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U.S. Handling of Financial Crisis - A Less Optimistic View

Obama is certainly not the first President who got elected and then discovered that "the world is ruled by very different personages than it would appear" (I think I'm misquoting what FDR said upon leaving office, though I may have the wrong President, but that's the gist of the message).

I think Obama really believed that the Presidency would give him the power to implement the kinds of changes that he thought would improve America. Then he discovered that banksters own the economy and various sub-system interest groups rule their own fiefdoms within the country; the medical-industrial complex for e.g., and the trial lawyers.

I think most of us on SA have to admit that we have learned a lot about how the financial system is run, things we didn't know before, over the past year. And there is no reason to think Obama understood the system and its rulers when he took office. Only a few Wall St insiders know what has been going on over the past decade or more and it is only recently that investigative journalists and bloggers like Matt Taibbi and Edward Harrison have been making that information widely known.

To make the changes he wanted Obama would have to pry all the entrenched interests out of their fiefdoms and subject them to the kinds of regulations that serve America as a nation rather than merely serve the interests of the fief-lords and their vassals. But how can a President hope to win battles against trillionaire banksters who understand their system, when Obama has no money and no understanding? Likewise with other captured industries. The entrenched interests have all the weapons and all the power.

It's not too late for Obama. He's still in his first year in office. But if he's to succeed he'll have to transform himself from a naive idealist into a hardass realist. He'll have to be a trustbuster, an enemy of oligopolists and entrenched interests, a restorer of free markets. Obama still seems to think central planning can solve a lot of America's problems. So I'm not sure he's the right guy to break up the central planners in America's captured financial, health care, military and other industries. But I wouldn't be shocked if Obama did a mid-term about face in his thinking, after realizing the true state of the nation that he genuinely wants to heal.

After Securitization: Who Owns America Now?

Great article Andrew. A very crisp perception of our recent financial history, starring MBS and its red headed stepchild CDS, and brought to you of course by the good folks at GS et al.

ING Shows How Bank Dismemberment Is Done

Put Paul Volcker and Thomas Hoenig in a room for a few days and they can write up a detailed plan to do for US money center banks exactly what is being done with ING. We already have the expertise and the willingness on the part of these honest central bankers. Unfortunately guys like these are not the ones who own the government. But if US citizens could control their government then their government could control the banksters via a Volcker-Hoenig plan to break up the too bigs.

Ultimately, Who Benefits from Too-Big-To-Fail

Calomiris wrote, "Limiting the size, complexity and global reach of financial institutions is fraught with downsides for the international economy. We can solve the too-big-to-fail problem without destroying global finance."

Is he talking about the same "international economy" that has seen all the benefits for the past 3 decades flow to corporate profits and zero to US workers? And the resultant overconcentration of wealth in the top 10% and overconcentration of debt among the middle class? The same international economy that saw China sell $2 trillion more goods to the US than it bought from the US creating a debt fueled US consumer bubble whose ongoing collapse is still threatening to bring down the very global finance that Calomiris defends? The global finance that securitized unpayable US mortgages on bubble priced houses and sold them to suckers across the planet to earn fees and commissions? The same MBSs that the Fed is now buying en masse to prevent a Depression?

If that's the "international economy" and "global finance" that Calomiris seeks to defend then I suggest this man is our enemy, not our ally.

Diana Farrell And The White House Theory Of Bank Size

greencanbgood wrote,

"All you "too big" people out there, I wonder why you aren't writing to your congressional representatives to break up Microsoft also. You can't have it one way for one industry and anohter way for a different industry. Let a free market reign and eventually, the poorly run will fail."

This is precisely our complaint. Too big HAS failed, but unlike companies in any other industry these banks still exist. Their shareholders have not been wiped out. Their employees have not been thrown out of work with no severance pay and no pensions as happens in other grossly insolvent bankrupt companies. Their successful, solvent competitors are not presently feasting on their assets at firesale liquidation auctions.

Instead the TBTF honchos are still paying themselves billions of dollars in "bonuses". I suppose they deserve a big bonus for "succeeding" in controlling the government and f___ing American taxpayers out of hundreds of billions of dollars.

I'm not arguing that we should have let capitalism run its course and wiped out these failures last winter. I don't want a Depression any more than Ben Bernanke does. What I do want is for the failure to be acknowledged and some discipline to be accepted by these people. Failure is supposed to be humbling, not exhilarating and highly profitable.

Shortly before the central bankers get-together in Jackson Hole last summer Kansas City Fed President Thomas Hoenig (who was hosting the conference) published "Too Big Has Failed", in which he advocates an orderly unwinding of these failed businesses. So even among the monetary elites within the Fed there is not consensus that these megabanks should be allowed to exist. Sadly, I saw no mention of Hoenig post-Jackson Hole. His rational approach to actually solving the financial logjam was likely ignored just like BIS economist William White was ignored by Greenspan when he stridently warned of the bubbles that were forming. These TBTF guys are making WAY too much money to let a little thing like causing an economic crisis with mass unemployment and currency devaluation bother them.

There are valid arguments for economies of scale. A one man shop can neither afford nor utilize a $400,000.00 machine that does the work of 100 men. A larger scale operation can afford and use the machine to vastly increase its productivity which ultimately reduces costs to consumers.

But when an operation gets so large that no individual ever knows everything that's going on in the company at any given time, then the operation becomes LESS efficient. All kinds of redundancies and other waste happen because the big picture of the company is too big for one person to see. From that point up the only reason these too-big-to-be-efficient companies appear to be 'efficient' is that they enjoy oligopoly pricing power. The consumer (or the taxpayer) can be made to subsidize the inefficiencies so the company remains highly profitable even while overpaying its employees and wasting large amounts of its resources.

I would argue that the TBTF "bank-like businesses" are in this latter category. They get laws and regulations written that favor them over their competitors. They have large scale money that enables them to move markets, and profit on the moves because they alone know beforehand which direction they are going to move the market. They are allowed to park their computers at the NYSE to front run and 'tax' equity trades.

All of this enhances profitability for these companies, but all of these "excess profits" are not from creating additional value but from sucking money away from everyone else in the economy. By this standard IRS employees should also be paying themselves billions in bonuses because the taxman is the money sucker par excellence.

As John Lounsbury implies in his comment above, overconcentration of wealth is an economy killer. It is not "envy" that should motivate policymakers (and shareholders) who want to rein in the big bankers. It is the desire for a sustainable economy and for sound economic policy that should motivate them.

Closing Update for Friday, August 21: New Highs for 2009

Despite no fundamental reason for it, I think this market is going to keep edging higher. If the market is being manipulated by GS with HFT then it's with the blessing of the Fed and administration who all want to see at least one asset class rebounding. I think there's a whole lot of weight behind the push up so if you can suspend your disbelief you can share in the gains.

When Journalism Misses the Big Picture

Before you can give an accurate simple explanation of anything you have to understand the big picture. Nothing exists in a vacuum. Everything exists in a context, a bigger picture. If trade journalists can't give a relatively simple explanation of some aspect of their subject it's probably because they really don't understand the field very well.

How AIG FP Brought Down the World

Madoff's investors did not carefully scrutinize his model because he gave them 12% returns. Why would anyone care what's in the financial products they are selling when they are getting millions of dollars in bonuses for selling them? Even if somebody sees that the models can't work, the bonuses are real. You get what you pay for.

The Virtue of the Republic

Superb article.

Harry quoted Jefferson, "When virtue is banished, ambition invades the minds of those who are disposed to receive it, and avarice possesses the whole community."

Whether we like it or not, leaders 'lead'. When ordinary people see the leaders (or their neighbors) getting fabulously wealthy they want to get in on the action, regardless of the immorality of the means. 'Avarice possesses the whole community.'

In the post-war era people saw their leaders and neighbors getting ahead by being productive workers and this created a virtuous cycle. Now we're in the vicious cycle of getting ahead by entitlements and bailouts; by getting money we haven't earned with no concern for who we're robbing. This is the kleptocracy phase of a society and I don't know how to get out of it. Hopefully there is the beginning of a bottom-up realization that basic reality has not changed: we need to earn our living producing real things of real value to each other. Maybe a nation of honest earners will refuse to accept a cabal of kleptocrats ruling them.

Misunderstanding the Great Recession

Steven wrote,
"The innovation system in America has been damaged by adhering to an economic model which rewards profits before substance."

I think this is the core of the problem. When you set up an economy where people can 'earn' money without producing anything that other people are willing to pay you for, you have effectively replaced the rewards-structure of a natural productive "substance" economy with the rewards structure of an arbitrary socialized "profit" economy; a politicized economy.

The further a person's work is from direct production, the more abstract that job becomes and the more arbitrary the determination of the income that job should pay. At its extreme we see CEO's collecting millions of dollars in income in the same year the business they are supposedly managing goes bankrupt. You cannot say they 'earned' that money. Putting in time on the job is not equal to performing the job you're supposed to be doing.

In small-medium business if you lose money it comes straight out of your pocket, and if you earn money it goes straight in. There is a direct relation between how much you 'earned' and how much you actually get to put in your pocket.

Bureaucrats 'earn' as much money as their union can extract from the other bureaucrats who the politicians hire to negotiate public sector wages. Taxpayers are happy to pay for pothole filling and snowplowing, but where is the taxpayer value in 'equity consultant'? No business in their right mind would hire an equity consultant unless the threat of some government law or policy forced them to. Too much bureaucracy is definitely part of the problem, both in Big Business and Big Government, and too many people get the wrong idea about how to 'earn' money.

In small-medium business the owner is directly involved. You spend all your time trying to minimize your costs and maximize your profits; or to minimize your effort and maximize your production. It's these mentally engaged on-the-ground owners and workers who think up new technologies that make their line of work more efficient. In Alberta where I live there are lots of rich guys with very little formal education who figured out an ideal solution to some problem relating to drilling and producing oil and gas. They got some money together, built and perfected a prototype of their idea, patented it, and now it's what the world uses. You don't get that by sitting in the office.

Economies of scale maybe apply to production with existing technologies, but it is individuals who think up the new technologies. Maybe part of the problem is that since WWII companies have become global behemoths generating profits only because their industry is an oligopoly and everyone else charges the same high prices to mask their economic inefficiency. In this way Big Business is able to 'tax' the consumer and pay their employees and management higher incomes than the free enterprise sector is able to earn and pay.

Bigger is not necessarily better. Small is often far more economically efficient. But you won't see this by looking at the financials, as Steven points out.