Marshall Auerback argues that we can't let the BP crisis go to waste, as we did the financial crash.

Just 35 days after the explosion on BP's Deep Horizon offshore drilling rig, (and two months after President Obama himself opened up vast swathes of the outer continental shelf to offshore drilling), the federal government has launched a criminal probe into the massive oil spill in the Gulf of Mexico, U.S. Attorney General Eric Holder said last Tuesday.

All well and good. But it invariably begs the question as to why, some three years after the start of the greatest financial crisis since the Great Depression, there have been ZERO criminal investigations launched by Justice against Wall Street. The contrast is striking. Perhaps there are investigations proceeding as we write, but it does seem curious that Justice has held its fire against Wall Street (a large donor to the Democrats), whilst aggressively going after Big Oil (which happens to have been one of the bigger paymasters for the GOP in the last few elections).

The U.S. has two severe problems that could be in crisis next year. Commercial real estate is a disaster (another burst bubble), and banks are largely not recognizing their losses in this area. The banks used their political power, and Ben Bernanke's blessing, to cause Congress to extort the Financial Accounting Standards Board to gimmick the accounting rules to prevent loss recognition. The Department of Justice even failed to act after the release of the Examiner's Report on Lehman's bankruptcy, which provided clear evidence that as one of the largest banks in our nation teetered on the brink of bankruptcy, its executives were masking accounting gimmicks that inflated their quarterly earnings. It's worth asking again, as Eliot Spitzer and Josh Rosner asked in a blog on New Deal 2.0: where were the Treasury, the SEC and the Fed? (The Fed's inaction is particularly alarming given the new regulatory powers it is about to receive under the new financial reform bill.)

Imagine the uproar today in the US (even in oil loving states, such as Louisiana) if BP was involved in the watering down of legislation to govern energy policy and offshore drilling. Oh wait, that did happen...under the Bush Administration, where he drafted Enron's Ken Lay precisely for this purpose. We are reaping the consequences of that perverse executive action, much as I suspect that in a few years hence, we will be reaping the consequences of our failed financial regulatory "reforms" that do nothing to effect structural change and prevent a recurrence of the current crisis.

The other severe problem is nonprime mortgage paper (where losses range from 50 to 85 cents on the dollar). These losses are not being recognized. Worse, they are being hidden by the Fed and dumped on Fannie Mae and Freddie Mac while the politicians and Treasury declare that we "resolved" the greatest financial crisis in 80 years at virtually no cost to the taxpayer. We've now had a number of narratives to that effect, no doubt spun aggressively by the Geithner Treasury: Joshua Green's "Inside Man" and John Heilemann's "Obama is from Mars, Wall Street is from Venus" are two obvious examples of this genre which spring to mind.

As my friend Bill Black has noted repeatedly, our government and our regulators continue to sanction accounting fraud to hide losses that are, in fact, the product of accounting fraud. The losses are still there. Indeed, as Black argues, they've grown.

The fundamental perverse incentives that cause recurrent, intensifying crises remain in place, almost entirely untouched by the reform bills: executive and professional compensation, bad accounting, "control fraud," regulatory black holes and the appointment of anti-regulators who have a track record of failure and don't believe in regulating. Many of those regulators have been reappointed by the Obama Administration, including the non-regulator in chief, Ben Bernanke.

As awful as the BP spill is, the magnitude of its regulatory failure is dwarfed by what has happened on Wall Street over the past 30 years. The same people who have presided over the mess are still in power. There have been zero criminal charges.

Perhaps the criminal charges will come. In the meantime, Obama has an opportunity to harness public anger in a more productive direction than has been the case with financial or health care reform. There is an alternative to our addiction to oil, but as long as deficit hawks dissuade us from supporting government-funded initiatives needed to strike out on another energy path, we will not realize it.

In addition to my work in finance, I happen to do a lot of work in clean tech and come across endless science programs on alternative energies. There is no magic bullet, but there are technologies in existence today that can reduce our addiction to oil. But most require a massive government push, on a scale along the lines of the Manhattan Project. The concentrated effort of the Manhattan Project produced a bomb perhaps decades earlier than it would have otherwise, in a mere few years, literally from theoretical scratch. The government diverted 11% of the nation's electric power to produce those few handfuls of uranium and plutonium for the first bombs. The facilities were the biggest ever built by mankind. The government did it and it worked.

The Manhattan Project was done in secret, which I do not advocate. But it represented an extraordinary historical precedent. If we could devote ourselves in similar fashion to energy, just imagine the possibilities. A number of experts argue that in twenty years pushing existing technology, solar will be less than fifty cents per installed watt, which is the cheapest energy there can be. With government funding, we could vastly accelerate that timeframe (and create jobs at the same time). Many will say that we cannot store solar power. Nonsense. It can be converted it into hydrogen, which can be stored. The units are small. It works perfectly well in autos. Iceland uses hydrogen. The Swedes have a new hydrogen highway that works. We just need to change the entire gas station infrastructure. The private sector will not do it. Governments can.

The prevailing motto surrounding energy for the past few years seems to have been "Drill baby, drill." The Palinites have gone curiously quiet on that score as we've come encountered the horrible ecological calamity that awaits us thanks to "Spill baby, spill."

In finance, we let a crisis go to waste. One hopes that the same will not apply in energy and that criminal investigations will lead to something far more substantive than the Swiss cheese of "change you can believe in" which has characterized the Obama response to our respective health care and financial crises.

Lawrence Goldenhersh, CEO of Enviance, has come up with a solution to combat climate change. What he calls "supply chain environmentalism" is a system that differentiates products for consumers on the basis of their carbon footprint. If he succeeds, consumers will choose the lower carbon footprint between two products of the same price. I caught up with Larry the day the Kerry-Lieberman climate bill came out to discuss this idea and ways to combat climate change.

BC: Why does your solution focus on the supply chain rather than, say, a cap and trade system?

LG: Supply chain environmentalism lashes the powerful US market to the quest for a climate solution. And it does that by basically recognizing that 75% of the greenhouse gas that gets emitted is supply chain-related. There are big box retailers than spend $5 billion a year in Asia, and source 100,000 products, so if we somehow allow these retailers to reduce the carbon in the supply chain so they can win at the cash register, we will drive more positive climate change than any set of regulations ever could.

Take the example of a $1.39 screwdriver. How it would work? Everyone sells a $1.39 screwdriver wherever you go. Consumers buy based on convenience -- these are commodity products. But retailers say: I'll produce it with 10 pounds of carbon versus 30. I'll go to Asia and say I will not buy screwdrivers from you unless you use hydro [power] instead of coal or adjust other things in the manufacturing process. These guys have measured greenhouse gas in the manufacturing process, so they can detect what greenhouse gases the manufacturer is emitting. So I say I want you the manufacturer to reduce your footprint from 30 pounds of carbon to 10. The manufacturer wants $50 million in business, so he says great, we're going to do that. The retailer puts a label on that product and the advertisement is: our $1.39 screwdriver is very different than the $1.39 screwdriver of our competitors. It has 80% less CO2 in it. Fix your house and fix the planet at the same time.

Surveys show that 71% of American consumers, if given the choice and if there isn't a difference in price, will select the more sustainable product. We've just described a market approach that involves differentiating same-priced commodity products based on carbon. Put that powerful weapon into the hands of most the powerful, competitive players on earth.

BC: Are consumers putting their money where their mouth is?

LG: I think that consumers have voiced their concern and taken the first step toward promising to put their money where their mouth is. What we need is a reliable and responsible labeling regime that will give consumers an easy way to cast their vote at the cash register. The ideal would be, with the [Kerry Lieberman] bill we have out today, that Congress decides to include a labeling provision in the climate bill to provide incentives to the largest retailers to engage in supply chain environmentalism. All it would need to do is set up a regime by which retailers submit their greenhouse gas footprint to an agency for approval. Then when they reduce their carbon they submit a revised footprint for approval. We pick an agency and the agency validates it. And then whatever agency is involved creates a label. There are systems out there like Enviance that manage carbon emissions that agencies can use to give credibility, make it auditable and enforceable in the event of fraud. We need some sort of labeling provision to give retailers a metric to use to give the consumer the information he needs to vote at the cash register.

And I go one step further. Let's say Congress decides to launch a voluntary labeling regime. In a separate provision, if you do submit your carbon footprint and get a label and prove that you reduced carbon out of the screwdriver, we the government would authorize you to sell 20 pounds of carbon into the market and take the money and do whatever you want with it. We'll let you sell credits into whatever voluntary market you can find. And that retailer will undoubtedly do that. They can use that money to reinvest in their business or return that money to consumers as the first 21st century green stamp. Now all of sudden because you're a responsible consumer and you went to the market and saw a label and bought it, the $1.29 coupon goes to $1.19 and you've been rewarded at the cash register for buying the right product. I think ten products will change the planet.

BC: What if the product with a lower footprint costs slightly more?

LG: Consumers are definitely price sensitive. That is why I think it's important to be able to allow retailers to reward the consumer base with 21st century green stamps for buying green, to put money into consumers' pockets so it is the same cost. But the problem today is that there isn't really a price on carbon in the marketplace because there is this sort of general effort to report carbon but not cap and trade or tax it. With supply chain environmentalism, we will drive the price on carbon through the actual market, not the government. We'll do it through the actions of powerful US competitors.

So yes, products might cost a bit more initially. And if these companies are allowed to sell credits into the market they will cost less. But I think cost is definitely a very important thing to consumers around the world.

BC: A comprehensive climate bill has hit a lot of political hurdles. How much of your plan would need government backing and coordination?

LG: Lowering carbon footprints is absolutely happening without the assistance of the government today. Companies are asking us to help them measure and account for the financial risk of carbon in the supply chain today. These companies anticipate a tax or cap and trade system to come down the pipe in the next three or four years and to compete they need to start planning now. Carbon's not the only one. We look at fresh water, which we think is free. I think the water crisis will make the carbon crisis look like a walk in the park. It's necessary for many things we do and to life and it's scarce. So companies have come to grips with the fact that we need something. We call it environmental ERP (enterprise resource planning), and the idea is that in the 21st century we've awakened to the fact that we're confronted by a vast array of scarce natural resources that we rely on to live. As those go from free to constrained and to costing money, American business and all businesses need to have a way to evaluate the cost of those free but scarce and soon to be expensive resources.

If congress does put a labeling system in this bill and goes further and incentivizes it by letting retailers sell credits, it will supercharge the effort to lash the US to a climate solution. But it's not necessary. These competitors, who live and die every day by succeeding in the market, understand the need to have a view into what resources are going to cost money -- whether it's carbon, water or a host of other things. They see it coming.

Another thing that's important: I put up a slide talking about a price on carbon [at a client meeting]. Either you think it's imminent, meaning it's coming tomorrow, inevitable, meaning we have to deal with it, or it's just chat. For everyone who believes it's just chat, I told the audience that for first time in American history the Department of Defense declared in its quadrennial review of global circumstances that climate change is a matter of national security. And I said to that group, those who believe climate change will not drive the price of carbon need to look to the DoD review as maybe the most powerful market signal that the nation will put price on carbon. You have a conservative institution so focused on its mission and unaffected by politics saying it's a matter of national security. It's a very sober judgment with respect to the urgency of dealing with climate change. I think we'll see cap and trade or a tax very soon in this country.

Everyone is focused on the Kerry Lieberman bill that came out today. But I think it would be a mistake not to also focus very substantially on the California midterms in November, which I regard as the Normandy invasion equivalent for the climate. And that's because two very interesting things are going to happen. First of all, we will probably have on the ballot a proposition that asks California to vote up or down on AB 32. I think without a doubt AB 32 is the most aggressive greenhouse gas legislation on planet Earth. And that proposition is framed in such a way as to delay, some would say kill, the implementation of AB 32. It is not a representative democracy, it's a direct democracy. 37 million people in California will vote yes or no on the most aggressive legislation on the planet. Point two is we will elect a governor. One presumptive nominee is Jerry Brown who has publicly supported AB 32, is committed to moving forward, and putting in a cap and trade system by 2012. (Which was signed into law by Republican Governor Schwarzenegger.) Then you have Steve Poizner [among other GOP candidates] who is against the implementation of AB 32. So if in California the proposition to beat down AB 32 loses, and simultaneously Jerry Brown is elected, California will have cap and trade by 2012 and the eighth largest economy in the world will be the first in the US to put a price on carbon. It's the Normandy invasion for the climate because if it goes the other way and people say we don't care about the climate it's a very strong signal. One way or the other it's a strong signal. And if in November AB 32 survives the direct democracy and if we elect a Democratic governor, you will see an immense amount of pressure on the US Congress to do something collaborative or preemptive with legislation. California will have tipped the nation. With all the discussion of the current climate bill, I for one will be looking at the pre-emption provisions. The people of California will be interested to see if the government wants to cut them off, let them go on as an experiment or do something in the middle. It's a referendum on climate legislation.

BC: How would your labeling system deal with accuracy? The system that verifies organic produce, say, has been deeply flawed with inaccuracy and bureaucracy.

LG: The calculation of CO2e [carbon dioxide equivalent] in a manufacturing process is a very finite calculation. It is a function of the type of fuel consumed and the emissions coefficients coming off of the manufacturing process, plus purchased electricity and carbon emissions associated with transport. It's not like organic food [regulation] that says spray three times a day, can't do this, can't do that. In the CO2e calculation, much can be reduced and we have reduced it to protocol calculations. For example, by the time we finished the army installation [in Fort Carson], we had a library of over 140 stationary sources, 100+ mobile sources, and over 80 munitions sources. So if you had a stack or a boiler or a heater or 120 commonly used things in industry, we had a model we could copy and paste into the system to attain protocol designs for who will collect data, how to calculate CO2e from the data, and how to create a reporting regime. I think it's a mistake to compare the complexity of organic labeling with the relative straightforward requirements of greenhouse gas reporting.

BC: Couldn't businesses protest this as a cost and inconvenience in an already difficult economy?

LG: What I envision is not a government-mandated program; it's voluntary, like the rest of the market. A lot of the criticism of the climate bill has been that we need less government, that government mandates aren't a good thing, that they're expensive for business. My suggestion is totally voluntary. If you have the vision that the world doesn't care about climate change and you don't want to waste time with labeling things and you think you can beat your competitors then go for it. It's a perfect way to let the market judge. And if all of those are still in business I will have been wrong. And if none of them are in business I will be right.

Another criticism of the climate bill is that it will hurt business. But this can help business. A third criticism of climate legislation is that it inordinately affects the US to the benefit of other countries who are less concerned about climate change. This goes the other way. The very powerful US markets are being used to induce other countries to manufacture goods in ways that are more sustainable. It meets all objectives and objections.

People say it's complicated, you can't measure carbon in the supply chain. To that I say "wrong". We've been monitoring carbon in very complex facilities for 5 decades and tracking waste emissions for a decade. It's doable and we ought to do it today.

BC: How does this solution fit with the overall effort to combat climate change? What other steps do we need to take?

LG: Well you can't manage what you can't measure. Anyone who's ever built a building or evaluated a project knows that if you can't measure it accurately you can't do it. The first step is to define its scope and measure it. I think the EPA, in the greenhouse gas reporting rules it is mandating, is taking that first step. It has mandated the reporting of greenhouse gas to all that have 25 metric tons of carbon or more. Once you see the scope of a problem you can articulate policies to address the problem. Whether it's mandatory reductions, fuel switching, renewables, alternatives, all sorts of things. But to really formulate a solution that works in a complex economy like ours you need to scope the size of the problem first. And the EPA has done that. There's nothing wrong with launching a labeling system even as we are getting the reporting going.

And then you see what it is and where the problems are and then you start thinking about how to solve the problem and translate the cost of a solution to the economy in a fair way. If you live in a sate powered by coal but weren't planning to, you just grew up there, it's not fair that you would be treated differently than a person that lives on water. There's got to be a way to translate cost across regions of the country so people are treated fairly.

BC: Do you have an opinion on the Kerry-Lieberman bill?

LG: I think at the highest level I am very happy that the US Senate again has taken steps forward to address what now the DoD has classified as a national security issue. It's important that it be addressed and debated in congress. They seem to have sense of urgency about all matters of national security and I don't see why climate should be any different.

The solution lies in establishing the price of carbon. Business will understand the cost on revenue and profit. So once there's a price on carbon then business can understand what the financial risk is inherent in not doing anything about carbon emissions and will move to reduce carbon to be competitive. And by the way, I think supply chain environmentalism will drive a price on carbon very quickly. Because the industry acting in own self interest will drive carbon out of the supply chain. Hopefully Congress will let them sell credits into a market to reward consumers. We need a market signal. We need a price.

Henry C.K. Liu continues his analysis of the global post-crisis economy by examining how the banking industry of the 1920s became the byzantine financial sector of today.

The 1929 banking crisis that launched the Great Depression was caused by stressed banks whose highly leveraged retail borrowers were unable to meet margin calls on their stock market losses, resulting in bank runs from panicky depositors who were not protected by government insurance on their deposits.

In the 1920s, there were very few traders beside professional technical types. The typical retail investors were long-term investors, trading only infrequently, albeit buying on high margin. They bought mostly to hold based on expectations that prices would rise endlessly.

By contrast, the two decades of the 1990s and 2000s were decades of the day trader and big time institutional traders. New powerful traders in major investment banking houses overwhelmed old fashion investment bankers and gained control of these institutions with their high profit performance. They turned the financial industry from a funding service to the economy into a frenzy independent trading machine. Many of the investing public aspired to be the Master of the Universe, as caricatured in Tom Wolf's Bonfire of the Vanity, which was turned into a movie starring Tom Hanks. Derivative trading by hedge funds was routinely financed through broker dealers funded by banks at astronomically high leverage.



Greenspan - the Wizard of Bubble Land

But the debt joyride was by no means all smooth sailing in a calm sea. Repeated mini crises were purposely ignored by regulators who should have known better. Greenspan, notwithstanding his denial of responsibility in helping throughout the 1990s to unleash serial equity bubbles, had this to say in 2004, three year before the 2007 tsunami of a century, in hindsight after the bubble burst in 2000: "Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion." The Greenspan Fed adopted the role of a clean-up crew of otherwise avoidable financial debris rather than that of a preventive guardian of public financial health. Greenspan's one-note monetary melody throughout his 18-yesr-long tenure as the nation's central banker had been when in doubt, ease.



LTCM - the Crisis that the Fed Papered Over

In the 1920s, there were no derivative markets. In the case of Long Term Capital Management, the hedge fund that failed in 1998, the firm had equity of $4.72 billion and had borrowed over $124.5 billion to acquire assets of around $129 billion, for a debt-equity ratio of about 25 to 1. But even that it was conservative when compared to the 40 to 1 ratio used by investment banks in the 2000s.

LTCM had off-balance-sheet derivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps, equaling to 5% of the entire global market. LTCM also invested in other derivatives such as equity options. LTCM was bailed out by its counterparty creditors under the guidance of the NY Fed. (Please see my December 3, 2009 series: Reform of the OTC Derivative Market - Part One: The Folly of Deregulation)

The Enron Fraud

In the 1920s, there was no structured finance or securitization of debt. The case of Enron, a large brave new energy trader, and its spectacular bankruptcy marked the high watermark of legalized financial fraud. The evidence is undeniable that the Enron scandal exposed critical flaws in the entire financial system and the ineffective policing of US capital markets and corporate governance. In a December 18, 2001 Senate Commerce Committee hearing on the Enron collapse, Arthur Levitt, former Democratic head of the Securities and Exchange Commission (SEC), characterizes corporate financial statements as "a Potemkin village of deceit". Senator Ernest Hollings, a Democrat from South Carolina, characterized Enron Chairman Kenneth Lay's political prowess as "cash and carry government". Embarrassingly, the New York Times reported the following day that Hollings had received campaign contributions from Enron and its auditor Arthur Andersen dating from 1989.

Until Enron filed for bankruptcy in 2001, the system's top law firms and accounting firms were providing professional opinion that what went on in Enron was "technically" legal. The international dealings of Enron received unfailing support from the US government. Many of the schemes undertaken by Enron and other companies were devised by investment bankers who collected fat fees advising their clients and who profited handsomely from providing financing for schemes they knew were towers of mirage. It was known in the industry as "finance engineering" and the vehicle was structured finance or derivatives. (Please see my August 1, 2002 article: Capitalism's bad apples: It's the barrel that's rotten)



Greenspan - Enron Prize Recipient

Chairman of the Federal Reserve since 1988, Alan Greenspan gave a lecture at Stude Concert Hall sponsored by the James A. Baker III Institute for Public Policy on November 13, 2001. Following his lecture, he received the Baker Institute's Enron Prize for Distinguished Public Service. The prize, made possible through a generous and highly appreciated gift from the Enron Corporation, recognizes outstanding individuals for their contributions to public service.

Greenspan's speech offered an assessment of what lies ahead for the energy industry to an admiring audience. In the wake of the September 11 attacks and the then weakened state of the economy, Greenspan stressed the need for policies that ensure long-term economic growth. "One of the most important objectives of those policies should be an assured availability of energy," he said.

Greenspan said that this imperative has taken on added significance in light of heightened tensions in the Middle East, where two-thirds of the world's proven oil reserves reside. He noted that the Baker Institute is conducting major research on energy supply and security issues.

Looking back at the dominant role played by the United States in world oil markets for most of the industry's first century, Greenspan cited John D. Rockefeller and Standard Oil as the origin of US pricing power, notwithstanding the nation saw fit to break up the Rockefeller/Standard Oil trust. Following the breakup of Standard Oil in 1911, he said this power remained with American oil companies and later with the Texas Railroad Commission. This control ended in 1971 when remaining excess capacity in the US and oil pricing power shifted to the Persian Gulf. Greenspan was saying better Standard Oil than OPEC. He seemed oblivious to the development since the 1973 oil embargo that US oil companies have been working hand in glove with OPEC producers to keep oil prices high.



The Power of Markets against Market Power

"The story since 1973 has been more one of the power of markets than one of market power," Greenspan said. He noted that the projection that rationing would be the only solution to the gap between supply and demand in the 1970s did not happen. While government-mandated standards for fuel efficiency eased gasoline demand, he said that observers believe market forces alone would have driven increased fuel efficiency. Greenspan appeared to be the only one who sincerely believed that a free market existed or could exit for the trading of oil. All oil traders know that the price of oil is one of the most manipulated components in world trade.

"It is encouraging that, in market economies, well-publicized forecasts of crises more often than not fail to develop, or at least not with the frequency and intensity proclaimed by headline writers," Greenspan credited free markets with mitigating the oil crisis.

As it turned out, the California energy crisis of rolling blackouts was not caused by Middle East geopolitics. It was the handy work of Enron fraudulent trading strategies.



Greenspan against Reform

All though the 1990s and early 2000s, there were much talk of reform that led nowhere near what was actually needed. Less than a decade later, a financial crisis that Greenspan characterized as the market failure of a century imploded with a big bang.

On Greenspan's 18-year watch at the Fed, government-sponsored enterprises (GSE) assets ballooned 830%, from $346 billion to $2.872 trillion. GSEs, namely Fannie Mae and Freddie Mac, are financing entities created by the US Congress to fund subsidized loans to certain groups of borrowers such as middle- and low-income homeowners, farmers and students. Agency MBSs (mortgage-backed securities) surged 670% to $3.55 trillion. Outstanding ABSs (asset-backed securities) exploded from $75 billion to more than $2.7 trillion.

Greenspan presided over the greatest expansion of speculative finance in history, including a trillion-dollar hedge-fund industry, bloated Wall Street firm balance sheets approaching $2 trillion, a $3.3 trillion daily repo (repurchase agreement) market, and a global derivatives market with notional values surpassing an unfathomable $220 trillion. Granted, notional values are not true risk exposures. But a swing of 1% in interest rate on a notional value of $220 trillion is $2.2 trillion, approximately 20% of US gross domestic product (GDP). Grated that much of the derivative trades were hedged, meaning the risks are mutually canceling. But the hedges would only hold without counterparty default. All that was needed to unleash a systemic failure was for the weakest link to fail. Greenspan created a monetary situation that permitted the market to speculate on risks that it could not afford.

Having released synthetic credit of dangerously high notional value, Greenspan raised the Fed funds rate target to 5.25% on June 29, 2006 from its lowest point of 1% set on June 23, 2003, to dampen inflation expectations, adding aggregate interest payments to the financial system greater than US GDP in 2006. That was like striking a match to like a candle in a dark kitchen filled with leaked gas. Under such fragile and explosive conditions, there was little wonder that the market collapsed a year later. (Please see my March 16, 2007 article: Why the US sub-prime mortgage bust will spread to the global finance system, written at a time when mainstream opinion was that the housing market, being geographically disaggregated, would not spread.)

Much of the precautionary measures instituted during the New Deal to prevent a reply of the 1929 crash, such as the separation of investment banking from commercial banking, requiring banks to be neutral intermediary of capital funds rather than profit-seeking market makers, in the form of the Banking Act of 1933 (Glass-Steagall), were repealed, as a result of bank lobbying. Glass-Steagall was replaced by the Financial Services Modernization Act of 1999, (Pub.L. 106-102, 113 Stat. 1338, enacted November 12, 1999), aka the Gramm, Leach-Bliley Act (GLBA).

Wholesale Credit Market Failure

Yet with the benefit of deposit insurance instituted during the New Deal remaining operative, the current financial crisis that began in mid-2007 was caused not by bank runs from depositors, but by a melt down of the wholesale credit market when risk-averse sophisticated institutional investors of short-term debt instruments shied away en mass.

The wholesale credit market failure left banks in a precarious state of being unable to roll over their short-term debt to support their long-term loans. Even though the market meltdown had a liquidity dimension, the real cause of system-wide counterparty default was imminent insolvency resulting from banks holding collateral whose values fell below liability levels in a matter of days. For many large, public-listed banks, proprietary trading losses also reduced their capital to insolvency levels, causing sharp falls in their share prices.

To read the full article, please visit HenryCKLiu.com.

Roosevelt Institute Braintruster Henry C.K. Liu is an independent commentator on culture, economics and politics.

The Sibyl, with frenzied mouth uttering things not to be laughed at, unadorned and unperfumed, yet reaches to a thousand years with her voice by aid of the god.

-- Heraclitus

Sibyls were the oracles of ancient Greece. You'd go to them when you had a heavy decision, but the problem was their advise was never straight forward and prone to misinterpretation.  Not quite as bad as a modern pollster, but they could get you in serious trouble. For example, Croesus, a great king of ancient Greece, went to the Delphic Oracle seeking advise about attacking Persia. She replied, "If you attack Persia, a great empire will fall." He did, and a great empire fell.  Unfortunately for Croesus, it was his. Looking at the global economy today, one can't help but think you'd get a better view of the future from any Sibyl.

Global financial markets are so manipulated and pumped full of discount dollars, they are relatively useless in divining. The US stock market on p/e value is approaching historical highs, while a metal like copper sits near historic highs, despite a global economy that sits well below its peak of two years ago. Now, there's no denying Asian economies led by China started growing again, but how sustainable that growth is, considering the faults of over-indulging history has revealed with any command and control economy, is truly an important question. The question of over-capacity in China is an important one, and the Chinese have announced they are beginning to shutter smaller steel and electricity plants.

Now, if you look at China, India, Australia and the other Asian economies minus Japan, they are a little over 20% of the global economy. Nothing to sneeze at; however, a great chunk of that is tied to exporting to what we can call the old global economy -- that is the US, Japan, and the EU, which still comprise almost half the global economy. Now the old global economy is drowning in debt, and depending on who you ask, that either matters or it doesn't. Right now for the Greeks, who need a trip up to Delphi, it matters. For the EU as a whole, it seems to matter too, as growth seems at best spotty. The Japanese remain entrenched in deflation and the American economy appears little better than flat.

The most interesting oracle for the modern world is the price of oil, which, despite the greatest global slow-down in post-war history, managed to stay above $70 a barrel and today sits around $87, which in no way helps the global economy as presently structured. Begging the question, what if the global economy gets back to its 2007 peak, where then the price of oil?

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.