Money and the Midterms: Are the Parties Over? Interview with Thomas Ferguson

Nov 12, 2010Lynn Parramore

lynn-parramore-web-headshot-1It was clear that cash was king in the midterm elections, so I spoke with Roosevelt Institute Senior Fellow Thomas Ferguson, the leading authority on money in politics.

lynn-parramore-web-headshot-1It was clear that cash was king in the midterm elections, so I spoke with Roosevelt Institute Senior Fellow Thomas Ferguson, the leading authority on money in politics. Our conversation covered what November 2nd said about Democrats, the problems with campaign finance, and where Wall Street's loyalties really lie.

Lynn Parramore: What do you make of the 2010 Election?

Thomas Ferguson: The 2010 election was not like others. It was certainly not simply 2006 in reverse, this time with the Republicans winning by a landslide. There is an obvious cumulative process at work here, with first one party and then the other receiving lopsided votes of no confidence from voters. The U.S. economy is barely moving; millions of Americans are looking for work and struggling to find ways to salvage their life savings and pensions; the international position of the U.S. is sliding; and the government is largely paralyzed on issues that voters care about most. We have clearly been in a political crisis for some years; the meaning of the 2010 election is that this crisis is becoming much deeper, moving into an entirely different stage. The parallels to the Great Depression are eerie: At that time, in many countries, voters seem to have followed an "in-out," "out-in" rule. But that process does not go on forever. As the Depression deepened with no solutions, all kinds of strange creatures started creeping out of the shadows. The U.S. seems to be entering that stage.

Lynn Parramore: You're implying the political system failed in some serious way. How so?

Thomas Ferguson: 2008 had all the earmarks of a classic realigning election, as my old colleague Walter Dean Burnham describes them. In the wake of the financial collapse, it looked for all the world like voters were ready for, even demanding, major reforms. They had elected a Democratic President on a promise of "Change," with both houses of Congress solidly Democratic. That's why many people were thinking that Obama was going give us a modern New Deal. They really believed him when he promised change. Instead, Obama's failure on the economy has discredited the whole idea of the activist state. The dimensions of this failure were spectacular: he didn't move aggressively to combat unemployment, the economic stimulus was half as large as it needed to be, and he didn't deal with the mortgage crisis. So unemployment stayed way up, and many people remain in danger of losing their homes or are underwater on their mortgages, with the whole housing sector stalling out. To make matters worse, the administration lavished aid on the financial sector. The spectacle of the government aiding bankers, who turned around and paid themselves record bonuses, has just been unbearable for millions of people.

What the election really shows is not that the parties can't agree -- Democrats and most of the GOP leadership finally agreed on the bank bailouts, for example -- but that the American people will not accept the policies that leaders in both parties prefer. In 2006 and 2008, the population voted no-confidence in the Republicans on the war and the economy. They have just now presented the Democrats with another resounding a no-confidence vote. What makes the current situation intractable is the fundamental reason for these serial failures. It's obvious: big money dominates both major parties. The Obama campaign's dependence on money and personnel from the financial sector was clear to anyone who looked, even before he won the nomination, promoted Geithner, brought Summers back, and reappointed Bernanke. For years I've promised people that I'll tell you who bought your candidate before you vote for him or her, by simply applying my "investment theory of political parties." When I analyzed the early money in Obama's campaign in March, 2008, it was impossible not to see that many of the people responsible for the financial crisis were major Obama supporters. As I wrote for TPM, serious financial reform would not be on President Obama's agenda.

Lynn Parramore: Lots of people point out that the banks have paid back the bailout funds and that the government actually made money on the deal. Can Obama at least claim that this policy was good for the American people?

Thomas Ferguson: The bailout was originally not Obama's but George Bush's, though Obama supported it during the campaign. The "banks-paid-us-back" story is mostly Treasury propaganda. The claim is really based on a narrow accounting of TARP funds. In fact, a lot of that aid has not been paid back. AIG, for example, is still heavily owned by the government. Secondly, the aid was way, way underpriced -- meaning that the federal government got very little for its money. If you want to see what market-driven terms you could get for aiding banks at the height of the crisis, just look at what Warren Buffett received for buying into Goldman Sachs. Most importantly of all, the banks actually got far more help than the direct TARP monies. They received sweeping FDIC guarantees on their debt and truly gigantic amounts of aid from Freddie Mac, Fannie Mae, and the Federal Reserve. All three of these entities have supported the market for mortgage-backed securities that the banks own. They bought huge amounts of them, taking the risks right out of banks, putting it on taxpayers, and in the process handing handsome profits to banks. Regulators allowed the banks to rip off their depositors and credit and debit card holders, while the Fed handed out virtually free money to banks. To add insult to injury, the regulators have allowed the bankers to use the profits from all these government subsidies to award themselves huge, indeed, record-setting bonuses. Those funds should have been used to strengthen the balance sheets of the banks. And if all this weren't enough, regulators also permitted the banks to hide the true value of their bad loans and they let it be known that the largest ones were Too Big To Fail, which allows them to borrow funds more cheaply than smaller banks. The net result of these big bank-friendly "forbearance" policies is that we have all paid to make these banks fabulously profitable, yet they still remain very weak institutions and are not lending. The resemblance to Japan's "lost decade" is obvious.

Lynn Parramore: Was there ever a chance that Obama could be a new FDR?

Thomas Ferguson: People who were hailing Obama as a new FDR were viewing American politics through the wrong lens. They were treating public policy as the result of the will of voters. But in fact, American political parties are mostly bank accounts. What you are told is the voice of the people is usually the sound of money talking.

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Much of my research has been devoted to showing how both parties are dominated by blocs of large investors. The policy choices political parties present to the public on Social Security, macroeconomic policy, campaign finance reform, and indeed nearly every other policy area save a handful of hot-button "social issues" are basically dominated by big money. The consequences are disastrous: Neither party can level with the American people in crises. They cannot diagnose problems like the financial crisis with any honesty and they can't make any detailed case for why the policies they do sponsor would actually benefit ordinary Americans. What we get instead are pseudo-explanations, myths, and sometimes, obvious mendacity. Political discussions in the media, where they are not distorted by the plain interests of the concerns themselves, are dominated by denizens of the "think tank" and "policy institute" world. Most of these institutions are heavily driven by, surprise, surprise, big money in the form of donors. As Robert Johnson and I documented in our paper for last year's INET Conference, growing inequality in the United States complicates this dismal picture by converting regulatory agencies into recruiting grounds for would be millionaires via the revolving door, while at the same time permitting the financial sector to substitute virtually untraceable stock tips for direct contributions.

Lynn Parramore: Where do you see politicians making up policy myths right now?

Thomas Ferguson: On the Republican side, you again have people claiming that the problems of the Great Recession can be solved by reapplying the policies of Herbert Hoover. Surely this is amazing; they are plumping for going straight back to the deregulated market economy that brought you the 2008 disaster. It's simply crazy, for example, to even consider leaving financial houses free to decide on their own level of leverage, to sell derivatives on exchanges that are not fully transparent, or to sell junk securities to their own customers without telling them. But the Republicans are threatening to roll back even the anemic Dodd-Frank financial "reform" legislation, though, to be fair, they will have plenty of Democratic support for some of this.

And it's obvious that neither party wants to address the problem of campaign finance reform. Instead, the Democrats spent part of the campaign talking up dangers from "foreign" money. It's not as though the problems of the system of American political financing come from foreign money. The problem is mostly domestic money. And the Supreme Court has made everything worse with its Citizens United decision. But, note well, the tragedy of big money in the Democratic Party was clear long before that Supreme Court ruling or even before Obama started running for president. Just look at the earlier cases I analyzed in my Golden Rule.

Fundamentally, the problem of money and politics is very simple: campaigning is costly, much more costly than classical democratic theory has acknowledged. Some way has to be found to pay for it. We may take it as an axiom that those who pay for the campaign will control it. So the choices boil down to just two: either we all pay a little, through public financing of campaigns, or a relative handful of the super-rich end up controlling the system because they pay for the campaign.

Lynn Parramore: Does the financial sector give more to Democrats or Republicans?

Thomas Ferguson: We've all seen the staggering statistics on lobbying and political contributions by the financial sector over the last couple of years. More recently, we've also heard about how finance is supposed to have turned against the Democrats. There's something to this: bank contributions to the Republicans increased when discussions of a Consumer Financial Protection Bureau started as the House began considering Dodd-Frank. Contributions to the GOP swelled when the White House panicked after Scott Brown won the special election to fill Ted Kennedy's seat in Massachusetts and endorsed the so-called "Volcker Rule", just as public indignation about bank bonuses was at its height. But the size of the shift toward Republicans has been exaggerated. If you look at total political contributions from securities and investment firms over the entire 2009-2010 election cycle, you will see that more money still flowed to the Democrats. Commercial banks, a narrower sub-group of the financial sector, gave more to Republicans, but only by about 60-40.

Lynn Parramore: So where does all this leave the American political system?

Thomas Ferguson: I think the answer is pretty clear: The political system is disintegrating, probably heading toward a real breakdown of some sort. The striking thing is that if you look beneath the surface of the victorious Republican Party, it is about as contentiously divided as the Democrats. The Tea Party's distrust of the party establishment is apparent, but the divisions within the GOP predated the Tea Party's emergence. They were obvious in 2008. At that time, it was pretty clear that a majority of the party did not want McCain. But there was no consensus on an alternative. 2012 is looking like a repeat of 2008: All kinds of people are eyeing the race, including several would-be candidates who can probably raise large war chests. In the end, somebody is going to win -- my dark horse candidate is Haley Barbour, probably the Republican politician who is most closely connected to big business -- but the whole party is unlikely to unite around him or her. In all probability, the GOP primaries will turn into a demolition derby, tending to discredit everyone involved. I also doubt that the Republican governors who are now promising to cut state budgets will find the public nearly as receptive to deep cuts as they think it will be, as people watch essential social services disappear, prisons empty, and see educational institutions trashed out that are in many cases the only hope of lagging states. Nor do I believe there is any popular majority for cutting Social Security, which is clearly emerging as a major issue just as we speak. And parts of the health care legislation are really popular, so that just saying no is going to look pretty foolish after some months.

The key to the future of American politics is the course of unemployment, though that is linked vitally to housing markets and how you deal with people's lost pensions and savings. If unemployment stays high, I would not be surprised to see some intra-party challenges to President Obama, even though right now everyone dismisses that possibility. The unions went down the line with Obama for the last two years and they have little to show for it; some of them are already scouting other possibilities. It is also interesting to speculate about Jerry Brown -- just watch his star rise if he succeeds in overcoming the California fiscal crisis. Were Brown to defeat Obama in a few primaries, then the temptation for Hillary Clinton to come in would be intense. And right now the United States is mired down in two shooting wars that are not going very well.

Even more interesting are the possibilities of a third party candidacy -- the obvious entrant is Mayor Bloomberg. He's plainly considering it. I notice that he does not appear to have folded the network of organizations that quietly talked up his candidacy in 2008. That tells you plenty.

Lynn Parramore: So is American politics fated to be all doom and gloom?

Thomas Ferguson: If you want a happy ending, you probably shouldn't follow our system too closely in the next few years. Instead, go see a Disney movie, unless perhaps Tim Burton is making it. Bloomberg, Brown, or Hillary Clinton, though, are all known quantities. But the experience of the Great Depression was that as things failed to improve the swamp creatures got their chance. And when the economic situation shook out, the geopolitics became more sinister. It would be a rash person indeed who counted on a happy ending to this mess.

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Currency Wars and QE2: How Bad Ideas Can Plague the G20 Meetings in Seoul

Nov 11, 2010Mario Seccareccia

A fiscal policy reversal threatens global economic recovery.

A fiscal policy reversal threatens global economic recovery.

When the G20 leaders met in Washington in the depth of the financial crisis in November 2008, there was an optimistic note that such an august body of world leaders could coordinate policy to get the world economy out of the crisis. To some extent, this significant coordination in preventing the world economy from collapse took place, despite the criticism of the deficit hawks and neocons that the sky would fall as a result of the important and much needed doses of fiscal deficits at the time. However, slowly, these neocons have been gaining influence and garnering political momentum through their continued fear-mongering about the so-called unsustainably high budget deficits in most Western countries. In reaction to the political pressures and media hype, these world leaders have been changing their discourse and reshaping their policy in conformity with what their critics have been articulating. Indeed, as discussed in a previous post, we have now witnessed a complete U-turn in fiscal policy since the last summit of the G20 leaders in Toronto in June 2010.

Given the uncertainties connected with private sector spending, economists well-steeped in the Keynesian tradition would argue that this reversal in fiscal policy is probably the biggest threat to a significant recovery of the global economy today. Instead from the G20 world leaders in Seoul this week and from economists working for such important international agencies as the IMF and the WTO, we are being told that the principal threat to world prosperity are imminent currency wars which are being fueled by a declining US dollar in the international currency markets.

In a world economy in which all countries are seeking to get out of the recession via a policy of export-led growth, the fact that the US dollar is declining significantly may well trigger "beggar-thy-neighbor" currency retaliations. However, it belongs to the G20 leaders to prevent such a currency war, by addressing the actual source of the problem. But what is the source of these currency threats? The source is, of course, the lack of sufficient world demand, with each country being currently under economic pressure domestically to grab a larger share of what is essentially a shrinking world demand through near-sighted mercantilist policies of export-led growth. If the problem is a shrinking global demand, the solution would hardly be what the G20 leaders committed themselves to in June by cutting government expenditures to deal with their ballooning budget deficits. Clearly, a more enlightened policy would be to stimulate domestic demand through stronger boosts of expansionary fiscal policy that would also stimulate private domestic spending, much as it had been understood in November 2008.

In contrast, we are now being told that the culprit is the sliding US dollar. And, what is the supposed cause of the depreciating greenback in the foreign exchange markets? According to these policy leaders, the offender is the original fiscal stimulus that led to a build-up of excessive reserves that had not been sterilized by the Federal Reserve authorities, dubbed "quantitative easing" (QE). This excessive accumulation of reserves or QE, whose intent was to insure that central bank-controlled interest rates should remain at their lowest possible level to encourage private sector spending, is now also supposedly putting strong downward pressure on the US dollar.

To the ordinary reader, all of this reasoning may sound quite logical. However, the analysis rests on an outdated and pernicious theory that has been completely discredited since the early 1980s and, perhaps, even more so, during the present crisis: namely old-line "monetarism" -- a theory associated with ideas of Milton Friedman. According to the old monetarist framework, when a central bank raises the amount of reserves in the banking system (resulting, say, from federal government deficit spending), these reserves will be lent out to creditworthy borrowers who, in turn, will increase their spending. These higher expenditures will eventually trigger a higher inflation and, with it, an accompanying depreciation of the value of the currency in the foreign exchange markets. It is this monetarist model of the transmission mechanism of money to economic activity and prices which presently seems to be etched in the mind of these leaders and their economic advisors and which guides them to see the problem as one of excessive public spending and the ensuing excess reserves in the banking system.

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But where is the evidence to support this view? It is true that reserves have been multiplied by many hundredfold over the last several years through the US Fed's purchases of either government or private-sector securities (in an attempt to bring down also long-term interest rates). It is also true that the Fed has not sterilized these excess reserves, although it is highly debatable that the Fed hopes that the mere existence of these excess reserves would encourage banks to lend more. However, these advocates of the supply-led view of bank lending do not seem to comprehend that US banks could be sitting on as many reserves as the Fed wants but, unless there are creditworthy borrowers out there, these reserves are irrelevant to the dynamics of credit expansion. In any case, as we all know, if the theory was correct, we should have been experiencing hyperinflation as a result of the exponential rise of these reserves because of QE in the US since 2009. But nothing is further from the truth. Moreover, the reason for the declining US dollar is simply because the US has become less attractive for footloose financial capital which goes where the returns are highest. It is certainly not because of QE but essentially because US interest returns are very low and because the US economy is in a very deep recession, which makes the latter less attractive to foreign capital.

What is hoped is that the G20 leaders will break away from a narrow focus that rests on reliance on private sector spending as the only legitimate source of economic growth and to go back to what had originally inspired them to engage in significant public sector spending at their historic meeting in November of 2008. All these G20 countries are prematurely cutting back on public spending today and, by so doing, have left themselves vulnerable to engaging in ridiculous and futile currency wars that had once plagued the world economy of the 1930s. Surely they could learn from the mistakes of the past. The biggest threat to world prosperity is not the potential for so-called currency wars, which are merely the symptom of a deeper problem -- that is, the lack of sufficient aggregate demand in a world economy that continues to generate persistent mass unemployment. This fear-mongering over currency wars and the blaming of US policy because of QE is just a diversionary tactic from the Chinese and German governments to continue with their export-led strategy à outrance and to deflect criticism of their own mercantilist policies cum domestic austerity that are endangering the stability of the world economy.

Mario Seccareccia is editor of the International Journal of Political Economy.

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Just What is Bernanke Up To?

Nov 11, 2010L. Randall Wray

money-question-150The 411 on the Fed's latest move and what it could be doing instead.

money-question-150The 411 on the Fed's latest move and what it could be doing instead.

On the eve of President Obama's arrival to the G20 talks in South Korea, a growing chorus of voices is questioning the direction of U.S. monetary policy. Germany's finance minister, Wolfgang Schaeuble, went so far as to scold Chairman Bernanke, saying "With all due respect, U.S. policy is clueless." Some critics (with justification) have argued that America is guilty of the "currency manipulation" policy for which it castigates China. Others have argued that US policies are opening the door to a complete revision of the international monetary system based on the dollar. World Bank president Robert Zoellick appeared to even suggest a return to the gold standard when he talked of "employing gold as an international reference point of market expectations about inflation, deflation and future currency values."

I already argued that QE2 is more of a slogan than a policy, and will not repeat those criticisms here. Rather, I will deal with the two most important issues and misunderstandings surrounding quantitative easing. The first concerns the consequences of injecting another $600 billion of excess reserves into the banking system. The second is associated with the Fed's attempts to lower long-term interest rates through purchasing treasuries. Both of these issues are in turn connected to the belief that QE2 will devalue the dollar and threaten its status as the international reserve currency. That, however, is a topic for another column.

All developed countries' central banks now operate with an overnight interest rate target (the fed funds rate in the US). To hit this rate, they must supply reserves more or less on demand. We can think of the supply of reserves as "horizontal", that is, as an infinitely elastic supply at the target interest rate. The simplest way to operate such a system is to offer "overdraft" facilities at the central bank, lending on demand at the target rate (this is done in Canada). Knowing that they can obtain reserves any time they want, banks would never hold substantial excess reserves, since they could borrow them as needed.

The Fed has never explicitly operated this way, preferring to supply most reserves through its open market operations (purchasing treasuries) while imposing "frown" costs on banks that come to the discount window. Most of the time, this does not really matter. However, when the financial tsunami hit, the fed funds market froze up as banks refused to lend to one another, even on the basis of good collateral. There was a general run to liquidity, and no bank felt it could get enough reserves to see it through the crisis. The Fed played around with an alphabet soup of auction facilities rather than simply announcing that it would supply reserves on an unlimited basis to all comers. That cost the economy dearly by dragging out the liquidity crisis. Fortunately, the Fed finally stumbled upon the obvious: supplying reserves in sufficient quantity. The liquidity phase of the crisis passed, and the Fed got the short-term interest rates down to its near-zero target.

So here is where Bernanke's pet, quantitative easing, came in. Conventional wisdom is that the once the central bank takes the short-term rate to zero, it has shot its wad. Nayeth, sayeth Bernanke -- the Fed can continue by flooding banks with excess reserves, which they do not want to hold. Some commentators have said that banks would eventually begin to lend out the excess reserves, seeking a higher interest rate than the Fed pays them. One hopes Bernanke never made that mistake -- banks do not lend reserves (except to one another), since they exist only as entries on the Fed's balance sheet. Only an institution with a "checking account" at the Fed can hold reserves, so there is no way a bank can lend these to households or firms (which do not have accounts at the Fed). So Bernanke presumably understood that if for some reason holding excess reserves caused banks to want to increase lending, this would simply shift the reserves around the banking system while leaving the outstanding quantity unchanged. But that means that offering Canadian-like overdraft facilities, promising banks they can have reserves anytime they want them, would have had the same impact as quantitative easing. Rather than actually holding excess reserves, the banks would have been just as happy knowing that they were safely "locked up" at the Fed and available anytime they were needed. In other words, pumping about $1.5 trillion into the banks would be no different than telling them the Fed would supply any amount at any time.

In sum, adding excess reserves to bank portfolios will not, by itself, do anything if the overnight interest rate has already been driven down to its near-zero target. QE2 proposes to add another $600 billion of excess reserves -- but whether banks have $1 trillion or $10 trillion in excess reserves will have no impact.

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So why would QE have any impact at all? Because to get those excess reserves into the banks, the Fed buys something from them. What did the Fed buy? Good, safe (mostly short-term) treasuries, and bad, toxic waste: mortgage backed securities. Now, treasuries are effectively reserves that pay a higher interest rate; they are like a saving account at the Fed, rather than a checking account. So when the Fed buys treasuries from a bank, it debits the bank's saving account and credits its checking account. This will have no appreciable impact on the bank's behavior and thus will have no discernible economic effect.

But if the Fed buys trashy assets, and at a nice price, the banks are able to shift junk they don't want off their balance sheets and onto the Fed's. And if the Fed were to do that in sufficient volume, it could turn insolvent banks into solvent ones. In truth, the Fed did buy a lot of junk, but banks were left with trillions of dollars of toxic waste assets -- probably much worse than the trash they sold to the Fed -- so they are still massively insolvent. Thus, while QE1 was useful, it did not come close to resolving the insolvency problem. It bought time for some of the trashiest banks, which they devoted to ramping up their dangerous and largely fraudulent activities, digging the hole ever deeper -- but that, too, is a story for another day.

With QE2, the Fed proposes to buy longer-term treasuries. Since these are not toxic, it will not help the banks. It is like transferring funds from CDs they hold at the Fed to their checking accounts, thereby reducing their interest earnings. I suppose the idea is that the Fed is going to reduce bank income, impoverishing banks to the point that they will finally throw caution to the wind and begin to make loans to struggling firms and households. It is simultaneously a strange view of banking and also a scary remedy to a financial crisis that was created by excessive bank lending to those who could not afford the loans. It's sort of like sending a covey of nymphomaniacs to the hospital bed of a nonagenarian suffering from myocardial infarction initiated by an age-inappropriate tryst.

The only plausible scenario in which this can prove useful is that QE2 pushes up prices of long maturity treasuries, lowering their yields. This could cause other longer-term interest rates to fall through competitive bidding by banks seeking better returns in alternative assets. Now, mortgage rates are already at historic lows, and what is needed to spur real estate markets is not lower interest rates (which will only generate big problems later when rates rise, crushing the holders of legacy mortgages that earn well below 4%) but rather the recovery of real estate markets. Only when it is clear that home prices have reached bottom and turned up will real homebuyers step forward -- that is, buyers other than the vultures making speculative purchases of blocks of homes at pennies on the dollar. So far as business borrowing goes, the problem is the market for firms' output, not excessively high interest rates. So the "bang for the buck" in terms of inducing domestic spending by lowering long-term rates cannot be very large and may not even be positive, since reducing interest rates also reduces the income of savers, which could depress spending.

This brings us back to the international sphere, and the fear that QE2 really means to succeed by "beggaring thy neighbor". Bernanke has talked openly of his desire to raise inflation expectations, and that, in combination with lowering interest rates, could make America a less attractive investment option. If so, the dollar could depreciate, increasing US competitiveness in traded goods and services. This could boost exports.

At the same time, international managed money would be looking for more attractive investments in strong currencies with higher interest rates -- say, the BRICs (Brazil, Russia, India, China) -- fueling appreciation of their currencies. In other words, QE2 would do for the US what Geithner claims Chinese currency policy is doing for China: cheapen our exports. At the same time, many developing nations are also facing destabilizing capital inflows, and worry about a reprise of the Asian crisis of the late 1990s when the flows reversed and wrought havoc on their economies. That is why they are threatening to drop the dollar, reduce capital mobility, and move to some sort of fixed exchange rate based on gold or a new international currency.

I do not have the space to completely address all of these issues, but I will just say that while much confusion surrounds the complaints thrown at the US, there is at least an element of truth in the claim that QE2 puts the burden of adjustment on other nations. The critics are certainly right to argue that so far as domestic policy goes, QE2 does nothing to get the US out of its crisis. In fairness to the Fed, Bernanke has argued that relying solely on monetary policy for stimulus is less than ideal, so one could argue that the Fed is just doing the best it can in the absence of stimulative fiscal policy. That is correct, up to a point -- only fiscal stimulus will get us out of the recession.

But Bernanke is not dealing with the one area for which the Fed does have primary responsibility, and in which a strong Fed policy initiative would do a lot of good: dealing with bankster fraud. Indeed, I believe that even with a huge fiscal stimulus (which is not going to happen) we would not escape another financial collapse and a long and deep economic depression unless the biggest banks are foreclosed. Right now the fraudsters are the biggest barrier to recovery.

At best, QE2 is a diversion from the task at hand.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.

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Obama's Problem Simply Defined: It Was the Banks

Nov 5, 2010James K. Galbraith

fat-cat-150Obama must break his devil's pact with the banks in order to succeed.

Bruce Bartlett says it was a failure to focus. Paul Krugman says it was a failure of nerve. Nancy Pelosi says it was the economy's failure. Barack Obama says it was his own failure -- to explain that he was, in fact, focused on the economy.

fat-cat-150Obama must break his devil's pact with the banks in order to succeed.

Bruce Bartlett says it was a failure to focus. Paul Krugman says it was a failure of nerve. Nancy Pelosi says it was the economy's failure. Barack Obama says it was his own failure -- to explain that he was, in fact, focused on the economy.

As Krugman rightly stipulates, Monday-morning quarterbacks should say exactly what different play they would have called. Paul's answer is that the stimulus package should have been bigger. No disagreement: I was one voice calling for a much larger program back when. Yet this answer is not sufficient.

The original sin of Obama's presidency was to assign economic policy to a closed circle of bank-friendly economists and Bush carryovers. Larry Summers. Timothy Geithner. Ben Bernanke. These men had no personal commitment to the goal of an early recovery, no stake in the Democratic Party, no interest in the larger success of Barack Obama. Their primary goal, instead, was and remains to protect their own past decisions and their own professional futures.

Up to a point, one can defend the decisions taken in September-October 2008 under the stress of a rapidly collapsing financial system. The Bush administration was, by that time, nearly defunct. Panic was in the air, as was political blackmail -- with the threat that the October through January months might be irreparably brutal. Stopgaps were needed, they were concocted, and they held the line.

But one cannot defend the actions of Team Obama on taking office. Law, policy and politics all pointed in one direction: turn the systemically dangerous banks over to Sheila Bair and the Federal Deposit Insurance Corporation. Insure the depositors, replace the management, fire the lobbyists, audit the books, prosecute the frauds, and restructure and downsize the institutions. The financial system would have been cleaned up. And the big bankers would have been beaten as a political force.

Team Obama did none of these things. Instead they announced "stress tests," plainly designed so as to obscure the banks' true condition. They pressured the Federal Accounting Standards Board to permit the banks to ignore the market value of their toxic assets. Management stayed in place. They prosecuted no one. The Fed cut the cost of funds to zero. The President justified all this by repeating, many times, that the goal of policy was "to get credit flowing again."

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The banks threw a party. Reported profits soared, as did bonuses. With free funds, the banks could make money with no risk, by lending back to the Treasury. They could boom the stock market. They could make a mint on proprietary trading. Their losses on mortgages were concealed -- until the fact came out that they'd so neglected basic mortgage paperwork, as to be unable to foreclose in many cases, without the help of forged documents and perjured affidavits.

But new loans? The big banks had given up on that. They no longer did real underwriting. And anyway, who could qualify? Businesses mostly had no investment plans. And homeowners were, to an increasing degree, upside-down on their mortgages and therefore unqualified to refinance.

These facts were obvious to everybody, fueling rage at "bailouts." They also underlie the economy's failure to create jobs. What usually happens (and did, for example, in 1994 - 2000) is that credit growth takes over from Keynesian fiscal expansion. Armed with credit, businesses expand, and with higher incomes, public deficits decline. This cannot happen if the financial sector isn't working.

Geithner, Summers and Bernanke should have known this. One can be fairly sure that they did know it. But Geithner and Bernanke had cast their lots, with continuity and coverup. And Summers, with his own record of deregulation, could hardly have complained.

To counter calls for more action, Team Obama produced sunny forecasts. Their program was right-sized, because anyway unemployment would peak at 8 percent in 2009. So Larry Summers said. In making that forecast, the Obama White House took responsibility for the entire excess of joblessness above eight percent. They made it impossible to blame the ongoing disaster on George W. Bush. If this wasn't rank incompetence, it was sabotage.

This is why, in a crisis, you need new people. You must be able to attack past administrations, and override old decisions, without directly crossing those who made them.

President Obama didn't see this. Or perhaps, he didn't want to see it. His presidential campaign was, after all, from the beginning financed from Wall Street. He chose his team, knowing exactly who they were. And this tells us what we need to know, about who he really is.

James K. Galbraith is the author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. He teaches at The University of Texas at Austin.

*This post originally appeared at Common Cause.

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Johnson to Treasury: Resist Slick Banker Talk in Implementing the Volcker Rule

Nov 5, 2010Robert Johnson

In a letter to the Financial Stability Oversight Council, Roosevelt Institute Senior Fellow Rob Johnson explains how banks will try to evade regulation.

Financial Stability Oversight Council

Department of the Treasury

1500 Pennsylvania Avenue, NW

Washington, DC 20512

c/o The Honorable Timothy Geithner, Chairman

Re: Docket Number FSOC-2010-0002, Financial Stability Oversight Council study on Section 619

Dear Chairman Geithner and Council Members:

In a letter to the Financial Stability Oversight Council, Roosevelt Institute Senior Fellow Rob Johnson explains how banks will try to evade regulation.

Financial Stability Oversight Council

Department of the Treasury

1500 Pennsylvania Avenue, NW

Washington, DC 20512

c/o The Honorable Timothy Geithner, Chairman

Re: Docket Number FSOC-2010-0002, Financial Stability Oversight Council study on Section 619

Dear Chairman Geithner and Council Members:

I write in response to the request for public comment on the Financial Stability Oversight Council study on how to implement the Volcker Rule, embodied in section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The previous five years has proven with ringing clarity that the health of Wall Street is not sufficient to guarantee the health of Main Street, and may in fact be detrimental to the health of the non-financial economy. Following the disastrous financial crash of 2008 and the continuing economic consequences, the recent financial reform effort should, at its core, be about putting Main Street back in the driver seat economically: making investment in the real economy rather than investment in bubble financial assets the focus of our policy incentives, restoring the health and vitality of community and regional financial networks, and getting rid of the tricks, traps, and conflicts of interest of financial engineering, at every level. The Volcker Rule is a central part of that effort.

I believed strongly that a full return to the separation between banking and securities dealing would be in the best interests of our nation. At the same time, recognizing that Congress was unlikely to go down that path, I also endorsed the work of Senators Merkley and Levin -- and their two dozen Senate co-sponsors -- who crafted a strong version of the Volcker Rule that seeks to achieve many of the same objectives. Congress adopted their framework, and it is now incumbent upon you as regulators to implement that vision.

I fully expect that Wall Street will continue to place many obstacles in the path of strong implementation, just as they sought to do so during legislative consideration. Powerful interests will undoubtedly put forward arguments as to why specific details ought to be implemented in ways that do not disturb their business models or put them at perceived disadvantages with their international counterparts. You should recognize their arguments for what they are -- distractions -- and reject them.

Quite simply, banks under the protection of taxpayer guarantees should be in the business of banking: holding deposits, making loans, and serving clients. The Merkley-Levin provisions let them remain in certain parts of securities dealing, but sets limits on what those activities can entail. You should be certain to implement those limits to the full extent of your authority and ensure that the permitted activities do not swallow the protections offered by our taxpayers.

In particular, terms like "market-making-related" and "risk-mitigating hedging" should be defined narrowly. Market making is where a firm provides liquidity to trading markets but avoids long or short exposures to the instruments being traded. The goal is to provide clients with buy and sell opportunities without incurring substantial risk. This contrasts with the goal of proprietary trading, where firms seek to accumulate financial holdings and profit from changes in the value of the held financial instruments. Similarly, hedging is where firms take a position in order to reduce a specific financial exposure created by another position or holding.

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Market participants know full well when they are marking a market in a product or hedging a position in that product, versus when they are making proprietary bets. You should dive deeply into the inner workings of financial entities and subject their trading records to close inspection. Talk directly to the traders inside and outside of these institutions who will tell you how things really work. In short, do the hard work necessary to implement the Congressional directive.

It is also critical that terms such as "trading account" and "short term" or "near term", as well as "material conflict of interest," "high risk asset" and "high risk trading strategy" be defined so as to capture the full range of risk that the Congress intended section 619 to cover. When studying how to define these terms, you should look carefully at the nature of the exposures that brought down Long-Term Capital Management in 1997, Amaranth Advisers in 2006, and the major Wall Street firms, including Bear Stearns and Lehman Brothers, in 2008. The definitions of these terms should flow from those investigations, as they were clearly the types of failures that Congress is seeking to keep out of the nation's critical financial infrastructure.

Your study should also pay close attention to the provisions governing how firms relate to private funds. I agree with Chairman Volcker that our banking system would be better off if banks did not maintain any connection channel investments into hedge funds or private equity funds. There is simply no reason why the bank needs to pool client funds into these entities to invest. But Congress chose a compromise position that permitted firms to organize and manage funds, seed funds, and maintain de minimis fund investments to "align their interests" with their clients. To achieve the intent of the Merkley-Levin Volcker Rule, these provisions should be interpreted narrowly. In particular, I urge you to do a broad survey of market participants (including major competitors of the banks) regarding precisely how large seed funds need to be. I believe most will tell you that true seed funds are quite small, in the $5 million to $20 million range. Your regulations should reflect your findings, and not permit the de minimis exception to allow $100 million revolving "seed" funds.

As to the argument that nothing should be done until the international community acts, that argument should be rejected outright. The United States remains the world's most important financial market, largely because of its reputation for integrity and security built on the back of decades of thoughtful regulation. The world needs U.S. leadership, and our foreign counterparts need you to take a strong position to counter the increasingly global reach of the banking lobby, which now conducts lobbying efforts through several industry-sponsored channels. If the giant U.S. banks have concerns regarding perceived competitive disadvantages from being unable to take the same kinds of extraordinary risks that certain of their "too big to fail" foreign peers may be permitted to continue to take (and in fact, the world seems to be converging towards the U.S. approach of tougher regulation anyway), then the better approach would be to protect U.S. depositors and taxpayers from those risks by directing the Federal Reserve to reject applications to acquire U.S. institutions by foreign firms with material exposures to the risks of proprietary trading and investments in hedge funds and private equity firms. This is well within U.S. regulators' discretion under the prudential safeguards of global trade rules.

Lastly, I urge you to be aggressive in your inclusion of nonbank financial companies for supervision by the Board, and therefore, coverage by the Volcker Rule. The weakness of Glass-Steagall was its failure to keep up with the shadow banking system. The Merkley-Levin Volcker Rule properly corrects that oversight by subjecting nonbank financial companies supervised by the Board to significantly higher capital charges for their proprietary trading and fund investments. These capital charges accommodate the diversity of financial firms that could pose a risk to U.S. financial stability, but can only do their job if vigorously applied and if the right firms are covered.

If the financial reforms of 2010 are to keep the U.S. out of another financial crisis and recession, you as regulators must not be unduly influenced by the smooth talking bankers who lobby you on a daily basis. Conduct your study on implementing section 619 with an eye on keeping our nation's banks out of the business of gambling, and back in the business of serving clients and the real economy.

Sincerely,

Robert A. Johnson

Director of Global Finance, Roosevelt Institute

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With Trouble at Home, FDR Found Success Abroad

Nov 5, 2010David B. Woolner

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

The success enjoyed by the Republicans in the 2010 midterm elections and the loss of the House of Representatives by the Democrats has raised questions about President Obama's future relationship with Congress. Given the sharp partisan divide that has characterized the relationship between Congressional Republicans and Democrats in the past two years, there are fears among some analysts that the next two years will be even more difficult. As such, President Obama may find it extremely difficult, if not impossible, to advance even a watered-down version of his legislative agenda.

In some ways, the predicament faced by President Obama is not unlike that faced by President Roosevelt in the wake of the 1938 midterm elections. In both cases the state of the economy was a major issue. FDR had just weathered the so-called "Roosevelt recession", brought on in large part by his administration's misguided decision to cut the federal budget (and raise interest rates) after four plus years of strong economic growth.

This policy was quickly abandoned in favor of further expenditures to bolster employment and shore up the sagging economy, which brought an end to the recession and a resumption of growth. But not before FDR paid a fairly hefty political price at the polls, especially in comparison with the Democrats' stunning victories in 1932, 1934 and 1936. Indeed, for the first time in three election cycles, the Democrats actually lost seats in 1938, while the Republicans picked up eight seats in the Senate and an impressive 81 seats in the House.

Given the size of the Democratic majorities, however, even these gains were not nearly enough to bring about the Republican control of either chamber. Still, numbers can often be misleading. In spite of the fact that the Democrats continued to control both houses, FDR faced a much more difficult time with Congress from 1938 on. A good deal of this difficulty can be attributed to the political make-up of the parties themselves, which, unlike today, were much less monolithic in their outlook. On the Democratic side, for example, some of FDR's harshest critics -- particularly with respect to New Deal expenditures -- came from the conservative wing of the Democratic party. On the other hand, many of the staunchest supporters of the New Deal's social policies were Republicans, drawn from the populist/progressive wing of the Republican Party. It was the combination of liberal Democrats aligned with liberal Republicans that made much of the New Deal possible. By 1938, however, support for the New Deal began to wane. In the wake of the 1937-38 recession, the conservative wings of both parties began to coalesce into an anti-New Deal coalition that was greatly strengthened by the results of the 1938 midterm election. And it was not just the gains on the Republican side that were important -- 1938 also saw the reelection of a number of conservative Democrats, many of whom FDR had unsuccessfully tried to replace with more liberal candidates in the run up to the election.

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By 1939, the Congress FDR had to work with was a far more conservative body than that which helped him usher in the New Deal in his first term. This made it much more difficult for FDR to pursue further social reform. Aside from the G.I Bill, which was passed in 1944, no new major pieces of domestic social reform legislation were passed in the wake of the 1938 election.

This is not to say that FDR did not enjoy any additional legislative successes. On the contrary, his transformation of American foreign policy and of America's place in the world during World War II involved a number of legislative initiatives that required all the political skill he could muster. These included the revision of the Neutrality Act; the unprecedented peace and wartime expenditures that brought an end to unemployment and turned the United States into the most powerful nation on the planet; the passage of the Lend-Lease Act; the adoption of selective service; the re-organization of the executive branch and the establishment of a number of wartime boards and agencies; and shortly after his death, the creation of the United Nations Organization with the full backing of both the Republican and Democratic Party establishment.

Still, for all of this, major domestic reform for all intents and purposes was dead. Unable to move Congress toward further expansion of the New Deal at home, FDR concentrated on extending American moral, political and economic leadership abroad -- with great success.

The result -- a new multilateral world order that not only prevented a third world war, but led to perhaps the greatest period of economic expansion in history -- remains one of FDR's greatest legacies.

President Obama has made considerable, though largely unrecognized successes, to date in stemming the downward spiral of the US economy and in pushing through health and financial reform. But now prospects are bleak that the new Congress will grant him the opportunity to further his domestic agenda. Given this, perhaps he too should steal a page from FDR and shift more of his attention abroad. After nearly a decade of war in Afghanistan, an enormous effort to bring about a stable and peaceful Iraq, and 60 plus years of conflict and strife between Israelis and Palestinians, using his talents as a conciliator to bring peace to the world is something that people everywhere would herald as an unprecedented achievement.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.

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"Rules of Our Society Should Not Be Bought and Sold": Roosevelt Election Roundup

Nov 3, 2010

lynn-parramore-web-headshot-1In the wake of a Democratic loss not seen in the House since 1938, upended Senate seats, and Republican gubernatorial wins, Roosevelt Institute Fellows weigh in. Was the vote a referendum on Democrats? What will it mean moving forward?

lynn-parramore-web-headshot-1In the wake of a Democratic loss not seen in the House since 1938, upended Senate seats, and Republican gubernatorial wins, Roosevelt Institute Fellows weigh in. Was the vote a referendum on Democrats? What will it mean moving forward?

"The American people are voting against the political system. They are given the choice between the marketed vision of false hope and the vision of everyman financed by those who are attempting to take away vital services. Anger at the financial bailouts is understandable and a vote to cut off government from using our future tax burden to fortify the powerful is also quite sensible. The problem is that in the era of money politics, no coalition from either party can make good on the mirage of their marketed vision.

That both Alan Grayson and Russ Feingold were defeated after being ardent critics of the bailouts and the industry friendly financial regulatory reform is a clear warning that the money system can defeat the politician who represents the people's interest against powerful vested interests.

All of this points to the fundamental need for reform of government incentives in order to restore the power of votes relative to the power of money. And to the fact that reform is the precursor to limiting the domination of our state by concentrated money interests, both corporate and by wealthy individuals. The rules of our society should not be bought and sold."

-Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance; Executive Director of the Institute for New Economic Thinking

"High unemployment and a housing market that's right out of Twenty Thousand Leagues Under the Sea would wreck any regime's reelection prospects. This was no communication failure: The administration had nothing to offer ordinary people. Facing a wave of secret money, you can't win elections by just saving banks."

- Tom Ferguson, Roosevelt Institute Senior Fellow; Professor of Political Science at the University of Massachusetts, Boston

"In my view, President Obama had one key mission: to prove the value of government. He and his defenders argue that he has achieved much. In particular, they cite health care reform, financial re-regulation, the Recovery Act of 2009, and some even claim he has a workable strategy in Afghanistan. All these were agenda items that needed addressing. Obama has been able to convince too few Americans that any of them were adequately addressed. In fact, they were not, and he never seemed to come to terms with that central fact. To the contrary, he seemed to bury his head in the sand. His claim was that we got so much done but no one really knew about it. This was not bad public relations. It was not failure of government. It was inadequate policy and the failure to own up to it. Obama said a few times he got seventy percent of his agenda done. He got something done, sure, but in no case did it solve the pressing problems they were addressing. This is a man who willfully has averted his eyes from reality, I fear, and the public knew it. And the stunning electoral losses -- made a little more tolerable by the constant lowering of expectations -- don't look like they will shake him up. Equanimity is his constant goal, even in the face of such adversity."

-Jeff Madrick, Roosevelt Institute Senior Fellow and author of The Case for Big Government

"There was no mandate for the repeal of health care in this election, with Democrats who voted against the bill and for the bill equally joined in defeat, but that won't stop Republicans for claiming one. The Republicans will do all they can to terminate the biggest expansion of the social compact in decades, understanding that if health care reform is implemented, it will prove to Americans that government can actually work for them."

- Richard Kirsch, Roosevelt Institute Senior Fellow and formerly National Campaign Manager of Health Care for America Now

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"Barack Obama did not do what it took to pull the economy out of the doldrums. This is true for the fiscal stimulus, which was too small, too preoccupied with returning to a surplus as fast as possible, and contained too much lag. His banking bailout policies continued the Bush/Paulson approach and effectively reinforced the notion of government as an instrument of predatory capitalism, rather than an entity mobilizing resources for a broader public purpose. Obama didn't give us 'change we could believe in.' He instead used trillions of dollars in financial guarantees to sustain Wall Street (much more money than was spent on the stimulus) and consequently presided over one of the most regressive wealth transfers in American history. At a time when most Americans were experiencing stagnant or absolute declines in total wages, and Wall Street Robber Barons paid themselves even higher bonuses than before, the President was totally insensitive. He appeared to take pains to put down or ignore the aspirations of every single part of his base. And he wonders why there was an 'enthusiasm gap.'"

- Marshall Auerback, Roosevelt Institute Senior Fellow

"The most striking thing about the post-election landscape is the utter route of centrists Democrats. In the aftermath, as Chris Bowers notes, the Progressive Caucus is larger than the Blue Dog and the New Dems combined. Analysts will continue to go through the numbers, but right now there's nothing to suggest that 'liberal overreach' or a lack of centrist views was a factor. The truth is much worse: the ugly process of appeasing and buying off centrist Democrats on financial reform and health care turned what should have been landmark generational reform into a bitter, ugly view of corporate power and sleazy influence over our political system, the Senate and the political party that is supposed to defend the interests of working people."

- Mike Konczal, Roosevelt Institute Fellow

"Americans want bold ideas and a clear vision, not back-room deals and bank-centric policies. Until Democrats can offer these to voters, they will not succeed. For the next two years, those who would stand in the way of investing in jobs, schools, roads, bridges, and rebuilding the middle class will present even more obstacles to a prosperous future. But progressives are energized and see that the time for backing down and letting billionaires run the country is over. The fight for the future of ordinary Americans is on. Get the gloves off."

- Lynn Parramore, Editor of New Deal 2.0 and Media Fellow at the Roosevelt Institute

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Make Your Voice Heard with a Comments Submission for the Volcker Rule

Nov 1, 2010Mike Konczal

mike-konczal-2-100You may not be a lobbyist, but you can still make a difference in FinReg.

mike-konczal-2-100You may not be a lobbyist, but you can still make a difference in FinReg.

Just a reminder: this Friday, November 5th, 2010, is the last day to submit comments on the Volcker Rule. Here is the website for this, "Public Input for the Study Regarding the Implementation of the Prohibitions on Proprietary Trading and Certain Relationships With Hedge Funds and Private Equity Funds."

The rule-making and comment period is going to represent the best form of democracy we'll have in this process. Granted, banks have expensive lawyers on retainer to submit comments for them. But everyone out there, including those in my audience with expertise and the ability to write something like this, can do so. And their comments will at least get a shot at being as influential as a senior lobbyist.

Right now there's little attention paid to this part of the process. But it is the most important. If siloing out the riskiest parts of the financial sector from the insurance mechanism and the crucial intermediary functions that the financial sector provides is important to you, make the time to write and submit a comment.  Here is Simon Johnson discussing this.

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At the recent conference held by the Roosevelt Institute, The Future of Financial Reform: Will It Work? How Will We Know?, we included a chapter from Senators Jeff Merkley and Carl Levin, Making the Dodd-Frank Act Restrictions On Proprietary Trading & Conflicts of Interest Work (pdf), which is all about the Volcker Rule and how we can tell if the implementation has been successful.

Here is Ty Gellasch and Andrew Green, from Senator Levin and Merkley's offices respectively, presenting this chapter at the conference:

I encourage you to check it out to remind yourself that the stakes are very high.  You may not have a lobbying staff, you may not get your calls returned from Senators within minutes, you may not be running attack ads through slush funds connecting a dozen front groups. But you can have your voice heard right here in this comment period.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Democrats Are Running on Empty

Oct 28, 2010Joe Costello

downarrow-money-150Without meaningful reforms, our economy -- and our politics -- will continue to suffer.

downarrow-money-150Without meaningful reforms, our economy -- and our politics -- will continue to suffer.

New York, New York big city of dreams
And everything in New York ain't always what it seems
You might be fooled if you come from out of town
But I'm down by law, I know my way around
Too much, too many people, too much
- Grandmaster Flash and the Furious Five

David Leonhardt has a piece in the New York Times on how the economy is hurting Obama and the Dems. It's one of those articles that illustrates that when you're reading the NYTimes, sometimes you need to check to see if you accidentally clicked over to The Onion. Two punchlines:

On the evening of Dec. 3 last year, the Bureau of Labor Statistics sent an advance copy of the next morning’s jobs report to the White House... It showed that job losses had all but stopped in November, after nearly two years of big declines. White House aides exulted. Christina Romer, a top economist, brought a copy of the numbers to the Oval Office, and President Obama embraced her. A photograph of the moment, with a Christmas tree off to the side, was hung in the office of the Council of Economic Advisers. The good news -- and the optimism -- would continue for the next few months.

and:

“The health care bill alone is the most significant and far-reaching piece of domestic social policy in my lifetime,” says Neera Tanden, the 40-year-old chief operating officer of the liberal Center for American Progress, who worked in the Clinton and Obama administrations and was a top official in Hillary Clinton’s campaign. In all, Ms. Tanden added, “It is hard to see a more productive session of Congress in decades.”

The Dems are finding out that "productive" is in the eye of the beholder. Meanwhile, Ms. Tanden didn't seem to get the memo the Dems aren't running on their "most significant and far-reaching piece of domestic social policy."

And the complete capitulation concerning any real financial reform, where the Dems proved themselves for all who honestly care to look only loyal to Wall Street and the big banks, continues to be a drag on any sort of economic revival. The WSJ has an excellent piece on how the banks all posted profits this quarter by raiding their reserves shored up against bad loans. Because of course the housing market is getting better, right? The piece states:

The biggest U.S. banks virtually doubled their collective earnings in the third quarter just by injecting $8.1 billion into net income from funds they had set aside to cover loan losses.

There are 18 commercial banks in the U.S. with at least $50 billion in assets, and together they earned an adjusted $16.8 billion in the third quarter. Of those profits, nearly half, or 48%, were from drawing down what bankers call loan-loss reserves, according to an analysis by Dow Jones Newswires. A year ago, the same 18 banks earned $6.2 billion in quarterly profits; at that time, they added more than $7.8 billion to the same reserves, a move that reduced their profits. The analysis omits a $10.4 billion noncash charge to earnings that Bank of America Corp. disclosed during the third quarter.

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Finally, Chris Whalen has a must-read piece on how, until we restructure and reform the financial sector, we will have no economic vitality. Whalen writes:

Because President Barack Obama and the leaders of both political parties are unwilling to address the housing crisis and the wasting effects on the largest banks, there will be no growth and no net job creation in the U.S. for the next several years. And because the Obama White House is content to ignore the crisis facing millions of American homeowners, who are deep underwater and will eventually default on their loans, the efforts by the Fed to reflate the U.S. economy and particularly consumer spending will be futile. As Alan Meltzer noted to Tom Keene on Bloomberg Radio earlier this year: "This is not a monetary problem."

Forget Treasury Secretary Tim Geithner lying about the relatively small losses at American International Group (AIG), the fraud and obfuscation now underway in Washington to protect the TBTF banks and GSEs totals into the trillions of dollars and rises to the level of treason. And the sad part is that all of the temporizing and excuses by the Fed and the White House will be for naught. The zombie banks and GSEs alike will muddle along until the operational cost of servicing bad loans engulfs them. Then they will be bailed out -- again -- or restructured.

Make no mistake folks, there's a criminal element atop our financial industry, who operate with both the complicity and culpability of much of our political class. Until we reform our politics and the financial industry, we will not have economic vitality. And we will not have reform, until it is demanded and undertaken by the American people. That is where we are.

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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A Failed Dirt-Finding Expedition on the CFPB

Oct 27, 2010Mike Konczal

mike-konczal-2-100Regulatory capture is dangerous. But you won't find it in the agency's new hires.

mike-konczal-2-100Regulatory capture is dangerous. But you won't find it in the agency's new hires.

Today's New York Times came out with a bizarre hit piece on the Consumer Financial Protection Bureau and the first wave of hires. They attempted to argue that there are already huge conflicts between those staffing the creation of the Bureau and those that they will be tasked to regulate. This will be a problem for any agency, and it's one to be very conscious of and make sure that proper disclosures and vetting have occurred.

But what's so surprising about the article is how little they were able to find. After going through the record of the initial hires of advisors for the CFPB, the only thing they were able to flag was that Warren advisor Raj Date was, up until recently, a director of Prosper Marketplace Inc. The company is lobbying to be regulated as a bank, instead of regulated by the SEC, debating whether their practices constitute issuing securities. I read the piece waiting for a bang, but all I found was a whimper.

Having written a paper with Date on Glass-Steagall and the future of financial reform, as well as working with Date when he contributed to Roosevelt's Make Markets Be Markets financial reform conference on the subject of the GSEs, I was kind of curious to see if he was actually some sort of deranged financial hitman. But if this is all the 'dirt', I'm almost worried for the opposite reason: that the agency will be too academic and not take advantage of people involved in the shadier side of the financial world who want to repent.

The Times article relies entirely on the implied assumption that peer-to-peer lending is some sort of shady, fly-by-night operation. In reality, it is simply part of the over-hyped phenomena of trying to integrate the internet with new financial institutions. From Mark Gimein's very critical take on the company:

Person-to-person lending -- loans made by individual investors who had money to spare to borrowers hoping for better rates than they could get from banks or credit card companies -- was supposed to be to loans what eBay was to garage sales. Prosper.com, the pioneer, was one of most hyped internet startups of the last decade.

TIME Magazine chose Prosper.com as its top new website of 2007, and the Wall Street Journal featured it in a high profile story. Prosper television commercials picked out nifty stories like that of a New York cop who lent money to a Chicago fashion designer, and the press followed with quirky human interest stories (like a loan for breast implants). In short order, Prosper was followed by imitators such as Loanio and Lending Club -- the latter a Harvard Business Review featured in the Harvard Business Review's picks for “breakthrough ideas for 2009.”

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"Most hyped internet startups of the last decade." You don't get that impression from the Times article. It merely quotes a default rate to condemn the practice. And Prosper contested that measure of default rates when Gimein wrote about them for Slate, both as a solid measure of its business and particularly in the context of a gigantic credit bubble and the Great Recession (where everyone is having to take massive consumer credit writedowns).

In my personal opinion, in the same way middle-class people turned amateur stock analysts was the sign of a tech bubble, or middle-class people turned amateur realtors was the sign of a housing bubble, middle-class people turned amateur credit risk analysts and credit channel intermediaries was the surest sign of a credit bubble. But Prosper has been a useful experiment. It's challenged thinking about information, prices, the "wisdom of crowds" versus institutional information, fringe lending, and creative ways around low-quality high-churn payday-style lending, regardless of whether or not it is going to take off. Either way, wasn't the problem that the CFPB was going to kill small-scale financial entrepreneurialism? So isn't it good to include someone in the agency who has experience with it?

Even more striking is that the article fails to mention that Date and his former policy shop, Cambridge Winter, which they summarize as being "active in the Dodd-Frank debate", were really at the cutting edge of the consumer financial protection debate. I actually wasn't sure if the auto dealer exemption for consumer protection was something worth fighting until I read Date's Baseline Scenario post on the topic, Auto Race to the Bottom. Particularly pertinent was the excellent phrase: "Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived. Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have." Heh.

He was also active in the Volcker Rule debate, bringing sanity to the discussion of the strengths and weaknesses of resolution authority (also here), and a whole ton of other research that created markers for serious financial reform.

The case against him is so weak that even Mark Calabria, director of financial regulation studies at the Cato Institute, who loves hitting a regulatory conflict and capture slowball over the plate, seems kind of bored with it when he's quoted: “It would be very difficult to find anybody on either side of the aisle on this issue who doesn’t have a financial interest. What’s important is that those conflicts get aired.”

The issue of regulatory capture is a serious one, and I'll worry when President Palin is appointing credit card company executives to run the CFPB. But if this is the 'worst' that can be found out the door, the capture part of it is the least of my concerns.

Mike Konczal is a Fellow at the Roosevelt Institute.

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