Too Big To Fail: The U.S. Is Still at Risk

On March 20, 2013, more than two years after the Dodd-Frank financial reform legislation had become law, Federal Reserve chairman Ben Bernanke made it clear that the problem of too-big-to-fail banks had not been solved. “Too Big To Fail is not solved and gone,” he said in a press conference. “It’s still here.”[1] That is, providing an orderly liquidation process for bankrupt banks would be insufficient in keeping the U.S. economy free of vulnerability from even one of the biggest banks taking down the financial sector merely by going bankrupt. Congress should not have missed or minimized this point while working on the Dodd-Frank Act. The self-interested power of Wall Street in Washington and the need of campaign funds in Congress coalesced to dilute the law in spite of the detriment to the public good.

Suggesting that more legislation might be needed, Bernanke said, “Too Big To Fail was a major source of the crisis . . . and we will not have successfully responded to the crisis if we do not address that successfully.”[2] More would be needed to rid the U.S. economy of the threat of banks too big to fail. If holding more capital does not make the big banks safer, “we will have to take additional steps.” This, he said, “is important.” Yet somehow his voice was not adequately heard. Other voices were louder on Capitol Hill.

Meanwhile, Wall Street banks faced little downside. Because the mammoth size of big banks such as Citibank and Bank of America makes their failure a threat to the viability of the financial system and even the overall economy, such size is an advantage to the banks because the bankers can reasonably bet that the U.S. Government would have to bail them out even if they face financial ruin by having taken on too much risk as the economy sours. The sense of invincibility, plus lower borrowing costs, could lead big banks to not only stay big (or even get larger!), but also take bigger risks. Bankers at such banks may even feel free to commit fraud because U.S. Attorney General Eric Holder admitted in 2013 that large banks were nearly immune from government prosecution for crimes, given the risks to the economy from the failure of a convicted bank. What about the fraudulent bankers who sold "crap" while claiming the mortgage-based bonds were sturdy? In short, the risk taken on by a big bank could easily outstrip even the additional capital requirements in the Dodd-Frank Act.

Even apart from reckless banking at the top of the U.S. financial system, if a sizable market in the U.S., such as many of the housing markets, were to collapse all at once, as in 2007-2008, many banks would be hit. The additional reserves would not likely buttress individual banks from the domino effect that was evinced, albeit halted, in September 2008. I submit that more money in reserves would have stopped the cascading momentum. While higher reserves might safeguard a bank while others are intact, the claim seems doubtful at best when the undercurrent from the momentum of many banks being hit at once or in a row is strong. It is no accident, I contend, that the Obama campaign of 2008 accepted $1 million from Goldman Sachs. 

1. Mark Gongloff, “Ben Bernanke: ‘I Agree With ElizabethWarren100 Percent’ On Too Big To Fail,” The Huffington Post, March 20, 2013.
2. Ibid.

Larry Summers Bowed Out of the Race for Fed Chair: “Advise and Consent” Triumphant

On September 15, 2013, the White House announced that Larry Summers, Barak Obama’s prior chief economic advisor and a Secretary of the U.S. Treasury during the Clinton administration, no longer wanted to be considered to fill the upcoming vacancy as chairman of the Federal Reserve. In the announcement, Obama (or an advisor) wrote, “Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom and leadership that we wrestled the economy back to growth and made the kind of progress we are seeing today.”[1] Unfortunately, this statement suffers from a sin of omission, which admittedly had been minimized by the media as well. Accordingly, the Democrats in the U.S. Senate who had just come out against a Summers nomination can be regarded as done the nation a vital service. Moreover, the “check” of the “check-and-balance” feature of the U.S. Senate’s confirmation power worked.
With all its open points of access, democracy can have a splintering effect on a point worthy of public debate. The media dutifully plays its “scattering” role before any reasoned train of thought can gain traction in the public domain. For example, at the time of Summers’ retraction, the New York Times reported that a “reputation for being brusque, his past comments about women’s natural aptitude in mathematics and science, and his decisions on financial regulatory matters in the Clinton and Obama administrations had made [Summers] a controversial choice.”[2] A reader could be forgiven for concluding that personal vendettas, public gossip, and single-issue (not even monetary policy!) political activists have points just as important as the matter of Summers’ past decisions on financial regulation.
Any political interest having succeeded in getting its point to a microphone is deemed just as relevant or decisive as any other. Democracy is the great relativiser. The great equalizer. Is rule by "members of the club" the only practical alterative, or is it American democracy merely its front, only superficially relativising and equalizing the relevant and the less-than-relevant?

       Alan Greenspan, Larry Summers, and Robert Rubin. In the late 1990s, they pressed Congress to keep financial derivatives unregulated. A case of government doing Wall Street's bidding?   Image Source: pbs.org


Obviating the scattering effect, we can zero in on Obama’s attribution of “expertise, wisdom and leadership” and ask whether they apply to Summers when he joined Alan Greenspan and Robert Rubin in the late 1990s to lobby Congress to remove the CFTC’s authority to regulate financial derivatives. At the time, Brooksley Born, chairwoman of the CFTC, was recommending to Congress that mortgage-backed derivatives be regulated. That the unholy triumvirate, blessed by Clinton and supported by Wall Street, succeeded with the help of Sen. Phil Gramm in discrediting Born kept the financial system vulnerable to being blind-sided by a collapse in any of the securitized derivatives markets.
It is difficult to fathom how financial regulatory expertise, wisdom, or leadership could possibly pertain to Summers in his lobbying capacity during the Clinton administration, even if he did go on to help Obama mop up the fiscal thaw after Lehman's bankruptcy. Yet, sadly, Summers’ down-right discraceful bullying of Born, and being wrong on top of that on whether financial derivatives should be regulated were barely mentioned in the public discourse leading up to Summers’ decision to withdraw his name from the president's consideration.
Fortunately, the public can rely on the informed advise and consent power of the U.S. Senate. Is it just a coincidence, however, that bullish financial markets answered Summers' decision? Or was it the other way around: Summers' decision being the answer to a message he had received from Wall Street?
To be sure, Summers was "generally considered to be in the pocket of Wall Street."[3] Citibank had been paying him for what the Federal Reserve refers to as "participation" in "Citi events."[4] Additionally, his efforts to keep financial derivatives, including CDOs, unregulated enabled Wall Street banks to make "kazillions of dollars."[5] However, bankers have short memories, given the inertia of the financial interest of the moment. Traders and bankers tended to favor Yellen, according to a poll conducted by CNBC; whereas Yellen got 50 percent, Summers came in at a mere 2.5 percent.[6] Besides sporting an abrasive (Harvard?) manner, Summers had given vocal hints that he might tighten monetary policy, even reduce the Fed's bond-purchase program sooner than Yellen would.
Particularly given Summers' nature, I have trouble believing that he woke up one nice fall morning and decided to cave in to anticipated "political obstacles" to his getting confirmed by the U.S. Senate. Put another way, more was likely behind his loss of support among Democrats on the Senate committee than even concerns the senators might have had about Summers' prior participation in turning Congress against Born's plea to regulate derivatives. Could it be that Wall Street CEOs were pulling the strings, reaching from Boston to Capitol Hill without even leaving finger-prints?    

---

1. Annie Lowrey and Michael D. Shear, “Summers Pulls Name from Consideration for Fed Chief,” The New York Times, September 15, 2013.
2. Ibid.
3. Mark Gongloff, "Larry Summers' Withdrawal from Fed Race Is Good News for Wall Street and the Economy," The Huffington Post, September 16, 2013.
4. Reuters, "Fed Contender Larry Summers Cancels Citigroup Events," CNBC, September 14, 2013.
5. Gongloff, "Larry Summers."
6. Mark Gongloff, "Wall Street Overwhelmingly Favors Yellen Over Summers for Fed Chair: CNBC Poll," The Huffington Post, July 26, 2013.

Can the Federal Reserve Handle Banks Too Big To Fail?

The biggest banks operating in the U.S. reaped an estimated $13 billion of income by taking advantage of the Federal Reserve’s below-market rate of .001% on $7.7 trillion in emergency loans in the wake of the credit freeze in September 2008. Rather than using the additional funds to increase lending, the banks fortified reserves and paid bonuses out to executives. Had member of Congress had been able to anticipate all this, it is possible that they would have prescribed stronger medicine, perhaps even including breaking up the banks with over $1 trillion in assets.
As Shakespeare has Marcellius say in Hamlet in reference to moral and political corruption, “something is rotten in Denmark.” Another line could be added from Macbeth. “Out, out damn spot!” Bloomberg News reported that “the Fed and its secret financing helped America’s biggest banks get bigger and go on to pay employees as much as they did at the height of the housing bubble.”
Total assets held by the six biggest U.S. banks increased 39 percent to $9.5 trillion on Sept. 30, 2011, from $6.8 trillion on the same day in 2006, according to Fed data reported by Bloomberg. Employees at the six biggest banks made twice the average for all U.S. workers in 2010, based on Bureau of Labor Statistics hourly compensation cost data. “The banks spent $146.3 billion on compensation in 2010, or an average of $126,342 per worker. That’s up almost 20 percent from five years earlier compared with less than 15 percent for the average worker. Average pay at the banks in 2010 was about the same as in 2007, before the bailouts.”
When members of Congress were voting on the $700 billion TARP, they were being kept in the dark on the Fed’s loans. The general public was out of the loop as well. Ted Kaufman, a former U.S. senator from Delaware, said that if Congress had been aware of the extent of the Fed rescue, the knowledge “could have changed the whole approach to reform legislation,” He claims he “would have been able to line up more support for breaking up the biggest banks. More than three years after the financial crisis, Sen. Sherrod Brown of Ohio observed, “There are lawmakers in both parties who would change their votes now [i.e., in December, 2011].” Byron L. Dorgan, a former senator from North Dakota, says the knowledge might have helped pass legislation to reinstate the Glass-Steagall Act, which for most of the last century separated customer deposits from the riskier practices of investment banking. Had people known about the hundreds of billions in loans to the biggest financial institutions, they would have demanded Congress take much more courageous actions to stop the practices that caused this near financial collapse.”
The government’s response to the crisis has not significantly reduced systemic risk, even with the higher reserves requirements for the biggest banks. According to Bloomberg, “Kaufman says some banks are so big that their failure could trigger a chain reaction in the financial system.” For so few banks to hold so many assets is “un-American,” says Richard W. Fisher, president of the Federal Reserve Bank of Dallas. “All of these gargantuan institutions are too big to regulate,” he continued. “I’m in favor of breaking them up and slimming them down.” Oliver William, an economist, concluded that the “banks that were too big got even bigger, and the problems that we had to begin with are magnified in the process.” A conflict of interest may be part of the underlying cause.
It could be that the bankers at the Federal Reserve Bank have been overly friendly to the bankers getting the funds. This conflict of interest could expose the Fed to losing lent funds should one or more of the troubled banks become insolvent and with insufficient collateral. Therefore, in an attempt to make the Fed accountable in regard to its emergency lending,  Congress included in its Dodd-Frank legislation (2010) requirements stipulating that the Fed develop and submit guidelines regarding selection criteria to be applied to banks seeking emergency loans and requirements by which bank collateral is to be reckoned as sufficient.
The publication of selection criteria would reduce the risk of moral hazard. The cost of borrowing for so-called too-big-to-fail banks is lower than that of smaller firms because lenders believe the government won’t let them go under. The perceived safety net creates what economists call moral hazard—the belief that bankers will take greater risks because they’ll enjoy any profits while shifting losses to taxpayers.” Jeremy Stein, a Fed governor, has spoken of moral hazard, according to the New York Times, as “the belief that government support can subsidize banks and make them less careful about the dangers inherent in their businesses.” Depending how strict the selection criteria are, “the banks might then realize that the Fed will not be a pushover in times of market stress.” At least as of April 2013, the Fed had not followed through on the mandate in Dodd-Frank that the Fed promulgate rules.
The Fed might have good reason to stave off rules that could restrict the Fed’s flexibility in a crisis. “The Fed might be thinking, ‘We don’t want to make a lot of rules that might hinder us from acting in an emergency situation that we can’t anticipate,’” Michael Bradfield, a former general counsel at the Fed, remarked. “I think the Fed should have reasonably broad discretion to deal with systemic issues,” he continued, “(b)ut then the question is, What’s systemic and what’s really needed, and what conditions ought to accompany that lending?” Demanding too much in collateral, for example, might mean that some very big banks that are hemorrhaging capital might not qualify for an emergency loan and go under as a result. If those banks are too big to fail, the entire financial system could follow suit.
Unfortunately, discretion at the Federal Reserve could enable the “insider” conflict of interest to be exploited. Such exploitation is likely from the banking lobby as well as from the Federal Reserve. Bloomberg reports that “(l)obbying expenditures by the six banks that would have been affected by the legislation rose to $29.4 million in 2010 compared with $22.1 million in 2006, the last full year before credit markets seized up—a gain of 33 percent, according to OpenSecrets.org, a research group that tracks money in U.S. politics. Lobbying by the American Bankers Association, a trade organization, increased at about the same rate.
In a rare glimpse of how the banking lobby operates, there is evidence that the lobbying firm Clark Lytle Geduldig & Cranford sent a memo to the American Bankers Association expressing worry that the Occupy movement and the Tea Party movement might find common ground and become a potentially potent threat by joining forces. Tellingly, the memo’s writers reveal how even potential threats to big business are relegated: “If we can show they have the same cynical motivation as a political opponent it will undermine their credibility in a profound way.” Using the media outlets, the “messengers” of powers vested in the status quo can quickly discredit others, as if from a popular wave of mass opinion. Meanwhile, the matter of the very existence of the banks too big to fail continued to float below the radar—the media dutifully transmitting the transparent issue of tents and evictions in various cities. In other words, even the occupiers—the anarchists outside the system!—allowed themselves to be played. Perhaps we are all being played.

Sources:

Bob Ivry, Bradley Keoun, and Phil Kuntz, “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress,” Bloomberg Markets Magazine, November 27, 2011.

Peter Eavis, “Fed Still Owes Congress a Blueprint on Its Emergency Lending,” The New York Times, April 23, 2013.

Skip Worden, Essays on the Financial Crisis, available at Amazon.

Exaggeration on the U.S. Economy “Going Over the Cliff” after the Financial Crisis of 2008

As the U.S. Government faced down its own deadline in 2012 before the Bush tax cuts would expire and across-the-board budget cuts would commence, the Federal Reserve, which had been struggling to prop up the economy by buying bonds and keeping interest rates low, would, according to the Chairman, Ben Bernanke, be largely powerless to do more in the face of a recessionary policy on taxes and spending. "We cannot offset the full impact of the fiscal cliff," he said of the Fed. "It's just too big." That he had written a doctoral dissertation on the Great Depression and had specialized on it as a professor at Princeton lends a lot of weight to his judgment on the matter. However, he had also managed to be re-appointed to the Fed and thus knew how to play the game. In the case of the automatic budget cuts, major power-brokers, specifically in the military industrial complex, had a lot riding on Congress and the White House making a deal that would obviate the cuts in defense spending. The chairman of the Fed could have been carrying their water.

Ben Bernanke, Chairman of the Federal Reserve, in front of the lights.   Reuters

In September 2012, Bernanke had announced an open-ended mortgage-backed-security purchasing program that would put $40 billion a month into the economy. At the time, he said, “If we do not see substantial improvement in the outlook for the labor market, we will continue the MBS purchase program, undertake additional asset purchases, and employ our policy tools as appropriate until we do. We will be looking for the sort of broad-based growth in jobs and economic activity that generally signal sustained improvement in labor market conditions and declining unemployment.” Presumably the Fed would continue the mortgage-bond purchases were the automatic budget cuts and end of the Bush tax breaks to forestall a “broad-based growth in jobs and economic activity.”

In terms of economic impact, a stimulus of $40 billion a month, or $480 billion annually, would just about match the anticipated $500 billion hit from the “cliff.” How is it then, that the latter is “just too big”? Were the $480 billion insufficient, the Fed would be free to increase its purchases.  Time magazine describes the stimulus mechanism as follows: “Open-ended purchases of mortgages will have the effect of lowering interest rates, helping more people qualify for mortgages or refinance. But more importantly it will — in theory — have the effect of creating an expectation of generally higher asset prices in the future, which will motivate people to get off their duffs and spend money now. If companies and individuals are indeed convinced that prices will rise in the future, that would encourage them to spend, hire, and jump-start the economy out of its chronic underperformance.” Whereas monetary policy was contracted in response to the Great Depression, the scholar of that mistake could presumably do the opposite should we—in his words, “go over the cliff.” His $480 billion mountain of money could turn his $500 billion cliff into a mere bump.

To be sure, purchasing mortgage-bonds can only do so much. As David Dayen of Firedoglake argues, there’s only so much the lifting of asset prices can do without appropriate fiscal policy to accompany it: “(Y)ou have to question the role of monetary actions by themselves to generate an economic boost, especially at this time. Lower mortgage rates may or may not prove helpful . . . without fiscal stimulus and a reversal of the current trajectory of deficit reduction, we will never get to the desired trend for growth.” However, the Fed could presumably buy up more than mortgage-bonds, freeing banks up to lend more in the process.

Most telling is Bernanke’s claim that the Fed could not increase its stimulus enough to counter the anticipated $500 billion hit from sequestration and the end of the Bush tax breaks—and yet the Fed was already on record that it would spend $480 billion in 2013 unless the economy improved in the meantime. His inflexibility seems arbitrary, or dogmatic, in other words, given what the Fed can do, and this leads me to the alternative explanation that the chairman was actually doing someone else’s bidding rather than proffering a judgment steeped in decades of study. The real task would be one of locating the real power-brokers whose financial interests were so threatened.

Whereas the expiration of the Bush tax cuts and cutting entitlement programs had been perennially on the block for years, the sacred-cow of defense spending was all of a sudden susceptible as well. Hence, I believe, all the dire doomsday warnings coming out of Washington to the contrary, the pressure on a political deal was oriented to protecting the status quo of the military-industrial complex rather than obviating certain economic collapse. That is, even more fundamental than the interest of politicians and the media to over-dramatize “going over the cliff” in order to gain attention, the subterranean financial interest of the American military-industrial complex may have been pulling many strings—many puppets—to veer the debate toward a deal. Even as the major players on stage were posturing, a two-step could have been going on behind the scenes—dancing around the sacred cows. Perhaps the real news behind the Bernanke’s warning is that even the “non-politicized” central bank was “doing the dance.”

Sources:

John Cushman, “To Bernanke, ‘Cliff’ Says It All” The New York Times, December 12, 2012.

Christopher Matthews, “Ben Bernanke’s Heavy Artillery: Will Open-Ended Bond Buying Drive Down Unemployment?” Time, September 14, 2012.

The U.S. Federal Reserve as a Regulator of Banks: An Institutional Conflict of Interest

According to the Wall Street Journal, the Federal Reserve “has operated almost entirely behind closed doors as it rewrites the rule book governing the U.S. financial system.” The paper notes that this has been in sharp contrast to the trend at the Fed toward greater transparency in its interest-rate policies and emergency-lending programs. The complaint of a dearth of public meetings misses, however, not only the scripted nature of such displays, but also the more fundamental question of whether a central bank buffered from political pressure should play such a salient role as regulator. At the very least, the democratic deficit and a lack of accountability may be exacerbated by the Fed’s greater role as a regulator of banks—particularly after the major investment banks become commercial banks, and thus subject to the Fed’s regulations.

“While many Americans may not realize it,” the Journal continues, “the Fed has taken on a much larger regulatory role than at any time in history. Since the Dodd-Frank financial overhaul became law in July 2010, the Fed has held 47 separate votes on financial regulations.” This was as of February 22, 2012. In the process, the Fed was “reshaping the U.S. financial industry by directing banks on how much capital they must hold, what kind of trading they can engage in and what kind of fees they can charge retailers on debit-card transactions.” Unlike other regulatory agencies, not even the Fed governor’s votes were made public. Considering the contact that Fed officials had with their regulated banks on these issues and the Fed’s ties to banking itself, the lack of public meetings (only two on the 47 votes) suggests an opportunity for a conflict of interest to operate below the radar in the interest of the banks while the public holds the risk.

On the Volker Rule, which was to be the part of the Dodd-Frank law that prohibits banks from proprietary trading using their own funds because doing so is too risky for a bank too big to fail, Fed officials met with bankers at JP Morgan Chase sixteen times, Bank of America ten times, Goldman Sachs nine, and Barclays and Morgan Stanley seven each. On the Dodd-Frank provision on regulating derivatives—something a dissenting Fed governor claimed has exemptions that are too wide—Fed officials met with JP Morgan Chase fourteen times, Deutsche Bank and Goldman Sachs twelve each, and Bank of America, Barclays, Morgan Stanley and Wells Fargo eleven each. Even just in relying on these banks for information and feedback, the Fed risks getting biased input on which to make judgments.

Morgan Stanley may have insisted that the regulation of commodity derivatives would put farmers who rely on the futures market at risk. Moreover, the bankers could have insisted that an exemption would not be abused, or they could coordinate their own pressure with a farming lobby and U.S. senators from farm states. The bankers’ intent was obviously to minimize the cost to them in the regulations that are put in place. The public interest, or risk to the public, was beside the point.

The banks played a similar role in the late 1990s as they lobbied the White House and Sen. Phil Gramm to keep derivatives unregulated. That unseen monster winded up biting us in the ass in 2008. Therefore, putting the public interest at risk is not just part of some theory; giving the regulated too much influence in the writing of regulations involves a conflict of interest that can literally result in the collapse of the global financial system. A public-level perspective, rather than that of a firm or industry, must be primary among regulators or the system itself is put at risk.

Pointing to the lack of public meetings in the Fed’s approach as a regulator, Sheila Bair, former chair of the FDIC, stated, “People have a right to know and hear the discussion and hear the presentations and the reasoning for these rules. All of the other agencies which are governed by boards or commissions propose and approve these rules in public meetings.” Fed officials point out that open meetings tend to be scripted and even perfunctory. As if to state good intentions are sufficient, Fed chair Bernanke said in a 2010 speech, “As an agent of the government, a central bank must be accountable in the pursuit of its mandated goals, responsive to the public and its elected representatives and transparent in its policies.” However, a central bank is closer to its banks in many ways that it is to the public or its elected representatives. In fact, a central banks is supposed to be buffered from political influence. While this makes sense in terms of monetary policy, regulating is a separate function and a democratic deficit there is problematic.

I think the public meeting issue is a red herring. The real problem lies in a central bank going beyond monetary policy and acting as a bank for the banks to also be a regulatory agency. That the Fed’s regulatory process differs from those of the “real” agencies suggests that the Fed officials do not even seen the Fed as such an agency. As Bernanke said, “a central bank is . . .” This is the Fed’s identity. It is distinct from a regulatory agency. Accordingly, Congress should establish a separate regulatory agency to cover the banks, leaving the Fed officials to concentrate on their core functions in operating a central bank. It is not as if Bernanke “got it right” leading up to September 2008. Even in 2007, he did not think the declining housing market would cause much of a problem. He had no idea that the swap and derivative markets were about to implode. This is not a good basis on which take on additional responsibilities, particularly writing new banking regulations. In other words, it is not like much would be lost were banking regulation written and enforced by a regulatory agency rather than the Fed. In addition, such an agency would not be so closely tied to the banks as the Fed is, as hinted at by its myriad of meetings with them. Such an agency would not be explicitly distanced from political pressure as the Fed is.

There is nothing wrong with elected lawmakers and executive branch officials making sure that the laws they have passed and are enforcing, respectively, are being operationalized and enforced by regulators who keep the public interest foremost in mind. As a central bank, the Fed is neither under the U.S. President in the executive branch nor under Congress. Meanwhile, Fed officials are very close to the banks they regulate. The problem of accountability that is in the Fed’s independence from the two branches added to the conflict of interest of the Fed being so close to the banks it regulates sets the public up for the sort of thing we saw in September 2008. That crisis did not come out of nowhere, and the reasons for it go beyond the housing market. At the very least, relying so much on an “agency” (and chair!) that failed to anticipate September 2008 and then geared a bailout to the banks rather than to the millions of foreclosed borrowers (hint: conflict of interest!) to write and enforce additional banking regulations on an industry that does not want them is beyond stupid; it is suicide. Meanwhile, the issue was presented as one of public meetings, which were scripted anyway and did not prevent the Fed from meeting with its bankers.

Source:

Victoria McGrane and Jon Hilsenrath, “Fed Writes Sweeping Rules From Behind Closed Doors,” The Wall Street Journal, February 22, 2012.

Related books: 

Essays on the Financial Crisis

Institutional Conflicts of Interest

How a Chairman of the Federal Reserve Made Strategic Use of the Media

Just as the US Senate was to take up the matter of Ben Bernanke’s re-appointment as Chair of the Federal Reserve in 2010, Time magazine came out with its announcement that he is to be its person of the year.  According to the magazine, “when turbulence in U.S. housing markets metastasized into the worst global financial crisis in more than 75 years, he conjured up trillions of new dollars and blasted them into the economy; engineered massive public rescues of failing private companies; ratcheted down interest rates to zero; lent to mutual funds, hedge funds, foreign banks, investment banks, manufacturers, insurers and other borrowers who had never dreamed of receiving Fed cash; jump-started stalled credit markets in everything from car loans to corporate paper; revolutionized housing finance with a breathtaking shopping spree for mortgage bonds; blew up the Fed’s balance sheet to three times its previous size; and generally transformed the staid arena of central banking into a stage for desperate improvisation. He didn’t just reshape U.S. monetary policy; he led an effort to save the world economy.”  Not to be outdone in service to the Chairman, CNN furnished its own reporters, who gave credit to Bernanke for these measures.  Interestingly, however, even though one reporter admitted that Bernanke had said in 2007 that the subprime market and its derivatives would not threaten the financial market and the banks, she attributed the fault there to the imperfections in the market rather than to Bernanke himself in being wrong.   So, he gets credit for cleaning up the mess (ignoring the foreclosed homeowners) but not the blame for being wrong about the contagion (and not urging regulation of the derivatives).  He could have urged the regulation of derivatives (he is a smart person), and once the crisis occurred, he could have tailored his response to the homeowners facing foreclosures that could have been stopped. For example, the Fed could have created dollars to subsidize the inordinate rates on the variable rate subprime mortgages (i.e. those bank assets would not have been toxic and the banks’ balance sheets would have been fine…two birds with one stone…rather than doing the bidding of one of the parties).  To be sure, if the Fed is inordinately friendly to banks because of the power they have in selecting their regulators (the NY Fed Chair’s appointing committee consists of bankers), then Bernanke might have simply been playing the good politics for staying in office.   “Our ships must all sail in the same direction; otherwise who can tell how long you will…last…with us.” (The Godfather, part III)  Bernanke is a player from the perspective of the real power behind the throne: America’s financial elite.  That elite literally owns the media companies. So what I want to point out here is that the timing of Time’s announcement and the asymetry in CNN’s laudatory coverage of the Chairman just as the Senate was about to consider his re-appointment led me almost instinctually to  be convinced that coincidence was not the driver here.  The Chairman undoubtedly had some powerful friends in the media who were giving him a publicity offensive, or campaign, just in time for the Senate debate on whether to appoint him.

Through all the admiration of this person of 2009, it should be remembered that he did not urge the regulation of sub-prime derivatives issued or held by the banks regulated by the Fed.  He was wrong about the subprime housing bubble being contained.  And he failed to protect homeowners sufficiently.  If the media was being used by the Fed Chair in his re-appointment campaign, it could be that what we are fed by CNN, Fox, MSNBC and the main network newscasts is not really as neutral or beyond their control as we think.   News as a campaign.  News because it is in some powerful actor’s vested interests.  While there is certainly coincidence in life, an alignment such as I have outlined here is far too transparent—or at least it ought to be.

The subtext here is that we, the American people, have become too much the pawns even as we think we are not.  The illusion of popular sovereignty is that we are in control.   I don’t think we have any idea of the extent to which we are manipulated by the powers that transcend our elected representatives and their appointees.  It is no wonder that real change does not get beyond the interests of the real power in America, whose interest is in the status quo or at best in an incremental change.   Essentially, we have allowed the anti-democratic power to concentrate to a degree that is dangerous to a functioning republic (i.e., a representative democracy).  We should not be surprised to find that powerful actors are operating at a subterranean level where transparency is intentionally lacking.    How do we get it back, you ask?  Hah!   We would have to see it first—realize its extent and depth—and I’m not holding my breath that enough people will wake up to see the light.

Too many of us are ensconced in Plato’s cave, taking what the puppets say for reality.  As Jack Nicholson said in A Few Good Men, “You want answers? YOU CAN’T HANDLE THE TRUTH!”    Even if we could stomach the emetic manipulation behind the scenes that is directed to us (and even our representatives—when they aren’t doing it themselves), we would have to be able to see it—and it is so well hidden.  We can only grasp at straws…confluences that seem like more than coincidences.  As a member of the black caucus of the US House (surprisingly) said to a reporter of Frontline on the TARP program passing the House just days after it had been voted down by that same body, “You have no idea how powerful the anti-democratic forces are here.”    You and I get only glimpses.  The puppets seem more real so we believe in them.   Please don’t take my thesis to be that there is one huge orchastrated conspiracy; rather, I’m simply suggesting that our system of representative democracy does not seem to be able to sufficiently constrain the invisible powers that are pulling strings without being accountable to the public power.  It is my ardent hope that the people will look beyond the status quo in voting for candidates—perhaps getting back to citizen representatives who do their duty then return to their preferred occupations—that we would elect people sufficiently principled and not desirous of a life in power to be willing to take on the financial power.   Do I think it will happen?  Sadly, no.  I’m sorry, but I just don’t think we have it in us…or we don’t have enough of what it would take to confront that which is in us that favors comfort and sleep.   In the story of the rise and fall of empires, the United States is not exempt.  The culprit, as with most things, lies within.   It is ultimately about what kind of people too many of us are.  Such a thing is very, very difficult to change, let alone see.  Decadence tends to be invisible to itself.

Note: A day after CNN covered the announcement, the Senate finance committee debated and voted on Bernanke’s re-appointment. See http://www.msnbc.msn.com/id/34463144/ns/business-stocks_and_economy/

 Source: http://www.time.com/time/specials/packages/article/0,28804,1946375_1947251,00.html#ixzz0Zs8WgpV1

The Federal Reserve Expanded Its Turf in Spite of Having Come Up Short

Testifying before the US Senate Finance Committee on his re-appointment, Ben Bernanke volunteered that the Fed had been “slow” in protecting consumers from high-risk mortgages during the housing bubble and that it should have forced banks to hold more capital for all the risks they were taking on.  “In the area where we had responsibility, the bank holding companies, we should have done more.” he told lawmakers.  The hearing provided new evidence of doubt among lawmakers about the Federal Reserve’s  role as the nation’s guardian of the financial system. “In the face of rising home prices and risky mortgage underwriting, the Fed failed to act,” said Senator Richard Shelby of Alabama, the senior Republican on the banking committee. “Many of the Fed’s responses, in my view, greatly amplified the problem of moral hazard stemming from ‘too big to fail’ treatment of large financial institutions and activities.”  Accordingly, Senator Dodd proposed that the Fed’s powers as a bank regulator ought to be transferred to a new consolidated agency. Even though Bernanke admitted that the Fed made mistakes as a regulator of the bank holding companies, he and other top Fed officials adamantly opposed Dodd's proposal, arguing that the Fed has unique expertise nonetheless and that the Fed's ability to preserve financial stability depends on having the detailed information that only a regulator has about the inner workings of major institutions.

The Fed has “unique expertise," and yet, “In the area where we had responsibility, the bank holding companies, we should have done more.”   In other words, the Fed’s Chairman admitted that his agency had not done a satisfactory job of regulating banks during the housing bubble and yet his organization should be given even more power as a regulator anyway.  Were we to trust the Fed to regulate systemic risk, given the agency’s squalid record leading up to the financial crisis of 2008? Regardless of what qualms this question may have raised, the Dodd-Frank legislation charged the Fed with guarding the financial stability of the United States. It gave the central bank the power to oversee the largest financial institutions, even if they are not banks. Finally, it gave the Fed a prominent role on the Financial Stability Oversight Council, a body of regulators that will have the power to seize a systemically important company if it threatens the stability of the economy. Testifying before the Financial Crisis Inquiry Commission on September 2, 2010, Bernanke signaled that the central bank was eager to embrace its strengthened role provided for in the Dodd-Frank law. This role ought to give us pause, given his remarks in 2007 in which he thought the subprime problems were “manageable.” To the Commission in 2010, he said, “What I did not recognize was the extent to which the system had flaws and weaknesses in it that were going to amplify the initial shock from subprime and make it into a much bigger crisis.”

Sources: http://www.nytimes.com/2009/12/04/business/economy/04fed.html?ref=business ; http://www.nytimes.com/2010/09/03/business/03commission.html?_r=1&ref=business

Making Too Big To Fail Costlier: A Check on Empire-Building

Testifying before the Financial Crisis Inquiry Commission on September 2, 2010, Ben Bernanke, chairman of the Federal Reserve, observed, “As of 2003 and 2004, there really was quite a bit of disagreement among economists about whether there was a bubble, how big it was, whether it was a local or a national bubble. We certainly were aware it was a risk factor, but frankly by the time it was clear it was a bubble” it was too late to address it through monetary policy. The New York Times also reported that he spoke favorably of forcing huge banks to hold much more capital, particularly if they were systemically important — so much capital, indeed, that being big would be costly. He advocated that the increased capital requirements should include capital that is more aligned with risk and able to absorb losses more effectively, and that works in a countercyclical manner, so that banks have more of it during times of stress.
Given the difficulty involved in recognizing a bubble even as it crests, Bernanke’s statements on capital-holding changes make sense. Absent breaking up banks too big to fail, making it very costly for them to be big is the next best option. The regulators would be wise to be on the look out, however, for bankers who try to hide their banks’ true sizes (and risk). Given the empire-building proclivity in the business world, designing a system that makes bigness more costly could result in an overall balance of forces. The key is to make being big sufficiently costly that the drive to empire-build is sufficiently checked in the banks.

Source: http://www.nytimes.com/2010/09/03/business/03commission.html?_r=1&ref=business

On the Arrogance of Power: Greenspan, Rubin, and Summers in the Clinton Administration

Over two years after the financial crisis of 2008, a commentator on Fox News said that the banks should not stop the foreclosure process because that would not be good for the free market. He said that people who cannot afford their houses should lose them. Another commentator remarked that there was still too much government in the financial sector. This, according to the commentator, is “the problem.” It is particularly striking that Alan Greenspan’s stark admission to a U.S. House committee in 2008 that the deregulated laissez faire market paradigm contains a fundamental flaw was lost on the two commentators. In May 2011, House Speaker Boehner charged that business is over-regulated. This comment too is remarkable given Greenspan’s realization. If a people disowns its own lessons, history is destined to repeat itself.

The full essay is at Essays on the Financial Crisis.

The Federal Reserve to Buy More U.S. T-Bills but No State Debt

According to The New York Times, “At their first meeting of the year, Federal Reserve policy makers voted unanimously … to continue the central bank’s controversial $600 billion plan to spur the recovery by buying government bonds.”[1] In other words, the central bank would continue to “print money” to buy up U.S. Government debt, allowing that government to go into more debt without putting pressure on the interest rate to go up (which would cost the government more in interest payments to bondholders).

Theoretically, the Federal Reserve can buy an unlimited amount of bonds because the central bank can create money. Of course, creating money relative to GNP growth can spark inflation, but the central bankers are not worries. “The Fed did note that commodity prices had risen, but cautioned that long-term inflation expectations had been stable and that measures of underlying inflation had continued to trend downward.” Even so, “skeptics fear that the bond-buying — which has the effect of further expanding the Fed’s already large balance sheet — could lead to destabilizing asset bubbles or touch off inflation.”[2] I contend that this is a rather narrow (though certainly valid) concern; equally or more troubling for the long term is the asymetry in the Fed’s treatment of debt issued by the U.S. Government and that of the state governments. 

For instance, in 2010 Illinois issued $16 billion in additional debt. Whereas the U.S.Government could fall back on the Federal Reserve, the latter has refused to purchase debt from states like Illinois. Aside from the unfairness inherent in the Federal Reserve’s proclivity, the asymetry subtly undercuts federalism. In other words, the U.S. Government having an unlimited ability to have its central bank purchase its debt gives that government still another edge over the state governments, which one can expect will be even more compromised in being able to check encroachments by the U.S. Government. The resulting enervation of federalism means that consolidation may reach us sooner rather than later, at the expense of our governments being able to act as mutual checks on eachother.

Another way of making this point is to charge that the Federal Reserve’s refusal to do for the state governments what the central bank is doing for the U.S. Government evinces a structural bias in our system of federalism. The lack of balance (and the underlying unfairness) ought to be of concern to the citizenry. The result may well be that the U.S. Government will be enabled to get into unsustainable debt such that the empire itself may one day collapse under its own weight at the center.

1. Sewell Chan, "Fed to Continue Bond Buying Program," The New York Times, January 26, 2011.

2. Ibid.