Monday, November 22, 2010

Economic State Reviewed John Cassidy Wall Street Wins We All Lose

Tags: Financial System Safe or Not, Banks Need More Regulations, Breakup the Big Banks, Separate Our Bank Money from Speculators, John Cassidy, Adam Smith, Currency

Reporters are beholding to Wall Street in the sense they have to get information from them. John Cassidy has the advantage not given to most reporters in that The New Yorker allows their reporters time to investigate and think before reporting. Also he writes in a clear manner and is remarkably easy to understand. His 14 page article in the New York Review of Books is a blessing for those readers who cannot tolerate soundbites from reporters in columns or on television to explain more complex subjects such as the financial system.

Intelligent voters who voted for Obama in 2008 should have known from his background that he got along very well with free market economic conservatives at Harvard Law whom he would be heavily influenced by them after the financial crash. He chose advisors and reappointed a Fed Chairperson who had a similar ideology and appointed those who believed in the same economic policies which led to the financial meltdown.

All these folks claim they read Adam Smith’s 1,200 pages Wealth of Nations even though they had not read through the dense prose. For labor secretary has a forward in the current copy of this book and greatly improved the index. Look up banks and you will see that he said a number of things about banks. The most important is that banks in contrast to the economy must be strongly regulated and not allowed to get too powerful. He also send that we must not have unlimited currency exchanges between countries because it will seriously hurt weaker countries as we have seen throughout the last few decades.

Malaysia came out well during the Asia crisis because they did not allow investments go in and out at will. Chile did this to and came out well during turmoil. Unfortunately Argentina did not and they got hammered by George W. Bush’s punishing currency manipulations to bankrupt Argentina because they were starting to resist the takeover of their country by foreign corporations done by the previous administration. Even their subways and water was controlled by others. Yes, it has been a popular policy for us to bribe the leader of a country to give up its sovereignty.

Cassidy explains why the policies implemented by Obama will eventually lead Wall Street to take even higher risks because our government has no choice to bail them out again.

One lesson learned from the financial meltdown is to not put your money in money market funds. Unlike banks they are not insured and have no capital to pay investors if another crash occurs. When lots of people are worried and going into gold because they fear inflation which includes the hedge funds at least publicly, it is time to develop a more optimistic demeanor. Depending on your nature how much you invest will depend on your personality and safety concerns.

Jim Kawakami, Nov 22, 2010,

The Economy: Why They Failed, John Cassidy, The New York Review of Books, Dec 9, 2010,

John Cassidy is a staff writer at The New Yorker and the author, most recently, of How Markets Fail: The Logic of Economic Calamities. The article in this issue is drawn from the afterword to the paperback edition, which has just been published. (December 2010)

On Wall Street, the Great Recession didn’t last very long. Having sustained losses of $42.6 billion in 2008, the securities industry generated $55 billion in profits in 2009, smashing the previous record, and it paid out $20.3 billion in bonuses. In the spring of 2010, the Wall Street gusher continued to spew money. Between January and March, Citigroup’s investment banking division made more than $2.5 billion in profits. Goldman Sachs’s traders enjoyed their best quarter ever, generating an astonishing $7.4 billion in net revenues.

Barely a year and a half after the collapse of Lehman Brothers, Wall Street was once again doing well for itself—obscenely well, it seemed to many people. “For most Americans, these huge bonuses are a bitter pill and hard to comprehend,” noted Thomas DiNapoli, the comptroller of New York State, whose office tracks Wall Street profits. “Taxpayers bailed them out, and now they’re back making money while many New York families are still struggling to make ends meet.” In other parts of the country, Americans weren’t merely resentful; they were fiercely angry at the Wall Street bonus recipients and the politicians who had rescued them. (“Hank, the American people don’t like bailouts,” Sarah Palin, John McCain’s running mate, had warned Treasury Secretary Henry Paulson in October 2008.)

And yet, judged purely in economic terms, the Bush-Obama rescue program had proved fairly successful. Since July 2009, the Gross Domestic Product had been expanding steadily, confirming the predictions of recovery that Timothy Geithner and Ben Bernanke had made. The rate of growth was modest rather than spectacular—about 3 percent on an annualized basis—but it belied the doomsters’ prognostications. Measured by the economy’s overall output of goods and services, the recession had ended more quickly than expected. In May 2010, the Organization for Economic Co-operation and Development, an economic research body based in Paris, said that the world economy would grow by 4.6 percent in 2010 and 4.5 percent in 2011. Despite widespread fears of a “double dip” recession, the global recovery appeared to be continuing. …

The other losers in this game were those who had cash stashed in a savings account or money market mutual fund. “What we have right now is a situation where every saver in the country is, essentially, paying a huge tax to bail out the banking system,” noted Raghuram Rajan, the University of Chicago economist who, back in 2005, had issued a fateful warning about the dangers of a financial blowup. “We are all getting screwed on our money market accounts—getting 0.25 percent—and the banks are making a huge spread on nearly every asset they hold, because they are financing them at pretty close to zero rates.”

The Obama administration didn’t come out and say so, but enabling the banks to make big profits was one of its policy objectives. Rather than seizing control of sickly institutions, such as Citi and Bank of America, it had settled on a policy of allowing them to earn their way back to sound health, while also encouraging them to raise money from private investors. This was the rationale behind the controversial “stress tests,” which the Treasury Department and the Fed carried out in the spring of 2009; they were intended to find out how much new capital the banks needed to survive a deep recession.

In May 2009, when Geithner announced that the ten biggest US banks needed to raise just $75 billion, many economists had accused him of understating the banks’ remaining holdings of toxic assets. In fact, the official loss estimates were similar to those produced by independent analysts. But the government stress testers were assuming that other parts of the banks’ businesses, particularly their trading operations, would record greatly enlarged profits in 2009 and 2010, which would help them withstand big losses in real estate and commercial lending. Buried in the Treasury’s official report on the stress tests was the prediction that Citigroup’s net revenues in 2009 and 2010 would exceed by $49 billion its provisions for losses through bad loans. For Bank of America, the projected profit figure was $75.5 billion. For Wells Fargo, it was $60 billion.

When these enormous profits duly materialized and the banks distributed some of them to their employees, the public was outraged. Critics accused the Obama administration of overlooking less offensive options for stabilizing the financial system. One idea, widely canvassed in early 2009, would have been to seize control of troubled firms, move their tarnished assets into a state-run “bad bank,” and eventually refloat them on the stock market as smaller, healthier institutions. Twenty years previously, during the savings and loans crisis, this approach had been adopted successfully. Theoretically, it would have enabled the government to fire reckless bank managers, wipe out bank shareholders, and impose a “haircut,” i.e., a reduction in repayments, on bank creditors, thereby punishing the guilty rather than rewarding them with a bailout. “While the Obama administration had avoided the conservatorship route, what it did was far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses,” the Nobel-winning economist Joseph Stiglitz wrote in his 2010 book, Freefall: America, Free Markets, and the Sinking of the World Economy.

Members of the administration countered that its critics had greatly underestimated the practical difficulty of pursuing the nationalization option. If the government had seized Citigroup, one senior Treasury official told me, it could well have created creditor “runs” at other banks suspected of being on the government target list. The only way to prevent this from happening, the official said, would have been to spend $3 trillion and take over all the big banks. That figure may be an exaggeration, but the fear of sparking another financial crisis was a real one, and so were the political concerns of the White House and the Treasury Department. Neither President Obama nor Geithner had any appetite for a policy that smacked of radicalism and big government.

From an economic viewpoint, the most serious problem with the rescue programs was not that they further enriched the loathed bankers but that they exacerbated some serious incentive problems at the heart of the financial system. By extending trillions of dollars in loans, capital injections, and debt guarantees to troubled firms, the US government and its counterparts overseas had greatly extended the public safety net for banks and other financial entities. Left unchecked, this expansion will surely lead to more blowups, followed by even bigger bailouts.

The problem is one of rational irrationality. Once people in the financial sector come to believe that the government will cap their losses, they have an incentive to step up their risk-taking, what is called “moral hazard.” Simply announcing that there won’t be any more bailouts won’t solve the problem, a point noted by two Bank of England economists in an important paper published in November 2009. Policymakers may say “never again,” wrote Andrew Haldane and Piergiorgio Allesandri,

but the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop. …

One thing is clear, though: the economy needs more help. In the third quarter of 2010, the overall level of demand for goods and services produced in the United States expanded by just 0.6 percent on an annualized basis. (A surge in accumulation of inventories—goods prepared for sale that are still sitting in factories and stores—boosted the GDP growth rate to 2 percent.) In plain English, the economic recovery has faltered badly. Relying on Ben Bernanke and his colleagues at the Federal Reserve to get it going again is a very risky strategy—akin to asking the pilot of jetliner that has stalled in the middle of the Atlantic to fly the rest of the way on one engine. Things might just work out. But if the other engine can also be restarted—and it can be—why take the risk?

1 comment:

  1. Corrections: Former Labor Secretary Reich 3rd paragraph
    change send to said