Super Heroes of Macroeconomics

Somebody must have a lot of time on their hands to write a song called “Hey, Paul Krugman” but still, if the angsty, artsy fartsy creative class that foisted this POTUS on us is finally waking up, then Twitter me when the Revolution comes.  I’ve even read the orange cheeto place  and seems even a few of them are beginning to see the writing on their blackberries.

So, Paul is still appalled and speaking out against the Zombie Plan.   I’d say this is another sfz! warning to the White House.  What I can’t repeat enough is that it’s not just Paul.  It’s not just me.  It’s everyone with any knowledge of macroeconomics and the financial system.

Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

fiscal-flash-001I don’t know if you’ve ever sat in an economics class, but most of you who have will attest that few economics professors are what you would call the dramatic, excitable types.  However, I’ve seen more animation out of them recently than I’ve seen in all recent Marvel Comic Books.

From “Reasons Why The Obama Administration will not solve this crisis by the end of 2009” at The Underground Investor:

Consider that President-elect Obama voted FOR the horrible $700 billion bailout plan that accomplished less than zero in fixing the global economy while only transferring wealth from people that were struggling the most to the unethical financial executives that created this problem. These were my exact words in October, 2008, verbatim, about the eventual effect of the bailout plan: “Don’t believe the media spin. This will fix nothing. Even if and when the government overpays Wall Street and US banks by 300%, 500% and 1000% for their toxic assets, this temporarily recapitalizes these financial institutions but only creates A MUCH BIGGER PROBLEM for the future.” If I understood why the bailout plan would most definitely fail, as I blogged here, and the next President of the United States could not, that is a scary thought. On the other hand, if President Obama understood that the bailout plan would likely accomplish nothing but the transference of wealth from hard-working citizens to corrupt financial executives and still voted for the bill, then this action needs no further discourse.

From FT’s Willem Buiter:

Why are the unsecured creditors of banks and quasi-banks like AIG deemed too precious to take a hit or a haircut since Lehman Brothers went down?  From the point of view of fairness they ought to have their heads on the block.  It was they who funded the excessive leverage and risk-taking of banks and shadow banks.  From the point of view of minimizing moral hazard – incentives for future excessive risk taking – it is essential that they pay the price for their past bad lending and investment decisions.  We are playing a repeated game.  Reputation matters.

Three arguments for saving the unworthy hides of the unsecured creditors are commonly presented:

  • Unless the unsecured creditors are made whole, there will be a systemic financial collapse, with dramatic adverse consequences for the real economy.
  • If the unsecured creditors are forced to take a hit, no-one will ever lend to banks again or buy their debt.
  • The ultimate ‘beneficial owners’ of these securities – notably pensioners drawing their pensions from pension funds heavily invested in unsecured bank debt and owners of insurance policies with insurance companies holding unsecured bank debt – would suffer a large decline in financial wealth and disposable income that would cause them to cut back sharply on consumption.  The resulting decline in aggregate demand would deepen and prolong the recession.

I believe all three arguments to be hogwash.

Read the rest of this entry »

Those who forget the past are condemned …

(cross-posted at the Confluence)

I’m having difficulty digesting a lot of the news and hoopla surrounding this financial crisis.  There are some things that are really worrying to me.  It’s not so much the crisis itself, which I actually understand, but the responses.  I am reminded of the saying that those who forget the past are condemned to repeat it.  I think this basically sums up much of why I feel so desperate when I watch the response to this crisis unfold on TV. It’s time to stop the blame and start the problem-solving.

First, what really bothers me is the inability of ANY of the politicians to either REALIZE how they contributed to this or understand what lead to this.  A recent post by myiq2xu mentioned a speech by Senator Obama who offhandedly referred to the period of deregulation of industries that went on during the 70s.  He has been hammering his every talking point with the Republicans did this to us.  Useful, I suppose when trying to get elected based on something other than your credentials, but disingenuous at the very least.  I keep wondering if he JUST doesn’t know the history of deregulation or he’s purposefully lying to us.

The deregulation of the telcom industry, the airline industry and the banking industry came about during the Carter regime.  When I was a fresh out of grad school economist, I worked for a bank then a Savings and Loan.  The Monetary Control Act of 1980 (okay, i’m dating myself) was a response to the problem of traditional banks and thrifts hemorrhaging deposits to Money Market Accounts.  The root of deregulation started with Jimmy Carter’s administration. Hasn’t any one told him this or does he just like to go on misspeaking?  The fight against the deregulation against Fannie and Freddie–probably the biggest contributors to this latest moral hazard problem–was led by the Democrats also.  Why can’t we just be honest about this and say that each of the parties had a hand in this and learn from the past?

Second, I lived through the S&L crises and the economy that prevailed in the early 80s.  My first house loan had an interest rate of 17.67% which got discounted to a beneficent 12.67% because I worked for the thrift that gave me the loan.   House loans aren’t even half that at the moment.  Two other folks besides me got house loans that month from the biggest thrift in the heartland.  I’d say that was a credit crunch, wouldn’t you? I also worked the money desk at that time and remember the interbank loan (Fed Funds rate) bopping between 4% and 21% on any given day.  Both of these rates are a far cry from the current rates as is the unemployment rate which sat between 12 and 13% for some time.  Remember, these were the morning in America years of the early 80s.  We currently have a 6.1% unemployment rate.

My father lived through the great depression.  At that time, the unemployment rate peaked between 25% to 29%.   The foreclosures that happened during that time occurred because no one had jobs and no one had unemployment insurance.  When they closed the banks, there was no FDIC so, you lost your life savings.  Today, we have unemployment insurance, the FDIC, and various other types of insurance that minimize the loss you experience on your deposits –even money market funds.  You may experience paper losses, but you will not loose EVERYTHING!  There are safeguards against much of the worst situations experienced during the depression.  I’m not sure that given today’s economy, which is sluggish and experiencing problems but is not as bad as either of these two periods, we need this rush to judgment. Why aren’t we thinking this bail-out plan through more?

Which brings me back to today.  We solved many of the problems of the previous financial crisis with government intervention.  The HOLC bought up many defaulting mortgages, renegotiated them when possible, and held on to the properties, insuring they wouldn’t drive land and house prices down further.  During the S&L crisis, the RTC bought out S&Ls, unwound the assets, and sold the sellable ones while holding onto the bad stuff, until the market turned around.  The government can afford to hold paper losses on its books.  Private industry cannot.  Government can help put a bottom price on these markets.  This is what it needs to do.  It does not need to end the alternative minimum tax, change the taxes on corporations, or fund ACORN and La Raza.

Which brings me to one more point,  when do we stop turning these unprofitable behemoths into megacompanies that become too big to fail?  Haven’t we learned anything in the past about this?  Why are we creating more Freddies and Fannies?  It is not fair to the taxpayer for the profits to be privatized, but the losses to be turned to the public.  During the last 30 years, we’ve allowed mergers to create these giant companies that are behaving more and more like monopolies.  This is not good for a free market system.  If we are allowing them to become so big and letting them get away with extraordinary profits during good times, than making them subject to public largess if they fail, what is the difference between this and just nationalizing them altogether?  Didn’t we learn these lessons during the trustbusting years of Teddy Roosevelt?  Isn’t the basis of our monopoly law the Sherman Anti-trust regulations that were set up in the 19th century?  Why have we forgotten the excesses of the gilded age?

Yes, it’s broken.  Yes, it needs to be fixed.  But can some one in Washington just pick a few history and economics textbooks so we’re not condemned to relearn the lessons of the past and do it with everyone’s tax dollars?

Back to the Roots of the Problem (cross-posted at The Confluence)

I feel a strong need to remind people at this time of the roots of this financial crisis. They are not found beneath Wall Street, but in Washington, D.C. with Freddie Mac and Fannie Mae and the senators and congressman that empowered them.  

The beginning of this crisis was the subprime mortgage market and the loose underwriting standards encouraged by FNMA and FHMLC on mortgage loans.  Fannie (FNMA) and Freddie (FHLMC) are involved with about half of the mortgage loan originations in that market.  Loose standards were set up to expand home ownership to folks who couldn’t pay home loans back and to improve the odds of high compensation for its CEOs.  Before any bail-out, rescue, or whatever you want to call it,  regulation has to be put in place to STOP this from happening again.  It’s really a nice social goal to increase the level of minority ownership in the country and to move the poor into homes of their own, but you can’t force it by giving folks loans they are not prepared to handle.  The House and Senate Democrats, and specifically the Black Caucus, are squarely behind this problem.  It is folks like Chris Dodd and Barack Obama–folks expected to clean up this mess–that were the beneficiaries of Fannie and Freddie largess that created very poor public policy and lack of regulation that led to this problem.

Wall Street did buy up these loans up after they were “packaged” into securities by Freddie and Fannie.  Freddie and Fannie bonds have been assumed to be nearly as safe as Treasury bonds so no one figured there were these toxic loans stuck into the mix.  Banks are also allowed to invest in Fannie and Freddie bonds.  They can’t invest in really risky assets like equities.  Who would have thought that Fannie and Freddie would be so poorly run that what they were investing in, what they were originating and selling to Fannie and Freddie, and what was being put together by Fannie and Freddie, would be so risky as to send their capital into regulator  panicking levels?   Ask Jim Johnson.  Ask Franklin Reines.  Ask Barack Obama and the Black Caucus.  They felt prudent underwriting was basically discriminatory and worked hard to change banks into speculators.

Here’s some examples:

Credit History: Lack of credit history should not be seen as a negative factor…. In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts….

If you’d like to know more about the loosening of standards,  here’s a really good study to check out:

Recently, there were an entirely inexcusable number of underwriting lapses allowed and in fact, encouraged  by Fannie and Freddie (including spurious sources of income and no down payments) that increased the demand for housing by allowing people that should not have been in the housing market, into the housing market.  This drove up prices and led to the bubble and increasing speculation.  Once it became apparent, that there was increasing risk popping up in mortgages,  the financial innovations of derivatives (Wall Street enters now) popped up to help banks manage the risk and pass them on to folk supposedly more able handle the risk.  These things were supposed to act as insurance and were valued based on the idea that traditional Fannie and Freddie were very risk-free and there was implied government oversight, regulation, and back-up.

It is no wonder that the FBI is now looking at Fannie and Freddie.  It should also look at the democratic appointees and the senators and congressman that enabled them.  When credible economist like Greg Mankiw came to the senate and congressional committees to warn of this problem in 2003, folks like Barney Frank yelled at him for worrying more about safety and soundness rather than housing for the little guy.  The Wall Street Journal was all over this back then.

This is the same Barney Frank that is bloviating and stomping his foot about the inability of House Republicans to get with his program.  Well, Congressman, it was your program that put us in this position to begin with so why would we trust you now?

House and Senate Democrats also had a chance in 2005 to increase oversight and regulation of Fannie and Freddie.  John McCain was a co-sponsor of this bill called Federal Housing Enterprise Regulatory Reform Act of 2005.  At the time McMcain made this comment that seems almost psychic now.

“If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”

You know how Senator Obama is going around saying the Bush administration is the one that hates regulation and led to this?  As a professional economist and Puma, may I just say this: liar, liar pants on fire!

 WASHINGTON – Treasury Secretary John Snow urged Congress to restrain Fannie Mae and Freddie Mac, giving the Bush administration’s blessing to efforts to create a new regulator with broad power over the huge mortgage companies.

If you read the article, you’ll see that Allan Greenspan was also in front of congress and the senate begging for more oversight.

More from that article:

“The statements by Greenspan and Snow lent support to a new effort by Republican lawmakers to tighten controls on Fannie Mae and Freddie Mac, which hold or guarantee more than 45 percent of all mortgage loans in the country. Legislation recently proposed would set up a regulatory agency with the power to compel the companies to sell off any assets deemed not to be in line with their mission of making homeownership more widely available.

Notice the guarantee point.  Wall Street and Banks rely on these instruments to be low risk basically because of that guarantee.  This includes AIG and all the investment banks that just crashed.  They undervalued the risk on these instruments because of the implicit guarantee.

My point here?  Congressional republicans (who I usually find a source of great evil) are NOT the bad guys here for once.  They tried but were told they were racist and that they hated poor people if they didn’t go along with the plan of extending house loans to people that basically could not afford them.  Most of the blame for this financial crisis belongs squarely in Washington and the Democrats are relying on our extremely short memories.  Since all of this comes under my teaching and research responsibilities, I cannot have a short memory. The MSM should start asking Biden, Obama, Frank, and Dodd some very tough questions.  First Questions?  Why didn’t you support regulating Fannie and Freddie back before all of this snowballed into a financial crisis?  Why are you now saying that you always supported more oversight and regulation and Republicans and the Bush Administration did not when the record clearly shows it was the opposite?

I’d like to suggest one of the first CEOs to turn back his salary and face the FBI is Franklin Raines.

He turned Fannie Mae into a mortgage factory to get higher bonuses and was investigated for cooking the books.  He is undoubtedly one of the folks that has interested the FBI.  Another person is Jim Johnson. (You’ll recognize these names because they are both Obama friends and advisors).

In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report  on September 20, 2004, alleging widespread accounting errors, including shifting of losses so Raines and others could earn bonuses.

In June 2008, the Wall Street Journal reported that two former CEOs of Fannie Mae, James A. Johnson (1991-1998) and Franklin Raines (1999-2004) had received loans below market rate from Countrywide Financial. Fannie Mae was the biggest buyer of Countrywide’s mortgages.  Don’t forget the three biggest recipient of FNMA money are Dodd, Kerry, and Obama. Dodd also appears to have a sweetheart mortgage deal.  The Democrats are not the white knights in this mess.  They would probably like to get this deal through as quickly as possible so voters do not find out that the bailout is not just a Wall Street Mess.  It is a K Street and Washington-created mess.  There is plenty of blame and greed to go around.

The very same people that created this mess are the ones writing the terms of the bail-out.  Be afraid!  Be very afraid!  I never put a steak on the kitchen counter and leave the dog alone in the room with it.  I would not leave the U.S. economy in the hands of these folks who are deciding the fineprint in a room with closed doors either.