A Foreclosure Lawyer Goes to Washington

Dec 8, 2010Thomas A. Cox

white-house-150Foreclosure lawyers may be better off working in the states than getting DC involved.

white-house-150Foreclosure lawyers may be better off working in the states than getting DC involved.

A couple of weeks ago, I was invited down to Washington to testify before the House Judiciary Committee hearing, "Foreclosed Justice: Causes and Effects of the Foreclosure Crisis." The panel that I was to be on included two other lawyers who represent homeowners, Professor Christopher Peterson (the University Of Utah law professor who has really got MERS's number), and representatives of three of the large loan servicers. Since one of those loan servicers representatives was to be from GMAC Mortgage, LLC, an outfit that has commanded quite a bit of my time and attention over the past six months, I hoped for the opportunity to make sparks fly with him in the hearing room.

I worked hard on my written testimony, giving GMAC Mortgage a lot of special attention. I headed down to DC on the day before the hearing just to be sure I made it on time. At 7pm, a call came in from the committee staffer telling me that the servicers were not going to be at the next day's hearing after all. Perhaps I am getting a swelled head, what with all of the recent media attention, but I wondered if the last-minute bailout meant that GMAC's representative did not want to sit before the committee with me as I much as I wanted to be with him.

Despite the absence of the servicers on our panel, I was still feeling energized the next morning. After all, after two recent hearings conducted by the Senate Banking Committee and one by the Subcommittee on Housing and Community Opportunity of the House Finance Committee, the House Judiciary Committee hearing was to be the first one where real, everyday foreclosure defense lawyers were appearing to explain the foreclosure crisis from a personal perspective. (No disrespect here to Diane Thompson of NCLC, who testified before the Senate Banking Committee -- she surely is a real lawyer, but she sits at the right foot of God as the country's preeminent expert on HAMP.)

The next day there were to be two panels before the 40-member committee, which meets in a big, impressive room. The first would include representatives from the OCC, Treasury and the Federal Housing Finance agency and a State Supreme Court (trial court) judge from New York. I was geared for action, but when the hearing started, there were only nine committee members in their seats. Later, the number shrank to three -- one of them distracted by an animated cell phone conversation.

Between a recess for a House vote and the glacial progress of the hearing, my fellow panel members and I were informed by a staffer mid-afternoon that, while they were thankful for our attendance, our panel would not getting an opportunity to testify that day.

Despite this unpleasant surprise, I came away with four observations:

1) I believe that an activist federal intervention into state property laws  to help solve the foreclosure scandal should be avoided. There are some areas where our federal government can handle issues better than the states, but this is not one of them. Example: The recent win that I scored in the Maine Supreme Court in August, where, construing more than 150 years of Maine foreclosure law development, our Court ruled that MERS cannot have standing to conduct foreclosures in Maine. This much-desired result came from local judges on a readily accessible state level court interpreting legal issues presented by local lawyers. We did not need, nor do we want, remote legislators in Washington telling us what the law will be for uniquely local matters.

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2) During the hearing, one of the Republican committee members argued that if the rule of law was enforced across the board, then perhaps the mortgage servicers would not be behaving as they do. He asked why there is not much more activity at the state level to sanction the lawyers who enable and present the servicers' dishonest claims. He wondered why the state courts are not being much more active in sanctioning misconduct, and why there is no criminal prosecution of misconduct, simple as submitting affidavits filled with perjury. I felt that these were legitimate questions. The dishonest affidavits issue is a simple one and I do not think that there is a good excuse for state boards of bar overseers failing to take action against the offending lawyers. And it puzzles me that no one state Supreme Court has taken any creative action, or undertaken a judicial inquiry to determine what, if any, remedy should exist for homeowners who lost their homes based upon dishonest affidavits. On the other hand, state judiciaries are tremendously overloaded and underfunded and have little to no spare capacity to take these issues on.

3) I wanted to ask this Republican if Congress should demand that Attorney General Eric Holder bring federal criminal charges against those who broke the law by submitting thousands of dishonest affidavits. I met with our newly appointed U.S. Attorney here in Maine about a month ago to urge him to consider using federal mail fraud and wire fraud statutes to pursue criminal charges against the servicers and perhaps their lawyers. The cryptic response seemed to be that the direction to do so would need to come from Washington. Apparently there is no such direction. Months ago, Holder said he was investigating. What is there to investigate? The crime is simple. We have served the evidence up on a silver platter of thousands of dishonest affidavits filed all over the country. Attorney General Holder should instruct U.S. attorneys in all fifty states to immediately start indicting those responsible for filing the dishonest affidavits, including the affiants and the notaries right on up to senior officers in the servicers who had to know what was going on. A wave of such indictments would surely change the culture in the servicing industry.

4) Another thing that stuck with me from the hearing is an apparent fundamental misunderstanding on the issue of principal reductions. Those who advocate against a foreclosure moratorium until there can be certainty that servicers will behave are also generally against forcing servicers to provide principal reductions as a part of the loan modification process. What the advocates of the "foreclosures are good" school seem to ignore is the fact that every foreclosure is, in fact, a principal reduction. Each foreclosure of an underwater mortgage reduces the principal recoverable on that loan. The rub is that foreclosures result in larger principal reductions than do loan modifications, which reduce the loan balance to market value, where homeowners can afford to pay. This is so because once a foreclosed property goes into REO inventory, it usually sells at a 20% discount to market value (and it also depresses the value of surrounding properties). Wouldn't it be better to avoid this deep discount and keep a homeowner in his home with a principal reduction to market value, rather than putting that homeowner on the street where his ability to become a consumer again will be delayed so much longer?

The House Judiciary Committee reconvened this hearing for December 8, 2010. I was about to leave Maine when I was advised at the last minute that the Republicans were now demanding another delay of one week. While I have agreed to return to Washington for this now twice delayed hearing, I wonder how much value I can really bring to that Committee's process. Relatively few committee members are even willing to show up, and the lame duck House of Representatives leaves me doubtful about really being heard and having a meaningful impact.

I came away feeling that I may be more useful in focusing on solutions up here in Maine in the hope that they may continue to ripple outwards. Because not much is happening in Washington.

Thomas Cox is a retired bank lawyer in Portland, Maine who serves as the Volunteer Program Coordinator for the Maine Attorney’s Saving Homes (MASH) program. He represents homeowners in foreclosure and assists and consults with other volunteer lawyers in providing pro bono legal services to these Maine homeowners.

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Whose Side is the White House On?

Dec 6, 2010James K. Galbraith

2-face-obama-150In a speech given on November 20, 2010 at the ADA Education Fund's Post-election Conference at the Harvard Kennedy

2-face-obama-150In a speech given on November 20, 2010 at the ADA Education Fund's Post-election Conference at the Harvard Kennedy School, Galbraith asks who Obama is really working for, and demands that progressives seek leaders who will fight the good fight.

I want to raise a hard question -- a question on which Americans are divided. It seems to me, though, we will get nowhere unless we realize where we are, what has actually happened, and what the future most likely holds.

Recovery begins with realism and there is nothing to be gained by kidding ourselves. On the topics that I know most about, the administration is beyond being a disappointment. It's beyond inept, unprepared, weak, and ineffective. Four and again two years ago, the people demanded change. As a candidate, the President promised change. In foreign policy and the core economic policies, he delivered continuity instead. That was true on Afghanistan and it was and is true in economic policy, especially in respect to the banks. What we got was George W. Bush's policies without Bush's toughness, without his in-your-face refusal to compromise prematurely. Without what he himself calls his understanding that you do not negotiate with yourself.

It's a measure of where we are, I think, that at a meeting of Americans for Democratic Action, you find me comparing President Obama unfavorably to President George W. Bush.

In economic policy it was said earlier we have a lack of narrative. This afternoon, Gregory King asked why the people didn't know that the Republican Party is uniformly and massively opposed to job programs, to state and local assistance, and to every legislative measure that might aid and promote economic recovery from the worst crisis and recession in modern times. Why is that that they didn't know? Could it have anything to do with the fact that the White House didn't tell them?

And why was that?

The president deprived himself of any chance to develop a narrative from the beginning by surrounding himself with holdover appointments from the Bush and even the Clinton administrations: Secretary Geithner, Chairman Bernanke, and, since we're here at Harvard, I'll call him by his highest title, President Summers. These men have no commitment to the base, no commitment to the Democratic Party as a whole, no particular commitment to Barack Obama, and none to the broad objective of national economic recovery that can be detected from their actions.

With this team the President also chose to cover up economic crime. Not only has the greatest wave of financial fraud in our history gone largely uninvestigated and unpunished, the government and this administration with its stress tests (which were fakes), its relaxation of accounting standards which permitted banks to hold toxic assets on their books at far higher prices than any investor would pay, with its failure to make criminal referrals where these were clearly warranted, with its continuation in office -- sometimes in acting capacities -- of some of the leading non-regulators of the earlier era, has continued an ongoing active complicity in financial fraud. And the perpetrators, of course, prospered as never before: reporting profits that they would not have been able to report under honest accounting standards and converting tax payer support into bonuses; while at the same time cutting back savagely on loans to businesses and individuals, and ramping up foreclosures, much of that accomplished with forged documents and perjured affidavits.

Could the President and his administration have done something? Yes, they could have. Where was the Federal Deposit Insurance Corporation? Why did they choose not to implement the law -- the Prompt Corrective Action law -- which requires the federal government to take into receivership financial institutions when there is a significant risk of large taxpayer losses to the insurance fund? Where were the FBI and the Department of Justice? Did the President do anything? No. Is he doing anything now? No. Why not? The most likely answer is that he did not want to. My understanding, in fact, is that there was one meeting where this issue was raised, and the President stated that his economic team had assured him they had the situation under control.

On the larger economic policy front, the White House gave away the game from the beginning. How? First by guessing at the scale of the disaster. When leading economic advisers (I believe, in fact, it was President Summers) announced that the unemployment rate would peak at 8%, they not only guessed wrong, but gave away the right to assign responsibility to the previous administration when things got worse. This was either elementary bad politics or deliberate self-sabotage. But it gets worse. The optimistic forecast helped to justify a weak program. Useful things were done, but not nearly enough to convey the impression of a forceful policy to the broader public. Then once the banks were taken care of and the stock market took off again, it seems clear that the team at the White House didn't care anymore.

Again, could they have done differently? Of course. The President could have told the truth, which is that we faced a historic meltdown, a collapse of the core financial institutions of our economy, and that we had really no way of knowing how bad economic conditions might get or how long this would endure and that therefore the situation would require a full mobilization: all resources, all hands on deck, major departures of policy, no holding back, and the responsibility for trouble and failure falling plainly on those who would obstruct the course. None of the people he chose to advise him on economic policy was remotely capable of thinking in those terms.

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We've learned from Vic Fingerhut and Mike Lux that the administration went down in public esteem when people realized it was working for the banks and not for them. Why did they think this? Why did they go from "blaming Bush and Wall Street to blaming Obama and Wall Street"? Because plainly they could see what was in front of their faces. Except in manner, President Bush never really pretended to be a President for ordinary folks; President Obama did. Bush was who he was; Obama held out, fostered, and promoted vast hopes, mobilizing the American population behind his leadership on that basis. And he disappointed those hopes -- to use a very harsh word, one could say he has betrayed those hopes. How can one therefore blame the voters for acting as they have acted?

What happens next? Let's again not kid ourselves, we have lost a great many seats in the House of Representatives and the House of Representatives isn't coming back into a Democratic majority in the near future. Simply because of the balance of exposures -- the larger numbers of Democratic Senators exposed to reelection in the next cycle, the greatest likelihood is that the Senate will also go Republican in two years time. President Obama has set his course. He has surrounded himself with the advisers of his choice and as he moves to replace President Summers we hear from the press that the priority is to "repair the rift with his investors on Wall Street." What does that tell you? It tells me that he does not have President Clinton's fighting and survival instincts. I've not heard one good reason all day to believe that we are going to see from this White House the fight that we want, that he could win in two years, or any reason we should be backing him now.

The Democratic Party has become too associated with Wall Street. This is a fact. It is a structural problem. It seems to me that we as progressives need -- this is my personal position -- we need to draw a line and decide that we would be better off with an under-funded, fighting progressive minority party than a party marked by obvious duplicity and constant losses on every policy front as a result of the reversals in our own leadership.

What is at stake in the long run? Two things, mainly, in my view. First, it seems to me that we as progressives need to make an honorable defense of the great legacies of the New Deal and Great Society -- programs and institutions that brought America out of the Great Depression and bought us through the Second World War, brought us to our period of greatest prosperity, and the greatest advances in social justice. Social Security, Medicare, housing finance -- the front-line right now is the foreclosure crisis, the crisis, I should say, of foreclosure fraud -- the progressive tax code, anti-poverty policy, public investment, public safety, and human and civil rights. We are going to lose these battles-- get used to it. But we need to make an honorable fight, to state clearly what our principles are and to lay down a record which is trustworthy for the future.

Beyond this, bold proposals are what we should be advancing now; even when they lose, they have their value. We can talk about job programs; we can talk about an infrastructure bank; we can talk about Juliet Schor's idea of a four-day work week; we can talk about my idea of expanding Social Security and creating an early retirement option so that people who are older and unemployed or anxious to get out of the labor force can leave on comfortable terms, and so create job openings for younger people who, as we've heard today, are facing very long periods of extremely aggravating and frustrating unemployment; we can talk about establishing a systematic program of general revenue sharing to support state and local governments, we can talk about the financial restructuring we so desperately need and that we'll have to have if we are going to have a country which has a viable private credit system and in which large financial power is not constantly dictating the terms of every political maneuver.

We are not going to get these things, but we should have a clearly defined program so that people know what they are. And then, frankly, as was said earlier today, said most elegantly by Jeff Madrick, in the long run we need to recognize that the fate of the entire country is at stake. Its governance can't be entrusted indefinitely to incompetents, hacks, and lobbyists. Large countries can and do fail, they have done so in our own time. And the consequences are very grave: drastic declines in services, in living standards, in life expectancies, huge increases in social tension, in repression, and in violence. These are the consequences of following through with crackpot ideas such as those embodied in the Bowles-Simpson deficit commission, as Jeff Madrick again outlined, such notions as putting arbitrary limits on the scale of government, or arbitrary limits on the top tax rate affecting the wealthiest Americans.

This isn't a parlor game. The outcome isn't destined to be alright. It will not necessarily end in progress whatever happens. What we do, how we proceed, and how we effectively resist what is plainly about to happen, matters very greatly for the future of our country, of our children, and of another generation to come. We need to lose our fear, our hesitation, and our unwillingness to face the facts. If we thereby lose some of our hopes, let's remember the dictum of William of Orange that "it is not necessary to hope in order to persevere."

The President should know that, as Lincoln said to the Congress in the dark winter of 1862, he "cannot escape history." And we are heading now into a very dark time, so let's face it with eyes open. And if we must, let's seek leadership that shares our values, fights for our principles, and deserves our trust.

James K. Galbraith is a Vice President of Americans for Democratic Action. He is General Editor of “Galbraith: The Affluent Society and Other Writings, 1952-1967,” just published by Library of America. He teaches at the University of Texas at Austin.

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The Beginnings of a Credit Card-Free Revolution? Maybe Not.

Dec 1, 2010Bryce Covert

More consumers shred their plastic, but the picture may not be so rosy.

More consumers shred their plastic, but the picture may not be so rosy.

Welcome to the club, eight million new people without a credit card! CNNMoney reported yesterday that credit card use is in decline, with the number of cardless people jumping up to 78 million this year from 70 million last year. In a recession where every penny counts, many consumers shredded their cards in a move to reduce their debt (and probably avoid fee hikes). The article reports, "TransUnion said the average U.S. credit card debt fell more than 11% over the past year to $4,964 in the third quarter." Gerri Detweiler of Credit.com called the phenomenon "unprecedented." Consumers never abandon their plastic, she says; the numbers have "always gone up." Perhaps a silver lining of our economic misery could be consumers moving from debt and risk to saving and building real wealth.

But the drop in users isn't all due to penny pinching and/or outrage. Part of this trend is from "charge-offs in the higher risk segments," says TransUnion. Because the new credit card act puts a kink in card companies' ability to jack up interest rates and impose fees, they dumped consumers who they "saw as dead weight," the article reports. With a recession causing more defaults on debt, the companies are getting out of riskier accounts. So both consumers and companies are parting ways with risk.

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And with easy access to credit cards dried up, some see the opportunity to cash in by creating new products. Enter the Kardashians -- because we should always take financial advice from celebrities famous only for being famous. The reality TV celebs planned to market a pre-paid debit card to young teenage girls with their faces painted across the front. While they decided to shut down the venture (after Connecticut Attorney General Richard Blumenthal questioned the legality of the card's "pernicious and predatory fees"), they aren't alone in trying to get in on a growing trend. Annie Lowrey reports that "the total market will double in size in the next three years, with customers loading a whopping $672 billion onto prepaid cards by 2013." The cards are sometimes used to get money to underserved communities such as immigrants and the poor. But they are also seen as a way for banks to cash in on a new distaste for credit cards among young people and to avoid rules that could limit profits on credit and debit cards. Lowrey points out that the Kardashian Kard (yes, with a 'K') would have had "more fees than the Kardashians have reality shows." On top of that, these cards don't have "the protections or the financial-education benefits of plain-vanilla banking products," she adds.

So good news: more people converting to the non-credit card cause. Bad news: not all of those people chose to leave credit card ownership of their own accord, and financial wizardry is already on the case, filling our need for predatory products. Innovation at its best!

Bryce Covert is Assistant Editor at New Deal 2.0.

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What if Obama Prioritizes Bondholders Over Workers?

Dec 1, 2010Mike Konczal

mike-konczal-2-100Obama's federal pay freeze may not be a blunder but a deliberate move to align himself with the banks.

mike-konczal-2-100Obama's federal pay freeze may not be a blunder but a deliberate move to align himself with the banks.

In case you haven't seen it, Brian Buetler has a roundup of reactions to President Obama's two-year federal pay freeze. Ezra Klein has three ways of looking at the freeze, which are not mutually exclusive: 1) This is more unwise, unilateral bipartisanship, 2) This is a smart way to protect the federal workforce, 3) This is bad economics and bad policy.

I think we should discuss a fourth option: President Obama thinks this is a really good idea and wants to spend political capital and energy to carry it out.  Rather than a piece of strategy to force concessions from the other side, this is instead something he wants his administration associated with and wants to take the lead in making a reality.  He's asking for the middle class to suffer first, before bankers and before the richest, without asking for anything in return.

When people refer to this as self-defeating or a political miscalculation, they are assuming that Obama isn't weak on core liberal values, or that his version of liberalism isn't far different than what was expected, or that he doesn't think this is worth fighting for. This is precisely what needs to be interrogated and challenged. The reality might simply be that his administration has different goals much more aligned with traditional centrist Democratic positions, prioritizes fighting for different objectives, and views the world through a different lens. They put bondholders over unions and public workers.

I see this with Treasury issues. The people I've met at Treasury are quite brilliant. I think they are wrong about a lot of what just happened, about what they prioritize and what they isolate or obscure, but I do not think it is because of ignorance. Obama is a smart person, smarter than me and probably smarter than you.  If your reading of this situation requires the assumption, "Obama is consistently making the wrong choice and is misled," you should rethink your position without assuming that and see where it leads you.

It would be one thing if this was an ambiguous part of Maritime law or something, but this gets at a core debate. Liberals think that the work government does is both worthwhile and crucial to the functioning of our country. Conservatives think it is not. Conservatives want to sow discord between factions of middle-class people to distract from lowering taxes and providing goodies for the rich, and this is precisely one avenue for doing that.

I talked about state and local government not being overpaid here. They are definitely not overpaid in their salaries. What closes the gap partially -- but not entirely -- is that health care costs have spiraled out of control for many middle-class people and retirement risk has been shifted more aggressively to working-class people. There is a failure to provide adequate benefits for private workers, and Republicans and now Obama want to convince you that this is normal. It isn't.

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Larry Mishel brings up the important point that Federal workers are clustered in major cities where their pay lags city workers. When I first worked in the private sector in San Francisco, I received a pay bump that was clearly targeted for the higher cost of living there. I wouldn't have if I had decided to work for a regulator. Here's how shocking it is (table 4):

Again, benefits close that gap, but that is a failure of providing benefits by the private market. This failure is anxiety producing for middle-class voters.  It isn't surprising that it works as an effective lever against government.

Meanwhile, here's the President of Third Way, Jonathan Cowan, sounding just like Obama:

As the former chief of staff of HUD, I’ve seen how crucial and committed the federal work force can be. But a pay freeze is the right thing to do. It shouldn’t be seen as a critique of their hard work, and federal employees should get behind it. We have a long-term structural deficit crisis and either everyone is going to contribute to spending cuts, or the United States will cease to be the number one global economic power. Federal employees can lead by example, showing the American people that they place the financial health of the country above a pay increase these next few years. If we’re going to trim Social Security and Medicare -- which are essential steps to balancing the budget -- we’re also going to have to show that we can bring the costs of running the federal government in line as well.

What's the difference here?

So much for Ed Kane's vision of stronger financial market regulators who are more talented and more public-minded.   You simply won't get that without being willing to invest in the people you hire.

Mike Konczal is a Fellow at the Roosevelt Institute.

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End This Fed

Dec 1, 2010Matt Stoller

the-fed-150Our Federal Reserve doesn't work. Progressives have to get out in the fight to change it before Sarah Palin claims victory.

the-fed-150Our Federal Reserve doesn't work. Progressives have to get out in the fight to change it before Sarah Palin claims victory.

“We probably know more about tribes in the Amazon jungle than we do about the real nature of power in the United States. Neither political science, nor history, nor economics do very well on this.” - Tom Ferguson

Something new is happening around the contours of monetary policy. It’s becoming part of our popular political landscape. We saw this a few weeks ago, when Sarah Palin injected into the 2012 presidential race the idea of fundamentally reorganizing the Federal Reserve’s mandate. Republican Mike Pence, Senator Richard Shelby, and a host of other Republicans have jumped on this concept, and there will soon be legislation introduced to make this happen.

Beyond Republican politicians, the public is beginning to rethink our monetary order. A YouTube video on quantitative easing has over 3 million views. The video slams the Fed for missing the dotcom bubble, the subprime crisis, for being fundamentally undemocratic and unaccountable, and for being engaged in collusive dealings with Goldman Sachs. Financial blogs and CNBC discuss the Fed, and its associated characters, with deep insight and passion. And Bernanke drew 30 no votes in his confirmation hearing in 2009, the most ever for such a position, just four years after drawing almost none. The market nearly crashed on the possibility that Bernanke’s nomination would fail before the White House stepped up aggressive lobbying efforts. On the left, the last few years saw a remarkable grassroots coalition of economists and activists to bring transparency to the central bank, joining a long-sought libertarian crusade. I was a staffer for Rep. Alan Grayson, who was working with that coalition to require an independent audit of the Federal Reserve. Tomorrow, because of provisions put into Dodd-Frank by Senator Bernie Sanders and Congressmen Grayson and Ron Paul, the Federal Reserve will release details of its 2007-2010 emergency loans to the web.

This network of politicians, advocates, and bloggers will go to town on whatever revelations come out of that. (Although the Fed obnoxiously put its Maiden Lane disclosures in a non-copy or printable PDF format, so we’ll see how easy they make it to get this info.) The defenders of technocracy are out in force as well. Paul Krugman is defending the institution, if not every decision. The Democratic partisan class is going after right-wing Fed critics, while more liberal independents are pointing to the Fed in the 1940s and the Reconstruction Finance Corporation as a very different monetary model. Not since the populist movement of the 1890s has there been this much discussion of monetary structures among the public, and so much dissent about how money is created and circulated throughout the economy. It’s happening for a reason. The public is now paying attention to finance. We ran a focus group in Orlando last year, and one of the surprising conclusions was that nearly every independent voter knew who Ben Bernanke was. People don’t like the structure of our financial oligarchy, and they are talking about it. Even the deficit hysteria and the Fannie/Freddie GSE fights are a function of this monetary debate.

It is good that this debate is happening. It means that we will be able to examine the real power structure of the American order, rather than the minor food fights allowable in our current political system. This will bring deep disagreements, profound ones, but also remarkable possibility. Modern American industrial policy is to push capital into housing, move manufacturing abroad, build a massive defense establishment, and maintain an oligarchic financial sector. This system isn’t a structural inevitability. People built it, and people are unbuilding it. People with names, motivations, and reputations. People like us, and like Sarah Palin.

In 1989, Bill Greider published a remarkable book called "The Secrets of the Temple: How the Federal Reserve Runs the Country" in which he described how Fed officials were the real decision makers in the American political order. Shielded by the argument of ‘political independence’, most politicians wouldn’t and still won’t dare interfere with the workings of our economic structure, even though the Constitution clearly mandates that the monetary system is the province of Congress. The dramatic and overt coordination of this ‘independent’ central bank with the executive branch and the banking sector, and its flouting of Congressional and public scrutiny, have removed its institutional legitimacy.

Like most American institutions, the Fed has shrouded itself in myth, with self-serving officials discussing the immaculate design of the central bank as untouchable, secretive, an autocratic and technocratic adult in the world of democratic children. But the Fed, and specifically the people who run it, are responsible for declining wages, for de-industrialization, for bubbles, and for the systemic corruption of American capital markets. Take this passage from Greider’s masterpiece, on the inflation battles of the early 1980s.

“When White House officials congratulated themselves on how swiftly inflation was declining, Volcker pulled out his card on union wages and warned them not to be too optimistic. Until labor got the message and surrendered on its wage demands, the underlying rate of inflation would continue to push prices upward -- and collide with the stringent reality imposed by the Fed’s money policy.”

Here was the Federal Reserve Chair, a Democrat, carrying around union wage stats in his pocket so he would know whether he was driving worker pay down fast enough. If you want to understand the poverty of the financial reform debate, that Volcker was ‘the hero’ of the reform side should illustrate it.

On a basic level, the Federal Reserve has two jobs. One is to maintain price stability, and the other is to maintain maximum employment. This ‘dual mandate’ comes from debates in the 1970s about full employment, and was part of the Humphrey Hawkins legislation that President Carter watered down from its original liberal origins. While the Fed ostensibly has to care about full employment, Carter made sure this would be more of a guideline, and it is quite obvious to anyone who pays attention to FOMC minutes that most Fed officials don’t take it seriously. Nevertheless, the Fed has a bunch of tools to accomplish these goals. It regulates the money supply through its balance sheet and a variety of market interventions, it maintains the payments and clearing system, and it regulates banks. It also has a number of consumer protection responsibilities, and has emergency lending authority that was radically expanded by Wall Street super-lawyer Rodgin Cohen in 1991 through a very subtle secretive maneuver.

Structurally, the Fed is a two-part system, with a Board of Governors in DC and Reserve Banks that sit in 12 separate regions of the country that represented roughly equivalent sectors of the economy in 1913. The Board of Governors has 7 members, each of whom can have one 14-year term, and a Chairman who has a four year term. These members are appointed by the President and confirmed by the Senate. Monetary policy is set through the Federal Open Market Committee, which has members from both the board and the Reserve banks. If you ever want to see how the country is actually run, read the transcripts of FOMC meetings, which are released on a five year lag (they used to be shredded as a matter of course). It is stunning to read how Reserve bank presidents basically talk to WalMart and high-end headhunter firms to find out how their regional economy is doing, and then set monetary policy. It’s also crazy that we still do not know what the FOMC was saying from 2005 onward, during the height of the mortgage boom and bust. All of this is secret, and very much open to subpoena for some enterprising politician. (It is one of my great disappointments that neither the Democratic House or Senate tried to get these transcripts, given that we know that Alan Greenspan was muffling dissent on the housing bubble in 2004, the last released transcript.)

The Reserve Banks are quasi-public and quasi-private entities owned by member banks. The New York Fed, for instance, pays dividends to JP Morgan, and has a .org web address. The Reserve banks are governed by Boards of Directors that are drawn mostly from the banking sectors of their regions, as well as large companies and the occasional union leader or university president. The Fed also has a large research staff and funds most macro-economic monetary policy research. It is uncommon to find ‘credible’ economists in monetary policy who have no financial ties to the Federal Reserve banks. The Fed is actually one point of contention between the right-wing billionaire Koch family and the Ron Paul libertarians; the Kochs are supportive of Federal Reserve-tied scholars, and Paul’s people are not (the Palin Tea Party had no involvement in the Audit the Fed fight, the Ron Paul Tea Party was the driving force on the right for that legislation).

This structure is the result of a political compromise in its inception, a holdover from the Wall Street-populist fights of the 1890s, the financial panic of 1907, as well as legislative shifts over 90 years. It is a deeply corrupt and indefensible system rife with conflicts of interest. The Reserve banks conduct a good amount of the regulatory work in our banking system. Their boards are staffed with bank leaders, and the presidents of the Reserve banks are actually hired by these bankers. Reserve banks even pay dividends to their bank members (attention Congresscritters who want to find a pay-for!). This ‘I’m a dessert topping and a floor cleaner’ identity allows Reserve banks -- particularly the NY Fed -- to intimidate courts and aide its allies on Wall Street. Additionally, the Reserve banks aren’t subject to the same government policies regarding Federal wages, so they can pay higher wages and give lucrative and prestigious consulting contracts to economists. In one hearing in the 1960s, a Reserve Bank was busted for buying thousands of ping pong balls. That lack of accountability, while silly, was and is still the norm.

The ambiguous identity is the reason the Fed was able to bureaucratically box out the FDIC as a center of intellectual gravitas. It also leads to overt corruption. Jamie Dimon, for instance, was on the board of the New York Fed when JPMorgan was negotiating with the New York Fed to buy Bear Stearns. Pete Peterson is a former New York Fed President, and hired Tim Geithner to be the New York Fed, who he is now presumably pushing to cut entitlements. Steven Friedman was on the NY Fed board, buying Goldman stock at the same time.

The list of failures goes on and on. But fundamentally, it is not corruption that is at the heart of the problem for this Fed system, it is a lack of democratic accountability. The Fed failed to stop the S&L crisis, the dotcom boom and bust, and the mortgage boom and bust, and shoveled money to AIG with an overtly disdainful approach to the public. Despite the best efforts of Fed allies, the center cannot hold. During Dodd-Frank, Chris Dodd and Barney Frank tried their best to protect the Federal Reserve, lavishing praise on Bernanke, and ultimately blocking the move to make the New York Fed president an appointed position. They did nothing about the egregious 14-year term, the banks appointing their own regulators, the dividends that go directly from the Reserve banks to private banks, the lack of ethics restrictions and pay scale restrictions, or the corruption of the macro-economics profession at the heart of the Federal Reserve’s research imperatives. Frank did not legislate out of malice. Indeed, he often expressed respect for democratic input into the legislative process, insisting, for instance, that the conference committee be televised. But ideologically, Frank took a Reagan-era liberal view that the goal of the banking system was to provide housing for the poor while protecting consumers’ rights. The rest of the capital markets structure was, as he put it in one caucus meeting, “rich people fighting other rich people."

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The new intellectual order dismisses this attitude as small bore. Institutionally, the environment has changed for the Fed and its traditional allies. Whereas at the beginning of the financial panic in 2007-2008, the Fed was a sole provider of expertise and credibility on finance to the political class, by 2010, the new financial blogosphere destroyed the Fed’s mythic stature. It is common for staffers to get more and better information from blogs, and for hearings to be driven by the conversation online, than from the Congressional liaison group at the Fed. Read this remarkable Q&A between Ben Bernanke and Senator Bunning during Bernanke’s confirmation hearing, which was a series of questions inserted into the record, questions largely drawn from bloggers. The public has changed its appetite as well. This YouTube clip of Elizabeth Coleman, the Inspector General of the Fed, was my boss’s most successful hearing appearance, and possibly the most consequential hearing put on YouTube, ever:

Over 3 million people have now seen this official say that she wasn’t tracking where trillions of dollars have gone. I prepped Rep. Grayson for that hearing, and I used materials from the blogs to do it. Many members watched this hearing on YouTube and signed on to the bill to audit the Fed as a result. And so tomorrow, we are going to get a peek at the Fed’s emergency lending activities from 2007-2010 because of this legislative activity. Even before that, though, the Fed has become far more open and responsive to requests for information. We’ve already seen, via Maiden Lane disclosures, that the Fed has been lending money to random companies, like the Red Roof Inn, and buying up lots of toxic crap. We’re going to see a whole lot more. The conversation is no longer in the hands of the bankers.

This is a tremendous step forward. Of the many castle walls the Fed used to keep the rabble out, secrecy and complexity were critical. The Fed couldn’t keep its dealings secret, and financial bloggers are constantly explaining, explaining, and explaining. Those walls have fallen. A lack of public debate was another. That too has fallen. A monopoly of public information dissemination, via personal contacts between bankers and outlets like the Washington Post (whose owner in the 1930s was Hoover’s Federal Reserve Chairman), has broken down as well through internet communities. Gradually, a new generation of politicians is gaining the confidence that the people themselves through their elected representatives should be making critical decisions about economic efficiency and banking. The Fed is adapting to these changes, building up its communication staff and doing town hall-style meetings. Bernanke is on TV all the time, a far cry from the days when the Federal Reserve head simply refused to even brief Congress. In some ways, the hardest part of the fight is generating public debate, but that has been accomplished. The structure of our monetary system is now up for grabs.

As we move forward in this debate, it is important to understand that Sarah Palin is coming from a tradition genuinely rooted in American economic debates, from the era of the late 19th century, when Wall Street came together to finance railroad mega-corporations. Her argument is one against the mutability of money; she rejects the idea that money is a political object, because that implies that it is collective decision making that determines property values and ultimately the social hierarchy. She believes in a natural and fixed social hierarchy, which is a very conservative idea deeply held by the business class. Palin is using the lack of legitimacy of the modern Fed, the failed technocratic screw-ups and the elitist tendencies, to push for the equivalent of a societal debtor’s prison. She is speaking for creditors, and many of the conservative forces within the Federal Reserve agree with her. It is important to understand that reflexively defending the Federal Reserve, which is what the Democratic establishment is doing, is a foolish and anti-populist attempt to pretend that the Fed is a legitimate decision making body. It isn’t. It is powerful, but not legitimate.

Liberals must move beyond our consumer-driven approach and think about reform of the credit system and of the monetary order, as Elizabeth Warren has done through her remarkable tenure on the Congressional Oversight Panel. The basic problem is the one that poet and economist Jane D’Arista puts forward in her 1991 paper No More Bank Bailouts. (And yes, she wrote that in 1991, so it is worth listening to her.) The link between the Federal Reserve and the ‘real economy’ is broken. When banks were the main conduit between the financial world and economic activity, translating savings into investment, the Fed could manipulate the economy by manipulating the banking sector. But now that shadow banks dominate our credit markets, and the Fed has allowed hot money to take over monetary policy, the Fed’s tools just don’t work. That’s why quantitative easing is foolish. We must dispatch with the ridiculous notion that pushing hundreds of billions of dollars into a broken banking system will have useful consequences.

Instead, let’s recognize that the Fed doesn’t fulfill either part of its mandate, and work toward a better and more plausible system of monetary stability. That’s not a long-term process, it’s a constant process. D’Arista argues that the Fed must connect itself to the shadow banking system and force credit to flow. This necessarily implies important changes in how the Fed interacts with financial services firms and entities. To give some idea of what this might look like, at least conceptually, Timothy Canova paints the portrait of a more democratic Federal Reserve financing the government debt during World War II. Cooperating with a phalanx of institutions, such as the Reconstruction Finance Corporation, and government boards that directed wartime rationing, the Fed was able to bring unemployment down to 1% and dramatically equalize economic opportunity and wealth building for the middle class. Another possible conceptual framework, though one that wouldn’t work today for obvious reasons, is the subtreasury plan put forward in the 1890s by the Populists, which would tie the monetary supply to real economic activity -- in that era, agricultural output. I’m not sure how to tie intrinsically worthwhile economic output to the growth of the money supply, but it should be quite obvious that growing money to help credit default swap traders is a deeply corrupt way to think about how we as a society should define money.

Reform also requires what Ed Kane, a scholar at Boston College, has tackled, which is regulatory capture and growing a new cadre of publicly-minded policy makers and regulators. One of the biggest problems at the Fed is that its people simply do not work in the public’s interest, and see their goal as preserving the existing secretive banking structure. I found this to be true in my limited dealings with the Fed. At one point, I was trying to understand why the Fed granted Goldman Sachs an exemption from regulatory scrutiny as a bank holding company. The examiners and Goldman’s lobbyist were both happy to help me understand that I needn’t worry. When I mentioned that my boss was going to send a letter on the matter (it’s here, as well as the response from the Fed), both Goldman and the Fed examiner's responses were the same. They turned hostile, and whined, ‘Can’t we handle this privately?’ The Fed examiner told me that he would not be able to give me good information if he was forced to work on a public response on the matter.

Leaving aside whether the Fed made a good decision on that particular regulatory decision, this is no way to run a legitimate institution in a democratic society. With a loss of legitimacy comes a lack of public trust and a vulnerability to any form of critic. The Fed is now less respected than the IRS. And so Sarah Palin has her opening, as do the conservative hard money creditor interests. Liberals should stop their love affair with conservative technocratic myths of monetary independence, and cease seeing this Federal Reserve as a legitimate actor. At the very least, we need to begin noticing that these people do in fact run the country, and should not. We must also begin to internalize the new forces of openness and rethink how a monetary system can function in an internet-enabled society. This will require thinking about Fed 2.0 from the perspective of the social web, as well as building upon the increase in transparency being forced on governing elites by such groups as Wikileaks. The top-down backroom system just won’t work if it relies on retaining secrets between Bank of America and the Fed that a third party or a court can release. The Fed can’t print its way out of a public that has lost faith in the banking system and the dollar. If we rethink money creation properly, however, we will be able to remove money creation from the hands of the oligarchs, and strike deeply at the uncompetitive nature of the American political economy. I do not know how to do this, but it is possible.

Tomorrow, we’re going to see some of what the Fed did from 2007-2010. And there will be ample justifications for why the Fed needed to do what it did, just as the Treasury keeps talking about how TARP made money. But the Fed gave $13 billion to Goldman Sachs through AIG, a direct transfer of $80 from every working American to the employees of Goldman Sachs. We’re soon going to find out who else got our money. And this disclosure, and the accompanying political debate over the monetary order, is the beginning of changing the way we think about money itself.

And with that, here’s the new law and the disclosures it forces:

From p. 754 of Dodd-Frank:

(c) PUBLICATION OF BOARD ACTIONS.—Notwithstanding any other provision of law, the Board of Governors shall publish on its website, not later than December 1, 2010, with respect to all loans and other financial assistance provided during the period beginning on December 1, 2007 and ending on the date of enactment of this Act under the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Term Asset-Backed Securities Loan Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, the Term Securities Lending Facility, the Term Auction Facility, Maiden Lane, Maiden Lane II, Maiden Lane III, the agency Mortgage-Backed Securities pro- gram, foreign currency liquidity swap lines, and any other program created as a result of section 13(3) of the Federal Reserve Act

(as so designated by this title)— (1) the identity of each business, individual, entity, or for-

eign central bank to which the Board of Governors or a Federal reserve bank has provided such assistance;

(2) the type of financial assistance provided to that busi- ness, individual, entity, or foreign central bank;

(3) the value or amount of that financial assistance; (4) the date on which the financial assistance was provided; (5) the specific terms of any repayment expected, including

the repayment time period, interest charges, collateral, limita- tions on executive compensation or dividends, and other mate- rial terms; and

(6) the specific rationale for each such facility or program

Matt Stoller is the former Senior Policy Advisor to Congressman Alan Grayson. Stoller specialized in legislation on auditing the Federal Reserve and on the problem of foreclosure fraud.

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Ireland's Lesson: Take Democracy Back from the Banks

Nov 30, 2010Joe Costello

ireland-200We have to save our government from the clutches of the big banks.

ireland-200We have to save our government from the clutches of the big banks.

There is a very excellent piece on Ireland in the NYRB and it really should be read. It contains a couple of very important points and thoughts that are as relevant for the United States as for Ireland. First, it gives a great description of the distorting power of bubbles, in this case the Irish housing bubble. The article cites these figures:

Many counties have more ghost estates than Leitrim -- Cork has ninety of them -- but Leitrim emerges as Ireland's champion when empty houses are compared to the number of the local population. NIRSA's director Rob Kitchin calculates that 2,945 homes were built in Leitrim between 2006 and 2009 when the growth trend suggested that only 588 would be needed -- an oversupply of around 400 percent.

In 2006, at the height of the boom, construction accounted for almost a quarter of Ireland's GDP and occupied a fifth of the workforce... Bank lending for construction and real estate rose from €5.5 billion in 1999 to €96.2 billion in 2007 -- an increase of 1,730 percent -- while house prices doubled in the six years to 2006.

That, folks, is a bubble. It distorts the economy and, depending on its size, can do so on a massive scale. Thus, after it pops, no amount of money poured into the system is going to reflate it. In a related note, the Case-Shiller index released today shows US housing prices continuing to fall across the country.

Secondly, the piece does a nice job of explaining the culpability and complicity of the Irish political class in creating the bubble. This doesn't in anyway absolve the bankers' fraudulent actions. But it does again show, despite the protestations of the Greenspans, Bernankes, Summers, Geithners, Clintons, and Obamas, that we know enough about finance to prevent bubbles. It takes an active and forceful regulatory environment, limits on size and scope, enforcement against fraud, and limits on leverage.

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Finally, the piece concludes with an excellent paragraph on what went wrong with the Irish political economy, but could just as well be applied to the US:

It was a little too good to be true that Ireland could go from the pre-modern to the post-modern without ever fully creating the structures and habits of a modern democracy. Large chunks of classic democracy were missing -- the shift from religious authority to public and civic morality; the idea that the state should operate objectively and impersonally rather than as a private network of mutual obligations; the notion of the law as a universal and neutral check on everyone's behaviour, whatever their status.... Plonking a hyper-charged globalised economy on top of such an underdeveloped system of political governance and public morality was always likely to create an unbearable strain.

While you can argue one way or the other about whether the Irish ever developed a rule of law, a de-clanning of politics, and a vibrant public and civic morality, there is no doubt the US at some point had moved in these directions. It also can be said that the plonking of a hyper-charged globalized economy on top of the US political economy ripped all of these things asunder. It has not just been labor that was arbitraged by corporate globalization, but government regulation, the rule of law, and maybe most important of all, public and civic morality.

Oscar Wilde quipped at the end of the 19th century, "America is the only country that went from barbarism to decadence without civilization in between." But being very much a product of contemporary Europe, the vibrant democratic public and civic morality at the bottom of much of American society at that time would have been lost on him, just as today it is lost on us. If we are to have self-government, we have to renew and revive our public and civic morality. Know one thing: it is not comprised of listening to presidents, or watching 30 second ads, or voting every couple of years. It is comprised of the actions we take on a daily basis and the motives behind them. You've been given a clear view of the greedy violent rabble who have floated to the top of this decaying republic, and each day they do more to secure their reign. They will only be stopped by a concerted effort of the American people, defining and reviving self-government for the 21st century.

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

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Understanding Retirement Funds is as Easy as... Well, it's not Easy

Nov 30, 2010

Trying to plan for your retirement? So are these two... uh... dogs?, who have gone to Charles, their financial adviser, and given him all of their money in the hopes of a steady income in old age. Charles, they've been told, knows all the good brothers (not Lehman Brothers) on Wall Street and all the good stocks, so he will never make bad bets with their money. Does he understand derivatives? No, but why would he need to? And all he asks is a fee, even when the animals lose money. Totally fair.

Trying to plan for your retirement? So are these two... uh... dogs?, who have gone to Charles, their financial adviser, and given him all of their money in the hopes of a steady income in old age. Charles, they've been told, knows all the good brothers (not Lehman Brothers) on Wall Street and all the good stocks, so he will never make bad bets with their money. Does he understand derivatives? No, but why would he need to? And all he asks is a fee, even when the animals lose money. Totally fair.

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Budget Reform Can Act as Financial Reform

Nov 29, 2010Mike Konczal

mike-konczal-2-100A progressive counter-proposal on the deficit saves money by reining in Wall Street.

mike-konczal-2-100A progressive counter-proposal on the deficit saves money by reining in Wall Street.

The team at Our Fiscal Security, a collaboration between Demos, the Economic Policy Institute, and The Century Foundation, have just put out Investing in America’s Economy: A Budget Blueprint for Economic Recovery and Fiscal Responsibility (PDF here). I'm sure the blogosphere will be kicking the plan's tires over the next weeks.

For those who think of financial reform as an incomplete project, there are four things of interest in their budget proposal that act as de facto reform:

This proposal would also replace the mortgage interest deduction with a fully refundable tax credit. Under current law, homeowners can deduct interest payments on up to $1 million in mortgage debt and up to an additional $100,000 in other loans, such as home equity loans, regardless of their use. Value of this benefit goes disproportionately to upper-income homeowners because of the greater value of their mortgages and because they receive a larger benefit per dollar of mortgage debt.

Making the deduction a refundable credit would increase the value of the credit for many homeowners. The deductibility of mortgage interest on owner occupied homes is projected to cost $149.6 billion in 2015, or $637.6 billion over 2011-15. We propose converting the deduction to a refundable tax credit of 15% of interest on up to $500,000 in mortgage debt, which in itself would save $51.6 billion in 2014 and $387.6 billion over 2010-19.

It shouldn't surprise us that a credit bubble inflated our housing market, given the subsidies we have for housing. If you are a fan of housing policy, you should also be a fan of homeownership, not home buyership or home indebtedness. And this subsidy creates incentives for consumers to become indebted. This subsidy also is ineffective and highly regressive, and as such should be abandoned. The proposal gets us part of the way there.

Limit the deductibility of corporate debt interest payments for financial firms

When planning investment strategies, corporations take advantage of a tax preference that encourages debt-financed projects over projects financed by other means. Interest payments on corporate debt are counted as a business expense and are thus paid from pre-tax income. Requiring that interest payments be made from after-tax income, as dividend payments and stock repurchases are made, would encourage corporate financing using retained earnings or new equity. While there are many legitimate reasons for firms to take on debt, limiting the so-called “debt tax shield” for financial firms would generate significant revenues and discourage destabilizing high ratios of financial leverage, which have proven to impose significant economy-wide costs.

We propose limiting the tax preference for corporate debt interest payments for financial firms to 25%, below the top corporate tax rate of 35%, by making the preference an after-tax credit of 25% rather than a pre-tax expense. We estimate that limiting the tax preference to 25% of interest payments would generate $77.1 billion by 2015. Less revenue would be collected if there were a large reduction in borrowing resulting from this policy, but the policy objective of decreasing systemic financial risk would be furthered and capital would be freed up for more productive, less speculative investment. This proposal gives policy makers significant scope to adjust the parameters. Extending the 25% proposed limitation of the tax preference on interest payments to nonfinancial corporations, for example, would generate additional revenue of $38.0 billion in 2015. This variant of the proposal would help to level the playing field between firms that rely on equity financing and firms reliant on debt financing, but taxing nonfinancial sector debt would not come with the added bene#t of dampening speculation and reining in systemic financial risks.

This is a game-changer. A comment I've often heard is that if reformers are so worried about leverage in the system, why encourage it with the tax code? We would need less regulators to watch leverage if there is less of it, and there is more debt than there should be because  interest on leverage is shielded from taxes. Mark Calabria of Cato has written about this ("Nor has there been any discussion in Congress about removing the tax preferences for debt. Washington subsidizes debt, taxes equity, and then acts surprised when everyone becomes extremely leveraged."), and so have Felix Salmon and Steve Randy Waldman ("Debt financing externalizes the risks of business activity and magnifies social costs, while equity financing concentrates risk among stockholders who signed up to bear it. Yet under current rules, taxpayers literally pay firms to get rid of stockholders and take on ever more debt."). It's great to see it introduced as part of the discussion, and I hope people worried about leverage in the financial and non-financial system see this as a way of reducing these risks.

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Financial crisis responsibility fee

We recommend adopting the president’s proposal to impose a “financial crisis responsibility fee” designed to recoup taxpayer losses associated with the Troubled Asset Relief Program (TARP), which primarily benefited major financial institutions. The fee would apply only to financial institutions with over $50 billion in assets (estimated at roughly 60 institutions) and would be equal to 15 basis points (0.15%) of a financial institution’s covered liabilities. The fee proposed in the president’s budget is projected to raise $9 billion in 2015 and $90 billion over 2011-20, and it will continue until all of the costs associated with TARP are repaid. The Congressional Budget Office estimates that the fee would have a negligible effect on economic growth.

I discussed this Responsibility Fee when it was first proposed back here. A chart I created:

(That’s data from ffiec on total asset size for the top 50 bank holding companies, and Wikipedia’s participants amounts in TARP.) Taking the log of both sides, a 10% increase in bank size is associated with a 10.5% increase in TARP money received.

I was a big fan of prefunding the resolution fund for the largest firms. This didn't tax financial activity, but instead it taxed a certain type of financial institution -- the ones that were troublesome to resolve and/or push through bankruptcy in the past. This would ensure that only firms that genuinely benefited from ballooning would do so. A more aggressive approach to this part of the government budget would put this into action.

Financial speculation tax

While a financial transactions tax would not eliminate speculation or necessarily stave off financial crises, instituting disincentives to short-term speculating would be a step toward building a more resilient financial sector. The tax could generate revenue to fund investments to strengthen the economy in the wake of the financial-crisis-induced recession.

In 2004, the Congressional Research Service estimated that a 0.5% tax on stock transactions would raise roughly $65.6 billion a year, assuming no reduction in trading volume (Shvedov 2004). Adjusting for nominal GDP growth and assuming a 25% reduction in transactions, we estimate that a financial transactions tax would raise $77.4 billion by 2015. Expanding the tax to derivative financial products would generate significantly more revenue... The United States used to have a financial transactions tax, and many advanced economies, including Great Britain, collect revenue from financial transactions without any noticeable harm to economic performance. This policy would complement the financial crisis responsibility fee, discussed above, and revenue from the tax could be used to invest in jumpstarting the broader economy.

Until this report, nobody has put a financial transaction tax on the table. Some have argued that the explosion in derivatives is simply a capital structure arbitrage for bankruptcy formalized in the 2005 bankruptcy bill. A slight tax could make sure that banks could only replace a supply order with a "swap" to confuse capital structures if it added real economic value. There are many ways, both on the drawing board and implemented across many countries, to structure this financial transaction tax.

It's good to see financial reform, a crucial piece of our government that is still a work of progress, bolstered by a strong liberal vision of our priorities as put into action by a budget plan.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Bankers Gone Wild in Ireland AND Germany

Nov 29, 2010Marshall Auerback

marshall-auerback-100Despite a blame-a-thon on Ireleand,  Germans banks are really at the core of the eurozone catastrophe.

marshall-auerback-100Despite a blame-a-thon on Ireleand,  Germans banks are really at the core of the eurozone catastrophe.

Much ink has been spilled in the press over the Irish problem and the laxity of the country's southern Mediterranean counterparts in contrast to the highly "disciplined" Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany's bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.

One of the traditional rationales for the creation of the euro was that a single currency and strict Maastricht criteria would keep the profligate Mediterraneans and their Celtic equivalents in line. Instead, critics, particularly in Germany, increasingly see the European Monetary Union as a means for freeloading nations to offload their liabilities onto fitter neighbors.

Not surprisingly, this has engendered much discussion that perhaps it would serve Germany's interests to leave the euro, rather than booting one of the Mediterranean "scroungers" out. But as Simon Johnson has pointed out, this comforting narrative of German prudence matched up against Irish profligacy doesn't really stack up:

German banks in particular lost their composure with regard to lending to Ireland -- although British, American, French and Belgian banks were not so far behind. Hypo Real Estate -- now taken over by the German government -- has what is likely to be the highest exposure to Irish debt.

But look at loans outstanding relative to the size of their domestic economies (using the BIS data on what they call an "ultimate risk basis").

German banks are owed $139 billion, which is 4.2 percent of German G.D.P. [my emphasis]

Where were the German regulators? As my colleague Bill Black has noted:

They seem to have believed that ‘What happens in Vegas (Dublin) stays in Vegas (Dublin).' Instead, their German banks came back from their riotous holidays in the PIIGS with BTDs (bank transmitted diseases). The German banks' regulators continue to let them hide the embarrassing losses they picked up on holiday, but that cover up will collapse if any of the PIIGS default. The PIIGS will default if the EU does not bail them out, so there will be a bail out even though the German taxpayers hate to fund bailouts.

German banks' relatively high exposure to Ireland does pose the question as to whether there is some wild, Weimar-style hyperinflationista lurking deep in the heart of every German, only able to express itself fully when away from the prying eyes of fellow citizens.

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone's problem children could get their fiscal houses in order -- and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the "medicine" is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

But here's the thing: these fiscal straitjackets obscure the history of how we came to today's horrible impasse and, more specifically, the German banks' role in helping to fuel the credit binge. Also lost is the reason why this has metastasized into a far greater crisis: as part of the eurozone, Ireland does not have the fiscal freedom to come up with a sufficiently robust government response. The UK had a comparable real estate bubble in the late 1980s, which culminated with the Soros attack on the pound in 1992 and the ejection of sterling from Exchange Rate Mechanism (the precursor to the EMU). This was a blessing in disguise. Withdrawal from the ERM saved the UK because it allowed the country sufficient latitude to reflate. Yes, the country had a major recession (in many ways a consequence of the surrender of fiscal freedom as a result of joining the ERM in the first place), but there was never a systemic risk that posed a threat to the country's overall solvency as is the case in Ireland today. And this is exacerbating the problem in Ireland because it persists in chasing its tail repeatedly with futile fiscal austerity measures.

The truth of the matter is this: the eurozone seems rotten to the core, literally. Germany represents that core. The Germans might occupy the penthouse suite, but it is the suite of a roach motel. And we know what happens to those who enter such "establishments."

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Yes, longer term the problems currently afflicting the eurozone could be sorted via the creation of a supranational fiscal authority -- a "United States of Europe". But with each crisis (Ireland today; Portugal and Spain tomorrow; Italy and then France next?), the political forces are coalescing in a radically different direction. The Germans are becoming increasingly resentful as they perceive their country as the bailout mechanism of last resort (even though the Irish experience suggests that their bankers are also guilty of many of the same excesses as the "Celtic Tiger"). The PIIGS themselves are seeing that the benefits of euro membership have been vastly overstated and in fact now act as a cancerous influence through the Germanic embrace of austerity. (Paradoxically, it has been the "profligate" behavior of those so-called lazy Mediterraneans that has enabled Germany to retain its export-driven model, as well as allowing it to run lower budget deficits than most other countries.)

The eurozone could ultimately end up like Yugoslavia writ large. Prior to the break up of that country, the relatively rich republics, Slovenia and Croatia, resented policies that transferred wealth to the poorer republics like Serbia, Macedonia, Montenegro, or the autonomous region of Kosovo. Once Tito's organizing genius disappeared, the links stitching the country together became frayed and eventually snapped as old grievances manifested themselves in newer forms. The same could happen to the Europe Union if it underwent a supranational fiscal union -- the beginnings of which are already in evidence. I think the Germans are beginning to recognize that, which is why there is discussion about leaving the euro.

But let's first be clear: German Chancellor Angela Merkel has persistently argued that it is essential that private investors, notably the bond holders, begin to suffer losses so that they will have the proper incentives to provide effective "private market discipline" going forward. She has further argued that it is fair that they suffer losses, given the premium yields they received and their lack of due diligence. That's an honorable policy. But it's like the old Irish joke of the driver who gets lost, asks for directions, and is told, "Well, I wouldn't be starting from here." By the same token, Ireland clearly illustrates that German banks, as well as their Mediterranean counterparts, would be big losers under the Merkel proposal. Ironically, German financial institutions could find themselves subject to the same kinds of bailouts that Chancellor Merkel and many of her counterparts in Berlin are urging on the Irish and Greeks.

As always, leave it to the Irish to come up with the most poetic response to the crisis. True, W.B. Yeats did not live to see this disaster, but his passionate "September 1913" does evoke the tragedy of today's Ireland and the futility of the current policy responses for their people (and beyond):

Was it for this the wild geese spread
The grey wing upon every tide;
For this that all that blood was shed,
For this Edward Fitzgerald died,
And Robert Emmet and Wolfe Tone,
All that delirium of the brave?
Romantic Ireland's dead and gone,
It's with O'Leary in the grave.

Graves that might soon include not only the O'Learys, but also the Garcias, Texeiras, Moreaus, and Schmidts if a more rational course of action throughout the euro zone is not adopted soon.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Michael Hudson: Applying 3000 Years of History to the Modern Debt Crisis

Nov 26, 2010

With each new story about ordinary Americans struggling to keep their heads above water despite little to no help from our leaders in Washington, UMKC economist Michael Hudson seems more and more prescient. In this February 2009 interview with the Renegade Economist, Hudson discusses the unfolding debt crisis and contrasts the Obama administration's response with the way rulers handled debt relief in biblical times.

The rulers of ancient civilizations may have understood debt relief better than some of today's Nobel laureates.

With each new story about ordinary Americans struggling to keep their heads above water despite little to no help from our leaders in Washington, UMKC economist Michael Hudson seems more and more prescient. In this February 2009 interview with the Renegade Economist, Hudson discusses the unfolding debt crisis and contrasts the Obama administration's response with the way rulers handled debt relief in biblical times.

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In many ways, Hudson explains, the rulers of 2000 B.C. understood economics better than some of today's Nobel Prize winners. "They realized that debts tend to grow in excess of the ability to pay, and when the debts did that in antiquity, the ruler would cancel the debts." Though today's web of creditors is far more complex than anything Sumerian leaders had to deal with, Hudson maintains that "one way or another the debts are going to have to be written down to the ability to pay. Otherwise, they're not going to be paid!"

While the FIRE sector is wrapped around the real economy and extracts interest like a parasite, "the fact is, you can't serve both the parasite and the host." The government, Hudson argues, has a choice between saving the economy or saving the creditors, and it has clearly chosen the latter path. As a result, the U.S. is in danger of becoming an oligarchy. Barack Obama promised change, but Hudson doesn't believe he'll achieve any meaningful economic progress as long as he's employing the same team of insiders who helped break the Russian economy in the 1990s. In the wake of his midterm defeat, will the President finally begin to draw on the lessons of the past, or is he doomed to repeat it?

Tim Price is a Junior Fellow at the Roosevelt Institute.

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