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."

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SEC & MMS: A Tale of Two Failures

Jul 8, 2010Eliot SpitzerWilliam K. Black

thumbs-down-150How many disasters will it take to overhaul the regulatory agencies?

thumbs-down-150How many disasters will it take to overhaul the regulatory agencies?

The SEC and the Minerals Management Service's (MMS) share a number of characteristics we can't help but notice in the wake of the worst environmental disaster in U.S. history, which followed the second-worst financial disaster in same. We have endured two cataclysms in which a regulatory agency upon which our nation's economy and environment depended failed to meet even the minimum requirements for doing its job. The ecological disaster was aided and abetted by the systematized incompetence and cronyism of the MMS, just as the financial meltdown was stoked by the laxity and inadequacy of the SEC. Both regulatory agencies were designed to fail. At the time of the critical regulatory lapses, they were run by leaders chosen because of their anti-regulatory stance. Both agencies have been failures for at least a decade.

In both instances, the regulators accepted industry assertions about the reliability of their safety mechanisms while failing to acknowledge -- much less investigate -- the darker, more complex reality. In each crisis, we had the same story of a belief in the reporting done by corporations, and in each case, we had a failure to recognize the enormous potential for fraud and the lack of incentives these corporate entities have in ascertaining and measuring potential risks to the public. The regulators continued to believe the lies fed them by CEOs even when the lies had become absurd. Both times, the agencies charged with regulating ignored the advice of their own experts, neglected to enforce rules, and engaged in an alarmingly cozy relationship with the industry they were supposed to be monitoring.

So far, the Obama administration has failed to fully grapple with the weaknesses and corruption of the regulatory agencies meant to guard the public from harm. Across the entire spectrum of regulatory agencies, there exists a dangerous atrophy of infrastructure which may lead to disasters we cannot yet imagine. Maybe now, as the oil slicks spread across the Gulf, killing wildlife and wrecking lives, our false sense of security is dissolving. We hope so, because if we don't learn from these horrific experiences, we can expect more of them. Where will the next disaster occur? At the Food and Drug Administration? At the National Transportation Safety Board? At the Nuclear Regulatory Commission?

The Government Accountability Office (GAO) is supposed to identify "high risk" governmental activities and require that the agencies address any weaknesses. Unfortunately, the GAO has traditionally excluded key regulatory activities from this high risk designation. It has only treated a regulatory activity as "high risk" if the taxpayers were likely to be the direct victims of the fraud or abuse. So far, the GAO has failed to designate either the SEC or MMS' regulatory activities as "high risk" even after recurrent scandals at both agencies that have led to multi-trillion dollar losses and epic catastrophes. That must change. The Obama administration should not only direct regulatory agencies to thoroughly audit themselves, but it must also instruct the GAO to systematically review the agencies' effectiveness and integrity, identify critical weaknesses, and require their timely correction.

Let's not wait for another catastrophe.

Eliot Spitzer is a former attorney general and governor of New York.

Roosevelt Institute Braintruster William Black is a professor of economics and law at the University of Missouri-Kansas City.

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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Treasury versus Progressives on the Financial Reform Bill

Jul 8, 2010Mike Konczal

58960658Treasury never stepped up to fight against the status quo on Wall Street.

58960658Treasury never stepped up to fight against the status quo on Wall Street.

Bob Kuttner wrote an essay about disappointment with ObamaJon Cohn and Jonathan Chait responded. On a related note, people have asked me what I think about Senator Feingold deciding not to vote for the financial reform bill.

- For my overall impression of the bill, I want to echo points brought up by Roosevelt Institute Senior Fellow Rob Johnson here:

The financial reform legislation is both disappointing and inspiring. The legislation is the product of a broken government process where dollars overwhelm voters. Lobbying in the gazillions predictably stopped the needed major structural reforms that were revealed by the scope and scale of the financial crisis...

What is heartening is to see how so many people and organizations — who had little knowledge of this arcane subject matter two years ago — have contributed the energy to learn and engage and push relentlessly for reforms against the monied odds...It is also heartening to see people like Michael Greenberger, Elizabeth Warren, Damon Silvers, Dennis Kelleher, Matt Stoller, Jane Hamsher, the AFR team, Bob Kuttner and Senators Cantwell, Dorgan, Levin, Kaufman and Merkeley leading this formidable effort.

This is the first act of a many act play. Finance was too large in proportion to our economy. It is still too large, and our dysfunctional political system that aided and abetted the growth of the financial sector over the last 20 years cannot be expected to turn on a dime and enact profound and needed change. That agenda is still ahead. This first round was not the whole fight. It was the wake-up call and the beginning of the fight. Rest up and get ready. There is so much more to do.

I think that's right. Considering that every financial industry bill going back to the early 1980s has been written hand-in-hand with the financial industry, the first bill to push back on this failed deregulation was going to be a nightmare. But I'm impressed and humbled by the works, education and advocacy network that was put into place in such a short period of time and against such odds.

- Jonathan Bernstein notes that Feingold's opposition gives extra power to the centrist Republicans. I'm not sure how I feel about the debate over how much President Obama could have done or could do, especially in terms of the military or in terms of the health care bill. But I do think Treasury could have moved this bill in a lot of ways. They set the terms under which the debate would unfold. And whenever they got involved with Congress, they pushed for less structural reforms. They pushed for the solution that embraced the status quo with arms wide open.

Treasury against Progressives on FinReg

Examples? Off the top of my head, ones with a paper trail: They fought the Collins amendment for quality of bank capital, fought leverage requirements like a 15-to-1 cap, fought prefunding the resolution mechanism, fought Section 716 spinning out swap desks, removed foreign exchange swaps and introduced end user exemption from derivative language between the Obama white paper and the House Bill, believed they could have gotten the SAFE Banking Amendment to break up the banks but didn't try, pushed against the full Audit the Fed and encouraged the Scott Brown deal.

You can agree or disagree with any number of those items, think they are brilliant or dumb, reasonable or a pipe dream. But what is worth noting is that they always end up leaving their fingerprints on the side of less structural reform and in favor of the status quo on Wall Street. These are some of the many ideas that progressives brought to the table, and there's a documentable trail of each one of them being opposed and fought against by the administration.

This is not to say that the administration is against reform. But it is to say that the problem I see is that they think we had was a crisis where regulators didn't have enough powers, not that the financial sector in 2007 was too dangerous and too risky. They did push hard for the CFPA, and I am thankful for that. But if they had put any effort to move just a few of the items above, even watered down versions, I could feel comfortable criticizing Feingold for not voting.

(I also want to note Ezra Klein here: "If he wants to vote no, he should vote no. But he should vote against the Republican filibuster.")

But I didn't see any effort. Maybe there are probably some examples. What documentable examples do you know of? And at what moment did Geithner and Treasury push for something stronger?

One of Kuttner's problems with financial reform is that how it was going to unfold was obvious from the personal and their choices around PPIP and the stress test. That weaker reform was always pursued instead of stronger reform in the financial sector should come as no surprise given the way Treasury decided to handle this bill.

And it is their bill. If it fails, if resolution doesn't work, if derivatives stay in the dark, if banks are still too big to fail, it won't be because progressives hijacked this bill. It will belong with those who supported the status quo.

Mike Konczal is a Fellow at the Roosevelt Institute.

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How Did Wall Street's Looting Become Public Policy?

Jul 7, 2010Joe Costello

money-and-greed-150The economy can't recover so long as we allow Wall Street to rob us blind.

money-and-greed-150The economy can't recover so long as we allow Wall Street to rob us blind.

Gretchen Morgenson has a good piece based on newly released documents concerning the single greatest crime committed by the looting class in the past two years, the bailout of Wall Street with the taxpayer payout of a hundred cents on the dollar for AIG's worthless derivatives. Morgenson writes:

The documents also indicate that regulators ignored recommendations from their own advisers to force the banks to accept losses on their A.I.G. deals and instead paid the banks in full for the contracts. That decision, say critics of the A.I.G. bailout, has cost taxpayers billions of extra dollars in payments to the banks. It also contrasts with the hard line the White House took in 2008 when it forced Chrysler's lenders to take losses when the government bailed out the auto giant.

But the best part of the piece is not only did Wall Street get the backdoor bailout:

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks -- including Goldman, Société Générale, Deutsche Bank and Merrill Lynch -- over any irregularities with most of the mortgage securities it insured in the precrisis years.

Any irregularities, that is more appropriately fraud, which was and remains rampant across the system. Fraud is the main criminal device of the looting class. Yves Smith digs deeper into the crime scene and its perpetrators. It's essential to understand that many in government are not simply colluding with the looting class, but are full fledged members. Chris Whalen at IRA has a good piece on Public Enemy #1, Robert Rubin, writing:

Reasonable people might call Robert Rubin the chief architect of the financial crisis and also of Wall Street's grand strategy to minimize the political damage from the subprime crisis. From his mismanagement of the U.S. Treasury's dollar policy in the mid-1990s to his bailout for Mexico (for Goldman Sachs and other Wall Street dealers), to the rescue of Citigroup and AIG in 2008, Rubin has met or exceeded the most demanding expectations for duplicity from our public servants.

Nearly two decades after first migrating to Washington, he apparently is still calling the shots of U.S. financial and economic policy with the full support of President Barrack Obama. Working through his favorite marionettes, Treasury Secretary Tim Geithner and Economic Policy Czar Larry Summers, most recently Rubin managed the defense of Wall Street following the great crisis.

The fleecing of the public by the looting class has now become a matter of general public policy. The looting class' transference of much of the private losses, that is fraud, onto the public books, now ransoms the entire economy for full payment. In an excellent piece(tx jesse), a Professor Hossein-zadeh at Drake University writes:

Never before has so much debt been imposed on so many people by so few financial operatives--operatives who work from Wall Street, the largest casino in history, and a handful of its junior counterparts around the world, especially Europe.

External sovereign debt, as well as occasional default on such debt, is not unprecedented. What is rather unique in the case of the current global sovereign debt is that it is largely private debt billed as public debt; that is, debt that was accumulated by financial speculators and, then, offloaded onto governments to be paid by taxpayers as national debt. Having thus bailed out the insolvent banksters, many governments have now become insolvent or nearly insolvent themselves, and are asking the public to skimp on their bread and butter in order to service the debt that is not their responsibility.

After transferring trillions of dollars of bad debt or toxic assets from the books of financial speculators to those of governments, global financial moguls, their representatives in the State apparatus and corporate media are now blaming social spending (in effect, the people) as responsible for debt and deficit!

This debt is illegitimate and needs to be repudiated. Pouring more money into an economy that has a criminal financial system is no solution, and it doesn't matter how much you spend, the economy will be moribund. The greatest crimes are those committed in full public view, grandiosity is their cover. People simply cannot conceive of criminal activity on such a scale. Such has been our looting class' quarter-century crime spree, climaxing with the collapse of the global economy and the massive swapping of private loss onto the public books. The looting class is private public partnership headquartered on Wall Street and the Fed, but with affiliations across the banking system and government. They will in the end only be stopped by a concerted effort of the American people to reclaim both their government and control of their economic destiny. The looting class needs to be to brought to justice.

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

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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Rob Johnson's Favorite Read of the Year on World Financial Markets

Jul 2, 2010Robert Johnson

idea 150Rob Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance, has a recommendation for everyone's summer reading list: the Bank for International Settlements' 80th Annual Report.  You may not want to bring the 216-page document to the

idea 150Rob Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance, has a recommendation for everyone's summer reading list: the Bank for International Settlements' 80th Annual Report.  You may not want to bring the 216-page document to the beach with you, but if you've worn out your copy of Twilight and you're looking to expand your horizons, the report offers a comprehensive analysis of the state of world markets and what lies ahead for financial reform and fiscal policy.

The report begins with an overview of the causes of the financial crisis and notes that "by fighting the wrong battles or not fighting at all, weak regulators and supervisors allowed the build-up of enormous risk."  It argues that reform must be focused on three key tasks: "(i) reducing the systemic importance of financial institutions; (ii) minimising spillovers from an institution’s failure by ensuring that the costs of failure will be borne by the institution’s unsecured liability holders; and (iii) bringing all systemically relevant financial institutions and activities within the regulatory perimeter and keeping them there."

It also notes that the economy has moved "from the emergency room to intensive care" in the last year, but warns that growth is still sluggish and recovery may be endangered by out-of-control deficits and unusually low interest rates.  It recommends that policymakers focus more on the long term because "with a relatively short forecasting horizon, monetary policy could inadvertently accommodate or even contribute to the build-up of financial vulnerabilities."

You can find the report on BIS.org or click here to read the PDF.

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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The Financial Reform Bill: A Very Limited Step Forward

Jun 29, 2010Dean Baker

money-question-150FinReg bill falls short, especially in not ending Too Big to Fail.

money-question-150FinReg bill falls short, especially in not ending Too Big to Fail.

The final compromise bill approved by the conference committee on Friday will improve regulation in the financial sector. However, given the severity of the economic crisis caused by past regulatory failures, the public had the right to expect much more extensive reform.

On the positive side, the creation of a strong independent consumer financial products protection bureau stands out as an important accomplishment. Such an agency would have prevented some of the worst lending practices that contributed to the housing bubble. It will be important President Obama choose a strong and effective person, such as Elizabeth Warren, as the first head of the Bureau to establish its independence.

The requirement that most derivatives be either exchange traded or passed through clearinghouses is also an important improvement in regulation. However, important exceptions remain, which the industry will no doubt exploit to their limit.

The creation of resolution authority for large non-bank financial institutions is also a positive step, although the fact that no pre-funding mechanism was put in place is a serious problem. Also, the audit of the Fed's special lending facilities, as well as the ongoing audits of its open market operations discount window loans, is a big step towards increased Fed openness.

On the negative side, there is little in this legislation that will fundamentally change the way that Wall Street does business. The rules on derivative trading will still leave the bulk of derivatives to be traded directly out of banks rather than separately capitalized divisions of the holding company. The Volcker rule was substantially weakened by a provision that will still allow banks to risk substantial sums in proprietary trading.

More importantly, there is probably no economist who believes that this bill will end too big to fail. The six largest banks will still enjoy the enormous implicit subsidy that results from the expectation that the federal government will bail them out in the event of a crisis.

Also, the fact that no regulators, most obviously Ben Bernanke at the Fed, were fired for failing to prevent the crisis leaves in place serious doubts about the structure of incentives for regulators. Cracking down on reckless behavior by politically powerful financial institutions will always be difficult for regulators. On the other hand, if regulators know that failing to crack down carries no consequences, even when it leads to disastrous outcomes, we can expect that regulators will have a strong bias toward ignoring reckless behavior.

It is possible that Congress may take stronger steps toward restructuring the financial sector, most obviously in the context of a financial speculation tax. While this is not likely to pass at the moment, in the context of severe budget pressures, a tax that can raise $150 billion a year in revenue may look more appealing than most alternatives. Such a tax would do far more to restructure the industry than this financial reform bill.

Dean Baker is the co-director of the Center for Economic and Policy Research.

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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Rob Johnson on fiscal austerity: 'If it wasn’t so tragic I would say it was humorous'

Jun 28, 2010

As the world waits for the decisions to roll out from the G20 summit, Rob Johnson discussed fiscal austerity with the Real News Network. "If it wasn't so tragic I would say it was humorous," he started out. But tragic it is. A lot of it all comes back to banks: why are deficit numbers so high? The financial crisis, caused by big banks. Who does fiscal austerity benefit, when it risks killing economic recovery? Those who hold treasury bonds at 0% interest -- big banks. "Finance is supposed to be a servant to commerce, [the] economy, [and] social goals. Well the servant's servant has become the master's master. And it's time to reinvert that," Rob says. Watch the full interview:

As the world waits for the decisions to roll out from the G20 summit, Rob Johnson discussed fiscal austerity with the Real News Network. "If it wasn't so tragic I would say it was humorous," he started out. But tragic it is. A lot of it all comes back to banks: why are deficit numbers so high? The financial crisis, caused by big banks. Who does fiscal austerity benefit, when it risks killing economic recovery? Those who hold treasury bonds at 0% interest -- big banks. "Finance is supposed to be a servant to commerce, [the] economy, [and] social goals. Well the servant's servant has become the master's master. And it's time to reinvert that," Rob says. Watch the full interview:


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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The New American Can’t-Do Spirit

Jun 28, 2010Jon Rynn

flag-150Defeatist political attitudes be damned.  America needs bipartisan reconciliation and perseverance to escape the doldrums of recession.

flag-150Defeatist political attitudes be damned.  America needs bipartisan reconciliation and perseverance to escape the doldrums of recession.

Americans have always been known to have a "can-do" spirit.  During the 1930s, the Roosevelt administration tried out many different programs to confront the Great Depression and to spread rural electrification and support agriculture.  Nowadays, however, much of the political spectrum seems to have turned to a  "can't do" spirit.  The sequence is often the following: Left-of-center ideas are proposed to solve some long-term, gigantic problem.  The Right says that the government can't implement the idea because if the market had liked the idea it would have happened, and since the market didn't do it...it can't be done.  The center-right looks at the world as it currently is, notes the Right's reaction to the Left, and then, with furrowed-brow and a studied look of being "realistic", announces that the progressives proposals are...can't do.

A prime example of this "realistic" impulse can be found on display in an article by Michael Lind of the New America Foundation, entitled "Goodbye, Bullet Trains and Wind Mills," at Salon.com.  Even though high-speed rail and wind farms are expanding at prodigious rates around the globe, in the U.S., it's all "no we can't".  While it would take a longer article than this to challenge all of Lind's factual inaccuracies, let me concentrate on a few of the larger errors of his ways.

First, he invents the strawmen of "greens" who hate cars,  and "urbanists" who despise suburbs, who have  somehow hijacked that repository of caution and timidity, the Democratic Party.  In real "reality", most greens live in suburbs and drive cars, simply because most Americans do.  In my experience, environmentalists are scared to even mention alternatives to car travel, lest potential supporters run away in panic.  Anybody who dares to raise a voice for designing walkable neighborhoods does so in the most hushed tones.   Besides James Howard Kunstler, I'm not sure who Lind is talking about (Disclosure: I don't have a driver's license and I prefer Manhattan-style neighborhoods).  Meanwhile, the allegedly brainwashed Democratic Party continues to support many times more funding for highways than for transit, continuing the trend between 1978 and 1999 when half of all transportation money went to highways, and 15% to rail and transit; meanwhile, one of the few items in Obama's 2011 budget that declines is funding for rail.

Second, Lind argues that because we don't currently have high-speed rail and a significant percentage of our electricity generated from wind power , it won't ever happen.  What would he have said in 1900?  There were 4,000 cars made that year, and 6 billion kilowatt hours of electricity.  Now we have about 250 million cars and 4,000 billion kilowatt hours of electricity.  In the 1950s and 1960s, we spent over $400 billion in current dollars to construct probably the largest "socialist" project in world history, the Interstate Highway System.  The U.S. High-Speed Rail Association estimates that it would cost about $600 billion to build a 17,000 mile system in 20 years.  The same sum would build a large chunk of a continent-spanning wind network that would take advantage of the fact that wind is always blowing somewhere.   We spent decades and trillions of dollars building the suburbs; why can't we do the same to build up dense, walkable cities and towns?  Why is something possible in the past, but not in the future?

Third, Lind proposes an alternative - more of the same.  More nuclear power plants, more highways for more trucks, more airports, more asphalt and concrete, more natural gas, and apparently, more sprawl (Lind's colleague at New America Foundation, the oil expert Lisa Margonelli, doesn't do much better).  Since Lind dissed rail by proclaiming that it is oh-so-19th century, it might surprise readers to know that the most recent development in transportation technology has been high-speed rail.  Cars and trucks predate diesel locomotives; electrified freight rail is more than 10 times more efficient than trucks.  An efficient car wastes 99% of its energy, using only 1% to actually move the human occupants.  And Lind doesn't even consider looming, permanent price increases in oil as it becomes harder and harder to find more oil  - even in places one mile under the Gulf of Mexico.

However, I agree with Lind in one area - we need "more government spending for years to come", and "massive public investment in infrastructure that increases long-term U.S. economic growth ".  That's exactly what a multi-trillion dollar, multi-decade program of building high-speed rail, intra-city rail such as trolleys and subways, wind farms across the country and off-shore, and myriad other renewable energy and rail-based projects, would accomplish.  These systems use all parts of the core of a modern industrial system - machine tools, semiconductors, high-skill labor, advanced materials, cutting-edge engineering, and more.  I like to think that if the New Dealers were around today, they would agree that we can do it, yes we can!

Jon Rynn is the author of the book "Manufacturing Green Prosperity: The power to rebuild the American middle class", from Praeger Press, in the summer of 2010.  He has a Ph.D. in political science from the City University of New York.

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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Owning the Banking System

Jun 28, 2010Wallace Turbeville

man-on-money-150How banks shape the marketplace for their own ends -- not for ours.

man-on-money-150How banks shape the marketplace for their own ends -- not for ours.

Senator Carl Levin relentlessly questioned Goldman Sachs executives regarding conflicts of interest in the mortgaged backed securities markets.  This is a story of conflicts that are far more pervasive and dangerous than those which drew the ire of the Senator.

The banks have always dominated the derivatives trading markets by taking risks and making markets for other trading firms. Historically, the amount of risk taken on and the profits have been staggeringly large.

There came a time (roughly coinciding with de-regulation) when the banks discovered a way to enhance profits from dominating trading activity. They discovered the immense advantage of owning the infrastructure of the markets.  The value of investments in infrastructure could be assured if banks used their market power to direct trading volume through the structures they owned. Non-bank traders would have no choice.  They had to use the infrastructure which the banks preferred and a flow of business would be captured.

Perhaps more importantly, banks could influence the evolution of the marketplaces.  The market structures would suit their trading businesses. The scope of the markets and prevailing practices would serve their strategies. These influences are less obvious than pumping up value of investments, and are more of a concern for that reason.

The events of 2008 have made clear to the public that these markets are not merely a playground for banks to trade esoteric investments with each other and large businesses.  The derivatives markets impact the supply and cost of energy, food, essential manufactured products and money itself. It has never been more important to secure the independence of market infrastructure from the banks. With regulatory reform in place, the ability to avoid its intended purpose by influencing the mechanisms of the market to enlarge gaps in regulation will be a central goal of the financial institutions.  They must be told that the infrastructure is not theirs to use to avoid regulatory control.

Robert E. Litan, writing for the Brookings Institute, referred to a "Derivatives Dealer Club" of the top 5 bank dealers.  There is no doubt that he has identified the group which, in various combinations, exerts tremendous control over market infrastructure.

It is important to note Goldman Sachs' interest in market structures with particular interest.  When Goldman is an investor in a structure, its influence is disproportionate to that of other investors.  Its strategy is to deploy greater expertise to the role of investor, advising management and sometimes seconding executives to fill key roles. Goldman also represents large volumes of business that can be directed to the structures. This increases both the value of the investment as well as Goldman's influence over the structures on themselves. Goldman is by no means the only firm to pursue this strategy - it just seems to be the best at it.

In 2000, the Intercontinental Exchange ("ICE") was founded with an initial investor group of Goldman, Morgan Stanley, BP, Total, Deutsche Bank, Shell and Societie Generale. ICE was originally an electronic platform that was intended to displace brokers in the over-the-counter energy markets.  The investors would to profit from the fees (including those paid by the investors) which would otherwise go to brokers and would shape the marketplace to meet their needs.

ICE evolved and its scope expanded. Cutting out the brokers was small potatoes compared with cutting out the exchanges and clearinghouses.  ICE added a clearing function and the electronic trade matching was adapted to compete with the exchanges. ICE took on NYMEX and other exchanges as its product list grew.

Trade volume was critical to ICE as a source of fee income and the owners did their best to accommodate by directing trade flow to the platform. If major institutions sent trades to ICE, lesser players in the market had to follow if they wanted to transact with them.

An incentive plan was also created.  Stock warrants, very valuable if there was an IPO, were awarded to customers based on volume. Sure enough, some customers (not Goldman) undertook "round trip trades."  In short, A will buy from B if B agrees to subsequently buy the same thing from A, all at an agreed price. This inflated volume and earned warrants.  The other reason for the round trip trades was to establish artificial prices, also problematic.  The regulators discovered this activity and took appropriate action.

In 2005, ICE shares were very successfully offered to the public. This IPO (Morgan Stanley and Goldman were senior underwriters) was quite unusual.  Relatively little capital was raised by ICE.  The vast majority of the offering consisted of the shares of the original investors.  They cashed out. But that did not end their influence.  The original investors, and predominantly Goldman Sachs, retained great influence not only because of relationships and corporate DNA, but because of the market volume they controlled. Remember, volume is the life blood of ICE.  Much of the evolution of the energy market was driven by ICE.

The credit default swap market developed with dealer bank influence in parallel with energy. The CDS market was exclusively transacted over-the-counter and un-cleared. There were three significant market structure providers: Depository Trust Clearing Corporation ("DTCC"), Markit and CreditEX.

DTCC has a long history as an institution created to serve the dealer banks by providing data and other services that they can share.  Of the 18 board members, 12 are representatives of financial institutions.  DTCC is the primary repository of information on CDS transactions.  It is widely known that DTCC serves the interests of the banks and would be loath to act against those interests.

Markit managed information, creating price indices for various derivatives and provided other processes. Goldman Sachs and other dealers were owners since its early days in 2003.  CreditEx provided an electronic environment in which OTC traders could meet up and transact.  Goldman was not an owner of CreditEx, but other banks were.  Goldman's influence was soon to be felt by CreditEx, however.

Markit and CreditEx were partners in a number of initiatives.  One such strategic partnership changed the CDS market dramatically, facilitating explosive growth. In 2005, Markit and CreditEx developed a Credit Event Fixing product.  It provided standard methods for determining valuations and procedures in the event of default for CDS.  It also provided an environment for effecting transactions conforming to these processes and procedures.  The success of this joint venture led to the absorption in 2007 of two competing credit index providers by Markit, each of which was partially owned by Goldman Sachs - CDS Index Co. and International Index Co.

To complete the circle, and with an eye on the coming storms in the CDS market, ICE acquired CreditEx in 2008.

After the financial crisis, it became apparent that clearing of CDS was not only politically essential but a good business opportunity.  There were two US-based initiatives that raced to provide the service, one effort sponsored by ICE and the other by the Chicago Mercantile Exchange.

ICE chose to separate clearing from its energy and other clearing businesses.  It set up ICE Trust which could receive swaps transacted in the OTC markets in the past and contemporaneously.  Its structure was very friendly to the banks.  In fact, 50% of ICE Trust profits go to Goldman, JP Morgan, Morgan Stanley, Bank of America and Citigroup. The banks sit on the ICE Trust risk committee, allowing the great influence over what is offered for clearing. The bank own profit shares, not equity investments; perhaps ownership would have been impolitic under the circumstances.  However, the profit share clearly aligns the interests of the big banks and the clearing entity. Bank influence on ICE Trust was immense.

CME took another route.  The swaps were to be cleared through its main clearing operation.  CME proposed an electronic front-end trade matching function, mimicking an exchange. This would, of course, be an aid to price transparency.

ICE Trust was successful in attracting volume.  CME was not successful. It attempted to modify its product to please the dealer banks, in part by abandoning the front-end system. CME volume continues to lag ICE Trust's substantially.

The financial reform legislation promises to inspire a new set of structures to markets subject to real regulation.  If the new structures are subject to the undue influence of the primary targets of regulation, the results may not be what Congress and most of the American public hoped to achieve. Control and influence over the companies which provide new structures is worthy of careful scrutiny.

Mr. Litan suggests that the scrutiny should include consideration of the applicability of anti-trust laws to their ownership positions.  If that route is pursued, there are several practices which emerged in the years of operation of the murky OTC derivatives markets which might also warrant anti-trust examination.

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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