An uninformed mob is practicing McCarthy-style guilt by association, abetted by a failure to report on the AIG Bonuses.

Guilt by association without any shred of evidence is as wrong coming from the online Progressive netroots community as it was from "Tail gunner" Joe McCarthy or is today from Rush Limbaugh and effectively the whole damned House Congressional delegation. It is especially prevalent in the TV so-called news community and in most talk radio, left or right. I find it suffuses everything in discussion on Talking points Memo, too. Something that surprises and saddens me. It's time for it to stop, and for a little real reporting on AIG as it is today along with a lot more logic to begin to appear in the discussions of AIG and the totally mischaracterized "bonus issue!"

I consider myself part of the Progressive online community, a member who generally but not always supports the positions of the Democratic Party because nothing I have seen from Conservatives is either rational or useful. My key issue is the critical need in this nation for universal healthcare, but my training has been in economics, business, military and mostly political history. When Edward Liddy testified to Congress on the AIG mess, I was initially ready to come down on AIG Chairman Liddy as though he were another overpaid over privileged Tobacco Executive selling poison and refusing to admit wrongdoing because it would hurt his pocket book. Instead, I saw a capable, quiet rational man who had come out of retirement to try to deal with the disaster created at and through AIG by others. As Liddy tried to make his explanation to the posturing, uncomprehending louts on the Hearing committee I found that it was Congress that deserves opprobrium. No one listened to Liddy when he told them that the individuals responsible for the Credit default Swaps mess were gone.

Yet I saw, and still see, no evidence that he was lying. Nor can I see that he had any reason to. He was retired, for Christ's sake. He is getting $1 a year for taking the abuse.

I have also watched the distrusting online Progressive community attacking Chairman Edward Liddy as untruthful and untrustworthy with great vigor, and when I earlier posted a TPM cafe blog to defend his testimony it was ignored in favor of Liddy-bashing. Yet,

I saw and still see no evidence to support the assumption that Chairman Liddy was not telling the complete truth in his Congressional testimony.

I see nothing but incomprehension, anger and distrust either online or in the media.

When do we get a little real reporting into what the Executives at AIGFP really do, and what they were actually involved in the Credit Default Swap fiasco? Has anyone bothered to actually report on what the bonuses were supposed to reward the recipients for doing? Every piece of (limited) information I have seen says they were NOT BEING REWARDED FOR SALES. AIGFP is not selling product any more, and hasn't since January 2008 at least. I have written AIG's Public Relations department and gotten no response. Probably they are in a bunker mentality and trust no one now. I don't blame them.

The same kinds of questions applies to the executives like Jake DeSantis who remain at AIGFP and are helping to wind it down by maintaining the investments that are the only asset of that organization. I see no evidence that those individuals had anything at all to do with creating those assets. I don't even see anyone bothering to try to report on the current AIGFP. Everyone there now is just assumed to be Evil! They are being punished simply for working in the same office as Joe Cossano and his Michael Milken acolytes as they took their poisonous work to AIG and trashed a great insurance company.

Now one of them, Jake DeSantis, has gotten tired of being bashed for stuff others did and being demonized as the American public and the general media are doing to all individuals from AIG who carry or carried the job title "Executive." He has resigned from AIG and the New York Times has published his letter yesterday. It is very much worth reading. Here is the beginning:

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

He accuses government officials of persecuting him, and he is right. But I have listened to radio and TV "news" personalities stating the common wisdom of the media as though it were reporting doing exactly the same thing.

When does the mob back off and let someone speak of reality? Is there still any reporting function going on in America? I have seen no evidence of it. Just blowhards on TV and people spewing what they seem to think is their rightful anger on line. Even the NPR reporters speak only gossip from the reporting community - a community which has now sunk into uselessness.

I was used to much better when major newspapers existed and TV was just an admitted provider of headlines and images instead of claiming to report news. Our society lost a lot when CBS fired its last newsman, Dan Rather, abandoned the news business and replaced him with an over aged entertainer who still has no clue regarding what news is or should be.

It’s time to stop kicking people for associating with failure. Someone do some real reporting, or tell me how to get the information out of AIG. I used to delegate that kind of work to reporters, but I guess there are none any more.

The hearings today with AIG's Liddy

Today Congress had AIG's Chairman Liddy in front of them to explain why he approved and permitted the payment of $165 million dollars to executives of the AIGFP division out of taxpayer funds. There is a great deal of public outrage at the appearance made by giving the bonuses, called retention bonuses, on March 15th. Some of the multimillion dollar bonuses were paid to individuals who have already left the job. The video of Liddy's testimony can be found here.

My reaction to his testimony started with disgust at Liddy's initial evasiveness (as I had expected), but then became more sympathetic to the problems Liddy was dealing with. I'd have to say that by the end of his testimony I feel that the media simply has not given the AIG situation a fair break. My reaction frankly surprised me, and it is NOT one I was inclined to make for him. But Liddy is not a tobacco executive.

Liddy was at the beginning evasive on whether he would comply with NY State AG Cuomo's subpoena for the names and amounts of the bonuses which were paid. He seems to feel that the employees have privacy rights that might override AG Cuomo's subpoenas, so Liddy cannot right now commit to compliance with the subpoena. When pressed for a yes or no answer to the question of whether he would comply with the subpoena that NY State AG Cuomo had sent asking for the names and amounts of bonus of individuals getting the payments Liddy would not say either way. He does not seem to believe that is a decision he can make without his attorneys. Upon reflection, I think I would agree with him. That's a Congressman's PR-hungry trap question.

Liddy is not a PR expert, and I have to have sympathy for him. He has neither the training nor the experience in putting public lipstick on a pig to pretty is up when it is already hated by the mob. He is sitting in front of Congress trying to defend actions that he felt were critical to the continued survival of AIG but which run counter to the current wave of public and Congressional outrage.Let me explain that.

The bonuses were apparently contracted for back in January 2008, and it is my reading of Liddy's responses that the retention bonuses were contracted to guarantee that the individuals would work out highly complex books of derivative contracts which require daily evaluation and manipulation until those books could be shut down and closed out without going into default along the way. That would mean that the reference retention was completed in the year 2008, not on-going. Liddy also makes the point that those contracts were written long before he came on the scene last September, and that he would not have written the contracts that way. While the payment of the bonuses occurred this year, the decision to pay them was made in January 2008 upon completion of the work contracted for. These were not performance bonuses in the sense of being for successful sales. They were for completion (performance) of services contracted for in January 2008. They were contracts to get individuals to shut the books of derivatives down without loss of great sums that default would have involved.

Liddy said that he knew making those payments was going to lead to public outrage, but he felt that the work had been contracted for at a price and performed as contracted for so he was committed to making those payments.

That's no doubt what Secretary of the Treasury Geithner and Chair of the Economic Advisers Summers saw when they let it pass without blocking it.

I'm glad that I didn't have to make the decision to make those payments and then have to defend my decision before Congress. Liddy's job has been to parachute in after the credit crunch of last Fall, take over AIG, isolate the destructive CDS and shut them and the derivative books down without losing any more money than necessary (a complex process easily screwed up at extreme cost in case of default), and then sell off the various parts of AIG to pay the Treasury back for the funds that were put into it. The assets are there, and given time and effort to maintain them until the end of the contract, can permit full recovery of their value for the taxpayers. Default would destroy their value and instead create massive losses. The guys getting the bonuses were doing the daily maintenance and shut down. Apparently the crooks who created those contracts were removed in September.

When anticipating the public outrage the bonus payments made, Liddy, top AIG managers, and US government officials were anticipating normal public outrage. The ability and intent of the ignorant Washington media to blow the issue up to "Terry Shiavo" levels to feed to a ravening, angry public was not anticipated.

That's what I gleaned from Liddy's testimony. It's also an explanation that would explain why Larry Summers and Timothy Geithner (grudgingly) approved of the bonus payments before the "loyal opposition" and the Washington Media looking for a scandal blew it up into a media firestorm.

I guess I'll have to shelve my earlier, more paranoid conclusion that the payment of the bonuses was the result of a scam by holdover Financial Products executives. I sort of regret that. My crooks-running-a-massive-scam over non-lawyers was more fun. But Liddy's explanation fits the facts better and requires a lot less criminality.

Josh Marshall, however, is looking into the possible criminal fraud that occurred in AIGFP. He seems to think that there is a RICO investigaion going on. The previous head of AIGFP, Joseph Cassano, was a protege of crooked bond trader Micheal Milken who went to prison for his junk bond dealings.

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Note:

The division that has caused all of AIG's problem, AIGFP, is a separate apparenlty wholly-owned organization called AIG Financial Products.

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.

Who was Bernie Madoff?

Julie Creswell and Landon Thomas Jr. at the New York Times attempted to answer that question. Here is an excerpt from the article:

So who was the real Bernie Madoff? And what could have driven him to choreograph a $50 billion Ponzi scheme, to which he is said to have confessed?

An easy answer is that Mr. Madoff was a charlatan of epic proportions, a greedy manipulator so hungry to accumulate wealth that he did not care whom he hurt to get what he wanted.

But some analysts say that a more complex and layered observation of his actions involves linking the world of white-collar finance to the world of serial criminals.

They wonder whether good old Bernie Madoff might have stolen simply for the fun of it, exploiting every relationship in his life for decades while studiously manipulating financial regulators.

“Some of the characteristics you see in psychopaths are lying, manipulation, the ability to deceive, feelings of grandiosity and callousness toward their victims,” says Gregg O. McCrary, a former special agent with the F.B.I. who spent years constructing criminal behavioral profiles.

Mr. McCrary cautions that he has never met Mr. Madoff, so he can’t make a diagnosis, but he says Mr. Madoff appears to share many of the destructive traits typically seen in a psychopath. That is why, he says, so many who came into contact with Mr. Madoff have been left reeling and in confusion about his motives.

“People like him become sort of like chameleons. They are very good at impression management,” Mr. McCrary says. “They manage the impression you receive of them. They know what people want, and they give it to them.”

As investigators plow through decades of documents, trying to decipher whether Mr. Madoff was engaged in anything other than an elaborate financial ruse, his friends remain dumbfounded — and feel deeply violated.

“He was a hero to us. The head of Nasdaq. We were proud of everything he had accomplished,” says Diana Goldberg, who once shared the 27-minute train ride with Mr. Madoff from their homes in Laurelton, Queens, to classes at Far Rockaway High School. “Now, the hero has vanished.”

If, in the end, Mr. Madoff is found to have been engaging in fraud for most of his career, then the hero never really existed. Authorities say Mr. Madoff himself has confessed that he was the author of a longstanding and wide-ranging financial charade. His lawyer, Ira Lee Sorkin, declined to comment.

During the decades that Mr. Madoff built his business, he cast himself as a crusader, protecting the interests of smaller investors and bent on changing the way securities trading was done on Wall Street. To that end, like a burglar who knows the patrol routes of the police and can listen in on their radio scanners, he also actively wooed regulators who monitored his business.

This seems to be the view that is coming out from the investigations into Bernie Madoff's scheme. In a nutshell, Madoff is a psychopath with a real sense of grandiosity and a well practiced ability to lie, a pleasure in deception, no sense of shame and no sense of regret at what he does to the people he manipulates and steals from.

That seems likely to me to be a set of personality traits that are well-rewarded on Wall Street, and similarly rewarded in politics.

For more information on who Bernie Madoff is and his history, here is a link to the Wikipedia article on Bernie Madoff. It contains an interesting technical description of his alleged investment strategy (it helps to know that ITM means In The Money, ATM means At The Money, and OTM meants Out of The Money. For good, brief explanation of those term, see this wikipedia article.)

It is now coming to light that Madoff probably used the strategy described in the wikipedia article, known as collar trades to bamboozle people who wondered how he was making his profits. It is not clear if he started using it and it failed, leading him to move into the ponzi scheme or he simply didn't use it except as a bamboozlement tool. In addition, he had a sophisticated marketing plan that targeted charitable foundations that are required to pay out 5% of their capital every year. By doing that he had a stable set of buyers who could not withdraw everything at once, and only had to offer that 5% return. This avoided the short term problems that normally cause a ponzi scheme to collapse quickly. Then he sold the investments through his country club connections in an affiliation swindle. The article also goes into how the so-called sophisticated investors and the regulatory agencies were bamboozled. For the latter, the general attitude of laissez faire deregulation that has been predominant both on Wall Street and in Washington helped a great deal.

It has been a Hell of a scheme conducted by a an immoral master schemer, and if the entire structure of unregulated banking on Wall Street had not collapsed, it probably would have continued until Madoff died.

A better way to bail out companies "too big to fail"

A major problem with the Bush/Paulson bailout plan for Wall Street is that after Paulson let Lehman Bros. go bankrupt it frightened the rest of Wall Street and most of the world's investors. Since finance is the most globalized industry in the world, this had world-wide chilling effect on lending. That was a significant factor that led Paulson to go in and hand AIG tons of money instead of letting them go bankrupt, and on Paulson's use of the bailout money to recapitalize failing banks instead of letting them go bankrupt. Unfortunately, recapitalizing the banks hasn't given them any incentive to lend, leading to the current economic downturn that goes far beyond the financial industry. If you don't think so, just go look at the car companies.

Hilzoy, riffing off a two-part New York Times article, discusses the problems that have been created, including moral hazard and propping up failed banking institutions in ways that cause well-managed companies who are not on the government teat to fail.

I've always thought that one way to deal with this would be to find a way of bailing out firms while sacking their managers and wiping out their shareholders. Bankruptcy does this, of course, but when for some reason letting a firm just go bankrupt looks like a bad option, we ought to preserve the basic principle that even if a firm is saved, the individuals -- investors and managers alike -- who either took or profited from those risks should be slammed.

The point here is not punishment. It's creating incentives not to do stupid things. You might think of it as a way of turning the divergence of interests between principals and agents to good account. That divergence creates problems when an agent (e.g., a manager) who is supposed to be working for a principal (e.g., a firm) finds it in his interests to do things that damage the firm -- for instance, taking risks that produce short-term profits, and thus large bonuses for him, but that place the firm itself at unconscionable risk. But I think it can also be used for good.

In the case at hand, we want a firm (or significant parts of it) to survive, and we think that bankruptcy is, for some reason, not an option. We thereby risk moral hazard. But if we ensure that even though bad things do not happen to the firm, they absolutely do happen to its senior management and its investors, we might be able to create a set of incentives that work against taking unconscionable risks. After all, if managers know that if things go badly wrong, they will abruptly lose their jobs and their bonuses, they will not be nearly as likely to take those risks. And if shareholders know that they will not be made whole, they will be more likely to ask just how much risk a company is taking, and not to accept blithe assurances in place of real evidence.

But we haven't done this. We have not asked managers to resign. We have not tried to separate sound from unsound banks, or parts of banks. We have not tried to purge our financial system of the parts that got everyone into trouble. Instead, we have tried to prop up everyone, and to inflict as little pain on the financial wizards who created this mess as possible.

I think this is a profound mistake.

I thought from the beginning that the best solution was to nationalize the bank, wipe out the shareholders and replace the management, but keep the essential operations going. This was the solution used by the Bank of England with Northern Rock Bank failed because of problems with subprime mortgages. Northern Rock bank was nationalized in February 2008.

In my opinion the main reason this was not done was the belief in free market fundamentalism that permeates the Bush administration, the Republican Party, and some misguided Democrats. True it is an extreme decision, but it would put the good of the financial system and the American people as greater priority than the good of the bank managers and shareholders who are currently the ones being bailed out as the economy collapses around them.

Socialism? No. It's not. It's a form of bankruptcy that allows the financial system-critical portions of the failed organization to continue operating as the rest of the organization gets sold off as would happen is Chapter 7 bankruptcy. Face it. AIG was and remains bankrupt, as to most of Wall Street's investment banks. (I haven't heard of one that is still operating successfully on its own. The business model has failed.) AIG is not a going business. It is on life support because it has too many operations that are needed to keep the rest of financial system operating. In the long term the government does not want to be in the bank operating business, but in the short term it has to step in in some way to keep the financial system operating and help it come back to health.

But the health of the financial system is important to the government only because it is necessary to keep the economy operating. The government should not be bailing out failed managers and investors, which is what the current Bush/Paulson bailout operation is doing.

The Bush/Paulson market fundamentalism bailout is both not working, and too damned expensive. It is also rewarding the exact same people who caused the problem with taxpayer money. It's time for a complete rethink of the financial bailout without ideological blinders on.

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.

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.

The bank-induced credit crisis has created the worst problems GM, Ford and Chrysler are having

Really think that the problems the American automotive industry is having come from bad management and excessive labor wage rates? You're wrong.

Yeah, the automotive industry has made a number of bad decisions. One good one, though, was to work with the unions and to off-load the cost of health care for retirees onto the unions. That has already been put into place.

The problem now is that the automobile makers can't get credit to sell their goods. Emptywheel points out that according to GM's restructuring plan presented to Congress, where GMAC could finance 50% of the cars it sold last year, this year they can finance only 6% of the cars.

That's a financial problem caused by the credit crisis, not bad decisions by the automotive management.

Go read Emptywheel for the details. If the government can bail out banks, they can bail out GMC, which is a lot more important than any Wall Street firm, when the bank-created credit crisis threatens the automotive companies. Besides, the loan the automotive companies is asking the government for is a bridge loan to temporarily replace the lending the banks were doing before they created the credit crisis.

GM, Ford and Chrysler have always borrowed the money to lend to customers. It's just that the banks have stopped lending it. They'll start lending again sometime in the future, but it won't help the American automotive industry if in the meantime they are forced into bankruptcy, the pensions they are paying are handed to the taxpayers to pay, and the assets of the American automotive companies are sold to the Chinese at fire sale prices. After that, when the banks decide to go back into the banking business, there will be no American automotive industry left to save, and three million or more American workers will be out of work and out of jobs.

It really is a "bridge" loan. But it's a bridge over a really nasty chasm that the automotive companies cannot traverse without the government's (temporary) help.

Wonder why Bush has been so passive as the U.S. economy collapses? It's because he believes in conservative ideology

The American economy is coming to a halt as the banks shut down lending. Where's Bush? Never has his inherent passivity been so obvious.

Steve Benen states the answer:

...for all the talk in far-right circles about Bush not being conservative enough, some of his most painful disasters came because he refused to stray from his conservative ideas.

This is probably a little too casual an analysis, but it seems this touches on one of the more glaring differences between Bush and Reagan -- both instinctually backed conservative ideas driven entirely by far-right ideology, but Reagan reversed course when those ideas failed. Bush didn't.

When Reagan's tax cuts didn't work, he reversed course and approved significant tax increases (several times). When Reagan's antagonism towards the Soviets didn't work, he reversed course and compromised on arms control.

But Bush, with very few exceptions, could ever own up to his errors.

Right now, he has nothing to lose by accepting a stimulus package, except his ideological pride. So it doesn't happen, no matter how much it might help. His approach to the economy has been a spectacular failure, and when given a chance to go in a different direction, Bush has decided on a legacy of consistency, instead of success.

Bush will go to his grave with two mistaken beliefs. First, he still believes that God appointed him President to do God's will. Second, he will have to believe that his decisions were God-inspired and correct in the long run. He will never accept the fact that the current recognition of his utter failure will be the one that historians tag him with in the far future.

How could he be wrong? He is a conservative who has accepted Jesus Christ as his savior and he has applied conservative principles consistently.

Aristotle: a successful society focuses on the middle class

Those who have too much of the goods of fortune, strength, wealth, friends, and the like, are neither willing nor able to submit to authority....On the other hand, the very poor, who are in the opposite extreme, are too degraded....Thus arises a city, not of freemen, but of masters and slaves, the one despising, the other envying; and nothing can be more fatal to friendship and good fellowship in states than this: for good fellowship springs from friendship; when men are at enmity with one another, they would rather not even share the same path. But a city ought to be composed, as far as possible, of equals and similars; and these are generally the middle classes.

....Thus it is manifest that the best political community is formed by citizens of the middle class, and that those states are likely to be well-administered in which the middle class is large, and stronger if possible than both the other classes, or at any rate than either singly; for the addition of the middle class turns the scale, and prevents either of the extremes from being dominant. Great then is the good fortune of a state in which the citizens have a moderate and sufficient property; for where some possess much, and the others nothing, there may arise an extreme democracy, or a pure oligarchy; or a tyranny may grow out of either extreme — either out of the most rampant democracy, or out of an oligarchy; but it is not so likely to arise out of the middle constitutions and those akin to them.

From Aristotle. Twenty-three hundred years ago Aristotle recognized this truth. Why do modern conservatives not understand it? A democracy and a successful economy both require a strong and economically healthy middle class. Greatly unequal income leads to a plutocracy, or as I have frequently written before, the Latin American model of society in which there are about ten percent very wealthy and 90 percent poor or struggling.

The absence of an effective progressive income tax system and a strong inheritance tax leads directly to the Latin American model of society. The Latin American model fails both as a democracy and as an economy. Politically it becomes a plutocracy in which society is ruled by the wealthy because most power is held by members of wealthy families.

An even greater problem is that a plutocracy with a small middle class has a great deal less total wealth to distribute. Consider the basic macroeconomic equation.

Total Demand = Consumption + investment + government expenditure.

Consumption is about 70%, investment is about 20% and government is the difference, about 10%.

Gross Domestic Product is the same as total consumption. Everything that is produced is consumed at some price. And the goal of producers is to have their goods consumed. Producers plan to produce the amount of goods and services which will be consumed, and so they look primarily at consumers when they plan to produce and invest what is needed to do so. That's 70% of the markets. The consumers reliably spend most of their income on consumption. They are the primary market producers plan to produce for.

Some producers produce investment goods to supply the producers who supply consumers. These investment goods add to total consumption, but the planners who spend those investment goods base their planning on anticipated consumption. Since consumption is 70%, much of investment is also based on anticipated on that 70% if consumption, with a factor built in for changes in anticipated consumption. That is, if consumption is expected to increase, investment will increase based on that anticipated increase in consumption. Unfortunately, if consumption is expected to decrease, then investment will also decrease. So investment spending is largely based on anticipated consumption spending.

Investors spend their money unpredictably, based on how they think they can get better returns in their investments. Those expenditures are too unpredictable to be planned for, so the consumption of investors does not guide other investments. It is not part of the consumption that investors use to guide how they spend money. The key point is that only the 70% of GDP that is consumption predicts future expenditure, and that prediction of future expenditure is the key to how well the economy will function. Assuming constant government expenditure, if investors withhold investment, the economy will drop. If they increase investment, then the economy will increase.

Consumers are mostly the middle class. The poor are too poor to spend much. The middle class still spend most of their income on consumption items, but they can spend on education, health-care and business training. The more well-off consumers will also save money and invest it, but only the more well-off middle class will do so. They don't have that much investment money to spend.

The wealthy are investors. They don't have to spend most of their income to survive. Instead they spend what they need and want to spend as consumption, then invest the remainder to add to future income.


[h/t to Kevin Drum as he riffs off of Andrew Sullivan's sudden revelation. ]

American economy spiraling rapidly downward

The big indicator of the direction of the American economy right now is unemployment. The Wall Street Journal gives the information:

A rash of new job data show the labor market is now the worst it's been since the two prior recessions in 2001 and the early 1990s. One of the starkest indicators is that the number of people who have been unemployed for 27 weeks or more reached two million in September. That's 21% of the total unemployed, and approaching the prior peaks of about 23% in 2003 and 1992. The prospects of these job seekers grow dimmer as layoffs spread beyond the financial, home-building and auto industries.

Also in September, companies saw 2,269 mass layoffs -- in which at least 50 people are let go at once -- more than at any time since September 2001. And while the unemployment rate is at a five-year high at 6.1%, a broader measure of weakness that includes people who have stopped looking for work or whose hours have been cut to part-time is 11% -- the highest in 15 years.

What worries many economists is that labor markets usually reach their weakest point after a recession has ended. During the so-called "jobless recovery" following the 2001 recession, jobs continued to be shed after it was officially declared over. But the current weakness comes as the country heads into a recession that is now forecast to be deeper and longer than previously thought.

"No one thinks we are anywhere near the bottom of this, and we're already rivaling these other recessions," says Heidi Shierholz, an economist at the Economic Policy Institute, a left-leaning think tank in Washington.

This is the key indicator right now. Unemployment is headed sharply downward and will continue for the near future for certain. There is no indication that anything will slow this downward direction any time soon.

Krugman describes the economy and what needs to be done

Paul Krugman today gave a good description of the current economy and how we got here.

Just this week, we learned that retail sales have fallen off a cliff, and so has industrial production. Unemployment claims are at steep-recession levels, and the Philadelphia Fed’s manufacturing index is falling at the fastest pace in almost 20 years. All signs point to an economic slump that will be nasty, brutish — and long.

How nasty? The unemployment rate is already above 6 percent (and broader measures of underemployment are in double digits). It’s now virtually certain that the unemployment rate will go above 7 percent, and quite possibly above 8 percent, making this the worst recession in a quarter-century.

And how long? It could be very long indeed.

Think about what happened in the last recession, which followed the bursting of the late-1990s technology bubble. On the surface, the policy response to that recession looks like a success story. Although there were widespread fears that the United States would experience a Japanese-style “lost decade,” that didn’t happen: the Federal Reserve was able to engineer a recovery from that recession by cutting interest rates.

But the truth is that we were looking Japanese for quite a while: the Fed had a hard time getting traction. Despite repeated interest rate cuts, which eventually brought the federal funds rate down to just 1 percent, the unemployment rate just kept on rising; it was more than two years before the job picture started to improve. And when a convincing recovery finally did come, it was only because Alan Greenspan had managed to replace the technology bubble with a housing bubble.

Now the housing bubble has burst in turn, leaving the financial landscape strewn with wreckage. Even if the ongoing efforts to rescue the banking system and unfreeze the credit markets work — and while it’s early days yet, the initial results have been disappointing — it’s hard to see housing making a comeback any time soon. And if there’s another bubble waiting to happen, it’s not obvious. So the Fed will find it even harder to get traction this time.

So what can be done for the economy?

It should be clear to the most extreme free market ideologues right now that the free market is frozen in place. we call it "the Credit Crisis." What that means is that no one who has money to lend dares lend it to someone who needs cash to operate their business because the lender has no clue which potential borrower is going to go bankrupt tomorrow morning and default on tonight's overnight loan. There is no free market solution to this problem. Worse, while the credit crisis freezes borrowing, the real economy goes into a downward spiral that feeds back into the very pressures that have frozen lending.

The solutions to the current economic problems are Keynsian. John Maynard Keynes laid them out in his 1936 book. Tax cuts will not work because there is no consumer demand for businesses to sell to because consumers don't have the money to buy with, and especially because consumers with good sense are not going to borrow money to jack up consumption spending this time around. The fear of economic collapse already prevents that. So - back to Krugman for the solutions:

In other words, there’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

This is ideologically very unpalatable to the Bush administration conservatives, which is why they have done so little that is effective to head off or ameliorate the current recession.

The conservative ideology has to be thrown aside. It has caused the current economic problems, and it will only make them worse.

Rescue efforts too late to keep the economy running well

The chart originated at the web site Calculated Risk.

Paul Krugman makes a very important point about the rescue actions that Paulson and the administration are trying to set in place. They have acted too late to keep the economy from going into recession. Here's Krugman's exact quote:

This reinforces a point I’ve been trying to make: even if the rescue now in train succeeds in unfreezing credit markets, the real economy has immense downward momentum. In addition to financial rescues, we need major stimulus programs.

What follows is my impression.

Paulson hadn't figured out that the credit crisis that was destroying his beloved Wall Street banks was going to require that he and the Bush administration take over those banks until the British government showed him the way and Paulson watched the market reaction. Even then he did so begrudgingly and with caveats which will probably make it slower and less effect than the bail outs the European bankers are conducting. At least that is what the European reaction to Paulson's actions predicts.

Paulson isn't going to initiate any stimulus actions until it is too late for them to be effective, either. He is a conservative banker who creates and sells deals, not an economic theorist who has a broad understanding of how the economy works and what it takes to change it. The difference in thinking between the two disciplines because obvious when the original "Paulson Proposal" was offered and it became clear that it was a bankers' proposal which no significant economist supported and many actively opposed.

I wonder of David Frum watches Jon Stewart?

OK. Here is Jon Stewart on "The first Great Depression."



Now actually this is quite ahistorical - as you would expect from an American. History in America is what happened last week, and last year never happened. But the renown British historian Erick Hobsbawm points out in his excellent book "The Age of Empire" that the first Great Depression occurred between 1873 and the mid 1890's. Sine America was still an agricultural economy with relatively little international trade outside cotton, this has generally escaped notice in America. But by WW I America had entered international trade in a big way, besides which there are still people around from the 1930's who can argue the severity of the Depression of the 1930's, so the earlier one Great Depression gets no real press.

Still, who am I to actually argue with the great comedian Jon Stewart?

Besides, Stewart's follow up to the above video, Clusterf#@k to the Poor House - The Decabox, is really outstanding comedy.



One pundit on one screen isn't enough? Add another - and another - and another - and another - and...

Is the Decabox enough? Do we need even MORE pundits cluttering inhabiting our TV screen at once?

Please! Don't ask the unthinking TV "news" executives. This is another idea they don't need to hear. They won't think. They'll just try it!

They are TV executives, after all.

Roubini; This will be the worst recession in 40 years

Bloomberg reports what Nouriel Roubini says about the coming recession:

Oct. 14 (Bloomberg) -- Nouriel Roubini, the professor who predicted the financial crisis in 2006, said the U.S. will suffer its worst recession in 40 years, driving the stock market lower after it rallied the most in seven decades yesterday.

``There are significant downside risks still to the market and the economy,'' Roubini, 50, a New York University professor of economics, said in an interview with Bloomberg Television. ``We're going to be surprised by the severity of the recession and the severity of the financial losses.''

The economist said the recession will last 18 to 24 months, pushing unemployment to 9 percent, and already depressed home prices will fall another 15 percent. The U.S. government will need to double its purchase of bank stakes and force lenders to eliminate dividends to save them from bankruptcy, Roubini added. Treasury Secretary Henry Paulson said today he plans to use $250 billion of taxpayer funds to purchase equity in thousands of financial firms to halt a credit freeze that threatened to drive companies into bankruptcy and eliminate jobs.

``This will be the first round of recapitalization of the banks,'' Roubini said. ``The government has to decide to intervene much more directly in the provision of credit and the management of these companies.''

Paulson made it clear today that he is being forced into recapitalizing the banks instead of just buying off the toxic loans, and he hates it. PRI's "The World" reports that Europeans have real doubts as to how effective the American actions to prevent/alleviate the credit crisis will be because of the slow and ideological reaction from Secretary of the Treasury Hank Paulson.

As Ezra Klein says, Pauson is not going to come out of the current crisis with much of a reputation for effective decision-making.

To say Hank Paulson has not done a good job during this financial crisis may be going too far. Since no one else has held this job during this period, there's relatively little compare him to. Maybe others would have made worse mistakes. But we can certainly say that he's proven eminently fallible. His decision to let Lehman Brothers collapse now looks like a catastrophic error. As Dani Rodrik says, "As bad as things were, what caused credit markets to seize up was Treasury Secretary Henry Paulson's refusal to bail out Lehman Brothers. Immediately after that decision, short-term funding for even the best-capitalized firms virtually collapsed and the entire financial system simply became dysfunctional." And Paulson made that decision over the objections of others, like Timothy Geithner, head of the New York Federal Reserve.

Whether it was Lehman's collapse that turned a crisis of liquidity into a crisis of capitalization, Paulson also didn't see that capitalization had become the nature of the crisis. The powers he now promises to use to recapitalize the banks were powers he didn't want. He wanted to buy assets and address a liquidity crisis. He didn't include -- and in fact opposed -- a provision for the possibility that capitalization was the problem. Democrats gave him capitalization powers because they were listening to economists like Jamie Galbraith and Nobel prize winner (it's so fun to say that!) Paul Krugman. Now those powers are central to his strategy and public statements.

Banking is a highly technical business. Political ideology is a risk bankers can afford only during very good markets. The political "free market" ideology as bought into by Alan Greenspan (an Ayn Rand Libertarian) and by Henry Paulson has led directly to to the current credit crisis because in large part Greenspan, depending on his Libertarian ideology, refused to apply the Federal Reserves' powers to regulate underwriting standards used by banks to issue mortgages. Similarly the bank bail-out bill demanded by Paulson only three weeks ago was inadequate because - for ideological reasons - it did nothing to recapitalize the banks. Neither of these poor decisions made for ideological reasons were the only reasons why the American and the international banking system are failing, but those decisions are strongly implicated in causing and delaying effective preventive regulatory reactions to keep the collapse from getting much worse than it had to.

When the honest history of the worst recession since the Great Depression of the 1930's is written it will begin with a statement "The predictable working out of the anti-regulation philosophy embodied in the Reagan Revolution led directly to the massive Recession that started in 2008."

An economy cannot be based on primarily banking and finance. Those functions are themselves derivative of the underlying real economy. This was proven first by the British Empire and now again by the collapse of the American Empire. America's effort to outsource or abandon the real economy and replace it with banking and finance as the leading functions of the economy have now failed. Only bankers, Libertarians and conservative deregulators should be surprised.

The prove it we are now going into the worst Recession in four decades or more.

It was Friday again: 14th and 15th banks closed by regulators

The FDIC Failed Banks List announced yesterday that Meridian Bank, Eldred, IL and Main Street Bank, Northville, MI were closed down yesterday. That's number 14 and 15 failed banks for 2008.

The AOL Money reports

The Federal Deposit Insurance Corp. was appointed receiver of the banks. Main Street Bank, based in Northville, Mich., had $98 million in assets and $86 million in deposits as of Oct. 7. Meridian Bank, based in Eldred, Ill., had assets of $39.2 million and deposits of $36.9 million as of Sept. 25.

The FDIC said all of Main Street Bank's deposits will be assumed by Monroe Bank & Trust of Monroe, Mich. The two offices of Main Street Bank will reopen Saturday as branches of Monroe Bank & Trust.

All of Meridian Bank's deposits will be assumed by National Bank of Hillsboro, Ill. Meridian's four offices in Altamont, Carlyle, and Eldred will reopen for normal hours on Saturday, and its Alton office will reopen Tuesday, as branches of National Bank.

The 15 bank failures so far this year compare with three for all of 2007, and federal banking officials have said that more banks are in danger of collapse.

There is currently no reason given for the failures of the two banks. Bad real estate loans? That's been the prevailing reason for the other 13 bank failures in 2008.

There is also a Meridian Bank in Arizona. There is no connection between this failed Illinois bank and the Meridian Bank in Arizona.

Amid global financial chaos Bush calmly assures America "We're working on it."

October 10, 2008

Stock markets world wide dropped sharply yesterday in spite of the announced bail out plans by both American and European governments. Today the DOW Jones opened 7% lower than yesterday, causing European markets to also drop sharply. This means that the Dow Jones has lost nearly 25% of its value in the last eight day. European markets are reacting in a similar panicky fashion. All the markets, American and European, then recovered some as the Dow Jones led the way for the European markets. The Japanese Nikkei index has also lost a lost nearly a quarter of its value this week.

It's a rather stunning display by the markets of two things. First, the banks world wide are extremely interdependent. Second, that they think the bail out plan by the American government and the plan announced yesterday by the British government to buy stakes in British banks as well as the the coordinated interest rate cuts announced by European governments yesterday are simply too little too late.

Perhaps more significant than the falling stock markets is the continued very high rate of interest that banks are charging other banks for interbank loans. In spite of the coordinated interest rate cuts by governments, the London Interbank Interest Rate (LIBOR) increased slightly to 4.82 percent. This is two percent age points higher than it was last month. The coordinated interest rate reduction by the governments should have lowered the LIBOR, but failed to do so. The banks which might have money to lend simply don't know which other banks are likely to default on the loans, and they don't think the government actions are likely to work any time soon.

In other words, the interbank credit crisis continues apace with no end in sight.

Into this financial mess steps George W. Bush. At 10:25 A.M. EDT this morning Bush stepped up to the microphones in the Rose Garden and announced to the world "We are aware that there is an economic problem and we are working on it." His short talk contained no new news and has had the reaction appropriate to his lame duck status and record low disapproval ratings.

As to the economic problems - bankers and government financial authorities around the world will be working long hours again this weekend, and no one really knows what will come out of the effort.

Economies around the world are headed into recession now primarily because of mismanagement of the financial sector by Wall Street bankers, by the Federal Reserve under Alan Greenspan, and by excessive deregulation from the Washington D.C. politicians they bought. How long the recession will last remains up in the air. Bush's total irrelevance is a bit of a surprise.

---

• Yesterday Nouriel Roubini reported The world is at severe risk of a global systemic financial meltdown and a severe global depression.

  The US and advanced economies’ financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.
  
  On the real economic side all the advanced economies representing 55% of global GDP (US, Eurozone, UK, other smaller European countries, Canada, Japan, Australia, New Zealand, Japan) entered a recession even before the massive financial shocks that started in the late summer made the liquidity and credit crunch even more virulent and will thus cause an even more severe recession than the one that started in the spring. So we have a severe recession, a severe financial crisis and a severe banking crisis in advanced economies.

• Today in the Wall Street Journal the last great Federal Reserve Chief, Paul Volker reports We Have the Tools to Manage the Crisis
  Now we need the leadership to use them. Here is a sample from his article:

  Today, the financial crisis has reached a critical point. The sharp decline in the stock market and its volatility dramatically make the point. More important if less visible, the flow of credit through the banking system and the financial markets is seriously impaired -- even in part frozen.
  
  For months, the real economy, apart from housing, had not been much affected by the developing crisis. Now, a full-scale recession appears unavoidable. Important state and local governments face deficits they may be unable to finance. Recessionary forces are apparent in other important countries and exchange rates are unstable.
  
  Those are facts. [Snip]
  
  Fortunately, there is also good reason to believe that the means are now available to turn the tide. Financial authorities, in the United States and elsewhere, are now in a position to take needed and convincing action to stabilize markets and to restore trust.

  Go read the article to see what the tools are.
  
  
• Calculated Risk (CR)This morning eports CNBC: Treasury Preparing Term Sheet for Recapitalization.
  
  
• Earlier today CR also reported Financial Crisis: A Global Response?, a short summary of four different reports on the reactions to the international credit crisis.

Wall Street's failure and Credit Default Swaps explained - and the future guessed at

Calculated Risk offers a video from "60 Minutes" in which Steve Kroft explains the mortgage crisis, credit crisis, and now the financial melt down on Wall Street and overseas. The key to it is Credit Default Swaps.

There is a short advertisement before the video starts. The video is worth sitting through the advertisement.


Watch CBS Videos Online

This is background information. It does not explain what the bail out legislation is supposed to do to solve the problem. Nor does it explain what the problem is with banks now refusing to lend money to borrowers and especially to other banks. For an explanation of the current problem in which banks are now refusing to lend to anyone, Robert Reich offers as good an explanation as I have seen recently in his recent blog entitled "The Meltdown (Part I)".

Global capital markets have seized up. Confidence is evaporating. Put simply, no lender trusts any borrower to repay, fearing that that borrower won't be able to rely on anyone else to honor obligations. Even banks are hoarding cash, unwilling to lend to other banks. Everyone with any savings is heading for the hills -- for gold, for under the mattress, for wherever savings can be watched. We're witnessing a huge international bank run. We have not seen a global financial crisis on this scale since the 1930s.

What's happened? Put simply, the Bailout of All Bailouts has been a dud, at least so far. Most obviously, it hasn't done what it was intended to do -- reassure financial markets that the Treasury and the Fed would have enough money to handle any financial crisis.

So it's everyone and every institution -- and every country -- for itself. Several nations (Ireland, Greece, Germany) have basically guaranteed all deposits. As a result, global capital is moving their way. They're also thereby creating a new form of socialized capitalism. At the rate they're going, these nations will soon own and run their financial markets, and maybe a big chunk of the world's.

I fault Hank Paulson, first and foremost. He never succeeded in explaining to anyone what exactly he'll do with the bailout money -- how, for example, an auction to acquire mortgage-backed bad debt would work, and whether and to what extent he's planning to recapitalize the banking system. Even now, the American public has no idea what he's up to. Nor, for that matter, do many insiders.

Leadership isn't just about passing a big piece of legislation. It's about explaining and thereby gaining trust and confidence from a public -- including a global public -- that's otherwise afraid and confused. A credible and powerful explanation is necessary right now -- about where we've been, how we got into this mess, and how a particular plan (in this case, the bailout), will get us out of it. Yet Paulson has proven himself uniquely unable to explain anything to anyone. George W. Bush, for his part, is hopeless and hapless. Worse than a lame duck, he's a seriously disabled parakeet, with no remaining store of public trust. Ben Bernanke seems like an able fellow but his capacity to communicate is almost as bad as his predecessor's. Congressional leaders are too busy pointing fingers of blame to be capable of explaining much of anything and summoning confidence. And fewer than three weeks before a national election, both candidates are inevitably caught up in partisan wrangling. Obama does understand what's happening, and could calm global capital markets if he were already president. But he is not president as yet, nor even president-elect.

The leadership vacuum could not happen at a worse time. If credit markets remain frozen, we'll soon witness a huge round of business bankruptcies. We're in completely uncharted terrain.

So what happens next?

That's what "completely uncharted terrain" means. No one knows. But a good guess would start with assuming that economic conditions are going to rapidly get worse between now and the Presidential election on November 4th.

After that?

The problem right now is that no one knows what will happen next, and the current political and financial leadership are all fighting each other for individual advantage. There is no established leader who anyone trusts. Bush, for example, refused to even recognize the housing bubble until recently and when the Paulson Proposal was developed overnight and handed to Congress like the hot potato it was, Bush's name couldn't even be placed on it. The generally unknown Paulson was a much better name to apply to the sales job. And Paulson has also demonstrated no political leadership.

Without leadership, the trust the bankers need to start lending again will not be recreated. The House conservative Republicans who killed the first effort to pass the Paulson Proposal (as directed by Newt Gingrich, in the name of saving the "Free Market" on Wall Street) similarly have no clue. They are fighting to retain the power they have had since Gingrich led the conservative Republican takeover of the House in 1994.

But they are fighting to retain their power and the ability to enforce their ideology, with no regard to what happens to America. That's what happens when a corrupt leadership faces a new threat to the nation. The scrap over power instead of working to solve the problems.

Brad DeLong said last week or so that the problems America face will not be solved until the Republican party is gone. The conservative Republican party needs to be buried, the ground they are buried in needs to be plowed under, and the ground needs to be salted so that they cannot grow back.

I agree with him. The conservative ideology is totally incapable of dealing with the current economic crisis, and the conservatives will continue to obstruct effective actions as long as they are allowed to remain in the government.

After that? Let's hope that the new President can provide some effective leadership quickly - and McCain does not have that capability as the current disastrous condition of his Presidential campaign clearly shows.

We'll have a decent idea what's going to happen by New Year's, I think. But the Recession will last at least the next two years. Beyond that? No telling.