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.

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.

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.

Anatomy of a Meltdown

Read this first draft of history from the New Yorker called "The Anatomy of a Meltdown" by John Cassidy. Be sure you're sitting down.

Ben Bernanke and the financial crisis.

At Princeton, where Bernanke taught economics for many years, he was known for his retiring manner and his statistics-laden research on the Great Depression. For more than a year after he was appointed by President George W. Bush to chair the Fed, in February, 2006, he faithfully upheld the policies of his immediate redecessor, the charismatic free-market conservative Alan Greenspan, and he adhered to the central bank’s formal mandates: controlling inflation and maintaining employment. But since the market for subprime mortgages collapsed, in the summer of 2007, the growing financial crisis has forced Bernanke to intervene on Wall Street in ways never before contemplated by the Fed. He has slashed interest rates, established new lending programs, extended hundreds of billions of dollars to troubled financial firms, bought debt issued by industrial corporations such as General Electric, and even taken distressed mortgage assets onto the Fed’s books. (In March, to facilitate the takeover by J. P. Morgan of Bear Stearns, a Wall Street investment bank that was facing bankruptcy, the Fed acquired twenty-nine billion dollars’ worth of Bear Stearns’s bad mortgage assets.) These moves hardly amount to a Marxist revolution, but, in the eyes of many economists, including supporters and opponents of the measures, they represent a watershed in American economic and political history.

Ben Bernanke, who seemed to have been selected as much for his predictability as for his economic expertise, is now engaged in the boldest use of the Fed’s authority since its inception, in 1913.

Bernanke, working closely with Henry (Hank) Paulson, the Treasury Secretary, a voluble former investment banker, was determined to keep the financial sector operating long enough so that it could repair itself—a policy that he and his Fed colleagues referred to as the “finger-in-the-dike” strategy. As recently as Labor Day, he believed that the strategy was working. The credit markets remained open; the economy was still expanding, if slowly; oil prices were dropping; and there were tentative signs that house prices were stabilizing. “A lot can still go wrong, but at least I can see a path that will bring us out of this entire episode relatively intact,” he told a visitor to his office in August.

By mid-September, however, the outlook was much grimmer. On Monday, September 15th, Lehman Brothers, another Wall Street investment bank that had made bad bets on subprime mortgage securities, filed for bankruptcy protection, after Bernanke, Paulson, and the bank’s senior executives failed to find a way to save it or to sell it to a healthier firm. During the next forty-eight hours, the Dow Jones Industrial Average fell nearly four hundred points; Bank of America announced its purchase of Merrill Lynch; and American International Group, the country’s biggest insurance company, began talks with the New York Fed about a possible rescue. Goldman Sachs and Morgan Stanley, the two wealthiest investment banks on Wall Street, were also in trouble. Their stock prices tumbled as rumors circulated that they were having difficulty borrowing money. “Both Goldman and Morgan were having a run on the bank,” a senior Wall Street executive told me. “People started withdrawing their balances. Counterparties started insisting that they post more collateral.”

The Fed talked with Wall Street executives about creating a “lifeline” for Goldman Sachs and Morgan Stanley, which would have given the firms greater access to central-bank funds. But Bernanke decided that even more drastic action was needed. On Wednesday, September 17th, a day after the Fed agreed to inject eighty-five billion dollars of taxpayers’ money into A.I.G., Bernanke asked Paulson to accompany him to Capitol Hill and make the case for a congressional bailout of the entire banking industry. “We can’t keep doing this,” Bernanke told Paulson. “Both because we at the Fed don’t have the necessary resources and for reasons of democratic legitimacy, it’s important that the Congress come in and take control of the situation.”

Paulson agreed. A bailout ran counter to the Bush Administration’s free-market principles and to his own belief that reckless behavior should not be rewarded, but he had worked on Wall Street for thirty-two years, most recently as the C.E.O. of Goldman Sachs, and had never seen a financial crisis of this magnitude. He had come to respect Bernanke’s judgment, and he shared his conviction that, in an emergency, pragmatism trumps ideology. The next day, the men decided, they would go see President Bush.

On October 3rd, Congress passed an amended bailout bill, giving the Secretary of the Treasury broad authority to purchase from banks up to seven hundred billion dollars in mortgage assets, but the turmoil on Wall Street continued. Between October 6th and October 10th, the Dow suffered its worst week in a hundred years, falling eighteen per cent. As the selling spread to overseas markets, the Fed’s failure to save Lehman Brothers was roundly condemned. Christine Lagarde, the French finance minister, described it as a “horrendous” error that threatened the global financial system. Richard Portes, an economist at the London Business School, wrote in the Financial Times, “The U.S. authorities’ decision to let Lehman Brothers fail will be severely criticised by financial historians—the next generation of Bernankes.” Even Alan Blinder, an old friend and former colleague of Bernanke’s in the economics department at Princeton, who served as vice-chairman of the Fed from 1994 to 1996, was critical. “Maybe there were arguments on either side before the decision,” he told me. “After the fact, it is extremely clear that everything fell apart on the day Lehman went under.”

The most serious charge against Bernanke and Paulson is that their response to the crisis has been ad hoc and contradictory: they rescued Bear Stearns but allowed Lehman Brothers to fail; for months, they dismissed the danger from the subprime crisis and then suddenly announced that it was grave enough to justify a huge bailout; they said they needed seven hundred billion dollars to buy up distressed mortgage securities and then, in October, used the money to purchase stock in banks instead. Summing up the widespread frustration with Bernanke, Dean Baker, the co-director of the Center for Economic and Policy Research, a liberal think tank in Washington, told me, “He was behind the curve at every stage of the story. He didn’t see the housing bubble until after it burst. Until as late as this summer, he downplayed all the risks involved. In terms of policy, he has not presented a clear view. On a number of occasions, he has pointed in one direction and then turned around and acted differently. I would be surprised if Obama wanted to reappoint him when his term ends”—in January, 2010.

Bernanke and Paulson’s reversals have been deeply unsettling, perhaps especially so for the millions of Americans who have lost jobs or defaulted on mortgages so far this year. And yet, for the past year and a half, the government has confronted a financial debacle of unprecedented size and complexity. “Everyone knew there were issues and potential problems,” John Mack, the chairman and chief executive of Morgan Stanley, told me. “Nobody knew the enormity of it, how global it was and how deep it was.” In responding to the crisis, Bernanke has effectively transformed the Fed into an Atlas for the financial sector, extending more than $1.5 trillion in loans to troubled banks and investment firms, and providing financial guarantees worth roughly another $1.5 trillion, making it global capitalism’s lender of first and last (and sometimes only) resort.

“Under Ben’s leadership, we have felt compelled to create a new playbook for the Fed,” Kevin Warsh, a Fed governor who has worked closely with Bernanke, told me. “The circumstances of the last year caused us to cross more lines than this institution has crossed in the previous seventy years.” Paul Krugman, the Times columnist, a former colleague of Bernanke’s at Princeton, and the winner of this year’s Nobel Prize in Economics, said, “I don’t think any other central banker in the world would have done as much by way of expanding credit, putting the Fed into unconventional assets, and so on. Now, you might say that it all hasn’t been enough. But I guess I think that’s more a reflection of the limits to the Fed’s power than of Bernanke getting it wrong. And things could have been much worse.”

Read more here.

Fed Won't Identify Recipients of $2 trillion

The Federal Reserve is refusing to identify all of the recipients of $2 trillion.

What???

Bloomberg is reporting:

The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.

Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends
far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities
the banks are pledging in return.

"The collateral is not being adequately disclosed, and that's a big problem,'' said Dan Fuss, vice chairman of Boston-based Loomis Sayles & Co., where he co-manages $17 billion in bonds. "In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin.''

Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.

"It's your money; it's not the Fed's money,'' said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. ``Of course there should be transparency.''

The $2 trillion is taxpayer money, and taxpayers have a right to know where that money is going, and what sweetheart deals Bernanke is giving out, and who's getting what. Bernanke needs to go, and either before or after he goes, the Fed needs to come clean about who it has given 2 trillion in loans to, and what the collateral is.

Fed Backs New Stimulus Plan

Fed Chairman Ben Bernanke called for a new stimulus plan to pump cash into the flagging US economy on Monday as stock markets worldwide bounced back from recent lows.

In remarks to the House of Representatives budget committee, Bernanke said the US economy risked a "protracted slowdown," and that US lawmakers were right to consider a second stimulus plan this year as activity slows across the country.

"With the economy likely to be weak for several quarters and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," said Bernanke.

These remarks came after a report was published which predicts that the financial crisis could push worldwide unemployment to a record high.

Also yesterday, U.S. Treasury Secretary Henry Paulson came out with more details concerning the U.S. rescue plan that was recently passed. He stated that banks had until November 14 to apply for some of the 250 billion dollars that have been set aside for capital injections by the government.

Paulson said "a broad group of banks of all sizes" had shown interest in a capital injection in exchange for preferred shares, or partial nationalizations.

This Was Helpful???

Democrats and some Republicans had made a lot of headway on the bailout plan. Then Republican John McCain came to town (having never read the bipartisan plan) and instead promoted "tax cuts for corporate America and less regulation". Again lets remember that for decades John McCain has been for deregulating the economy, and has up until the last two weeks run on an economic plan of tax cuts for corporate America and less regulation, so his grand idea was more of the same. Republican John McCain's radical injection of himself into the bailout negotiations is just more of the same and is exactly what led us into this economic failure.

For a week John McCain tried to cast himself as a populist, but then when a deal was about to be made he threw out an alternative plan that Henry Paulson and Ben Bernanke had already said would not work in Congressional testimony to the House (which McCain probably missed as he was meeting with U2's Bono) and came out against the plan.

Some highlights of the bailout plan that John McCain now doesn't want:

- Two oversight boards would be formed—one with congressional representation, another would have the power to undo decisions by the Treasury Secretary.

- The Treasury Secretary would be prohibited from acting in an arbitrary or capricious manner or any way inconsistent with existing law.- Regular, detailed reports would be made to Congress disclosing exercise of the Treasury Secretary's authority.

- An independent inspector general would be set up to monitor the use of the Treasury Secretary's authority.

- The Government Accountability Office would be required to perform audits to ensure proper use of funds, appropriate internal controls, and to prevent waste, fraud, and abuse.

- Maximize and coordinate efforts to modify mortgages for homeowners at risk of foreclosure.

- Loan modifications would be required for mortgages owned or controlled by the federal government.

- A percentage of future profits from the bailout fund would be made available to the Affordable Housing Fund and the Capital Magnet Fund to meet America's housing needs.

White House Hides While Seeking Money

With Wall Street in turmoil, the White House yesterday canceled all press coverage of President Bush’s meeting with his chief advisory group on the reeling financial markets. They of course were looking where they could find 85 million dollars.

George W. Bush had been scheduled to make a statement Tuesday to a pool of White House reporters after huddling with his financial working group. That didn’t happen.

Spokesman Tony Fratto said the White House had decided it would be best to limit public comment about markets. Yes, the American public will feel better the less we see of Bush. I know every time I am reminded that he is running the ship, I get more jittery.

The meeting went on as planned. The group is led by Treasury Secretary Henry Paulson and included Federal Reserve Chairman Ben Bernanke and the chairpersons of the Securities and Exchange Commission and the Commodity Futures Trading Commission. It is a good bet this is where the decision to reverse course and bail out AIG took place.