The Summer(s) of Our Discontent

Jul 19, 2010Marshall Auerback

no-nonsense-150Larry Summers's misguided approach to deficits and surpluses could strangle our long-term vitality.

no-nonsense-150Larry Summers's misguided approach to deficits and surpluses could strangle our long-term vitality.

Virtually every profile on Larry Summers tells us that he is one of the most brilliant economists of his generation, celebrated for having allegedly helped to create the boom of the 1990s.  Statistical maven at age 10, the youngest tenured professor at Harvard, chief economist of the World Bank, this is a man whom the French would surely call "un homme serieux".

But after reading his latest defense of President Obama's fiscal policy in Monday's Financial Times - "America's Sensible Stance on Recovery" - one wonders.   Only Robert Rubin and Alan Greenspan played a more important role than Summers in promoting the deregulation and lax oversight that laid the foundations for the current crisis. Certainly the plethora of innocent frauds that the Director of the National Economic Council peddles in Monday's Financial Times calls his economic perspective into question.  In addition to the usual apologia of the Clinton Administration's budget policies, the latest FT defense reflects Summers's fundamental lack of understanding of modern money. Contrary to his view, the late 90s surpluses was not the reason for that period's prosperity. The surpluses are what ended the prosperity. And until the public understands this, we should expect no fundamental improvement in economic policymaking from the Obama Administration.

Let's go to the article concerned itself.  To begin with, Summers first takes issues with critics, who "have complained that the continued commitment by the administration of President Barack Obama to support recovery in the short term and also to reduce deficits in the medium and long term constitutes a 'mixed message'". In fact, he goes on to argue:  "The only sensible course in an economy facing the twin challenges of an immediate shortage of demand and a fiscal path in need of correction to become sustainable."

In this instance, Summers reflects the usual deficit dove position that budget deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the debt ratio in line with the ratio of the real interest rate to output growth. In so doing, he violates one of Abba Lerner's key laws of functional finance:  a government's spending and borrowing should be conducted "with an eye only to the results of these actions on the economy, and not to any established traditional doctrine about what is sound and what is unsound." In other words, Lerner believed that the very idea of what good fiscal policy means boils down to what results you can get  -- not some arbitrary notion of "fiscal sustainability".

Deficit cutting, whether now or in the future, is not a legitimate goal of public policy for a sovereign nation. Deficits are (mostly) endogenously determined by the performance of the economy. They add to private sector income and to net financial wealth and, in any case, decisions by the non-government sector to increase its saving will reduce aggregate demand and the multiplier effects will reduce GDP. If nothing else happens to offset that development, then the automatic stabilizers will increase the budget deficit (or reduce the budget surplus).  This is the kind of insight that Summers should be sharing with the readers of the FT if he were to demonstrate the economic leadership we need.

Then we get this misguided statement:

"A range of other considerations - including the crowding out of investment; reliance on foreign creditors; misallocation of resources into inefficient public projects; and reduced confidence in long-run profitability of investments - all make a case in normal times for fiscal prudence and reduced budget deficits.

And there are numerous examples, notably the US in the 1990s, where reducing budget deficits contributed to enhanced economic performance."

Where to begin?  The "crowding out" thesis was discredited by Keynes over 70 years ago!  The basis of the "crowding out" claim is that such government spending causes interest rates to rise, and investment to fall.  In other words, too much government borrowing "crowds out" private investment. Because investment is important for long-run economic growth, government budget deficits reduce the economy's growth rate.

Summers's argument reflects a complete misunderstanding of government spending. Increases in the federal deficit tend to decrease, rather than increase, interest rates. In reality, fiscal policy actions are those which alter the non-government sector's holdings of net financial assets. This is because deficit spending leads to a net injection of reserves into the banking system. (And big deficits imply big injections of reserves.) When the banking system is flush with reserves, the price of those reserves -- in the U.S. the federal funds rate -- is driven to zero in the absence of countervailing measures (such as bond sales). Unless a zero-bid is consistent with Fed policy, the central bank will begin selling bonds in order to drain excess reserves. The bond sales continue until the fed funds rate falls within the Fed's target band.

It is also questionable whether budget deficits do, as Summers suggests, reduce confidence in long run profitability in all investments.   In fact, the historical record suggests that given spare capacity, public expenditures are not only productive but also foster additional activity in the private sector.  In a study of a century of UK macroeconomic statistics, Professor Vicky Chick and Ann Pettifor provide very compelling evidence illustrating that active fiscal policy promoted economic growth and helped to REDUCE the UK's public debt to GDP ratio.  By contrast, periods during which the single-minded focus on debt and deficit reduction became the main focus on policy, economic growth slowed and the UK's debt to GDP ratio rose.

This study validates one of Keynes's central conclusions: "For the proposition that supply creates its own demand, I shall substitute the proposition that expenditure creates its own income" (Collected Writings, Volume XXIX, p. 81). Summers ought to read the study before he perpetuates myths to the contrary which continue to be used by unscrupulous people, to support cuts in Social Security and Medicare that can neither be justified by economic logic, nor empirical evidence.

Nor do we rely on foreign creditors, notably China, to "fund" our spending, another horrible, but eminently predictable canard trotted out by Summers.  The folklore he is trying to etch firmly into the public debate is that when China finally sells of its US bond holdings, those yields will sky-rocket, no-one else will want the debt and it will be the end America as we know it.  But Summers has the causation all wrong: government spending comes first and debt (in the form of bond sales) only comes afterward.  Bonds are issued as an interest-maintenance strategy by the central bank.  Their issuance has no correspondence with any need to fund government spending.  The denomination of the debt, NOT the denomination of the debt holder, is the key consideration. China can only do what the Americans and everyone else it trades with allow them to do. They cannot sell a penny's worth of output in USD and therefore accumulate the USD which they then use to buy US treasury bonds if the US citizens didn't buy their stuff.

As Bill Mitchell has argued repeatedly, Americans buy imported goods made in China instead of locally-made goods because they perceive it is their best interests to do so. By the same token, America's current account deficit "finances" the desire of China to accumulate net financial claims denominated in US dollars. The standard conception is exactly the opposite - that the foreigners finance the local economy's profligate spending patterns. Unfortunately, people like Summers apparently believe the latter, and they allow Beijing to play us for fools.

Good for China. They are playing a weak hand very skillfully. We, by contrast, are being played for patsies. The Federal Reserve sets the key interest rate in the U.S., and it can always hit any nominal interest rate it chooses, regardless of the size of the budget deficit (or debt). And this isn't just true of the Fed, but of any central bank which issues its own free floating, non-convertible currency.

Of course, an article from Larry Summers wouldn't be complete if he didn't repeat the usual claims of virtually all the Clintonistas - namely, that reducing budget deficits and running 4 consecutive years of budget surpluses contributed to enhanced economic performance.

No, it didn't. The government budget surplus meant by identity that the private sector was running a deficit. Households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. Growth was a product of a private debt bubble, which in turn fuelled a stock market and real estate bubble, the collapse of which has created the foundations for today's troubles. This destructive fiscal policy eventually caused a recession because the private sector became too indebted and thus cut back spending. In fact, the economy went into recession within half a year after Clinton left office.

No criticism of the government deficit is ever complete without the usual invocation of concerns for our grandchildren and the omnipresent threat of "intergenerational theft", and here again, Summers does not disappoint:  "Fiscal responsibility is not only about our children and grandchildren. Excessive budget deficits, left unattended, risk weakening our markets and sapping our economic vitality." As we have argued before, forget about future public debt service becoming a yoke around the neck of future generations.  A person plunged into long-term unemployment in the US faces a high chance of becoming poor (relatively in this sense) and losing a significant proportion of the assets they had built up while working (housing etc), largely as a consequence of the types of myths championed here by Summers. Their children also inherit the disadvantage that they grew up with and face major difficulties in later life  because the retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die.  But the youth want jobs and the prospects of a life worth living, which they won't get if we cut expenditures today on things like education and proper job training.

Fiscal hawks and deficit doves alike are strangling the baby in the crib today by denying a sensible fiscal response for the current generation's plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow. That, in a nutshell, is what is truly sapping our long term economic vitality. The only way to avoid this ongoing plight is to champion a return to full employment policies, and stop being enslaved by the economic shibboleths which people like Larry Summers and his ilk continue to champion recklessly.

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

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The Trouble with Tim's Treasury

Jul 19, 2010Marshall Auerback

thumbs-down-150FinReg may fall short if power is channeled into Geithner's hands.

thumbs-down-150FinReg may fall short if power is channeled into Geithner's hands.

More depressing news from the "change" President.  The Washington Post has reported that one of the major impacts of the FinReg bill passed last week by Congress is the accretion of new power to Obama's Treasury Secretary.  According to the Post, Tim Geithner stands to inherit vast power to shape bank regulations, oversee financial markets and create a consumer protection agency.

Make no mistake:  this is Timmy's bill, plain and simple, as the Post makes clear: "The bill not only hews closely to the initial draft he released last summer but also anoints him -- as long as he remains Treasury secretary -- as the chief of a new council of senior regulators."

The Geithner Treasury repeatedly pushed back against many sensible legislative proposals that would have made significant structural changes to practices that brought about the current economic crisis. And the article itself represents latest in a series of attempts to embellish the Treasury Secretary's hagiography.

Reading it, one wonders whether the Washington Post inhabits a strange parallel universe.  Have the writers actually paid attention to what is truly happening in the economy? The WaPo persists in towing the party line that Geithner's tenure has been marked with conspicuous success, supposedly by advocating a response to the financial crisis that allegedly later proved correct: "Geithner vigorously resisted calls by some lawmakers and financial experts to nationalize the nation's largest and most troubled banks during the most perilous days. Instead, he helped get the financial system back on its feet, in particular by pressing for stress tests of big banks." (my emphasis)

Oh, really?  I would argue that Washington continues to allow the big banks to operate "business as usual" and to cook the books to show profits so that they can pay out big bonuses to the geniuses who created the toxic waste that brought on the crisis. Most continue to show profits based not on fundamentally health lending activity, but one-off gains, and accounting gimmickry.  Commenting on the latest JP Morgan results, my friend and colleague Randy Wray has noted:

JP Morgan's results were horrendous: it lost deposits, it made fewer loans, and even its fees fell by 68%. So how could a bank manage to profit on such dismal results? Well in the old days it was called window dressing-banks would move one little chunk of gold among themselves to show that they were credit worthy. In Morgan's case, the profits supposedly came from 'trading"' In reality they mostly came from reducing 'loan loss reserves'. In other words, Morgan decided it had set aside too many reserves against all the bad loans it made over the past decade. After all, borrowers will almost certainly start to make payments on all their debt over the next few months and years, won't they? Sure, homeowners are massively underwater, and losing their jobs, and cutting back spending, but recovery is just around the corner.

Sure it is.  Other than the Big 5, it's hard to make a case that we have a vigorous and healthy banking sector today. The Big 5 continues to benefit from a massive financial subsidy courtesy of the Fed and an unfair playing field in which they are perceived to be "too big to fail." This, in turn, creates huge competitive disadvantages for the smaller banks seeking to attract deposits. Small banks, in particular, are being crushed by a substantially higher cost of funding than the big banks. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate that large 'too big to fail' banks are paying for their funding. And remember, the small banks for the most part were not the institutions at the forefront of great financial innovations such as credit default swaps and collateralised loan obligations.

The Post, like virtually every other mainstream publication, continues to perpetuate the fiction that the stress tests performed on the banks were real.  But as Yves Smith has noted repeatedly: "Just look at the numbers. 200 examiners for 19 banks? When Citi nearly went under in the early 1990s, it took 160 examiners to go over its US commercial real estate portfolio (and even then then the bodies were deployed against dodgy deals in Texas and the Southwest). This is a garbage in, garbage out exercise. The banks used their own risk models to make the assessment, for instance, the very same risk models that caused this mess. And there was no examination of the underlying loan files."

Given his hapless performance at Treasury, one can begin to understand why Timmy was so loath to have government take over the banks via an FDIC style restructuring.   It's a projection of his own incompetence and timidity.  Rather than ask what needed to be done to be sure of a solution, Geithner asked instead, what was the best Treasury could do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress?

Why did a new administration, confronting a huge crisis, not try to change the terms of debate?  Contrast the behavior of the Geithner today with the actions undertaken by the Roosevelt Administration. During the period in which the banking system was being restructured under Jesse Jones, Chairman of the Reconstruction Finance Corporation, the RFC required letters of resignation from the top three bankers of any institution receiving aid. These were not always accepted, but their mere existence was a potent deterrent to repeat behavior.

How many managers have been replaced during the current crisis? How many are being charged for fraudulent behavior?  Elizabeth Warren has at least made attempts at some sort of public accounting. As a result, her future job security is being compromised, despite the fact that Warren is the obvious choice to take over the newly formed Consumer Protection Agency.

By contrast, the Geithner Treasury has persistently frustrated every attempt to gain better understanding of the causes of the financial crisis via endless court challenges, obfuscation, lies and delaying tactics.  Additionally, Treasury has consistently opposed any serious attempts to engender structural changes in the banking system as the Financial Regulation bill worked its way through Congress.  Because Elizabeth Warren has refused to play ball with this insidious bankers' club, she's deemed not to be a "team player" by Geithner.

They extol his calls for great capital, but don't seem to have noticed the blatant failure of the Geithner strategy to "just raise capital requirements" as the way to deal with distorted incentives and the tendency of banks to take irresponsible risks has been comprehensively blown off by the financial sector.   Treasury insisted on "capital first and foremost" throughout the Senate debate this year - combined with their argument that these requirements must be set by regulators through international negotiation, i.e., not by legislation.  But the big banks are chipping away at this entire philosophy daily through their effective lobbying within the opaque Basel process - as one would expect.  Take a look at the article below from the Wall Street Journal:

Banks Gain in Rules Debate

Regulators Seen Diluting Strictest New 'Basel' Curbs; Fear of a Credit Crunch

By DAMIAN PALETTA and DAVID ENRICH

The world's banks appear to be winning a reprieve from tough new capital requirements and curbs on risk-taking, as regulators and central bankers are moving toward less stringent rules than initially proposed.

Bowing in part to fears that tougher requirements would diminish the credit needed to revive a sluggish global economy, officials gathered in Basel, Switzerland, are trying to strike a compromise over a set of new international banking standards initially proposed in December. The final accord will have a more global reach, and thus in some respects a more potent impact, on banks and borrowers than the financial regulatory bill likely to pass the U.S. Congress Thursday.

The new Basel rules, as they are called, would still be stiffer than existing standards. Industry officials fear the changes could shrink bank profit margins and make credit tighter and more costly for consumers and businesses. Alterations under discussion this week would ease key requirements that have been under discussion for months. Advocates for a tougher line have argued that excessive concessions could leave the financial system vulnerable to problems the entire process is intended to address.

Check out the rest of the article here.

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

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Fed Up with FinReg: Rooseveltians React

Jul 15, 2010

With financial reform on its way to the President's desk, the Roosevelt Institute's fellows and colleagues weigh in on the bill's weaknesses and the way forward.

Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance; Executive Director, INET:

With financial reform on its way to the President's desk, the Roosevelt Institute's fellows and colleagues weigh in on the bill's weaknesses and the way forward.

Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance; Executive Director, INET:

Scott Brown made them go back to the woodshed, and that made them look worse once again, but other than that, the bill is the same industry-crafted/not-up-to-the-task/so-called "accomplishment" that leaves 4 out of 5 Americans in the Bloomberg survey yesterday suggesting that they wouldn’t feel protected from a future financial crash.  They missed on Too Big to Fail, on Derivatives they got about 20 percent of the way there. Gary Gensler was a positive dimension of this process at the CFTC.  His work and the introduction of Elizabeth Warren's consumer financial protection agenda merit applause,  and that for Elizabeth herself, and not so much for the political process locating the Consumer Financial Protection Bureau in the Central Bank which, by tradition, will subordinate those concerns.  On to mortgage modification, GSE reform, reform of high frequency trading and usury limits.   This bill is forbearance.  Pressure for real reform must be sustained.  That may be the only way to deter Too Big to Fail management from being reckless again soon.  They cannot afford to unmask how weak this legislation is with another crash in the short term.

Elizabeth Warren, Harvard Law School Professor and current chair of the Congressional Oversight Panel to oversee banking bailouts:

President Obama's leadership on Wall Street reform over the past year has paid off, and soon he will have the opportunity to sign the toughest set of financial reforms in three generations.  For the first time, families will have a tough, independent cop in Washington to help clear out the tricks and traps hidden in consumer credit agreements.

Michael Greenberger, Founder and Director of the Center for Health and Homeland Security and professor at the University of Maryland School of Law, who participated in the Roosevelt Institute's Make Markets Be Markets conference:

In last Sunday's New York Times, Paul Volcker, with a tinge of unhappiness and regret, graded the Dodd-Frank financial reform bill as a B-. With an equal amount of regret, I agree. But, I am not unhappy. I consider the B- a mid term grade. I say this, because the bill places so much emphasis on effective implementation. To be sure, legislative directives are now in place to guide the regulators to a path of effective enforcement. For example, for purposes of regulating the completely opaque and highly risky derivatives market -- whose synthetic collateralized debt obligations and naked credit default swaps turned our economy into a unpoliced and poorly capitalized multi-trillion dollar casino-- Dodd-Frank sets the contours that have the potential of converting that entire market into a fully transparent and fully capitalized environment. But, dozens of rulemakings, studies and reports stand in the way.

If properly regulated, the very kind of risky trillion dollar bets that brought down the economy can be collared, reduced and, if necessary banned. If that happens, the derivatives title would get a final grade of A. If, however, in the subterranean agency processes through which implementation will be birthed, well funded Wall Street advocacy predominates, and the progressive institutions -- the unions, consumer and environmental groups, and small businesses -- are checked by a lack of resources, the B- could turn into an F. In short, the fight to stabilize the economy through banning the poorly capitalized casino trillion dollar bets depends completely on regulatory follow-through. Dodd-Frank gives reformers the weapons. The question is do progressives have the staying power and resources to make a success of this legislative effort.

Thomas Ferguson, Roosevelt Institute Senior Fellow and professor at the University of Massachusetts, Boston:

The bill makes some marginal changes, but it does not attack the fundamental problems that got us into the disaster of 2008. It just ducks the too-big-to-fail problem. The large banks will continue to dominate the derivatives business, as only portions of that move to clearinghouses or exchanges. In fact, the legislation is going to lock in the positions of the largest banks. At the start of the crisis, the four largest had about 40 percent of all deposits; now they hold something like 56 percent. That will probably only increase, with all that implies for consumer choice. The legislation creates a new council of the regulators, who are precisely the people who failed in the years before 2008. There is a consumer product safety agency that's to be established, but it's in the Federal Reserve, which simply hates consumer product safety. And the auto dealers got exempted from regulation.

It's easy to understand why Sen. Russ Feingold said he just could not vote for this bill -- but you may get a worse bill under another Congress. The very same Congress that's pushed this bill through at a snail's pace also created the Angelides Commission, which is supposed to inquire into what happened and why. This, of course, is not going to report until after the November elections. And so right from the beginning you knew the folks who were pushing this bill were not serious. I mean, that is to say, if they learned anything from the Commission, they weren't planning to use it in the bill. But they were planning to take in record amounts of campaign contributions and allow lobbyists to go wild offering them the sun, the moon, and the stars.

Mike Konczal, Roosevelt Institute Fellow:

The plan of counting on moderate Republicans instead of progressive Democrats like Cantwell and Feingold gave people like Scott Brown the chance to make crony-style changes to the bill that cheat the general public and help the biggest players. People with generic checking accounts will pay more to protect the largest hedge funds and investment banks. Is that what we want?

Wallace Turbeville, ND20 contributor and former Goldman Sachs VP:

Passing financial regulation is good politics and consumers will benefit from some protection. But the twin evils of incentivized risk taking and "too big to fail" survived. Congress did not swing and miss, but it managed only two foul balls. Perhaps we should have waited until Treasury and the Fed were past being petrified of the weakened financial system.

On bank abuse of market power, Congress did not swing and miss; the bat never left its shoulder.

During implementation, vigilance must be maintained. The banks will work overtime. They don't see the justification for change.

Henry Liu, ND20 contributor:

Much focus has been placed on financial regulation as a way to prevent future financial market failures. It is true that the financial market meltdown that began in the summer of 2007 was the result of excessive debt, opaque debt securitization, over-leverage, underpricing of risk, banks acting as proprietary traders, credit default swaps insurance not backed by sufficient capital, etc. But the root cause is insufficient worker income to absorb rising worker productivity to generate a global overcapacity. The FinReg bill missed the target by not addressing the problem of cross-border wage arbitrage by U.S. transnational corporations.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Heather McGhee on FinReg Passage

Jul 15, 2010

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

"The meltdown of 2008 was a costly example of what happens when we dismantle the public structures that are the foundation of America's prosperity. Today we begin to rebuild those structures, and in so doing, start rebuilding the American middle class. With this vote, the Congress has begun writing financial rules of the road that will once again benefit Main Street, not just Wall Street. After the new consumer regulator opens its doors, Americans will open a checking account or apply for a loan with greater security because their lender will be accountable to basic standards of fairness and transparency. Investors will know that their broker-dealers are acting in their interest. Businesses hedging risk will know the real price of the derivatives contracts they buy. And if we have truly independent regulators with the will to stop reckless speculation, those regulators will have the power and tools to do so.

The Wall Street Reform and Consumer Protection Act's consumer reforms, investor protections and new Wall Street rules are necessary for a strong economic recovery. Although the Act falls short of transforming the financial sector in the way that the Glass-Steagall Act did after the last great banking crisis, it represents a victory of the public interest over the status quo in virtually every provision and rule. Demos applauds the tireless efforts of experts and advocates in Washington and across the country who have worked together to create this historic set of reforms."

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FinReg Achilles' Heel: Not Too-Big-To-Fail, But Too-Connected-To-Fail

Jul 14, 2010Henry Liu

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

There is an invisible, but solidly anchored assumption in all structured finance and derivative trading models -- namely, that a systemic collapse would trigger a government bailout. Since each and every derivative trading model derives protection by externalizing risk to the trading system, systemic risk expands automatically (making systemic meltdown inevitable). Institutions, then, have an incentive to be considered of "systemic significance" in order to secure a fail-safe advantage in interconnected transactions, even though by themselves they are not "too-big-to-fail". These trading models are operative when they are marked-to-model, but inoperative when they are marked-to-market in a downturn. This is the point when these models' fail-safe strategy by government bailout is activated.

Even a government like Hong Kong, which assumes a radical laissez faire posture, has had to intervene directly in the equity market because of the connections between a fixed exchange rate and unregulated financial markets that allow manipulators to attack its equity markets by rigging the automatic effect of exchange rates on interest rates to create deflationary pressure on stock prices.

As you will see, focusing on "too-big-to-fail" alone leave windows of vulnerability for "too-connected-to-fail" hazards.

Hong Kong Monetary Authority Fought Off Hedge Fund Attacks in 1997

In October 1997, three months after China recovered Hong Kong following a century and a half as a British colony, the HK$, which had been pegged to the US$, came under powerful, repeated, speculative and manipulative attacks due to the contagion effects of the Asian financial crisis. The automatic monetary adjustment forced interbank interest rates in Hong Kong to shoot up to unprecedented levels (up to an astronomical 300% at one point), reflecting substantial risk premiums on the HK dollar. This generated severe deflationary consequences for the financial and property markets, as well as the entire economy.

The interventionist role the Hong Kong Monetary Authority (HKMA) played in handling violent market turbulence was controversial by the standard of its own free market ideology. HKMA later admitted that as Hong Kong's link mechanism was on "autopilot" during the attacks, the interest rate adjustments were part and parcel of the working of a currency board regime, and therefore generating an inevitable and painful financial crisis. The fact that such financial and economic pain was avoidable by de-pegging was not officially acknowledged as an option.

Hong Kong was the target of speculative and manipulative attacks four separate and sequential times during the Asian financial crisis of 1997. The first three attacks took the form of garden variety currency dumping, whereas the fourth attack targeted the structural vulnerability of the Hong Kong's currency board regime after speculators were convinced that HKMA would defend the peg at all cost. And speculators were waiting to be the happy recipients of guaranteed profit from HKMA's fixation on the peg.

The first attack took place in October 1997, as a result of contagion from the regional financial turbulence that began in Thailand in July 1997. Currency speculators took large naked short positions against the HK dollar, with the expectation of profiting from the breakdown of the Hong Kong linked exchange rate regime. However, interbank interest rates soared in response, forcing speculators to unwind their naked short position as the high cost of borrowing made leveraged naked short trades unprofitable.

Although the automatic defense mechanism inherent in the currency board regime prevented the breakdown of the currency peg, the penalty took the form of unsustainably high interest rates. For example, the overnight interbank interest rate on October 23, 1997 reached as high as 500%. This local interest rate volatility echoed the external market volatility, created psychological shocks to market participants that forced the market to put a risk premium on Hong Kong dollars. Consequently, local banks increased their precautionary demand for liquidity, resulting in continuing high level of interest rates for the HK market. A liquidity crisis developed, further exacerbating already abnormally high interest rates.

This high interest rate anomaly incurred huge adjustment costs in the Hong Kong economy, particularly in the finance, business and property sectors. Labor costs, even though they accounted for only about one-third of the operating expenses of an average corporation in Hong Kong, as compared to the US average of two-thirds, had to be reduced by management through lay-offs and cuts in real wages and benefits in the early 1998. Asset prices such as land, real property and company shares, together with rental and dividend income, also plummeted sharply and swiftly.

The high cost of defending the currency peg system manifested itself in severe price deflation. It triggered further speculative and manipulative attacks in January and June, 1998, each time draining substantial wealth from Hong Kong companies and residents into offshore hedge fund accounts. The monetary defense mechanism successfully maintained the currency peg in the market at the cost of generating sharp, across-the-board price deflation in the economy.

The Hong Kong dollar continued to trade at the pegged exchange rate to the US dollar, but the same US dollar was buying more assets in Hong Kong than before the crisis. The currency board regime merely deflected currency devaluation toward asset deflation. The exchange value of the HK dollar remained fixed to the US dollar, but Hong Kong asset prices and wages fell. It would be less painful to the local economy if asset prices and wages remained unchanged while the HK dollar was devalued against the US dollar.

The HKMA was able to defend the fixed exchange rate of its currency because it had large foreign reserves, but it did so by allowing wealth to be drained from the Hong Kong economy through asset deflation, weakening its market fundamentals. The net economic outcome was negative on balance. The monetary operation was successful, but the economic patient was left near dead.

In August 1998, the fourth and near-fatal attack took place, targeting at the automatic adjustment mechanism of the Hong Kong currency board regime. This took the form of simultaneous attacks on money and equity markets, known in hedge fund tactics as a "double play".

In a double play, before launching attacks, manipulative traders would pre-fund their attacks with highly leveraged positions with HK dollars in the debt market, engaging in big swaps to access large sums in HK dollars that multilateral entities had raised through their bond issuance. Speculative and manipulative traders then spread rumors about imminent Chinese yuan devaluation and a pending collapse of the Hong Kong equity and property markets. At the same time, they made large naked short positions in the stock futures index market. Then, they induced an interest rate hike by dumping their pre-funded HK dollars in the spot and forward market to force the HKMA to buy HK dollar with US dollars from its reserves. All these actions induced the Hang Seng index to plummet sharply and abruptly, from 16802 in June 1997 to 6708 in August 1998. Within three days beginning October 20, 1997, the Hang Seng index dropped 23%.

As the Hong Kong stock market started to plunge, other speculators saw opportunities for profit through massive naked shorting. The Hong Kong financial markets fell into chaos, as further naked short selling created panic selling of shares in free fall.

The Damage by Naked-Short Attacks

The current ban against naked short selling by Germany during the 2010 EU sovereign debt crisis is driven by more than mere phantom fears. The German defensive measure has the 1992 experience of the British pound and the 1998 experience of Hong Kong dollar with naked short selling as cautionary guides.

During the Asian financial crisis of 1997, speculators and manipulators exploited the automatic interest rate adjustment mechanism of the currency board regime, turning speculation into manipulation for certain profit. Hedge funds took naked short positions simultaneously in the Hong Kong stock and futures markets. Simultaneously, they sold yet-to-be-borrowed Hong Kong dollars against the US dollar. Under the currency board regime, the HKMA must stand ready to buy back HK dollars released into the market to maintain the peg.

This was the structural dilemma inherent with the currency board regime. On the one hand, continuing buybacks of HK dollars by the HKMA automatically shrank the Hong Kong monetary base and drove HK dollar short-term interest rate up sharply. On the other hand, the overnight interest rate having risen sharply to 500% at one point in October 1997, triggered precipitous drops in stock and stock futures prices and produced hefty profits for short-sellers. After every attack, market confidence plummeted further by the hour, creating an imbalance of sellers over buyers to push share prices further down.

The HKMA feared Hong Kong's economy could very well bleed to death if the downward vicious cycle was permitted to continue. If the economy should die from hemorrhage of wealth, no further purpose would be served by preserving the currency board. And if the downward asset price spiral was allowed to continue, the currency board would eventually also collapse after the large foreign reserves was exhausted, because wealth was draining from Hong Kong with no stop loss limits.

It soon became clear that the option was not even to choose between letting the economy collapse and letting the currency board regime collapse. The two are linked so that as one sinks, the other would be dragged down with it. The economy must be saved along with the fixed exchange rate. Yet few acceptable options were available to reverse the trend of depleting foreign currency reserves while bleeding the equity market dry. Among all the unpalatable options available, only two stood out with some uncertain promise: 1) outright capital control and 2) direct market intervention. Both were not cost-free silver bullets.

Malaysia's Capital Control Not Operative for Hong Kong

While earlier in the 1997 Asian financial crisis, Malaysia had adopted capital control with positive results, Hong Kong would not benefit from similar measures because, unlike Malaysia, the Hong Kong economy was primarily an outward-oriented trading economy with no sizable domestic market of its own. Hong Kong therefore chose direct market intervention with its huge foreign reserves. When manipulative and speculative attacks intensified again in August 1998, the HKMA intervened with its reserves of US dollars simultaneously in the money, stock and futures markets, in addition to buying back Hong Kong dollars in the foreign exchange market.

During the last two weeks of August, 1998, the HKMA imposed temporary penalty charges on targeted lenders that served as settlement banks for the manipulators and speculators to make speculative funds more expensive while HKMA itself bought US$15 billion worth of Hang Seng Index constituent stocks (8% of the index's capitalization). In addition, it took naked long positions that pushed the stock futures 20% higher to squeeze the naked short sellers. After the massive market intervention by the HKMA, the exchange rate of the HK dollar quickly stabilized, and currency futures and short-term interest rates returned to sustainable levels. Manipulator and speculators were left licking their wounds but not until substantial damage had been done to the Hong Kong economy. To soften anticipated neo-liberal criticism, the HKMA labeled its market intervention as "market incursion".

Still, for this unprecedented "market incursion", the HKMA received harsh criticism for deviating from its long-standing "positive nonintervention" policy. In defense, the HKMA argued that the "incursion" was justified by Hong Kong's strong economic fundamentals as well as the severity of the regional financial turmoil. The HKMA contended that without forceful incursion to foil market manipulation, not only would the currency board have collapsed but there would also have been serious regional and global ripple effects. It was a "too-big-to-fail" argument that was summarily dismissed by US neo-liberals who quietly did the same on a much larger scale in 2008.

The 1998 market incursion was a deviation from Hong Kong's economic policy of "Positive Non-Interventionism" adopted under British imperialism after WWII to appease US free market ideology. The policy was first officially implemented in 1971 by John James Cowperthwaite, a Scottish civil servant in the British Colonial Office who worked to remove all colonial government interventionist preference toward trade with Britain in order to facilitate more trade with the US, the world's biggest market with seemingly inexhaustible purchasing power.

Friedman Condemned Hong Kong for Market Intervention

Milton Friedman's opinion in the October 6, 2006 Wall Street Journal, less than a year before the global credit crisis that imploded in New York in July 2007, criticizing Hong Kong for abandoning Positive Non-Interventionism, praising instead Cowpertheaits as having been "so famously "laissez-faire" [in ideology] that he refused to collect economic statistics for fear this would only give government officials an excuse for more meddling." This is an amazing praise from Friedman who was known for his 1953 propositions for a "positivist" methodology in economics which stresses the important of economic data.

Hong Kong's Sin Repeated by the US

Notwithstanding their stern criticism of the HKMA in 1998, the Federal Reserve and the US Treasury also engaged in direct market intervention in US markets a decade later in 2008. This was done under the rationalization of saving "systemically significant" private institutions that were deemed "too big to fail". At least the HKMA bought all the listed shares in the Hang Seng index, rather than toxic assets from only selected distressed firms as the Fed and Treasury did, which was decidedly less evenhanded or market neutral.

Click here to read the full article.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Tom Ferguson on FinReg Bill: "Not Worth the Hype"

Jul 13, 2010

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."


Tom says that the bill does almost nothing to address the problem of too-big-to-fail and invests more power in the same regulators who failed to prevent the last crisis. Despite some changes to derivatives, "in the end they let the big banks keep about, probably, 80 percent of the derivatives business they've got." Because of this, Tom predicts that "you are very likely sometime—maybe in the not too distant future if things don't go well in Europe—to see yet another big bank brought down by some stupid business deal."

Tom counts the one-time audit of the Federal Reserve and the creation of the Consumer Financial Protection Bureau as two of the bill's modest victories. However, he believes it is a mistake to house the consumer agency in the Federal Reserve, which already has the power to create and enforce consumer regulations and has instead "sat back for years and let banks rip everybody off."

As for whether the bill is worth passing in its current form, Tom says that "you'd probably better take this one, because you'll probably get a worse bill next time," but he's sympathetic to those who want to start over. Ultimately, he views the bill as a victory for Wall Street lobbyists and a prime example of how corporate money can undermine and corrupt the legislative process. He says the banks "know they just dodged a silver bullet" and will wind up paying and changing far less than they should have. "In the end, we have a tale full of sound and fury, signifying nothing."

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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ND20 Interview: Elizabeth Warren Says Big Banks Must Stop Blocking Reform

Jul 13, 2010Lynn Parramore

elizabeth-warren-150Senate Dems are making the final push on financial reform this week, but will big banks really change the way they do business?

elizabeth-warren-150Senate Dems are making the final push on financial reform this week, but will big banks really change the way they do business? Or will we still be pawns in a game rigged in their favor?  I caught up with Elizabeth Warren to talk about the need to reform Wall Street culture, the pernicious influence of bank lobbies, and the debt-fueled threat to America's middle class. **Warren will discuss these issues and more at this weekend's Hamptons Institute symposium, sponsored by Guild Hall in collaboration with the Roosevelt Institute (details below).

LP: Has the financial crisis changed the culture of Wall Street?

EW: I would have expected the financial crisis to sweep through Wall Street like a hundred-year flood -- wiping out old business practices and changing the ecology profoundly. So far, the financial services industry has seemed to treat the crisis like a little rainfall -- inconvenient, but no significant changes needed. The real question moving forward is how the industry will respond to Wall Street reform and growing public anger. Will it react to all the new cops on the beat just by hiring more lobbyists? Will it continue to spend $1.4 million a day to beat back anything that could mean more accountability and oversight? Or will the financial services industry finally begin to rethink its business models, lobbying approach, and attitude toward the public?

LP: Have unregulated financial products slowed our economic recovery?

Let me put it differently: meaningful rules in the consumer credit market can accelerate economic recovery, I really believe that. Rules would increase consumer confidence and, more importantly, weed out all the tricks and traps that sap families of billions of dollars annually. Today, the big banks churn out page after page of incomprehensible fine print to obscure the cost and risks of checking accounts, credit cards, mortgages and other financial products. The result is that consumers can't make direct product comparisons, markets aren't competitive, and costs are higher. If the playing field is leveled and the broken market fixed, a lot more money will stay in the pockets of millions of hard-working families. That's real stimulus -- money to families, without increasing our national debt.

LP: Why is marketplace safety so much harder for people to accept than safety in other realms?

EW: Think about it: cars, toys, aspirin, meat, toasters, water -- nearly every product sold today has passed basic safety regulations well in advance of being marketed and sold. But consumer credit is a kind of buyer-beware, wild west. That is partly the result of history. Usury laws that existed since Biblical times, through the colonial period and into the 1980s, provided basic consumer protection. Once those laws were quietly undercut, the industry moved to a tricks-and-traps business model. The big banks would promise something for free, like credit cards or checking accounts, or for very low cost, like teaser-rate mortgages, then make their money on the back-end with fees and interest rate escalation. Most people don't know they have been fooled until it is too late. Last year, for example, families paid a total of $24 billion on overdraft -- mostly on "free" checking accounts. People can see exploding toasters, and the newspapers run plenty of headlines about lead in children's toys. But smaller hits, day after day hitting millions of people, don't catch the same kind of attention -- even though fixing those hits will help make people much more secure over time.

LP: What are the consequences of distrust in the marketplace? How does it affect our social fabric?

EW: For three decades, the once-solid, once-secure middle class has been pulled at, hacked at, and chipped at until its very foundations have started to tremble. Families have done their best to adjust -- sending both mom and dad into the workplace, cutting back flexible spending on food, clothing and appliances, and spending down their savings. When they learn that they have been tricked -- a $39 fee that they shouldn't have to pay or an escalating mortgage that will cost them their home -- they start to wonder who wrote the rules that allow that to happen. Distrust spreads everywhere -- to industry, to politics, to the institutions that were supposed to make us a stronger country. The costs imposed by a banking industry that makes its money tricking people go far beyond dollars.

LP: Have lenders and creditors preyed on our human weaknesses? Do they drive us to be profligate and irresponsible?

EW: Personal responsibility matters. There are no excuses for those who spend money on things they cannot afford. But it's a whole lot harder to act responsibly when consumer credit contracts are designed to be incomprehensible, when prices are obscure and risks are hidden. I would like to see a world where families can read their credit terms and easily shop for better deals. When we get to that world, it will be a lot fairer for families to be held to every last clause they agree to.

LP: How can consumer trust be restored?

EW: First, big banks can stop pouring so many resources into blocking meaningful reform. Families have made it clear that they are sick and tired of all the lobbying and that they think enough is enough. From the beginning, I think the Wall Street banks underestimated the furor they would provoke by acting like nothing changed and continuing to lobby just like they did before the bailouts. I also think they underestimated the good faith and trust they could have built by cutting back. Second, we need two-page credit card, mortgage, and overdraft contracts. Until the deals are clear up front, until the fine print is gone and the banks price products so people can see the true costs and risks, consumers won't trust any lender claims. And I don't blame them.

LP: What is the most important thing ordinary people can do to protect themselves from abusive financial practices?

EW: Get out of debt. In a world of stagnant incomes and rising core expenses like mortgage and health care costs, that's a lot easier said than done. The middle class is under enormous pressure. But families can stop the bleeding by reducing their reliance on debt wherever they can. They can also start fighting back by taking a hard look at whom they do business with and rethinking whether they want tricks-and-traps banks to hold their money. They can also demand that public officials take the side of families over the side of banks.

ND20 ALERT: Join Elizabeth Warren in NY July 16-18 at a special event sponsored by Guild Hall, in collaboration with the Roosevelt Institute. Thought leaders in the arts, the economy, and the media will gather in East Hampton for a can’t-miss symposium featuring Warren, George Soros, Van Jones, plus ND20 contributors Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

Harvard Law School Professor Elizabeth Warren is currently chair of the Congressional Oversight Panel created to oversee the banking bailouts and first proposed a new federal agency for consumer financial products in 2007.

Lynn Parramore is Editor of New Deal 2.0, Fellow at the Roosevelt Institute, and author of Reading the Sphinx.

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ND20 Alert: Mike Konczal to speak on New America Panel

Jul 12, 2010

alert-button-150Roosevelt Institute Fellow Mike Konczal will be appearing on a panel at New America tomorrow called Dodd-Frank: How Will Financial Services be Transformed from Main Street to Wall Street.

alert-button-150Roosevelt Institute Fellow Mike Konczal will be appearing on a panel at New America tomorrow called Dodd-Frank: How Will Financial Services be Transformed from Main Street to Wall Street. The panel promises to tackle key questions such as: Will FinReg end “too big to fail”? Will it stifle or stimulate innovation? How will it alter the financial services landscape from Wall Street to Main Street?

The panel is at the New America Foundation in Washington, DC and will take place Tuesday, July 13, 2010 (tomorrow) from 10:00am - 11:30am. Hope to see you there!

Meanwhile, read up on some of Mike's recent ND20 posts:

Getting the Best of Both Bills: A Conference Committee Report

Treasury versus Progressives on the Financial Reform Bill

Underwater Mortgages and the Odd Definition of the Experian Study

The Case for Regulating Interchange and Banking Accounts

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DON'T Let Goldman Be Goldman

Jul 12, 2010Wallace Turbeville

wall-street-150Is it fair to single out Goldman in a sea of financial wrongdoing? Absolutely, says Wallace Turbeville, a former Goldman VP.

wall-street-150Is it fair to single out Goldman in a sea of financial wrongdoing? Absolutely, says Wallace Turbeville, a former Goldman VP.

William D. Cohan's op-ed piece in the July 7th New York Times had the same title as this article, but for the word "Don't."

At first glance, I thought the Times piece might be a report on New Age self actualization for investment banks. But the title suggests something more troubling. The whole point of financial reform is that Goldman (and the others) should no longer be permitted to be Goldman. A return to business as usual is the last thing we need.

Mr. Cohan is a student of Goldman, but he profoundly misreads the firm's role in the Wagnerian drama we know as "The Great Recession." He begins by imploring us all to "fess up" to the fact that financial reform would have been impossible had the Administration and Congress not "demonized" Goldman.

"Demonization" is a popular word in today's political discourse. It suggests unfairness. Mr. Cohan does not dispute the facts asserted by the Administration and Congress. Instead, he points out that underlying ethical flaws were shared throughout Wall Street. They arose from the shift toward a business model that rewards taking imprudent risks with other people's money. Mr. Cohan says that "Goldman Sachs did nothing differently in the years leading up to the crisis than did other firms of its stature."

Anyone who has raised a child is familiar with a common excuse for bad behavior. The proper response to "Everyone else is doing it" is a stern demeanor and the answer: "Maybe, but so what?"

But let's give the article a generous interpretation. While the casual reader might interpret the shared lapse in ethics as an excuse, perhaps it is not intended to be read this way. We will assume that Mr. Cohan intended not to excuse Goldman but to find fault with political leaders who unfairly singled out the firm.

It seems obvious that the example of a single firm is a more effective rhetorical device than calling out generalized bad behavior. Politicians used this device and public opinion was successfully mobilized. The job got done. I believe that the public understood that the bad behavior was widespread, and that Goldman was merely one example.

Was it unfair to make Goldman the example? The article argues that Goldman was just like all the other firms. It was not.

Goldman was actually better at executing a certain investment banking business model than anyone else. It became a leader in the industry, admired by competitors, the media and politicians. The problem was that the business model, so effectively executed by Goldman, turned out to be bad for America. The model inherently risks the survival of critically important institutions. It is also nearly impossible to use the model and, at the same time, maintain business ethics conforming to the shared values of the society.

Goldman historically promoted its commitment to ethics when soliciting clients. I am convinced that Goldman people genuinely believed this commitment to be true. It may even be the case that ethics were taken more seriously at Goldman than at its competitors. But seeking business based on ethics carries with it a responsibility. Pursuit of a business model with inherent ethical challenges has consequences that are unavoidable, especially to a firm which has held itself out to clients as particularly ethical.

Goldman's success was envied up and down Wall Street. The pressure to keep pace with Goldman's earnings drove other firms to emulate its model. At a minimum, managers at other banks were driven to take greater risks hoping for greater rewards as proof to shareholders that they measured up to the Goldman team.

It is ironic that Goldman was first to foresee risks of a deteriorating market and acted to defend itself. Goldman's aggressive preparations, including the extraordinary demands to AIG for collateral, may have actually contributed to the intensity of the panic. Goldman was so prepared that, when the tsunami finally hit, the only real threat to it was a total systemic collapse. Congress and the Fed stepped in with cash to avoid catastrophe and Goldman, now even more powerful compared with competitors, immediately prospered. The real irony is that Goldman was greatly responsible for the problematic business model; yet, because management pulled the plug so effectively, the value of the bailout to Goldman shareholders was disproportionately large.

Mr. Cohan suggests that it was unfair to use Goldman as an example because of its relative ethics and its effective response to the danger. Those points may be relevant if the real issues were incompetence and larcenous intent. Instead, the core concern was and is the dysfunctional business model that generated massive profits for the firms but devastated the society.

Goldman was not just like all of the others. It was the leader. Becoming the leader involves a trade that should be well understood at the highest levels of Wall Street. Investment bankers often engage in businesses with underdeveloped rules of conduct. Pushing the envelope may be risky, but the rewards are more than worth it. If a firm is a leader, its profits and the wealth and power of its managers are virtually limitless. If it turns out that the business has consequences to society that are intolerable, even if the consequences were unforeseen, the leader will be the example held out to the public. Management is held to a high standard, but the pay scale more than reflects the level of difficulty.

Is this an unfair trade? I don't think so.

Finally, Mr. Cohan concludes that we should "lay off the firm and allow Goldman and the rest of Wall Street to return to some semblance of normalcy." Besides unfairly demeaning the entire financial reform effort, this statement suggests that our problems have been solved.

In fact, it would be a monumental error if financial reform ends with the passage of the legislation this month. James K. Galbraith points out in testimony to the Commission on Deficit Reduction that focusing on Medicare and Social Security as a means to reducing deficits is misguided. Economic growth is the only sensible solution. He cites the need to restore the financial sector's role of capital formation for productive purposes, i.e., commercial lending and equity investment. The current legislation focuses on curbing dangerous behaviors and on procedures to deal with financial panics. It does not reconnect Wall Street capital to the engine of economic growth: productive and innovative businesses which employ American workers.

No one wants to drive Wall Street out of business, certainly not politicians whose campaigns rely on it as a source of funds. But the economy will not prosper unless Wall Street reengages with the broader economy. Current bankers will keep their Hamptons estates under the new regulations. But their successors may not be able to afford mansions if 10-20% unemployment is the new American reality. Wall Street's attention must turn away from churning derivatives on existing products and instruments and toward growth of the economy and jobs. If more government intervention is needed to force this turn, so be it. Neither the public nor its political representatives should feel regret if this means Goldman and the other banks must fundamentally change.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Mike Konczal Talks FinReg on GRITtv: Taxpayers Still on the Hook for Wall Street's Recklessness

Jul 9, 2010

Roosevelt Institute Fellow Mike Konczal joined Demos's Nomi Prins and GRITtv host Laura Flanders last week to discuss the state of financial reform, whether the current bill does enough to change the culture of risk on Wall Street, and whether taxpayers are going to be stuck holding the bag -- again.

Check out the full interview:

More GRITtv

Roosevelt Institute Fellow Mike Konczal joined Demos's Nomi Prins and GRITtv host Laura Flanders last week to discuss the state of financial reform, whether the current bill does enough to change the culture of risk on Wall Street, and whether taxpayers are going to be stuck holding the bag -- again.

Check out the full interview:

More GRITtv

Mike notes that one of the key questions of reform is "who's going to pay for this, and ideally we want the people who caused the trouble to pay for it, not regular citizens." Instead, he says Republicans like Scott Brown have transferred the cost from banks to the FDIC and the savings accounts of average Americans.

On the subject of possible criminal charges for Goldman Sachs, Mike says that the lack of major arrests compared to previous crises "shows how much people haven't internalized the disaster they've caused. The culture is still very much the same." The problem, he explains, is that firms like AIG "thought they were being very clever when they were actually getting gamed." The fact that we still aren't sure how much of this was illegal "shows how disturbed the regulation is."

Mike pushes back on AIG's attempts to shift the blame for its reckless bets, noting that "when we talk about what AIG was doing, that's millions of Americans who are actually in those bonds, that were given loans that they shouldn't have so that AIG could juke some statistics." Unfortunately, he offers a grim prognosis for AIG's victims: "The foreclosure crisis is ongoing, it will be ongoing next year, and the President's plan there, HAMP, has been a total failure that most credible people have walked away from at this point. We have a quarter of homeowners underwater and they have no relief, and they're paying into a system that is pretty much insolvent."

Finally, responding to deficit hawks' calls for cuts to programs like Social Security, Mike argues that "if they were very concerned about protecting anyone, they would go much harder into financial reform. Because this is really where the deficit's coming from right now, the fact that we have a major financial crisis. There's two things that destroy an economy: financial crisis and war, and Republicans over the past decade have put us through a lot of both with no plans on paying for it."

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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