Deal-making at Copenhagen: Five Nations, the Battle to Maintain the Earth’s Fragile Atmosphere, and the Emerging Carbon Trading Market

The two-week United Nations Climate Change Conference held in Copenhagen, Denmark, concluded with the leaders of the world’s five largest economies executing an accord of intent to act rather than a requirement to act. The signatories to the Copenhagen Accord are the United States, China, India, Brazil, and South Africa. In relevant part, the Copenhagen Accord establishes a global commitment to limit global warming by 2 degrees Celsius or 3.6 Fahrenheit, and to provide $100 billion in periodic payments to developing nations. The European Union has already volunteered to decrease its carbon gas emissions by 30 percent of the 1990 levels by 2020.

Many consider the Copenhagen Accord a failure because it does not bind either developed or developing nations to utilize energy efficient power sources or to lower carbon dioxide gas emissions, which create atmospheric concentrations of the greenhouse gases linked to global warming. In particular, the European Union considers the Copenhagen Accord a failure because it expected the United States and China to provide more concessions towards establishing global emission target decreases by 2020 that would have placed pressure on other developed nations to decrease their global emissions. A number of developing nations including Venezuela, Cuba, Saudi Arabia, Bolivia and Pakistan consider the Accord a failure because it does not provide a fixed payout schedule that specifies when developing nations can expect to receive financial assistance. However, as President Obama, a principal force behind the final deal noted, “the agreement is only a modest step toward healing the Earth’s fragile atmosphere.”

Approximately 193 nations were represented at Copenhagen, and many of the delegates believe that the agreement is a failure. The Copenhagen Accord is a mere 12-paragraph (not page) document, which provides as many forwarding looking statements as a dot.com investment prospectus. In truth, many argue that the Copenhagen Accord is more a political agreement than a mandate of conduct, because it lacks firm targets for mid-term and long-term reductions of greenhouse gas emissions, and a deadline for finalizing a global treaty. This tangible impasse, settled over the course of the conference, and evidences what some participants refer to as a “fundamental breakdown of order and defiance of a broad consensus.” Many are concerned that the impasse may undermine the consensus amongst various nations that was established after the climate summit in Rio de Janeiro in 1992, which in part, resulted in the United Nations Framework Convention on Climate Change and a series of 15 conventions to better achieve a global consensus to decrease global warming. Many delegates believe the “process has become unworkable,” because it is impossible to create consensus when countries are fighting over who bears the blame for climate change, the cost of climate change, and who should monitor a nation’s reported decrease in carbon dioxide gas emissions. Perhaps the critics are correct, self monitoring may not be the best methodology. We need only look to the America investment securities industry for confirmation.

The impasse at Copenhagen has not derailed efforts to reach a global warming accord. As Michael Levi from the Council of Foreign Relations stated, “the climate treaty process isn’t going to die, but the real work of coordinating international efforts to reduce emissions will primarily occur elsewhere.” As a result, the number of nations participating in the continuing global warming debate will decrease from 193 nations to approximately 30 nations. These 30 nations have been dubbed (behind closed doors) the Dirty Thirty because a significant portion of these 30 countries are responsible for 90 percent of global warming emissions. It was the Dirty Thirty whose consent was critical for the Copenhagen Accord to be achieved, because it is ultimately the decreased carbon dioxide gas emissions from the Dirty Thirty that will have the greatest overall impact on the Earth’s atmosphere. In October 2009, the International Energy Agency published the latest information on the level and growth of CO2 emissions, their source and geographic distribution will be essential to lay the foundation for a global agreement. A copy of the report is available for download here.


The Copenhagen Accord anticipates several inter-linked initiatives. In addition, to the global consensus to decrease carbon dioxide gas emissions, the accord promises billions of dollars of financing for developing economies such as Ayiti (Haiti) to develop clean-energy economies and to cushion the effects of climate change on their vulnerable economies. The accord also provides for the establishment of an international system for major economies to monitor and report their greenhouse carbon dioxide gas emissions. The accord further provides for the sharing of technology, and the merging of national carbon trading markets into a transnational carbon market. The Kyoto Protocol established carbon offset trading as part of the Clean Development Mechanism and Joint Implementation designed to reduce global carbon dioxide emissions. The mechanism encourages self-interested private sector investment in developing countries' carbon abatement projects, translating those emissions reductions into allowances.

Despite the pledges from developed nations to decrease their carbon dioxide gas emission, some scientists are doubtful that the changes will be sufficient to alter the course of what they perceive as the inevitable destruction of the Earth’s ecosystem. For example, changes in intense rainfall and drought have already occurred, ecosystem sustainability of the oceans and polar ice coverage are approaching critical levels. The probability of success, to alter the course of history to a substantial extent rests on the shoulders of one man’s ability to fulfill the promises that he made in Copenhagen. President Obama’s promises to reduce America’s greenhouse gas emissions, and to raise billions to assist developing and other developed countries create and share energy efficient technology may well be the codex that saves the “Earth’s fragile atmosphere.”

President Obama met the Copenhagen challenge and based on his diplomacy and genteelness emerged with an Accord that many believed could not be done. President Obama recognizes that the Copenhagen Accord is a modest victory as he solemnly stated, “[T]this progress did not come easily, and we know that this progress alone is not enough. We’ve come a long way, but we have much further to go.” However, President Obama cannot fulfill the promise that he made in Copenhagen without Congress’ commitment. Congress must adopt the environmental bill that is currently pending before the Senate, which will place a price on carbon and earmark a substantial part of carbon trading proceeds as foreign aid to assist developing and other developed countries to adopt energy efficient power sources.

The United Kingdom will also play a major role in the United States’ ability to fulfill President Obama’s promises in Copenhagen. London is the principle carbon trading market in the world. It is also a heavily regulated industry in the European Union. In 2005, the E.U. Emissions Trading System required limitations on emissions from heavy industry, and obligated companies that exceed the limit to purchase additional carbon emission permits to continue polluting the atmosphere. This is the quintessential environmentalist meets arbitrager paradigm, and in the process creates an entirely new financial product poignantly analogous to the era of Michael Milken and the creation of junk bonds into an investment grade security. The Emissions Trading System is the principle regulatory (dare I say, capitalist) “enhancement” that the European Union utilizes to achieve its 2020 carbon gas emission reductions target by 20 percent. Of course, this has become a very attractive (lucrative) business sector for carbon traders who are primarily located in London. This also creates an excellent opportunity for the United States, Wall Street in particular, to develop and expand the carbon trading market. Philippe de Buck, the director general of BusinessEurope, a lobby group in Europe, stated it is likely that “industries based in Europe would increasingly move their operations to less regulated parts of the world as a result of the weak accord struck in Copenhagen.” This may be a corporate opportunity for the United States with its weak carbon market regulation to attract the European carbon trading market. I am not sure that we would wish to attract the industries themselves to American shores, to continue their excessive carbon emission operations.

Although there was little assurance at Copenhagen, that carbon markets were poised to expand, the environmental bill pending in Congress may usher in a new market as Wall Street begins to calculate the potential money to be made in carbon trading, especially on a transnational level. After all there is nothing that American speculators adore more than unregulated markets, especially the utilities sectors. We need only look at the historical evidence regarding electricity, gas, and oil to find confirmation of American investors’ panache for trading in unregulated markets. The carbon market may well be the next global bubble.

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law

Efficiency, Distribution & Growth II: Distribution Matters

That is an ugly chart. It is from economist Emmanuel Saez, and what it depicts is a historic surge in inequality at the very top of the income scale. The very rich (1 in 10,000 rich) command six times more income than they did 30 years ago. Another 30 years like that and I figure we all will pretty much be living like peasants--or at least 9,999 out of 10,000 will.

So, even aside from fairness, this raises many questions. Is it just a coincidence that inequality spiked to all time highs in 1929 and 2007, just before major macroeconomic disruptions? Is inequality harmful to macroeconomic growth? What does this kind of inequality mean in terms of law and justice? What can and should be done to address such raising inequality? Is the US in an inequality trap?

Let me be clear: It is not a coincidence that inequality soared right before economic collapses because excessive concentration of economic power is as problematic as excessive concentration of political power. Either way the law is likely to serve the narrow interests of the powerful at the expense of any rational rule of law. While inequality is not inherently harmful to macroeconomic performance, particularly if it reflects rational incentives and disincentives at play, inequality may reflect elite entrenchment or the marginalization of disempowered groups. An entrenched elite or significant economic marginalization will lead to retarded macroeconomic growth everywhere and always. An entrenched elite simply does not face appropriate incentives to produce and is far more apt to use excessive economic resources to seek rents--that is money payments or government subsidies without production. Entrenched elites are unlikely to assure appropriate human capital formation (which is critical to growth), and are much more likely to exploit marginalized populations for political or economic profit. Marginalized minorities always reflect wasted human potential and the destruction of human capital. The US passed the tipping point of inequality and faces entrenched political subversion of the rule of law, and dangerous marginalization of disempowered populations.

So what does economics say of my view? Well, identifying the key drivers of macroeconomic growth can be complicated. Nevertheless, the economic evidence does fairly suggest that my conclusions are sound.

The Injustice of Inequality (by Edward Glaeser, Jose Scheinkman and Andrei Shleifer) shows that during the Gilded Age in the United States and during the transition from communism in Russia, inequality soared. In both instances elites used their newly accumulated wealth to subvert the rule of law and entrench themselves from competition. Macroeconomic growth suffered. Glaeser, Scheinkman and Shleifer also present cross country evidence consistent with their findings from the Gilded Age and transitional Russia.

Dietrich Vollrath of the University of Houston recently posted a paper showing the pernicious impact of inequality on the funding of education. He found that higher wealth inequality in the US was associated with diminished funding for public education (at the county level) in 1890. "The effect of inequality was dramatic. The difference between the county at the 90th and the 10th percentile of the inequality distribution was a decrease in tax rates by one half." Moreover, this effect was driven almost entirely by the effect of inequality on school funding, while there was no effect of inequality on non-school funding.

In Human Capital Inequality and Economic Growth: Some New Evidence, Amparo Castello and Raphael Domenech show that inequality in human capital attainment drives differences in economic growth trans-nationally. More recently, they showed that human capital inequality begets human capital inequality as investment decisions regarding human capital formation are tainted by factors such as life expectancy.

The World Bank in its 2006 Development Report: Equity and Development also links high inequality to stunted economic growth:

high levels of economic and political inequality tend to lead to economic institutions and social arrangements that systematically favor the interests of those with more influence. Such inequitable institutions can generate economic costs. When personal and property rights are enforced only selectively, when budgetary allocations benefit mainly the politically influential, and when the distribution of public services favors the wealthy, both middle and poorer groups end up with unexploited talent. Society, as a whole, is then likely to be more inefficient and to miss out on opportunities for innovation and investment.

The World Bank argues that in order to maximize the economic potential of a nation's human resources, economic opportunities must be redistributed to combat the influence of high economic inequality.

In short, distribution matters to growth and there is powerful empirical evidence demonstrating the impact of inequality. Inequality may corrode the rule of law and impairs human capital formation.

We already knew this. Can any American in 2009 really argue that the US exploits all the talent of all of its people. Does anyone really believe that legacy admits at Harvard or admits based upon star-power at Brown does not operate to allocate economic opportunity based upon privilege instead of merit?

As long as the neo-classical paradigm ignores distributional concerns it cannot deliver maximum economic growth. The neo-classical paradigm ignores the reality that inequality can be excessive.

OppenheimerFunds Agree to Pay $77 Million for Mismanagement of 529 College Savings Plan But Damaged Caused May Be Irreparable

During the pre-Christmas hustle and bustle of gift buying and bargain shopping, it is not unusual for many parents and God-parents to forego temporal gifts such as toys, clothing, electronics (especially cell phones), and to give more substantive gifts to their children (and God-children) by establishing 529 college savings plans for the benefit of the children. Imagine my surprise when I discovered while researching 529 college savings plans for my God-children that OppenheimerFunds Inc. had agreed to pay Illinois residents $77.2 million, to resolve a one year investigation into OppenheimerFunds’ mismanagement of the State of Illinois’ 529 college savings plan, known as the Bright Start Fund.

At first I did not understand how parent-investors in a theoretically long-term, conservative investment for the benefit their children could have a viable cause of action against OppenheimerFunds for losses that the Bright Start Fund had incurred. After all investments by definition carry a certain level of risk; returns are not guaranteed, and losses can very possibly occur. As I continued deciphering the various articles that was hitting the news wire, press releases, and the complaint itself, I realized that it was not the losses that the parent-investors were incensed about, but the inability to send their children to college, as a result of the Bright Start Funds’ unexpected losses. It was the lack of adequate disclosure to parent-investors regarding the Bright Start Funds’ aggressive management strategy and risky investment philosophy, which contradicted the language in Bright Start Fund program brochures and prospectus that described the investment style as conservative, and focused on capital preservation for college bound students. The parent-investors relied on the disclosure language contained in the prospectus, to the detriment of their children’s future.

Within approximately one year the Bright Start Funds’ underlying fund, Core Plus Fixed Income Strategy Fund, lost approximately $150 million (so much for capital preservation). The approximately $150 million loss seemed excessive in comparison to the bond index that Bright Start Fund used as its benchmark. The discrepancy was discovered by Illinois Treasurer Alexi Giannoulias and he encouraged Illinois Attorney General Lisa Madigan to begin an investigation. OppenheimerFunds had marketed Bright Start Fund as a conservative investment vehicle “appropriate for beneficiaries who were at or near college age.” However, Core Plus Fixed Income Strategy Fund, an underlying fund within the Bright Start Fund, contained very risky investment exposure in highly leveraged mortgage derivatives. It was the underlying fund which resulted in excessive losses for Bright Start Fund and for parent-investors. This fund within a fund investment strategy is why I do not recommend mutual funds as a primary investment vehicle. It is never clear to what degree investments in the underlying funds will impact the main fund, nor whether the investment strategy of the fund managers within the underlying fund is in sync with the investment strategy of the main fund.

The Bright Start Fund was marketed to numerous states to be operated as a particular state’s own 529 college savings program. The lack of adequate disclosure in the prospectus vis-a-vis the Core Plus Fixed Income Strategy Funds’ highly leveraged risky investment strategy was the same for every state in which Bright Start Fund was marketed as the particular states' 529 college saving program. Oppenheimer spokeswoman Jeaneen Pisarra stated that “the firm has also reached a tentative $67 million settlement with New Mexico… and agreed to pay $20 million to settle a lawsuit filed by the state of Oregon.” Additionally, the OppenheimerFunds is in talks with Maine, Nebraska and Texas regarding tentative settlements. I am sure that there will be many more states which permitted OpenheimerFunds to operate the Bright Start Fund as the state’s 529 college savings program, with which OppenheimerFunds will be “in talks” regarding tentative settlements. Nevertheless, OppenheimerFunds maintained that it "acted lawfully and in good faith in managing the investments in the Bright Start program."

However, some parent-investors don’t believe that the settlement is adequate. Joseph Sinopoli stated, "I think it's a lousy deal." Mr. Sinopoli invested in the Illinois' 529 college savings plan, Bright Start program, to help pay for his children’s' college tuition. He specifically wanted a fund with very little risk. However, the OppenheimerFunds’ managers "did something that they were not permitted to do under the mandate of the fund. They took very risky bets and lost half the money…It was fraud. I think they stole the money." It is clear that Sinopoli was not happy that Illinois Attorney General Lisa Madigan and State Treasurer Alexi Giannoulias settled for $77 million, when OppenheimerFunds lost $150 million. The settlement only requires OppenheimerFunds to repay half of what was lost. However, Giannoulias stated that they wanted to “…get as much money as quickly as possible for families that would be the best thing for the state of Illinois."

I have a basic question-- what about the children? What is in their best interest? For many parent-investors OppenheimerFunds’ conduct will undoubtedly result in their inability to pay for their children’s college. What is the market price for a dream deferred to borrow the language of prophetic American poet Langston Hughes? The sad reality is that there are times when there is no adequate legal remedy for the harm that is suffered, as a result of corporate misconduct. As Mr. Sinopoli astutely points out, "if this was the sole source of funding for some families for college, they're probably in trouble. I'm sure there's a lot of pain because of these losses."

Lydie Nadia Cabrera Pierre-Louis

Efficiency, Distribution & Growth: Anatomy of a Debt Crisis

The Section on Socio-Economics plans an all day meeting on January 7, 2010 addressing "The Economic Recovery and the Obama Presidency" at this year's Association of American Law Schools annual meeting in New Orleans. I will speak on a panel entitled "Efficiency, Distribution and Growth" from 9:40 to 10:40.

My presentation will focus on three points, each of which played a central role in the subprime debacle. First, the efficiency paradigm operated merely as a shill for deregulation, instead of as an occasionally useful theoretical construct. Second, the current crisis demonstrates the central role distributive justice plays with respect to growth. Third, the emergence of yet another bubble followed by a debt crisis highlights the intellectual bankruptcy of the neoclassical paradigm, as it lacks any ability to predict such a crisis, explain such a a crisis or remedy such a crisis. This post will summarize my comments regarding debt crises.

The economic framework that did predict the current crisis, with powerful explanatory power, is Hyman Minsky's Inherent Financial Instability Hypothesis: "Instability is an inherent and inescapable flaw in capitalism." Basically, extended prosperity imbues reckless optimism, leading to excessive debt that ultimately looks only to increasing asset values for repayment. The resulting bubble is bound to burst leading to excessively tight credit conditions until debt levels stabilize, resulting in a "collapse in asset values." Debt deflation then sets in, with "the potential to spin out of control." Debt deflation means massive asset liquidation, slashed expenditures, layoffs, and the destruction of investment incentives as the economy struggles to deleverage.

This approach directly contradicts the Efficient Market Hypothesis. As Minsky stated:

"from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes the economic system's reactions to a movement of the economy amplify the movement--inflation feeds upon inflation and debt-deflation feeds upon debt-deflation. . . .These historical episodes are evidence supporting the view that the economy does not always conform to the classic precepts of Smith and Walras: they implied that the economy can best be understood by assuming that it is constantly an equilibrium seeking and sustaining system."

Mainstream Law and Economics erred in embracing the Efficient Market Hypothesis as a foundation for policy analysis and prescriptions. The siren call of deregulation (which not coincidentally served to entrench the economic power of our financial elites) spawned disaster. Minsky on the other hand, in his famed Stabilizing and Unstable Economy, articulated powerful arguments for robust financial regulation as a means of countering financial excess and innovation (313-328).

The worry today is the continuing failure to embrace the implications of Minsky's work. The debt crisis has not been resolved, it has simply transmogrified into a sovereign debt crisis as witnessed in Greece, Iceland, Dubai, and who knows where else. Prodigious dangers still face the global economy. The credit crunch marches on.

Minsky argued that the road to macroeconomic stability required the government acting as employer of last resort. After all, deleveraging is a two way street--it can be achieved by either reducing debt (through painful debt deflation) or by expanding income (through government stimulation of employment and growth).

The Obama administration still fails to appreciate that this is no ordinary recession--it is a debt crisis that could drag on for years if the debt burden is allowed to continue to weigh down economic growth and become heavier and heavier.

A.I.G. Off the Hook?

In yesterday's New York Times, an important (and under the radar) op-ed was published by Eliot Spitzer, Frank Partnoy and William Black entitled "Show Us The E-Mail."

In this Opinion piece, Spitzer, Partnoy and Black recognize the recent efforts by bailed-out financial institutions to repay the bailout money in order to emerge from under the thumb of government regulation and oversight. It appears that A.I.G. is now in early talks with the Treasury in pursuit of an agreement to "sell[] the taxpayers’ 80 percent ownership stake in that company." Not so fast, urges Spitzer, Partnoy and Black.

To this point, precious little has been done to unwind A.I.G.'s massive role in torpedoing the American economy and setting off a global meltdown. This blog has carefully followed attempts by the Government to re-regulate the financial services industry, and has discussed A.I.G., credit default swaps and over the counter derivatives trading often. Can it be true that A.I.G. is about to make a deal that will allow it to emerge unscathed from its role in the crisis?

According to the NY Times op-ed:

"A.I.G. was at the center of the web of bad business judgments, opaque financial derivatives, failed economics and questionable political relationships that set off the economic cataclysm of the past two years. When A.I.G.’s financial products division collapsed — ultimately requiring a federal bailout of $180 billion — those who had been prospering from A.I.G.’s schemes scurried for taxpayer cover. Yet, more than a year after the rescue began, crucial questions remain unanswered. Who knew what, and when? Who benefited, and by exactly how much? Would A.I.G.’s counterparties have failed without taxpayer support?"

If the Treasury allows A.I.G. to sell its taxpayer owned portion of the company, then the Government will have no leverage to force the release of all of the e.mail traffic that may very well contain the evidence of "who knew what, and when?" and "who benefited and by exactly how much?" This is an unacceptable result.

Again, according to Spitzer, Partnoy and Black:

"As fraud investigators, we would like to examine the trading patterns of A.I.G.’s financial products division, and its communications with Goldman Sachs and other bank counterparties who benefited from the bailout. We would like to understand whether the leaders of A.I.G. understood that they were approaching a financial Armageddon, and whether they alerted their counterparties, regulators and shareholders to the impending calamity.

We would like to see how A.I.G. was able to pay huge bonuses to its officers based on the short-term income they received from counterparties for selling guarantees that, lacking adequate loss reserves, the companies would never be able to honor. We would also like to know what regulators knew, and what they did with the information they had obtained."

The American public, in fact the world, deserves to see what A.I.G. and its leadership was up to during the run-up to the greatest financial collapse since the Great Depression. The op-ed concludes:

"The longer it remains hidden, the less likely we will be to answer many questions about the A.I.G. collapse and the larger economic crisis — including the most important one: how do we prevent a repeat? Time is the enemy of effective investigation; records disappear, memories fade. The documents should be released — without excuses, or delay."

Will we have the political will to force this investigation?

List Of The Ten Highest Paid American CEO's: Are These Guys Really Worth What They Make?

Just last week I wrote about executive salaries and compensation on this blog. I think it is important to revisit the issue in a sense. Last week in preparing my piece on pay czar Kenneth Feinberg’s decision to cap executive salaries among the largest TARP recipients I came across some disturbing but interesting data. I run across data containing the total compensation packages for the top ten (10) highest paid CEO’s and executives in 2008, in terms of salaries, bonuses, stock and options. It forced me to ask myself a question. Are these individuals, all males by the way, really worth what they are getting paid? The answer is NO! This is just my humble opinion. I thought that I would share the list of the ten (10) highest paid American CEO’s with you. Here goes the list:

Individual: Company: Total
Compensation
Package:

1. Sanjay Jha Motorola $104.5 million

2. Larry Ellison Oracle $84.6 million

3. Robert Iger Walt Disney Co. $51.1 million

4. Kenneth Chenault American Express $42.8 million

5. Vikram Pandit Citigroup $38.2 million

6. Mark Hurd Hewlett-Packard $34 million

7. Jack Fusco Calpine $32.7 million

8. Rupert Murdoch News Corp. $30.1 million

9. David Cote Honeywell International $28.7 million

10. A.G. Lafley Procter & Gamble $25.6 million

"Precious" the Movie: What Does This Have To Do With Corporate Injustice?

For almost five weeks I resisted seeing the movie “Precious”. I didn’t want to see the movie because I’m tired of the omnipresent stereotypes in the media and popular culture about African Americans, particularly poor African Americans. But I finally saw the movie this week because I was curious and I was concerned about yet another graphic depiction of Black women as hyperactively sexual, Black men as brutes, and Black mothers as lazy welfare queens.

Let me explain why I saw the movie. Two weeks ago I overheard a conversation between my physical therapist and another patient. This other patient was a white man who excitedly told my therapist that she had to go see the movie. He said that Monique did a great job in playing the physically abusive mother of a teenage girl who had been raped by her father. Then he explained that he had retired after thirty-five years of teaching and that this is how it was with these kids – they are really afraid of their parents. I think that he genuinely believed that the movie offered some insight into Black life. And this is why movies like “Precious” are so very dangerous.

There is very little in popular culture that reveals the textured layers of Black life in America. Most books, movies, and television shows are about Black people who are superrich – Black entertainers or sports icons – or about Black people who live in abject poverty. There are also television shows like “Meet the Browns”, a sequel to the buffoonery and antics of minstrel shows which were popular in the first half of the twentieth century. There is very little in popular culture that reflects the rich diversity of black socioeconomic life. The fascinating lives of the black American middle class are left largely unexplored.

Racial segregation is still a salient reality of twenty-first century life. Black and white children attend schools that are either predominantly Black or white. Neighborhoods are also racially segregated. So are churches. Americans of all races come together in the workplace but our personal lives, for the most part, remain separate. Many white Americans get to “know” Black Americans only by consuming the images of African Americans in popular culture. Take for example, the response of a student at Boston College to a presentation I made about the role that racial discrimination plays in impeding the advancement of people of color in the corporate workplace. He explained that, in his opinion, discrimination was not the problem. He thought that there was something in African American culture that prevents Black achievement. When I asked him to explain his position, he referred me and the rest of the class to a television show called “The Wire”.

The movie “Precious” is a compelling piece of fiction. But, it is just fiction. In an interview with Katie Couric, the author of the novel on which the movie is based explained that her work was a “montage” of several people she had met in her life. The movie is dangerous because white Americans and Americans of color live, play, worship, and learn separately. Some white Americans will believe that they are learning something about Black people when they watch the movie. The universal nature of child abuse – the fact that it poisons the lives of families of all races and at all economic levels – will get lost because there are so few healthy images of Black Americans in popular culture.

One commentator lamented that there is “clearly a segment of [Black Americans] that worries about what white people think.” We have to worry about what white people think. I research and write about racial discrimination in the corporate workplace. The senior executive ranks at all major American corporations are almost all white and are predominantly male. White people make decisions about the lives of Black professionals and working people. We have to wonder whether the decisions white managers make about hiring, promotion and pay are influenced by the parade of negative portrayals in the media and popular culture. And, even Black Americans who start their own businesses must worry about what white people think when they go to financial institutions for capital to fund their businesses. These decisions are also made primarily by white Americans.

There is so much that has been said about the movie “Precious”. There is much more to say about the way such projects are funded and the role of private companies in determining the content of pop culture. I’ll save that for another day.

President Promises "No Problem" Ordering State Takeover of Banks

Late last month, President Hugo Chavez threatened to nationalize Venezuelan banks that had violated banking regulations. "Do you want me to nationalize the banks," he demanded in his weekly radio and television program entitled Alo Presidente? The Venezuelan banking sector had approximately 248 billion bolivars ($115.5 billion) in deposits spread out amongst 50 banking institutions both privately-owned and state-operated at the end of October 2009, according to Softline Consultores, a banking consulting firm in Caracas, Venezuela.

President Chavez stated that he would do whatever was necessary to prevent irregularities amid a scandal that has already prompted the Venezuelan government to take over management of four private Venezuelan banks. The four banks are Banco Confederado SA, Banco Canarias de Venezuela CA, Banco ProVivienda a/k/a Banpro Banco Universal, and Bolivar Banco CA, which collectively account for approximately 6% of Venezuela's banking sector. This month the Venezuelan government took over four additional banks, which brings the total nationalized banks to eight, and their collective deposits represents 9% of the Venezuelan banking sector.

Last week, the Venezuelan government closed down and will nationalize the eighth banking institution in less than three weeks in a growing government intervention to control fraud and greed in the Venezuelan banking sector. A state-run banking agency has appointed officials to oversee operations of the banks. The Venezuelan National Banking Council and the Venezuelan Banking Association, both privately operated entities, have voiced their support for the government’s takeover, saying the initiative is aimed at protecting depositors.

The four private banks that were nationalized last month were all purchased in September and October 2009 by a group of investors headed by Ricardo Fernandez Barrueco, who is involved in the food industry and sells products to a network of state-run subsidized food markets known as Mercal. Allegations amongst banking officials and private bank owners include widespread violations that have allegedly led to Venezuela’s financial problems. Banking officials, private bank owners, and in certain cases their attorneys have been arrested and jailed on charges of misappropriating or assisting to misappropriate deposits, failing to meet lending targets, making unauthorized share transactions and diverting deposits by providing loans to other businesses in which bank owners were investors. Apparently, corporate governance fiduciary duties which prohibit directors and controlling shareholders from engaging in transactions, in which there would be a conflict of interest or self-dealing, were not of paramount concern.

Additionally, Venezuelan Attorney General Luisa Ortega Diaz has barred 16 bank executives from leaving Venezuela. President Chavez has sent a very strong warning to the Venezuelan private banking sector, “[t]o all private bankers in the country, he who slips, loses, independent of the size of the bank.” As a result, at least 10 people have been jailed, including the recently dismissed president of the Venezuelan National Securities Commission, Antonio Marquez Sanchez. Mr. Sanchez allegedly allowed a transfer of bank shares on the Caracas Stock Exchange without approval from the Venezuelan banking regulatory agency. In particular, Mr. Marquez authorized a transfer of Banco Canarias shares (one of the private banks that was nationalized in November) to another bank, Banco ProVivienda (BanPro) (another private bank that was nationalized in November). Venezuelan securities and banking authorities stated that BanPro owner Barrueco, was arrested last month for fraud because he illegally used depositor funds to purchase Canarias bank.

Earlier this year, President Chavez purchased Banco de Venezuela, a unit of Spain based Banco Santander SA, for $1.05 billion to expand the Venezuelan government’s presence in the banking sector. Currently, the Venezuelan government controls 21 percent of the Venezuelan banking sector. The Venezuelan banking sector would not be the first sector to be nationalized. President Chavez has ordered the nationalization of major business entities in the steel, electricity, oil, metal and cement industries. The Venezuelan government this year, has already taken control of Stanford Bank SA, Banco Comercial, and closed the local offices of Antigua based Stanford International Bank Ltd. after the majority shareholder, R. Allen Stanford, a Texan financier was accused by U.S. regulators of defrauding investors of $8 billion. Approximately $3 billion came from Venezuelan investors.

During the past ten years, President Chavez has nationalized a number of privately-owned businesses such as coffee processing plants, sugarcane mills, and cattle ranches. In part, it is these “takings” of privately operated businesses that has brought a lot criticism of President Chavez’s nationalization policy. The current scandal regarding Mr. Barrueco and the banking sector has prompted opponents of President Chavez to point to the scandal as evidence that President Chavez has failed to control corruption and cronyism involving government officials and certain individuals in the private-sector. However, the issue may go deeper than cronyism or corruption. It goes to the historical relationship between certain government officials and the often unrestrainable need to “capitalize” on their position by engaging in “private” transactions with certain members of the private sector. It is a dark dichotomy that has plagued numerous governments, including the American government, in the developmental stages of their economies from a local to global economies, and also when certain business sectors remain unregulated tradable markets that are vulnerable to speculators. President Chavez stated that "[w]e aren't here to make money." This philosophy must seem very bizarre from the perspective of capitalistic driven economies. Where the maximization of profit and aquisition of money is often the predominant focus.

President Chavez’s nationalization measures are a major cause of concern for multinational banks. At least four international banks have a very strong presence in the Venezuela banking sector, including Spain based Banco Bilbao and Vizcaya Argentaria SA, Amsterdam based ABN Amro Holding NV and U.S. based Citigroup Inc.

Prudential Divestitures II or III or IV or. . . .

Barney Frank did it. He passed a sweeping financial reform bill entitled The Wall Street Reform and Consumer Protection Act of 2009. Weighing in at 1279 pages, I am sure there is plenty to argue about, and I am sure many of us will be writing about it for years to come. It shocks me, for example, that lawmakers used this crisis, which epitomizes the problems with laissez faire economics, to strip state attorney generals of law enforcement power. The initial reaction has been interesting: Paul Krugman is amazed that no GOP Representative voted for the bill; the unions apparently think it was major victory over monied bank interests; the Mortgage Bankers Association opposes the bill; and the banks' lobbyists spent $300 million and caucused with the GOP in a futile effort to stop the bill. All of this suggests a rare triumph of policy over our money-driven political system. But, I think Ohio Representative Dennis Kucinich makes some compelling points that give me pause, such as the bill's failure to adequately regulate OTC derivatives, the continuation of regulatory power to pursue bailouts of troubled mega-banks, the failure to restructure the regulation of credit rating agencies, and the failure to really reform asset securitizations. So, I suppose on some levels it looks like a mixed bag.

Nevertheless, I was pleased to see that section 1105 of the bill authorizes a new regulatory authority to order divestitures of "business units, branches, assets or off-balance sheet items." I have argued for this power to order prudential divestitures on this blog since July, gave thanks for the Kanjorski Amendment that inserted this power, and formalized my proposal in a forthcoming Dayton Law Review symposium article. So this blog entry constitutes at least my fourth effort to urge our lawmakers to impose this sanction against firms that are too-big-to-fail.

Let me review my argument: Banks that benefit from an implicit government guarantee enjoy a lower cost of capital and are apt to shoulder more risk than if they knew that real insolvency would result to destroy their firms (and the careers of senior managers) in an FDIC receivership or bankruptcy filing. They therefore attract too much capital to fund too much risk system wide. This supports asset bubbles. Bailouts also give managers perverse incentives to fail, for failure can lead to golden parachute and other severance payouts that now are government guaranteed. Firms that are not implicitly guaranteed are forced to compete with government subsidized firms. In short, too-big-to-fail destroys markets across the economy and subsidizes ineptitude. It is socialism for the rich.

Giving the government the power to order divestitures means creditors must risk the possibility that firms they lend to will be cut down to size instead of bailed out. Managers too must be concerned that if they take too much risk they will be in line with all the other unsecured creditors if their firm becomes insolvent.

There are certainly other important issues. And the coming months will tell if the bankers and their hoards of cash (our cash) will prevail.

But the power to order divestitures is a pretty good litmus test--some commentators call it the "biggest threat to Wall Street." If it gets killed in the Senate then look out! The fix is in.

The Federal Pay Czar Moves to Cap Executive Salaries At TARP Firms

On Friday, Kenneth Feinberg, the White House’s “pay czar” unveiled new pay restrictions that are aimed to limit the pay for top employees among the largest TARP bailout recipients. Thus far, this Feinberg’s actions on Friday represent the largest effort to cap or limit the pay of top employees. Feinberg’s ruling will impact 75 out of the top 100 highest-paid employees at Citigroup, AIG, General Motors, and GMAC.

Feinberg’s ruling prevents employees at the largest TARP recipient companies from receiving base salaries of more than $500,000. Of this $500,000 base salary cap, at least ½ of that amount must come in the form company stock, and the remaining ½ in cash. In a press conference yesterday, Feinberg noted: “We want to minimize these runaway perks and other compensation practices.” Feinberg’s ruling takes effect on Friday and is not retroactive.

This is the second time since October that Feinberg has weighed in on executive compensation. In October, Feinberg cut the compensation packages for the top 25 executive at the seven companies that received federal bailout money more than once. In October, Feinberg’s shrunk salaries by 90% and transferred bonus payments into a performance-based pool of long-term stock options. Feinberg’s October pay pronouncements affected 136 executives. This time around, 450 executives will likely be affected by Feinberg’s plan.

Companies opposed to Feinberg’s plan have presented two (2) main arguments in opposition. First, companies affected by Feinberg’s plan have argued that government imposed pay curbs have prompted the best and brightest to flee their ranks. Second, they have argued that caps would hinder the overall performance of their companies’, thereby making it harder to pay back their TARP funds. Feinberg indicated that he carefully evaluated these concerns. Indeed, Feinberg has granted an exemption for nearly a dozen individuals “deemed to be very essential” to be paid more than $500,000. Most of these “essentials” will earn between $500,000 and $950,000 annually. One individual will make over $1 million. Feinberg indicated that his office would have the final say on the size of a company’s bonus pool and how it is allocated.

TARP bailout recipients have been scratching their heads to figure out how to quickly repay their TARP funds. This week Bank of America rushed to payback $45 billion in TARP funds to escape Feinberg’s salary death-grip. This week we were informed that Citigroup is exploring a number of options to raise capital to pay-back billions of dollars in TARP funds.

Are we seeing a larger movement to limit or cap executive compensation? Perhaps. However, it is still too early to tell. On Thursday, Goldman Sachs announced that the 30 executives who comprise the company’s management committee will not receive cash bonuses this year. Also, Goldman Sachs announced that shareholders would get an advisory vote on pay packages for executives. This is an indication of some positive movement. Undoubtedly, more traction and movement is needed to tackle the difficult problem of executive compensation. Certainly, the issue is on the radar screen for many.

Wall Street Reform and Consumer Protection Act of 2009

The House of Representatives just voted to approve the Wall Street Reform and Consumer Protection Act of 2009. The 1,279 page bill (pre-amendment) was approved 223-202 in the House and now must wait for the Senate to approve its version of a Wall Street Reform Bill.

Previously, this blog has discussed various provisions in both the House bill and the Senate bill.

Time Magazine writer Justin Fox discusses the House version of the bill here:
http://curiouscapitalist.blogs.time.com/2009/12/11/they-passed-it-they-really-passed-it/

More Cowbell . . .

Important matters that have crossed the wires in recent weeks:

(1) On apologies and regrets: In November, the Wall Street Journal reported that investment banking giant Goldman Sachs had acknowledged publicly that the bank had "made mistakes" that it regretted, in connection with the financial market crisis. Goldman CEO Lloyd Blankfein openly admitted "We participated in things that were clearly wrong and we have reasons to regret and apologize for." This admission comes on the heels of news that Goldman expects to pay enormous bonuses to employees and executives at year end.

Simultaneously with its admission of error, Goldman also announced that it was initiating a small business rescue effort where it would contribute $500 million to "help thousands of small businesses recover from the recession." The investment bank said that it was working with billionaire investor Warren Buffet to help 10,000 small business by offering business and management education, mentoring and access to capital.

While Goldman has "bounced back spectacularly from the financial crisis" the same cannot be said for Main Street Americans. Many argue that the newfound humility on the part of Goldman's chief executive and the small business rescue plan have much more to do with softening a tarnished image, than in changing status quo business as usual. As expected, in announcing the billions of dollars in bonuses it expects to pay out shortly, Goldman argued that "it has to pay its employees well to retain top talent." Seriously.

(2) On TARP and its "effectiveness": This week, the Congressional Oversight Panel that was established to function as a bailout watchdog group, released a report finding that the Troubled Asset Relief Program (TARP) stemmed a larger global panic, but that it has left in its wake a "trail of woe." The oversight panel found that the bailout stopped the financial panic and stabilized the banking system when TARP was hurriedly passed in October 2008, but that is failed to stem or address problems of lackluster lending and growing foreclosures that continue to plague the U.S. economy. The group went further by suggesting that TARP may have done more harm by making some banks and firms even larger and ever more "too big to fail" and by creating expectations that big banks will always be saved, regardless of their leadership failures.

The Congressional Oversight Panel's chair, Elizabeth Warren, a Harvard University Professor, stated that "the TARP program was not authorized for the sole purpose of bailing out large financial institutions. . . . Congress specifically states in the legislation that it expects the benefits will be to get ahead of the foreclosure crisis and to deal with the larger economic crisis. That hasn't happened." The oversight panel identified five ways in which TARP is failing: (a) Many consumers and businesses are still having trouble getting loans; (b) Banks are still failing at a rapid rate; (c) Toxic assets remains on balance sheets of large banks; (d) Foreclosures continue to grow; and (e) Unemployment continues at a record pace.

(3) On reform legislation: In November, Senator Dodd introduced legislation that would impose sweeping curbs on the Federal Reserve. The proposal calls for "curbs on the Fed's ability to offer emergency loans to individual companies, strips away virtually all of its bank-supervision and consumer protection powers, and gives the White House and Congress some say in how the Fed's 12 regional banks are governed."

This proposed legislation is part of the Obama administration's attempt to overhaul regulation of the financial sector. This Federal Reserve legislation would create a single bank regulator, a powerful council of regulators to monitor systemic risks to the economy and a Consumer Financial Protection Agency to write and enforce rules on products such as mortgages and credit cards. Further, aside from greatly diminishing the power of the Fed, the bill would create new powers for the Securities and Exchange Commission, toughen regulation over derivatives and create new investor protection rules for public companies.

Transactional Education: What’s Next? Conference

Emory University School of Law’s Center for Transactional Law and Practice is delighted to announce its second biennial conference on the teaching of transactional law and skills, Transactional Education: What’s Next? The conference will be held at Emory Law on Friday, June 4, and Saturday, June 5, 2010.
We are accepting proposals immediately, but in no event later than 5:00 p.m., February 1, 2010. We welcome proposals on any subject of interest to current or potential teachers of transactional law and skills.
To find out more information about the conference or how to submit a proposal, please click here.

Emory Law's Center for Transactional Law and Practice is at the forefront of educating students and professionals on topics related to business transactions. Students participate through Emory's Transactional Law Certificate Program, while the center offers a number of workshops and seminars designed specifically for practicing attorneys.

The Center regularly hosts a conference for educators in the area of teaching transactional skills.


The Steering Committee
Tina L. Stark, Chair, Emory University School of Law
Danny Bogart, Chapman University School of Law
Deborah Burand, University of Michigan Law School
Joan MacLeod Heminway, The University of Tennessee College of Law
Jeffrey Lipshaw, Suffolk University Law School
Jane Scott, St. John’s University School of Law

Thinking About the Trilateral Commission

The Trilateral Commission arouses many conspiracy theories. A recent story about the number of Trilateral appointments in the current administration reignited a longstanding interest in the organization. Its fascinating.

First, amazingly for an organization that is supposedly a secret cabal, you can apparently get a membership list from their website. That's right the Trilateral Commission is on the internet! So I requested a membership list, and assume I'll receive one tomorrow via email.

Second, I really think they need to hire a marketing expert. Their logo really sends all the wrong messages. It is at left. If you look carefully there is an obscure even twisted peace symbol in there. But, whatever, the real problem is the converging arrow heads look somewhat menacing and sneaky, as if to surround and pressure, in a vaguely militaristic way. Man, I do not want to mess those arrow heads.

Third, the stated purpose of the organization is innocuous if not laudable: they basically recognize the reality of national interdependence, the need for transnational cooperation, and the special responsibility of the Western democracies (Japan, Europe and the US) to reduce conflict and create conditions conducive to prosperity. In fact, their express goals includes recognition of this challenge: "shortages in world resources could breed new rivalries, and widening disparities in mankind's economic conditions are a threat to world stability and an affront to social justice."

Fourth, although the organization keeps a low profile, it cannot really be termed secretive. Its senior officials write openly about the organization in places like the New York Times . Its agenda is relatively transparent with an emphasis on free trade, but with common sense concerns on issues such a global warming.

Finally, and perhaps most importantly, the organization includes many high-powered leaders. It was founded by David Rockefeller and Zbigniew Brzeziniski. Brzezinski advised both the Carter and Bush I administrations regarding foreign policy issues. Rockefeller is a legendary billionaire. Presidents Carter, Bush I, and Clinton were members before becoming president. Fed Chairs Volcker and Greenspan were members. Apparently, Timothy Geithner, Susan Rice, and a bevy of other current administration members are Trilateralists. Lawrence Summers is a member.

About the worst that could be said of the Trilateral Commission is that one very powerful member, David Rockefeller, admitted possible ambivalence regarding the US, when he said in his Memoirs: "Some even believe we (the Rockefeller family) are part of a secret cabal working against the best interests of the United States, characterizing my family and me as 'internationalists' and of conspiring with others around the world to build a more integrated global political and economic structure---one world, if you will. If that's the charge, I stand guilty, and I am proud of it." I happen to remain convinced that for all of its many shortcomings the US still stands as humanity's greatest hope for human rights, prosperity and peace. But I fundamentally agree with Rockefeller that further global integration is inevitable and desirable. One of the key elements, for example, of the subprime mortgage crisis is the lack of a global regulatory authority for financial regulation. Isolationism does not work, and neither does global laissez faire.

But the uber-elite nature of the group's membership invites this kind of criticism. By definition you cannot have any shot at diverse viewpoints when your membership is limited to about 300 elite leaders. Moreover, when a nation as great as the US has less than a hundred members shuttling between high level government posts and lucrative private positions, it is bound to lead to accusations that your group is a cabal.

In an echo chamber of free marketeers, it is also likely that policies would tilt too far in favor of deregulation and non-regulation and financial crises would follow. Look at what the Trilateral Commission's work has wrought: Long Term Capital Management, the East Asian Crisis, Enron and the subprime debacle. Its not a cabal, its an ideological narrowness that borders on intellectual obsolescence. They all ignored the plain lessons of history (1929) and embraced market fundamentalism is unison, right off the cliff like lemmings. Some globalization!

Of course, like all organizations the Trilateral Commission is neither monolithic nor all-powerful. They notoriously failed to stem the neocon stumble into Iraq (The Proud Internationalist, 61-63), which seemingly made the Trilateral Commission appear far less powerful than the now discredited Project for a New American Century. Member George Soros has long been a voice against market fundamentalism.

Ultimately, the Trilateral Commission is a highly influential institution among many. Their dialogue needs expansion. Their intellectual underpinnings require refurbishment based upon the past 30 years of economic science. I urge my fellow bloggers to think about the Trilateral Commission as another opportunity to educate elites. Interest convergence theory suggests this narrow and hyper elite organization may be more open to new ideas in the wake of the catastrophe sown by market fundamentalism, largely pursued under the tutelage of the Trilateral Commission. Think of the Trilateralists as a transnational uber-congress. They have no formal power. But they clearly wield great influence in creating ideological heuristics that govern the behavior of their members and former members.

Economic Crisis Lands Heaviest on Communities of Color

The economic meltdown has fallen hardest on minority Americans and communities of color in the United States.

As discussed many times on the Corporate Justice Blog previously, unemployment figures while reaching alarming levels in the United States report even more devastating levels in African American and Latino communities. The foreclosure crisis is landing and will land most harshly on African American and Latino homeowners, as statistics of U.S. foreclosures and delinquencies continue to be reported in record numbers.

Studies indicate that predatory lending and "steering" of prime qualified minority borrowers into subprime loans is one of the root causes of these destructive outcomes reported above. African American and Latino borrowers are somewhere between two and nine times more likely than white borrowers to have high cost mortgages. This predatory lending and steering of minority borrowers into high interest loans, of course, is contrary to the "dirty little myth" that circulated widely in the early blame game days of the global crisis (Fall 2008) and that continues to percolate and simmer in many circles today. That dirty little myth is a narrative that seeks to pin blame onto overreaching minority borrowers and the Community Reinvestment Act of 1977 as the primary cause of the global economic collapse.

To the predatory lending and steering issues above, this week the Washington Post reported that an FDIC study shows that "unbanked" and "underbanked" Americans, those who do not or cannot utilize traditional bank services such as checking accounts and savings accounts, and who rather primarily use payday lenders, check cashing services and pawn shops (predatory in their own right), are disproportionately Latino and African American. The Washington Post reported:

"One-quarter of American households -- about 60 million people -- have limited or no access to banks or other traditional financial services, with low-income and black families among the hardest hit, according to a government report released Wednesday [December 2, 2009]."

Laying blame for the global economic meltdown at the feet of minority borrowers is pernicious. Ignoring all of the true causes for the collapse, including securitized subprime loan investment vehicles, credit default swaps, deregulation, failure of personal borrower responsibility, reckless lending, Commodities Futures Modernization Act, avarice and greed, executive compensation, mortgage brokerages, Gramm-Leach-Bliley, ratings agencies, regulatory capture, overleveraging of corporate conglomerates, Private Securities Litigation Reform Act and unregulated over-the-counter derivatives trading (amongst others), in order to create an easy minority scapegoat is unconscionable.

President Obama's Economy

On November 12th I posted a commentary entitled “Business-Related Changes During the First Few Months of Obama’s Tenure” on the Corporate Justice Blog site. I described some of the President’s business-related accomplishments in his first nine months in office. Only fellow-blogger Jo Grant joined me in my optimistic expectations about our nation’s economic future. An anonymous commentator asked whether “the President just optimistically hopes that things are improving.” Steve Ramirez lamented the fact that “there has been little change from the Bush financial policies that got us into this mess.”

I do not disagree with Steve and Anonymous. Things are still very, very bad for too many Americans, and more should be done to help them. And, things are still very, very good for many executives at the financial institutions that caused the crisis. This is truly contemptible. But, none of this detracts from the fact that President Obama and his administration inherited a direly sick economy. And even though they have not nursed our sick economy back to health, they have carefully, cautiously and conservatively implemented policy that may avoided the depression that many economists (including Richard Posner) thought was inevitable.

Today, President Obama is holding a White House jobs forum where business leaders, academics, and economists will discuss our nation’s high unemployment rate. I applaud these nascent efforts to stimulate job growth, but with respect to this initiative, I am far less optimistic. Participants at the gathering will address our nation’s 10.2 percent unemployment rate, but there is no indication that any of the participants will address the much higher unemployment rate among people of color, particularly African Americans and Latinos. Cynthia Gordy at Essence magazine asked White House Press Secretary Robert Gibbs whether the there was a plan to address the disproportionately higher rate of unemployment among minorities. Gordy concluded from Gibbs’ “vague” answer that the unique issues that people of color face will be ignored at the jobs forum.

Are Banks Strangling the Recovery?

The latest FDIC Quarterly Change in Loans Outstanding shows a dramatic tightening in credit, as the chart at left shows. Remember the awful days of late 2008 and early 2009, when the economy fell into a tailspin and the S&P 500 bottomed at 666? The cause of that pain ultimately stemmed from contracting credit as shown by the steep fall in loans of some $256 billion over the six month period of late 2008 and early 2009.

Well, the most recent data shows that the contraction is now more severe than that period. Loans outstanding fell over $210 billion in the fourth quarter alone. Apparently, the primary factor between the US economy and a further tailspin is the Obama stimulus bill, which has added up to 3.2 percentage points to GDP, according to the non-partisan CBO. A secondary factor is probably the Fed, which is single-handedly keeping the residential real estate market afloat through massive purchases of mortgage backed securities (MBS). Given the contraction in lending shown above we should all be very thankful for the Obama stimulus and the Fed's quantitative easing program, which includes expanding the money supply by purchasing MBS. But, we are nearing the halfway point in stimulus spending and the Fed's purchase of MBS is winding down, as it is scheduled to end in the next quarter.

What then?

Bad things, I fear. And I am not alone. Paul Krugman sees a rising risk of a double dip recession. Jeremy Grantham, the stellar value fund manager with an unrivaled knack for getting predictions right, says that right now things look like April 1930, when the stock market went up nearly 50% over a six month period before the real crash later that year. I could cite a bevy of statistics to support the view that we should all fasten our seatbelts.

But I think it all comes down to the banks. The amounts of cash they are hoarding boggle the mind. The four largest banks in the US now hold $1.53 trillion in cash--which is putting a huge dent in their profitability--up 67% since 2008.

The chart at right shows that banks now hold about $1.1 trillion at the Fed earning a measly .25 percent in interest. Most of this money is government money, in that it most likely came from the various efforts of the Fed to bailout the financial sector.
Note that it is now at an all time high and soared $300 billion in the last quarter.

At one level, I am tempted to think the hoarding is about paying back TARP money, as BOA announced today. But, the numbers are way too large for that explanation. I also thought for a while that the banks were fearful of general macroeconomic instability. But, the hoarding accelerated as the downturn decelerated.

So the only remaining conclusion is the banks are terrified by their own balance sheets. They are holding reserves against losses yet to come. I think we could have avoided this by forcing out managers and letting new management write-down everything in sight. Or, as Joseph Stiglitz urged we could have just formed a new bank with no legacy asset hangover. But that train left
the station.

We just have to wait for losses to come in. Goldman Sachs posits that we will have 13 million more foreclosures in the next 5 years. Others note that commercial real estate is melting down right now. If correct, this suggests serious pain to come.

The banks know. Their hoarding may be leading indicator as well as the best predictive tool we have.

Did you know the Nikkei Index was at 40,000 on 1/1/1990 and today its under 10,000?

Any cursory analysis suggests we may be turning Japanese.