned by the fact we were already swimming in a sea of red ink courtesy of the Reagan-Bush years and the bank bail outs of 2008/2009. Had we been in a modest surplus, as we were at the end of the Clinton era, our response could have been more robust and the recession less damaging. People’s jobs were destroyed by our history of fiscal ineptitude stretching back to 1981.

The second reason we need smaller banks is competition. The record profits now being reported by the banks, in their trading accounts at least, stem in large part from the reduced competition in many fields of investment banking. Our entire banking system lacks sufficient competition to keep the big players honest. The suspicion of rigged markets and abnormal profits hangs over Wall Street because there are so few active players in the game. We need more, not fewer, banks. The quickest way to get more banks is to break up those we already have. It wouldn’t be the first time America has gone down that road.

The proposal Obama is expected to announce include negative incentives to discourage bank growth, and rules to reinstate the separation of investment and commercial banking. These are two very important actions needed to shore up the banking system, but already we can detect the Obama weakness.

Instead of proposing outright break up for the big banks – splitting them into two or three and breaking out their investment banking pieces as new organizations – the administration is simply proposing ‘rules’ and ‘regulations’ to achieve the same goal in a less aggressive manner.

This sounds like a slippery slope again.

The banks are already ramping up their formidable lobbying efforts. We can almost hear certain senators trembling at the thought of the money that will flow into their coffers if they suddenly find a reason to oppose anything too disruptive. The Federal Reserve Board opposes bank break ups as being unnecessary. Bernanke recently gave his opinion on the causes of the crisis: he attributed it to a lack of sufficient regulation, so he supports the creation of more rules as the preferred method for reform. Presumably he will make sure these rules are enforced – unlike the rules he didn’t enforce before. Larry Summers and Tim Geithner are too wedded to Wall Street to argue for anything radical. In fact, nowhere in the current corridors of power do I see an advocate of anything remotely like strong reform. Except for Paul Volcker perhaps.

We are ruled by timid or corrupt bureaucrats.

The analogy that springs to mind – in view of the health care mess – is of Neville Chamberlain and appeasement. I have a vision of Obama stepping off a plane waving a book of new rules and regulations, claiming to have reformed the banks, and having saved us from a new melt down. While in the background armies of lawyers and accountants trample through those same rules and regulations and reduce them to valueless garbage within hours of the ink having dried.

The risk of fighting tanks with paper is that tanks tend not to notice the paper. And the banks are acting like armies of tanks raging through the economy and pillaging it at will. They need to be blown up.

Fundamental reform is just that – fundamental. If we honestly believe the banks are too large then we should have the courage and foresight to make them smaller. We shouldn’t ‘suggest’, ‘guide’ or ‘ask’. We should force. Frankly force is the only language the banks seem to understand given their total disregard for the public as expressed in those annual bonuses they are handing out to themselves.

Of course we might disagree as to whether the banks are too large. In which case lets discuss that. The onus is on the banks to prove that they are not anti-socially managed or constructed. And yes I mean ‘anti-social’. I have read some commentators argue that the banks have no social responsibility and that their only goal is to make profits for their shareholders. That is true only in part, and even then the banks fall short.

As long as taxpayers are acting in bail out mode the banks have to take social claims against their behavior seriously. They are not solely beholden to private interests if social money is to be used at any point. Society has both a right and an obligation to interfere in bank management to ensure our money is being deployed wisely. Having smaller banks is one way to get such assurance.

Even if we don’t agree that society has an active interest in internal bank affairs, shareholders surely do. In which case we should ensure that shareholders actively participate in matters such as bonus policy. At the moment bank shareholders – and in particular the institutional shareholders like retirement funds – are far too passive. The idea that 60% of Goldman Sach’s revenue is syphoned off for pay and bonuses suggests that the managers have the upper hand against the shareholders. Imagine the retirement fund’s valuations if that revenue was passed on to the shareholders instead of being carved out for the employees. If your retirement fund has shares in Goldmans Sachs you should be wincing every time you read about those bonuses – its your money being paid out to those traders!

So what do we conclude?

The health care mess gives us little assurance that Obama has the character to take on an entrenched industry. He seems not to have the stomach for big political debates. Instead he is a bureaucrat and thinks that tweaking rules will ‘nudge’ the banks to do the right thing. Later today we will learn how he interprets the lessons of the Massachusetts election. Will he become even weaker? Will he trim even more to the right? Will he cave in more quickly to the powers that be?

The good news is that he appears to be taking that advice of Paul Volcker who has been an active advocate of braking up the banks. This may be a sign that the lesson learned was that the country needs strength at the top.

We can hope can’t we?

Hope … I seem to remember a presidential campaign in which that was a big word.

Doesn’t that seem a long time ago?

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The Crisis Commission: Day One

This is a week where news about the economy is scarce – the only notable data was the fact that the trade balance widened to $36.4 billion in November, which is both the worst since January last year and a fairly good sign that domestic activity is improving. So we learn nothing new even from this little piece of news.

So the focus stays on banking and, in particular, the proceedings of the Federal investigation of the financial crisis. Today is the first day of public hearings with notables like Lloyd Blankfein of Goldman Sachs and Jamie Dimon of JP Morganm Chase in the hot seat.

Already we’ve had a tense moment: Phil Angelides, the commission chairman, got us off to a fun start when he lashed into Blankfein with questions about Goldman’s nasty habit of selling investments such as mortgage backed securities, and then immediately turning around and selling those same securities short. You would only sell something short if you were convinced it was going to go down in value. So the obvious question is: did Goldman let investors know it thought the assets it was selling were worth a lot less than the amount it was charging for those assets?

Naturally Blankfein dithered in his answer, before admitting that, no Goldman did not advise investors of such problems.

His defense, if one can call it that, was that all the investors were ‘sophisticated’ and ‘analytical’ professionals who knew full well the risks they were taking. So Goldman had a right to presume the investors had done their due diligence on the assets before they went ahead and bought them.

In the sordid and ethically challenged world Goldman apparently inhabits such a response seems perfectly reasonable. To the less jaded and less ethically challenged eye, however, the fact that a purveyor of investments immediately hedges against those investments suggests that the disclosure was less than transparent, and may well border on fraud. That is fraud in an every day sense, not in the legal, carefully protected, and suitably obfuscated world of ‘Goldmanian’ finance.

Blankfien’s defense is intensely revealing. It opens up to our view a world where supposedly slick professionals who are ‘sophisticated’ and analytical’ shovel toxic crap into each others laps in order to make a quick buck. This is called high finance. Since everyone knows the rules, no one takes due diligence that seriously – instead they hedge against losses. They sanitize their lack of care by palming the loss of on someone else. The end game is to be stuck with less rubbish than anyone else, and to make sure all the toxic stuff you may own is covered by some sort of insurance.

It is a world where the old meaning of words is perverted. Due diligence used to be a careful method of risk mitigation. Now it is a perfunctory pre-sales function diminished by the after sales function of insurance. I suspect that much, if not the entire, volume of derivatives trading has become infected with such perversion. Indeed I would wager that most of the volume of derivatives exists because of the manic need of the big banks like Goldman to dump what they know full well to be toxic waste into an unsuspecting lap before it explodes and damages the bank’s bonus pool. No one does proper due diligence because everyone is buying insurance.

Angelides himself gave an analogy for the benefit of the press: Goldman’s method of investment sales is, he suggested, like selling a car knowing it had no brakes, and then buying insurance ‘in case’ it crashed.

To add to the blatant sleaze of Goldman’s business practices is the asymmetrical nature of Blankfein’s claim. Apparently his firm is correct to foist garbage on someone else because that someone else is presumed to be as sharp as Goldman in evaluating the risk of the transaction. But what happens when it is Goldman supposedly doing the due diligence,when it is the buyer, not the seller of a transaction?

Aaah. Then the rules change. How odd. When, for instance Goldman is suckered by AIG,. and has bought completely useless credit default swaps, AIG should be ‘honest’ and make Goldman whole. Poor little Goldman Sachs surely should not take a loss on transactions that big nasty AIG knew were rotten. This is, of course, the position that Tim Gethner took when he allowed the reimbursement of AIG’s counter-parties using taxpayer money. Those slick, smart and world class bankers had been given a sucker punch. They had failed totally in their due diligence. But instead of laughing at their stupidity, Geithner felt sorry for them and wrote out billions of dollars worth of checks. AIG not able to pay out all those CDS contracts simultaneously? Who knew? . Welfare checks for the poor bankers of Goldman anyone?

Double standard? Cheap and sleazy? Venal?

All of the above.

One thing is for sure: no one should ever respect the ethical standards of Goldman Sachs. There aren’t any. Which is a terrible shame, becasue when I did business with Goldman, years ago, their reputation was for being smart and slick – sharp in a good sense. Not simply sharp. The difference between the old Goldman and the current sleaze version is that it is no longer a private bank, and yet still pays as if it were. The risks are dumped onto shareholders, while the returns are kept inside for the employees. With that basic relationship severed the bank’s ethics went overboard and making a quick buck became the only thing that mattered.

Clearly customer relationships and reputation don’t count.

Too bad.

Break it up.

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Obama: A Year End Economic Report Card

This has all the appearance of a slow news week coming up. At least for the economy. On Thursday and Friday we will hear a little more about unemployment, consumer sentiment, and retail sales, but before then we will have nothing to do but watch the slow moving lunacy that is the health care ‘debate’.

And, yes, it justifies those quote marks.

Given this, I thought now would be a good time to reflect on the overall Obama economic agenda and start to hand out his year end grades. So here we go:

  • Growth, or lack thereof:

I begin here because everything else has to be placed in the context of the overall economy. As those of you who follow my comments closely will no doubt recall – how could you forget? I have shouted loudly enough! – I have been a regular critic of the administration’s luke warm efforts with regard to stimulus. I thought from the outset that they set the bar too low and failed to fight for the necessary injection of cash to guarantee an end to the recession.

This failure was based on two parallel lines of reasoning: first there was a shallow sense of political possibility – the administration deemed that in the aftermath of TARP Congress was not in the mood to spend enough to save the economy, and so it chose not to spend its capital on getting the right stimulus package together; and, second, there was a clear rift within the administration’s economic advisory wing between those who sought a larger stimulus and those who believed the forgoing about the political landscape. This internal conflict resulted in any discussion of a properly configured package being eliminated before the start of debate.

We began the discussion with one hand tied behind our backs.

Naturally the outcome was messy. Far too much of the stimulus was allocated to low effectiveness items – tax refunds being the classic example – and too little was allocated to big spending, and therefore big employment, capital projects. There was to be no second New Deal.

The political calculation was both cynical and misdirected. Opponents of government spending were not mollified or muzzled, and advocates were left doubting the administration’s political will. Both camps ended up with something to grouse about. The opponents were given ample leeway to complain about the failure of government intervention, while advocates – like yours truly – have been left to fret constantly about a missed opportunity. Either way the administration looks a little lame. But that seems to be a theme lately.

As we now know, with the Congressional Budget Office report last week, what stimulus there was had the predicted and desired effect. It put a considerable floor under the economy. Fewer jobs were lost, and growth has returned earlier than would have been possibly without such a stimulus.

The enduring problem is that the weakness of the original package echoes on through the economy’s current struggles. Because the stimulus fell way short of the amount needed to guarantee a return of solid self sustained growth within the private sector, we are faced with an ongoing worry that growth is so weak it could evaporate at the first sign of reversal. Plus, as we all know, unemployment has risen to a sadly high level, notwithstanding its slight decline last month. So while the CBO points to success, that success is sufficiently muted that many regular folks just don’t see it.

As a result, opponents of stimulus still rant about its failure and their complaints resonate well with a populace regularly spoon fed a diet of anti-government ideology over the past thirty years. The opposition has tapped into a populism deeply entrenched and steeped in suspicion of all things to do with government spending. So when the Federal budget is announced to be growing by leaps and bounds, opponents of stimulus find easy access to the media and have an equally easy time convincing voters that now is the time to reverse course and ‘balance the books’.

That these same folks were silent during the great debt surges under Reagan and Bush never seems to register with voters. As I have written here before nothing is more confounding of the stereotypical view of our political parties than the fact that, in its history, the US has had exactly two non-crisis surges in its national debt. Both were associated with Republicans – Reagan in the 1980’s, and Bush in the 2000’s – and yet neither gets the opprobrium it deserves. Let me repeat: national debt should go up in times of necessity. That’s what it’s for: to provide cash when the country faces a crisis. It should never go up when the economy is healthy.

Nonetheless, here we are, the stereotypes are being trotted out, the fiscal hawks are gaining strength, and the economy is still weak.

So what grade should we give? The economy is growing, for that we should allocate a B++. Growth could have been more robust so an A is not in order, but the odds are that we will grow modestly for a while. Unemployment is very high, that garners a C+. We could have attacked it with more energy and commitment, but much of the damage came on Bush’s watch. Most importantly, the political landscape is now strongly set against further intervention, even though the original stimulus was a success. This deserves a C. I can’t help but feel the political sands shifting against us – call it a lack of will, or call it a fine calculation, either way we have deliberately reduced our policy options at a critical moment in our economic development.

Overall grade? B or B- [with a plus trend] depending on how annoyed you are about the poor politics.

  • Financial Reform:

It would be easy to say ‘what financial reform’? given the slow dance going on in Congress, but this is a very important part of our economic agenda so we have to eschew giving an incomplete and grade what we know so far. Next year we will hand out the final grades.

I begin by repeating my comment about tepid leadership. Nothing speaks more to the administration’s style than its almost aloof handling of the financial crisis. Again we must be careful: this disaster festered and sprang to life under the auspices of the Bush regime so Obama is left to carry the bag. But that should be an opportunity to write history, not to wallow in bureaucracy. I am afraid the administration’s efforts so far are so way off target that they should not be dignified with the word ‘reform’. The current proposals have all the reformist thrust of a limp carrot. A wilted one to boot. It looks fine but has absolutely no crunch. The administration’s efforts have all the hallmarks of a bureaucrat’s small minded wish list: petty rule tweaks, minor adjustments, and lots of discussion about exactly where to staple the papers together. None about attacking the root causes of our problems. Which is a subject that might upset the bankers, so it gets shunted off to one side.

I see it as boiling down to this:

  1. Break up the big banks. They are too big for us to afford as a nation. Until they are cut down to size policy makers will live – understandably – in their thrall. This should have a nice patriotic and populist ring to it, bit instead is treated as a hair brained scheme thrown in from the fringe. Except that both Volcker and Greenspan have now endorsed it. That the administration doesn’t speaks volumes of its willpower.
  2. Cut the Federal Reserve Board down in size and scope. It failed. It failed as a systemic regulator. It failed as a monetary policy institution. And it failed as a protector of consumers. Of these three it should be allowed to keep the monetary policy portfolio alone. The others need to go elsewhere. Plus, and this is another populist measure that should be bringing Obama plaudits from Main Street, we need to open the Fed up. Currently the Fed is still an opaque gentlemanly bankers club. It is riven through with conflicts of interest and is overwhelmingly banker sympathetic. It needs to become a more balanced economic institution akin to central banks elsewhere. At the same time let’s reject the plainly silly notion that we can manage the economy without a Fed. Only extreme libertarians and neo-classical economists could think such a thing. And recent history has just dealt their worldview and nasty blow.
  3. Establish a true consumer finance regulator. This should be a no-brainer. And kudos to the administration for backing the idea. The Fed has been horrible as a protector of consumer interests. It fell hook line and sinker for the ‘let the markets decide’ version of regulation. It had a positively Ayn Randian perspective on the benefits of deregulation, so it should come as no surprise that consumer protection fell off its radar entirely. This needs to be fixed.
  4. Either abolish or regulate the derivatives markets. Properly speaking there are no centralized ‘markets’, which meant that the world of derivatives possessed all the sanity of the Wild West. No wonder it blew up. I fail to see the underlying economic or social purpose behind most of what goes on in the murky world of the derivatives business: it simply aggrandizes the players while we pick up the tab. Agricultural and commodity futures and their ilk I see a place for, but CDO’s and CDO ‘squared’ … not so much. If the game is to be continued put it out into the open. No more ‘dark pools’ and other testosterone polluted quagmires.
  5. Combine. Combine. Combine. Let’s have one financial regulator. No more regulatory arbitrage. Let’s have one national insurance overseer. And let’s get all the financial market regulation under one roof – preferably not the SEC’s given their record of pandering to business, but it will probably have to be there. Plus, and this won’t happen, let’s update Congress itself: one oversight committee and not the current mess.
  6. Lastly, ban corporate political contributions. Ban them. I know it won’t happen. But until it does our politics will remain corrupted by the flow of cash.

Well that’s my list. How does the administration stack up? C-, that’s how. They only score that well because the reform effort is still underway and Congress is adding in its own proposals to help stiffen the administration’s spine.

My problem with the administration and its attitude towards banking is predicated on what I perceive to be its over weighting towards the industry. Too many of its key players are closely aligned and sympathetic with industry positions. Geithner, Summers, and Bernanke are all schooled and experienced in the same way as the big industry insiders. They believe the same things. They differ only in degrees. Which is why the administration’s reform is redolent with tweaks and not bold action. They have bought the notion that a few nice nudges are all that is necessary to prevent another meltdown.

I couldn’t disagree more. That C- is under pressure already!

  • Health Care Reform:

I have never been more disappointed with Congress, the administration, and the entire structure of political discourse than I am over this issue. It has been a low point in American political life. This is an issue of supreme economic and social importance and the country has been treated to a spectacle worthy of a lower grade school bun fight. Pathetic dignifies it.

I give the administration enormous credit for getting the notion of health care reform on the agenda. That alone deserves an A+. It’s subsequent abject inability to shape the discussion is just appalling. It gets an F for that.

The entire process has been a long drawn out appeasement of a few senators. It has exposed the arcanity of the Senate process, which is designed to enforce compromise even on subjects as divisive as health care reform. Hence we watch people like Olympia Snowe being courted as if she is a world expert on health care, and have to listen to Joe Leiberman – painful at the best of times – twist and turn as he attempts to sink the public option.

As you know I love argument and debate. But this has been neither. It has been mudslinging and avoidance of fact. The name calling and hysteria over things like rationing has been demeaning to a nation that thinks of itself as a world leader. No one, seemingly, wants the public to hear what the central issues are. No one wants to inform.

This is the administration’s fault.

It has the soap box.

Nothing is more telling about the administration’s weakness as a source of leadership than this pseudo debate. Having put the ball in play the administration spent the entire summer avoiding getting entangled or even staking out a clear position on the choices. Even yesterday as he attempted to rally the Democratic caucus, Obama couldn’t bring himself to refer to the public option.

Let me not dither that way: we need reform. Said reform should expand coverage as much as possible. In the absence of a true single payer system – which is the least cost option – the system should highly regulate the insurance companies. We should all recognize that the health care coverage we get from employers is not ‘insurance’ it is a benefit. We need true insurance. But the economic nature of privately supplied insurance militates against widespread provision – private ‘for profit’ companies naturally want to cherry pick who they cover and what they pay for. Private companies ration health care via the prices they charge. Rightly so. The question before us is thus simple: do we agree that we should have limited, higher cost, and private insurance? or do we want more widely available, cheaper, but government provided insurance? They are the two central choices. Both are forms of rationing. All economic choices are a form of rationing. If we want cheap, we need the government’s size and indifference to profit to drive prices down. It is a scale argument. Plus: only the government will be willing to insure everyone. Even sick people.

And that’s what I thought a health system was for.

I don’t blame you if you have turned off from the ugliness that has passed for ‘debate’ this year.

I do blame the administration for not having provided a more muscular leadership to keep us focused on the big issues. Instead we were left to muddle through.

And what a muddle it is. Even now, right at the end of the process, it is hard to tell what will emerge.

So somewhere between an A+ and an F? Pending the outcome I give the administration a C+/Incomplete

There you have it. The year end report:

Economy: B

Financial Reform: C-

Health Care Reform: C+/Incomplete

And a lot of ‘must try harder’!

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