Wall Street got it wrong and very nearly threw the world into Great Depression II

Now we are traveling through the Great Bush Recession with no real economic road map to get us out of it. The free market in investment banking failed and there is no alternative yet. To compound the problem the media is spreading happy talk again about how the recession is over, and the economists have been touting the fact that for the first time in a year the GDP increased rather than decreased. The stock market went up Thursday based on the happy talk.

Then we got the news that consumer confidence is down badly. Today the stock market lost all the phantom gains it made yesterday. Why is consumer confidence down? Consider this.

Cities in California, Florida and Nevada accounted for the 10 highest foreclosure rates in Q309 among metro areas with more than 200,000 people. However, five of those cities reported decreasing foreclosure activity from Q308, offset by many other markets reporting spikes in foreclosures, according to the report.

Sharga sees the foreclosure crisis coming in three waves, and with this new data, the market is showing signs of the second one.

“That first wave of foreclosures cratered the economy, which created job losses, which created the second wave. Now, we’re seeing prime rate loans affected by unemployment. And the third wave will be really a repeat of wave one, except this time we’re going to see a switch of Option ARM and Alt-A loans out for the subprime loans. It will probably be as big but somewhat shorter lived,” Sharga said.

Sharga said that he expects a peak in foreclosures in 2010, only a marginal improvement in 2011 and a return to normal monthly foreclosure activity sometime in 2012.

“Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation’s foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave,” said James J. Saccacio, chief executive officer of RealtyTrac. “While toxic subprime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A Option ARMs are spreading the foreclosure flood to more metro areas in 2009.”

Those increased foreclosures are caused by the increase in unemployment.

But wait! Hasn't the media happy talk been saying that unemployment isn't that bad? No, what they have been doing is spinning the fact that unemployment is no longer falling off a cliff as it was early in 2009. The stimulus money has slowed job loss, but not stopped it. Happy talk means the media is taking not-so-bad news and spinning it as good news.

Want an example? So-and-so stock beat analyst's expectations, so it rose in the market. That just means the analysts thought it would lose more money than they actually did, but they still lost money. That's taking not-so-bad news and spinning it as good news. Don't forget that consumer spending makes up 70% of the total GDP, and investment spending is not going to increase until the consumer markets are growing for the investors to plan to sell to.

Krugman addresses the unemployment problem.

Just a quick note on the GDP report. Obviously, 3.5 percent growth is a lot better than shrinkage. But it’s not enough — not remotely enough — to make any real headway against the unemployment problem.

[...]

Basically, we’d be lucky if growth at this rate brought unemployment down by half a percentage point per year. At this rate, we wouldn’t reach anything that feels like full employment until well into the second Palin administration.

So the only solution is Keynesian stimulation of the economy, and the stimulus pushed by both Paulson and by the Obama administration simply wasn't big enough. Krugman told us so, and he was right. The problem is, the economists don't have any real idea how to deal with this, and until they do, the government is not going to be able to get its act together and get something through Congress that will provide any more help than the current inadequate stimulus. (Inadequate for recovery, but thank god for what there is. Otherwise we would be deep in the first year of Great Depression II. Instead we are only in the Great Bush Recession, also brought to us by Alan Greenspan.)

More ideas from economists are badly needed. George Soros is planning on setting up a foundation for dissident economists who ignored the free market boys who got it wrong. Michael Hirsh in Newsweek describes the state of the community of Macro Economists right now.

[W]ith no rules of the road, we have entered a Mad Max world of economics in which even the most eminent of our top regulators and central bankers can't seem to agree on the fundamental nature of financial markets. One clash of titans is occurring between Paul Volcker and Ben Bernanke. Volcker, the former Fed chief, wants commercial banks barred from heavy proprietary trading. "I don't want them to be Goldman Sachs, running a zillion proprietary operations," he told me recently. Bernanke, the current Fed chairman, doesn't want to tamper nearly as much with the structure of the Street; instead, he wants to restrain the big banks through changed incentives, such as by tying compensation to long-term performance, and through increased capital requirements. Across the Atlantic, Mervyn King, the governor of the Bank of England, is engaged in a fierce debate with Britain's chancellor of the Exchequer, Alistair Darling, over breaking up big banks. King says breaking them up is the only way to prevent another catastrophe; Darling says King doesn’t know what he’s talking about.

Even Alan Greenspan appears to be engaged in a fierce argument ... with his own younger self. "U.S. regulators should consider breaking up large financial institutions considered 'too big to fail,' " he said earlier this month. But for most of his life, Greenspan was an Ayn Rand libertarian who abhorred the idea that government should break up anything; he once wrote that "the entire structure of antitrust statutes in this country is a jumble of economic irrationality and ignorance." Bigger was better, he said, and that way of thinking largely governed his stewardship of the Fed from 1987 to 2005. "The control by Standard Oil, at the turn of the century, of more than eighty percent of refining capacity made economic sense and accelerated the growth of the American economy," Greenspan wrote in Capitalism: the Unknown Ideal in 1961. But Greenspan now has this to say about banks: "If they're too big to fail, they're too big. In 1911, we broke up Standard Oil—so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."

So we don't know what to do, but anyone with a background in Macroeconomics 101 will know when we are finally coming out of the craptitude. It will be when consumer sentiment starts up, and then when consumer spending starts up. And that will not happen until at least half a year after employment starts climbing again.

Personally I think that will require a return to Glass-Stegall and the hard separation of consumer banks and investment banks. The current talk out of Treasury of making the big Wall Street Banks plan for how the government will take them over when they fail is a start. But anti-Trust should also be considered. As Greenspan said - "Too big to fail is just too big."

What went wrong with macro economics and financial economics

I have previously written about Paul Krugman's article in the NY Magazine about how the economics profession got a real black eye out of the current Recession-and-almost-Depression. Here's some more writings on the same subject:

• What went wrong with economics Jul 16th 2009 from the Economist.


• Why I didn't go medieval on Krugman, and other book newsSept 10, 2009 in Time.com


• Hoisted from the archives – my old post on Freshwater and Saltwater macroeconomic theorySept 16th, 2009 posted in the TPM reader blogs by John Hempton.

They all tell pretty much the same story. Financial economists and Macro economists essentially overlooked the warnings that the economy was coming off its rails.

The articles are all quite good, and each takes a mildly different look at the issues so reading them all helps in understanding what has been happening to us. My earlier blog can be found at The US economy is surprisingly dysfunctional. . It contains links to other writings, as do many of the articles in the list above.

One important point to remember, though. Even though the economists got some important points wrong, the politicians have been consistently much worse and should not be trusted.

Nobody could have predicted .... Macroeconomics in the ashes of the Recession of 2008

The Macroeconomics profession had essentially concluded by the end of the century that they knew enough so that another Great Depression was now impossible. Not that if it started economists and policymakers could head it off, but that it was impossible for it to even start. That conclusion was based on the assumption that the price valuations set my markets were perfect, given the available information at the time along with a great deal of very complex mathematical models and a lot of high-level statistics.

The assumptions that financial markets provide perfect prices and that people are perfectly rational were the same assumptions made by the Classical Economists before the Great Depression. It became the new assumption when Keynesian explanations of Depressions being caused by a lack of adequate demand were rejected in a flurry of new mathematical models and a flash of computer monitors. Unfortunately the models were essentially based on what Krugman calls ketchup economics.

Ketchup economics means the "...because a two-quart bottle of ketchup costs twice as much as a one-quart bottle, finance theorists declare that the price of ketchup must be right." It ignores the underlying factors that establish the true value. So if you compare home prices at a given point of time and the price of two comparable homes is roughly the same, then the price is right. There is no consideration of whether the income of the homeowners can support the mortgage required to meet that price. Those fancy mathematical models threw out answers that just don't match up with reality in the long run.

Financial markets, unfortunately, are well known to be based on short term considerations and to not consider long term factors.

The economic and financial experiences world wide of the last two years has left economies world wide in much worse shape than previously and also it has left the profession of Macroeconomics strongly questioning where they went wrong. Bankers are beginning to speak publicly about the need to put human beings back into the lending decisions and not depend on the mathematical models.

Paul Krugman has presented a fascinating overview of the questions the Macroeconomic profession are now grappling with The generally accepted new assumption goes back to Keynes' conclusion that recessions, even the depression, are caused by lack of adequate demand. But the beauty of the neo-classical models holds a powerful attraction. The recognition of what went wrong is not yet there.

Go read Krugman's article. It is lengthy, but written in language a layman with some understanding of Macroeconomics can handle.

OK. I want to quote Krugman on why the government has to be spending so much right now.

During a normal recession, the Fed responds by buying Treasury bills — short-term government debt — from banks. This drives interest rates on government debt down; investors seeking a higher rate of return move into other assets, driving other interest rates down as well; and normally these lower interest rates eventually lead to an economic bounceback. The Fed dealt with the recession that began in 1990 by driving short-term interest rates from 9 percent down to 3 percent. It dealt with the recession that began in 2001 by driving rates from 6.5 percent to 1 percent. And it tried to deal with the current recession by driving rates down from 5.25 percent to zero.

But zero, it turned out, isn’t low enough to end this recession. And the Fed can’t push rates below zero, since at near-zero rates investors simply hoard cash rather than lending it out. So by late 2008, with interest rates basically at what macroeconomists call the “zero lower bound” even as the recession continued to deepen, conventional monetary policy had lost all traction.

Now what? This is the second time America has been up against the zero lower bound, the previous occasion being the Great Depression. And it was precisely the observation that there’s a lower bound to interest rates that led Keynes to advocate higher government spending: when monetary policy is ineffective and the private sector can’t be persuaded to spend more, the public sector must take its place in supporting the economy. Fiscal stimulus is the Keynesian answer to the kind of depression-type economic situation we’re currently in.

This observation was at the core of Krugman's book "Depression Economics." It also explains why attempting to balance the federal budget anytime soon is likely to cause a second economic downturn.

At the end of his article Krugman lays out where he thinks the profession has to go next, with his reasons for thinking so. anyone interested in macroeconomics or in investing needs to read this article carefully.

Is the Recession ending soon? If so, then what?

Annie Lowrey presents a very interesting article on the state of the world economy in Foreign Policy. It consists of a short summary of what is happening and expected to happen in China, Japan, Africa and the United States and links to seven interviews with economic experts familiar with various parts of the world.

Let me summarize Annie Lowrey's summary found on the first page:

• China China has seen a sharp drop in exports and as a result, a sharp drop also its rapid internal export-fueled economic development. Their economy is being maintained by stimulus, but that can't go on forever. This is not a surprise to them, so the worldwide Recession is actually an opportunity to shift out of the export-fueled economic growth into something more sustainable. Since China expects to come out of the Recession in better shape than the rest of the world, that is going to give them the opportunity they needed to shift to a more sustainable economy.
  
  
• Japan With its essentially export based economy slowed by the drop in exports of its major high tech products, which have fallen out of favor with Japan's customers and potential customers, Japan has seen a 10% reduction in the overall economy. The move into the Recession has slowed, perhaps stopped, but there is no apparent engine of growth for them in the future.
  
  
• Africa The economy of the world's poorest continent has been based largely on aid, investment, and commodities. All are being reduced by the Recession, with no prospects seen for recovery of those items or replacements for them. Internally because their banks were not as integrated as in the west, they did not see the bank failures, so Africa has been economically devastated.
  
  
• The United States The dropping GDP that signals going into the Recession appears to be slowing, so the Recession is expected to reach the bottom, perhaps as early as this fall. How long the economy will remain at the lower level is very uncertain, being "variously described variously as "a curved L," a "Q," and a "U" -- not a real "V"." In short, things are getting worse more slowly, but the prospects of actually getting better any time soon are unlikely.

The article appears to present a realistic picture of the overall world economy. It's interesting that Lowery in her summary provides a lot more details of the internal situation for China, Japan and Africa than she does for the United States. Perhaps the many structural problems in the U.S. that make it at present an unstable economy are too much for her to find anyone to briefly deal with. Though perhaps she does not summarize it because there is no consensus regarding either what those structural weaknesses are or how to deal with the structural problems like the weak American financial sector. Meltzer, I think, has it right. "...we're going to have to export more to service debt we've sold and going to sell. Consumption growth has to slow down. We have to invest more to export more." In other words, the U.S. has to return to being a nation that produces and exports thinks and stops letting the financial sector tail wag the economic dog. To do that, the greed and arbitrariness - as well as most of the so-called "innovation" - has to be removed from the financial sector. Wall Street banks are going to have to become a utility useful to a manufacturing economy again, instead of being the powerful Gods wielding lightening bolts of money who determine which businesses and industries survive and grow and which ones die.

Lowery does not tell why there is no significant discussion of the European block (Edwin Truman briefly mentions it), Russia, or Latin America. That could be because those areas are not going to either further depress the world economy nor are they going to provide any engine for its recovery. Or again, she simply may not have been able to find an acknowledged expert who would summarize the common wisdom on those areas. Or maybe just a space limitation for the article., and they were the least consequential. In any case, it would have been nice to know why Lowery did not address them.

The picture Lowery presents is that the drop into the Recession will soon reach the bottom but that recovery any time soon after reaching the bottom is uncertain. China expects to lead the world when that recovery does occur. It's just very unclear how long the time period of that "bottom" will last. The level of the "bottom" itself is right now artificially dependent on national stimuli, and that stimuli cannot continue for a long period of time. Yet no one knows what can replace those stimuli payments provided by the various national governments. (Or at least none of her respondents are commenting on those prospects.)

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The interviews with the experts are short, essentially bullet points for question with a brief answer. They are worth reading individually. Links to the seven interviews Lowery is presenting are here:

• Louis Kuijs on China
• Shanta Devarajan on Africa
• Kyoji Fukao on Japan
• Allan H. Meltzer on the United States
• Jim O'Neill on emerging economies
• Robert Reich on the United States
• Edwin Truman on the United States and Europe

Roubini on the prognosis for the economy

Dr. Nouriel Roubini, the guy who predicted that the economic bubble was going to burst over two years ago, has more to say about how long the technical Recession is going to last.

Weymouth: What do you believe is happening to the economy today?
Roubini: The rate of economic contraction you have seen in the last two quarters—6 percent annualized—is going to slow down. The optimists are already talking about the "green shoots" of spring, about economic activity becoming positive. [They say] we will have positive growth in the third quarter, and in the fourth quarter we will grow 2 percent over the previous quarter. They expect that next year, growth will go back to above 2 percent.

Compared with this optimistic consensus, I believe that the rate of economic contraction is going to slow from minus 6 percent in the last two quarters to minus 2 percent by the fourth quarter. Next year, I believe that the growth rate is going to be 0.5 percent for the U.S. average. Even if we are technically out of a recession, we are going to feel like we are in a recession. The bottom of the economy is not going to be in three months, but rather toward the beginning or middle of next year.

That was my gut feel on the subject as I perused the statistics. But I also feel that the more the talking heads provide happy talk predictions, the more contrarian it seems I should be. They are snake oil salemen and they have been repeatedly wrong. Worse, they just want to start getting people to buy whichever product they are touting this week.

I'm gonna trust Roubini.

Here's some interesting articles about the economy and the banking system

The first one is by an automotive columnist in the Fort Worth Star-Telegram named Ed Wallace. He provides some of the clearest descriptions of the banking system I have read, and what he writes is confirmed by the other, more technical things I have been reading. This one is entitled False Prophets vs. Real Profits: What Wall Street Is Not on Main Street. It gives an interesting picture of (in part) how we got to the current economic mess. Ed has clearly ranged a bit far from reviewing the new cars that are coming out. And he gets it right.

A sample from his article:

Nobody is saying or even acknowledging it, but there’s only one set of economic numbers that will prove that this downturn has reached its bottom, that the long climb back to financial health has started in earnest. Those numbers will not be found in the nightly news concerning where the Dow Jones or the S&P 500 ended the day. Nor will we find them in the closing price of West Texas Intermediate Crude, accompanied by commentary explaining why oil should be that high – or that a high price is the looked-for indication that things will pick up in the last half of the year.

No, what those three indicators actually show is that far too much cash in our financial system is still chasing paper profits. Money is sitting on the sidelines waiting to be plowed back into the markets, where other investors and groups then pour their money back in and the rising tide of equities and commodities makes even more money – for a relatively small group of Americans.

The second is a description of how the current Secretary of Treasury, Timothy Geithner, thinks. He is probably the most critical man in the economy today, and he is willing to try extreme measures. This current situation is way out there in unknown land, so he is exactly what Obama and the nation needs. It's entitled Member and Overseer of the Finance Club .

Here is a sample from the article:

In a pair of recent interviews and an exchange of e-mail messages, Mr. Geithner defended his record, saying that from very early on, he was “a consistently dark voice about the potential risks ahead, and a principal source of initiatives designed to make the system stronger” before the markets started to collapse.

Mr. Geithner said his actions in the bailout were motivated solely by a desire to help businesses and consumers. But in a financial crisis, he added, “the government has to take risk, and we are going to be doing things which ultimately — in order to get the credit flowing again — are going to benefit the institutions that are at the core of the problem.”

Then we get the story of what is happening politically in Iceland because the banks collapsed there. Not really very different from what happened here, but on a much smaller scale.

REYKJAVIK, Iceland — It is a tale of light and dark — of a small but rugged country far from anywhere that has suffered as severely as any in the developed world at the hands of buccaneering free-marketeers, but which is now slowly digging itself out from the financial wreckage.

An important milestone was reached on Saturday, when the country’s voters went to the polls to elect a new government, three months after riotous street protests over the country’s banking collapse forced the country’s conservative-led administration from office.

With about a third of the final vote counted late Saturday, it seemed that the country’s leftist caretaking government would be formally voted into power, with the Social Democrats projected to gain 22 seats and their partners, the Left-Greens, appearing to gain 13 seats in the 63-seat Parliament. The conservative Independent Party, ousted after a wave of demonstrations in January, was projected to gain just 14 seats with less than 23 percent of the vote, down considerably from its total in 2007. Final results are to be announced on Sunday.

The conservatives were one of the first governments anywhere to lose office because of the global financial crisis, and it seemed clear Saturday that voters in this country of 320,000 were imposing a further reckoning.

GM Rick Waggoner announces he will leave CEO job of GM; Obama Rescue plan due tomorrow

So out of the blue, Rick Waggoner announces that he is going to step down as CEO of General Motors where he has been CEO for eight years. The timing is suspicious. Obama is scheduled to announce his bail-out plan for BM and Chrysler Monday.

There was apparently no advance warning that this might happen. So the question is, did he decide to go himself for REAL personal reasons, or was he pushed out. And if he was pushed out, was it an internal coup by powerful individuals inside GM, or was it outsiders, like someone in the government saying that they would treat GM better if Waggoner was gone. Bankers is another possibility.

The New York Times article says the government asked him to leave.

This is just the beginning of this story.

AIG has to pay those bonuses because there is a contract? That's a crock!

This post has gotten to complex to follow easily, so I want to add some structure. What we have is a fait accompli by the executives in the financial products division of AIG in which they are holding both AIG top management and the US government (representing the taxpayers) out of somewhere between $100 million and $450 million dollars in so-called retention bonuses.

Whoever these executives are, they somehow convince Chairman Liddy of AIG that he had no choice except to pay the bonuses, then manipulated him to convince Treasury Secretary Gaither and Director of the White House National Economic Council, Larry Summers that there was no viable way to stop from paying those bonuses because they are fixed in preexisting employment contracts. All of these people were as of earlier today convinced of the inevitability of paying those bonuses, as distasteful as such payments to the exact same individuals who destroyed AIG as an independent financial organization. The discussion here has four different parts.

In Part I, Glenn Greenwald provides the ways an experienced contract lawyer would poke holes in a so-called bullet-proof contract.

In Part II, Josh Marshall at Talking Points Memo posts weaknesses in the argument used by AIG Chairman to convince Treasury Secretary Geithner and Director of the White House Council of Economic Advisers Larry Summers that the payment of the bonuses was the least expensive of the various possible options for the government to (grudgingly) accept.

In Part III, I offer my opinion that the entire story is a massive scam, being run by executives from AIGFP, who it seems to me have few if any job prospects after leaving AIG because anyone who knows just how they destroyed the company AIG would (in my opinion) be a fool to hire them and give them any significant responsibility somewhere else.

In Part IV, the just published statement by Cal. Rep. Brad Sherman indicates that the TARP Law passed last October already contains a provision that gives the Treasury Department final control over all executive compensation at AIG. That provision supersedes all preexisting employment contracts. The so-called inevitability of paying the outrageous extortion demanded by the AIGFP executives appears to be a total figment. This would confirm my suspicion that the whole damned thing is a scam being attempted by the unethical AIGFP executives just to rip the taxpayers off for significant walking away money as those executives leave the company.

[Header added at 11:48 pm CDT.]

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Part I

Constitutional lawyer and writer Glenn Greenwald has weighed in on those unnecessary and excessive payoffs to the financial products crooks. Those crooks are, in fact, the very executives who sold the disastrous CD's that have required the federal government to step in and give the company $180 billion dollars (so far) to keep the overall banking system from collapsing.

there are almost certainly viable claims to be asserted that the contracts were induced via fraud or that the bonus-demanding executives themselves violated their contracts. Independently, it’s inconceivable that there aren’t substantial counterclaims that AIG could assert against any executives suing to obtain these bonuses, a threat which, by itself, provides substantial leverage to compel meaningful concessions. Many of these executives were, after all, the very ones responsible for the cataclysmic losses.

The only way a company like AIG throws up its hands from the start and announces that there is simply nothing to be done is if they are eager to make these payments. One might expect AIG to do so -- they haven't exactly proven themselves to be paragons of business ethics -- but the fact that Obama officials are also insisting that nothing can be done (even while symbolically and pointlessly pretending to join in the populist outrage over these publicly-funded "retention payments") is what is most notable here.

Legal strategies aside, just as a business matter, one of the first steps taken by every company in severe distress is go to its creditors, explain that it cannot make the required payments, and force re-negotiations of the terms. That’s as basic as it gets. To see how that works, just look at what GM and other automakers did with their union contracts – what they were forced by the Government to do as a condition for their bailout. Obviously, if a company goes into bankruptcy, then contracts to pay executive bonuses are immediately nullified, but the threat of bankruptcy or serious financial distress is, for obvious reasons, very compelling leverage to force substantial concessions. And the idea that, in this economy, AIG executives (of all people) will be able simply to leave and go seek employment elsewhere unless they receive their "retention bonuses" (even assuming that’s an undesirable outcome) is nothing short of ludicrous.

There may be other reasons why the Treasury Department decided it wanted AIG to pay these bonuses (Marcy Wheeler considers some of those reasons here), but this claim from Larry Summers that the sanctity of contracts precludes any alternatives is not just false, but insultingly so.

Glenn has more to say, but I want to add his addendum.

UPDATE: Jane Hamsher has more here on AIG's insultingly frivolous claims as to why these contract obligations are unavoidable, and here FDL has a petition, to be delivered to the House Financial Services Committee during Wednesday's hearing on the AIG payments, demanding full disclosure before any more payments are made.

This bank bailout is already much too damned expensive - and would have been unnecessary had Wall Street banks acted like prudent bankers instead of long-shot playing riverboat gamblers playing with someone else's money. Unfortunately, allowing the economy to go into a 1930's style Depression because of bank misdeeds is even more expensive. That's why the taxpayers are being dunned to save the crooks on Wall Street.

Still, the Wall Street Extortioners should not be allowed to gather even more misbegotten personal wealth directly from the taxpayers pockets, taxed by law. They must be stopped, as much of that wealth as possible should be extracted from the Wall Street bankers who do not and did not deserve it, and the entire Wall Street banking system has to be tightly regulated and restrained so that this cannot happen again.

It's not just the extortionate bonuses that's bad. In addition, Wall street is already spending large sums on lobbyists to get to Congress and prevent new regulatory bills being enacted.

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Addendum I at 7:34 pm CDT

Part II

There are some seemingly very important issues about whether or not failing to pay the bonuses allegedly due under employment contracts would be considered a default by AIG on its CD contracts. That's what the link above to Marcy Wheeler was explaining. Apparently that was the argument that AIG used to convince Larry Summers that those employment contracts had to be paid no matter how bad they are. You may notice that I am emphasizing the fact that the contracts that (allegedly) require payment of the bonuses are employment contracts, NOT finance contracts of the type purchased by the CD counter parties. Keep that in mind as you read the discussion .

The discussion can be found at Josh Marshall. He quotes a few people who seem to know what they are talking about. It is highly illuminating.

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Part III

My suspicion is that a very few AIG lawyers who have reputations for understanding CDS contracts have essentially pulled the wool over a number of non-lawyers like Larry Summers (PhD. Economics), AIG Chairman Edward Liddy and the current Secretary of Treasury, Timothy F. Geithner (M.A. in international economics and East Asian studies from Johns Hopkins University's School of Advanced International Studies in 1985 and studies in Chinese and Japanese.)

I am guessing that this is a scam being pulled by the same unethical individuals in AIG's financial products Division who killed AIG as a viable financial organization in the first place. First they snowed their own Chairman, Liddy, and then manipulated him to snow the government officials. If, as I suspect, the US Treasury Department and the Federal Reserve have no high-ranking attorneys who know the law governing the CD contracts inside and out, that would not be all that difficult.

I'm not saying that the scam I postulate DID occur, but all the evidence I see in the media, as well as the discussions at Greenwald and TPM I have referenced above, makes me extremely suspicious that it is quite likely. The behavior of the AIGFP individuals demonstrates the very kind of unethical behavior that should make them targets of suspicion.

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Addendum 2 at 9:57 pm CDT

Part IV

According to California Democratic Congressman Brad Sherman, the Treasury Department already has all the authority it needed to stop those outrageous AIG bonuses. Rep. Sherman knows, because he specifically placed the provision into the TARP legislation before it passed, and it still has it in there. Here's what he says about it:

We had a provision in there that said Treasury was supposed to establish, by regulation, standards for executive compensation. We required that to be done -- had it been done, it would have been binding, whether [or not] these contracts had been signed earlier. It's entirely within the power of the federal government to have contracts modified [at companies receiving public aid]. Nixon had contracts modified by the federal government. We gave a similar power to Treasury.

Henry Paulson, Treasury Secretary until Obama was sworn in, clearly did not believe that it was within the proper jurisdiction of the federal government to use the powers given by this provision.

Since the TARP law was already being administered, it seems likely to me that the new Secretary of Treasury, Geithner, did not bother to go back and reopen such previously established decision. Beside, Geithner is also a Wall Street banker, and probably has the same view of the proper role of government. It also seems likely to me that Geithner never bothered to give Obama the option that provision of TARP offered. It was a previously settled decision, and seems unlikely to have caused anyone who read it to consider that those higher in government were not aware of it and how it could be used. That would particularly be true since Obama was so damned non-committal on the subject of those bonuses until the last day or two.

It will be interesting to see if California Rep. Sherman can change that and get Obama to act on the powers he has already been given by law.

AIG's inappropriate bonuses to Executives must not be allowed to stand

AIG has given $millions in bonuses (See also this Reuters article) to the very same executives who are running the unregulated side of the company that caused all the losses that drove AIG into bankruptcy. The Bush administration was convinced that the financial collapse of AIG would drive the overall financial economy into collapse, so the government could not afford to let AIG go into it's well-deserved bankruptcy. This has since required the government to step in giving AIG close to a fifth of a $trillion dollars of taxpayer money (so far) to bail them out and keep them functioning. Had AIG been smaller, then the government could have let them go into bankruptcy as they had the smaller Lehman Bros. earlier.

Josh Marshall reported briefly this morning on why the AIG administrator (appointed by the Secretary of the Treasury) claimed he felt it was necessary to provide those bonuses. The Reuter's report explained it this way:

AIG Chairman Edward Liddy said in a letter to U.S. Treasury Secretary Timothy Geithner that the firm was legally obligated to make already-committed 2008 employee-retention payments, the value of which were set early last year before problems at the Financial Products unit became public.

About half of the $1 billion was due to be paid to staff of AIG's main insurance businesses and the rest to employees of the largely unregulated AIG Financial Products.

AIG Financial Products was the unit that made bad bets on toxic mortgages and credit default swap contracts that led to the company's near collapse.

The decision to give out those bonuses is so wrong on so many levels that it is beyond ridicule. AIG is on life support, based on the earlier decisions made by the very executives now getting these bonuses as payment for their earlier services. Without taxpayer funding, there would be NO MONEY with which to pay these bonuses! So why did Liddy make that decision? Here's what we know about Liddy.

AIG Chairman Edward Liddy was appointed as Chairman of AIG back in June 2008 after AIG had gotten into severe credit problems. Liddy is a long-time Wall Street banker, clear trusted by the Board of AIG to protect AIG from the problems it was in. The timing of his appointment, well before the general Wall Street Financial Crisis demonstrates clearly that his loyalty is to AIG as an institution first rather than to the government, the taxpayers, or even the overall banking system.

This orientation would have made him a good match for the Bush Treasury Secretary, Henry Paulson, also a long-time Wall Street banker. By the end of the Bush administration, it was generally clear that Paulson similarly had a greater loyalty to the institutions of Wall street Banking than he did to taxpayers, government or to society in general.

Unfortunately, most of Obama's experts have similar backgrounds, not least being Timothy F. Geithner the current Secretary of the Treasury.

So what, you say? That's where the expertise is. Quite true. But consider Chairman Liddy's explanation for his decision to pay those bonuses, shown above. Then consider this article at CFO.com. It's title, "Creditors Could Go After Lehman Bonuses," is not even hinted at by Chairman Liddy's explanation.

The CFO article, based on the earlier experience of Lehman Bros. after they went bankrupt, rather strongly suggests that a bankrupt company not only did not need to pay out bonuses to it's executives, but also that if they did, the bankruptcy court could later demand that those bonuses be returned for redistribution to the creditors. Such a payment of bonuses when bankruptcy looms literally amounts to theft from the creditors.

The only difference in situation between the earlier, smaller Lehman Bros. and AIG is that the Treasury stepped in to provide funds that allowed AIG to remain outside the jurisdiction of the bankruptcy court. By so doing, the Treasury also became AIG's largest creditor.

Why Liddy and his attorneys might think the government would not sue to get those bonuses back is a mystery, unless they were depending on the kindness of Timothy Geithner based on his prior history at the Federal Reserve Bank of New York and on the general nature of the incoming personnel at the Obama Treasury Department. That may not have been a bad bet. Liddy many also have believed that they could weather the firestorm of political objections.

On this latter bet, I sincerely hope they were wrong. Those bonuses must not be allowed to stand. That's MY money, and yours, being paid to crooks and fools as a reward for failure. Wall Street cannot be allowed to float along with impunity above the financial disaster that they, specifically, are largely responsible for.

Wall Street must change before it drags America (and the World) back into further financial crises like this one. They have largely created this financial mess. They must not be allowed to do it again. Retrieving those bonuses will not change Wall Street, but it will be a strong signal that the old rules they wrote are dead.

This is going to be a clear battle. It is between them and us, and we'd better win.

Why are each of us paying at least $1000 to bail out the gamblers of the AIG hedge fund?

Barry Ritholtz explains in simple terms what the essential problem is with AIG and the excuses given for bailing out the gambling crooks after they took their losses. You need to go read his post.

If you don't want to click through to his post, he explains that AIG is in fact two different companies.

The first. the old firm, is the largest life insurance company in the world. It is AAA rated because it is state regulated. State regulation means that a company that sells life insurance, where they sell a policy that is basically a promise to pay a certain amount when the insured dies. Because an insurance company collects premiums for years, even decades, before it comes time to pay what it promised, a lot of companies used to keep too little in reserves and simply gamble that they can keep collecting money and not have to pay "until later." So the states inspect life insurance companies and guarantee that they have sufficient reserves to be able to pay the claims and are not wasting those already committed reserve funds elsewhere. AIG not only was regulated, it did everything possible to guarantee that the funds were on hand. It was, and remains, a very conservative AAA rated insurance company and made (and continues to make) good money based on its reputation.

The second company has grown out of the first, and is an unregulated hedge fund that sold CDS and other derivatives into the shadow banking system. Trading on the reputation and AAA rating of the insurance company, they became one of the biggest gamblers on Wall Street. This is the bankrupt company (created because of the disastrous Commodities Futures Modernization Act pushed through the Senate by Sen. Phil Gramm and signed by Bill Clinton. It is this second nest of gamblers, operating under the shadow of the first companies' AAA rating (a scam if there ever was one) that is now bankrupt and has caused the government to nationalize both companies.

Henry Paulson, Secretary of Treasury under Bush and previously Chairman of Goldman Sachs, made the decision that in order to protect the counterparties to the disastrous CDS sold by the AIG hedge fund company the taxpayers were going to have to bail out the unregulated, uninsured gamblers at the AIG hedge Fund side and pay off all those bad CDS even though they were uninsured and had no guarantee of government backing. Ritholtz offfers his suggestion.

What should have been done?
Simple: When we nationalized AIG, we should have immediately spun out the good, solvent life insurance company. It is a highly viable standalone entity.

The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades, the rest go to zero. End of story.

You as a credit default swap gambler have no reasonable expectation that anyone other than the incompetent firm you placed your bet with is going to make good. You had as your counter party another hedge fund. That was the risk YOU — not the taxpayer — assumed. That is was under the roof of a legitimate insurance company is irrelevant.

Right now, we are into this clusterfuck for $166 billion — every last penny of which is a needless waste.

Taxpayers should not be bailing out hedge fund trades. This insanity must cease immediately .

I agree that this is the decision that should have been made. Why did Paulson not make it? Here are three facts to consider:

• From what I have read, no one knows who the counterparties out there who will be damaged are. Bank secrecy, you know.
  
• But I have also read that Goldman Sachs was AIG's biggest customer for derivatives and CDS.
  
• The disastrous decision to pay off the uninsured debts for AIG was made by Hank Paulson, ex-Chairman of Goldman Sachs.

I can certainly connect the dots and see what probably motivated Paulson, one of the very largest crooked gamblers out of the now failed shadow banking system of Wall Street. How likely is it that he is protecting his fellow gamblers?

Whatever you decide about Paulson's decision, one thing is completely clear. Any so-called bank that is too big to fail is also too big to operate without close, intensive government regulation. Such regulation does not imply insuring their product, though. That needs to be made absolutely and publicly clear.

Here's why AIG is costing the taxpayers over $150 billion and counting

The New York Times has a good article that explains why AIG is in so much more trouble than any of the other financial firms. Go read it. "Propping Up a House of Cards" is a good description.

Next week AIG is going to post the greatest quarterly loss that any American corporation has ever reported. It even surpasses the very worst losses by General Motors. Maybe the money spent to prop AIG up would have been better spent helping Detroit auto firms.

Things have changed, but the D.C. media doesn't get it

It's a Disaster! It's Horrible! The Conservatives are coming back into control of the Government after eight and more years of proven incompetence!! Two weeks into office and Obama has lost control of his Presidency and the government!!!

Or at least that's the conclusion that a lot of people seem to be jumping to, based on the ignorant froth and ranting in the political media.

It seems to me that I recall one or maybe two occasions during Obama's campaign for President when they lost a week or so in the media and everyone was screaming that it was a disaster. Then for no reason that was obvious in the media, the situation was turned around. Obama was a real long shot, but he won.

I think that the Obama campaign specifically eschewed the use of the Bill Clinton-style media-focused warroom rapid response operation in favor of deeper understanding and control of the problem. They were using different, none media-centered levers to manipulate public opinion. And somehow the Obama campaign then seemed to almost effortlessly to turn such "disasters" around.

The same small group of people is still running the Obama operation. They didn't miss much. When they did, they quickly adjusted their focus. And since they operated below the media radar, their opponents did not know what was happening to them and found it difficult to prepare a defense.

Many of the same otherwise sensible anti-conservatives were reacting to the Obama "disasters" during the campaign much as they are reacting to this situation, with much noise, anguish and wringing of hands. Remember when McCain had his Palin-bounce after the Republican convention?

These Obama guys didn't expose their strategy in public to the media. (Or if they did, the media never figured it out. Either way, they didn't see it. Why should that change now? When was the last time a media-generated flap like this one was anything more than the result of the fevered imaginations of people looking for something to write or broadcast about to fill a news hole or empty airtime? I don't think the public is being influenced my the media nearly as much as the media is feeding the public what they want to hear so they can get ratings/advertising revenues. The public is already quite set in its opinions and demands. The Obama camp is trying to change those basic public opinions, and they in the past seem to have learned how to actually get what they want in spite of the media.

I don't think those of us who try to keep informed will have a clue what is really going on until after it has happened. No amount of screaming, wailing, shrieking and rending-of-clothes will make a difference. But the same is true for the conservatives.

The conservatives, now, are (probably) badly misreading the situation. They think (as do the writers of the articles Steve is responding to and as do much of the rest of the political media) that they really do think they have caught up with the Obama juggernaut. That's certainly the talk show conceit. But if the pattern holds true, at some time soon the obstructionists will suddenly find that the situation has changed and they have been outflanked. They, along with the rest of us, will not know in advance how or when.

I suspect that we need to learn more patience. I have little doubt that Mitch McConnell and his compatriots are going to learn a touch of humility - to the extent that they are capable of learning anything. Rush and most of his ilk never will.

[ h/t to Steve Benen at Washington Monthly's Political Animal. ]

There's nothing wrong with stimulus projects that don't start immediately.

The Wall street Journal today has a breathless article bemoaning the fact that the stimulus bill may not stimulate jobs right away.

So What? The fact that it may take a while for the highway projects and such to kick in is a feature, not a bug. That's not to say that shovel-ready projects that can start very quickly are not needed, but they mustn't be the only projects considered, and even those will have some delay as they get ramped up to start.

This recession is going to last a while, at least two more years and I am betting even longer. The stimulus won't prevent the recession and bring us back to the status quo ante. It can't. There is too much damage that has already been done to the economy. But a lot of the stimulus is already targeted at social safety net projects through existing agencies anyway and other short term expenditures. Perhaps not enough, but those will hit the economy quickly. The thing is, the stimulus has to also keep on providing stimulus over time because the market is not going to be back - no matter what the government does - to where it supports itself for quite a while. Two years from now would be a highly optimistic projection.

That means that there has to be long term stimulus built in, and not just for individuals. Jobs have to be created and maintained. That's what the highway and infrastructure investments will do. By the way, the problem for businesses is demand for what they produce, not money to meet that demand. Any tax cuts given to businesses that aren't making a profit anyway are wasted. They won't get anything. Similarly, tax cuts and grants to businesses that are making a profit will not help them. They still need increased demand. That demand will largely be government contracts. The assistance to business has to be provided by creating a demand for their products. And for it to start in the future gives them time to ramp up, arrange financing and capital and get contracts.

Remember, no business is going to see that there is a one-time stimulus hitting the economy and ramp up to hire employees and go to work on that basis. They know that the one-time stimulus like last May hits, has a short term effect, and then dies out. If nothing else, no sensible bank will loan money for a business that cannot assure a long term stream of revenue. That's what the infrastructure expenditures will do.

The fact that they will not kick in soon means they can be planned for and businesses can be built based on those plans. Fast, short-term stimulus by itself is close to useless.

Economist Raghuram Rajan warned in 2005 that the financial markets were in trouble

Economist Raghuram Rajan (a well-respected free-market economist) warned the Fed, bankers and economists that the financial system was headed for trouble, and much of what he specified has come to pass. Why was he ignored?

The Wall Street Journal has an article with one explanation and with links to other helpful articles. Here's part of the explanation from the Wall Street Journal:

The episode suggests one reason that the crisis went unchecked: A dangerous all-or-nothing orthodoxy had come to dominate the policy debate, where one was either for free markets or against them.

Another reason that many policymakers may have missed the risks is that macroeconomists didn’t have a good understanding of the changes that were occurring within financial markets and the banking system.

There has long been a marked distinction between economists who study finance and economists who study the broader economy, with limited communication between the groups. As a young Harvard University economist, Mr. Summers argued this was a dangerous shortcoming in a now famous screed, where he unfavorably compared finance specialists to “ketchup economists” who are too narrowly focused on their field of study, while also complaining about general economists tendency to continually rediscover conclusions that the finance specialists had come to long ago.

Finally, many academic economists privately worried that a housing bubble was building, and that it’s bursting would cause severe problems, but didn’t publicize their concerns. An exception is New York University’s Nouriel Roubini, who in 2006 said that the U.S. was almost certainly heading into a recession. Mr. Roubini is often characterized as a grand stander, but Mr. Rajan says that he deserves credit for acting on his convictions.

“Most academics are really reluctant to take part in the public dialog, because the public dialog requires you to have an opinion about things you can’t really be sure about,” says Mr. Rajan. “They fear talking about things where everything is not neatly nailed in a model. They stay away and let the charlatans occupy the high ground.” – Justin Lahart

While it is clear that the free market systems provide better overall results when compared to government run financial systems, it assumes the existence of free markets. That doesn't just mean no government interference. It means that information needs to flow freely and not be suppressed.

A free flow of information is opposed by bankers, often for good operational reasons over and above just the additional cost of collecting it. But a lot of data has to be available about the overall system, and to get that will require government collection and publication. That means regulation, such as that supposedly provided by the SEC. That's why the SEC is ultimately responsible for supervising, collecting and reporting financial information in corporate financial reports, for example. Without that regulation, each company would collect and report what it wanted to in whatever way it desired. Comparison between companies would be impossible. Standardization and enforcement of honest reporting are a clear government function. That's not government interference with the free market. It's government support for it by keeping data available so that it can do what it is supposed to do - flexibly provide the goods and services demanded by consumers and businesses and properly asses the risk that the bankers are taking making loans.

There are good arguments for getting government involved in the financial system other than just being there to try to pick up the pieces when it fails. It certainly has not been there enough for the last thirty years.

The recession will continue to get worse for at least a year

The clearest proof that we are in a Recession has been the way the economy is shedding jobs at the rate of half a million a month. But that's a result, not a cause. There are a lot of causes, and they've built up over the last thirty years.

The causes of the recession include the reckless and incompetent banking out of the deregulated Wall Street, the extreme leverage that all of the investment banks adopted in the assumption that the market would always go up, and the sloppy risk management that ran all through Wall Street in the investment houses, from the large investors and funds and in the insurance companies. The utterly incompetent practices of the rating agencies pervade the entire mess, making an otherwise murky financial world totally opaque. But the core reason for the current recession is still the collapse of the housing bubble. That was the trigger that demonstrated that Wall Street's bankers were blindly and greedily working entirely to fill their own pockets and ignoring everyone else. The result is that right now no one in the big firms trusts anyone else to be able to pay back a loan. It doesn't matter what their financial condition looks like right now because the financial reports can't be trusted, and even if they could, the economy is still trending down and is very likely to provide more, mostly negative, surprises.

The short story is that the economy is not going to turn around until the housing market hits bottom and home values start to turn up. IN much of America that is not going to happen anytime soon, almost certainly not in 2009.

Kevin Drum looks at the reports that housing prices are still plunging, and compares the current value (See the Case-Shiller Index and also S&P/Case-Shiller Indices) to what it will be when the market has worked out the false value of homes caused by the housing bubble. Currently

...the Case-Shiller index is still only down to 158, and we've always known that it's not going to stop much before it gets into the 100-120 range. What's more, rapid declines aren't entirely bad news. We're probably better off getting to 100 sooner rather than later, since economic recovery almost certainly can't start until housing prices bottom out. (...)

Even at 2-3% per month, we've got at least another year before the housing market starts to reach its natural level. Until then, we're screwed.

No amount of "happy talk" by financial sales people, other bankers, politicians, or media financial figures is going to change that.

2009 is going to be a rough year financially.

The WaMu story; how the Wall Street banks screwed up

Wamu's story is rather extreme, but unfortunately, not very extreme. The Executives of WaMu simply took the Wall Street philosophy to its logical conclusion.

As you read these excerpts from the New York Times, notice the motivation of chief executive Kerry K. Killinger. Then notice how he influenced the entire bank by choosing and financially motivating the supervisors who worked for him.

On a financial landscape littered with wreckage, WaMu, a Seattle-based bank that opened branches at a clip worthy of a fast-food chain, stands out as a singularly brazen case of lax lending. By the first half of this year, the value of its bad loans had reached $11.5 billion, nearly tripling from $4.2 billion a year earlier. [Snip]

According to these accounts, pressure to keep lending emanated from the top, where executives profited from the swift expansion — not least, Kerry K. Killinger, who was WaMu’s chief executive from 1990 until he was forced out in September.

Between 2001 and 2007, Mr. Killinger received compensation of $88 million, according to the Corporate Library, a research firm. He declined to respond to a list of questions, and his spokesman said he was unavailable for an interview.

During Mr. Killinger’s tenure, WaMu pressed sales agents to pump out loans while disregarding borrowers’ incomes and assets, according to former employees. The bank set up what insiders described as a system of dubious legality that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers, sometimes making the agents more beholden to WaMu than they were to their clients.

WaMu gave mortgage brokers handsome commissions for selling the riskiest loans, which carried higher fees, bolstering profits and ultimately the compensation of the bank’s executives. WaMu pressured appraisers to provide inflated property values that made loans appear less risky, enabling Wall Street to bundle them more easily for sale to investors.

“It was the Wild West,” said Steven M. Knobel, a founder of an appraisal company, Mitchell, Maxwell & Jackson, that did business with WaMu until 2007. “If you were alive, they would give you a loan. Actually, I think if you were dead, they would still give you a loan.” [Snip]

“I never had a clue about the amount of off-the-cliff activity that was going on at Washington Mutual, and I was in constant contact with the company,” said Vincent Au, president of Avalon Partners, an investment firm. “There were people at WaMu that orchestrated nothing more than a sham or charade. These people broke every fundamental rule of running a company.” [Snip]

“It was a disgrace,” said Dana Zweibel, a former financial representative at a WaMu branch in Tampa, Fla. “We were giving loans to people that never should have had loans.”

If Ms. Zweibel doubted whether customers could pay, supervisors directed her to keep selling, she said.

“We were told from up above that that’s not our concern,” she said. “Our concern is just to write the loan.”

The ultimate supervisor at WaMu was Mr. Killinger, who joined the company in 1983 and became chief executive in 1990. He inherited a bank that was founded in 1889 and had survived the Depression and the savings and loan scandal of the 1980s.

An investment analyst by training, he was attuned to Wall Street’s hunger for growth. Between late 1996 and early 2002, he transformed WaMu into the nation’s sixth-largest bank through a series of acquisitions.

A crucial deal came in 1999, with the purchase of Long Beach Financial, a California lender specializing in subprime mortgages, loans extended to borrowers with troubled credit.

WaMu underscored its eagerness to lend with an advertising campaign introduced during the 2003 Academy Awards: “The Power of Yes.” No mere advertising pitch, this was also the mantra inside the bank, underwriters said.

“WaMu came out with that slogan, and that was what we had to live by,” Ms. Zaback said. “We joked about it a lot.” A file would get marked problematic and then somehow get approved. “We’d say: ‘O.K.! The power of yes.’ ” [Snip]

Branches were pushed to increase lending. “It was just disgusting,” said Ms. Zweibel, the Tampa representative. “They wanted you to spend time, while you’re running teller transactions and opening checking accounts, selling people loans.”

Employees in Tampa who fell short were ordered to drive to a WaMu office in Sarasota, an hour away. There, they sat in a phone bank with 20 other people, calling customers to push home equity loans.

“The regional manager would be over your shoulder, listening to every word,” Ms. Zweibel recalled. “They treated us like we were in a sweatshop.”

On the other end of the country, at WaMu’s San Diego processing office, Ms. Zaback’s job was to take loan applications from branches in Southern California and make sure they passed muster. Most of the loans she said she handled merely required borrowers to provide an address and Social Security number, and to state their income and assets.

She ran applications through WaMu’s computer system for approval. If she needed more information, she had to consult with a loan officer — which she described as an unpleasant experience. “They would be furious,” Ms. Zaback said. “They would put it on you, that they weren’t going to get paid if you stood in the way.” [Snip]

The sheer workload at WaMu ensured that loan reviews were limited. Ms. Zaback’s office had 108 people, and several hundred new files a day. She was required to process at least 10 files daily.

“I’d typically spend a maximum of 35 minutes per file,” she said. “It was just disheartening. Just spit it out and get it done. That’s what they wanted us to do. Garbage in, and garbage out.”

WaMu’s boiler room culture flourished in Southern California, where housing prices rose so rapidly during the bubble that creative financing was needed to attract buyers.

To that end, WaMu embraced so-called option ARMs, adjustable rate mortgages that enticed borrowers with a selection of low initial rates and allowed them to decide how much to pay each month. But people who opted for minimum payments were underpaying the interest due and adding to their principal, eventually causing loan payments to balloon.

Customers were often left with the impression that low payments would continue long term, according to former WaMu sales agents.

For WaMu, variable-rate loans — option ARMs, in particular — were especially attractive because they carried higher fees than other loans, and allowed WaMu to book profits on interest payments that borrowers deferred. Because WaMu was selling many of its loans to investors, it did not worry about defaults: by the time loans went bad, they were often in other hands.

WaMu’s adjustable-rate mortgages expanded from about one-fourth of new home loans in 2003 to 70 percent by 2006. In 2005 and 2006 — when WaMu pushed option ARMs most aggressively — Mr. Killinger received pay of $19 million and $24 million respectively.

WaMu’s retail mortgage office in Downey, Calif., specialized in selling option ARMs to Latino customers who spoke little English and depended on advice from real estate brokers, according to a former sales agent who requested anonymity because he was still in the mortgage business.

According to that agent, WaMu turned real estate agents into a pipeline for loan applications by enabling them to collect “referral fees” for clients who became WaMu borrowers.

Buyers were typically oblivious to agents’ fees, the agent said, and agents rarely explained the loan terms.

“Their Realtor was their trusted friend,” the agent said. “The Realtors would sell them on a minimum payment, and that was an outright lie.”

According to the agent, the strategy was the brainchild of Thomas Ramirez, who oversaw a sales team of about 20 agents at the Downey branch during the first half of this decade, and now works for Wells Fargo.

Mr. Ramirez confirmed that he and his team enabled real estate agents to collect commissions, but he maintained that the fees were fully disclosed. [Snip]

By 2005, the word was out that WaMu would accept applications with a mere statement of the borrower’s income and assets — often with no documentation required — so long as credit scores were adequate, according to Ms. Zaback and other underwriters.

“We had a flier that said, ‘A thin file is a good file,’ ” recalled Michele Culbertson, a wholesale sales agent with WaMu.

Martine Lado, an agent in the Irvine, Calif., office, said she coached brokers to leave parts of applications blank to avoid prompting verification if the borrower’s job or income was sketchy. [Snip]

By the time shareholders joined WaMu for its annual meeting in Seattle last April, WaMu had posted a first-quarter loss of $1.14 billion and increased its loan loss reserve to $3.5 billion. Its stock had lost more than half its value in the previous two months. Anger was in the air.

Some shareholders were irate that Mr. Killinger and other executives were excluding mortgage losses from the computation of their bonuses. Others were enraged that WaMu turned down an $8-a-share takeover bid from JPMorgan.

“Calm down and have a little faith,” Mr. Killinger told the crowd. “We will get through this.” [Snip]

In September, Mr. Killinger was forced to retire. Later that month, with WaMu buckling under roughly $180 billion in mortgage-related loans, regulators seized the bank and sold it to JPMorgan for $1.9 billion, a fraction of the $40 billion valuation the stock market gave WaMu at its peak.

Billions that investors had plowed into WaMu were wiped out, as were prospects for many of the bank’s 50,000 employees. But Mr. Killinger still had his millions, rankling laid-off workers and shareholders alike.

“Kerry has made over $100 million over his tenure based on the aggressiveness that sunk the company,” said Mr. Au, the money manager. “How does he justify taking that money?”

This was a disaster caused by Killinger's greed, his excessive pay and his prospective bonuses. But on a more global scale, it was also caused by bankers hiring people who are motivated by money instead of the satisfaction of growing a long term effective business. The clearest example of that in this story is the role of the advertising slogan "The power of Yes." Policy was set to match the advertising slogan rather than to build a bank for the long term, and the proof of its effectiveness was the short-term growth of revenue (which was "jacked up" by dubious accounting.) Since Killinger had been an analyst himself, it's where that attitude came from - Wall Street. All that counts for the company is the bottom line, and financial reporting is done quarterly and annually, while stock market price is considered daily and even hourly.

Killinger had no interest in anything about WaMu except his salary and his excessive bonuses, and Wall Street's short-term obsession with quarterly performance fed right into that. True, the bonus system itself was clearly poorly structured, but remember that it was structured for Killinger by the Board of Directors who Killinger himself had appointed.

To achieve those bonuses, Killinger made sure that apparently high profit but dubious loans were pumped out at high rates of speed (1)by pressuring employees to do whatever it took to sell the loans and (2) by kickbacks to mortgage brokers who initiated the loans and faked the paperwork to make sure they could be sold to investors, then (3) by running loan approval sweatshops in which it was never permissible to say No because saying No meant the supervisors bonus was reduced. In every case the supervisors were motivated by high bonuses dependent on achieving short term goals by any means possible and by ignoring long term consequences.

As an exercise for the reader, consider how and why Wall Street itself, run by bankers motivated by money (instead of building businesses) and obsessed with the latest quarterly reports, has collapsed. Remember that Wall Street itself is now on life support being funded by none other than Henry Paulson, currently Secretary of Treasury and previously Chairman of Goldman Sachs Wall Street Bank. And Paulson himself is using taxpayer money to bail out his precious banks. The Wall Street attitudes that destroyed WaMu dominate Wall Street and have had much the same effect there as on WaMu.

Bush, Cheney and the conservatives caused the economic crisis and general Wall Street corruption

Iraqi journalist Muntader al-Zaidi threw two shoes at George Bush to remind everyone that Bush and his minions are directly responsible for the deaths of hundreds of thousands of Iraqis. They are also the reason that there are 4 million refugees spread around the Middle East. Eric Margolis points out what else Bush, Cheney and the conservatives are responsible for.

While al-Zaidi was being beaten in prison for his courageous act, off in New York, the fabled financial guru, Bernie Madoff, was accused of bilking clients of an astounding $50 billion while well-fed watchdogs of the Securities and Exchange Commission slept.

Thanks to Madoff and other Wall Street bandits, tens of millions of Americans have lost their life savings and retirement funds, and the word financial system is on the rocks. The storm they created has blown as far east as the Gulf and South Asia.

Ironically, while Bush and Cheney were obsessed by al-Qaida, searching under every rock in Afghanistan for Osama bin Laden, the real danger to America was at home – on Wall Street. The same bin Laden who pointed out a decade ago that America’s economy, its Achilles Heel, would one day collapse.

Wall Street’s financial con men, hedge fund nabobs, and casino capitalists took home a staggering US $33.3 billion of bonuses in 2007 alone thanks to shady financial engineering and peddling fraudulent securities. So far, they have escaped prosecution and get to keep their millions and $30 million South Hampton beach houses. That these fraudsters go unpunished, and get to keep their swag, is unconscionable. [Snip]

The US national debt is twice America’s net worth.

Government and business encouraged a reckless credit binge to which the nation became addicted. Manufacturing fell to only 12% of GDP. Finance – the shuffling of paper – became America’s leading industry, at almost 25% of GDP. Americans saved nothing and had to borrow $1.2 trillion from China and Japan to keep their orgy of consumerism going.

Washington’s response to the financial crisis was panic, then flooding the economy with freshly-printed money in hope something positive would happen. Japan made precisely the same gamble when its bubble economy collapsed in the early 1990’s. Today, Japan has one of the world’s highest deficits and its economy remains stagnant.

Wall Street used the political conservatives to remove government supervision, then they converted the economy into a banker's paradise where bank loans were used for the consumption purchases needed to pump up the economy while their merger-happy parasites shifted real production off-shore to third world countries where they didn't have to share profits with the workers who actually produce the goods the economy has consumed.

The executives of large American companies were bought off with extravagant salaries and bonuses as they consolidated, merged and drove their companies into the ground. Here's Eric Margolis' description of what the car companies have been doing:

Worse is coming. Chrysler and Ford will shut plants in January. GM is next. In spite of the $ 13.4 billion auto industry bailout announced by President Bush last week, many plants may never reopen. Even the mighty Toyota just announced its first-ever loss.

The staggering US auto industry closely resembles the old Soviet Union: economically declining, bereft of new ideas, producing unwanted products, run by dimwitted careerist bureaucrats.

America produces the wrong cars, and far too many. The bloated auto industry must downsize. It has been selling cars only thanks to the steroid of cheap, easy credit – in effect, almost giving them away. Now that the drug is largely cut off, sales have nosedived.

The US economy has been running almost entirely on credit for a decade.

When MBA's, Economists and Lawyers run the economy and it is hard to find students who want to work hard enough to learn the relatively poorly paid jobs of engineers, the economy is being driven into the ground. But that's what Conservatives and Libertarians have been doing since Reagan was elected President.

It'll happen every time conservatives and bankers take control of the economy. The current economic crisis is just the chickens coming home to roost.

The Republican approach to solving the credit crisis, Recession, and foreclosure mess. Obstruct everything.

When Eric Holder was first announced as the Obama choice to be nominated as Attorney General, there was very little complaint. Even most Republicans considered him well-qualified. But now Karl Rove has decided to go after holder's scalp in the Senate hearings, and the Republican Senators are lining up behind Rove to attack. Why?

Steve Benen offers a good discussion, with this ending

It's possible that Rove, if the "word on the street" is accurate, may simply want congressional Republicans to prove a point, picking a fight they're likely to lose in order to set a combative tone for the next two years. The goal, in other words, would be to maintain as toxic an environment as possible, and the Holder nomination would simply be a means to an end.

It sounds like a pretty dumb strategy for an unpopular party facing off against a man who'll enter the White House with a lot of popularity and goodwill behind him.

Dumb? Yeah, probably, but it's what the Republicans in the Senate do. They can't govern, but as their actions to go after the Automotive Worker's Union no matter what their obstructionism costs the nation shows, they are great at obstructing good governance.

Of course, it's not just the Senate Republicans. They are all talking to each other and deciding how they are going to take the Obama administration down. Also from Steve Benen

The Republican National Committee, true to form, is going to comical lengths to try to connect Barack Obama to Rod Blagojevich, reality notwithstanding. The latest initiative includes a three-minute web video featuring a bunch of instances in which the senator from Illinois met the governor of Illinois. The horror.

The video is likely part of RNC chairman Mike Duncan's campaign to keep his job -- he's desperate to prove to Republicans that he can be at least as ridiculous as the other candidates for the post. But outside this context, the Republican National Committee's baseless smear campaign against the president-elect seems unusually cheap, even by RNC standards.

The Republicans have created the mess America is currently in, and their solution to the problems their greed-first anti-union ideology has created is to attack the government that has been elected to try to solve the problems they have created.

Southern Republicans are out to kill off the Big Three bridge loan and the United Auto Workers Union

The new civil war over America's automotive industry has started. Japan, Germany and Korea between them are currently building 18 new automotive assembly plants, all in the Southern U.S., and none are union. This is the motivation behind the efforts by Senators Mitch McConnell and Richard Shelby as well as Representative Bob Corker to torpedo the Big Three bridge loan and kill off both the United Auto Workers and the Detroit auto companies.

This political move will strengthen their political hold on their respective states. It will not particularly damage the Republican Party since they have already lost and written off Michigan, Ohio, Pennsylvania, Indiana, and Minnesota. Besides, even if those states do vote Democratic in the future, the Detroit-based auto companies are going to be shutting down plants and laying off workers in those states as they shrink in the future anyway.

Consider how this is working. The Southern states have ponied up a lot of taxpayer money to get the foreign non-union auto plants to locate there. If the federal government provides taxpayer bail-out money to the Detroit auto companies, then the taxpayers in Southern states are also paying tax money to support the out-of-state auto companies that are competing with their in-state companies. Robert Reich explains further.

As for the clear anti-union bias demonstrated by the Republicans, that's just what they do. They hate unions because it allows workers to put limits on what the executives and investors can do and forces the executives to pay labor more, funds that come directly out of the return to investors. That's the reason for this memo about union-busting sent to Senate Republicans.

As long as the Republicans regain the power they have lost in the last two elections they don't care of America goes into Depression or if foreigners buy up the industrial jobs in this country. It's no skin off their noses. So we can expect even more obstructionism from the Senate Republicans for the next two years. Since the recent two years saw the Republicans conduct the highest number of filibusters ever, to exceed that is going to be something to watch.

Joe Stiglitz lays out the causes of the current severe recession

Nobel-laureate economist Joseph Stiglitz lays out what he considers the five major mistakes that led to the current economic disaster. The problem is that we have undergone a financial system failure, one the result of numerous bad decisions. Here are the bad decisions:

1. Back in 1987 Reagan replaced the world class central banker Paul Volker with the Ayn Randian Libertarian gold bug and free- unregulated- financial market apostle Alan Greenspan. Throughout his nearly two decades as Federal Reserve Chairman Greenspan ran a loose money low interest policy that created excess of liquidity, and he combined this with his belief that financial markets were self-regulating, so he did not provide the banks with the regulations they needed. This led directly to two financial bubbles followed by the current financial freeze-up.
   


2. In 1999 the bankers and financial industry succeeded in removing the Depression era Glass-Steagall Act. The Glass-Steagall Act had separated the commercial banks which made loans from the Investment banks that organized the sale of stocks and bonds. The intent was to keep the bank which sold the equity or bonds of an organization from pressuring its lending arm to loan money to the organization if that organization was getting into financial trouble. The difficulty is that combining the two kinds of banks causes commercial banks - which are supposed to conservatively invest other people's money - are sucked into the high-risk highly-leveraged financial operations of the investment banks. The entire American banking system became a great deal more risky and less able to deal with economic downturns.
   
   Then in 2004 the SEC "... allow[ed] big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process." This was based on the assumption that the big banks were capable of regulating themselves. The results show that they were not. Among other problems, no one bank is capable of identifying the systemic risks that exist when numerous banks all operate similar computer models to manage their portfolios. There is no control that prevents them all from selling the same stock at the same time, an even sure to cause a financial disaster in the market.
   


3. Then there were the two separate tax cuts aimed primarily at the rich in 2001 and 2003. They were supposed to stimulate the economy, but actually did very little stimulation. The economy was primarily stimulated by Greenspan's low interest rates and enlarged money supply, which worked through inflating the housing bubble.
   
   The tax cuts also lowered the capital gains tax but there was no tax on interest. This encouraged investors to borrow money from the home equity to invest and deduct the interest each year on their taxes. The capital gains were not taxed until the investment was sold, sometime far in the future. The already excessive borrowing and lending was being encouraged by the Bush tax cuts.
   


4. Two additional items were the exclusion of stock options from consideration in company's financial reporting and the incentive of the companies selling bonds and mortgage back bonds paying the rating agencies to rate the financial instruments. Stock options were used to pay executives when the market was going up and other payments were used to pay them when the market did not go up.
   
   But the fact that rising markets increased the value of stock options led a lot of companies to fudge the financial reports to increase the value of the options. The fact that the rating agencies were paid by the sellers of the rated financial instruments meant that the rating agencies competed to see who would rate each issue the highest. Both of these factors led to less accurate financial reports. Everyone knows not to trust them.
   


5. The most recent problem has been the bail-out package to preserve Wall Street. The initial package demanded from Congress consisted of three pages that amounted to a demand by Secretary of the Treasury Paulson for $700 billion to be spent in any way he saw fit with no oversight. It amounted to a demand to Congress "Gimme tons of money and I'll take care of the Wall Street banks." (It's no real surprise, with Paulson's attitude, that the Detroit auto makers attempted the same strategy on Congress a few weeks ago.)
   
   When a slightly improved bill was passed right before the election, Paulson then did not know what to do with it. His original plan to buy up bad loans quickly was abandoned as the massive insurer AIG failed and had to be rescued, but nothing that Paulson attempted was directed at the real underlying problems causing the economy and the markets to collapse. No surprise, because the Bush administration and Wall Street all operated on the Neo-Hooverian philosophy that the markets were self-correcting. Stiglitz describes the administration's efforts to turn the economy around with the bail-out this way:

   ...it didn't address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding-and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, "cash for trash," buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America's taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
   
   The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues-they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely-which they hadn't-the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
   
   The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems-the flawed incentive structures and the inadequate regulatory system.

Stiglitz sums up the causes of the current financial and economic crisis this way.

Was there any single decision which, had it been reversed, would have changed the course of history? Every decision-including decisions not to do something, as many of our bad economic decisions have been-is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You'll hear some on the right point to certain actions by the government itself-such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.'s had the same perverse incentive to indulge in gambling.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, "I have found a flaw." Congressman Henry Waxman pushed him, responding, "In other words, you found that your view of the world, your ideology, was not right; it was not working." "Absolutely, precisely," Greenspan said. The embrace by America-and much of the rest of the world-of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

In short, it is as I have been writing since this Recession started, we are living out the predictable results of the Reagan Revolution put into place by the conservative movement.

Any time the financial sector is deregulated the result will always be a series of booms and busts, each larger than the previous one. Markets are NOT self-adjusting, and they can only be protected from themselves by appropriate government regulation.

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Addendum December 11, 2008 11:42 am CST
Digby also posted on this Stiglitz article and she makes a really important point.

Democrats are working very hard to discredit the very concept of ideology in favor of technocratic competence. And I would guess most Americans find that to be something of a relief by now. But I think it's as much a mistake to sweep this under the rug as it is to let bygones be bygones on the torture regime. There is ideology and then there is ideology and people should know the difference. These dogmatic deregulators and market fundamentalists ran a decades long experiment that failed on an epic scale. If the country doesn't understand what went wrong here -- if they get confused by complexity and propaganda --- there is every reason that the free lunch mentality these ideologues promoted will make a comeback the minute we see the light at the end of the tunnel. Ideology matters.