Saturday: This song is for you, Simon Johnson

Simon Johnson, former chief economist of the IMF, professor at MIT and blogger at baseline scenario and WaPo’s The Hearing, has written another excellent post on the financial industry’s walking dead.  In Zombie Oligarchs, Simon lays out why these guys, interested in self-preservation only,  just continue to feed but don’t improve entrepreuneurship in the world:

Some new entry and productive reallocation of talent is possible in this situation.  For example, John Mack is saying that pay caps mean his bankers are leaving – among other things – for “other industries”.  But the G20 policy of stabilization-through-rollover, at the national and corporate level, means that incumbents’ implicit subsidies actually go up.  The environment for starting businesses in the US has not completely collapsed, but it has also definitely not improved.

So we get to keep many of our oligarchs, but relative to the recent past they will hunker down.  You might be fine with that – although remember that it does not prevent reckless risk-taking and an increase in your taxes down the road.  Larry Summers says this happens only twice per century, but his own argument is that we have moved away from the kind of financial system that was built in the mid-20^th century.  If we’ve gone back to the wilder days of the 19^th century, the cycles could be quite different (look at the NBER’s data).  If the US has really become more like an emerging-market-with-a-reserve-currency, that is also not encouraging.

We’re looking at a near term dominated by the existing economic power structure.  The remaining big banks (in the US) and big banks/corporates (elsewhere) are made invincible by campaign contributions, political connections, and everyone’s reasonable fear of a great depression.  It will be hard for outsiders to challenge that structure effectively – either as new companies or with new ideas.  But you won’t see a great deal of innovation, investment, and growth coming from these survivors.

In light of current events, I think this song is very timely.  This one’s for you Tom, er, Simon.

Friday: Tunnel Vision

Just when you thought it couldn’t get any worse with the banking system, we have a *new* concept to grapple with and this one should make you want to sharpen your pitchfork.  It’s called “tunneling”.  In short, tunneling occurs when bankers on the brink of insolvency are kept afloat just long enough for them to hide the good assets while they leave the bad assets for the government to absorb at taxpayer expense.  Isn’t that fun?  You can read all about it at NakedCapitalism.  And our administration’s resident genius, Tim Geithner, has set up conditions in a way that seem to be perfect for just this sort of thing.

Simon Johnson of Baseline Scenario explains what is going on:

Emerging market crises are marked by an increase in tunneling – i.e., borderline legal/illegal smuggling of value out of businesses…

Boris Fyodorov, the late Russian Minister of Finance who struggled for many years against corruption and the abuse of authority, could be blunt. Confusion helps the powerful, he argued. When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

Treasury has made it clear that they will proceed with a “mix-and-match” strategy, as advertized. And people close to the Administration tell me things along the lines of ”it will be messy” and “there is no alternative.” The people involved are convinced – and hold this almost as an unshakeable ideology – that this is the only way to bring private capital into banks.

This attempt to protect shareholders and insiders in large banks is misguided. Not only have these shareholders already been almost completely wiped out by the actions and inactions of the executives and boards in these banks (why haven’t these boards resigned?), but the government’s policy is creating toxic financial institutions that no one wants to touch either with equity investments or – increasingly – further credit.

Policy confusion is rampant. Did the government effectively sort-of nationalize Citigroup last Thursday when it said Vikram Pandit will stay on as CEO? If that wasn’t a nationalization moment (i.e., an assertion that the government is now the dominant shareholder), what legal authority does the Treasury have to decide who is and is not running a private company?

Will debtholders be forced to take losses and, if so, how much and for whom? As part of last week’s Citigroup deal, preferred shareholders – whose claims had debt-like characteristics – were pressed into converting to common stock. You may or may not like forced debt-for-equity swaps, but be aware of what the prospect of these will do to the credit market. Junior subordinated Citigroup debt (securities underlying enhanced trust preferred shares) were yesterday yielding 26%….

What do rapidly widening credit default spreads for nonbank financial entities (such as GE Capital and many insurance companies) signify? Is it something about expected behavior by the insiders or by government, or by some combination of both?

Confusion in policy breeds disorder in companies, and disorder leads to the loss of value. This is the reality of severe crises wherever they unfold; we have not yet reached the worst moment. And, of course, there are many more shocks heading our way – mostly from Europe, but also potentially from Asia.

The course of policy is set. For at least the next 18 months, we know what to expect on the banking front. Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches (I’ve asked). The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails.

Read it and weep, Obots.  This is what you worked for.  Obama is in bed with these people.  They helped him buy off superdelegates and pay for massive amounts of advertising.  They helped him trash the reputation and career of a much better candidate.  They footed the bill for those stupid Greek Columns.   Our retirements are in jeopardy right now and the bankers are using the confusion to loot whatever’s left and stash the booty in an underground banking system.  It’s the finance version of the Shock Doctrine.  Before you know it, there won’t be anything of value left.

Paul Krugman is also alarmed by the “dithering” that is leading to more confusion and the possibility of acts of bad faith among bankers.  When Krugman starts to worry about the deficit, you know the situation has gotten out of control.  The administration keeps throwing money at the problem, hoping to kick start it to life.  But the administration seems to be adamant about protecting the bankers from taking their medicine:

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it’s just not going to happen.

So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.

Um, I don’t think I can wait a decade or more to see *if* my 401K investments bounce back.  I want to see things returning to some kind of normal state pretty damn quick so I know that recovery is possible.  Now, I’m no financial wiz but I think we’ve all seen something like this happen before. Your computer starts to hiccup.  At first, it’s just a minor thing and you ignore it.  Then it happens again and again with greater frequency.  Before you know it, you’re opening and closing windows, relaunching programs and tinkering under the hood with network settings.  The last thing you try that you know you don’t want to have to do (because you’re not sure everything is saved) is a reboot.

It’s time to hit that power off switch.

Wednesday: I will gladly pay you Tuesday

The kid has AM detention (don’t ask), so I have to make this short.

Quick question:  What do the following American taxpayers have in common?

• GM auto workers
• middle class suburbanites
• state workers with pensions

Answer:  They all agreed to defer part of their employment compensation package for future retirement benefits in the form of healthcare, 401K savings and pensions and they are the ones who are seeing massive failures in all three future compensation mechanisms. 

We’ve heard a lot about how Americans don’t save enough and I think we all know people who spend money like there’s no tomorrow.  But what about the vast majority who *did* save for tomorrow by buying into the notion that the company or state or financial services provider was carefully stashing away money on our behalf?  We gave them our trust and our money and many of us, including yours truly, are paupers today.  I’ve just seen 12 years of savings wiped out in the blink of an eye.

The finance industry has a pretty sweet deal.  They had access to our savings for years now and they gambled it all away.  For the stupid wage slave out there (and let’s face it, that’s how they see us), there’s very little left from the promise of future rewards if we just defer our savings.  This is the result of deregulation. We gave them our money in good faith and there was no accoutability for what happened to it.  It was like giving your life savings to a gambling addict with no requirement that the money had to be returned, in full with interest, by the end of the night.  No penalties for failing to do so.  We were *encouraged* to do this.  My employer signed me up for the 401K plan the first day I started to work.

For the banking industry, the insurance companies, the shareholders, it’s all NOW, NOW, NOW!  For the rest of us, “take and old, cold tater and wait” and oh, by the way, all your taxes are belong to us.

They never meant to keep their promises and no one was going to make them.  This is the price we paid for deferral.

Recommendation: Simon Johnson of Baseline Scenario did an interview with Terry Gross recently on Fresh Air.  He says the banking industry is very powerful and says what we’ve all been thinking:  they bought Obama and he can’t say “No” to them.

Sunday: Bad Bank

Take the red pill and go down the rabbit hole

Knowledge is power, Conflucians.  When it comes to the economy, I feel like a novice.   Playing with money never interested me.  It was enough to diversify my options in my 401K and leave it at that, although, I had a sneaking suspicion in the back of my mind that I should learn what it was they were up to.  But I opted for a degree in chemistry, not finance.  The truth is, it isn’t possible to know everything about everything.  There are limits to how much time out of our very busy lives we can dedicate to learning someone else’s area of expertise.  That has always been the danger of the 401K, IRA and pie-in-the-sky Grover Norquistesque wetdream of private Social Security accounts:  We’re busy and we have to trust people to handle our money responbsibly.   Needless to say, they’ve really let us down and now we are faced with the sometimes overwhelming task of learning the rules of  this high-stakes financial risk game.

The past several months have left me feeling a bit like Neo in the Matrix after they pulled his headplug and the world is revealed as it truly is.  I should have taken the blue pill.  What I see is not pretty.  I see a lot of shallow CEOs, oblivious to the fates of the people whose money they are entrusted with, determined to protect their lifestyles at any cost.  I see traders, addicted to adrenaline, looking for fixes and laying our nest eggs on the line for the rush of a big payoff.  I see corporations walking away from their future obligations because the people who work for them put their faith in them and deferred their compensation for promises that were never meant to be kept.  I see a government that was bought and paid for by these people and who will sacrifice the working class to pay its debt to its backers.  I see a Whole Foods Nation that doesn’t realize that it entered the ranks of the working class a couple decades ago in the era of Reagan’s “voodoo economics”.

You can’t be too careful these days.  If you want to know how to protect yourself from the predators who, in the end, are really no better than the common thugs who rob you at gunpoint, you’ve got to learn how to avoid the financial dark alleys. I’m so glad that we have Dakinikat to help explain stuff like “moral hazard” and “collateralized debt obligations”.  We have Paul Krugman, NakedCapitalism and Baseline Scenario who are keeping their ears to the ground and interpreting the entrails for us.  And we also have Planet Money and This American Life who are teaming up to break down the complex so we all get it.  Tonight, their joint project called Bad Bank airs on NPR and PRI stations at the This American Life regular time slot.  You can catch the podcast here or check your local NPR station.  The feed from WNYC starts at 4:00PM EST.  I urge everyone who has a mental black hole where their finance center should be to tune in for Bad Bank.

It’s time they stopped playing us for suckers.