Paul Krugman: The Big Dither

Paul Krugman writes today in the New York Times about the need to fix America’s banks. Professor Krugman asks the question if President Obama is being bold enough, or is he and his administration dithering too much?

I do think that Obama has been slow in the steps that are necessary to fix the banking mess, but I do wonder if the President is constrained by politics, and the need to keep the markets some what calm. I think Krugman brings up great points, and as an academic and a pundit Professor Krugman provides a strong progressive argument. It is not his job to worry about the politics, but to suggest the best course from an economic sense.

The Big Dither
By PAUL KRUGMAN

Last month, in his big speech to Congress, President Obama argued for bold steps to fix America’s dysfunctional banks. “While the cost of action will be great,” he declared, “I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along for not months or years, but perhaps a decade.”

Many analysts agree. But among people I talk to there’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern.

Here’s how the pattern works: first, administration officials, usually speaking off the record, float a plan for rescuing the banks in the press. This trial balloon is quickly shot down by informed commentators.

Then, a few weeks later, the administration floats a new plan. This plan is, however, just a thinly disguised version of the previous plan, a fact quickly realized by all concerned. And the cycle starts again.

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away.
Thus, in a recent interview Tim Geithner, the Treasury secretary, tried to make a distinction between the “basic inherent economic value” of troubled assets and the “artificially depressed value” that those assets command right now. In recent transactions, even AAA-rated mortgage-backed securities have sold for less than 40 cents on the dollar, but Mr. Geithner seems to think they’re worth much, much more.
And the government’s job, he declared, is to “provide the financing to help get those markets working,” pushing the price of toxic waste up to where it ought to be.
What’s more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions. Earlier this week, Ben Bernanke, the Federal Reserve chairman, was asked about the problem of “zombies” — financial institutions that are effectively bankrupt but are being kept alive by government aid. “I don’t know of any large zombie institutions in the U.S. financial system,” he declared, and went on to specifically deny that A.I.G. — A.I.G.! — is a zombie.
This is the same A.I.G. that, unable to honor its promises to pay off other financial institutions when bonds default, has already received $150 billion in aid and just got a commitment for $30 billion more.

The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn’t going to fly.

Take the plan’s latest incarnation: a proposal to make low-interest loans to private investors willing to buy up troubled assets. This would certainly drive up the price of toxic waste because it would offer a heads-you-win, tails-we-lose proposition. As described, the plan would let investors profit if asset prices went up but just walk away if prices fell substantially.

But would it be enough to make the banking system healthy? No.

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it’s just not going to happen.

So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.

The truth is the Bernanke-Geithner plan will not work and I hope President Obama soon realizes this, and makes the changes that are necessary to fix this country.

Bankers Don't Care About the Banks

I am a huge fan of the Young Turks and wanted to point out this must-read piece that their host Cenk Uygar wrote:

Tim Geithner and Larry Summers and many others are missing the fundamental flaw in the system. The bankers don't care about the banks; they care about the
bankers.

These days, the way executives make money instead is in the form of bonuses for years where they bring in a lot of return (and often times for years they don't), but the threat of being fired for too much risk taking is minimal. The more risk you take, the more money everyone makes. And it's not the partner's money you're playing with anymore. You're playing with house money. No one is minding the store anymore.

So, now we have Tim Geithner and the rest of Treasury working so hard to prop up not just these failed banks - but these failed bank executives - because we don't want government running these large companies. The self-interest of the market will do a better job of managing these companies. But it hasn't - because of this fundamental flaw.

These executives did not actually fail. They succeeded wildly. It's just that they had a different goal - to take home as much money as they possibly could for themselves. Mission accomplished!

The Treasury plan is all wrong. We have to first acknowledge that the boards of these companies are not truly representing the shareholders. They are largely friends with most of the CEOs and they do not have an incentive to reign in out of control compensation for the top executives. Then those CEOs pass on the wrong incentives to the executives below them. The more risk they all take, the more money they take home. And if their company goes broke one day - who cares?

Most of these guys took home millions upon millions of dollars already for profits that never really existed. If the company goes under, okay the gravy train came to an end but they still have all the money they made from all those years. It's in their personal bank accounts. That's enlightened self-interest!

Do you know that last year, as Merrill Lynch was in its death throes, 696 executives got bonuses over a million dollars? 696! As the company lost tens of billions of dollars, the executives took home a combined $3.6 billion that year. Billions in bonuses in the worst year in the company's history. They're not stupid; they're smart. They're looting the store before the cops show up.

This is the financial equivalent of the federal government not showing up to rescue people after Hurricane Katrina. Last year the five biggest Wall Street securities firms lost $25.3 billion. The executives at those companies still took home $26 billion in bonuses. In other words, they wouldn't have lost a nickel if they hadn't taken any bonuses.

The Treasury Department still hasn't shown up to take over these looted stores. In fact, they keep pouring taxpayer money into these same shops, as the money continues to move out the back door. Tim Geithner is the worst sheriff in the world.
But we already knew that. Because the main guy who was overseeing all of these banks in New York, as they took these giants risks, was the president of the Federal Reserve Bank of New York - Tim Geithner.

He is under the misimpression that his job is to protect the sanctity of the banks.
Not only is that not his job, but that is working against his actual goal. His real job is to stabilize the financial system, with or without these particular banks or bank executives. The longer he keeps these guys in charge, the longer the looting continues.

Another Reason To Get The Pitchforks

The other day Cenk Uyger of the Young Turks explained in the "Memebers Only" portion of the show how the top 5 Wall Street Finanacial Institutions lost 25.3 Billion Dollars and then gave out 25 Billion Dollars in bonuses.

Get that the companies lost 25.3 Billion and in the same year they paid 25 Billion in bonuses. If they cut the bonues, they would not have lost any money.

Now we are just talking bonuses here, this is not their full compensation. They would have been paid, they would just not have received their bonuses, and considering the job they had done, no bonuses should have been paid.

If you are not a member of the Young Turks, I would recommend joining so you can have access to the "Memebers Only" portion of the show.

Playing Symantics

Yesterday Fed Chairman Ben Bernanke had this to say about nationalizing banks:

"Nationalization, to my mind, is when government seizes the banks, zeros out the shareholders and begins to manage and run the bank, and we don't plan anything like that."

Some our saying this is proof that the Obama administration is not considering nationalizing some of the major banks which are on the verge of collapse. I however take from this that the Obama administration will be taking control of these banks, but calling it a different name.

Roubini: US Banking System is Insolvent

Nouriel Roubini, of RGE Monitor, was one of the first people to predict the housing crisis, and now he has come out and said that "the US Banking System is Insolvent." While at Davos Nouriel Roubini said he believes this because expected losses for the US banking system will be about $2 trillion, which far exceeds bank capital of about $1.5 trillion. Roubini has also said that he believes total financial system losses could hit $3.6 trillion.

Because of this fact Roubini does not believe the government plan for buying the toxic assets of US banks may not work.

Instead Nouriel Roubini suggests that the Obama administration should look towards Sweden's plan of nationalizing all insolvent banks, cleaning them up and then selling off the good assets to the private sector.

I can just hear the Republicans howling now.

Now the Fed is Trying to Give Away Cash

I honestly don't know what to think. A few years ago when Alan Greenspan dropped the key interest rate to 1 I thought it was a huge mistake. I did not think that the situation warrented it, and I was concerned about the flood of money into an economy based on perceived wealth. Now today the Federal Reserve has again cut its target for overnight interest rates, but this time they have dropped the rate from zero to 0.25%. I'm not even sure what that means, is it zero or is it 0.25%?

Whatever it is, its a pretty unconventional action. I know that the Fed and Bernanke are trying to do everything they can to lift the economy out of a year-long recession, but is this the right action? Cutting interest rates to 0.25% or 0% is not going to resolve any of the fundemental problems in the economy, other than to provid banks with very cheap money. I would not have done this unless there was a guarantee that the banks would drop their interest rates.

Paul Krugman writes in his blog today:

ZIRP!

"That’s zero interest rate policy. And it has arrived. America has turned Japanese."

"This is the thing I’ve been afraid of ever since I realized that Japan really was in the dreaded, possibly mythical liquidity trap."

"Seriously, we are in very deep trouble. Getting out of this will require a lot of creativity, and maybe some luck too."

With the Fed's key rate now essentially zero, the central bank is moving into uncharted territory. Nonetheless, Fed Chairman Ben Bernanke has made it clear the Fed isn't running out of ammunition to fight the worst financial crisis since the 1930s. Except that it basically has.

Bernanke claims that the Fed is exploring using tools other than rate cuts to revive the economy. Trouble is he does not have the authority or clout to really do anything else. Bernanke and his colleagues wrap up a two-day meeting Tuesday, but no one is sure what will come out of it.
The Fed is trying to send a message that it is ready to do everything in its power to stop the economy's free fall, but they have pretty much used up all their power.

Obama Calls For No Bank Bonuses This Year

President-elect Barack Obama has suggested that bank executives should forgo their bonuses this year to show they are taking responsibility amid difficult economic times. I have to agree, in this economy, any additional reward for those who played such key roles would not be popular with the American public. Millions of Americans are losing their jobs, losing retirement savings, and their taxes are paying out enormous sums to keep these Wall Street institutions afloat. Taking a pass on bonuses is the only option this year for the management of these companies. The bonus freeze needs to run deep, very deep on Wall Street.

In an interview with Barbara Walters to air Wednesday, Obama said bank executives should make sacrifices because so many other people are struggling as the nation's economy slips further. Some financial firms, including Goldman Sachs, the Swiss bank UBS and the British bank Barclays, have said they aren't handing out annual bonuses to top executives, and Obama encouraged more to follow."I think that if you are already worth tens of millions of dollars, and you are having to lay off workers," Obama said, "the least you can do is say, 'I'm willing to make some sacrifice as well, because I recognize that there are people who are a lot less well off, who are going through some pretty tough times.'"

Economy Watch

US Factory Orders Plunge More Than Expected

Government data show orders to U.S. factories plunged by the largest amount in nearly two years as the credit strains are hitting manufacturing with full force.

The Commerce Department reported Thursday that orders for manufactured goods dropped by 4 percent in August, compared to July. That's a much worse performance than the 2.5 percent decline that economists had expected. It was the biggest setback since a 4.8 percent plunge in October 2006.

The weakness was led by big declines in orders for aircraft, down 38.1 percent, and autos, which fell by 10.6 percent, the worst performance in nearly six years.

The report on manufactured goods showed that durable goods, items expected to last three years, dropped by 4.8 percent in August. Orders for nondurable goods, items such as petroleum products, food and clothing, fell by 3.3 percent.

The dismal report on orders for August followed a report Wednesday from the Institute for Supply Management showing that manufacturing activity fell to the lowest level since the aftermath of the 2001 terrorist attacks.

U.S. Employers Cut 159,000 Jobs in September

Employers slashed payrolls by 159,000 in September, the most in more than five years, a worrisome sign that the economy is hurtling toward a deep recession.

The Labor Department’s fresh snapshot, released Friday, also showed that the nation’s unemployment rate held steady at 6.1 percent as hundreds of thousands of people streamed out of the work force for any number of reasons.

The reduction in payrolls was much sharper than the 100,000 cuts economists were forecasting. They expected the jobless rate to be unchanged.

Banks, Firms Borrow Record Amount from Fed

Banks and investment firms borrowed in record amounts from the Federal Reserve's emergency lending facility over the past week, providing fresh evidence of the credit stresses squeezing the country.

The Fed's report released Thursday said commercial banks averaged a record $44.5 billion in daily borrowing over the past week. That compared with a daily average of $39.36 billion in the previous week. On Wednesday alone, banks borrowed a record $49.5 billion, surpassing the previous high that came one day after the Sept. 11, 2001, terror attacks.

For the week ending Wednesday, investment firms drew a record $147.7 billion. That was up significantly from $88.15 billion in the previous week. This category was broadened last week to include any loans that were made to the U.S. and London-based broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley and Merrill Lynch. On Wednesday alone, investment firms borrowed a record $146.6 billion, breaking the previous record set on Sept. 24.