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Archive for March, 2009

As the leaders of the G-20 gather in London, an interesting dichotomy in views has become apparent.  The continental European leaders are generally reluctant to follow the US lead in adopting massive government stimulus programs to try to jump-start their faltering economies.

Deservedly, the bulk of the blame is being placed on the collapse of the US financial system and the way that has rippled throughout the rest of the world.  And not surprisingly, there is an appetite for new rules of the game to make sure that such a collapse cannot occur again.  Leading the reform agenda is the idea that these new entities — these hybrids composed of commercial banking, investment banking and insurance products — must be governed by an international set of regulations.  Gramm-Leach-Bliley allowed them to be created without any corollary rules by which they would be governed.  Is it really any surprise that these enterprises grew too big to be allowed to fail, even as greed ran rampant?

In all this an interesting fact is little discussed in trying to understand the different approaches between Europe and the US.  European countries generally have a better developed social safety net, while we have allowed ours to develop massive holes.  As a result, they have less need for government stimulus.  They have universal health care.  In many countries, education is free up through university.  Trade unions are strong so that wages are relatively high.  Unemployment benefits ensure that people who lose their jobs can survive the financial downturn.  Because their safety net is intact, they are able to look at preventing the next crisis rather than being forced to focus almost exclusively on solving the current one.

The conservatives will argue that European taxes are also high, which is true.  But consider what they get back in terms of government services in exchange for their taxes.  How many Americans would be better off if they could count on no additional out-of-pocket costs for health  care and education? How many fewer bankruptcies would there be? How many Americans would look at four weeks of paid vacation as a good thing?

For all of the hand-wringing about impending socialism, one fact is completely ignored.  Of the countries whose people score higher on happiness scales, most, if not all, of them have strong government-provided safety nets.  And just where does the US rank in terms of standard of living?  Varying criteria can be used to measure standard of living.  But according to the United Nations Human Development Report of 2007-8, the US ranked fifteenth.

Human Development is a development paradigm that is about much more than the rise or fall of national incomes. It is about creating an environment in which people can develop their full potential and lead productive, creative lives in accord with their needs and interests. People are the real wealth of nations. Development is thus about expanding the choices people have to lead lives that they value. And it is thus about much more than economic growth, which is only a means —if a very important one —of enlarging people’s choices.

Fundamental to enlarging these choices is building human capabilities —the range of things that people can do or be in life. The most basic capabilities for human development are to lead long and healthy lives, to be knowledgeable, to have access to the resources needed for a decent standard of living and to be able to participate in the life of the community. Without these, many choices are simply not available, and many opportunities in life remain inaccessible.

This means that we can do better.  We have assumed that because we represent a significant portion of global GDP and spend as much or more on defense as the rest of the world combined that we must have the highest standard of living.  Yet we lag in infant mortality rates, in life expectancy, in science and math scores, and more.  We spend twice as much per capita on health care as any other nation yet do not achieve the best outcomes.  We have the highest per capita incarceration levels in the entire world.  Several countries have a greater percentage of their populations in school at all levels.  Perhaps a little humility is in order — a little less chest beating, a little less rugged individualism, and a recognition that we do have responsibilities and obligations to each other.

UPDATE:  Much was made yesterday that Nicolas Sarkozy, President of France, was threatening to walk out if the G-20 didn’t get serious about regulations.  Here‘s an op-ed piece he wrote.  You decide if he’s likely to walk.  Actually, he sounds quite rational.  I’m hopeful that the four principles he says were agreed to in the previous G-20 meeting will be fleshed out in London.

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The first post on the topic is up, with more to follow.  Let’s have a discussion.

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Recently, an anonymous blogger in Alaska was “outed” by a state politician.  His rationale was that AK Muckraker lacked the right to exercise free speech while retaining anonymity and privacy.  I discovered AK Muckraker’s Mudflats blog last August as I was trying to learn more about John McCain’s selection of Sarah Palin as his running mate.   Not only did I learn things about Governor Palin before they appeared in the mainstream media, but I discovered an entire global community.  AKM’s readers engage in a lively but overwhelmingly civil discussion of politics, both Alaskan and national.  Dissenting views are expressed, but the conversation is almost always at a higher level of civility than on many other political blogs I’ve read.  AKM and Mudflats’ readers provide links to sources to back up their statements, allowing readers to delve more deeply into issues and in so doing become better informed voters and citizens.

AKM’s biggest contribution to the discussion is to hold politicians accountable by pointing out where actions and words diverge.  When AKM used Mike Doogan’s own words as a sort of “macaca moment,” he took umbrage.  Why Doogan, an elected state legislator and former journalist, would take the step of revealing a blogger’s identity with an official communique to his constituents, ignoring the long and important history of anonymous political expression in this country, says more about him than it does about AKM. (It should be noted that Tom Paine’s Common Sense and The Federalist Papers were both initially published anonymously.)  As a public figure, Doogan is fair game for citicism.  He chose his public role.  AKM, on the other hand, is not a public figure but rather a single, albeit effective, voice who chose to remain a private figure.  Political speech, including private or anonymous political speech, is constitutionally protected in this country.  Rep. Doogan, as a politician AND a journalist, should be well aware of that fact.

Because there is a direct line between Mudflats and why I began blogging, I feel compelled to respond.  Let me begin by explaining how I see my role.  I was trained as a historian and an educator.  Therefore, I see my role in large part as providing background and context to the events I write about.  As a historian, I understand that one’s biases or philosophy of history shape how we view events, but while a narrative can be shaped by one’s views, it should not ignore contrary facts.  Facts are what give weight to a theory — whether in science, in economics, or in history.  My biases and my opinions are shaped by a combination of my education and my life experiences. That is why I outlined my biases in my About page, knowing that they would necessarily creep into my writing.  I make no claim to being a journalist, citizen or otherwise.

I welcome contrary views in the comments on this blog —  so long as they are civil.  But I will take issue with views that are not informed by facts or where there are logical inconsistencies in them.  I don’t expect that people are entirely logically consistent in their opinions, only that they are aware of such inconsistencies.

A functioning democracy is dependent upon citizens knowing what their government does.  Indeed, news organizations have been called the fourth estate.  There are several converging trends that are worrisome.  Some are benign or neutral, others not.  Some are related, others not.  And these trends have begun so slowly that we are like a frog in a pot of water — unaware that the temperature is rising until it is too late to escape.

Each of these trends is worthy of its own post, so for openers, here’s a list.  The key question for me in each of these trends is its effect on journalistic independence and whether the resulting “news” can be trusted.

  1. Melding news with entertainment
  2. Media consolidation
  3. New media forms and sources
  4. The 24-hour news cycle
  5. Journalism redefined?
  6. Economic issues
  7. Time for a new business model?

It will take a few days for my thoughts to congeal sufficiently to address each one, but bear with me.  And if you see additional trends that are affecting contemporary journalism and that warrant a separate discussion, feel free to suggest them.  That’s how a conversation begins.

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The hypocrisy of the Republicans in Congress is on full display right along with emptiness of their ideas.  First, they criticized Sec. Geithner (with some justification) when his bank bailout plan wasn’t quite ready for prime time.  But their own much trumpeted budget wasn’t either.  Taking their cue from former Treasury Secretary Hank Paulson, their entire alternative budget proposal came to a grand total of … [drum roll, please] … nineteen pages.  How hypocritical is that?!

And to make matters worse, not only was it devoid of details, it essentially consisted of the same old tired, failed thinking that has been the only element of Republican budget thinking for 30 years — lower taxes, cut spending, starve the beast.  The problem with that is that the American public isn’t buying it any longer.

Yes, a balanced budget is desirable, but when was the last time a president managed to produce a budget surplus? A budget surplus that could actually go to help reduce the national debt that concerns most people.  Oh, yeah, it was … President Clinton, a Democrat.  Not Ronald Reagan, not the first George Bush, and most certainly not Bush the lesser.  And while reducing spending is appropriate for individuals during hard times, it’s the opposite of what government should do.

They’ll release the details next Wednesday — April Fool’s Day.  After the way their press conference went — including harsh comments even from the National Review! — wouldn’t you have thought someone might have checked the calendar?  As it is, between the clear lack of strategic thinking, complete lack of new ideas, and Rep. Michelle Bachmann calling for armed insurrection, the Republican party is rapidly becoming irrelevant.  And that’s a shame.  How very far the Party of Abraham Lincoln has fallen!

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We’re learning a bit more about the “unprecedented powers” that President Obama and Sec. Treas. Geithner are seeking to deal with instability that exists in the financial system. But to understand what’s needed going forward, it’s important to see how we got here.

In the 1920s, commercial banks were selling stocks to their customers in addition to making loans and taking deposits.  As stock prices rose, buying on margin became the way to leverage money into larger gains.  For example, you could buy 100 shares of stock, pay a portion and borrow the rest from the bank or brokerage house.  That worked so long as the prices continued to climb.  But as prices started to fall, the banks insisted that buyers cover their loans.  If you didn’t have the cash, you had to sell some or all of your shares, thus forcing the price even lower.  Not only were individuals speculating, but so were the banks themselves, and when the banks were no longer able to cover requests for withdrawals, panic ensued.  There had been previous panics, but nothing like what happened at the start of the Depression. Over 4,000 banks failed. Deposits were not insured.  If your bank failed, you were out of luck.

In 1933, the government passed the Glass-Steagall Act.  It established the FDIC to insure deposits and provide for an orderly take-down and resolution of failing banks.  (Banks pay into the FDIC insurance fund, and the taxpayers make up any overages.) We take the FDIC for granted, knowing that as depositors we will be made whole (currently up to $250,000) if our bank fails.  But that security came with restrictions and regulations for the banks.  To limit speculation, Glass-Steagall also separated financial institutions — commercial banks, investment banks, and insurance companies — based on the type of business they did.

All went well until we forgot the lessons of the Depression, and once again the siren song of laissez-faire economic theory took hold.  The Depository Institutions Deregulation and Monetary Control Act of 1980 allowed banks to merge.  It also gave banks, rather than the Federal Reserve, the power to set interest rates on deposits.  Two years later, the Garn-St. Germain Depository Institutions Act deregulated the savings and loans, and adjustable rate mortgages were allowed.

Within a decade, the savings and loan industry in the United States collapsed.  The cause of individual failures varied, but a common factor seems to have been the combination of reduced regulation, a lack of oversight, and the introduction of new and unproven financial instruments.  Loan underwriting got sloppy, and there were home equity credit cards.  Again, so long as prices climbed, all was well, but when other economic factors caused a slump in real estate prices, those credit cards resembled the margin buying of the 1920s.  The number of savings and loan failures swamped FSLIC, the S&L version of the FDIC, and The Resolution Trust corporation was established to dispose of the failed institution’s assets, i.e., the loans on their books and the bank-owned properties.  Many of these institutions were purchased by banks so that for depositors, life went on.

Despite all this, the pressure for additional deregulation continued.  In 1999, Congress passed and President Clinton signed the Gramm-Leach-Bliley Act.  It repealed that portion of Glass-Steagall that prohibited the mixing of commercial banks, investment banks, and insurance companies.  A series of mergers followed, and a new raft of exotic financial instruments was born.  It was a perfect storm, and the consequences were completely predictable. In fact, Senator Byron Dorgan (D-ND) was eerily prescient at the time, predicting the timing as well as the need for massive government bailouts and putting a lie to any who claim that nobody could have foreseen the current crisis.  One simply needed to remove ideological blinders and look at history.

When word first came that the administration was seeking new regulations, I hoped that they repeal Gramm-Leach-Bliley along with some of the other deregulatory actions and reinstitute Glass-Steagall.  But alas, it seems that the effects of Gramm-Leach-Bliley will be as difficult to undo as are those credit default swaps that sank AIG.

If financial institutions have combined into these new hybrid, uber-institutions, then it makes sense that to have regulations that apply to all aspects of their business.  And it also makes sense that we need a mechanism to ensure an orderly take-down should they fail.  FDIC works well, and it can serve as a model for any new mechanism.  I still hope Congress will re-think the wisdom of permitting a corporation to become so big and so entwined in the financial system that it cannot be allowed to fail.  “Too big to fail” sounds like it is a prescription for taking excessive risk — for looking at short-term, easy money.  While FDIC insures deposits, that’s not to say that the failure of a bank comes at no cost to the taxpayers.  The recent failure of Indy Mac cost the shareholders as well as the taxpayers.  The shareholder losses came as a result of Indy Mac ceasing to exist.  The taxpayers had to pay the administrative costs of disposing of the bad loans and foreclosed properties.

I don’t begrudge some people making more money than others.  But I wonder if anyone is worth 350 times the salary of the average American worker.  And I don’t begrudge bonuses, but shouldn’t there be some relationship between a bonus and performance?  Between a retention bonus and the recipient actually still working for the corporation?  I’m a big fan of stock options as a bonus, especially if there is a time lag between the time they’re awarded and the time they can be exercised (at the stock price at the time of the award).  That time lag ensures that employees will continue to perform; there isn’t much incentive to exercise the option if the stock value has declined.  I’m all for regulating to contain greed as greed (combined with the relaxation of regulation and oversight) was a major cause of the current situation.

Clearly we are part of a global economy; solutions need to to be developed in concert and cooperation with other nations.  And consumers need better protection from the rapacious ways of the economic Masters of the Universe.  These elements are also part of Geithner’s proposal.  There are still powerful forces who, despite the current situation, are disciples of laissez-faire economic theory.  They will fight any and all regulatory attempts.  And because Congress counts on them to fill their campaign coffers, Congress must be reminded that they represent the people, not just corporations.

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Perhaps I’m just impatient.  Perhaps Treasury needs to staff up first.   But rather than trying to figure out “legal” ways to restrict salaries and bonuses for the folks in companies getting public bailout funds, I’d much rather see Congress work on re-regulating the system.  Sure, it doesn’t fuel populist anger like taxing bonuses does, but it would be far more important in the long run.

Start with repealing Gramm-Leach-Bliley.  That was the charming piece of legislation that removed the “wall” between various kinds of financial institutions.  It allowed these entities to become to large to fail because they had tentacles into commercial banking, investment banking, hedge funds, and insurance.  And it allowed legal space for companies to push the risk of loans far and wide while raking in the (temporary) profits.  Thus the rise of credit default swaps, securitized mortgage loans, and all those instruments that are now so toxic.

President Obama is pushing to allow the government to seize not just banks but insurance companies (think AIG, or whatever they’re calling themselves these days), and investment banks (like Merrill Lynch, Lehman, Morgan Stanley and the others who’ve gone belly up in the melt-down).

I just caught a bit of Sec. Geithner’s testimony before Barney Franks’ committee, and he made a statement that bears repeating again and again.  The topic was the monies AIG paid to its counterparties — the investment and foreign banks that had purchased the credit default swaps AIG was selling.  The take away comment was that Treasury lacked the authority, even as the majority owner of AIG, to demand that the counterparties be made less than whole. The counterparties purchased CDSs as a hedge against mortgage backed securities — insurance in case these sliced-and-diced mortgages turned out to be worth far less than anticipated.

There is a direct line between Geithner’s statement, the need to repeal Gramm-Leach-Bliley, and the President’s proposal.  Gramm-Leach-Bliley dismantled the regulatory wall that stood between commercial banks (the entities who traditionally have written mortgages), the investment banks (the entities who created the mortgage backed securities), and the insurance companies who created the credit default swaps.  That wall had been erected as part of the regulatory framework created after the Great Depression to prevent another one.

A new or revised regulatory framework could mean that these hybrid companies would have to decide what they really want to be.  They would have to create separate companies for each part rather than simply combining them into one uber-institution, now deemed to big to fail because failure would create systemic risk.  There is danger in being too big to fail, and perhaps the best solution is to make sure that no business can get to that point.

As another part of the Depression Era regulatory framework, the FDIC was created to allow the government to seize a failing bank, pay depositors out of an insurance pool, and sell off the bank’s assets (its loans).  A similar framework that would facilitate the orderly resolution of a failed investment bank or insurance company does not exist.  That’s the direction the Obama Administration is heading — to create some sort of entity or entities that would serve the same function as the FDIC but for investment banks, hedge funds and insurance companies. FDIC has proven to be a successful model for making sure that depositors are protected and that assets can be sold off.  Clearly part of the current difficulty lies in the question of how to unwind the legacy assets so they can be sold off and removed from the institutions’ balance sheets.  In the process of a bank take-over, contracts with creditors and employees are subject to revision, thus preventing bonuses that serve to reward bad behavior.

AIG has rightfully been the target of a great deal of public anger in recent days.  But it’s important to understand just how AIG got itself into its financial mess, because its story is a powerful argument for repealing Gramm-Leach-Bliley and establishing the kind of regulatory framework that will allow the financial system to return to long-term health.  The LA Times has an article today that is worth reading.  Unfortunately, its online edition doesn’t include some of the most interesting information — what went wrong.  So, here it is:

In 2007, AIG was one of the world’s largest companies with $1 trillion in assets, $110 billion in reserves, 74 million customers, and 116,000 employees.  Here are highlights of what happened.

  • In 2001 it began selling credit default swaps — insurance protection against default on mostly mortgage-based securities.
  • Those securities initially were given AAA ratings, which allowed AIG to expand this activity without putting up huge collateral or creating giant reserves.
  • As homeowners began to default on mortgages in 2007, AIG began to incur heavy losses.
  • Those losses led to reduction of AIG’s credit rating in September 2008, forcing it to post billions in collateral.
  • With the credit crisis and the economy unraveling, AIG could not find financing or sell assets to cover its collateral.

Interestingly, but not surprisingly, the smaller community-based banks have generally fared well during the melt-down.  They chose not to participate in sub-prime lending practices, did their own underwriting, and kept the loans in house.  By assuming the risk themselves, rather than spreading it out among investors and then purchasing credit default swaps to hedge their bets, they were careful to lend only to credit-worthy borrowers.  In hind sight, it’s fairly easy to see how the house of cards was built — and why it collapsed.

Instead of responding to and fueling popular anger, it’s time for Congress to lower the temperature, do their homework, and work with the Administration to determine the best way to prevent another feeding frenzy wherein greed and the promise of a quick buck reign supreme.  Have we learned our lesson yet?  That remains to be seen.  Unfortunately, so long as the financial sector contributes so heavily to Congressional campaigns, we can expect that their influence in determining policy will remain strong.  We — the voters and taxpayers — must remain vigilant.

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Today it’s Vikram Pandit of Citibank’s turn, and he gets a “twofer.”  Mr. Pandit announced recently that Citibank has turned around and begun to show a profit.  And he talked proudly of how he was being responsible and taking a much lower salary of only $1 million.  Great, we thought, now he can start repaying the loans we taxpayers gave him.

But, no.  Wrong on both counts.  Seems he was fudging the facts on the salary — that he was earning something north of $5 million.  Those pesky bonuses, I suppose. Frankly, I don’t care what you call it — salary, bonus, deferred compensation, whatever — it’s all money going from the Citibank (and our) coffers into his personal one.

And today, like John Thain, our first award winner, Pandit is treating himself to a pricey renovation of his executive office suite — a renovation that makes Thain’s look like a bargain.  Citibank has taken out permits for the basic construction portion of the refurb –permits that indicate over $3 million just for things like moving and removing walls, plumbing, fire safety.  And that’s way before the really pricey stuff like rugs, furniture, and yes, trash cans.

I’m sure all those recently laid-off Citibank employees are just thrilled to know that Citibank is once again turning a profit.  I wonder how many of them are renovating their offices or their homes these days.  Mr. Pandit, I don’t begrudge you a spiffy new office — AFTER YOU’VE PAID ME BACK!  The construction industry could use the jobs, but if you have $10 million to spend on your office re-do, you certainly can afford to use some of Citibank’s recent profits to start repaying the American taxpayers.  And that money should be repaid before you even start thinking of new digs.

Do these guys not read the newspapers or watch TV?  Do they still not realize the degree of taxpayer rage at their arrogance? Is it time to grab the pitchforks and torches and man the barricades yet?  Vikram Pandit, you’ve been awarded the “Let them Eat Cake” award.

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