President Obama and Goldman Sachs: A Quid Pro Quo?

Wall Street and the White House may be closer than the typical American thinks. One way this is accomplished is for a bank to contribute heavily to both presidential campaigns so as to be able to hedge political risk by getting ex-managers into strategic posts in the executive arm of the U.S. Government. This can be the case even when one of the candidates has campaigned on holding Wall Street accountable, such as after the financial crisis of 2008. There is the campaign slogan, and there is the political-economic reality underneath. 

U.S. President Obama nominated Timothy Geithner to be Secretary of the Treasury. While president of the New York Federal Reserve Bank, he had played a key role in forcing AIG to pay Goldman Sachs’ claims dollar for dollar. Geithner, as well as Henry Paulson, Goldman’s ex-CEO who was serving at the time as Secretary of the Treasury under President Bush, stopped AIG from the leverage in its bankrupt condition to pay claimants much less than full value, which would have been expected given AIG's plight. Once Geithner became Secretary of the Treasury under Obama, Geithner’s chief of staff was Mark Patterson, a former lobbyist for Goldman Sachs.

To head the Commodity Futures Trading Commission—the regulatory agency that Born had headed during the previous administration—Obama picked Gary Gensler, a former Goldman Sachs executive who had helped ban the regulation of derivatives in 1999. Born had pushed for the securities to be regulated, only to be bullied by Alan Greenspan (Chairman of the Federal Revere) and Larry Summers, whom Obama would have as his chief economic adviser. To head the SEC, Obama nominated Mary Shapiro, the former CEO of FINRA, the financial industry’s self-regulatory body.

In short, Obama stacked his financial appointees during his first term with people who had played a role in or at least benefited financially from financial bubble that came crashing down in September 2008. Put another way, Obama selected people who had taken down the barriers to spreading systemic risk to fix the problem. Why would he have done so? Could it have been part of the quid pro quo the president had agreed to when he accepted the $1 million campaign contribution from Goldman Sachs (the largest contribution to Obama in 2007)? Might Goldman’s executives have wanted to hedge their bets should the Democrat win? Unfortunately, getting Goldman alums in high positions of government would essentially make the U.S. Government a Wall Street Government—one that would be hampered in holding Wall Streeters accountable, even in terms of criminal prosecutions related to the financial crisis. It is no accident, we can conclude, that the spiraling economic inequality increased during the Democrat’s first term of office.

Source: Inside Job (2010), directed by Charles Ferguson

Undermining the Dodd-Frank Act: An Incessant Desire for Profit

In the Dodd-Frank financial reform Act of 2010, financial firms in the U.S. are required to set aside higher reserves to cover losses on trades of securities, including those that “swap” the risk of default of a given security, such as bonds based on subprime mortgages. Almost immediately, the Wall Street bankers set about minimizing the new hindrance.  
Traders in the banks set about getting around the “margin requirements” by treating the “swaps” as futures, which do not require the higher reserves in Dodd-Frank. Whereas a futures contract for corn to sell at a certain price limits residual risk, swapping the risk of the default of an investment puts a party on the line for the entire investment. Moreover, unlike futures contracts, swaps have significant systemic risk because claims can all be made at once, overwhelming the parties assuming the liability in the swaps (e.g. AIG in September 2008). 
Managers at Wall Street firms have tended to not only minimize safeguards even though they protect the banks (from themselves), but also discount or even dismiss such high-risk, low-probability outcomes as come with risk to a bank as well as the entire financial system (i.e., systemic risk). Meanwhile, less money held in reserve means more money available to be lent or put into high-risk investments such subprime mortgages or bonds based bundles of such high-risk mortgages. 
Accordingly, the gradual trajectory already as of the beginning of 2013 was toward yet another systemic collapse of the financial system should enough housing markets take a down turn. “As the market gravitates to the cheaper platform—and it’s cheaper because it’s unsafe—that creates risk for everyone,” said James Cawley, CEO of trade execution firm Javelin Capital Markets.[1]  Put another way, market participants were operating according to the greatest profit, the greater risk notwithstanding. “In a distress scenario, you basically have what you had from AIG in 2008,” Cawley said; “Then someone has to step in, and we all know who that someone is: the U.S. taxpayer.”[2] So the question at the time was perhaps whether the SEC had the taxpayer’s back or was reflective of, or enabling a cozy revolving door between the federal government and Wall Street firms.
To be sure, the Volcker Rule, part of the Dodd-Frank Act, would, unless weakened, bar banks from short-term proprietary trading (i.e., on their own accounts, except for market-making), and from taking ownership states in private equity funds and hedge funds. U.S. Senator John Hatch speaking at Jack Lew’s confirmation hearing in early 2013 raised the question of whether Lew would act as U.S. Secretary of State to constrain banks’ risky proprietary trading, given that he had headed units at Citigroup that were involved in just such practices that would violate the Volcker Rule. 

Jack Lew at his confirmation hearing for U.S. Treasury Secretary. Lew had been the chief operating officer at units at Citibank.     NPR

Lew had been the COO of Alternative Investments at Citi. MAT and Falcon investment funds were sold as low-risk even though those funds were actually hedge funds with high risk.  As COO, Lew refused to offer the misled customers full refunds.  At least fourteen arbitration panels subsequently gave the customers the full refunds they had sought. Although he had not been involved in selling the funds, he did manage units that engaged in risky proprietary trading. The public would be justified in wondering if they too would be left on the hook as taxpayers rather than protected should Lew favor Wall Street's incessant desire for profit over the government's role to place that desire in check for the good of the system/whole.
After Lew, during President Trump's first term, the Federal Reserve Bank voted unanimously in late May, 2018 to weaken the Volcker Rule. The move was consistent with the president's desire to deregulate Wall Street. The flip side of the move that would enhance Wall Street profits was that the government would be doing less to protect the financial system as a whole even though the systemic risk of the largest five banks had increased with their growth. As Senator Dick Durbin had said after the financial crisis when people were looking to Congress to protect even the banks from themselves, “Congress is owned by the banking lobby.” So looking to the legislative branch should the executive be in sync with Wall Street's financial interests may not play well. Even after semi-stringent regulatory constraints have been passed, Wall Street can still have the edge in circumventing or mollifying the speed-bumps even though they are in the bank's own long-term interest, which can come to roust even in the short term as in 2008.

See Essays on the Financial Crisis, available at Amazon.

1. Eleazar Melendez, “Wall Street Setting Itself Up For Next Derivatives Crisis, Market Participants Warn,” The Huffington Post, February 14, 2013.
2. Ibid.

On the Gravitational Pull of Clearinghouses in Congress after the Financial Crisis

Lest it be assumed that the Dodd-Frank financial-reform Act, which became law in 2010, two years after the financial crisis, would render it less probable that taxpayers would again be faced with having to bail-out financial institutions even without strings attached in order to keep the financial system intact and the American economy from collapsing, Gretchen Morgenson of The New York Times wrote two years after the Act's passage that “failing to confront the too-big-to-fail question is a serious oversight.”[1] For one thing, disproportionately increasing the amount of money that the biggest banks must hold against a rainy day once again neglects the possibility that every bank is having such a day on the same day and so none of the banks will loan to other banks (i.e., the commercial paper market). When a financial system itself is sick to the extent that it cannot stand, all the heavy dominoes may topple, one after another, even though each has more support. Secondly, widening the too-big-to-fail category enables more financial institutions to engage in risky bets because the expanded net could limit any eventual downside. Sure enough, Morgenson points out that the legislation “actually widened the federal safety net for big institutions. Under the law, eight more giants were granted the right to tap the Federal Reserve for funding when the next crisis hits.”[2] Those institutions, including the Chicago Mercantile Exchange, the Intercontinental Exchange, and the Options Clearing Corporation were even able to avoid the penalties for failure specified in the Act. The clearinghouses had successfully argued that even though only banks had been allowed to borrow from the Fed’s discount window, the clearinghouses are not financial institutions; rather, they are financial utilities. So, should they fail, they should not have to be “wound down” by regulators. This is essentially having it both ways and getting away with it. To explain this comfortable arrangement, we would need to look under the hood, so to speak, where I suspect we would find an exclusive world wherein vast private wealth is itself political power even apart from any attendant lobbying activity.

In 2011, the CME Group, the parent company of the Chicago Mercantile Exchange, made almost $3.3 billion in revenue. Craig Donohue, the CEO, received $3.9 million in compensation and held an additional $10 million worth of equity outstanding. With this kind of money comes inherent influence, politically speaking. A very large concentration of wealth has a certain mass, by analogy, that bends space itself and thus has the force of gravity on other masses. This subtle force operates on legislators and regulators too, and thus complements both the influence of lobbying and campaign contributions. Even beyond the ability or wherewithal of great wealth to reward and punish, money talks; it is respected in itself. 

So great concentrations of wealth, like giant planets warping the space nearest to them, intrinsically warp a democratic system, which facilitates the natural tendency of great masses of wealth to attract even more. Hence after the financial crisis and the TARP and Fed infusions of cash, the five largest American banks were even bigger, and thus carried more systemic risk from the vantage-point of the financial system as a whole. In other words, it was even more likely that any of those banks, should it fail, could bring the system down. Additional reserve requirements seems like a paltry means of countering this natural law of great concentrations of wealth. Given their inherent and practiced influence, it should come as no surprise that they leverage the natural law by using even elected officials to bend the space appreciably more. 

It should be no surprise, according to Sheila Bair, the former head of the Federal Deposit Insurance Corporation, that just when the managers at the clearinghouses “were drooling at the prospect of having access to loans from the Fed, top officials at the Treasury and the Fed, over the objections of the F.D.I.C.,” pushed Congress to allow the non-banks access to the Fed’s discount window as part of the Dodd-Frank Act even while saving the clearinghouses from being subject to the law’s “wind-down” requirements.[3] Approving members of Congress likely either saw the huge amount of clearinghouse wealth as impressive and thus eminently worthy of being tapped for political contributions or were already tapping. It is as the density of the wealth had a warm glow even though a cold winter. 

According to Morgenson at the time, the clearinghouses had "considerable clout in Washington. From the beginning of 2010 through [November 2012], the CME Group . . . spent $6 million on lobbying.”[4] Warping space even more by redesigning artificial contours is apparently not cheap. 

As though a rationale were needed, managers at CME argued that once their institution received Dodd-Frank’s designation of “systemically important,” the Fed “should provide access to emergency lending” and without strings.[5] Without strings! It would seem that a certain presumptuousness comes from prolonged exposure to the warped space near the immense concentrations of wealth. Not included in the Act’s penalties for failure, CME hardly deserved an “offsetting” benefit. The lack of symmetry alone is indicative of the sheer influence of great wealth. Would such wealth, as almost the entire wealth on the planet concentrated, be a black hole? No one could escape its pull! 

More realistically, when, according to Morgenson, “large and systemically important financial utilities that together trade and clear trillions of dollars in transactions appear to have won the daily double—access to federal money, without the accountability" in being wound down after failing—the rest of us can legitimately wonder how much of the Dodd-Frank Act can be relied on to protect the financial system and economy, and thus us, after the warping effect of the giant planets. Shouldn't they be pared down, given their sizable risk to the system? If so, democratic government would be less warped and thus more directly oriented to the public good. For if a government is thwarted in this role, who is going to look after our macro systems, whether they be economic, political, or societal in general? 

See Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon. 

1. Gretchen Morgenson, “One Safety Net That Needs to Shrink,” The New York Times, November 3, 2012.

2. Ibid.

3. Ibid.

4. Ibid.

U.S. Presidents Buckle at Constraints: The Case of Obama's Recess Appointments

A constitutional system of checks and balances is premised on the assumption that government officials will seek to get as much power as they can. Constraint itself becomes a dirty word. Admittedly, the desire to resist or ignore constraints may be in human nature itself, though people differ in how much self-discipline they will bring to the task of restraining themselves from walking through constraints as if they were Chinese walls made out of paper. A constitutional system that checks ambition with ambition must not assume that some of the more beloved elected representatives can be relied on to resist the temptation to go too far. I have in mind the case of the U.S. president being able appoint officials without the confirmation by the U.S. Senate.

The President cannot decide that the Senate is on recess in order to be able to make recess appointments without  needing confirmation. This was the ruling of the federal court of appeals in Washington, D.C. The case involved the appointment of three members of the National Labor Relations Board. A three-judge panel of the court ruled that the appointments “were constitutionally invalid” because the U.S. Senate was not in recess on January 4, 2012 when President Obama made the recess appointments. If the president were free “to decide when the Senate is in recess,” it “would demolish the checks and balances inherent in the advice-and-consent requirement, giving the President free rein to appoint his desired nominees at any time he pleases,” the court opinion reads.[1] Of course, the Senate could also abuse its privilege by declaring itself in session when it is de facto in recess in order to prevent recess appointments. The balance in “checks and balances” implies that neither side is able to render the other impotent to act. In other words, neither side should try to game the constitutional system.
For its part, the White House viewed the ruling as applying only to the three NLRB appointments in the suit, rather than extending to Obama’s appointment of Richard Cordray as director of the Consumer Financial Protection Bureau (CFPB). That appointment too was made on January 4, 2012. Because the court ruled that the U.S. Senate was not in recess, it stands to reason that any recess appointment made by the president on January 4, 2012 was invalid. Even so, White House spokesman Jay Carney said that Obama’s appointment of Richard Cordray was not affected by the court’s decision. “The decision that was put forward today had to do with one case, one company, one court,” Carney said. “It has no bearing on Richard Cordray.” I contend that it did.
The ruling states that no recess appointment can be made by the president when the U.S. Senate is not in recess. Even if the Obama Administration disagreed with the ruling, to narrow it dogmatically to just three of the appointments made when the U.S. Senate was not on recess (as determined by the court) is nonsensical. Besides offending reason itself, the “reasoning” evinces a tendency then in the White House to evade the very notion of constraint. The same tendency could be discerned in the next president as well, suggesting that to protect the viability of the constitution it is necessary for Congress to keep a vigilant eye on the executive arm of the government. In other words, resisting constraint itself is likely in human nature itself and thus must be closely watched in cases in which a lot of power is involved. 

 1. Tom Curry, “White House Sees No Impact of Court Ruling on Finance Protection Agency,” NBC News, January 25, 2013.

Addressing Systemic Risk: Beyond the Dodd-Frank Act of 2010

After the U.S. financial crisis in September 2008, the former chairman of the Federal Reserve, Alan Greenspan, admitted to a Congressional committee that his free-market notion that a market will automatically self-correct itself had a major flaw. He had come to this realization because the financial market for mortgage-backed bonds had failed to correct in terms of price for the dramatic increase in risk. Instead, that market, and that of overnight commercial paper, had seized up rather than simply adjust price to the decreased demand. Fear had paralyzed what had hitherto been thought to be a self-correcting market. The failures of Bear Stearns and Lehman Brothers introduced us to the concept of systemic risk, wherein the failure of a bank (or company) causes a market to collapse. Such a bank is thus too big to fail. If actualized, such risk interferes with even the basic operation of a market, not to mention its self-correcting feature. One question is whether banks that are too big to fail should merely be more adequately regulated or broken up, as the U.S. Supreme Court broke up Standard Oil in 1911.

Alan Greenspan, former chairman of the U.S. Federal Reserve Bank

In March 2013, Alan Greenspan said in a TV interview that banks like JPMorgan that are too big to fail should be allowed to fail. “[What] we ought to do is to allow banks to fail, go through the standard Chapter 11 type of process of liquidation, and allow the markets to adjust accordingly,” said the 87-year-old Greenspan. “That has worked for a very long time.” Had he forgotten his own Congressional testimony in which he had admitted that markets may not “adjust accordingly” to irrational exuberance and systemic risk? Decades of the central banker’s experience had not prepared him for the “financial cliff” that the financial system nearly went over in the fall of 2008. Apparently for Greenspan at least, old habits (of thinking) die hard.

Greenspan said that the Dodd-Frank Act of 2010, which was oriented to saving the banks from their own risky excesses and providing such banks with an orderly liquidation process should they declare bankruptcy, had been a failure. He said the “too big to fail” problem was getting worse, not better. Banks such as JPMorgan had been “gaming” the new regulations, attracted by the high profits gained from risky trades outlawed by the Volcker Rule. That FDIC deposits were used at JPMorgan to make the trades suggests that the taxpayers have been underwriting the continued high risk, at least in part. In other words, free-market capitalism does not completely account for the risk that banks willfully assume even though it can cause the financial sector to suddenly seize up as a big bank goes under.

Greenspan’s answer to the failure of Dodd-Frank involves a return to his faith in the free market, as if the freezing of commercial paper had not occurred in September 2008 after Lehman failed. A year after that crisis, the former central banker had urged the break-up of the big banks too big to fail. “If they’re too big to fail, they’re too big,” Bloomberg News reports Greenspan said in October of 2009. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.” One might add that the sheer existence of a bank with over $1 trillion in assets is too big for not only the financial markets, but also the republic as well. Even after the banks’ culpability had been made transparent in the financial crisis, Wall Street still had considerable lobbying pull over Congress—enough to get lawmakers to scrap Sen. Dick Durbin’s amendment that would have allowed judges merely to adjust mortgages that are in foreclosure. The allure of large contributions is simply too overpowering to a candidate or elected official for such concentrations of private wealth to be compatible with representative democracy. One or the other must inevitably give way. Relying on chapter 11 bankruptcy and market re-adjustment does not even begin to touch such ramifications.

In short, Dodd-Frank can be viewed as a piece of legislation that did not go far enough. This is perhaps no coincidence, given the power of the banks in Congress. Furthermore, as the $6.2 billion trading loss at JPMorgan demonstrates, bankers are able to evade and obstruct whatever incremental strengthening of financial regulation that lawmakers and regulators are able to enact over the objections of the bankers. The Volcker Rule, which bars the risky proprietary trading of banks, is no match for the wizzes on Wall Street. Systemic risk demands public policy beyond some additional regulation, or even a return to New Deal regulation. Going back to the Glass-Steagall Act of 1933, which had separated investment from commercial banking, would be insufficient, as banks had been gaming that law for decades before it was repealed in 1998 by Bill Clinton and Sen. Phil Gramm. Systemic risk and risks to democracy warrant public policy that changes the economic map, rather than merely giving the existing players some additional instructions or letting them fail and hoping the market will not collapse as a result. Addressing systemic risk warrants a systemic rather than an incremental or laissez-faire approach. I suspect that in addition to the obvious vested powerful interests, an aversion to substantive change and an associated preference for incrementalism account societally for much of the aversion to breaking up the big banks, as they had become ensconced in the system as part of the status quo.

Caroline Fairchild, “Greenspan Says Too Big To Fail Problem ‘Is Getting Worse, Not Better’,” The Huffington Post, March 15, 2013.

For more essays on that financial crisis, see Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

ICE Bought NYSE: Profiting from the Rules?

Tell me what the rules are, and I’ll make money with them.” This statement, made by Jeffrey Sprecher of Intercontinental Exchange, captures well the attitude that business practitioners should have toward government regulation in a republic. That is to say, businesses should be regulation-takers rather than makers. For the regulatees to make regulation to which they themselves would be subject is an oxymoron, or contradiction in terms. At the very least, it involves a conflict of interest. At the macro level, business as “regulation-maker” effectively turns a democracy into a plutocracy. Accordingly, the strategic use of regulation should pertain to the use side, rather than the regulating side. Crafting regulations—essentially dictating them to legislators or regulators—in order to make money from them takes the strategic use of regulation too far.

 Jeffrey Sprecher of ICE.  Making money playing by the rules.  (nypost)

Sprecher began by working at electric companies. He picked up on the need of those companies to hedge energy contracts so he bought a small exchange and built it up around derivative trading. Eventually, he did away with the exchange’s trading floor—preferring 24 hour computer trading. In 2010, the passage of the Dodd-Frank Act of financial reform requires that derivative trading be done through a clearinghouse. Sprecher’s company stood in a position to take advantage of the new rule. In fact, the intent of the new regulation being that regulators could have a better idea of the volume of derivatives “out there,” Sprecher created a derivatives database in his company. In other words, he anticipated in a way that meant more profits, and he did so without trying to manipulate legislators or regulators with a huge lobbying effort. Rather, he anticipated weaknesses in the market and devised company-based solutions that would be profitable. It is no surprise that the Dodd-Frank Act essentially adopted his business model regarding derivatives—effectively forcing it on the industry as a whole.

In fact, observing the heightened scrutiny of swap contracts under Dodd-Frank, Sprecher decided to convert them to futures contracts. Here again, profit was also in the mix. “The reality is that there are incentives to convert swaps into futures, where there’s less competition,” according to Richard McVey of MarketAxess. “There’s no requirement for [Sprecher’s company] to open [its] futures clearinghouse to other exchanges.” This restriction of competition to increase profit is ironic for ICE because in late 2012 came the announcement that the company would purchase the New York Stock Exchange, which had capitalized on monopolizing the trades of its members. Ironically, Sprecher’s actions had undercut this monopolization and here he was exacting his own version in turning “insurance” swaps into garden-variety futures contracts. Business skill can be regarded as the art of knowing when to ride a wave—and which wave to ride.

It should be noted that both the computer-trading and derivative-trading trends furthered by Sprecher’s very company enabled it to buy the vaunted New York Stock Exchange for $8.2 billion rather than something much higher. According to the New York Times in late 2012, the “transformation of the New York Stock Exchange from its position at the apex of the world financial system to an asset to be bought and sold like any other—and one that is not deemed to be worth as much as it would be if it traded more modern derivative securities rather than old-fashioned stocks—has been going on for decades, but has accelerated in recent years.” Essentially, Sprecher took advantage of this trend by making the purchase, and he would capitalize on owning the “temple of commerce” through intra-company synergies even while committing to keep the NYSE floor up and running.

In short, business acumen has no need of being sidetracked into manipulating lawmakers and regulators into formulating rules favorable to one’s particular company. The strategic use of regulation is most profitably accomplished over the long run on the use side. Take the rules as given and make money with them. This is entirely consistent with business in a viable republic. An implication of this thesis is that it’s the bad—both in terms of business intuition and moral disapprobation concerning manipulating public policy for private gain—manager who represents the plutocric threat to a republic.  The business practitioners knocking on Congressional doors are not the brightest guys in the room as regards innate business skill, and they are not the most forthright concerning getting what they want, whether by money or even information. Unfortunately, turning opportunities into profit is instinctive only for some practitioners, while it is forced or contrived in many others, who therefore feel compelled to circumnavigate business by pressuring public officials. It is significant—and telling—that ICE did not have a substantial lobbying presence in Washington, as Sprecher and his subordinates undoubtedly “kept to the knitting,” being good at it, and thus they did well in profiting from gaps in the market and the related regulatory changes.

Sources:

Ben Protess and Nathaniel Popper, “Exchange Sale Reflects New Realities of Trading,” The New York Times, December 21, 2012.

Floyd Norris, “A Temple of Commerce that Failedto Keep Up with Change,” The New York Times, December 21, 2012.

Michael J.de la Merced, “At the Big Board, Seeking Rejuvenation in Consolidation,” The New York Times, December 21, 2012.

Limiting Bank Size: Crude But Advisable

In February 2012, Tyler Cowen claimed in the New York Times that people across the political spectrum were “talking about splitting up America’s large banks.” At the time, I could discern no such talk, although this does not mean that it was not going on. As the Dodd-Frank financial reform law was being written in 2010, the option of splitting up banks like Bank of America, Goldman Sachs, and JP Morgan Chase was quietly but assiduously kept off the front burners. It is difficult to believe that the big banks would have relaxed in their efforts to relegate such threats in early 2012 as if the passage of the legislation in 2010 meant that more astringent options were no longer possible. In his article, Cowen includes some other questionable claims. Reading between the lines, he seems to have been “playing by the rules” in support of the big guys.

Even as Cowen notes that “before its collapse, Lehman had a capitalization of about $60 billion, compared with the $143 billion capitalization of JPMorgan Chase [in early February 2012],” he goes on to characterize breaking up the biggest banks as penalizing size rather than failure. In doing so, he is conflating a regulation with the market mechanism. Whereas the latter is supposed to penalize failure, there is nothing wrong with a regulation limiting size, as it is often correlated with market (and political) power at the expense of competition (and democracy). Moreover, limiting size is not to penalize it. As Cowen himself admits, “banks are usually wealthier, nimbler and smarter than their regulators, at least when it comes to finding loopholes in the regulations or making their moves more opaque.” Limiting the power of bankers by limiting their respective bank’s assets makes perfect sense in protecting the regulators from being unduly pressured from their regulatees.

Furthermore, Cowen conflates bailing out a big bank with bailing out its parts after a spin-off as if a small bank failing were somehow as damaging as a big one going down. He argues that “if the resulting parts of a divided bank cannot turn a profit, the split-up may prompt the very bailout it was trying to avoid.” This is not true, as “the very bailout” to be avoided pertains to that of the big bank rather than any of its parts.

Cowen also assumes that the smaller banks would necessarily be bumping their heads against the maximum size allowed. He argues that “the incentives for the new, smaller banks would be unhealthy. Those banks could make mistakes or take on bad risks without being punished very much in terms of capitalization or revenue, because of their legally capped size. Even if they made big mistakes, these banks would probably be pushing on the frontier of maximum allowed growth.” In other words, he assumes that a limit on size would somehow eclipse any remaining market mechanism. Perhaps he is assuming an overly astringent limit, such as 50 employees. There is a lot of room for limits below a $143 billion capitalization without eviscerating the market mechanism.

In fact, Adam Smith would doubtless maintain that a market with smaller competitors functions better in terms of competition “rewarding” good performance and “penalizing” incompetence. It is as if we are so used to corporate capitalism that we assume that Adam Smith’s version cannot work. I would argue that Smith’s version is actually superior with regard to the market mechanism. Because that mechanism can “freeze up” rather than price-adjust for added risk, we should not rely exclusively even Smith’s competitive market. Given the downsides of the market mechanism itself, limiting the size (and thus power) of the participants is certainly justified. It is not “penalizing size.” I do not believe that Cowen has a firm grasp on either the market mechanism or the nature of government regulation.

Source:

Tyler Cowen, “Break Up the Banks? Here’s an Alternative,” The New York Times, February 11, 2012. 

On the Strategic Use of Regulation: Financial Reform at the Bequest of Wall Street

According to The New York Times, Wall Street bankers were busy working on how to weaken the regulations or otherwise profit from them before the ink was dry on the financial reform law of 2010 . First, regarding trying to profit from the new regulations, BOA, Wells Fargo and other big banks that were faced with new limits on fees associated with debit cards were imposing fees on checking accounts. Compelled to trade derivatives in the daylight of closely regulated clearinghouses rather than in murky over-the-counter markets, titans like J.P. Morgan Investment Bank and Goldman Sachs were building up their derivatives brokerage operations. Their goal was to make up any lost profits — and perhaps make even more money than before — by becoming matchmakers in the vast market for these instruments. That critics were pointing to them as a principal cause of the financial crisis made no difference to those bankers. Even when it comes to what is perhaps the biggest new rule — barring banks from making bets with their own money — banks found what they thought was a solution: allowing some traders to continue making those wagers as long as they also work with clients.

Lest one conclude from the banks’ stretegic responses that the new law passed in the wake of the financial crisis of 2008 goes strongly against their interests, it is important to remember that the reform is more geared to giving government officials adequate power to mop up a future mess than to enabling them to prevent one in the first place by clamping down on the banks. The devil is in the details. This in itself can be an opportunity for banking lobbyists to work over regulators who depend on information from the industry and can be swayed by legislators who have received campaign contributions and fund-raisers from the bankers. Regulators are tasked under the new law with writing the specific rules of the road governing limits on risk-taking by financial firms and previously unregulated trading. By leaving so much to the discretion of existing regulators, the new law is “a boon to Wall Street lobbyists, who will now be working behind the scenes to influence the regulators,” according to John Taylor, president & CEO of the National Community Reinvestment Coalition. Furthermore, in enforcement, there is evidence that regulators are apt to look the other way. The wave of predatory lending that sank the housing market, for example, could have been largely prevented if the Federal Reserve had enforced existing rules on mortgage lending, according to Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University.

Under the financial reform law of 2010, banks and other financial institutions are overseen by a council of  regulators. That group is charged with identifying the kinds of “systemic” risks that spun out of control in the collapse of Bear Stearns and Lehman Bros. in the financial panic of September 2008. But there’s little to be gained by entrusting that task to the same regulators who failed to spot the causes of the panic the first time, said Isaac, the former FDIC head. “If a bank went to the regulators and said, ‘We’ve got a good idea: we’re going to put our lending officers in charge of risk management,’ that bank would be put out of its misery immediately,” said Isaac. “That’s what the government just did. It put the regulators in charge of assessing their own performance. It’s a very bad system.” While the law creates a separate agency with a single consumer mandate, even it remains beholden to those regulators, who retain the power to veto its regulations and enforcement actions. That setup, said Taylor, could seriously hamper the board’s effectiveness. “That club of regulators is very insular, and usually in agreement,” he said. “They can kill serious reform, and the financial lobby remains much more influential with regulators than consumer advocates.”

The problem can be broadened by considering that President Obama brought to head his economic team people like Larry Summers, who while in the Clinton Administration lobbied against regulating derivatives, and Tim Geithner, who had been appointed as President of the New York Federal Reserve at the urging of Citigroup and its major stockholder. In other words, it is not just a matter of relying on the same regulators; the construction of the law involved the same advisors.  Indeed, that members of Congress listened to the banking lobby at all even as the banks were complicit in the financial crisis of 2008 can be viewed as going back to the same. At a fundamental level, the banking industry may have too much leverage over top government offiicals, whether legislators or regulators.

Sadly, according to Newsweek, “the bill does more to help regulators detect and defuse the next financial crisis than to actually stop it from happening. In that way, it’s like the difference between improving public health and improving medicine: The bill focuses on helping the doctors who figure out when you’re sick and how to get you better rather than on the conditions (sewer systems and air quality and hygiene standards and so on) that contribute to whether you get sick in the first place.” This might be because it is in the big bankers’ interest that the government come in and clean up, but not restrict them in the meantime.  In the 1980s, the financial sector’s share of total corporate profits ranged from about 10 to 20 percent. By 2004, it was about 35 percent. According to Newsweek, “What you get for that money is favors. The last financial crisis fades from memory and the public begins to focus on other things. Then the finance guys begin nudging. They hold some fundraisers for politicians, make some friends, explain how the regulations they’re under are onerous and unfair. And slowly, surely, those regulations come undone.”

In the wake of the financial crisis, the American people had a chance to brake up the banks too big for our republics, but even then the bankers were able to quietly get this option off the airwaves. I contend that the too big to fail systemic risk is actually greater with respect to the viability of the US than to the financial system. That is to say, the ability of Wall Street to dodge the bullet even when it was culpable for a near melt-down of the financial markets may mean that we are living in a plutocracy rather than a democracy—the latter being mere window-dressing. Even when Wall Street is “bad,” it owns Congress, according to Sen. Dick Durbin of Illinois.  This ought to tell us that the game is over, yet with regard to the regulators I suspect the games will go on for some time.

Sources:

http://www.msnbc.msn.com/id/38266914/ns/business-eye_on_the_economy/ 

http://www.newsweek.com/2010/07/15/five-problems-financial-reform-doesn-t-fix.html  http://www.cnbc.com/id/38272518

The Banking Lobby Amid Goldman Sachs' Culpability: A Danger to the Republic?

To simplify how Goldman Sachs got into trouble with the SEC: According to Annie Lowrey, the hedge fund Paulson & Co. handpicked mortgage-backed securities that were doomed to stop performing, being backed with subprime mortgages, and Goldman packaged them into a kind of bond. Paulson & Co. bet against the bond by buying short-sales, with Goldman acting as the broker. At the same time, Goldman sold the bond to other clients without disclosing that Paulson had engineered the bond to fail. The SEC filing notes that those other clients lost $1 billion. Goldman had no direct stake in the success or failure of the CDO. It made money either way. “This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another,” Chris Whalen, a bank analyst at Institutional Risk Analytics, said in a note to clients on April 16, 2010. Someone at Goldman said on the same day that “the SEC’s charges are completely unfounded in law and fact.” If the SEC charges hold up (and it is doubtful that the agency would bring such charges without supporting documentation; it is more apt to miss something than go overboard), I am astonished that the people at Goldman simply dismissed the matter out of hand. It might make sense as their legal defense, but if the bankers are convicted, those lying ought to be fired even if they were not a party to the scheme. It also appears that the bankers lied about whether they made money in betting against the housing market. “The 2009 Goldman Sachs annual report stated that the firm ‘did not generate enormous net revenues by betting against residential related products,’ ” Senator Levin, chairman of the US Senate’s committee on investigations, said in a statement in April, 2010. “These e-mails show that, in fact, Goldman made a lot of money by betting against the mortgage market.” When a spokesperson for the bank says something in the future, a rational person will be wont not to trust him or her. Lying has (or ought to have) consequences rather than being dismissed as harmless PR or a legal defense. The bank’s credibility is at issue here. The SEC has accused Goldman of outright lying to customers in order to make money both ways on a deal. Even though this ought to reflect negatively on Goldman’s future business, bigger issues involved that ought to consume more of our attention than how Goldman fares.

Given the strength of the financial sector’s lobby in Washington, this case involving Goldman suggests that we, the American electorate, were unwittingly putting our financial system and our republics in danger by enabling the lobby to have such effect in watering down the regulatory reform in the wake of the financial crisis of 2008.

In the election cycle in which the US Senate’s agricultural committee took up legislation that would regulate all derivatives (2010), people and organizations affiliated with financial, insurance and real estate companies gave members of the committee $22.8 million. Wall Street firms raised $60,000 at two fund-raisers for the committee’s chair’s re-election campaign in the cycle before the committee took up the legislation. Many of the chairs constituents want a crackdown on the speculation. This put Blanche Lincoln in a difficult situation, ethically speaking. At the very least, accepting money from the firms that would be subject to the legislation involves the appearance of a conflict of interest. I contend that given human nature, even such an appearance ought to be avoided or even outlawed. At the very least, it is unseemly in a republic, and I would argue dangerous to its viability.

Furthermore, as if the banks’ culpibility in the crisis was not sufficient to cancel their reservations at the regulatory table, the Goldman case strongly suggests that the banks ought not to be trusted as contributors to regulatory reform. And yet they push ahead to reduce the regulatation, in spite of it all. A child who drops his milkshake doesn’t turn around and tell his mother that she better not clean it up and that she had better not get involved if it happens again. Rather, such a child stands back. As if there is not enough of a natural feeling of shame at having made a mess, there is, or ought naturally to be, an even greater sense of shame in presuming to be in a position to direct the clean-up according to one’s self-interest over objections that the person who caused the problem is not the one best suited to fix it. Even if corporations can enjoy the legal fiction of personhood, there are actual human beings running them, and it is telling when those people dismiss their innate shame in their presumption–even pretending that it is not presumption! We are to blame in not calling them on it, and relegating them. We must relegate them if they won’t do it for themselves, as would be natural for them to do. In other words, we ought to call the artiface for what it is and relegate it as a parent would naturally tell a spoiled and misbehaving yet dogmatic child to go to his room. We, the American people, are enablers; bad parents. We ought to look toward solving the bigger problem, which the case of the Goldman children intimates.

The theory of regulatory capture points to the government’s need for information that the industry being regulated can provide. This theory ignores the broader power-base that an industry is apt to have in lobbying the government (and supporting candidates). In other words, information is just small change from the standpoint of an industry’s ability to influence a government. A better theory would have its primary focus on the macro level, asking the question, in effect, whether (and how) a republic is compromised by its moneyed corporations and banks. Besides looking at campaign finance law and uncovering actual lobbying practices, we ought to look at how much the society in question values money, commerical gain, wealth and economic freedom. We ought not be limited to the managerial or technocrat perspective in ascertaining whether our financial system and indeed our very republics are in danger from being used by unscrupulous firms or industies according to that which fits their peoples’ desires. Once we have uncovered the real problem, we really won’t have any excuse for not fixing it, and we would be bad parents indeed if we let the children fix it.

Sources:
http://washingtonindependent.com/82571/sec-charges-goldman-sachs-over-subprime-tied-product  http://opinionator.blogs.nytimes.com/2010/04/16/goldmans-stacked-bet/?ref=opinion
http://money.cnn.com/2010/04/16/news/companies/sec.goldman.fortune/index.htm?postversion=2010041616 ; http://money.cnn.com/2010/04/16/news/companies/goldman_sachs_questions.fortune/index.htm?postversion=2010041615 ; http://www.nytimes.com/2010/04/20/business/20derivatives.html?hp
http://www.nytimes.com/2010/04/25/business/25goldman.html?ref=us

The Volcker Rule: Taking in Water on Proprietary Trading

Under the Dodd-Frank financial reform law of 2010, Goldman Sachs had to break up its principal strategies group, the trading unit that had been very profitable. Goldman was considering several options, including moving the traders to another division or shutting the unit altogether. Morgan Stanley was considering ceding control of its $7 billion hedge fund firm, FrontPoint Partners. At Citigroup, executives had sold hedge fund and private equity businesses and were discussing reducing proprietary trading, which relies on a bank’s own capital to make bets in the financial markets. JPMorgan Chase had already begun dismantling its stand-alone proprietary trading desk and was modifying the structure of some investments of One Equity Partners, its internal private equity business. “This is the real stuff,” said Brad Hintz, an analyst at Sanford C. Bernstein & Company. “It shows that if you squeeze Wall Street, like a balloon it will come out somewhere else, and we really are squeezing Wall Street. Their business models are changing.”

However, loopholes in the legislation may enable the banks to continue to trade on their own books, even apart from serving as a counterparty for client transactions. Citigroup and others, for instance, are considering moving proprietary traders to desks that handle trades for clients, although the traders would still be able to make their own bets in the markets. The Volcker Rule’s definition of proprietary trading is open to interpretation. At first blush, it looks watertight: the rule forbids banks from buying and selling financial products for their “trading account.” That, in turn, is defined as an account meant to profit in the “near term” from “short term” movements in prices. Besides not covering such long term bets as shorting in anticipation of a fall in the housing market, the rule states that banks can still trade government and agency securities for their own account. Some of the problems at the hedge fund Long-Term Capital Management stemmed from trying to arbitrage prices between Treasuries of different terms. And the Carlyle Capital Corporation, a heavily leveraged debt fund, crashed in 2008 when prices of Fannie Mae and Freddie Mac mortgage bonds dropped. So in allowing for continued proprietary trading apart from serving as a short-term counter-party for a client’s transaction, the Dodd-Frank Financial Reform law may not change Wall Street’s landskip all that much. This is hardly surprising, as members of Congress allowed the banking lobby to participate in the writing of the legislation in spite of the industry’s culpability in the financial crisis of 2008.

Sources:
http://www.nytimes.com/2010/08/06/business/06wall.html?_r=1&scp=2&sq=wall%20st%20faces%20specter%20of%20lost&st=cse
http://www.nytimes.com/2010/08/06/business/06views.html?scp=1&sq=anthony%20currie%20christopher%20swann&st=Search

Banking on Buffett’s Bank

Beyond wondering what could Ken Lewis have been thinking when he ok’d Bank of America’s purchase of Countrywide, it might be worth pondering why the Dodd-Frank Financial Reform Law of 2010 did not mandate splitting up banks such as Bank of America, which with over $1 trillion in assets are too big to fail. In other words, is simply increasing their reserve requirements tantamount to gambling with the financial system in a reckless manner? Should the elected representatives of the people and the states in the U.S. House and U.S. Senate, respectively, have displayed more fortitude in resisting the banking lobbyists even when that industry was known to have been culpable in the 2008 credit crisis?

The risk still remaining in August 2011 was evident when Bank of America’s stock price went down to $6. According to the New York Times, “the speed of the descent and the surge in the cost of insuring the company’s debt awakened memories of the financial crisis, when companies like Bear Stearns and Lehman Brothers found themselves short of capital.” To be sure, BOA’s capital held at $218 billion at the end of June 2011 by one key measure, though some investors did not trust the bank’s numbers. Of course, when there is a run on a bank, a capital figure is almost irrelevant, as are claims that additional capital are not necessary. Fortunately, Warren Buffett ignored such an asseveration from Brian Moynihan, the bank’s $9 billion loss over the previous 18 months, and the bank’s increased reserves ($18 billion from $4billion in January 2010) for investors of soured CDOs. Not wasting time scheduling a meeting with Moynihan, Buffett went to the board and soon had a deal wherein the investor would put down $5 billion in exchange for preferred stock paying a guaranteed 6% annual dividend and warrants good for ten years for 700 million shares. Like Buffett’s $5 billion deal with Goldman Sachs, which netted the investor over $1 billion as of mid-2011, the BOA deal looks like a money-maker for him. In exchange, the bank gets a huge vote of confidence, which regardless of any capital needs, was of great value to the bank (as the other deal had been to Goldman even though that bank had not yet needed $5 billion in additional capital).

Tossing around $5 billion to Goldman (and $3 billion to GE, which had been relying on the repo market) and $5 billion more three years later—in both cases to buttress a bank too big to fail—ought to make clear to the rest of us that merely allowing the $1 trillion club of banks to continue to exist is itself of such systemic risk that high stakes gambling is necessary to avoid catastrophe. My point is that through our elected representatives, the American electorate has a choice; we need not accept the presupposition that economic liberty requires that even banks whose very existence represents systemic risk have a right to continue to operate as going concerns. To put it differently, Warren Buffett was 80 years old when he put together the BOA deal.

Isn’t there something precarious about an empire the size of the U.S. relying on an old man to keep a major bank from imploding due to the financial fallout stemming from a stupid decision to acquire a mortgage servicer on steroids? Had anyone from BOA bothered to do what Larry McDonald did while he was at Lehman—Dick Fuld’s Lehman for Christ’s Sake!—namely, simply going a restaurant near Countrywide’s headquarters in California to chat at lunchtime with a few of the many brainless salesmen wearing gold watches and driving new sports cars bought from the double commissions on the known-to-be junk mortgages—BOA’s managers and board would (hopefully) never have agreed to ingest the leprosy, let alone play with it and touch it. Strangely, Ken Lewis had a reputation at the time as an expert on M&A; after all, that is how he had expanded BOA. Nevertheless, Lewis on Countrywide seems a lot to me like Lee at Gettysburg (what could possibly been in the confederate general’s head as he disregarded Longstreet’s objections to Pickett’s charge?—Lee might as well have used a firing squad on the division and saved the Union army the trouble). I think we are too enamored with authority that comes with position, whether in corporations, government or religion.

In summary, relying on one rich old man to prevent the financial system from imploding from the demise of a bloated, misguided bank like BOA does not sound very prudent to me. We might as well make every American city into Las Vegas and paint the towns red. Forgive me but I have to ask, Do we really know what we’re doing, folks? Minding the store might mean slapping some hands (or worse) when our elected representatives get to playing too much with the self-absorbed banking lobby.

Sources:

Nelson D. Schwartz, “Buffett to Invest $5 Billion in Shaky Bank of America,” New York Times, August 26, 2011. 

Ben Protess and Susanne Craig, “Buffett’s Bank of America Stake Viewed as a Seal of Approval,” New York Times, August 26, 2011.

Real or Incremental Change?

On October 13, 2010, Fox News reported a poll that found that women were turning on Obama.  The reason cited was that they feel there has been too much change—that it has been “jarring.”  I was stunned—wondering if I was listening to a broadcast from another planet. I remembered that when I had been sampling a fattening food item in a grocery store in my antiquated home town in Illinois; the old woman who gave me the sample, said, “We have lots of devils here!” as she was handing me the sample.  She was referring to the array of food samples in the store that day a few weeks before Thanksgiving.  My reaction, which I charitably did not share with her, was, Oh, horrors! I wondered what century she was from (probably Calvin's, I concluded privately as I chewed a “devilish” olive). I wondered, moreover, why some people magnify little things into horrendous sins. Such people, I concluded, cannot seem to let go of what is to the rest of us so utterly antiquated and get with it. That is, why are some people so resistant to change? Why do they perceive small, incremental changes as somehow momentous—even jarring?

In a preface to one of his books, Milton Friedman wrote, "Only a crisis—actual or perceived—produces real change. When the crisis occurs[,] the action taken depends on the ideas that are lying around.” That is to say, human nature is not exactly designed in favor of substantial change—being more inclined to the incremental variety. When a culture says that real change is to be feared and people don’t bother to come up with a broad array of ideas, even a crisis may not result in real change. Such can be said of modern American society, even as “change” shows up consistently in American political campaigns.

In terms of the jarring change being reported on Fox News, the journalist pointed to the health-insurance reform law as a case in point.  In spite of its purported “socialism,” the law relies on private health-insurance companies, whose lobby pressured Obama into dropping his “public option” requirement and adding a mandate that requires Americans to become customers of those companies.  If relying on extant private companies—giving them a guaranteed and vastly enlarged customer base—is somehow “jarring” change, I have to start wondering about whether some people have a pathological issue with change itself.

One need only point to the Dodd-Frank financial regulation law of 2010, which subjects banks deemed too big to fail to additional capital requirements and requires the banks to develop liquidation contingency plans. This “change” pales in comparison to breaking up the banks having $1 or more trillion in assets so they do not pose a danger while extant. That some people might find increasing capital requirements as jarring boggles the mind. Are such people familiar with real change—even if they voted for it in 2008? I suspect they would not recognize it if it jumped up and bite them on their asses, and yet political campaigns are ostensively all about change—or the illusion thereof—but just enough to tell people what they want to hear.

Not surprisingly, much of the campaigning in the 2010 midterm elections was oriented to incremental change on a variety of issues, rather than to real change, even though the latter would have been more fitting given the systemic negative effects of the financial crisis of 2008. Even in states bordering on bankruptcy, like California, Florida and Illinois, campaigning as usual belied any purported crisis. 

For example, I watched a candidate forum that was being held in Illinois and one of the main questions was why a candidate’s business was so successful.  Meanwhile, the last governor had been impeached and removed from office by a nearly-unanimous vote in the legislature, and the government was borrowing $18 billion in 2010 alone.  The forum struck me as an exercise in “rearranging the deck chairs on the Titanic” as if the ship of state was not on the verge of sinking.  In other words, it was business as usual in a context that demanded substantial change. Clearly, the candidates knew of Illinois’s fiscal (and corrupt) condition. It occurred to me that they were either bereft of ideas or too accustomed to going along on the track of status quo to proffer any real alternatives. Lest one heap all the blame on the candidates at the forum, it is important to note that it was a citizen of Illinois who asked about the candidate’s business. Perhaps the society in Illinois is too entranced by custom and thus insufficiently equipped for real change—ironically even as one of Illinois’ former U.S. senators was serving as the “real change” president of the United States.

Lest the pallid phenomenon be presumed to be limited to the heartland, the California Governor’s race between Jerry Brown and Meg Whitman also evinced politics as usual. The two candidates had a chance in their debates to persuade a California-wide audience that they could turn around the economically-troubled republic. Instead, they resorted—at least in their third debate—“to many of the personal attacks that have dominated the last few weeks of the campaign,” according to MSNBC, whose verdict can be said to apply to American politics even in the wake of a crisis: “Neither candidate presented any new ideas.”

Source:

Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Alfred A. Knoff, 2011).

TARP Paid Off: But What about the Foreclosures?

TARP, the "bailout" for banks rather than mortgage borrowers, was the first big issue facing the Obama administration before the roughly $800 billion stimulus plan and the health insurance overhaul that stoked the rise of the Tea Party movement. After supporting TARP, several Republicans lost in the elections of 2010 largely because of their votes. For many Americans, TARP is a symbol of big government at its worst, intervening in private markets with taxpayers’ billions to save Wall Street plutocrats while average Americans continued to struggle to make mortgage payments or lost their houses outright.  “This is the best federal program of any real size to be despised by the public like this,” said Douglas J. Elliott, a former investment banker now associated with the Brookings Institution. “It was probably the only effective method available to us to keep from having a financial meltdown much worse than we actually had. Had that happened, unemployment would be substantially higher than it is now, the deficit would have gone up even more than it has,” Mr. Elliott added. “But it really cuts against the grain for a public that is so angry at banks to think that something that so plainly helped the banks could also be good for the public.” TARP was good for the public not in that the funds enabled Wall Street bonuses; rather, the good was solely on the macro level, as the frozen credit markets eventually thawed such that the financial system meltdown was averted.  However, this does not mean that it was "the only effective method available."

Specifically, the TARP funds could have been used to subsidize mortgage borrowers demonstrating difficulty in making the payments. On a CBS news show May 15, 2011, Speaker Boehner was asked about the four foreclosure programs of the U.S. Government. "They have all failed," he told the journalist. However, the Speaker then refused to have the government get involved; the best we can do is wait for the market to solve the problem as more buyers enter. However, that would only spur foreclosures, as more buyers would make it easier for banks to sell their foreclosed houses. It is interesting that hundreds of billions of taxpayer dollars could go the big banks, enabling record executive bonuses, whereas all we can do is rely on the market to mitigate the foreclosures. This squalid double-standard can be explained by simply looking at the bankers' interest, which is at odds with that of the mortgage borrowers. Considering the problematic way in which the sub-prime mortgages had been produced (e.g., liars' loans and no-document mortgages), I contend that the interests of the banks' customers ought to be given primacy here. The problem is that the borrowers are dispersed, whereas the bankers have concentrated leverage via their capital and lobby over government officials who would like to be re-elected. In a republic, the leverage ought to go in the opposite direction: elected representatives coming down on the bankers for their shaddy lending and related double commissions at the expense of the borrowers.

Laying the power reality aside, an alternative to TARP can be envisioned. This exercise, although inexorably futile, can tell us something about the opportunity costs involved in enabling the powers that be rather than holding them accountable. Along with a federal law limited the rate resets on the ARM sub-prime mortgages (resisting the pressure of the banking industry that recklessly had originated or bought the mortgages), subsidies could not only have removed a major toxic element from banks' balance sheets and thus opened up lending, but also perhaps fortified the housing markets in the U.S. such that homeowners duped into houses over their heads could have had some time to sell and find more suitable housing. In other words, the "two birds with one stone" could have applied, instead of the top-directed infusion. TARP did not come with requirements that lending reach a minimum level so even though the banks did not fail, it took even the TARP banks a long time to raise lending again; the return to lending should have been immediate.

It could be argued that the TARP funds put into banks gave the U.S. Government the corresponding benefit of bank stock. To be sure, selling the stock has made up a large part of the TARP funds already by 2011, but it was at that time uncertain whether the government would make a profit. In the fourth quarter of 2010, the U.S. Treasury projected that taxpayers wouuld lose less than $50 billion at worst, but at best could break even or even make money. Its best-case assumptions, however, assume that A.I.G., which had received $182 billion in TARP funds, and the auto companies would remain profitable and that Treasury would get a good price as it sells its corporate shares in coming years.

In May 2011, AIG and the Treasury Department announced that they would sell $9 billion in stock altogether, but for less than half of the expected price. As of May 10th, the AIG stock pre-market price was thirty cents off from the government's breakeven point. AIG stock had slid from the mid 40s to the mid 20s. I submit that these considerations of U.S. profit-taking, although appealing from a capitalist standpoint, misses the bigger picture in terms of a government's mission. I contend that governments do not exist to make profits. Furthermore, a government's primary charge is to protect citizens, whether from foe or famine. Failing to mitigate or obviate foreclosures even as banks got funds to keep them afloat is thus a blight on the U.S. Government. To be sure, maintaining the viability of the financial system is legitimately part of the government's job, that function could have been accomplished by protecting citizens who otherwise lost their homes. This is not to say that the homeowners deserved to stay indefinitely in houses too big for them; rather, it is to say that homeowners could have been kept from being tossed onto the street. The U.S. Government could have helped two birds with one bag of birdfeed while meeting its own obligations as a government.

Sources:

Jackie Calmes, “TARP Bailout to Cost Less Than Once Anticipated,” The New York Times, September 30, 2010.

The Huffington Post, "AIG, U.S. Will Sell $9B in Stock -- But for Less than Half of Expected Price," May 11, 2011.