Credit Card Debt and Subprime Mortgages: Who’s to Blame?

Aug 2, 2010Bryce Covert

credit-card-fees-150Are you in the 'sweat box', the place where credit card companies make money off of your misery?

credit-card-fees-150Are you in the 'sweat box', the place where credit card companies make money off of your misery?

A few weeks ago I wrote a post about my personal decision to stay away from credit cards and my struggle with a society that is rigged in favor of them. The post didn't advocate getting rid of credit cards; it advocated getting rid of a credit score system and other incentives that make it difficult not to have one.

The comments section for the post on reddit had a variety of opinions in response, both positive and negative. But many of them used the words "dumb," "idiot," "lazy," "stupid." They used words such as "responsibility" and "discipline" and "self-control." The crux of these arguments is that those who get into heavy credit card debt are financially illiterate (or just plain naive). This viewpoint rests the blame of soaring American credit card debt on those who get the cards, rather than the companies who issue them. There is of course a grain of truth in this -- many people who have credit card debt spend beyond their means. And there are ways to be savvy about credit cards and not run up a balance.

But that is not what a credit card company wants, and you may in fact find yourself rejected from getting a card if you are that responsible. You are far outside the sweet spot, or what Ronald J. Mann, a professor of law at UT Austin, calls the "sweat box":  "the spectrum from those who carry balances, to those who routinely make minimum payments, to those who miss payments altogether... [where] the interest rates that borrowers pay...greatly exceed the cost of the lender's funds." Mann wrote a paper in 2006, right after Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act. Proponents of the act relied heavily on a moral argument: that it is shameful Americans could ‘easily' walk away from their debt by filing for bankruptcy. Those pushing the reforms were concerned that consumers used bankruptcy as a convenient part of financial planning, not as a last resort. Thus the rules for filing had to be tightened.

But Mann smelled something fishy: the credit card companies had lobbied heavily and expensively with this bill. But the bill was unlikely to return enough income through increased bankruptcy payouts to justify the expense of lobbying. In fact, it had none of the effects you might think credit card companies would want: deterring risky borrowing, increasing bankruptcy payouts, or lowing bankruptcy filing rates. So why did they do it? It turns out that the major outcome of this bill, and all that lobbying, was to delay consumers from filing for bankruptcy. The credit card companies weren't worried about losing money when a customer defaulted; they were worried that too many defaults too early led to lower profits. This is where credit card companies make their money. Not off of customers who are so irresponsible as to default right away, not off of customers who are so responsible that they pay their bills on time. Rather, off of those who are just bad enough to drag out their balances for a long period of time. And that's where they want to keep you -- in the sweat box.

Credit cards have evolved along the same path as mortgages. As Elizabeth Warren, tireless consumer advocate, puts it: "The financial industry has perfected the art of offering mortgages, credit cards, and check-overdrafts laden with hidden terms that obscure price and risk." Need proof? The average credit card contract has bloated up to 30 pages, from a page and a half in the early 1980s. Issuers advertise a single interest rate and then bury the real details in the contract. (It's no coincidence that the landmark Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. case was decided in 1978, which said that states could no longer regulate interest rates on nationally-chartered banks, leading them to easily find the laxest state laws and regulators.) Similarly, to quote Elizabeth Warren again, "More than half of the families that ended up with high-priced, high-risk subprime mortgages would have qualified for safer, cheaper prime loans." Wonder why that is. Maybe all those families were interested in high-stakes gambling with their houses? "A recent Federal Trade Commission survey found that many consumers do not understand, or can even indentify, key mortgage terms." Hmm, maybe not.

The responses to my credit card post mimic the response to the subprime mortgage catastrophe, which placed the blame on homeowners who got mortgages without the adequate funds to pay them back. Again, there is truth in this viewpoint. It is true that many people with little to no income bought houses that they couldn't afford. But why were so many of these mortgages given out? Who gave them? And what were their motives?

Gary Rivlin may answer some of these questions in the chapter "The Birth of the Predatory Lender" in his book Broke USA. He writes about the early 1990s, when nonbank lenders started to realize that there were profits to be made from low-income neighborhoods. They preyed upon the poor, as "the typical customer...didn't feel ripped off paying interest rates of 20% or more but instead felt grateful that finally, someone was saying yes." A lawyer working to help some of these customers climb out of their debt "suspected that the lender was more interested in seizing homes through judgments of default than in accruing steady profits through regular monthly payments." And indeed, Fleet, one of the first large banks get into the business, "lost $17,000 per home on the 101 homes it sold at a loss, [but] it made an average of $32,000 per home on 194 homes." Again the story of relaxed regulation in the 80s comes to play: the state caps on interest rates banks could charge on mortgages were barred in 1980. Two years later, Reagan went further and gave lenders the ability to sell creative home loans, including balloon mortgages and adjustable-rate mortgages. A whole new lingo emerged: "packing" a loan, in which a salesperson was able to load it up with points and fees and credit insurance; "flipping," in which a broker could convince customers to refinance loans again and again, each time adding more points and fees; and all of these practices falling under "equity stripping," in which banks siphoned off the equity customers had in their homes. The cards were stacked against mortgage customers so that banks could profit. By the turn of this century, "Increasingly, mainstream banks were revving up profits by purchasing or starting a subprime subsidiary," Rivlin recalls. And we all know how that turned out.

It's tantalizingly easy to place the blame for huge problems like credit card debt and subprime mortgages on individual consumers. The solution to that is for them to "just man up," as one of the reddit readers suggested. And as I said above, individual responsibility will always be a factor when it comes to these issues. In Elizabeth Warren's words: "Nothing will ever replace the role of personal responsibility. The FDA cannot prevent drug overdoses, and the CFPA cannot stop overspending. Instead, creating safer marketplaces is about making certain that the products themselves don't become the source of trouble." And therein lies the rub. It is far more difficult to think and talk about the system in which so many of these decisions are taking place.

The flood of comments and reactions to my piece heartens me, however, for two reasons. One is that people who had similar stories to mine came out of the woodworks. Friends, family, coworkers, strangers all started telling me how they either stayed away from credit cards for similar reasons or got into debt early on, found a way out, and then stayed away. The second heartening thing is that clearly this is something that people care about. President Obama just signed sweeping financial regulation into law, and whether or not it's strong enough to prevent another crisis, the new Consumer Financial Protection Bureau promises to right many of the wrongs listed above. Contracts will become clearer. Regulators will do a better job of regulating these products. Consumers will actually be able to compare credit products, because they will really understand them, and innovation and competition can come back to the market. But none of this will deal with the problem my original post addressed, which is the way our society tethers its people to debt products. If so many people care, so many people wish to be credit card-free, maybe this can change too.

Bryce Covert is Assistant Editor at New Deal 2.0.

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Elizabeth Warren to Netroots Nation: We Have the Tools; Let's Use Them

Jul 30, 2010

netroots-nation-150At last weekend's sizzling Netroots Nation conference in Vegas, strategist Jen Ancona gathered a group of economic luminaries on stage to discuss a progressive vision of our economic future.

netroots-nation-150At last weekend's sizzling Netroots Nation conference in Vegas, strategist Jen Ancona gathered a group of economic luminaries on stage to discuss a progressive vision of our economic future. ND20 contributor Elizabeth Warren started her speech off with the story of her grandmother. This woman drove a wagon full of younger siblings to Oklahoma during the land rush, after her own mother died and her father had already ridden ahead. After she married Warren's grandfather, they built one-room schoolhouses and modest homes, and "stretched and scratched" to put away some money. That money got wiped out in 1907. So they stretched and scratched again, only to be wiped out one more time in the Great Depression. Such was the boom and bust cycle of the turn of the century.

But three laws that came out of the Great Depression helped to build a strong middle class that lasted for 50 years: FDIC insurance, Glass-Steagall, and SEC regulations. It wasn't until a few years after her grandmother died that the regulations were thrown out. Productivity and wages, which had been rising in tandem, began to diverge, and middle class families were spending more on core necessities while making less. Credit companies saw an opportunity to make money off of this problem -- and that led to the "tricks and traps" business practices that they employ today.

But now FinReg has been signed into law. "We have now the tools on the table to make significant change...but we've got to pick up the tools and use them. [The CFPB] must be built," Warren says. As the bureau is her brainchild, she is perhaps the best person to come up with suggestions for how it should be done. She has four: 1) it must stand for families, 2) it must be reality-based, 3) it has to be able to grow and change, and 4) it should make use of our wired world, involving consumers in its research.

The fight is clearly not over, nor will it be an easy one, she reminded the crowd. But, she says, "Remember, Franklin Roosevelt faced his economic royalists. Remember, it took him years to get his entire economic package into place. It was tough, but it paid off." It's time to pick up the "unused tools" of the financial reform bill and put them to good work.

Watch the full speech here.

And check out Warren's pieces on ND20:

The Fight for Vital Consumer Protections

Feminomics: Women and Bankruptcy

New Agenda for America: The Great Lesson

Real Change: Turning up the heat on non-bank lenders

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Deregulated Energy Trading: Uncompetitive Competition

Jul 28, 2010Wallace Turbeville

earth-150The accidental protection of end user activity will ensure toxic energy trading.

earth-150The accidental protection of end user activity will ensure toxic energy trading.

In an earlier article, I described the so-called "Enron Loophole" in the Commodities Futures Modernization Act of 2001.  Deregulation of energy derivatives trading via the Loophole was touted as a way to lower cost through the efficiency of competition.  In reality, the markets are not competitive.  They are dominated by an oligopoly of banks which profits at the public's expense.

The Enron Loophole has been partially closed, but a large portion of the energy market remains unregulated.  The new financial reform legislation permits bilateral (i.e., un-cleared) hedging transactions in which one party is an "end user." Congress failed to consider the level of market abuse in these transactions. It was mesmerized by huge volumes in other transaction types, ignoring the fact that volume is only one factor in measuring the amount of systemic risk.

End users are companies who produce or purchase energy as an integral part of their business and use derivatives to hedge price risk.  They wanted the exemption primarily to avoid having to post collateral to cover credit exposures, as required by regulated clearinghouses.  All end users transact some business on exchanges and these transactions are all cleared.  So end users have systems in place to post collateral.  Their concern was that they would have to post more collateral unless exempted from the law's general requirement that derivatives be cleared.

This concern is curious. End users trade mostly with banks and a few of the large oil and gas companies.  They receive special deals in which the banks and oil companies extend credit in lieu of requiring the posting of collateral. These deals are, in all relevant aspects, the same as extending a loan to the end user in the amount of the foregone collateral - except that no cash changes hands.  The deals are like unconditional letters of credit in which a bank will pay an amount if the account party fails. A letter of credit is treated like a loan by the bank and account party on their respective books.

If a special collateral deal is just like a loan or letter of credit, why don't end users simply clear their trades and borrow money as needed for collateral?  It is because these special deals are not recorded the same way as loans and letters of credit on the books of the end users. End users wanted the exemption to preserve the opaque trading credit deals so that their debt appears to be smaller than it should.

These special credit deals are much riskier for the end users than conventional loans. They routinely include "triggers," requiring that collateral must be funded immediately on occurrence of specified events (e.g., a credit rating downgrade). This means that cash is required at the precise time when it is hardest to come by. Credit rating agencies are put under immense pressure because well-deserved, modest downgrades could induce a death spiral and bankruptcy. Such liquidity events laid low AIG, Enron and many other firms engaged in bilateral trading. End users are exposed to liquidity risks that well capitalized financial institutions can scarcely deal with.

The banks were also keen on the end user exemption.  The special credit deals are useful to entice end users to trade with the banks.  A bank can extend only a finite amount of credit to a company. Allocating credit to a company for trading reduces a bank's capacity to lend for purposes like capital investment. It is well known that the banks make far more money using credit capacity assigned to a company in their trading activities, rather than using it for conventional corporate lending. If the banks are profiting more tying credit to trades, the end users are paying more than they need to for the credit in order to obscure their indebtedness.

The special credit deals are not merely sweeteners for the end users; they are often crucial to the end user's share value. Banks use them to capture and control end user business.  Sometimes this is done with great fanfare, such as a deal in which Pepco transferred all of its hedging activity to Morgan Stanley.  Sometimes it is less formal. I have been told of a major energy producer which shockingly does more than 80% of its business with a single bank. These are not characteristics of open and competitive markets.

End user energy trading volume is not as large as the volume in credit default, currency and interest rate swaps. However, it is extremely profitable for the banks.  They charge a lot for the special credit deals, in effect profiting from the end user's reporting advantage. But the strategic value for the banks is even greater. It allows banks to dominate markets and become sole sources of hedges which can be priced accordingly.

The peculiar nature of the energy markets is at the root of this strategy.  It is useful to look at the power markets, the most extreme example, to understand the strategic play. The general principles apply to all energy markets.

The central dynamic is that power cannot be stored in any practical sense.  Its economic value is fleeting.  A quantum of power only has value at an instant in time and at a particular location where it is needed to fill a demand.

There is no single power market. Value depends on local supply and demand. There is very little relationship between the market value of power in California and the same power in Pennsylvania. This is because power transmission is constrained. There are absolute engineering constraints over great distance; and even over short distances there are "line losses" of the amount of power generated and fed into the grid.  Regionally, the market values of power at nearby points are usually correlated, but congestion on a transmission path can destroy these correlations, especially at times of high volume each day. Weather is a major factor, but congestion can be as unpredictable as a truck backing into a transformer, storm damage to lines or a generation plant outage

The power market is really a collection of thousands of delivery points, each with unique factors governing valuation.

Power at each delivery point is not monolithic.  Grid operators run day-ahead auctions to secure predictable supplies for forecasted demand. But they also run same day auctions to fine tune supply and demand during the day of delivery.  So there are separately priced day-ahead and real time markets for each delivery point. There are corresponding separate derivative instruments traded for each of these markets.  There is even a derivative for the difference between the two markets at a given delivery point and time.

The value of the transmission between two delivery points is defined by the price differential between the points.  Derivatives transactions for this value are called "basis trades."

Power price is a composite of two values.  The grid operator's ability to access power if required has a value since actual demand and supply can never be known in advance. This is known as "capacity" value. Capacity derivatives are traded.  The difference between capacity value and the actual value of delivered power is referred to as "energy," also a traded derivative.

Most of the value of a power plant is the difference between the price of power it produces and the cost of the fuel required to produce it. For natural gas this is known as the "spark spread," and for coal it is known as the "dark spread." Both are traded as derivatives.

Finally, as demand increases, grid operators call on increasingly less efficient generating resources to supply power and to meet demand.  "Heat rate" swaps are derivatives based on the efficiency of the marginal assets called on at a given time. A heat rate swap is a derivative of a spark spread derivative.

This all means that the power market is really thousands of small markets which are separately priced.  Each delivery point is a "mini-market" which represents multiple potential derivative contracts for trading. Sometimes prices in nearby markets are related, and sometime they are not.

Each end user has regional strengths.  Since markets are really very small, a bank can easily become a dominant force in targeted "mini-markets," effectively "cornering" strategically enabling it to dictate price. Any trader who wants to do business in one of these markets has to deal with that bank.  That is why trading under the end user exemption is so very profitable for the banks.

This all means that the end users' cost of doing business is higher than makes sense in a truly competitive market.  As a result, consumer energy prices are higher than they should be. It also means that the cost of producing almost everything in the economy is too high.

Unregulated energy derivatives have allowed the financial sector to extract extraordinary value from the rest of the economy. It is one reason that the sector has increased dramatically as a percentage of the GDP.  There is no justification for this related to the well-being of the public and the health of the economy.  The end user exemption was misguided.  Other ways to curb these unhealthy practices through regulation must be explored, perhaps focusing on energy policy rather than financial reform.

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

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Which is the Bigger Threat: Terrorism or Wall Street Bonuses?

Jul 26, 2010Wallace Turbeville

stockmarket-1500001The current system of trader compensation will continue to decay the heart of Wall Street.

stockmarket-1500001The current system of trader compensation will continue to decay the heart of Wall Street.

Which is a greater threat to the nation -- terrorism or the relentless decline of middle income families? Unless we abandon our core values out of unwarranted fear, terror cannot fundamentally change our way of life. The number of people affected by growing income disparity is vast. When I was a student, income disparity was indicative of an underdeveloped and unstable society.

The government appropriately devotes enormous resources to protect our lives and property from terrorism.  It is unthinkable that a leader would display any weakness opposing this threat.  Politicians have stiff backbones when it comes to terrorism.

In contrast, the government is timid and half-hearted in its approach to the system which perversely rewards a few Wall Street traders with billions of dollars of bonuses, yet allows the foundation to decay.

Kenneth Feinberg issued his report identifying outrageous Wall Street compensation of executives despite their role in the financial disaster and bail out. He proposed that the banks voluntarily adopt "brake provisions" that permit boards of directors to nullify bonuses in the event of a new financial crisis.

He might have more success asking the lions of the Serengeti to give the wildebeests a sporting chance of making an escape.

Over the last fifteen years, the financial sector's percentage of GDP has increased dramatically.  At the same time, the median family income stagnated and then declined.  I do not believe that this is a coincidence.

The large banks have changed. They slice and dice the constituent elements of a stagnant economy, squeezing value out in ever more sophisticated ways.  Wall Street has turned away from its roll as the financial backer of industry and commerce. In the short term, it is more profitable for them to use their capital for trading. Newfangled software and MIT "quants" allow the traders to "rip the faces off" of corporate counterparties and investors which were once trusted clients.

These young traders are simply doing what America has told them to do.  They are allowed to earn obscene amounts of money using the advantageous information, technology and capital of their employers. Making money from less powerful counterparties is like shooting fish in a barrel.  The banks make so much money that they have no problem shoveling it out to the traders.

The alternative careers for these talented young people offer upside which is modest by comparison.  Besides, the trading world, in which the law of the jungle prevails, appeals to youthful aggressiveness.  Michael Lewis expected that college students would be appalled by the amoral environment he described in "Liar's Poker." Instead, the overwhelming response he received from students was a desire to get in on the action. The draining of talented and energetic young professionals away from corporate America where they could help create jobs by the millions may be as damaging as the new allocation of wealth.

The government's flaccid approach to Wall Street compensation, embodied in the Feinberg report, is appalling.  Geithner and Bernake appear intimidated by Wall Street, yet intent on its approval.  Why do they guilelessly buy into the notion that giant, multi-purpose banks dominated by trading are essential to America's competitiveness in the world? Smaller, less risky institutions aligned with economic growth would seem to be a better idea for the vast majority of Americans.

Greenspan and his progeny, including Geithner and Bernake, are enthralled by financial innovation. Innovation, by itself, can be good or bad. Innovation does not fall into the "good" category if it corrupts the home mortgage market, siphons off business productivity and the jobs and wages of employees and unfairly enriches the few at the expense of the many. It is good if it creates jobs and enriches the public as a whole.

Trader compensation is at the heart of the problem. It encourages behavior that is inconsistent with Wall Street's most important function: raising capital for industry and commerce. The banks and the government are afraid that the traders will desert the banks and move to hedge funds if their compensation is reduced. If they do jump ship, it is all the better for America. At least hedge funds can blow themselves up without crippling the US economy in the process.

Former traders now run most of the financial sector.  They believe that the traders somehow deserve compensation at the prevailing levels. The system will not change unless it is forced to do so. The restrictions in the financial reform legislation only inhibit specific abuses.  The banks will concoct new ways to trade risk. It is the only way to maintain their unconscionable profits (that is, until the next bubble bursts and we are in an even worse predicament).  The only way to really change the system is to reduce short term incentives, that is to say limit bonuses.  The government needs the kind of resolve it uses when fighting terrorism.  After all, the stakes are actually higher.

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

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Mike Konczal Talks FinReg on The Breakdown

Jul 23, 2010

Now that Obama has signed FinReg into law, Roosevelt Institute Fellow Mike Konczal appeared on The Breakdown with Chris Hayes yesterday to discuss the bill. Confused about the entire financial meltdown? Mike's got you covered. He breaks the crisis down into four interconnected sectors: an exploitative, under-regulated system of consumer finance; dark markets in derivatives; the failures of "too big to fail" banks and the ripple effects they caused; and shadow banks that were able to avoid regulations (and also lacking, as Mike suggests, the "toilet training" necessary to behave).

These four sectors will also be the basis used for grading the potency of the bill. And as Mike notes, while it offers opportunities for some much-needed general changes, it still falls short in several areas.

Listen below to get the full explanation:

It looks like you don't have Adobe Flash Player installed. Get it now.

Now that Obama has signed FinReg into law, Roosevelt Institute Fellow Mike Konczal appeared on The Breakdown with Chris Hayes yesterday to discuss the bill. Confused about the entire financial meltdown? Mike's got you covered. He breaks the crisis down into four interconnected sectors: an exploitative, under-regulated system of consumer finance; dark markets in derivatives; the failures of "too big to fail" banks and the ripple effects they caused; and shadow banks that were able to avoid regulations (and also lacking, as Mike says, the "toilet training" necessary to behave).

These four sectors will also be the basis used for grading the potency of the bill. And as Mike notes, while it offers opportunities for some much-needed changes, it still falls short in several areas.

Listen below to get the full explanation:

It looks like you don't have Adobe Flash Player installed. Get it now.

And check out some of Mike's latest pieces on ND20:

How HAMP Makes Elizabeth Warren The Only Choice For Consumer Protection

Treasury versus Progressives on the Financial Reform Bill

Underwater Mortgages and the Odd Definition of the Experian Study

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How HAMP Makes Elizabeth Warren The Only Choice For Consumer Protection

Jul 22, 2010Mike Konczal

elizabeth-warren-150No one else has been a stronger advocate for public disclosure.

elizabeth-warren-150No one else has been a stronger advocate for public disclosure.

There's a debate going on about who should be nominated to run the Consumer Financial Protection Bureau at the Federal Reserve. One side says Elizabeth Warren, while another says someone from Treasury, likely Michael Barr.

At a quick glance you might not see a big difference. As Felix notes, Michael Barr is very strong on consumer finance.

But I think Warren would be a far superior choice. There are many reasons why, but I want to discuss a very specific one here that distinguishes her from anyone in Treasury. The biggest: she is a strong critic of HAMP, Treasury's largest intervention into the massive foreclosure crisis hitting millions of regular Americans, and she demands accountability on behalf of the people.

HAMP As Failure

The Home Affordability Modification Program is widely considered to be a failure. Here is Shahien Nasiripour reporting on the latest numbers from June. They haven't remotely hit the numbers they projected. Homeowners continue to suffer from a lack of modifications due to servicer problems and the overvaluation of their books. I wrote here about how the creator of the mortgage bond instrument in the early 1980s said in 2007 that a major market failure was coming. There was need for government action.

HAMP is such a failure that it is a bit of a game among the financial bloggers as to who has the best write-up of how bad it is each month and what the killer statistics are that prove it. I'm calling Stacy-Marie Ishmael over at FT Alphaville this month's winner with BarCap vs HUD on HAMP.

Evidence shows that there are principal increases for 80% of the people who go through HAMP. That is the exact opposite of what you'd like to see! It lowers interest rates, but it also increases the length of the loan. And for those who don't have principal reduction, there is a massively high redefault rate. People lose their homes anyway, even after jumping through cumbersome hoops.

Predatory lending is hard to define, but a product is predatory that sinks people deeper into debt without the expectation that they can pay it off. And that is exactly how HAMP functions. For millions of people HAMP is their main interaction with the government and embodies what the government is capable of, and this creates disillusionment and discredits the liberal state in a profound way.

And Warren Demands Accountability

The Congressional Oversight Panel, lead by Warren, has been in the lead at making information public and bringing the complaints of the people straight to those in power. (It falls under her jurisdiction because HAMP uses TARP money.) When you see the fights on youtube between Warren and Geithner, the biggest ones, the ones that make Geithner cringe the most, it is about how HAMP isn't working. Click through on that link to watch a video that gets straight to this. She demands accountability from the government and from the banking sector on the single most important issues facing Americans right now.

This is important. There's pressure to be quiet, to hope that a quick housing and economic recovery will just make this whole foreclosure crisis go away. But Warren has demanded answers. COP released a report in early 2009 about the problems with HAMP, data collection and foreclosure, a report that still stands up. She's done that at every step of TARP, but it matters here specifically for consumer protection.

And this is exactly how the CFPA should work. They fight to get good information disclosed to the public about how the banks and the Treasury department are failing the American people, reporters and wonks explain the information to the public, Treasury is held accountable. Treasury is currently working overtime to make HAMP work better; every month they are putting pressure where they can to make it better. That's how a healthy government is supposed to work, but it can only be done if the tone is set by an outsider. And Elizabeth Warren is the one qualified candidate with a proven track record of standing up to the banks and to the Treasury.

And as Steve Clemons wrote: "It's about time that at minimum, the White House got a 'team of rivals' on economic policy rather than just a 'Team of Rubins.'"

Mike Konczal is a Fellow at the Roosevelt Institute.

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Energy Deregulation - Troubled Past Portends Scary Future

Jul 22, 2010Wallace Turbeville

oil-rig-150A deregulated energy sector encourages manipulation, greed, and catastrophes.

oil-rig-150A deregulated energy sector encourages manipulation, greed, and catastrophes.

My earlier ND20 article outlined the deregulation of energy commencing in the 1990s.  Unleashed from government constraints, the industry was to serve the public's energy needs efficiently and economically. Free market forces were to supplant the waste and unwarranted burden of governmental oversight, forcing down prices and improving operations.

I must report that things did not work out very well.  Everyone is aware of the Deep Water Horizon oil spill and the Upper Big Branch Mine explosion.  The costs in human life, environmental damage, jobs and financial loss have been enormous.  It was all the direct result of the subversion of regulation by the oil and coal industries, a form of deregulation known as "regulatory capture."

Far less understood are the consequences of deregulating the other two energy sectors, natural gas and power.  After 60 years, price regulation of wholesale markets was ended by Congress and the regulators.  Vertically integrated power utilities divested many of their generating assets to unregulated Independent Power Producers to take advantage of the new free market.  Derivatives trading in these markets was then deregulated, allowing the banks and big oil firms to dominate price hedging.

Consumer prices were supposed to fall as fierce competition and unfettered trading improved efficiency.  That did not happen.  For the decade commencing in 2000, when the last phase of deregulation was completed, power prices increased 40% more than the rate of inflation. Natural gas price performance was worse. In 2009, gas prices plummeted as demand evaporated with recession. Before that year, gas prices increased 110% more than inflation for the period.

No doubt, competition drives down prices.  But if the costs of creating competition increase prices more, the net result is just a bad business deal.

Energy is a capital intensive industry.  Before deregulation, most capital investment was made by price-regulated businesses, such as gas pipeline companies and vertically integrated utilities operating within protected franchise territories. Regulated utilities and pipelines had extraordinarily low capital costs because of low risk. The new unregulated businesses were much riskier because they were exposed to market price changes.  For the consumer to benefit from deregulation, savings from competition had to overcome higher capital costs of the riskier companies.

This problem has gotten progressively worse since full deregulation.  Price risk was seen to be an unacceptable credit exposure for the unregulated companies.  Prices had to be hedged through derivatives transactions for the companies' credit standing to be acceptable.  Today, when energy companies present themselves to investors and ratings agencies, they feature their hedging strategies prominently to justify higher share value.

Most energy firms are not well-equipped to secure hedges in the conventional trading markets.  Derivatives positions require ready access to cash, and a lot of it.  Values change abruptly and the swings can be very large.  Adverse moves must be covered immediately with cash collateral posted to clearinghouses and counterparties.

Whipsawed by the need to hedge and the intolerable cash requirements of hedging, energy companies have turned to devices created by banks which can be used to avoid liquidity demands.  These devices involve risks and costs that the energy companies often do not understand (or, perhaps, care to understand). As long as they have access to hedges and the costs and risks are obscure, their businesses can survive.

Incidentally, the energy companies fought hard to secure the "end user" exemption in the financial reform legislation largely to preserve these devices.  If the cost of hedging were to become transparent under the reforms, share values would be lower.

The weakness and high capital cost of unregulated energy are illustrated by the bankruptcy of three of the largest unregulated power companies since 2003 - Calpine, Mirant and NRG. In 2008, Constellation went to the brink of bankruptcy, only to be bailed out by a cash infusion of $1 billion by Warren Buffet and the sale of a 49.9% interest in its nuclear facilities to Electricite de France for $4.5 billion.  Constellation was considered the most sophisticated unregulated producer since it was staffed largely by former Goldman Sachs personnel. Ironically, it almost failed because of a recordkeeping error related to trading.

The bankrupted companies and Constellation represent power generating capacity sufficient to serve all of the needs of New York, New Jersey, Pennsylvania and New England.

There is much, much more.  The effect of predatory bank energy trading of energy is the subject of a forthcoming article. In addition, several notorious events in the recent past were rooted in energy deregulation. Four are described below. Remedial action was taken in each case, but the stories should not end there.  Sharp minds are still hard at work seeking unfair advantages which endanger the system. We must expect similar disasters and scandals if regulatory controls are not somehow re-imposed.

California Energy Crisis. Anticipating deregulation, the state established a set of rules for the economic allocation of wholesale demand among competing power suppliers. A continuous auction process set prices during each day at levels necessary to secure supplies. In the summer of 2001, as demand peaked, suppliers implemented strategies to game the system. There were many complex strategies with ominously named, as if the traders were playing video games. (Enron's "Death Star" was most notorious.) Generally, they were designed to withhold supply, drive up prices and then sell at enormous premiums, all within short timeframes. The utilities commission refused to allow the power distributers to pass along the costs to customers. After suffering brownouts, $45 billion in losses and the bankruptcy of Pacific Gas and Electric (which serves most of northern California), the Federal Energy Regulatory Commission and the state combined to force an end to the crisis using price caps.

Round Trip Trading. Unregulated electronic trading on the Intercontinental Exchange offered a major opportunity for manipulation. Traders at two firms could collude to transact at a price and then execute a reversing transaction later so no one lost money. Energy markets are really collections of small markets based on specific delivery points.  Round trip trades artificially moved the price of gas and power at specific delivery points for the advantage of the participants. As an added incentive, ICE had a program of granting stock warrants (tremendously valuable in an IPO) based on customer volume which was inflated by the rigged trades.  When round trip trades were discovered in 2003, it became apparent that the practice was widespread.

Amaranth. This hedge fund put on a massive, highly leveraged position betting on the spread between natural gas prices for deliveries in March and April in each of the years 2007 and 2008. It was the idea of Brian Hunter, a 30 year old trader who was later dubbed by the DealBreaker blog as "the destroyer of all worlds."  In 2006, the trades lost $6.8 billion and Amaranth (a symbol of immortality in Greek mythology) collapsed. Energy markets were massively disrupted. To put this in perspective, Long Term Capital Management lost "only" $4.6 billion in 1998.  However, LTCM was integrated into Wall Street and the Fed stepped in to force a takeover by several banks to bail out investors. Does this sound familiar?

Financial Transmission Rights. The theorists behind deregulation of the power markets had a problem.  Power delivered to the grid nearer the site of demand and transmitted along uncongested paths is more valuable than the alternative. Power could not be priced efficiently in daily auctions without accounting for this value. Predictably, the experts came up with a market-based solution.  Rights to transmit from point to point would be periodically sold at auctioned by system operators to provide price signals.  But too few parties were interested in such rights to assure a valid auction.  The theorists proposed mechanisms to attract outside, financially interested bidders.  To a cynical, market-savvy observer, this was a recipe for speculation by traders in a highly volatile derivative instrument without having to post margin to cover risks.  In 2007, unsurprisingly, a few thinly capitalized shell companies which faced transmission rights losses to PJM (the system operator for the Mid-Atlantic region) simply walked away. PJM members had to kick in $100 million or so to cover the loss.  While this loss pales in comparison with Amaranth's, the episode illustrates how deregulation of complex markets can have perverse and unpredicted consequences.  If the members had refused to pick up the tab, claiming that PJM was inept and the risks were undisclosed, the largest power system in the United States might have financially failed.  In truth, this alternative appealed to many members.  We are lucky that the loss was small enough so that they paid up after a short struggle.

Some may say that the chicanery and ineptitude outlined above should not trouble us.  After all, remedies and firewalls have been put into place.  Do not believe it.  The deregulated energy sector is complicated, fast moving and large. It bristles with tempting opportunities to make a quick buck by manipulating the system. For deregulated energy, the past portends the future.

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

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Book Notes: McKibben's EAARTH

Jul 21, 2010Bryce Covert

earth-150Our Life on Earth is Too Big To Fail.

earth-150Our Life on Earth is Too Big To Fail.

Our world -- our food, our energy, our economy -- has become Too Big Too Fail, which is to say, Too Big. What used to be local, separate systems are now all interconnected, from fossil fuels to food supplies. And these systems are all insulated from the risk we take in destroying our planet slowly -- actually, these days, quickly -- but surely. No agribusiness or electric utility is paying the full cost of the damage to the system, just as no bank feels exposed to the cost of another financial meltdown (a good bailout will make you feel invincible). But in a world in the midst of a climate disaster, we're about to experience complete system failure.

Bill McKibben makes no attempt to comfort or calm the reader of his new book, Eaarth: Making a Life on a Tough New Planet. He makes it clear that we are beyond taking measures to save our grandchildren; we need to take measures to save ourselves. Eaarth, his term for this planet that human activity has so transformed it resembles a new one entirely, will require us to completely change our lives if we want to keep living on it. And you thought passing financial reform was hard!

This is not your father's Earth. Climate change has already permanently altered our landscape. "This is the current inventory: more thunder, more lightning, less ice. Name a major feature of the earth's surface and you'll find massive change," McKibben says. "We are overwhelming the system," says Richard Zeebe, assistant professor of oceanography at the University of Hawaii. While we pump carbon into the atmosphere, plants that normally absorb it are so hot that they are absorbing less. Hotter temperatures will mean falling crop yields while populations continue to grow. In 2008, 40 million people became hungry because of climate change. A "savannizing" process is turning swaths of rain forest into desert. Animals are shrinking to adapt to the new climate. Jellyfish populations, which thrive in warmer waters, are exploding. The oceans are acidifying as they absorb more of our carbon emissions. "Forget the grandkids; it turns out this was a problem for our parents," McKibben says.

Just as with the financial sector, the system's complexity will mean its downfall. "We've connected things so tightly to each other that small failures in one place vibrate throughout the entire system," McKibben points out. A decision to turn some of our corn crop into clean-burning ethanol sent food prices skyrocketing and nearly starved us all. When Peanut Corporation found salmonella in their food, they poisoned 19,000 people through products that ranged from dulce de leche cookies to dog treats before a recall in January 2009. "It's not just the banks that have gotten too big to fail, but all the arrangements of modern life." That includes the economy, power generation, and perhaps most important of all, our food supply. After all, as McKibben says, "The only truly crucial question that human beings ask is: ‘What's for dinner?'"

The name of the game is no longer grow, but maintain. Obama's stimulus program, McKibben points out, was not meant to build more roads, but to simply repair the crumbling ones we've got. "When the wind blows harder and lightning strikes more often and more rain falls and the sea rises, repair and maintenance become full-time jobs." We have to turn to safety rather than risk and start thinking in terms of long-term consequences -- this applies not just to Goldman Sachs' business practices, but our entire economy. And we have to stop trying to grow at breakneck paces and think about just staying the size we are. In McKibben's words:

The economy that has defined our Western world is like a racehorse, fleet and showy. It's bred for speed, with narrow, tapered legs; tap it on the haunch, and it accelerates down the backstretch. But don't put it on a track where the rain has turned things muddy; know that even a small bump in its path will break its stride and quite likely snap that thin and speedy leg. The thoroughbred, like our economy, has been optimized for one thing only: pure burning swiftness. (Also, both are now mostly owned by sheiks.) What we need to do, even while we're in the saddle, is transform our racehorse into a workhorse -- into something dependable, even-tempered, long-lasting, uncomplaining.

And it also means going from the Mega Big Corporation model to the local community model -- particularly in agriculture. We need smaller, more diverse systems that are reliable and harder to tamper with. "The vast conformity of our agriculture puts us at risk -- there are no more firewalls than there were in our financial system," McKibben says. As Move Your Money urges consumers to move to community banks and get away from the bad practices that ferment in hulking corporations, McKibben urges Americans to buy food at local farmer's markets to support diversified farming. Smaller farms can implement more Eaarth-friendly practices such as intercropping, planting more crops in a year, and crop rotation. Plus it will be cheaper -- getting rid of all the middlemen involved in producing food can bring down its cost. And it doesn't have to come solely from farmers, either: a garden in your backyard or on your roof can be an excellent source of low-carbon food.

McKibben also wants to find "the equivalent of farmers' markets in electrons": localized, distributed energy generation. Electrons are conserved by transporting them over smaller distances. Electricity can be generated from renewable energy sources that are close to home. Rather than building a forest of windfarms in windy North Dakota and shipping that electricity a long way over expensive-to-build, not-yet-existent transmission, use "hydropower in the Northwest, offshore wind in the East, solar energy in the Southwest." But none of these sources are as important as plain old conservation, which McKinsey estimated in 2008 as being able to cut world energy demand 20 percent by 2020.

A lot of these changes will need to come from above. "All this change would get much easier if the federal government favored small players, not huge corporations," he says. And as for us, moving from explosive growth to steady survival will take a huge attitude shift. But what other choice have we got?

Bryce Covert is Assistant Editor at New Deal 2.0.

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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


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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