Thursday, September 25, 2008
You Cannot Push on Piece of String Mr. Paulson
You Cannot Push on Piece of String Mr. Paulson
Treasury Secretary Paulson’s grand scheme to buy $700 billion of toxic derivatives from ailing financial institutions is a pipe dream that logic and history show will not work. The Paulson plan is nothing but manna from heaven for distressed institutions. No doubt there will be a momentary burst of confidence and markets will rally but longer term serious problems remain.
The bailout is an attempt to bring confidence back to the lending market that has seized up in fear and is not making loans. The concern is that the cessation of liquidity and lending will exacerbate the meltdown on Wall Street and ripple broadly into the economy. The Paulson plan fails to address the issue of fear that is behind the crisis.
History shows the Plan is Doomed to Fail
Over the past few weeks we have been consistently told that we face an epic crisis comparable to the 1929 stock market crash with its ensuing Great Depression of the 1930’s. So why are the lessons of the Great Depression being ignored?
During the Great Depression lending similarly dried up and confidence swooned. Lending and borrowing came to a standstill. The Lesson of the Great Depression was that it is next to impossible to get institutions to lend and companies/consumers to borrow once fear sets in. Renowned economist John Maynard Keynes said that trying to get banks to lend and borrowers to borrow during a banking crisis is like trying to “push on a string”—in other words it is impossible. Similarly in the 1990’s the Bank of Japan found trying to resuscitate lending in the wake of the Japan’s stock market collapse was impossible. The Bank of Japan even went to the extreme of making interest rates negative, in other words they paid you to borrow, and it proved ineffectual.
While pushing on a string refers to monetary policy, which the Fed has kept lose, and the Paulson plan is about buying assets they are similar because they are attempts to get banks to lend. Buying the bad assets of institutions is going to at best provide a temporary return to lending. Ultimately you can lead a horse to water but you cannot make him drink.
“All we to Fear is Fear Itself”
In his first inaugural speech FDR voiced the greatest challenge facing America and the world at the time when he said, “All we have to fear is fear itself”. Today fear has again set into the financial markets and is beginning to spread. Turning this tide is next to impossible.
The market runs from the extremes of greed to fear and once a mentality sets in its stays for a very, very long time. Nobel Prize winning economist Robert Mundell described the renitence of consumers to buy things in the 1930’s as a deflation (falling prices) mentality. Because demand fell off a cliff retailers were forced to reduce prices to sell their products. Consumers eventually realized that by postponing their purchases they could save money. As they held off buying retailers were forced to reduce prices further to entice buyers. This created a self fulfilling spiral pushing prices lower that eventually had many buyers forgoing buying totally.
Admit that Reaganomics and Free Markets Don’t Work
The unfortunate thing is that the Bush Administration and Republicans refuse to admit that the problem we are suffering from today is the failure of free market and Reaganomic ideology. The cause of our current problems from the meltdown on Wall Street, to higher gas prices, to higher food prices can be traced squarely to the failure of free market/neoliberalism/Reaganomics ideology.( See “Higher Gas Prices: The Failure of Free Markets and Reaganomics: http://www.peacecouncil.net/pnl/08/777/777gas.html )
Government needs to regulate and get rid of the excesses created by the free market’s binge of the past few decades. Bold and aggressive initiatives such as the government seizing control of financial institutions are needed at this time. Fear has set in and throwing good money at bad as we have done successively with bailouts since the 1987 stock market crash have not worked. Bailouts create a moral hazard and reckless behavior that necessitate further bailouts where eventually you reach a point where the size of the bailout bill is insurmountable. Today we are being forced to fork over a massive $700 billion.
Capitalism is failing again as it did during the 1930’s with the Great Depression. They say “fool me once shame on you, fool me twice shame on me.” How many more times will we allow our self to be fooled? Free market ideology does not work! Bold initiatives that empower “we the people” are needed.
Treasury Secretary Paulson’s grand scheme to buy $700 billion of toxic derivatives from ailing financial institutions is a pipe dream that logic and history show will not work. The Paulson plan is nothing but manna from heaven for distressed institutions. No doubt there will be a momentary burst of confidence and markets will rally but longer term serious problems remain.
The bailout is an attempt to bring confidence back to the lending market that has seized up in fear and is not making loans. The concern is that the cessation of liquidity and lending will exacerbate the meltdown on Wall Street and ripple broadly into the economy. The Paulson plan fails to address the issue of fear that is behind the crisis.
History shows the Plan is Doomed to Fail
Over the past few weeks we have been consistently told that we face an epic crisis comparable to the 1929 stock market crash with its ensuing Great Depression of the 1930’s. So why are the lessons of the Great Depression being ignored?
During the Great Depression lending similarly dried up and confidence swooned. Lending and borrowing came to a standstill. The Lesson of the Great Depression was that it is next to impossible to get institutions to lend and companies/consumers to borrow once fear sets in. Renowned economist John Maynard Keynes said that trying to get banks to lend and borrowers to borrow during a banking crisis is like trying to “push on a string”—in other words it is impossible. Similarly in the 1990’s the Bank of Japan found trying to resuscitate lending in the wake of the Japan’s stock market collapse was impossible. The Bank of Japan even went to the extreme of making interest rates negative, in other words they paid you to borrow, and it proved ineffectual.
While pushing on a string refers to monetary policy, which the Fed has kept lose, and the Paulson plan is about buying assets they are similar because they are attempts to get banks to lend. Buying the bad assets of institutions is going to at best provide a temporary return to lending. Ultimately you can lead a horse to water but you cannot make him drink.
“All we to Fear is Fear Itself”
In his first inaugural speech FDR voiced the greatest challenge facing America and the world at the time when he said, “All we have to fear is fear itself”. Today fear has again set into the financial markets and is beginning to spread. Turning this tide is next to impossible.
The market runs from the extremes of greed to fear and once a mentality sets in its stays for a very, very long time. Nobel Prize winning economist Robert Mundell described the renitence of consumers to buy things in the 1930’s as a deflation (falling prices) mentality. Because demand fell off a cliff retailers were forced to reduce prices to sell their products. Consumers eventually realized that by postponing their purchases they could save money. As they held off buying retailers were forced to reduce prices further to entice buyers. This created a self fulfilling spiral pushing prices lower that eventually had many buyers forgoing buying totally.
Admit that Reaganomics and Free Markets Don’t Work
The unfortunate thing is that the Bush Administration and Republicans refuse to admit that the problem we are suffering from today is the failure of free market and Reaganomic ideology. The cause of our current problems from the meltdown on Wall Street, to higher gas prices, to higher food prices can be traced squarely to the failure of free market/neoliberalism/Reaganomics ideology.( See “Higher Gas Prices: The Failure of Free Markets and Reaganomics: http://www.peacecouncil.net/pnl/08/777/777gas.html )
Government needs to regulate and get rid of the excesses created by the free market’s binge of the past few decades. Bold and aggressive initiatives such as the government seizing control of financial institutions are needed at this time. Fear has set in and throwing good money at bad as we have done successively with bailouts since the 1987 stock market crash have not worked. Bailouts create a moral hazard and reckless behavior that necessitate further bailouts where eventually you reach a point where the size of the bailout bill is insurmountable. Today we are being forced to fork over a massive $700 billion.
Capitalism is failing again as it did during the 1930’s with the Great Depression. They say “fool me once shame on you, fool me twice shame on me.” How many more times will we allow our self to be fooled? Free market ideology does not work! Bold initiatives that empower “we the people” are needed.
Wednesday, September 24, 2008
No Bailouts—Fix the Problem & Reform of the Fed
No Bailouts—Fix the Problem & Reform of the Fed
By madis senner
Lost in the debate over the failing of financial behemoths and the meltdown of Wall Street is an accounting about how this mess came about. The housing bubble that created bad mortgage loans did not just materialize out of thin air. Toxic derivatives which threaten financial institutions and the overall economy were not cooked up in someone’s garage like some high tech internet startup. The fact is that much of what threatens the world economy can be placed squarely on the shoulders of the Federal Reserve. Instead of throwing good money at bad we need to fix the problem and reform the Fed.
We are not just talking about bad policy choices by the Fed. We all make poor decisions, and as a former global money manager I am all too familiar with how the best analysis can at times lead to the worst of results. I am talking about something more insidious. The Fed, particularly under Greenspan, not only made poor policy choices, but pursued a radical free markets agenda and an experiment in financial alchemy from which we now suffer.
Who gave Greenspan the authority to push his agenda and have average Americans serve as guinea pigs for his experiments in free markets and financial sorcery? No one!
Fed 101
Greenspan was able to pursue his whims because the Federal Reserve exists as an independent entity unencumbered by rules that govern other government agencies.
The Fed is free from the checks and balances that are the backbone of the US constitution. The Fed is free from GAO reporting and Freedom of Information Act scrutiny. Its meetings are kept secrecy until long after the fact. It was mandated to report to Congress by the Humphrey Hawkins Full Employment Act until it expired in 2000. Although no longer required to report to Congress the Fed chairman still does. Arguably it is only beholding to its board of directors made up of primarily the largest financial institutions in America; a classic example of the industry supervising the regulator.
The Fed is responsible for conducting monetary policy, overseeing financial institutions and financial markets. In other words the Fed not only sets policy but oversees itself, a clear conflict of interest. Because the Fed can print its own money it is free from Congressional oversight. No need to worry about a budget, just turn on the presses; and don’t worry no one can audit you.
It is difficult for people outside the world of finance to understand the scope and power of the Fed since we are so used to thinking of line authority that gives certain powers to individuals. The Fed’s power rests in a mix of monetary policy tools and confidence in the institution; but in a world ruled by money, the one that controls money is the king. Bob Woodward’s book on Greenspan, Maestro: Greenspan’s Fed and the American Boom expressed the perspective of many that Greenspan was the most powerful person in the world when he said, "On January 20, 2001, a new president takes the oath of office. He assumes the presidency in a Greenspan era".
Amity Shlaes of the Financial Times similarly commented on the enormity of Greenspan’s power and the inherent failure of the design of the Federal Reserve system;
A Radical Agenda
Greenspan is an ardent devotee of the most radical element of capitalism and free markets. As William Greider notes, “His thinking is still anchored by Ayn Rand's brittle social philosophy: Let the strong prevail, let the weak pay for their weakness.” (http://www.thenation.com/doc/20040322/greider )
Throughout his career beginning with the 1987 stock market crash Greenspan has bailed out the rich while ignoring the plight of average Americans. During the Fed engineered bailout of the speculative hedge fund, Long Term Capital Management, the Wall Street Journal’s op-ed page would lament (“Decade of Moral Hazard”, 2/25/98):
The bailouts have only increased in frequency and size of money needed for rescue that today we face the “systemic collapse” the Wall Street Journal forecast.
Instead of balancing the needs of the well to do (inflation) with the interest of working Americans (jobs) as mandated by the Humphrey Hawkins Full Employment Act, Greenspan consistently championed the rich. The Fed has almost exclusively focused on keeping the rate inflation low and ignored the needs of working Americans’ for a strong economy to create jobs. Generally speaking low inflation benefits financial assets and modest, or higher inflation stimulates the economy. The decision to focus almost exclusively on keeping inflation low sent the value of financial assets rocketing higher. Since the advent of Reaganomics and the Greenspan Fed, the PE ratio of the stock market tripled from its historical range of 10 to 15 to 30 to 45. The PE ratio (Price Earning Ratio) is the price of stock divided by its earnings per share. The higher the PE the greater the value.
This explosion in the value of financial assets was a boon to the wealthy that own the bulk of the stock market. Having the value of their investments triple in value by having the Fed simply wave a wand and put the onus on average Americans meant that they had more money to spend on funding conservative think tanks and lobbyists, both of which have dramatically increased. The Fed’s decision to hoist the value of stocks at the expense of average Americans underscores what James Livingston argued in Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913, that the creation of the Federal Reserve was part of an effort to create a new ruling class of ‘corporate-industrial business elite’.
The Financial Experiment Gone Bad
One of the incipient factors behind our current financial maelstrom is financial derivatives. Derivatives are financial assets whose value is based upon the price performance of some underlying asset. They usually entail leverage.
Greenspan has consistently championed and protected government oversight of derivatives. On 9/11/00 the NY Times in “Greenspan Urges Congress To Fuel Growth of Derivatives” reported that:
One must wonder if would we be suffering today if Congress had not been railroaded?
One of the other financial innovations in derivative products creating havoc is subprime mortgages. The subprime market developed as a response to Reagan’s deregulation of the banking system. Banks were allowed to depart our inner cities where the most vulnerable in our country live. Greenspan stood by while this void was filled by loan sharks and shysters who found creative means to circumvent state usury laws and created the fringe banking market. New and innovative financial products were created to prey on the less well to do such as sub prime mortgages, payday loans, auto title loans, check cashing stores, tax refund anticipations loans and others all of which charged exorbitant interest rates. (see http://www.jubileeinitiative.org/RiggedDeregulation.htm )
Many community groups correctly pointed out that fringe banking preyed on the poor, the elderly and people of color. The Fed turned a blind eye to this abuse and did nothing to prevent or even regulate this industry!
Reform the Fed
New Humphrey Hawkins Act—A new Humphrey Hawkins Full Employment Act needs to be passed that has the Fed focusing primarily on creating jobs, the real economy and the interests of average Americans. The Fed’s mandate must be to focus on all Americans.
New Board of Directors—The Fed needs a new board of directors who is primarily made up of individuals and organizations that serve the common good. They need to have the power to rein in the chairman.
Supervision needs to be separated from oversight—The policy arm and oversight functions of the Fed need to be separated.
Fed Head Should be Elected—The head of the Federal Reserve needs to be an elected official.
Congressional Oversight—The head of the Fed has to report to Congress on a regular basis. Congress should receive a detailed plan as to Fed’s policy objectives.
No More PKO’s for the stock market—Since the 1987 stock market crash it is widely rumored that the Federal Reserve, like the Bank of Japan before the precipitous decline of the Japanese market, has been pursuing an active “Price Keeping Operation” (PKO) to buy stocks during dramatic price declines. This must stop! Congress needs to investigate the books of the Fed to determine whether it holds any stocks in its portfolio.
Member Services—Financial institutions that are members of the Federal Reserve system have to offer basic checking, savings and cash checking at minimal cost to our most vulnerable communities.
No more bailouts.
For more information on the Fed go to:
Federal Reserve Links: http://www.jubileeinitiative.org/FedInfo.htm
Fedhead Blog: http://fedhead.blogspot.com/
William Greider’s Secrets of the Temple—How the Federal Reserve Runs the Country after two decades since publication remains the authoritative text on the Fed. Greider has written a plethora of excellent articles on the Fed that can be accessed at: http://www.thenation.com/directory/bios/william_greider
The Financial Markets Center focuses on the Fed and has a rich archive of informative articles: http://www.fmcenter.org/site/pp.asp?c=8fLGJTOyHpE&b=213512
By madis senner
Lost in the debate over the failing of financial behemoths and the meltdown of Wall Street is an accounting about how this mess came about. The housing bubble that created bad mortgage loans did not just materialize out of thin air. Toxic derivatives which threaten financial institutions and the overall economy were not cooked up in someone’s garage like some high tech internet startup. The fact is that much of what threatens the world economy can be placed squarely on the shoulders of the Federal Reserve. Instead of throwing good money at bad we need to fix the problem and reform the Fed.
We are not just talking about bad policy choices by the Fed. We all make poor decisions, and as a former global money manager I am all too familiar with how the best analysis can at times lead to the worst of results. I am talking about something more insidious. The Fed, particularly under Greenspan, not only made poor policy choices, but pursued a radical free markets agenda and an experiment in financial alchemy from which we now suffer.
Who gave Greenspan the authority to push his agenda and have average Americans serve as guinea pigs for his experiments in free markets and financial sorcery? No one!
Fed 101
Greenspan was able to pursue his whims because the Federal Reserve exists as an independent entity unencumbered by rules that govern other government agencies.
The Fed is free from the checks and balances that are the backbone of the US constitution. The Fed is free from GAO reporting and Freedom of Information Act scrutiny. Its meetings are kept secrecy until long after the fact. It was mandated to report to Congress by the Humphrey Hawkins Full Employment Act until it expired in 2000. Although no longer required to report to Congress the Fed chairman still does. Arguably it is only beholding to its board of directors made up of primarily the largest financial institutions in America; a classic example of the industry supervising the regulator.
The Fed is responsible for conducting monetary policy, overseeing financial institutions and financial markets. In other words the Fed not only sets policy but oversees itself, a clear conflict of interest. Because the Fed can print its own money it is free from Congressional oversight. No need to worry about a budget, just turn on the presses; and don’t worry no one can audit you.
It is difficult for people outside the world of finance to understand the scope and power of the Fed since we are so used to thinking of line authority that gives certain powers to individuals. The Fed’s power rests in a mix of monetary policy tools and confidence in the institution; but in a world ruled by money, the one that controls money is the king. Bob Woodward’s book on Greenspan, Maestro: Greenspan’s Fed and the American Boom expressed the perspective of many that Greenspan was the most powerful person in the world when he said, "On January 20, 2001, a new president takes the oath of office. He assumes the presidency in a Greenspan era".
Amity Shlaes of the Financial Times similarly commented on the enormity of Greenspan’s power and the inherent failure of the design of the Federal Reserve system;
"How can it be, at a time of unprecedented faith in free markets, that we even think a government authority might have such strength? And how can it be that the world’s monetary order rests on the shoulders of an individual, much admired but still fallible economist?
The answer is America’s uniquely flawed and outdated monetary law, which gives the nation’s monetary chief the sort of discretion of which his peers in other developed countries can only dream. Mr. Greenspan is so powerful that today he is perceived as a loving dictator. This is only natural. For as we know from history, wherever the law is
weak-in any area of politics-public credibility tends to vest itself in an
individual."
A Radical Agenda
Greenspan is an ardent devotee of the most radical element of capitalism and free markets. As William Greider notes, “His thinking is still anchored by Ayn Rand's brittle social philosophy: Let the strong prevail, let the weak pay for their weakness.” (http://www.thenation.com/doc/20040322/greider )
Throughout his career beginning with the 1987 stock market crash Greenspan has bailed out the rich while ignoring the plight of average Americans. During the Fed engineered bailout of the speculative hedge fund, Long Term Capital Management, the Wall Street Journal’s op-ed page would lament (“Decade of Moral Hazard”, 2/25/98):
“As moral hazard grows you get a market so skewed by the expectation of bailouts that vital signals about genuine risk no longer get through. Eventually, the danger turns into one of systemic collapse…”
The bailouts have only increased in frequency and size of money needed for rescue that today we face the “systemic collapse” the Wall Street Journal forecast.
Instead of balancing the needs of the well to do (inflation) with the interest of working Americans (jobs) as mandated by the Humphrey Hawkins Full Employment Act, Greenspan consistently championed the rich. The Fed has almost exclusively focused on keeping the rate inflation low and ignored the needs of working Americans’ for a strong economy to create jobs. Generally speaking low inflation benefits financial assets and modest, or higher inflation stimulates the economy. The decision to focus almost exclusively on keeping inflation low sent the value of financial assets rocketing higher. Since the advent of Reaganomics and the Greenspan Fed, the PE ratio of the stock market tripled from its historical range of 10 to 15 to 30 to 45. The PE ratio (Price Earning Ratio) is the price of stock divided by its earnings per share. The higher the PE the greater the value.
This explosion in the value of financial assets was a boon to the wealthy that own the bulk of the stock market. Having the value of their investments triple in value by having the Fed simply wave a wand and put the onus on average Americans meant that they had more money to spend on funding conservative think tanks and lobbyists, both of which have dramatically increased. The Fed’s decision to hoist the value of stocks at the expense of average Americans underscores what James Livingston argued in Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913, that the creation of the Federal Reserve was part of an effort to create a new ruling class of ‘corporate-industrial business elite’.
The Financial Experiment Gone Bad
One of the incipient factors behind our current financial maelstrom is financial derivatives. Derivatives are financial assets whose value is based upon the price performance of some underlying asset. They usually entail leverage.
Greenspan has consistently championed and protected government oversight of derivatives. On 9/11/00 the NY Times in “Greenspan Urges Congress To Fuel Growth of Derivatives” reported that:
“The Federal Reserve chairman, Alan Greenspan, urged Congress today to encourage the growth of complex financial contracts known as derivatives before the United States share of that market and associated benefits are lost to other countries.”
One must wonder if would we be suffering today if Congress had not been railroaded?
One of the other financial innovations in derivative products creating havoc is subprime mortgages. The subprime market developed as a response to Reagan’s deregulation of the banking system. Banks were allowed to depart our inner cities where the most vulnerable in our country live. Greenspan stood by while this void was filled by loan sharks and shysters who found creative means to circumvent state usury laws and created the fringe banking market. New and innovative financial products were created to prey on the less well to do such as sub prime mortgages, payday loans, auto title loans, check cashing stores, tax refund anticipations loans and others all of which charged exorbitant interest rates. (see http://www.jubileeinitiative.org/RiggedDeregulation.htm )
Many community groups correctly pointed out that fringe banking preyed on the poor, the elderly and people of color. The Fed turned a blind eye to this abuse and did nothing to prevent or even regulate this industry!
Reform the Fed
New Humphrey Hawkins Act—A new Humphrey Hawkins Full Employment Act needs to be passed that has the Fed focusing primarily on creating jobs, the real economy and the interests of average Americans. The Fed’s mandate must be to focus on all Americans.
New Board of Directors—The Fed needs a new board of directors who is primarily made up of individuals and organizations that serve the common good. They need to have the power to rein in the chairman.
Supervision needs to be separated from oversight—The policy arm and oversight functions of the Fed need to be separated.
Fed Head Should be Elected—The head of the Federal Reserve needs to be an elected official.
Congressional Oversight—The head of the Fed has to report to Congress on a regular basis. Congress should receive a detailed plan as to Fed’s policy objectives.
No More PKO’s for the stock market—Since the 1987 stock market crash it is widely rumored that the Federal Reserve, like the Bank of Japan before the precipitous decline of the Japanese market, has been pursuing an active “Price Keeping Operation” (PKO) to buy stocks during dramatic price declines. This must stop! Congress needs to investigate the books of the Fed to determine whether it holds any stocks in its portfolio.
Member Services—Financial institutions that are members of the Federal Reserve system have to offer basic checking, savings and cash checking at minimal cost to our most vulnerable communities.
No more bailouts.
For more information on the Fed go to:
Federal Reserve Links: http://www.jubileeinitiative.org/FedInfo.htm
Fedhead Blog: http://fedhead.blogspot.com/
William Greider’s Secrets of the Temple—How the Federal Reserve Runs the Country after two decades since publication remains the authoritative text on the Fed. Greider has written a plethora of excellent articles on the Fed that can be accessed at: http://www.thenation.com/directory/bios/william_greider
The Financial Markets Center focuses on the Fed and has a rich archive of informative articles: http://www.fmcenter.org/site/pp.asp?c=8fLGJTOyHpE&b=213512
