Let the banks foreswear too big to fail insurance

Rarely do I agree with the Economist newspaper. I suggest these banks buy back all the toxicity on the Fed's balance sheet and formally foreswear government backing of their operations.

Wall Street and the taxpayer
Thanks for Nothing
Economist
Jun 11th 2009

Banks should be encouraged to pay back governments—but not to rewrite history

THERE is a new kind of queue in banking, and it is not formed of terrified depositors trying to withdraw their savings. Instead banks are lining up to repay the public capital they received during the depths of the crisis some six months ago. Having met regulators’ stress tests, ten of America’s stronger lenders, including JPMorgan Chase and Goldman Sachs, won approval on June 9th to buy back a collective total of $68 billion of government shares. In Britain, Lloyds Banking Group has begun to give the state some of its money back.

It is easy to see why the banks are keen. By reducing the government’s stake they hope to reduce its influence. Paying back the state is also a way of advertising that they have regained some of their strength. In most respects taxpayers should be happy, too. With the financial system more stable and profits and share prices showing signs of life, these banks have been able to sell new shares to raise cash, and so replace state funds without eroding their capital. The returned money can be recycled into smaller banks which still need equity (see article) or used to cut public debt. It will be a long slog: Western governments have injected about $450 billion of capital overall. If the economy deteriorates again, investors’ appetite for buying shares will evaporate. But the process of returning ownership of banks to the private sector has begun.

At the same time, however, a worryingly revisionist history of the credit crunch is being penned. It says that some banks did not really need government help and were bullied into accepting it last year as part of a wider bail-out of their flakier peers. There is a startling lack of grace: Jamie Dimon, the boss of JPMorgan, has fantasised about sending an ironic accompanying “Dear Timmy” thank-you letter to America’s treasury secretary, Tim Geithner, saying “We hope you enjoyed the experience as much as we did.” The boss of Wells Fargo has called the solvency tests “asinine”. The aim of such behaviour is presumably to convince regulators to focus the coming clampdown on the weakest banks. JPMorgan argues that since it was forced into taking capital, the terms of the remaining warrants the government owns should “out of fairness” be eased. Other big banks make similar cases, albeit less vocally.

Despite owning hundreds of billions of dollars of hard-to-value assets, banks seem now to regard as unnecessary the American government’s scheme to purchase toxic loans and securities. Those European lenders that did not get state capital are patting themselves on the back. The message is clear: we never needed government help, and we don’t want it now.
2008 and all that

That is both wrong and dangerous. Wrong, because in the depths of the crisis the share prices and borrowing costs of all banks indicated an almost complete collapse in confidence. Some firms did perform better than others, but only relatively so. All the banks benefited from an implicit state guarantee. Even those lenders who never got capital would probably not have survived without government rescues of weaker firms to which they had counterparty exposures.

Similarly all banks are now plugged into government life-support systems. Their liquidity is supported by more generous collateral rules at central banks. Profits are being boosted by rock-bottom short-term interest rates. Some banks have managed to issue debt without public guarantees, but the system needs to refinance $26 trillion of wholesale funding by 2011; without an implicit state backstop this would surely be impossible. And the value of banks’ assets is being sheltered by central banks’ asset purchases and more generous accounting rules. The truth is that the West has a thinly capitalised banking system that is being allowed to earn its way back to health. Save for defence and space exploration it is hard to think of a privately run industry more dependent on the state.

So the revisionist version of the crisis is plainly inaccurate, but is it really dangerous? Yes, if it distorts the way new rules are drawn up to regulate banks. It would be a disaster if regulators adopted a two-tier approach, judging that those banks able to avoid or repay quickly state capital early had more or less vindicated their business models, and that only those unable to pay up required closer oversight. Although Barack Obama has said repayment does not imply “permission for future misdeeds”, banks with government stakes seem likely to be subject to different rules on executive pay.

If anything, regulators should focus not on the tardiest payers, but on those banks that are too important to fail. And the main bits of the reforms needed—more liquidity and capital, less proprietary risk-taking and better incentives—should be applied firmly and consistently to all lenders. It was the entire banking system, not a few individual firms, that failed. It is the entire system that must now be fixed.

Kuttner putting in perspective the European electoral defeat of Center Left parties

Robert Kuttner of the American Prospect and Demos gives us the context of the political part of political economy of the next few years.

Left Out in Europe
by Robert Kuttner

The European left, such as it is, got clobbered in the recent elections for the European parliament. In the next parliament, center-right parties will have almost twice as many seats as social democrats. Of left parties, only the Greens gained slightly. Far-right nationalistic parties picked up strength.

This should hardly come as a surprise. Over the past generation, especially in places like Britain, Germany, and the Netherlands, Europe's center-left has worked hard to neuter itself as an opposition force, rivaling free market parties in an embrace of high finance and heedless globalization.

In the late 1990s and early in the present century, Gerhardt Schroeder of the Social Democrats, then the German Chancellor, was a leading sponsor of financial market liberalization. He also went to great lengths to weaken labor protections. His British counterpart, Britain's Tony Blair, went Schroeder one better in putting all of his economic eggs in the basket of Britain's financial elite. Blair intensified the financial policies of Tory Margaret Thatcher. As in the US, the seeds of the current financial collapse were sown under nominally left-of-center governments.

The Italian left has vanished almost entirely. In France, factional and personal disputes have prevented the Socialist Party from offering a coherent alternative to President Nicolas Sarkozy, who offers a characteristically French, paradoxical combination of nationalism and social protection.

For a generation, the European center-left has embraced essentially the same version of global laissez-faire and liberated finance as the center-right parties, tempered by only a marginally better version of the welfare state. The common formula is: liberalized capital markets; freer global trade; reduced protections for workers; flatter taxes. The very phrase, "center-left" is an emblem of the capitulation to global finance. Thus, leading moderately left parties have scant alternatives to offer voters at a time when free market capitalism has thoroughly disgraced itself.

Alienated voters either stay home or vote for the far right. It's an old story--and given what we know of twentieth century European history, a terrifying one.

The ideological lines are further blurred because the center-right also defends the welfare state. But everywhere, the cost of paying for the failures of capitalism is rising, leaving all of the mainstream parties with a fiscal crisis. Because of these costs, the welfare state in much of Europe has become a defensive fortress--a society of insiders and outsiders. The insiders are civil servants and a dwindling number of workers with secure jobs. The outsiders are increasing numbers young people, women, and immigrants, who cannot find good jobs and do not enjoy the full social protections. This bargain is not stable, either economically or politically.

The short term winners are the center-right parties, which form the governing party in most of the nations of the European Union. But they hardly offer the voters much either. The leader of the British opposition, Tory David Cameron, hasn't a clue how to help Britain recover from economic collapse. But he is likely to win the next election. The ruling coalitions in France, Germany, and Italy are not delivering economic recovery. But absent a believable left, they will continue to govern.

The EU, once a possible instrument of social democracy on one continent, itself has become something of a Trojan Horse. Its basic document, the Maastricht Treaty, makes free movement of capital, goods, services, and persons a core constitutional doctrine. Social protections are secondary.

Thus, the European Court of Justice has recently issued rulings defending the rights of nations such as Poland, Estonia and Latvia, with lower social protections, to impose their standards on the core nations of the EU. German contractors can end-run Germany's good labor standards by hiring Polish sub-contractors. Construction and transport firms from the Baltics can undermine Sweden's system of collective bargaining. Hedge funds based in London can buy Scandinavian firms and erode the local social compact. This has become Europe's version of a race to the bottom.

The politics of the EU compound the constitutional problem. The Commission of the EU, based in Brussels, could adopt stronger social defenses if it so chose. But center-right parties currently have a strong majority of governments of Europe's 27 member states. So policies to constrain the regime of global finance cannot win support. The British Labour government, nominally part of the center-left, invariably votes newer member states that have center-right governments, against anything that could be considered a restraint on free capital movements.

The exceptions to this sorry picture are the Social Democratic parties of Scandinavia and to some extent of Spain. The Nordic Social Democrats have insisted on a social model that spends enough money to provide security combined with flexibility. Denmark supports liberal trade, but there are powerful quid pro quos. When a Danish worker changes jobs, it is usually to move to a better job, with the mobility subsidized by the state. There are hardly any low-wage workers in Denmark, and no welfare state of insiders and outsiders, except for some immigrant groups. And Denmark did not suffer a financial collapse because it did not abandon bank regulation.

There are currently conservative governments in Stockholm and Copenhagen, but they don't dare tamper with the basic formula. The former Danish Social Democratic Prime Minister, Poul Nyrup Rasmussen, is currently Europe's leading advocate of much tougher regulation of financial capital.

Rasmussen might have been the next president of the Commission of the EU, had the left not been trounced. And so the vicious circle continues. The left offers little to voters, and the right keeps being elected.

This is surely a moment for a compelling program to constrain capital in the broad public interest. Capitalism has demonstrated once again why it is not capable of being self-regulating. American progressives used to look longingly to Europe, with its stronger trade unions and its more comprehensive social protections. Those are still there, but unraveling under assault. What's missing on most of the continent is political leadership, vision, and nerve.

Robert Kuttner

Mortgage Resets Chart

Idiot of the Week -- David Malpass

Podcast transcript:

[The following does not contain the audio from the podcast.]

We considered on this edition of idiot of the week comparing David Malpass to the Ptolmeic astronomers, an image I've used in the past for supply siders who must invent ever more elaborate and complicated intellectual machinery to do what demand side does so simply, easily, effectively and convincingly. But Brad DeLong hijacked the Ptolmeic astronomy analogy this week with a piece in the Times attacking Judge Richard Posner and his Chicago School apology A Failure of Capitalism.

We skewered Posner on Idiot back in April for the same book, though I see we misidentified him as Robert Posner. Not the same.

Here's DeLong on Posner.

DELONG

Back to Idiot of the Week, not Posner, Not DeLong, but David Malpass. I started to compare Malpass to the Ptolmeic astronomers because of his insistence on making a way for the facts to fit an unworkable scheme.

MALPASS

Seems to make sense. Does it work?

Here is Malpass in August 2008, nine months ago, just before the systemic collapse of the financial sector. As I mentioned, Malpass was chief economist at Bear Stearns. 'nuf said.

MALPASS

David Malpass, strong dollar, corporate welfarist, IDIOT OF THE WEEK!

We conclude with this question. If Citi fails, what happens to the toxic stuff on the Fed's balance sheet? Can the Fed become a zombie?

Footnote:

Ptolmeic Astronomy

1. All motion in the heavens is uniform circular motion.
2. The objects in the heavens are made from perfect material, and cannot change their intrinsic properties (e.g., their brightness).

3. The Earth is at the center of the Universe.
4. The 55 concentric circles around the earth are set in motion by the prime mover outside the last.
   

Stiglitz points to political dangers of bank dominance

Joseph Stiglitz was at the Council of Economic Advisers in the 1990s, where Christina Romer now sits. He also served at the World Bank. Stiglitz and Summers were not on the same page in the Clinton White House.

in an article on Project Syndicate

America has expanded its corporate safety net in unprecedented ways, from commercial banks to ... automobiles, with no end in sight. In truth,... this is an extension of long standing corporate welfarism. The rich and powerful turn to the government to help them whenever they can, while needy individuals get little social protection.

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don't break them up, then we have to severely limit what they do. They can't be allowed to do what they did in the past - gamble at others' expenses.

This raises another problem with America's too-big-to-fail, too-big-to-be-restructured banks: they are too politically powerful. Their lobbying efforts worked well, first to deregulate, and then to have taxpayers pay for the cleanup. Their hope is that it will work once again to keep them free to do as they please, regardless of the risks for taxpayers and the economy. We cannot afford to let that happen.

Joseph Stiglitz. The best economist of the 21st Century. As I read it, Stiglitz is saying the financial crisis is becoming a political crisis and may well take the political process down.

House price decline may not be abating

One of the recent claims is that house prices are falling less rapidly than they were before. Declining at a slower pace, is the term. We believe this is wrong. Even in the math. If zero were the base, it would be conceivable. But house prices are not going to fall to zero. They have some positive value. If this positive value is in any way significant, then the denominator of the percentage fall gets smaller faster than in the case of a zero base.

It's too damn bad the solution chosen was not an effective Home Owner's Loan Corporation or effective protection in bankruptcy. Instead it is the supply side of the market that is being salted with free money from the Fed to bring down mortgage rates. This may help those in good shape to refinance and generate some better cash flow, but that is going directly into the savings account and is not going to help demand.

Here is housing expert and noted economist Robert Shiller's take. This is the Shiller of the Case-Shiller Home Price Index.

Why Home Prices May Keep Falling,
by Robert Shiller,
Commentary, NY Times:

Home prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010.

...

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. ... If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And ... we still appear to be in a continuing price decline. ... One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers ... have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. ... And they don’t like shifting from being owners to renters... Among couples...,... any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn. This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting...

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

Larry Summers and White House Tension?

Truth be known, one of my least favorite economists is the brilliant Lawrence Summers now of the National Economic Council, the president's economic counterpart to the National Security Council. Summers was one of the three amigos -- Rubin, Greenspan and Summers -- of the Clinton economic miracle. In that position, he helped along the dismantling of the New Deal's Glass-Steagall structure that has allowed the banks to become too big. He was the chief proponent of Timely Targeted and Temporary, the stimulus that didn't work in the early part of 2008.

We understand that Obama needed immediate legitimacy and credibility for his economic policies and that one of the ways he did it was hire the Clinton economic team. Our objection to Summers is not entirely on policy grounds. We feel a continual posturing going on in the pauses of his characteristic verbal cadence.

So a piece in the New York Times on Sunday was not entirely unwelcome to our eyes.

Obama’s Economic Circle Keeps Tensions High

By JACKIE CALMES
Published: June 7, 2009
New York Times

WASHINGTON — President Obama was getting his daily economic briefing one recent morning when a fly distracted him. The president swatted and missed, just as the pest buzzed near the shoes of Lawrence H. Summers, the chief White House economic adviser. “Couldn’t you aim a little higher?” deadpanned Christina D. Romer, the chairwoman of the Council of Economic Advisers.

Mrs. Romer was joking, she said in an interview, adding, “There are only a few times that I felt like smacking Larry.” Yet few laughed in the president’s presence.

If the Oval Office incident was meant as a lighthearted moment, it also exposed the underlying tensions that have gripped Mr. Obama’s economic advisers as they have struggled with the gravest financial crisis since the Depression, according to several dozen interviews with administration officials and others familiar with the internal debates.

By all accounts, much of the tension derives from the president’s choice of the brilliant but sometimes supercilious Mr. Summers to be the director of the National Economic Council, making him the policy impresario of the team. The widespread assumption, from Washington to Wall Street, was that the job would be Mr. Summers’s way station until the president could name him chairman of the Federal Reserve when Ben S. Bernanke’s term expires early next year.

And the Times Piece goes on, though it does little to back up the claim of tensions. Whether Summers will go to the Fed or not is very much up in the air. I would be surprised unless he convinces somebody that he would not take the job and run the world with it.

For context, there is some audio of Summers on the podcast from the BBC's Business Daily talking about the economy.