Thursday, September 2, 2010


"The American Republic will endure
until the day Congress discovers that it
can bribe the public with the public's money."
- Alexis De Tocqueville, author of Democracy in America (1835) 

With corporate America sitting on more than $2 trillion dollars in cash, and the banks flush with bailout money and government guarantees, one has to wonder why our business class isn't spending any money. But, contrary to prevailing opinion from the right wing blogosphere, it has nothing to do with regulations, our tax code, and out of control "socialist" spending.

Think about it. Over 30 years of deregulation freed corporate America to extract wealth and to pillage the American economy. Today, due to deregulation and other corporate gifts from congress, wealth gaps in America are similar to what they were during the Roaring Twenties and during the time of the Robber Barons (though, to be fair, the Robber Barons actually created something of value).

As well, can anyone say with a straight face that Steven Jobs waited for the capital gains tax to drop before he had the Apple idea? Did Bill Gates develop Microsoft because he was in the right tax bracket? A good idea is a good idea (moreover, capital gains taxes are lower now than they were under Reagan).

Finally, it's sheer lunacy to claim that we're sliding into socialism when Federal spending represents 25% of the economy this year vs. 23.5% under Reagan during a similar period in his presidency (and Reagan didn't have to deal with two failed wars and a collapsed economy bordering on Depression Economics).

The simple reality is that corporate America - and this includes the banks - don't trust what's going on with the banks and their partners in crime in the financial sector. And this is NOT suddenly a new development.

Why Corporate America is Not Investing (It's not new)
As I pointed out in December 2007, "banks are in a financial storm of doubt and edginess because of the mess caused by fraud, stupidity, and the outright greed of big lending institutions." By December 2007 one institution after another was reporting that they were writing off billions of dollars in losses because of the toxic assets and other sub-prime lending packages they were sitting on.

As a result the financial sector found themselves short on cash, drawing on reserves, or seeking out other institutions, in the hopes that they would lend them operating funds. But banks were lying to themselves and to each other about what they had in the books. Doubt and distrust was in the air.

Investors and banks were reluctant to lend to anyone, especially each other. In December of 2007 the Wall Street Journal reported why:

Financial institutions remain suspicious of each other after multiple rounds of announcements of mortgage-linked losses, and are anticipating more. They also are eager to hold onto cash to shore up their troubled balance sheets.

Nine months later - with banks and other financial institutions hemorrhaging money - the Federal government had to step in and bailout Wall Street. The only problem is that the Federal government didn't demand changes in the operating status quo. Nor did it do anything to force financial institutions who received bailout money to clean up their books in exchange for their bailout and other market guarantees.

In effect, we said to Wall Street, "Here, take the money. You don't need to do anything for mortgage holders, or other Americans who are in debt ... in spite of wrecking the economy we'll let you muddle along with toxic debts on the books by creating mind-numbingly stupid "mark-to-market" arrangements that allow you to reprice toxic assets on your books.

And while we're at it, we'll create neat, but complex, programs for you to dump your toxic financial waste on the American taxpayer (Maiden Lanes, TALF, etc.)."

As if this wasn't enough, the Federal government (under Bush and Obama) pretty much told our moneyed elite, "And, by the way, if you want to gamble like idiots again, or purchase public debt with the money you've swindled out of the taxpayer, go ahead. The American taxpayer - who just bailed you out - will pay the interest on the Treasury debt too."

And just like that, Wall Street was able to walk away with bailout money courtesy of the taxpayer Washington, and then take that money to gamble on Wall Street (again), or to walk down the street and purchase interest paying U.S. debt securities.

Corporate America sees and understands this. Why invest $2 trillion if the banks haven't been disciplined, and continue to act like pigs at the trough?

But herein lies the problem. After forgiving Wall Streets stupidity and greed, we didn't do anything for the American consumer, or for U.S. mortgage holders.

Worse, after being forced to hand Wall Street trillions in cash and market guarantees, we didn't turn around and force Wall Street to take a financial hit and refinance Main Street's upside down mortgages (especially by reducing loan principal) and/or renegotiating it's debts. With financial credits and other guarantees in their pocket, the toxic waste on the bank's books could remain, indefinitely.

Why Main Street (and the economy) Will Continue to Stagger
As Christopher Whalen points out, today "the largest banks remain profoundly troubled by bad assets on their books as well as claims against these same banks for assets sold to investors." In layman's terms? No one trusts the banks, including other bankers, because they continue to hold toxic assets that they don't want to - and don't have - refinance or renegotiate.

Because Washington didn't demand any concessions from Wall Street - which could have provided relief to the American consumer and it's debt holders - the banks have been able to “muddle along” and pick and choose which recovery path is most profitable for them. In the mean time U.S. workers and households struggle along under a "death by a thousand cuts" threat of unemployment, lost jobs, record bankruptcies, collapsed home values, foreclosures, wage cuts, economic uncertainty, and on-going debt loads, among others.

Worse, because the Federal Reserves cheap money policies, and the bailout programs (referred to as "quantitative easing", or QE) , are designed to save the biggest banks, they've "broken the mechanism" which traditionally converted interest rate drops into debt refinancing for American debtors. But one former Federal Reserve official, who worked in the banking industry for decades, says that our problems are much deeper.

In this last easing ... [the biggest] banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.

Put more bluntly, as was the case in 2007, the banks that can afford it are hoarding cash. Our bailed out financial institutions can afford it. So no one's lending. The big banks aren't lending to the small banks. The small banks aren't lending to small businesses or the American consumer.

It doesn't matter that the American taxpayer footed a multi-trillion dollar bailout for Wall Street and it's largest financial institutions. Because both the Bush and Obama administrations failed to extract any concessions from either group, the American consumer, and the American economy, will continue to stagger in a cesspool of economic uncertainty.

How to Break the Bank's "Refinancing" Strike
According to Christopher Whalen, if our bailed out financial institutions don't care to help the American taxpayer and the American consumer - and they won't, no matter how much taxpayer help they received - the Obama Administration needs to do the following:

1. DEBT RELIEF: Use the power provided in the Dodd-Frank legislation to force an accelerated cleanup of bad assets and to mandate refinancing and principal loan reductions for performing loans with viable borrowers. If any banks resist, the Treasury should use the power under current federal law to remove recalcitrant officers and directors of these same banks.

2. REFINANCE MORTGAGE DEBT: Because the market collapse forced consolidation in the mortgageg industry it is "now dominated by a cozy oligopoly of Too Big To Fail banks" (the top three banks control 55% of all mortgage originations, while the top 10 banks control 95%). The Treasury needs to force these institutions to make rules changes to allow for the refinancing of all existing residential mortgages, if only to reduce the current cost of the debt and increase disposable income for households.

3. END TAXPAYER SUBSIDIES TO BANKS: With Federal Reserve rates so low, currently loan origination margins (what they get for setting the loan up) for the top four banks have gone from a minimum of ½ point to over 4 points in the last two years. This is a subsidy for Wall Street, especially since the zero interest rate policy of the Fed was designed to benefit Main Street by getting cheap money into their pockets. This subsidy needs to end.

There's more in Whalen's piece that needs to be considered. For the true die-hards, you can find even more in this Wall Street Sector Selector piece from John Nyaradi.

But one thing is clear. Without legislation or executive action to force our taxpayer bailed out financial institutions to begin making concessions in the form of loans, negotiations, and write-downs, our economy will continue to stagnate. We can no longer afford to place our trust in the "private" banking sector. And why should we? They don't even trust one another.

As long as the mission of the largest banks remain unchanged all the talk of pumping more money into the financial system (referred to as QE II) will NOT do any good. Without reconstituting the banks - by forcing them to work with the American taxpayer and consumers who saved their hides - even John Maynard Keynes would not support the cause.

And besides, simply pumping more taxpayer funded money into the economy because the banks don't trust one another, only delivers us to the steps of Alexis De Tocqueville's warning noted above, which was made over 175 years ago (hat tip to Fortune's Keith R. McCullough for the quote):

"The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money."

We need to stop the undeserved market subsidies, and force our bailed out banks to renegotiate and write-down loans. Otherwise we should prepare for ourselves for another market meltdown, or worse.

- Mark

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