Friday, September 19, 2008

Robert Reich's solution: honesty

The crisis on Wall Street right now is less about solvency and about capital than it is about trust. And the real question is, How do you restore trust to a system in which, basically, nobody trusts the numbers that are supplied by big banks on securities?
—Robert Reich, interviewed on Marketplace

That's a great idea, Robert (although America probably is insolvent). We could bring a culture of honesty and fairness to Wall Street. Brilliant. However, since Wall Street has never been honest, nor fair, ever, it might be a difficult idea to implement. But I have an idea for a good way to start: the US government could set an example. The government could instruct the Bureau of Labor Statistics to produce accurate statistics instead of horseshit for a change.

First, how about an honest CPI series, instead of ridiculous fantasy numbers? Even the mainstream media is starting to report the CPI with skepticism and sometimes sarcasm. Then, we could have an honest data series for the gross domestic product! Imagine - numbers that businesses and the American people trust.

Note that none of this would cost billions of dollars. The government could just stop lying.

After that, some pretty simple, common sense finance regulation would avoid all this insane mortgage bond trouble. Twenty percent down payment for a house. No off-balance sheet liabilities for corporations (or the government). Its not that hard.

I realize that admitting we have out of control inflation, negative economic growth, and un-payable debts would send this country into the worst depression ever, but that will happen in any case. We should admit our insolvency, and start building an honest nation.

Tuesday, September 16, 2008

Walking around Manhattan and seeing.. Lehman Brothers

My girlfriend and I were spending Monday in New York City after attending a wedding, and the only art museum open was the Modern, so that's where we went. I had heard the news about Lehman Brothers in the morning and was following the latest carnage on Wall Street, but I was mainly trying to enjoy a vacation day. After our art-touring, and looking for the mid-town subway stop we pause to gape at the most garishly lit building I've seen yet in Manhattan. It was a massive block of video display. This thing was zipping and flashing. Then I noticed that there were media crews up and down the block, with all cameras pointing to the flashing video building. I realized I was looking at Lehman Brothers!

I was of course thrilled to be looking at the eye of the financial storm. It turns out that Lehman had been in the World Trade Center, but had moved to mid-town after nine-eleven.

News reports were rather odd. NPR interviewed Gordon Steele, author of Empire Of Wealth, an very good economic history of America. Steele compared the Fed allowing Lehman to fail to the the New York banks letting Bank of the United States fail in the 1929. I don't get it. Bank of the United States was the immigrants bank. Lehman is an investment bank that caters to the ultra-rich. The failure of Bank of the United States did set off a chain reaction; a wave of bank failures across America that launched the real Great Depression, because it had far more impact of peoples lives than the more famous stock market crash. Steele wondered is Lehman's failure would set off a similar chain of events.

Other reports described how upset Lehman's employees were at being made into such a spectacle. Most of those interviewed were angry that the Fed had not bailed out Lehman. Wow. They think we should be sympathetic?

I think what is going on today is that the Fed, and the press, and the public, are realizing that bailing out this bank (i.e. Bear Stearns) or that bank is not going to solve anything. We are facing a systemic crisis. The Fed is dealing with this by exchanging credit for just about anything at its many discount windows and TAF facilities. That sure sounds like monetization to me. But it is doing this for the few bank it chooses to save. Bank of America and J.P. Morgan seem to be on the A list. Merrill Lynch and WaMu are on the shit list.

So, what next for the financial crisis? The failure of Washington Mutual is only a few days away, if things keep going at this pace. And, after the elections, we'll have accelerating inflation, probably hyper inflation.

By the way, this financial crisis affects our ability to innovate our way out of the energy crisis. We no longer have an investment banking industry to supply capital to American industry on favorable terms. There is going to be a wave of innovation for alternative energy? Which of the almost-dead banks will finance this project? European banks will prefer to finance Euro companies like Airbus and Siemens over General Electric.

Those bonds we just guaranteed, issued by Fannie and Freddy? We will have to keep making those coupon payments even when the homes they represent are no longer generating income, because the occupants have left. More monetization. Our hapless government will monetize everything they can until our dollars are well and truly worthless.

Tuesday, September 09, 2008

Fannie and Freddie, ad nauseum

So, the goverment has taken over operation of the America's two giant, government sponsored mortgage brokers, Fannie Mae and Freddie Mac. News reports say ominously that the bailout "could cost taxpayers tens of billions of dollars".

Tens of billions? Who are they kidding? Fannie and Freddie's liabilities were in the trillions (btw, a trillion is a thousand billions). At the rate that American mortgages are defaulting, tens of billions are not going to fix anything. It's hundreds of billions if we're lucky, probably well over a trillion dollars that the government will have to pay. Remember that Fannie Mae was notoriously resistant to audits, and the SEC kept letting them postpone their statements? No one knows the true mass of the black hole at the center of the mortgage galaxy.

Supposedly the holders of GSE debt (collateralized debt obligations, mortgage backed securities, etc) are relieved that the US Treasury will guarantee the monthly interest payments on this debt. Not to worry, the freshly printed notes will keep arriving in the mailbox on schedule.. but something is different here. Think of what those bonds used to represent. All those people going to their jobs, bringing in paychecks, making mortgage payments to banks.. that was a lot of economic activity. That was the process of wealth creation. Now that those homes have foreclosed (not all of them of course, but a lot of them) and mortgages defaulted, the treasury will simple write out a check to cover the mortgage - even though the people who originally borrowed the money no longer even own the home! What economic activity does that represent? Not a lot. No equity is being accumulated, no wealth is created, or value added. The government simply prints the money. The government could try to cover the cost with increased taxes, but that would only suppress economic activity even more (not to mention cause riots). These bailouts are simply the next stepping stone to hyper-inflation.

In the end, who owns all those homes? Bond fund PIMCO does, and the government of China, which are both huge holders of Fannie and Freddie debt. These are the owners of American homes, along with many others. And if those homes go into foreclosure, the mortgages will still be paid by the USA. In soon-to-be-worthless American dollars.