AIG and the case for torture

We have ways of making you unwind these transactions

Back in the Bush years we were told that the US government had to torture people.  The line of reasoning went something like this: “what if evidence had been discovered that a nuclear weapon had been set to go off  in downtown Manhattan and the person who planted it had been captured but wouldn’t talk.  If the bomb goes off, civilization as we know it ceases to exist.”

These days the executives at  AIG seem to in the position of would be financial terrorists.  Or, as the NY Times  put it the other day in a piece making the case for AIG bonuses on the grounds that we have to keep these guys around:

“A.I.G. built this bomb, and it may be the only outfit that really knows how to defuse it.”

So we are supposed to pay these guys to not destroy the world?  It seems to me that we have at least as strong a case for torture here as we had in the nuclear terrorist scenario.  Why don’t we have conservatives out there proposing “enhanced interrogation techniques” for the financial wizards at AIG?

But seriously, does the “retain talent” argument make any sense?  Sure we need experts to unwind this mess, but do we rely on the same people?  People who have every reason to hide their own screw ups and malfeasance?  I think not.

Cooperation

One thing that mystifies me about the current economic crisis is the inability of the big banks to get their house in order.  Or the inability of us (the government) to force them to get their house in order.  We are not talking about very many banks:  Citi, Chase, Bank of America, and Wells Fargo.  Together they own something on the order of 60% of all banking assets.  But for six months they’ve been sitting on assets that everyone knows are worth much less than the banks have them recorded at.  They need to be written down to prices that will let the market clear.  However management doesn’t want to do it.  They prefer to wait for “things to turn around”; maybe some day those assets will be worth more.  They don’t want to have a fire sale.

When this happens to smaller banks the FDIC shows up at the bank on Friday, closes the doors, look over the books, and sells off the assets to another bank at whatever price they can get from the other bank.  Then they use the proceeds to payoff depositors.  If anything is left over, they pay off debt holders and shareholders, but usually, since the the FDIC is there because the bank has bad assets, shareholders get nothing.  Management is asked to polish up their resumes and look for a job.  On Monday, the bank re-opens and everyone gets on with their life.

But with the big banks, it apparently can’t happen this way.  For one thing, they are so big, no one can buy them, and when there are this many bad assets, assigning price to the assets is a real problem.  Still, can’t we get the key players together, come to some agreement, and move on?

As Thomas Friedman said the other day

“I wake up every morning hoping to read this story: “President Obama announced today that he had invited the country’s 20 leading bankers, 20 leading industrialists, 20 top market economists and the Democratic and Republican leaders in the House and Senate to join him and his team at Camp David. ‘We will not come down from the mountain until we have forged a common, transparent strategy for getting us out of this banking crisis,’ the president said, as he boarded his helicopter.”

One of the problems with this approach is that the holders of the banks’ debt aren’t just depositors in this country.

As Michael Mandell at Business Week observed

The international angle is very important. Geithner and Bernanke keep saying that the problem is that no one knows how much the toxic assets are worth. But that’s not the full story. If the counterparties and beneficiaries of the toxic assets held by American banks are also American, it would be relatively easy for Geithner and Bernanke to gather them in a room and make them come to a ‘reasonable’ agreement about how much these securities were worth. After all, even the most powerful hedge funds must ultimately bow to the power of the Fed and Treasury, especially in a crisis.

But with most of the counterparties in other countries, the job becomes much more difficult. There’s no way for Bernanke and Geithner to force European banks, for example, to accept any particular valuation of derivatives or bank bonds—not without the cooperation of the foreign regulators.

So, if this is correct, this will all come down to a big international deal in which it is finally decided who is going to take the hit when these assets are finally written down.  If only W were still president.  He was so awesome at getting international cooperation.

Whew

What an unbelievable relief to have Peter Orszag at the Office of Management and Budget.  Here he is introducing Obama’s first budget:

“The single most important thing we can do to improve the long-term fiscal health of our nation is to slow the growth in healthcare costs.  …the path to fiscal responsibility must pass directly through healthcare”

Orszag is one of the few people I’m aware of who really understands that the federal budget (and realistically everyone’s budget) depends on getting healthcare under control.  If McCain had won in November, we would be listening to someone railing against “entitlements” and “government waste, fraud, and abuse”, and the desperate need for tax cuts.

Earmarks

Big news of the day (via AP):

WASHINGTON – President Barack Obama, sounding weary of criticism over federal earmarks, defended Congress’ pet projects Wednesday as he signed an “imperfect” $410 billion measure with thousands of examples. But he said the spending does need tighter restraint and listed guidelines to do it. Obama, accused of hypocrisy by Republicans for embracing billions of dollars of earmarks in the legislation, said they can be useful and noted that he has promised to curb, not eliminate them.

In a 910 word article that uses the word “earmark” 24 times we are never told exactly what an earmark is, and the spending on earmarks is never placed in context–in terms of the total appropriations now or in the past.  Furthermore, even though this is a report on a spending bill, people who read this entire article will likely have almost no idea what the spending is about or why Congress is voting on it.  What a reporting train wreck.

For some insight on earmarks I’d recommend that people read Thomas Mann’s recent piece for the Brookings Institution. Earmarks, he says, constitute “less that 1% of the federal budget”.  Further

In most cases, they don’t add to federal expenditures but merely allow Congress to direct a small fraction of program funding that would otherwise be allocated by formula or grant competition.

Yes, the expenditure would “otherwise be allocated by formula or grant competition”.  That’s why they call it an earmark.  Congressmen earmark it.  Now, those earmarks might be wasteful or wonderful, depending on your point of view.  The entire appropriation might be wasteful or wonderful depending on your point of view, but if you read the news (see AP report above) you will almost certainly have no idea what the spending is on.  And you will almost certainly be led to believe that any earmark is an absolute, total waste of money.

Is this informing the public?  I think not.  Meanwhile, (and I guess I’m doing some reporting here) 98% of the spending in the bill Obama signed goes to keeping government operating through the current fiscal year.  This is something the previous administration should have addressed, but didn’t.  Further, virtually every economist on the planet thinks government should be engaged in spending–earmarked or not– to counter the massive economic contraction we are living through.

And the AP is reporting on the appropriateness of earmarks.  Unbelievable.

Upside down

According to the this chart from Calculated Risk 55% of homeowners in Nevada owe more on their house than it’s worth.

Somewhere I’ve read that 20-30% of homeowners do not have a mortgage, so it’s not this many homeowners who are upside down on their home.  Still, it’s a lot of people!  And what happened in Nevada?  It looks like people walked out of the casino and into the realtors office in the same “double down” state of mind.

The Speech–upon further review

OK, maybe it wasn’t flat.  From Boston.com:

“According to the CNN/Opinion Research Corp. survey of Americans who watched the address, 68 percent said their reaction to his address was extremely positive and another 24 percent somewhat positive.

Also, 85 percent said his speech made them feel more optimistic about the country’s path in the next few years.”

Also, a lot of people watched.  Fifty-twp million viewers, according to Nielsen, as opposed to 40 million for Bush’s first state of the union.

The Speech

I thought it was kind of flat.  When did Obama decide to abandon the “Yes We Can” style of speaking?  Not that I expected him to use that particular phrase, but I expected to be inspired.  And I wasn’t.  Take the beginning of the speech for example.  We’ve just witnessed the entrance of a new cabinet (wow, it’s Democrats), Supreme Court Justices (wow, there’s Justice Ginsberg recovering from cancer surgery, a new president—and so forth.  Applause all around.  The room is buzzing.  The nation is uncertain, concerned about the future. Surely the new president is going to give us a grand vision of country, put our current woes in historic context, personalize the trials we will face, and the grand sense of accomplishment when we triumph over adversity!!

Instead, in the first minutes of the speech (literally) He launches immediately into telling us how bad things are.  Here are the first words:

I know that for many Americans watching right now, the state of our economy is a concern that rises above all others.  And rightly so.  If you haven’t been personally affected by this recession, you probably know someone who has – a friend; a neighbor; a member of your family.  You don’t need to hear another list of statistics to know that our economy is in crisis, because you live it every day.  It’s the worry you wake up with and the source of sleepless nights.  It’s the job you thought you’d retire from but now have lost; the business you built your dreams upon that’s now hanging by a thread; the college acceptance letter your child had to put back in the envelope.  The impact of this recession is real, and it is everywhere.

But while our economy may be weakened and our confidence shaken; though we are living through difficult and uncertain times, tonight I want every American to know this:

We will rebuild, we will recover, and the United States of America will emerge stronger than before.

The buzz is gone.

I was expecting him to tell a great story, make me feel confident and ready to “rebuild and recover”.  Instead he just asserted that that’s how it would be.   The biggest applause lines seemed to be for some specific program proposals (ending agriculture subsidies!!  honest budgeting!!!).  Not what I expected and pretty much forgettable for most people, I suspect.

It seems very strange to me that the guy who inspired everyone on the campaign trail has abandoned that style of speaking as president.

Feeding the Myth

What is the deal with Martin Feldstein?  He’s a conservative economist, but unlike the political funtionairies now operating what passes for a conservative party in this country, Feldstein understands that the government cannot just stand back and let the market work its magic.  He understands  that our economy faces a crisis, that government spending is the only plausible solution, and that we have to do something now.  But he just can’t let go of the Fannie Mae myth.  Here he is being interviewed on Frontline’s “Inside the Meltdown” last week:

Frontline:  The conservatorship of Fannie [Mae (Federal National Mortgage Association)] and Freddie [Mac (Federal Home Mortgage Corp.)], again, a surprise that this step would be taken, or a necessity?

Feldstein:  I think it was a necessity…. Their purpose on paper was to facilitate lower interest rates and the spread of mortgage availability to low-income individuals, but because there were no creditors watching, of course, why would you care what risks they were taking if you had a U.S. government guarantee? They were able to take outrageous risks, and that’s what we saw happen.
Frontline:  And they contributed to the problem in a sort of big and fundamental way.

Feldstein:  They did, yes.

It would have been nice if the interviewer had asked if he had any evidence to support that conclusion.  Yes, we know they are big, government sponsored enterprises involved in the mortgage market.  But if they were not involved in originating or securitizing junk mortgages (or even owning them as investments) until 2007–how exactly did they contribute to the problem in “a big and fundamental way”? Even Alan Greenspan acknowledges that Fannie and Freddie were not prime drivers of this fiasco.

Yet, Feldstein won’t give it up.  I know everyone has a story they tell themselves about how the world works, and we are always looking for ways to confirm the truth of our own personal story.  Conservatives tell themselves that government causes all problems.  Therefore our financial meltdown must have been caused by some government action.  Enter Fannie Mae. Evidence is irrelevant when the Myth Must Be Fed.

Quote of the Day

Jonathan Chait on the need for government spending, wasteful or not:

The point of stimulus spending…  is simply to spend money–on something useful if possible, wasteful if necessary. Keynes proposed burying money in mineshafts, so that workers would be hired to dig it out. (Imagine what the GOP could do with material like that.) World War II was an effective stimulus that, economically speaking, consisted of 100 percent waste. If war hadn’t broken out, we could have enjoyed the same economic benefit by building all those tanks and planes and dumping them into the ocean.

The Banking Fiasco

I see Congress added a provision to the stimulus bill limiting CEO bonuses and the compensation of “all highly paid individuals at the 359 banks that are receiving government aid.”  According to the NY Times, industry insiders are worried:

“This is a big deal. This is a problem,” said Scott Talbott, chief lobbyist for the nation’s largest financial services firms. “It undermines the current incentive structure.”

Talbott said banking executives expected certain restrictions would be applied to them but are concerned that some of the most highly paid employees, such as top traders, who bring in hefty sums for the company, would flee to hedge funds or foreign banks that have not accepted U.S. government funds

I can see how this provision might cause some weird incentives.  I wish Congress didn’t have to do it, but the public outrage Congress must be hearing about CEO bonuses has to be deafening.

What’s interesting is that the CEOs and finance company executives apparently don’t hear it at all.  This tells you just how disconnected these people must be from life as we know it.  Consider a few facts:

• People are looking into the abyss of economic doom caused in large part by a dysfunctional banking sector.
• Wall Street stars paid themselves massive amounts of money over the last few years based on what we now know were phony profits.  They made no attempt to pay this back.
• Unless they can fix their own industry, there is a very strong case to be made that the banking sector should be nationalized and reorganized—this means current executives would lose their jobs and shareholders wiped out.

Given these facts it seems like the banking executives would be launching a massive PR campaign to explain how they aren’t making much money anymore and everyone’s working together to fix the system.  Instead they are apparently working as hard as possible to extract maximum dollars from the system EVEN NOW.

My prediction:  all of the major banks–Citigroup, JPMorgan Chase, B of A–will be taken over by the government and reorganized.  The guys running these institutions now just don’t get it.  They are practically begging Congress to take them out.