The Fed

Barney Frank and the Fed Bailout Fallacy

Zach Carter — Thu, 09 Dec 2010 10:05:49 -0500

Mike Stark has posted a provocative on-the-street interview with Barney Frank about the recently released Fed data. Frank offers what is now a standard defense of the Fed's bailout operations: Without them, the economy would have collapsed, so critics should just quit whining. But Frank takes this line a step further, accusing liberal Fed critics of playing into the hands of right-wingers who don't want to extend any economic relief to anybody for anything, ever. It's all hooey.

Here's Frank:

"On the whole, frankly, those who were looking for conspiracies and scandals were disappointed. I think the fact is, what you saw was a series of events that worked pretty well and helped the economy . . . . Would you have had the Fed do nothing? At a time when there was no credit available, would you have had the Fed do nothing? That's what the right-wing wants."

First, the "disappointed" critics line massages away the fact that the Fed failed to disclose an enormous amount of information. We still don't know the credit ratings of collateral accepted at some facilities, and we don't know the trading prices of securities they accepted as collateral at any of the facilities. Without that information, we can't determine whether many of these actions were scandalous.

Second, yes-- without major government intervention, the economy would indeed have collapsed. Really, the economy collapsed anyway—two years later unemployment is near double-digits—but it's safe to say the collapse would have been worse had the Fed failed to act. But just because the Fed had to do something doesn't mean it had to do exactly what it did. There were always other alternatives, and the most obvious would have involved attaching some strings to the bailout facilities.

If you want this money, you have to help homeowners avoid foreclosure, or your executives have to take a hike, or you all have to spend the next month wearing a shirt that reads, "I hijacked the U.S. economy and all I got was this lousy t-shirt." Just about anything to make clear that aid from the U.S. government came at a price would have been better than, well, nothing.

Frank spends a good deal of the discussion arguing that liberal Fed critics are catering to right-wing agendas:

"My friends on the liberal side shouldn't always focus on the negative. You're playing into the hands of the right-wing. You know, it's the right wing that thinks this is some terrible conspiracy. This was a case of government intervention. The Federal Reserve is a government entity. It intervened substantially to stave off worse damage than we would have gotten, and I think it's a great mistake for people on the liberal side to engage in this kind of Fed-bashing."

The Fed had extraordinary powers and was not faced with the choice of whether to intervene, but of how to intervene. I fail to see what is so ultraconservative about objecting to free money for fabulously wealthy criminals/fools who wrecked the economy with predatory loans.

Indeed, it seems to me that the ideological pressure here is really on Frank's shoulders. When a traditional liberal icon like Frank endorses a bankers-and-brokers-first policy, the public starts to believe that all Democratic policies are just handouts for Wall Street. This was the biggest reason why voters abandoned Democrats at the polls last month. The stimulus and the bailout were all mushed together in peoples' minds.

But things get really interesting when Stark proposes cutting checks to individuals instead of making loans to the banks. Frank responds:

"You understand how fallacious that is because the money was paid back . . . You acknowledge the money was paid back. Doing what you're suggesting, cutting everybody a check, they wouldn't have paid the money back . . . You're saying instead of lending the banks money, why don't we give it to individuals? Because then you would have had that much more deficit!"

Frank gets the best of this argument because Stark proposes cutting checks instead of making loans. But what if the Fed had offered everyone in the country a loan at zero or near-zero percent interest, on the condition that individuals put up sufficient collateral? This is a (very) charitable way of describing what the Fed did to support the banking system. If the same courtesy had been extended to individuals, I'm sure plenty of people would have defaulted. But certainly not everybody-- zero percent loans are actually pretty easy to pay back. And for those people who did in fact default, the Fed could have simply held onto the collateral to avoid taking a loss.

It's not obvious that this policy ends up working wonders—plenty of people would have been unable to post collateral, and for many who could, the risk of losing the lawnmower in order to pay the heating bill for another couple of months isn't really a great deal. There's no way to gauge whether the additional spending generated could have brought the unemployment rate down very much. And of course, personal loans wouldn't have helped debt-burdened homeowners very much. But then again, neither did any of the policies the Fed actually implemented!

And it is obvious that the government wouldn't end up taking a big loss on a big direct-lending-to-actual-people policy. As a result, crowing about the government turning a profit on the Fed's bailout facilities is really very silly. That doesn't stop Frank from doing it, however:

"It came back with interest! . . . The Fed is making money off that."

In short, you don't have to endorse Michelle-Bachmann-dystopia to object to the Fed's bailouts. Watch the whole thing:

The Fed Lied About Wall Street

Zach Carter — Thu, 02 Dec 2010 17:09:24 -0500

The data from the Federal Reserve audit is full of frightening revelations about U.S. economic policy and those who implement it. When Wall Street went off the rails in the fall of 2008, policymakers told the public we had a certain kind of problem, knowing all along that the actual nature of the problem was very different—and far more severe. This was a terribly destructive lie. Had policymakers fully explained the scope of Wall Street’s 2008 troubles, today’s problems with foreclosure fraud would simply not exist.

Here’s the basic issue. As Lehman Brothers, AIG and other major financial firms teetered on the verge of collapse, the Fed and the Treasury Department insisted that the trouble on Wall Street was one of “liquidity.” That’s a finance term meaning, “the banks are fine, but everybody is confused.” Banks have lots of money in long-term assets, but can’t convert those long-term assets into short-term cash.

In retrospect, that view was clearly an error. The bank held hundreds of billions of dollars worth of subprime mortgage assets, which were not merely worthless in the panic-stricken view of the financial mob, but worthless, full stop. At the time many people argued that the financial system faced not a liquidity crisis, but a liquidity crisis and a solvency crisis. That is to say, even if the government had helped the banks deal with day-to-day problems, the banks were still fundamentally unable to pay their debts. They were not merely illiquid, but insolvent.

I stole this perspective on the financial crisis from Mike Konczal, and the same basic framework was portrayed very forcefully by Nobel Prize-winning economist Paul Krugman in 2008 and 2009. Krugman’s major concern was that the U.S. would end up with a handful of dominant “zombie banks”—firms which were kept alive by government aid, but which were fundamentally insolvent, and unable to support the economy with productive lending.

The truth has been far worse than Krugman predicted. Not only are today’s major banks unable to support the economy, they are actively sabotaging the middle class with fraudulent foreclosures. This is a direct result of policymakers’ failure to address the fundamental solvency problem in 2008 and 2009. And what’s worse, it appears that the Federal Reserve was aware of the solvency problem, even as its top officials publicly insisted that the bailed out banks were fine.

To fix a liquidity crisis, the Fed has had a longstanding policy of offering short-term, low interest loans. In exchange for these loans, the Fed demands high-quality collateral. That’s as it should be: if a bank is truly experiencing a liquidity crisis, there is a public interest in keeping it afloat so it can meet its financial obligations.

And so in 2007 and 2008, the Fed created several facilities to ease liquidity based on this principle. The trouble is, starting on Sept. 15, 2008—right when Lehman Brothers was going under—the Fed started accepting total garbage as collateral for its loans. Not just a little bit of garbage, either. According to data released by the Fed yesterday, the central bank accepted $1.32 trillion in collateral rated “junk bond” status or lower, starting Sept. 15, through it Primary Dealer Credit Facility alone. That compares to $8.95 trillion in total loans extended through the Primary Dealer outlet from March 2008 through May 2009. From Sept. 15 onward, the Fed lend out $7.60 trillion through this window alone, meaning that a full 17 percent of its lending from this point was backed by junk bonds, or worse.

These total figures are somewhat exaggerated—the facility in question offered overnight loans, and many banks chose to roll-over their loans from one day to the next. Nevertheless, the collateral comparison is apt. However you measure it, nearly one-fifth of the Fed’s lending through this facility was backed by junk bonds.

What does all this mean? The Fed knew it was facing a solvency crisis, even as it publicly insisted that Wall Street was merely dealing with a liquidity issue. If the Fed had truly believed Wall Street only faced liquidity troubles, it would not have allowed major banks to pledge junk bonds as collateral for loans. And indeed, for months, the Fed did not allow banks to put up junk bonds as loans. But things changed when Lehman Brothers went under.

The Fed and the Treasury had to do something in the fall of 2008. But to fix liquidity without fixing solvency was a grave error. By denying the solvency crisis, major bank executives who had run their companies into the ground were allowed to keep their jobs, and shareholders who had placed bad bets on their firms were allowed to collect government largesse, as bloated bonuses began paying out soon after.

But the banks themselves still faced a capital shortage, and were only kept above those critical capital thresholds because federal regulators were willing to look the other way, letting banks account for obvious losses as if they were profitable assets.

So based on the Fed audit data, it’s hard to conclude that Fed Chairman Ben Bernanke was telling the truth when he told Congress on March 3, 2009, that there were no zombie banks in the United States.

“I don’t think that any major U.S. bank is currently a zombie institution,” Bernanke said.

As Bernanke spoke those words banks had been pledging junk bonds as collateral under Fed facilities for several months. From March 4, 2009 through May 12, 2009, when the Fed data stops, only two institutions borrowed money from the Fed’s Primary Dealer window: Bank of American and Citigroup. They borrowed almost every day, pledging junk bonds as collateral. Bernanke either knew this, or should have known it as a major public official.

This is the heart of today’s foreclosure fraud crisis. Banks are foreclosing on untold numbers of families who have never missed a payment, because rushing to foreclosure generates lucrative fees for the banks, whatever the costs to families and investors. This is, in fact, far worse than what Paul Krugman predicted. Not only are zombie banks failing to support the economy, they are actively sabotaging it with fraud in order to make up for their capital shortages. Meanwhile, regulators are aggressively looking the other way.

The Fed had to fix liquidity in 2008. That was its job. But as major banks went insolvent, the Fed and Treasury had a responsibility to fix that solvency issue—even though that meant requiring shareholders and executives to live up to losses. Instead, as the Fed audit tells us, policymakers knowingly ignored the real problem, pushing losses onto the American middle class in the process.

Fed Audit-- Liveblog on Data Dig

Zach Carter — Wed, 01 Dec 2010 12:23:17 -0500

Just starting to parse through the Fed audit data. Looks like the Primary Dealer Credit Facility is predominantly a bailout for Citigroup and Bank of America. More to come . . .

UPDATE:

Looks like in the early days the Primary Dealer Credit Facility was almost exclusively used by Bear Stearns, Countrywide, Barclays and Cantor Fitzgerald. At this point, Bear and Countrywide were JPMorgan Chase and Bank of America, respectively. From April 16, 2008 through July 30, 2008, these four firms were the only ones to access the PDCF, and they did it every day the facility was open.

UPDATE 2:

Until September 15, 2008, the collateral accepted by the Fed at the Primary Dealer Credit Facility remained relatively robust, in terms of credit ratings.

On September 15, as Lehman Brothers and everything else hit the fan, the Fed began accepting total garbage as collateral. Including CCC-rated (beyond junk bond status) collateral from JPMorgan Chase, Citigroup, Lehman Brothers, Goldman Sachs and Morgan Stanley.

UPDATE 3:

The Fed accepted CCC-or-lower collateral under the Primary Dealer Credit Facility from September 15, 2008 until May 12, 2009. A total of $490.9576 billion in such collateral was accepted. That's billion, with a "b." And you thought TARP was a bailout.

UPDATE 4:

The Fed began accepting a wide variety of junk bonds-- securities rated BB and below-- as collateral beginning September 15, 2008. Totals to come.

UPDATE 5:

The Fed accepted a total of $1.31 trillion in junk-rated collateral between Sept. 15, 2008 and May 12, 2009 through the Primary Dealer Credit Facility. TARP was nothing compared to this.

UPDATE 6:

Anyone suggesting that the Fed's "emergency lending" facilities are just part of macro or monetary policy is kidding themselves. The Fed refused to accept junk-rated collateral until Sept. 15, 2008. When it became clear that Lehman was going off the rails, they started accepting junk-rated collateral-- even from Lehman Brothers itself!

That makes it very clear that the Fed was bailing out these firms in the midst of a crisis. They made a conscious decision to lower their lending standards in order to save big Wall Street firms with no strings attached.

UPDATE 7:

From ~~February 24, 2009~~ March 4, 2009 through May 12, 2009, Citigroup and Bank of America were the sole companies to borrow through the Fed's Primary Dealer Credit Facility, and they used it every single day. A total of 16 firms were eligible for the facility.

UPDATE 8:

This Fed Audit data should shame all of the conventional-wisdom Democrats out there declaring TARP a success because of the recent CBO score. To put it mildly, these folks are totally missing the point. TARP was a "success" in large part because of the Fed's no-strings-attached efforts. And we now know that the Fed was willing to accept junk-- literally junk bonds-- as collateral for its no-strings-attached loans.

TARP and the stress tests only "worked" insofar as they convinced banks that the government would shoulder infinite future losses from the banking sector. We're now paying the price for that commitment in the form of massive foreclosure fraud, in which untold numbers of borrowers are being improperly kicked out of their homes in the name of bank profits.

TARP failed. Its losses are so low because the Fed stood behind the banks, allowing them to play one arm of the government against the other. Even if we had "turned a profit" on TARP at its formal interest rate without Fed malfeasance, look what we got in return. In the Depression, FDR secured massive national foreclosure relief and still turned a profit. Today, we have a predatory program called HAM

UPDATE 9:

When crisis goes nova in Sept. 2008, two Merrill Lynch facilities start borrowing everything they can from the Fed. They're called "Merrill Lynch Government Securities Inc." and "Merrill Lynch Government Securities Inc. -- London"

So far as I can tell, the distinction between London and the U.S. is just an excuse for Merrill to take double advantage of the Fed's bailout facilities. Both borrow every single day once the crisis sets in, and both pledge loads of junk bonds as collateral.

UPDATE 3:30

Goldman Sachs also used foreign subsidiaries to double-down on Fed bailout facilities. Just like Merrill, they hae a U.S. unit taking out loans, and a London unit.

UPDATE 3:45

Morgan Stanley also opened a London subsidiary to double-down on Fed bailout facilities, although it appears they caught onto the scam later than Goldman and Merrill.

UPDATE 3:51

Nope, my mistake. Morgan, Merrill and Goldman all came to the foreign sub conclusion at about the same time. Morgan Stanley and Goldman Sachs began simultaneously begging from the Fed from New York and London on Sept. 22, 2008, while Merrill Lynch got the idea on Sept. 23, 2008.

4:10

Moderately funny. Citigroup, home of Clinton Treasury Secretary Robert Rubin, didn't figure out the foreign subsidiary scam until Nov. 24, 2008, a month after its competitors.

4:17

By Nov. 28, 2008, only Citi, BofA/Merrill and Morgan Stanley/Mizuho were accessing the Fed's Primary Dealer Credit Facility. By March 4, Morgan/Mizuho had bowed out, and the bailout program was used exclusively by Citi and BofA.

4:50

BofA and its predecessors Countrywide and Merrill Lynch accessed the Fed's Primary Dealer Credit Facility 416 times, for a total of $2.783 trillion. A full $476 billion in junk bonds were pledged as collateral for the loans, or roughly 17 percent. The PDCF is an overnight facility, so a lot of these loans are simply being rolled over day-to-day. Nevertheless, it's a staggering amount of money, with an enormous degree of totally worthless collateral being pledged to justify it.

The Fed and Treasury had to do something in 2008 to keep the financial system from falling off a cliff. But by treating the problem as a liquidity issue with no strings attached, they didn't solve the underlying problem: lots of very big banks were simply insolvent.

Now, over two years after TARP, it's clear that many of our largest banks are only "solvent" due to accounting irregularities being approved by regulators that are terrified of letting big banks go under. As a result of this fear, we aren't really regulating our banks.

So Paul Krugman's prediction of zombie banks creating a drag on the economy has not come true. The reality is, in fact, much worse. Krugman foresaw zombie banks that didn't lend due to capital concerns, preventing the recovery from getting off the ground. We're seeing plenty of that, but we're also seeing zombie banks actively prey on the economy through the foreclosure process in an effort to repair their balance sheets. The zombie banks aren't just failing to boost the economy, they're actively sabotaging it.

I need to eat.

9:30

Mike Konczal deserves a citation here. Everything I said above about liquidity vs. solvency comes straight out of his financial analysis playbook.

GAO: Bank Regulators Not Even Looking At Foreclosure Practices

Zach Carter — Tue, 30 Nov 2010 15:13:00 -0500

A rather nauseating statement from a Government Accountability Office report on foreclosures:

Because they generally focus on the areas with greatest risk to the institutions they supervise, federal banking regulators had not generally examined servicers’ foreclosure practices, such as whether foreclosures are completed; however, given the ongoing mortgage crisis, they have recently placed greater emphasis on these areas.

You read that right. Bank regulators in the United States were not even looking at foreclosure practices before the media latched onto the foreclosure fraud outbreak. The Office of the Comptroller of the Currency and the Federal Reserve acknowledged this in hearings two weeks ago, but it's still harrowing to see the degree to which mortgage banking remains totally free of oversight, even after it drove the global economy off a cliff.

The rest of the report is about banks abandoning properties instead of proceeding with a foreclosure sale. Kind of sick-- throw a family out, then just abandon the house altogether, don't even bother to sell it. The GAO says it's not happening too much, but any sane businessperson would make sure that it never happens. A simple loan modification would cut everybody's losses here, but the banks can't be bothered with that. And nobody is bothering the banks about it.

You may recall that there was a tremendous legislative battle earlier this year over the creation of a new Consumer Financial Protection Agency. The bank lobby and regulators at the Fed, the OCC and yes, even the FDIC, all argued that we didn't need it, while essentially everybody else said we did. But the existing regulatory chiefs all made essentially the same argument against the CFPA: We have several regulators who oversee consumer protection, and they're all just great at it. Creating a new agency that focused only on consumer protection would be end up destabilizing the financial system, because regulating consumer protection without looking at bank safety and soundness would jeopardize bank capital levels.

This argument was absurd at the time, most obviously because the existing regulators were simply awful. They totally failed to restrain predatory mortgage lending for nearly a full decade precisely because they considered "safety and soundess" regulation to be their only job. Safety and soundness was construed as "bank profitability"—if a bank had lots of money, it was less likely to fail. In practice, that meant regulators would allow consumer protection violations so long as they made money for the bank. With the mortgage crisis, this consumer protection failure ultimately lead to a safety and soundness catastrophe, but that's not actually very common. Usually predatory lending is very profitable, which is why banks do it.

So what happened after all the top regulators went out in public and repeatedly screamed that we absolutely can't allow them to lose their consumer protection authority? They totally ignored consumer protection regulation. Look at the excuse that bank regulators fed to the GAO (emphasis mine):

Because they generally focus on the areas with greatest risk to the institutions they supervise, federal banking regulators had not generally examined servicers’ foreclosure practices.

Translation: Even after consumer protection violations wrecked the largest banks in the country, we still don't look at consumer protection unless it actually hurts a bank's bottom line, right away, right now.

The amazing thing here is that the legal liabilities from these foreclosure abuses once again could be putting bank solvency on the line. Global economy to Elizabeth Warren: Help!

Also, the link above is to a summary of the GAO report. The full report is here.

Will The Fed Withdraw Its Foreclosure Predator Bailout?

Zach Carter — Tue, 30 Nov 2010 13:17:48 -0500

Yesterday, The New York Times ran an editorial opposing a new Federal Reserve proposal to eliminate predatory lending penalties. The rule under consideration is the same obscure regulation I blogged about a couple of weeks back, and it's very encouraging to see major publications paying close attention to the technical workings of regulatory policy. Usually even important rules like this slide right by under the media radar, but this particular rule is a major signal as to how policymakers will deal with the ever-escalating foreclosure fraud problem. Will the Fed and it's allies stand up for homeowners and the rule of law, even if it means sticking it to the banks? Or will they continue to screw homeowners to preserve capital at too-big-to-fail behemoths?

The Times editorial makes essentially the same argument I did, and it's totally correct, if I do say so myself. Right now, when a bank is found guilty of illegally withholding information about a mortgage from a borrower, the borrower can "rescind" the loan. They still have to pay off the principal balance, but all profits that the bank would have reaped from the loan—interest, fees, etc.—are nullified, and the bank loses its right to foreclose on the borrower.

This process is called "rescission," and it reflects a standard feature of contract law that dates back several centuries. If a contract is fraudulent, the minimum proper remedy is to undo the contract. With mortgages, this means the bank gets its money back, but it doesn't get to keep the profits it would have made from an illegal loan. Restricting borrower access to information is a key tactic in predatory lending, and as The Times notes, rescission is essentially the only federal remedy available to homeowners who have been defrauded.

The Fed is now attempting to eliminate this remedy due to "concern over banks’ compliance costs," as The Times describes it. This is a rather generous description of the proposal, given the depth and severity of the foreclosure fraud outbreak currently sweeping the country. There are three key places that banks can commit fraud in the mortgage process—when the mortgage is pushed on a borrower, when the mortgage is sold to an investor, and when a bank is collecting payments or foreclosing. Much of the fraudulent activity we see among investors and in the foreclosure process helps cover-up fraud at the original sale of the mortgage to a borrower.

If borrowers cannot obtain relief through rescission, then they have little reason to press claims about fraud in other parts of the mortgage process. This is an enormous gift to the nation's four largest banks, with major public policy implications that go beyond the very critical problem of rampant, illegal foreclosures. If borrowers don't press claims about foreclosure fraud, investors will not be able to access key information for filing lawsuits.

The single gravest threat to bank balance sheets (and bonuses) is a slew of lawsuits from mortgage bond investors. Banks packaged lousy mortgages into bonds and sold them off to investors, often without making proper disclosures to the investors, who subsequently lost a ton of money. Investors are currently organizing to take action against the banks, and in many cases have obvious, open-and-shut fraud claims against Wall Street titans if their cases come to court. But the key is actually getting their case before a judge. To do that, 25 percent of the investors in any bond have to file a lawsuit together. For multi-billion-dollar bond issues, that requires coordination among dozens of different institutions, often from different countries. That's a difficult technical feat, but investors will be much more likely to participate if they have lots of evidence of fraud before them. That evidence is produced by homeowners pressing their own individual cases. If homeowners don't go to court because they can't get anything out of it, the investors will have a harder time organizing.

So the Fed isn't really concerned about "compliance costs." This is, in fact, a rather absurd notion. Predatory lending is a form of theft. Imagine if the shoe were on the other foot, and the bank was being robbed. Can you imagine bank robbers complaining about the "compliance costs" of having to give back stolen cash? They would be laughed out of any courtroom. But the Fed is not only seriously considering such an argument from bankers, it is actively promoting it as official public policy.

The Fed's proposal is itself illegal. Regulators like the Fed have the right to make rules that enforce laws passed by Congress. When Congress passed the Truth in Lending Act in 1968, it explicitly granted borrowers the right of rescission as a remedy for predatory lending. The Fed is now attempting to interpret that statute to mean that, actually, borrowers have no such right. If the Fed's proposal is enacted, it will be a 180-degree reversal of the law on the books.

It's hard to imagine a way for the Fed to disgrace itself any further than it did by failing to rein in the mortgage mess over the past decade. But if it proceeds with this effort to protect banks that engaged in predatory lending, it will not only be guilty of falling down on the job and looking the other way, but of actively encouraging illegal mortgage lending.

Whether the Fed withdraws its proposal or not, this is not what bank regulators are supposed to do, especially in the middle of a foreclosure fraud crisis. Elizabeth Warren and the Consumer Financial Protection Bureau will get formal jurisdiction over these issues in July 2011, and it won't come a moment too soon. The Fed is proving, once again, that it cannot be trusted to protect the middle class from illegal abuses. Or even simply follow the law itself.

Ben Bernanke and Conservative Economic Sabotage

Zach Carter — Tue, 23 Nov 2010 16:01:39 -0500

The Republican Party's newfound political assault on Ben Bernanke is a grim reminder of the actual conservative economic agenda for the next two years. The midterm elections taught Republicans a destructive lesson: With Democrats in power, the worse the economy gets, the better Republicans do at the voting booth. Economic sabotage is the essential Republican strategy for winning the White House in 2012. They will block every effort to actually improve the economy they can, and make a big show out of criticizing any economic aid they can't block.

The Party's hypocrisy on the economy has been clear for months. They scream about the deficit when a few billion dollars worth of unemployment benefits are at stake, but deficit worries disappear when the $700 billion in Bush tax cuts for the rich are under discussion. When they do muster an economic defense of the Bush regime, it's the line that a recession is no time to raise taxes. This is a fundamentally Keynesian argument—a bad Keynesian argument, but Keynes through and through. And it's the same argument Republicans and conservative pundits deployed to enact the Bush tax cuts back in 2001 and 2003. It's a bad argument because tax cuts aren't particularly effective at stimulating the economy, especially when they target the rich. Unemployment benefits, in fact, would be a staggeringly more efficient mechanism, as former John McCain adviser Mark Zandi has repeatedly detailed.

Which brings us to Ben Bernanke, the most conservative candidate that President Barack Obama could possibly have appointed to head the Federal Reserve. The current Republican uproar against Bernanke shields the fact that he is, in fact, a Republican himself. He was a top economic adviser to President George W. Bush, who appointed Bernanke to the Fed's Board of Governors and eventually to Fed Chairman post. When Obama reappointed him to the job, a handful of Republicans objected on the grounds that Bernanke had approved generous bailouts of financial firms. Nevertheless, a majority of Senate Republicans still voted to reconfirm him—making his reappointment the most popular decision that Obama has made among Republicans. Republicans got their man, and they let him through.

But now Bernanke is taking a beating from conservative pundits and Republican politicians for the Fed's latest round of "quantitative easing." It's not just coming from the crazies, either. Even relatively milquetoast Senators like Bob Corker of Tennessee have threatened to strip the Fed of its mandate to promote full employment. Don't worry about whether people actually have jobs, you nervous Fed ninnies. Just focus on inflation, whatever the economic cost.

The timing of this argument is particularly instructive, since, right now, we are not experiencing inflation. We are, in fact, dangerously close to deflation, as rampant foreclosures continue to drive down home values.

But the Republican assault is not an attempt to fix the economy or even say intelligible things about the economy. It's straightforward political payback. Bernanke is directly contradicting the Republican midterm message, exposing the Republican anti-spending mantra as an economic disaster, and Republicans aren't going to stand for it.

Republicans just convinced a lot of voters that socialist intergenerational thief Barack Obama caused high unemployment with his budget busting economic stimulus. Government spending is the villain-- not the Wall Street excess or predatory lending that Republicans shepherded for eight consecutive years, not even the generous bank bailouts that Republicans approved.

But last week, Bernanke gave a speech emphasizing that the Fed's actions to revive the economy require Congressional help. Quantitative easing is basically an interest-free credit card for the U.S. government, allowing it to borrow money at negative real interest rates in order to spend that money on job-creation efforts. Since already record-low interest rates on Treasury bonds haven't been enough to convince congress that now is the time to borrow and spend, the Fed is driving those rates even lower. But for this credit card to work, Congress has to use it. It has to enact further economic stimulus, spending money to create jobs.

This kind of talk makes Congressional Republicans look stupid. Now it's not just Barack Obama and his anti-colonialist father who support government spending to boost the economy, it's a very high-profile Republican economist, too. Obama can't be a radical socialist when top-ranking Republicans agree with him. And God forbid that Bernanke's recent statements actually create pressure for Congress to do something about jobs. Lowering unemployment means reelecting Obama.

None of this is to say that Bernanke is some kind of liberal savior, or even a particularly good Fed Chairman. He oversaw bailouts that could have been much more effectively designed, to say the least, and he has not been open about those packages with Congress or the public. He's resisted calls for Fed transparency and waged misleading attacks on financial reform legislation.

But he isn't toeing the Republican Party line on Big Bad Government Spending. And Republicans are going to keep hammering him until he does.

Conservatives Are Clueless On Jobs

Zach Carter — Mon, 02 Aug 2010 15:00:45 -0400

Rep. Paul Ryan, R-Wis., is the Republican Party's latest effort at putting forward a credible economic ideologist. His recent interview with Ezra Klein reveals this effort to be a complete failure. Ryan's views about the financial sector completely contradict his statements about the federal budget deficit, making his policy prescriptions as an incoherent mess of meaningless talking points.

Paul Krugman and Matthew Yglesias do a nice job explaining how Ryan really doesn't know what he's talking about. But the conservative politician makes things much worse for himself when he attempts to defend himself against these criticisms. Here's Ryan, emphasis mine:

I'm not convinced – but intrigued – with the debate over the carry trade that is going on right now. What I mean by that is banks can borrow at essentially no cost from the Fed, plow the money back into no-risk Treasury securities, and earn that modest spread. This dynamic, while obviously helping banks recapitalize, could be curbing capital deployment in the private sector.

There's no question that banks are doing this. At the moment, banks can borrow from the Fed for 0 percent, and invest that money in U.S. government bonds. A 10-year bond pays the bank interest of 2.91 percent right now, with the 30-year bond closer to 4 percent. Since there is no funding cost, every basis point of that return is pure profit for the bank. It is a "modest spread," to be sure, but as Ryan says, it's all risk-free profit.

Banks are doing it because they know the U.S. government isn't going to default on its debt. Although 2.91% isn't an amazing return, it's a sure thing, and it's much less risky than lending to businesses during a deep recession. Banks can borrow as much as they want from the Fed, and they can invest that free money in as many Treasury bonds as they want, allowing them to make a killing in millions of small installments. It's called a carry-trade, and it's a huge part of what financial analysts are talking about when they say banks are "earning their way back to health." One arm of the government—the Fed—is enabling banks to make tons of money from another arm of government—the Treasury.

Unfortunately for Ryan, this behavior is totally inconsistent with everything else he says during his interview with Ezra. Ryan makes an aggressive push to claim that the U.S. budget deficit is a terrible, terrible problem that puts the economy in grave danger. The only way to deal with this, he says, is through drastic cuts in government spending. But it's impossible for the budget deficit to be a dire problem when Treasury securities to carry "no-risk." If the budget deficit was a big deal, Treasury securities would be extremely risky. Investors would be worried that the big, bad budget deficit was about to spark a default, and investors worried about default either don't invest or demand a very high interest rate to compensate them for the risk they're taking on.

There are really only two ways for budget deficits to create economic problems. First, if big enough, budget deficits can spark severe inflation, as governments print loads of money to pay off their debt. Inflation isn't happening-- it's below the Fed's target rate, and even inflation hawks at the Fed are now worried about the prospect of deflation. Second, they can spur high interest rates, as investors demand a greater return on their investment out of fears of default. Those high interest rates can impede economic growth. Ryan repeatedly tries to make the second case. Earlier in his interview with Ezra he says this:

"Locking in budget reforms and spending control will help us in the short run by taking pressure off interest rates."

and this:

"At this point, given the borrowing costs, stimulus is counterproductive."

But if there were any real pressure on interest rates, we'd be seeing high interest rates on Treasury bonds. Of course, we are not seeing high interest rates on Treasury bonds. We are, instead, seeing record lows, something Ryan acknowledges when he says that banks can only earn a "modest spread" by investing in Treasurys!

What's more, those low interest rates that Ryan acknowledges mean that the government has record low borrowing costs. Ryan tries to argue that spending money to create jobs will cost so much that the measure won't work. But there has never been a better, cheaper time for the government to borrow money than right now. The bank behavior Ryan cites means that the government should be borrowing as much as it can and spending that money to create jobs, since we are still in the middle of the worst jobs crisis in 75 years.

And make no mistake, Ryan's quest to slash government spending is a job-killing agenda. He has to resort to crazy incoherent arguments about interest rates because everybody can see that spending money to create jobs will, you know, create jobs. Ryan is simply ideologically opposed to the idea of government spending (at least now that Democrats are in power). He is looking for any excuse he can find to cut that spending, regardless of the consequences for the economy. Sane policymakers should be worried about creating jobs, not looking for ways to push a bizarre anti-government agenda.

The Bank Lobby Smear Against Elizabeth Warren

Zach Carter — Wed, 21 Jul 2010 15:26:59 -0400

Ezra Klein needs to stop repeating bank lobby smears against Elizabeth Warren. He's sympathetic to the charge that Warren is "too dismissive of the benefits of financial innovation," because, well, I don't know why. It's a baseless allegation being made by Warren's opponents without any evidence whatsoever. It relies on the stock bank lobby response to every effort to strengthen consumer protection rules in the past 30 years. It should be irrelevant to a conversation about reining in predatory lending in an era of rampant abuse.

It's significant that this weak "innovation" argument is the best that Warren's adversaries can muster to protest her potential nomination to head the Consumer Financial Protection Bureau. Yesterday, Klein reiterated the line, which was presented the previous day by his fellow Post-blogger Neil Irwin. It goes like this: Predatory consumer abuses are bad, but if regulators go too far with their regulations, they can end up unnecessarily restricting credit to poor people. Maybe Elizabeth Warren will go too far, the argument goes, because she's not attuned to how financial innovations can help poor people by giving them access to credit.

Neither Post blogger cites any evidence that Warren has ever backed a destructively overzealous consumer protection rule—they just note that some people say that Elizabeth Warren doesn't like financial innovation enough (and then they don't say who says it).

This is a theoretical objection that the bank lobby trucks out every time anybody tries to curb an obvious abuse. Hypothetically, it can always be the case that a bad rule can unnecessarily restrict consumer credit, but the bank lobby always deploys this argument in response to any regulation to distract people from the specifics of the rule in question. That they're doing that now against Warren suggests they have no case, and they know it. Irwin, in fact, actually acknowledged that the objection was unfounded:

Of course, the same question needs to be asked about the other reported candidates for the job . . . but Warren is the one who is attracting 100,000-plus endorsements through an online petition.

In other words, Irwin is saying that while there's no evidence that Warren is insufficiently attuned to credit access and financial innovation, that could still in fact be the case, just as it could be the case for literally any appointee to the CFPB post. Arguments don't come much weaker than that.

Has Warren ever said we need to roll back the 30-year mortgage or ban credit cards? No. Look at her actual record as a reformer—she was a key figure in getting new credit card regulations through Congress last year—were those "too dismissive of the benefits of financial innovation?" Anybody want to bring back double-cycle billing? Retroactive interest rate increases? Jacking up rates because you returned a library book late? That's what Warren has fought against and won. They were transparent abuses, they made a ton of money for banks, and consequently, banks do not like her. Since they can't come out and say that they want to keep their predatory profits, bankers make up this theoretical nonsense about Warren opposing financial innovation.

But Klein still wants Warren to explain "the test she would apply to decide whether consumer financial instruments were legitimate." This is silly. It implies that the CFPB director's job will mostly be about banning consumer financial products. The new agency probably isn't going to write tons of radical new consumer protection rules, much less go around banning loan types-- it just has a different incentive structure than the Fed and the OCC which will make its enforcement efforts more effective.

There has been a policy consensus on predatory lending standards for decades, and it basically amounts to ability to repay and adequate disclosure. Nobody really disputes these standards in principle, regulators have just decided not to enforce them for a long time. Take a look at the Fed's 2001 guidance on identifying predatory subprime lending. It's great, and with a few minor modifications, can apply to just about any kind of credit you can think of:

Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation;

Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced ('loan flipping'); or

Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.

Warren's opponents aren't worried that she'll get the standard wrong, they're worried that she'll actually enforce the standard and take away predatory profits.

Banks scored $38 billion in overdraft revenue in 2009, while the industry's total combined profit was just $12.5 billion. The subprime crisis actually happened. The entire country is still drowning in foreclosures, and unrestrained predatory lending helped crash the entire global economy. Predation is a mainstream business for major banks, and has been for decades. We've spent the last 30 years allowing outrageous abuses on a massive scale in the name of financial innovation. Banks are still the most powerful lobby group in Washington. The CFPB won't even have sole authority to write consumer protection rules-- other bank regulators will have veto power. Without a strong, committed reformer like Warren, the CFPB isn't going to make a lot of headway. Worrying about Warren because she might go too far, without any evidence that she will do so, simply does not make sense.

I don't know about Irwin, but so far as I can tell, Klein supports Warren to head the CFPB. He's just saying that an objection voiced by people who oppose her is not outrageous. The trouble is, the objection is, in fact, outrageous.

Don't Let Goldman Sachs Off The Hook

Zach Carter — Wed, 07 Jul 2010 13:53:44 -0400

When the nation's most prestigious investment banks found themselves on the verge of total annihilation in the fall of 2008, the most radical and effective government response was not the infamous $700 billion Troubled Asset Relief Program. The wildest salvation scheme for Goldman Sachs, Morgan Stanley and the securities system at large was a plan from the Federal Reserve to give these speculative institutions access to cheap loans from the central bank. It worked. With access to unlimited cheap funding from the Fed, the Wall Street titans survived. Hurrah.

Here's the catch. Cheap Fed funding is a subsidy during good times, and a bailout during bad times. These subsidies are supposed to spur productive activity. We want Fed money to be fueling business and consumer lending—we don't want it to be encouraging gambling in the securities and derivatives casinos. Those businesses are risky, they create big horrible asset bubbles and then put taxpayers on the hook for losses when the Fed backs them. That's why securities houses like Goldman and Morgan were never, ever granted Fed funding until the fall of 2008.

And Goldman has leveraged that Fed funding for all it's worth. Goldman had to create a commercial bank unit in order to borrow from the Fed, and Goldman chose to house its riskiest businesses in that unit in order to make sure that they would benefit from both cheap Fed funding and the better credit ratings that funding creates. Goldman has about $40 trillion in derivatives operations functioning under its commercial bank unit, which does nothing else but accept money from the Fed. The Fed is funding Goldman's casino, and the economy is getting nothing of value in return.

So what should we do now that Goldman and Morgan are getting access to all of the perks of being a commercial bank without any of the regulatory hurdles? According to William Cohan's latest, disastrous column for The New York Times, Goldman should cut its ties with the Fed and just be a securities firm again. When it inevitably gets into trouble at some point in the future, nobody should bail it out.

That all sounds very nice. Who could oppose ending bailouts?

The trouble is, it has absolutely no teeth. Once the Fed steps in to bail you out, everybody in the market knows it will step in again, regardless of how your business is structured. Every aspect of Goldman's business currently benefits from taxpayer perks, and the greatest perk of all is the fact that Goldman still has businesses. They would be totally and completely gone without massive government aid, and their destruction would be of their own making— they ran a business that operated with massive and unnecessary counterparty risks which was completely dependent on capital markets confidence for its functionality.

There can be no un-ringing of the bailout bell. Goldman absolutely must be aggressively regulated as a commercial bank to make sure that its subsidies are not destructive. That's the minimum reform. Still better would be to cut off the subsidies, claw-back the bonuses earned over the past two years, and break the bank up into smaller institutions that the Fed would not feel compelled to step in and save. But to pretend the bailout never happened and promise not to do it again is simply not credible.

Even if we could make the entire world forget that the bailouts happened, do we really want companies like Goldman to go back to the same business that got them into big trouble? If Goldman can put the entire financial system in jeopardy—or at least convince policymakers that its failure would do so—why do we want them to return to business as usual? We'd want them to be more rigorously regulated and structurally reformatted to prevent future disasters.

Cohan's argument is actually a bit worse than what I've presented above. There's always a tension in Cohan's writings between the broad public interest and the narrow interests of whatever firm he's writing about. He can never quite sort out whether he thinks a bunch of rapacious bastards are praiseworthy for enriching their shareholders by juicing the public, or whether the public has a right to be upset with the rapacious bastards who juiced them. But it appears that Cohan doesn't want to see Goldman to cut its ties with the Fed because those ties create problems for the broader economy. Instead, he wants them to spurn Fed money because he's worried that new regulations will make Goldman less profitable.

As it happens, I think Cohan has this profitability issue completely wrong. The two serious rules cracking down on banks with access to Fed funding were basically gutted at the final stage of the reform negotiations. Banks that deal derivatives will have to put up more capital for a small fraction of their derivatives businesses, and banks will only be able to gamble 3 percent of their capital in proprietary hedge funds. There's quite a bit of controversy as to how much of Goldman's business is straight prop trading disguised as client business, but the new rules do not seem likely to seriously curb those operations. But that cheap funding will always be there, and they'd be fools to give it up for such a paltry set of restrictions.

The important question about the Wall Street reform legislation is not whether the new rules will be good for Goldman profits and bonuses. The important question is whether Wall Street profits and bonuses are derived from activities that benefit the public good. Very little in the legislation that Congress is likely to soon approve will actually address that latter issue. And as a result, there's very little reason to believe that companies like Goldman Sachs will change their ways and stop screwing over the public for money. That doesn't mean the reform bill is a failure. It means it's a first step, and we need another, better bill after this one is approved.

Six Key Fights For Wall Street Reform's Next Phase

Zach Carter — Fri, 21 May 2010 11:59:08 -0400

Thursday night's passage of Wall Street reform by the U.S. Senate is an event to be celebrated, but several key issues remain in play as the House and Senate seek to iron out differences between their respective versions of the legislation. And while the final bill will provide regulators with important new tools to fight financial excess, many of the most critical issues facing our economy will simply not be addressed, leaving the next Congress with plenty of work to do.

Here's a list of key issues to watch as Congress moves to the conference committee between the House and Senate:

1. The Volcker Rule

The best version of President Obama's signature Wall Street reform was an amendment written by Sens. Jeff Merkley, D-Ore., and Carl Levin, D-Mich. It was never voted on in the Senate, and the House bill contains no version of any ban on proprietary trading by commercial banks. The Senate bill does include a weak version of the Volcker Rule that bank-friendly regulators can easily defang if they choose. Watch to see if negotiations lead to a concrete ban on gambling with taxpayer money.

2. The Consumer Financial Protection Agency

The House version of this agency is generally stronger than the Senate version, with more independence and broader authority. But the House version also exempts auto dealers from CFPA oversight, which the Senate version does not.

3. Derivatives

The Senate's language on derivatives is much stronger than that produced in the House, with one major exception. The Senate bill contains fewer and narrower loopholes than the House version, in addition to a requirement that banks spin-off their derivatives dealing operations into an independently capitalized unit. But both versions of the bill have weaknesses related to actually enforcing the new derivatives rules, and the problems in the Senate version are much deeper than those in the House (this is why Sen. Maria Cantwell, D-Wash., voted against the bill). Barney Frank has said he wishes the House had better derivatives language, so watch for this to be strengthened.

4. Capital and Leverage

Thanks to Sen. Susan Collins, R-Maine, the Senate bill contains the strongest language to toughen capital requirements at big banks, forcing them to have more money on hand to cushion against losses. There is no corresponding language in the House bill, but the House legislation does contain a related provision capping bank leverage--the amount of borrowed money banks can use to place bets in the capital markets casinos. How these good amendments fare in the conference committee will significantly impact how the financial system functions over the next decade.

5. Rating agencies

Sen. Al Franken pushed through an amendment that substantively changes the corrupt business model at rating agencies. Right now, rating agencies do not get paid by the investors who use their ratings, but by the very banks who are issuing those securities. Franken would end this system, having regulators to select which rating agencies rate which securities, rather than the banks who issue the securities. The House bill largely leaves the rating agency business model unchanged.

6. Swipe fees

When you buy something at a store with a credit or debit card, Visa and Mastercard charge that store a fee. The store, in turn, charges you more for its products, making everything everybody buys more expensive. Sen. Dick Durbin, D-Ill., pushed through language cracking down on debit card fees, but there is no language addressing swipe fees of any kind in the House.

How Did The Senate Do?

The fact that many of these issues are even in play marks a surprise victory for progressives and other reform advocates. Nobody expected Franken's rating agency bill to make it through, nor were swipe fees considered to be in play. Even better, we know with certainty that the Federal Reserve's multi-trillion-dollar bailout operations will finally be subjected to public scrutiny, no matter what happens in the conference committee. Progressives like economist Dean Baker and conservatives like Rep. Ron Paul, R-Tex., have been pushing for an audit of the Fed for years, with little progress. The fact that the Fed's most secretive and controversial programs will finally be revealed to the public is a major event, one that should fuel calls for further reform.

There were also several disappointments in the Senate. The fact that Merkley-Levin never came up for a vote is a major embarrassment to the Democratic leadership, especially Majority Leader Harry Reid, D-Nev., Chris Dodd, D-Conn., and Obama himself. The fact that the derivatives language contains serious loopholes is also unacceptable, as are the depth of Dodd's concessions on the Consumer Financial Protection Agency, and the measures the Senate adopted to impede state regulators who try to crack down on predatory lending.

Nevertheless, the bill really will establish some important new economic tools. The new resolution authority to shut down complex banking conglomerates will not end too-big-to-fail, but it will give regulators the ability to cope with some failing institutions that it currently cannot handle. Regulators already have the authority to shut down boring commercial banks, but they do not always invoke it when those boring banks are big enough, and we can expect a similar pattern for more complex institutions. Similarly, whatever concessions bank lobbyists ultimately get in committee, Congress will also create new infrastructure to bring this multi-trillion-dollar market out of the shadows, and an agency that will give Elizabeth Warren an avenue to go after predatory lending.

The Next Step

Of course, it has been clear for some time that this bill will not address many of the deepest problems plaguing the financial system. The only way to end the political and economic domination of our too-big-to-fail banking behemoths is to break them up into smaller firms that can fail safely. The bill does not do that. It also does not reform the corrupt structure of the Fed, in which banks are allowed to choose their own regulators. No serious action will be taken against hedge funds, private equity vultures, Fannie Mae or Freddie Mac. Nothing will be done to treat the foreclosure epidemic that is still hammering homeowners. The hard, clear division between boring commercial banking and risky investment banking that protected our economy from bailouts for over fifty years still needs to be restored.

In short, the Senate's passage of Wall Street reform legislation is a critical step in the right direction. But there is still important work to be done in the coming weeks, and even more important work for the next legislative cycle.