Tuesday, May 29, 2012

GLASS-STEAGALL 101

We are entering the section on economic policy making in my Introduction to American Politics class. Last week we made it to the Great Depression and discussed the rationale behind the Glass-Steagall Act. For those of you who are not familiar with the Glass-Steagall Act (1933) you can read about it in my book, or you can get a broader history from PBS here.


In brief, the Glass-Steagall Act (also known as the Banking Act of 1933) was passed by Congress in 1933. It specifically prohibited local commercial banks from doing what Wall Street investment banks do. It was enacted in response to the failure of nearly 5,000 local banks who, you guessed it, were using the bank deposits of their customers to gamble on investments and other projects they knew little about.

While Glass-Steagall was made possible by the stellar investigations done by the Pecora Commission, Franklin D. Roosevelt made it a cornerstone of his New Deal program.

Ferdinand Pecora

The Glass-Steagall Act gave the federal government more control over national banks, created the Federal Deposit Insurance Corporation (FDIC), and prohibited bank sales of securities. It didn't keep Wall Street from gambling with money from their clients accounts (see here and here) but it did protect the little guy on Main Street, for over 50 years.

Here's MSNBC's Dylan Ratigan explaining how Glass Steagall actually worked:





After being attacked by Wall Street for years Glass-Steagall was finally repealed in 1999 when President Bill Clinton signed the Financial Services Modernization Act (aka Gramm-Leach-Bliley). Commercial banks could now get into investment banking. Nice. This clip from 1999 reminds us that Senator Byron Dorgan (D-ND) saw a market collapse around the corner, even if he didn't know exactly when it was going to happen ...




The fact that we haven't done anything to bring back Glass-Steagall is just one of the reasons it's easy to argue that we're going to have another 2008 market collapse, again.

- Mark

REDEFINING PATRIOTISM IN AMERICA



I've discussed patriotism in the past (here, here, and here). This Memorial Day post from former Labor Secretary nails the idea behind economic patriotism ...

True patriotism isn’t cheap. It’s about taking on a fair share of the burdens of keeping America going.

Those who earn tens of millions of dollars a year but pay less than 14 percent of their incomes in taxes, and argue the rich should pay even less, are not true patriots.

Those who defend indefensible tax loopholes, such as the “carried interest” loophole that allows private-equity managers to treat their incomes as capital gains even if they risk no income of their own, are not true patriots.

Those who avoid taxes by putting huge amounts of their earnings into IRAs via foreign tax shelters are not true patriots.

Those who want to cut programs that benefit the poor — Food stamps, child nutrition, Pell grants, Medicaid — so that they can get a tax cut for themselves and their affluent friends— are not true patriots.

- Mark

Wednesday, May 23, 2012

WHY JP MORGAN'S BILLION DOLLAR DERIVATIVE DEBACLE MATTERS

A few years back officials from Goldman Sachs and JP Morgan Chase went in front of Congress to defend the practice of  betting trading for and against complex investment products that are also known as derivatives. Their argument was that derivatives allowed them to hedge their trades, which is critical for "risk management." This is what "sophisticated investors" and "smart money" do we were told.

What they were really defending was the practice of trading in artificial markets that produce little - if any - economic value.

Conceptually what Goldman and JP Morgan want everyone to believe is that they were doing little more than what the country farmer does. You know, the guy who hedges his bets when he plants corn just in case the wheat crop doesn't produce. Instead Goldman and Morgan executives sounded like a bunch of hucksters peddling toxic crap from the back of a showman's wagon.


Are they really con men? In my view, yes. In the aggregate their efforts at "risk management" in derivative markets amounts to little more than financial snake oil.

Con men or not it really didn't matter what they said in the hearings because many members of Congress are financial and economic illiterates (don't believe me ... check this out). Many only understand economic concepts if they fit on a bumper sticker.

What Goldman and Morgan executives were really trying to do was defend the practice of selling their clients certain products - some of which were designed to fail - with the idea that they could get another client to bet against it. For JP Morgan and Goldman Sachs it didn't matter who won the bet because they collect fees on both ends.

And they they certainly didn't have to worry about the derivative products once they dumped them on others either. They could always hide behind the market refrain caveat emptor ... you know, buyer beware.


Because many members of Congress are financial illiterates - who do the bidding of Wall Street - the executives of both firms gave testimony and left Washington with only a public slap on the hand. Business as usual would be the result. Bonuses were paid out. Mergers continued.

Not surprisingly, after appearing in front of Congress JP Morgan paid a $153 million fine to the SEC for misleading investors, while Goldman Sachs was caught rigging the game against their clients, and then made big bets with FDIC backed money (though they claim it's their money). But along the way the biggest banks got even bigger ...



And the casino continued.




Why do I bring all of this up (again)? Simple. JP Morgan's recent derivative debacle has them losing 2 ... 5 .... or 8 billion dollars. Nobody knows how much just yet. Even they aren't sure (they claim). JP Morgan would like everyone to believe that it's all an anomaly. They even let go of a few culprits (with the now standard golden parachute for screwing up).

My primary concern is that we have been here before.

Now I could take us back to the S&L debacle, the 1987 scare, the LTCM Fed-orchestrated bailout, or even back to 1929 (or any number of other "unforeseen" market failures). But let's not go there. Instead, let's go back even further to see how the "smart money" did things a really long time ago, and then decide whether what we're seeing today is really an anomaly.

The following is drawn from Chapter 4 of my book The Myth of the Free Market:

In A Short History of Financial Euphoria, John Kenneth Galbraith discusses the famous case of “Tulipomania” in Amsterdam at the beginning of the seventeenth century. What started as simple prestige for those who possessed novel tulip bulbs turned into wild speculation over successive price increases throughout 1636.
Specifically, competition over tulips turned into mania, with single bulbs trading for new carriages and homes, or fetching as much as $25-50,000 each. Demand reached such heights the Amsterdam Stock Exchange developed a futures market for the bulb. This market, as well as the dreams of many speculators, would collapse under the weight of its own nonsense and spectacular avarice.

As sellers demanded their tulip contracts be enforced, they were disappointed when their petitions fell on the deaf ears of the courts. Because the market had little to do with the production of actual goods and services, the courts viewed Tulipomania as little more than a gambling operation. As is the case throughout these histories, panic, default, and bankruptcy followed. Galbraith wrote “no one knows for what reason” the speculation and mania ended, but there’s little doubt common sense finally prevailed in a market spun out of control by deluded buyers and sellers.

Now replace "Tulips" in the story with "derivatives" and ask yourself how much has really changed since 1636. With at least a hundred trillion in derivative bets (or more) placed by Americas biggest banks we need to think about what this means for our nation today. Like our Tulip-crazed market players above, many of today's biggest market gamblers are simply interested in extracting wealth from artificial markets.

Oh, look at the pretty flowers ...


Anyways, we need to remember that at the hearings Goldman Sachs' executives sat in front of Congress and brazenly dodged questions as to whether it's their responsibility to "act in the best interest of their clients" (FF to 25:30 in this clip). What this suggests is that simply making money is the dominating mind-set of Wall Street — even if it means deliberately burning clients, or creating the conditions for another market meltdown (which they never see happening).

The focus on wealth extraction instead of wealth creation has been widespread in America for some time now. The following from Chapter 10 of my book helps illustrate the point:

Founded by a group of Wall Street hotshots and leading academics with Nobel prizes on their resum├ęs, Long-Term Capital Management (LTCM) was created in the 1990s to search markets for price anomalies in goods that had shown historical relationships. It didn’t matter, for example, why the price of toothpaste was diverging from the price of tooth brushes; the fact that a price divergence existed was all that traders needed to make a move.

But LTCM was not trading in tooth brushes and toothpaste. They were trading in complex financial instruments that, according to their formulas, had price relationships that rarely diverged. Because the price anomaly in each “product” that they tracked was small, LTCM had to spend big to make money.

After securing hundreds of millions from investors, no doubt impressed with their pedigreed analysts, LTCM still had to borrow big to make their wagers pay off. At its height, LTCM was highly leveraged and owed investors and banks billions of dollars ...

In many ways, LTCM had fallen into the same trap as the purchasers of tulips. The company was comprised of speculators who wanted to make a quick buck. As Martin Mayer put it: "The work done at LTCM, while not illegal or sinful, was totally without redeeming social value. This is not 'investing'; it enables the production of no goods or useful services. It is betting."
LTCM came crashing down in 1998 after Russia defaulted on loans, an event that neither LTCM’s computer models nor it's Nobel laureates in economics anticipated ... The company owed so much money to the banks that the Federal Reserve of New York stepped in and brought the banks to LTCM. The Federal Reserve wanted to make sure that LTCM didn’t suddenly dump their assets to pay the banks.

The Federal Reserve feared that if LTCM was forced to sell its assets they would depress markets by forcing losses on others. The Federal Reserve’s then new chairman, Alan Greenspan, even went so far as to testify that an LTCM “fire sale” could have ended prosperity in our time. The Federal Reserve had to intervene to — in what has become by now a standard refrain — “save the system.”

At the end of the day, if you are betting on the price direction of tulips (the Dutch) ... or betting on the price direction of market anomalies (LTCM) ... or betting on the price direction of derivative products (Wall Street / JP Morgan Chase) one thing is clear. You are not investing (or even hedging). You are gambling.

These guys shouldn't be on Wall Street. They should be on the Vegas strip ... far away from taxpayer funded bailouts.

- Mark

ADDENDUM: With the biggest recipients of taxpayer bailout money controlling over 90 percent of the $135 to $592 Trillion derivative market (yes, that's $592 Trillion) we need to ask more questions about the conditions that created the financial holes at JP Morgan Chase, led to the collapse of MF Global Financial, and other slow drip market "aberrations" coming out of Wall Street. This is especially the case when you consider that the global derivatives market - which takes its cue from the United States - has grown to about $1.14 quadrillion (that's 15 zeroes)

With the total U.S economy producing about $15 trillion in goods and services in 2011 this should be cause for concern.

Monday, May 21, 2012

LIBERTY UNIVERSITY NOT A REAL UNIVERSITY?

I'm scheduled to sit on a panel that will discuss the role of religion in society, with a heavy dose of church and state tied into the discussion. So with graduation for our campus coming up in a few weeks, this Bill Maher piece just kind of fits (fair warning, it's Maher so beware of the language) ...










- Mark

Saturday, May 19, 2012

HOW THE WORLD (REALLY) WORKS

One of the things that I regret from writing my first book is what I left out. Perhaps the biggest omission was leaving out Friedrich List. Who the hell is Friedrich List you ask? Good question.



In the pantheon of giant thinkers who studied and then tried to explain how our world works in the 19th and 20th centuries Friedrich List (1789-1846) ranks up there with Adam Smith and Karl Marx. We all know that the ideas that drove Adam Smith helped set the groundwork for the liberal revolution(s) that gave us our free market economies (and the American and French revolutions). We also know that Karl Marx's criticisms of market capitalism set the stage for the socialist revolutions of the 20th century.


Artwork from Artonfix.com

Unfortunately the ideas of Adam Smith have been used and abused to such a degree that the U.S. economy is currently dominated by reckless market players who treat the economy like a giant casino. For his part the writings of Marx were used to set up totalitarian states that got virtually everything wrong about incentives and the human condition.

The end result is that while the U.S. economy seems poised to collapse on its own debt and derivative-driven stupidity (again), the Soviet and Chinese experiments with "worker utopias" have been relegated to the dustbins of history.

The problem we have at the beginning of the 21st century is that adherents and zealots on both sides of the Smith-Marx continuum largely ignore key pieces of history and have not given much thought to how the world really works. Instead they blindly believe in misapplied theories of markets and people, as if the human condition is dominated by some kind of rational homo economicus man.


Those who claim some kind of intellectual bond with either Adam Smith or Karl Marx seem to believe that universal rules of profit and material production drive the human condition when this simply is not the case. Incredibly extremists on both sides ironically find common ground with one another because both see a shrinking (or "withering") state as ideal because of how a rational new man emerges to guide society (yes, they are much closer on this then either cares to admit).

I bring all of this up because a discussion on FB I had this morning got me thinking about what I should have mentioned in my first book.

Specifically, I should have been much more forceful explaining that how most people (especially market players) think the world works is not actually how it really works. Simply put, the state creates the conditions under which societies and markets prosper. If we understood this my guess is that we wouldn't be in the position we find ourselves in today: Praying that the Germans will save the day in Europe ... and hoping that Wall Street doesn't fall off an economic cliff (again) and then drag the rest of the world down with yet another "unforeseen" market collapse.

This article - "How the World Works" - from James Fallows goes a long way in explaining why politicians and market players in America are getting things so wrong. As you will see, it's not so much that they don't know as much as they never learned how the world really works.

- Mark

Monday, May 14, 2012

IS UNCLE SAM "MOM ENOUGH"?

I missed this from Mother's Day (via Barry Ritholtz). It's Wall Street, still breastfeeding from Uncle Sam ...



And, yes, it's a play on this ...



- Mark

Sunday, May 13, 2012

SURFER RIDES BIGGEST WAVE EVER



From the Washington Post ...



... Guinness World Records recognized pro surfer Garrett McNamara of Hawaii for surfing the biggest wave ever on Thursday. McNamara caught the 78-footer off Portugal's coast in November. The 44-year-old surfer told Guinness World Records that it was “the most challenging, dangerous wave” he had ever surfed.

- Mark

Friday, May 11, 2012

SANCTITY OF MARRIAGE POINTS TO PONDER



"Same sex couples should
be able to get married."
- Barack Obama

On Wednesday (May 9) President Obama announced that he believes same sex couples should be able to get married. It's about time. Naturally, some of the wackos came out the next day, defending the "sanctity of marriage."


Just in case someone from the family values crowd wants to have a discussion with you on the impact same sex unions might have on the institution of marriage be sure to ask them the following question: How do the actions of Newt Gingrich (serial cheater), Ted Haggard ("Spank me, I'm cured of the gay"), former RNC Chair and Bush campaign manager Ken Mehlman (gay), Republican Senator David Vitter (whore monger), former Republican Senator Larry Craig (airport bathroom enthusiast), former Republican Governor Mark Sanford ("I spend Father's Day with my mistress in Argentina"), former Republican Senator John Ensign ("I do staffer's wives"), et al., contribute to the sanctity of marriage in America?



Then ask them whether some of the things in the Bible just might not be entirely consistent ...




... especially if you are a woman trying to live a healthy, fruitful, and vigorous life ...





- Mark

Wednesday, May 9, 2012

Tuesday, May 8, 2012

FIGHTING REALITY



From time to time I get into e-mail exchanges with friends and colleagues that help me understand why America is so lost when it comes to policy debates. Simply put, many people exist in an intellectually bankrupt world, where their reality checks bounce ... on a regular basis.



Recently I got into an exchange with a friend who argued that there was no money in the social security trust fund. He was responding to my point that social security is not "broke" because the federal government owes the social security trust fund trillions of dollars. It's owed trillions because every single administration (Democrat and Republican) has drawn from social security surpluses to fund yearly budgets.

My point was that social security is flush with cash as long as the federal government honors its financial responsibilities and repays the trillions it has borrowed (often listed under "intragovernmental" holdings).

My friends response? It was straight from the republican book of magic numbers. He argued that what the government owes social security isn't real money since, as President Bush once put it, the promise to pay is nothing more than an IOU. So, ta da, there's no money, we're broke ... and it's all President Obama's fault.

I responded by pointing out that if the trillions the feds owe social security are simply IOUs (blue slice on pie chart below) then he just solved our national debt problem. Why? Because the promise to repay those who lend us money to run the government every year are also IOUs (other colors on the chart below).

I argued that if we don't have to pay back the nearly $2.7 trillion we "borrowed" from social security (because they're IOUs) then we should not have to pay the IOUs on our national debt either. So, ta da, no budget problem. Pretty simple, right?

After grudgingly acknowledging his failed logic my friend did what most Fox News watchers do. He switched topics.

He began by saying that our real problem is not that social security is broke but that President Obama and the Democrats are to blame for our debt mess because President Obama isn't taking responsibility for the economic condition of our nation.

Huh?

To make his point (forget that there really wasn't one except to change topics) my friend argued that Senate Democrats are irresponsible for not passing a budget (resolution) in over two years. This, according to his logic, is the height of irresponsibility. He added that at least President Bush's budget deficits can be explained by the fact that he had to deal with two wars, Katrina, and market bubbles.

I thought to myself, Didn't President Obama inherit two wars and have a bubble-induced financial Katrina dumped on his lap? So I sent my friend these comments ...


* ... why does President Bush - who inherited budget surpluses (yes, they were real) and who blew through projected surpluses of $5.6 trillion - get excused for his tax cut driven budget deficits but President Obama - who inherited trillion dollar deficits, two wars, and a collapsed market - have to accept responsibility for what was dumped in his lap? Strange.
* ... If we want to point fingers because there is no budget from Senate Democrats then we need to ask why every major budget proposal now requires a filibuster proof vote (which requires 60 votes to pass) when this has NEVER been a requirement for any president in the past?
* .. Let's get real, Senate Dems can not pass a budget resolution this year for two reasons: First, filibuster, filibuster, filibuster ... Senate Republicans have made it clear that they will filibuster (60 votes) anything they don't like ... Republicans won't cooperate on anything the Senate Dems pass because they want President Obama to look bad. Period. Second, this years budget was effectively completed when the debt limit bill passed last August (keep in mind that Appropriations take up discretionary spending). So, long story short, we do not need a budget resolution this year because Republicans already signed off on debt limit spending.
My friends response? He changed the subject. Again.

There's more, but you get the point. You can't argue with people who are more interested in either creating a strawman argument that only they understand or who want to believe that the world they see is reality.



If I get time I'll be posting about similar conversations I've had in future posts. While they're entertaining, they're also a bit disturbing.

- Mark

Wednesday, May 2, 2012

CEO PAY vs. MINIMUM WAGE SCALE ...






Minimum wage would be even higher if you ignored executives in general and just tagged minimum wage to the salaries of America's Chief Executive Officers (CEOs) ...



... who received generous tax cuts and did such a bang up job creating jobs and keeping our economy bailout free.





Query of the Day: So, how many minimum wage employees does it take to create a CDO (collateralized debt obligation), a CDO squared, a synthetic CDO, and the Credit Default Swaps (CDS) used to insure the CDO markets?
Answer: None, because their salaries and bonuses do not depend on the fees created by these "creative" market instruments.

Query for the Week: How many minimum wage workers asked for the trillion dollar bailouts so they could pay off incredibly stupid market bets (which kept many money managers out of court/jail) and make good on their bonus stuffed contracts?
Answer: None, because mimimum wage workers are forced to live with the stupid mistakes they make in their lives, and can not go to Congress to help solve their problems.

- Mark