Protect the rich and make them richer; Repub solution to the credit crisis and economic problems

Now that we know that the Bush administration is going to bail out Fanny Mae and Freddy Mac, something that as late as last Friday they were saying they would not do, let's look at how they are going about it. Dean Baker has a lot to say:

Bush and Congress Want to Raise Your Taxes to Help out Fannie and Freddie's Management and Shareholders
By Dean Baker - July 13, 2008, 11:27PM

That's the word from the press reports. Apparently the government is going to hand Fannie and Freddie bucket loads of taxpayer dollars, no questions asked. The NYT reports that they will be given access to $300 billion of government loans at below market interest. [Snip]

Some people say that we had to hand tens of billions of dollars to the country's richest people to prevent a financial collapse. This is simply not true.

We had to keep Fannie and Freddie in business, but we could have done this by putting conditions on the bailout. The government uses conditions all the time when it offers help to low and moderate income people. Unemployment insurance, TANF, food stamps, and even student loans come with all sorts of conditions.

It is only when it comes to giving money to extremely rich people that we find it impossible to impose conditions. Again, we could have told Fannie and Freddie that no executives will get more than $2 million a year in total compensation. We could have told their shareholders that they are out of luck, because that is what is supposed to happen when you invest in a bankrupt company.

Instead, we told the people who work as truck drivers, school teachers, and fire fighters that they will have to pay more in taxes to help some of the richest people in the country escape the consequences of their own stupidity. While kicking the poor is always fun for politicians, neither the Bush administration nor Congress are prepared to tell the very rich that they are on their own.

Congress and the administration have no interest in protecting the people who are losing their homes to foreclosure, often because they were put into mortgages they could not pay. This had the effect of forcing real estate prices up while allowing mortgage brokers and lenders to reap huge commissions before the mortgages were sold to investors as parts of collateralized debt obligations or similar arcane and not understood financial instruments.

The result was Alan Greenspan's housing bubble and a lot of very wealthy mortgage brokers knocking down commissions of as much as a million dollars a year, all at the cost of a lot of people spending a lot of money on homes that would inevitably be in foreclosure as soon as the bubble broke and investors who found that the "secure" investments they were sold a AAA instruments suddenly were worth much less than they paid for them.

IndyMac Bancorp, which failed and was taken over by the federal government last Friday existed to accept deposits from people who wanted to save their money and to make loans to people who wanted to buy homes. According to Mish's Global Economic Trend Analysis:

The Pasadena, California-based bank specialized in so-called Alt-A mortgages, which didn't require borrowers to provide documentation on their incomes. Its home state has been among the hardest hit by foreclosures.

"Given their focus on Alt-A and a heavy concentration in California, they would have suffered meaningful losses in almost any scenario...

Alt-A loans are often called "Liar Loans.")

IndyMac's big profits came from making more loans, so they did the logical thing - they stopped verifying income. Whatever the customer said his income was they accepted without question.

Of course, the mortgage broker trying to get the loan accepted by IndyMac Bankcorp would not get a commission unless the loan was accepted, and they got a bigger commission if the loan was bigger, so the mortgage brokers encouraged the home buyers to inflate their income. This was almost required in area where home prices were highly inflated, but when the loan was accepted, it added to the inflation of home prices. That was a major contributor to the housing bubble.

IndyMac is often described as a bank closely associated with CountryWide Mortgage Company, previously the nation's largest mortgage broker. So CountryWide was making the mortgage loans and making its money from the commissions, while IndyMac was lending the money that was used to buy the homes, and taking its commissions. IndyMac was then bundling the mortgages into CDO's and selling them to investors.

The investors, like Freddy Mac and Fannie Mae, would buy the CDO's, which would give IndyMac more money to loan. The investors would look at the CDO's and see investments that were backed by mortgages. Homeowners generally pay their mortgage first before they pay other bills, and if they stop paying, the home can be sold in foreclosure to recover the investment.

As long as home prices were rising, this seemed like a safe investment, so the bond rating agencies would quickly stamp them AAA quality, which meant that more investors could bid to buy them. (Many large investors are limited to buying only certified very safe investments by the people who give them money to invest.) We now know that the bond rating agencies were competing with each other by promising security sellers (like IndyMac) higher ratings as long as they got the job of issuing the rating. Since the bond rating agencies did not get paid unless they got the rating job, they were bidding the ratings up higher.

All of this was exaggerated by the Ayn Rand acolyte and Libertarian Alan Greemspan's Federal Reserve. He lowered interest rates to pump more money into the economy and avoid Recession prior to Bush's reelection in 2004, and then encouraged the use of exotic mortgages like Adjustable Rate Mortgages (ARM) so that more people could qualify for home mortgages. In addition, he refused to use the power the Federal Reserve has to set lending standards for lenders or to require mortgage brokers to provide comprehensible information to the borrowers on the risks to the loans they were issuing.

Finally, there was no regulator that any of the participants had to provide honest information about their loans or their own financial stability to. Investment banks (like Bear Stearns) have never been regulated and Congress, led by the Austro-Libertarian Senator Phil Gramm, repealed the Glass Steagall Act, removing most regulation from banks like IndyMac.

It is now clear in hindsight that this (lack of) system could not survive long. The question was not if it would collapse, but when.

So why did the credit crisis occur when it did? The answer is "Alan Greenspan." As noted in my previous post Politics of the federal Fund Rate, Greenspan lowered the interest rate to keep the economy out of recession prior to the 2004 Presidential election. The rate reached 1.75$, a rate so low that there was literally no incentive to save or invest in fixed rate securities. A major reason why large investors were investing in Collateralized Debt Obligations was that bank savings rates and federal bonds were so low that after inflation there was no effective return, and the rating agencies were saying that the higher paying CDO's were safe (see the rating agency discussion above.)

Even Alan Greenspan knew that the interest rate he had established was too low, so starting in November 2004 (immediately after it would effect the Presidential election) he started raising the interest rate 1/4% per month. This went on until the Summer of 2006. The first publicly announced warning of the impending mortgage market collapse was when CountryWide Mortgage Company warned in early 2007 that foreclosures were sharply increased. The rest has been a long, slow collapse of the credit markets, now to be followed by the collapse of more banks. Here's Jim Cramer:

We all know that Citigroup (NYSE: C) (Cramer's Take), Wachovia (NYSE: WB) (Cramer's Take), Washington Mutual (NYSE: WM) (Cramer's Take) and National City (NYSE: NCC) (Cramer's Take) are in trouble. Bank of America (NYSE: BAC) (Cramer's Take) says it isn't in trouble, but obviously the market doesn't believe management because the stock failed to rally when it said its dividend was safe.

The current economic problems are going to continue until the inflated prices of homes bought during the housing bubble are cleaned out of the system, and as they do get cleaned out, the banks that have those old over-priced mortgages on their books as assets are going to be losing money. That's what just killed IndyMac, and It's what the Federal Reserve is trying to head off by lending money to Freddy Mac and Fanny Mae. The fear is that as the losses mount, the investors/lenders/Depositors may decided that they have to remove their money first, because those who wait will find no money there to pay them. The race to be first to try to get your money back is called a run on the bank. The fed is promising that they will pump in taxpayer money to Freddy and Fannie to prevent that.

The financial managers who have been running this mess have the knowledge to recognize the ponzi scheme that our American investment and commercial banks had become, but they were staying in long enough to get their millions and move them to safer investments. They've lobbied Congress and the administration to head off the regulation that would have stopped their personal wealth-generating activities before they got out. Now the fed is bailing them out using taxpayer money, while letting the individuals who bought homes take the hit.

Note also that nothing in the bail-out adds any regulation to the system, so that the same thing is going to happen again as soon as this economic collapse finishes. And they guys who caused it have their wealth in safe places so that they can wait out the economic time of troubles and start a new boom as soon as it's over.

This is the logical working out of the Reagan Revolution and the conservative movement with its free market banking policies. It will always work this way, every time you allow bankers to operate without regulation and close, effective oversight.

A REAL economist trashes Phil Gramm's dissertation.

John McCain depended on Phil Gramm as his main economics adviser until Gramm demonstrated his inability to be sent out to represent the campaign politically. When Gramm left The Texas A&M University Economics Department it was widely known on campus that the entire department was delighted at his departure because he was not a research economist. So how bad an economist is Phil Gramm?

This was written by James K. Galbraith, an economist at the University of Texas and published on the net at Think Progress - the Wonk Room.

The public record is clear, and I summarized it a few months ago for The Washington Post: “Phil Gramm’s career was the most aggressive advocate of every predatory and rapacious element that the financial sector has. He’s a sorcerer’s apprentice of instability and disaster in the financial system.” (It is worth noting that when the Post asked Gramm about this, he denied it.)

Back in 1995, when Phil Gramm was politically invincible in Texas, various so-called friends suggested that I should be the sacrificial lamb to run against him. I ducked, as any sensible person would have. But (at their request) I did supply the Dallas Morning News with a referee report on Gramm’s dissertation, along with a few notes on that of his wife. Needless to say, hers was much better.

To inject a note of academic sobriety into this election campaign, my review follows.

To: Susan F—

From: James Galbraith

Subject: Phil Gramm & Wendy Gramm Dissertations

Date: June 8, 1995

Thank you for sending the Gramm dissertations. I have read them through with considerable interest.

Phil’s is a curious document. It is mainly an exercise in the history of economic thought, though I doubt that Gramm thought of it in those terms at the time. His topic is an issue in the theory of consumer demand, namely, what is the precise meaning of the idea that consumers have well-formed and unchanging preferences? His method is essentially, a critical review of literature.

For a Ph.D. dissertation, especially one which is not mathematical (and it isn’t), this one at 79 pages is short. It contains no advanced mathematics, no data or analysis of data, no archival or otherwise original research. It is based solely on published sources available in any well-equipped library at the time, and there is only one reference to anything written after 1960, which for a thesis submitted in 1967 is astonishing. The writing style is for the most part graceless and involute, marred here and there by misused words like “fecundities.” It is belabored and repetitive, with chapters that overlap each other. It is basically an extended discussion of a single idea.

Gramm’s basic point is that “the constant utility demand schedule is the only theoretically valid formulation of the demand schedule…” (p. 29). This is not without some interest. The point is quite subversive of modern empirical microeconomics, particularly in view of this statement, which is also possibly the only vivid metaphor in the thesis:

“Movement off the utility level from which the utility surface was projected in a dynamic context, with the specification of a time period of adjustment, alters the form of the utility surface and it flaps like a sheet blowing in the wind.” (p. 30)

What this means in English is that you can’t draw welfare conclusions (that is, inferences about whether people are better or worse off) from an empirical analysis of their changing choices under changing economic conditions (changing prices or technologies) — which is a lot of what applied microeconomics tries to do. The structure of preferences in the course of changes is unlikely to remain stable, Gramm argues, and therefore data cannot be interpreted along the lines that traditional theory requires.

It is probably not useful to speculate on what this dissertation means for Gramm’s later political views. His references are weighted toward Chicago and the conservative economists he is identified with.

However Alfred Marshall, author of the first modern principles text and a distantly historical figure even thirty years ago, seems to be the economist with the strongest influence over him.

Perhaps more significant is the skeptical attitude toward data and evidence. If you take Gramm’s methodological position, you are left with a real quandary as regards research: other than introspection, pure math and literary criticism, what is an economist to do? This may account in part for Gramm’s migration out of academic economics and into politics, where an unapologetic life can be built around simple verities. But then again that may be giving the man too much credit.

On the whole, Phil Gramm’s thesis could have been condensed to an interesting article at some point in the development of twentieth century microeconomic theory. My guess is that the proper moment for that article would have come in the late 1940s, or some twenty years before Gramm actually wrote his dissertation. By the time he did write it, the mathematical character of the field had long since outpaced the very modest display of technique here, and the concerns Gramm writes about would probably have already been considered antique in most quarters. It would be interesting to know if Gramm got anything published out of this, and if so, where.

In other words, Gramms Ph.D. dissertation is short and presents no new information, contains no economic data and without data cannot be considered economic analysis. The references are primarily ancient conservative Chicago School material.

Essentially there is no indication that Phil Gramm is really an economist if his dissertation is the measure. At best his economic philosophy is considered Austro - Libertarian, but without adding anything useful to even that impoverished school.

I find it unsurprising that he has no body of published research and that he is not held in any particularly favorable esteem by real economists.

Gramm is the guy John McCain chose as his primary economics adviser before Gramm opened his mouth in public and embarrassed the McCain campaign so badly that they fired him. He had been considered very likely to become Secretary of the Treasury.

That doesn't reflect well on McCain's judgment, either.

Ex-Senator Phil Gramm - a prime cause of today's economic troubles

One of the central players in the financial shenanigans that have led to the current American financial problems was - and remains - Ex-Senator Phil Gramm. Mother Jones has some more in his story.

Who's to blame for the biggest financial catastrophe of our time? There are plenty of culprits, but one candidate for lead perp is former Sen. Phil Gramm. Eight years ago, as part of a decades-long anti-regulatory crusade, Gramm pulled a sly legislative maneuver that greased the way to the multibillion-dollar subprime meltdown. Yet has Gramm been banished from the corridors of power? Reviled as the villain who bankrupted Middle America? Hardly. Now a well-paid executive at a Swiss bank, Gramm cochairs Sen. John McCain's presidential campaign and advises the Republican candidate on economic matters. He's been mentioned as a possible Treasury secretary should McCain win. That's right: A guy who helped screw up the global financial system could end up in charge of US economic policy. Talk about a market failure.

Gramm's long been a handmaiden to Big Finance. In the 1990s, as chairman of the Senate banking committee, he routinely turned down Securities and Exchange Commission chairman Arthur Levitt's requests for more money to police Wall Street; during this period, the sec's workload shot up 80 percent, but its staff grew only 20 percent. Gramm also opposed an sec rule that would have prohibited accounting firms from getting too close to the companies they audited—at one point, according to Levitt's memoir, he warned the sec chairman that if the commission adopted the rule, its funding would be cut. And in 1999, Gramm pushed through a historic banking deregulation bill that decimated Depression-era firewalls between commercial banks, investment banks, insurance companies, and securities firms—setting off a wave of merger mania.

That's the beginning. Go read the rest of the article.

Then for some background, here is the Wikipedia entry on Phil Gramm. If you are having trouble paying for gasoline or for your mortgage, Phil Gramm is a major reason. Add his name to Alan Greenspan and Ronald Reagan.

Republicans look busy in econmic crisis; Offer no real solutions

Paul Krugman has looked at the new proposals regarding how the government should deal with Wall Street. He's not impressed.

The financial events of the last seven months, and especially the past few weeks, have convinced all but a few diehards that the U.S. financial system needs major reform. Otherwise, we’ll lurch from crisis to crisis — and the crises will get bigger and bigger.

The rescue of Bear Stearns, in particular, was a paradigm-changing event.

So what do the Bush administration gurus propose doing?

Nothing.

They cover that up by pulling out an organization chart and saying that someone (party "A") who used to report to someone else (party "B") will, after their reorganization report to someone new (Party "C".)

Please note the utter lack of any substantial action to either help individuals who are being foreclosed, plan an orderly way to assist failing financial banks who are in trouble because the took on excessive risk and it caught up on them, or apply regulations to financial banks and force greater financial reporting transparency.

But that's what both Bush and McCain prefer. The "Herbert Hoover" approach to economic troubles. Bail out the banks, allow the wealthy to scoop up distressed properties for a song and increase the concentration of wealth, and do nothing at all for the average homeowner or borrower in trouble after the system collapsed.

This "new" plan is not a reaction to the current credit crisis and impending Depression. It is part of the deregulation of financial institutions that the Bush administration has spent 7 years trying to force through, and now that there is a disaster they rename it and continue to try to force it through. And, yes, they ignore the fact that the current financial problems are a direct result of financial deregulation that has come in as a part of the Reagan Revolution.

Krugman calls it the Dilbert Solution. See a problem and bring out organization charts to pretend you are doing anything besides just talking about the problem.

Paul's right.

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Addendum I - 7:59 PM
dday over at Digby's hullabaloo provides a good wrapup of reasons why the current Republican economic proposals are crap.

Barack Obama explicitly connected the current crisis to the bipartisan practice of deregulation. This is part of a culture of laissez-faire economics that has shifted risk to individuals and removed risk from corporations, and Obama's speech talked about the need to radically change that midset with actual regulation instead of putting new names on the same old ineffective regulatory agencies. Corporations for too long have, as Bob Borosage said, been given "the freedom to gamble with other peoples’ money ... protected by lavish campaign contributions and powerful lobbies."

One thing we all know is that John "Let's Schedule A Meeting Sometime" McCain would offer the same Hoover-like do-nothing approach. But it's striking how many connections there are between McCain allies and surrogates and every aspect of the financial crisis. After all, some top campaign advisors of his lobbied for the shady lender Ameriquest, one of his top surrogates Carly Fiorina is a welfare queen whose company paid off her mortgage between 1999 and 2003, the most recent RNC chair is saying that his non-plan to deal with the mortgage crisis is incomplete, and his top economic advisor is perhaps most responsible for the crisis itself:

That person is McCain's economic brains - Ex. Sen Phil Gramm (R-TX) about whom I wrote last Saturday.

McCain's economic brains - Ex. Sen Phil Gramm (R-TX)

When John McCains says he doesn't know too much about economics, then makes a statement on his economic policy, the question arises, who wrote the statement? A number of people see the hand of ex Texas Senator Phil Gramm, the man who more than anyone else in government was responsible for removing the 1930's Glass-Stegall Act that separated banks into regulated and government insured retail banks and unregulated financial banks and insurance companies and prevented the latter from using funds collected by insured retail banks for risky financial activities.

As Chairman of the Senate Banking Committee, Sen. Gramm got his wife (Wendy Gramm, also a Ph.D. economist) a seat on the Security and Exchange commissions (SEC). Both Phil Gramm and his wife Wendy were in the forefront of financial deregulation of the kind that has led to the merger and consolidation activity of the last decade and to the current credit collapse. At the SEC she proceeded to rewrite the SEC regulations so that Enron, who was operating as a financial market maker in energy markets, was excluded from SEC oversight. She moved directly from the SEC to the Board of Directors of Enron, where she was on the Audit Committee when Enron restated prior year's earnings (meaning the financial statements had been fraudulent) and then collapsed. When Enron collapsed, Wendy Gramm was one of the Directors sued for insider trading and violation of SEC regulations. The lawsuit was settled in early 2005. Go read this article in Salon for more details on Wendy Gramm's work at the SEC and her role in the collapse of Enron.

Lisa Lerer of the Politico today published an article providing more of Gramm's history and his role as John McCain's economic adviser. She provides a great deal of additional detail on Phil Gramm.

Phil Gramm has been as responsible for the current credit collapse and set of failures in Wall Street as any man in recent history, although possibly not quite as much as his fellow libertarian, Alan Greenspan. Gramm is a firm advocate of financial deregulation and small government, and was closely tied to the fraud involved in the Enron collapse. Now he is a key economic adviser to the self-admitted economic naif, John McCain and is being spoken of as McCains Secretary of Treasury of McCain is elected President.

The current financial problems are a direct result of the political philosophy behind the Reagan Revolution, and Phil Gramm and his wife Wendy were two major cogs in the machine that brought the current financial collapse to us. That he is advising McCain on economics is like the fox advising hens on security for the hen house. That's another major strike against a McCain Presidency.