Thursday, September 30, 2010

Revisiting Citizens United

When the United States Supreme Court decided Citizens United v. Federal Election Commission earlier this year, many commentators, including several on the Corporate Justice Blog, predicted that the decision would have a nefarious impact on future elections. Recall, that Citizens United essentially held that United States corporations are entitled to free speech rights in electioneering contributions and that Congressional prohibitions that restricted the ability of corporations to finance particular candidates in contested partisan elections were unconstitutional. The Supreme Court essentially freed corporations and unions to make unfettered election contributions to specific candidates in American elections. Now that the 2010 mid-term Congressional election period is in full swing, has Citizens United had the predicted nefarious impact? The answer to that question lies in one's perspective. Without question, corporate campaign contributions have increased in 2010 to levels never before seen.

Recent empirical analysis confirms what many feared: Citizens United has “liberated” corporations from most of the campaign finance restrictions imposed by the McCain-Feingold law which were struck down as unconstitutional. While 2008 was a record-breaking election year in terms of donations, now in 2010, due in large part to Citizens United, corporate political spending has increased by 10-15%, and this despite a relentlessly depressed economy. Compared to the last mid-term election in 2006, campaign contributions in 2010 are predicted to increase by more than 35%. “Super PAC’s” are taking in money like never before, including huge corporate contributions into and large negative advertising buys by Karl Rove’s American Crossroads group. More than anything else, Citizens United will likely increase exponentially the money spent on negative election advertising.

Thursday, September 23, 2010

The GOP's Pledge to America: Extending the Bushonomics Misery

Remember those horrific last days of the Bush Administration when in September and October of 2008 global capitalism collapsed and the Bushies rushed to Congress to get an $850 billion rescue for the big banks? Well, the GOP now pledges to bring that hellish nightmare back if you elect them. That's right, in a desperate effort to escape responsibility for being the party of "NO" during the worst economic crisis of our time, the GOP now pledges to bring back policies that simply cannot be distinguished from the Bushonomics that caused the entire economic maelstrom in the first instance.

For example, today we are all familiar with the efforts of the Bush Administration to render government incompetent and ineffective. This effort allowed New Orleans to be destroyed, Bernie Madoff to engage in an unprecedented Ponzi scheme and the banks to run wild. "Around the world the Bush name is synonymous with arrogance, ignorance, reckless insouciance, torture, violence and ineptitude." The Bush approach proved the costliest episode of near criminal negligence in our history. So now, The GOP plans to freeze federal hiring so that the new financial reform bill will lack any regulators to enforce the new reforms. In other words, they want to let the banks go wild again. Basically, having lost the effort to defeat Dodd-Frank democratically, in Congress, the GOP intends to jam unregulated banks down our throats by refusing to hire regulators to regulate the banks. Defanging Dodd-Frank has been a hard right goal since even before it was signed.

They also pledge to increase unemployment by slashing government spending in the face of an economy that teeters on the brink of deflation, which even conservative voices recognize failed to work in 1937. They pledge to crash the real estate market by ending federal efforts to use Fannie and Freddie to provide the only life support between us and total housing collapse. And of course, they pledge to increase the budget deficit and impose billions in debt upon our grandchildren and great grandchildren by slashing taxes even more than Bush, including for all those making more than $250,000, at a cost of $700 billion.

The ultimate irony here is that they make these upside down proposals just as powerful new evidence has emerged that President Obama's stimulus efforts certainly helped save us from a depression--for now, at least.

Basically, the GOP offers Bush II. So, if you enjoyed the first economic collapse, prepare for Economic Collapse II. The GOP Pledges it.

Wednesday, September 22, 2010

More on Fannie and Freddie

As detailed on this blog, last week the Federal Housing Finance Agency (“FHFA”) released the first of what will be quarterly status reports of the financial health and condition of the mortgage giants Fannie Mae and Freddie Mac. The report provides a revealing snapshot of the companies, and its conclusions challenge many commonly-held assumptions about the reasons the quasi-governmental agencies nearly failed.

A handful of economists, hundreds of politicians, and thousands of citizens place entire blame for the financial crisis on the two mortgage giants, in particular for creating and later bursting the housing bubble that nearly collapsed the global economy. Wrong. The Report shows that Fannie and Freddie’s market share plunged in 2003 and at the peak of the dangerous subprime mortgage and mortgage backed securities markets, Fannie and Freddie’s combined total share was only 1/3 of the mortgage market. Fannie and Freddie are not blameless, in that they clearly dipped their toes in the subprime market mania most notably in 2005 and 2006. Still, the report makes clear that private investment banks drove the appetite for subprime mortgages, the mortgage backed securities market and the collapse.

Tuesday, September 21, 2010

"Fannie and Freddie Acquitted"

Case closed.

Oh yes, there are the so-called GSE investments. Problem there is that they lost a relatively measly $20 billion. Hardly enough of an investment to stoke a massive bubble. Quoting from the GSE Conservator report:

"The Investments and Capital Markets segment accounts for $21 billion, or 9 percent, of capital reduction from the end of 2007 through the second quarter of 2010. Losses in the Investments and Capital Markets segment stemmed from impairments of private-label securities, fair-value losses on securities, and fair-value losses on derivatives (used for hedging interest rate risk)."

Of course, as I have long noted on this blog Fannie and Freddie actually leaned against the bubble by essentially exiting the market just when it reached bubble proportions:

These are damning facts for those claiming that Fannie and Freddie caused the meltdown. Basically, their subprime investments were a drop in the bucket and they had little or nothing to do with the worst of the lending.

The bottom line is this: in a desperate effort to save face, laissez-faire ideologues strove mightily to impugn government efforts to facilitate home ownership rather than massive financial deregulation as the primary cause of the meltdown of 2008. They lacked facts and they ignored history--after all, Freddie and Fannie have been around for decades before the housing bubble whereas massive deregulation immediately preceded the fiasco. The Conservator's Report will not stop their delusions.

Students of history and economics know that laissez-faire does not work--it did not work in 1929 (before Fannie, Freddie, the SEC, the FDIC, etc.) and did not work in 1995-2008. It has not worked anywhere. Laissez-faire may be an attractive political philosophy in theory but it is an economic dead end. The subprime fiasco is just the latest laissez-faire disaster.

Tuesday, September 14, 2010


The Basel III accords released this weekend may seem like financial and accounting minutia, but it actually goes to the very heart of the ongoing financial crisis. In order to pump up profits bank managers used leverage--debt--to enhance the profitability of their risky bank activities. When bank assets fell their thin capital cushions vaporized and the government rode to the rescue with trillions in morally repugnant and economically damaging bailouts. Because of ongoing capital problems we have a deeply dysfunctional financial sector at the foundation of a deeply dysfunctional economy. As such, the failure of Basel III (combined with a similar failure of Dodd-Frank) to impose meaningful regulatory discipline upon the financial sector can only be termed yet another missed opportunity to avert a future meltdown. I see two huge problems:

First, the new capital standards do not take full effect until 2019--and by then we could well experience multiple financial crises. Moreover, because banks have been hoarding capital they all comply with the new standards already, as shown in the chart above. So, while it appears that higher capital standards are on the way this regulatory requirement is illusory. This why bank analysts call the new regime "surprisingly accommodative." The new regime changes nothing in any meaningful time frame.

Second, the new capital rules have no impact on accounting standards that allow banks to hide losses (like the now infamous practice of extend and pretend) underlying those capital standards. This means that banks still face severe capital challenges that Basel III fails to address. At best banks have taken only 2/3 of total write-downs. Just because losses are buried, however, does not mean they disappear; instead, they fester and create more problems in the future, including an enhanced risk of future meltdowns. Lack of an accord on accounting standards effectively "will scuttle Basel III before it’s even implemented." The new regime allows this basic accounting scheme to continue.

Basel III will not prevent a future meltdown--indeed Lehman's 31 to 1 leverage ratio complies with the new regime--and therefore fails to address the gaping holes I previously decried in Dodd-Frank. Its getting more difficult to see a positive ending to this misshapen reform effort.

Tuesday, September 7, 2010

We Need More Money

I enjoyed reading Prof. Ramirez's previous post and think the analysis is spot on. I slightly disagree, however, with his policy prescription. I believe he is absolutely correct in that "instead of trickle down bailouts the Obama Administration needs to pursue bottom up bailouts." I also agree that a massive stimulus would help the economy. But, learning the lessons of the previous stimulus we know that there are certain practical limitations on how quickly the government can spend money. For this reason, many economists believe that monetary policy is the best way to stimulate a recovery.

Probably the bast way to explain why this is is to start with why recessions happen in the first place. It's not because people make bad business decisions or because people desire to work less, but because of poor policy decisions made by those who handle monetary policy, the Federal Reserve. Paul Krugman explains in a piece he wrote in 1998 (for explanation why structural reasons are an unlikely cause of this recession I'd suggest reading the whole piece):

"A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?"
What Krugman is saying here is that we have lots of people who want jobs and lots of work for them to do, but people value money more than they value what is produced. There is excess labor and capacity, but not enough demand. Why does this matter? In an excellent post, which contains some colorful language , Karl Smith explains:
This is not a big deal like the GOP doesn’t appreciate public goods. Or, Democrats don’t understand incentives. Or some other such second order debate that could reasonably concern us in different times.

This is a failure of our basic institutions of production. The job of the market is to bring together willing buyers with willing sellers in order to produce value. This is not happening and as a result literally trillions of dollars in value are not being produced.

Let me say that again because I think it fails to sink in – literally trillions of dollars in value are not being produced. Not misallocated. Not spent on programs you don’t approve of or distributed in tax cuts you don’t like. Trillions of dollars in value are not produced at all. Gone from the world entirely. Never to be had, by anyone, anywhere, at any time. Pure unadulterated loss.

Time and time again I see people speak about recessions as if they are a bad harvest – an unfortunate event wherein we have to figure out how to go with less. Some say we should all sacrifice – some say the sacrifice should be based on X or Y. Some say each family should take their lumps as they come.

However, they are all getting the basic idea wrong. This is not a bad harvest. The problem isn’t that there is less to go around. The problem is that we are creating less, building less, making less.

We have people who would be working but are instead watching Judge Judy. We have machines that could be spinning but are literally rusting for lack of use. This is a coordination disaster.

So what is the right policy to solve this problem? Certainly stimulus helps, it puts people to work and creates demand in the economy because these jobs put money in their pocket, something the economy craves. A better approach, however, is to favor inflation (or rather a NGDP target). Without explaining the intricacies of inflation, this would make the debts that people currently have worth less and make them easier to pay off, reducing the incentive to save and the demand for money. This policy would also not only provide debtor relief, but does not require the consent of Congress who is clearly clueless as to how this recession happened and the policies that are necessary to fix it. In the end, it doesn't matter how the economy gets the excess demand that it requires, whether through stimulus or an inflation target, but that our institutions are strong enough to solve the policy errors that got us into this mess. On that count I'm quite worried.

Monday, September 6, 2010

Obama's Latest Stimulus: A Drop in the Liquidity Trap Bucket?

President Obama announced a brand new $50 billion (over six years) infrastructure bill today which is infinitely more than any GOP proposal to fix the economy but still is woefully inadequate. To get a sense of the scale of the problem consider our so-called banks. As is evident from the above, banks are still hoarding unbelievable amounts of capital and continue to starve the economy of credit. The above chart shows that for two solid years now reserves have soared to unprecedented levels, no doubt because the banks still do not trust their balance sheets which are still bloated with toxic assets. And that is literally the tip of the iceberg: corporations are now hoarding capital rather than risking the hazards of a credit strapped economy ($500 billion more than before the meltdown); investors of all stripes have crowded into Treasury bonds causing yields to plunge across all maturities; and, finally, consumers are paying down debt and cutting back on expenditures at a record pace. So at a time when Apple Computer alone sits a top a $50 billion cash hoard, the President kicks-off the midterm election season by announcing a $50 billion infrastructure plan over 6 years--about $8 billion per year. The smallness of the plan boggles the mind, particularly in light of the scale of the problem.

Amazingly, the US real economy seems to absorb blow after blow from the financial sector without falling off the cliff. Although the latest jobs report saw unemployment measures increase and the all-important employment ratio continue to stagnate, the markets actually rallied because they expected worse. Nevertheless, most experts, especially those that have proven right again and again, are not optimistic going forward, largely because the government seems politically paralyzed and unable to muster the political will for decisive action.

The economy and the Obama administration now sit at the edge of an abyss. The economy seems likely to either tip into a double dip recession or stagnate for years to come. Team Obama faces a historic electoral drubbing in November.

Why would Obama go so small under these circumstances?

For reasons that are difficult to comprehend Obama is wedded to the Rubinites--Larry Summers and Timothy Geithner. Rubin opposes any new stimulus. He will only support more tax cuts, which I have long argued will lead only to debt repayments in a deleveraging economy and thus more money for the banks. The 2008 tax cuts for example, initiated to forestall the catastrophe we now face, failed to demonstrably reignite spending and consumption. Instead most of the money went to payoff debt. Notably, President Obama seems poised to announce new tax cuts for businesses--to the tune of $200 billion.

The solution could not be more clear. Instead of trickle down bailouts the Obama Administration needs to pursue bottom up bailouts.

In December of 2008, I called for a massive recapitalization of the middle class, stating: "Trickle-down bailouts are poisonous. . . .Instead of [the] failed trickle down approach, the government must now immediately throw a lifeline to the 99% of Americans who have so far seen only pennies of the trillions the government has expended in its rescue efforts. We need immediate direct stimulus from the government on a scale more massive than ever before."

Later in 2009, in my Dayton Law Review article entitled Subprime Bailouts and the Predator State I argued that empirical evidence from the world of economic science demonstrated that you must terminate bank managers and extend generous debtor relief in order to avert extended economic misery.

What we needed and what we still need today is debt relief in the form of massive loan modifications as advocated by bond expert Bill Gross; a massive jobs bill on the scale of the CCC as advocated by economist Robert Shiller; and massive investment in our economy so that we have the world's best physical and human infrastructure as Paul Krugman has long advocated.

The Administration's first stimulus package probably created or saved 3 million jobs based upon the best economic studies to date. But it will expire before the economic gloom and pain. It is a shame that the Administration has given up on its own success and caved-in once again to the Robert Rubin dominated economic team.

Saturday, September 4, 2010

Krugman on Economic Stimulus

Paul Krugman, winner of the Nobel Prize in economics, provided some interesting insights in the New York Times this week on the 2008 economic stimulus, including why it has not worked as hoped, and suggests ways to appropriately stimulate the economy in coming months. A few of the more salient points from Krugman include:

"The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round."

Krugman argues that the 2008 stimulus was too cautious, too minimalist and that a bolder, more profound stimulus would have better served the American people and the U.S. economy. He argues that a new round of stimulus is necessary and sound economic policy, but a second round of stimulus must be much bolder than the first.

Responding to critics of the 2008 stimulus as too much and those politicians suddenly concerned with Washington spending (where were they when tax cuts and defense spending drove the deficit into record territory?), Krugman rejoinders:

"And if, as expected, the G.O.P. wins big in November, this will be widely regarded as a vindication of the anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and his Keynesian economic doctrine was proved wrong.

But politics determines who has the power, not who has the truth. The economic theory behind the Obama stimulus has passed the test of recent events with flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware that there were political constraints — initially offered a plan that was much too cautious given the scale of the economy’s problems."

Krugman urges President Obama to go bold next week and in coming months, in connection with stimulating the economy. Krugman's N.Y. Times Op-Ed can be accessed here.