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    • The Lack of Belief In Good
      Are humans good, bad or neutral? It’s an old philosophical debate, and not just in the West. Confucius thought they were born neutral, for example, while the later Confucian Mencius felt they were good, noting that everyone who saw a child fall into a well would be horrified. Others, including many Confucians and the Christian church, with original sin, have […]
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Wednesday: Gambling on Resurrection

Japan eventually forced bankers to fall on their swords

Japan eventually forced bankers to fall on their swords

“Banks think with their capital.  When they have enough capital, they act smart because then they have something at stake.  When banks lose capital and don’t have anything personally at stake, for the managers and the shareholders, they act dumb.  They gamble.”

That was a quote from Adam Posen from an interview he gave last week on NPR’s Planet Money about Japan’s Lost Decade.  You see, although the bankers are wailing hysterically that this kind of financial meltdown has never been seen before. the truth is that Japan went through something almost exactly like it back in the 90’s when their own real estate bubble burst.  The crash for them took place in ’90-91 and didn’t really affect the Japanese until 1992.  Then it was bad.  The government left the economy to sort itself out.  Actually, it made the situation worse by planning to adopt austerity measures and they announced these measures, like tax increases, 18 months in advance.   Eventually, there were some changes in government and some kind of Keynesian economics wizard who started to hold banks accountable for what is called adverse selection.  As I understand it, adverse selection occurs when bankers hold onto their bad assets, like bad mortgage tranches, for example, in the hopes that they will be worth something someday, while they sell off all of their good assets for cash they need in order to do regular backing business like lending and borrowing.  When Japanese banks were finally forced to eat their bad stuff, the economy turned around. (This is from a non-econ major POV so I urge you to listen to the podcast and send your questions to Dakinikat for clarification.)

The creation of a “bad bank” where the bankers can push their bad loans is probably NOT what Posen was refering to when he said that banks were eventually held accountable.  The “bad bank” transfer that is planned for the US simply gives banks cash for toxic assets and they never feel the consequences of their actions.  They may feel tempted to “gamble on resurrection”.  After all, the capital they are receiving from us is paying their salaries and bonuses.  It’s not real money to them.  No, I’m afraid that sacrifices will be necessary for this to turn around even if it means nationalization.

Obama has announced that he will hold banker compensation down in the upcoming stimulus package.  Executive compensation would be limited to a measly $500,000, which some compensation experts say:

“That is pretty draconian — $500,000 is not a lot of money, particularly if there is no bonus,” said James F. Reda, founder and managing director of James F. Reda & Associates, a compensation consulting firm. “And you know these companies that are in trouble are not going to pay much of an annual dividend.”

Mr. Reda said only a handful of big companies pay chief executives and other senior executives $500,000 or less in total compensation. He said such limits will make it hard for the companies to recruit and keep executives, most of whom could earn more money at other firms.

“It would be really tough to get people to staff” companies that are forced to impose these limits, he said.

OK by me.

It’s a great idea but we will have to see the details to make sure it is enforced.  After all, last fall’s TARP bill was supposed to give us preferred stock in the banks we rescued.  But as it turned out, preferred stock really meant “silent partner”.  We have no control over how the money is spent or are their any requirements that the banks report to us and keep us in the loop.  So, for all we know, they could be back to their old gambling addiction and living it up on our dime.

As Krugman wrote yesterday in Bipartisan Bromides, there is no middle ground here that can be reached by a treacly anti-Randian bi-partisan compromise.

You see, this isn’t a brainstorming session — it’s a collision of fundamentally incompatible world views. If one thing is clear from the stimulus debate, it’s that the two parties have utterly different economic doctrines. Democrats believe in something more or less like standard textbook macroeconomics; Republicans believe in a doctrine under which tax cuts are the universal elixir, and government spending is almost always bad.

Obama may be able to get a few Republican Senators to go along with his plan; or he can get a lot of Republican votes by, in effect, becoming a Republican. There is no middle ground.

There are certain procedures and steps that need to be followed in order to prevent a severe recession and decade of stagflation like the one that Japan faced during the 90’s.  Acquiescing to Republicans for the sake of bipartisanship just dilutes the policy.  The question is, does Obama understand the policy that he needs to create?  Or is he so beholden to the big Wall Street firms that got him here that he can’t make them sacrifice for fear of angering them?

Hey, he wanted this job.  He was willing to break all of the rules to get the nomination and there were plenty of people with almost a billion dollars in campaign funds who were willing to help him break those rules.  But it is his responsibility now to fulfill the obligations of his oath, even if it makes him unpopular with the rich boys and even if the bankers and Broderites attack him mercilessly. No one expected him to govern as a tree-hugging lefty but they *did* expect him to govern as a Democrat.   It is his own fault that his scorched earth campaigning split the party and many of us don’t have his back but hundreds of stimulus package house parties are not going to make an inadequate stimulus bill into a thing of beauty that everyone wants to support.  He has to do the right thing or take the blame for f%*^ing things up.

Now is when the shmoozing stops and the real work begins.

Friday: Assume the position

Kiss your ass goodbye

Kiss your ass goodbye

Brace yourselves, Conflucians.  Today could be very scary.  The markets closed down sharply in the last minutes of trading last night and today is looking hairy as well.  For those of you who want to follow along at home, I recommend Planet Money from NPR and This American Life.  The correspondents are talking to the movers and shakers on a daily basis and summarize what’s going on right after the markets close. They break it down into easily digestible chunks for those of us who prefer to avoid this stuff like the plague.

So, what *is* going on?  Well, I will leave it to Dakinikat to give us the professional answer but here is how Planet Money describes it.  A lot of the same things that happened at the start of The Great Depression are happening now.  That is, during the years 1929-1932, there were similar problems with bank failures and credit freezes and loss of the commercial paper market.  And treasuries and reserves around the world did what they could to fix the problem, without much success.  After 1932, the FDR administration started making some major changes, like guaranteeing depositors’ money with the FDIC, and a number of other fixes that slowly but surely brought us back to solvency.  It took a world war to finally get us back on our feet.  We live in the internet age now though so what took four years to experience back then when the financial system was falling apart is happening now in the compressed time frame of 3 weeks.  The good news is that with the changes FDR made during the Great Depression and since then, Ben Bernanke is able to intervene in ways that were not available to the Hoover administration. Also, there are some automatic actions.  The markets themselves have a panic switch that was instituted after the collapse of 1987.  The question is will all of this intervention be enough?

The problem is the Fed is starting to run out of options.  The government is buying assets of failed institutions, it stepped in to fill the gap of the commercial paper market to get credit flowing again and now it is looking to recapitalize and take ownership of some banks.  These are all the right things to do but the problem is still somewhat intractable.  The instruments that got us into the mess are so complicated and so many players are involved that the whole world is trembling from them.

In the midst of all of this, the Planet Money people have discovered a mystery.  Last week when the Senate was debating the Paulson bailout bill, someone in the senate slipped in a provision that allowed for the recapitalization of the banks.  Now, I am no financial expert, as anyone who knows me can tell you, so I am not sure what all of it means but I think what is being done is that the US government now has the option to own portions of the banks.  The mystery is in how the provision got slipped into the bill because this is apparently the right thing to do and the banks themselves were dead set against it. The astonishing thing is that the Senate did the right thing, almost in spite of itself, and snuck this provision into the bill without the Bank lobby either knowing about it or being able to do anything about it.  It’s like one of those nasty little provisions that have happened in the past that we didn’t like much, like the one that allowed the president to fire US Attorneys at will that was slipped into  the Patriot Act.  Except that this one works in our favor.

Who did it?  No one knows.  Scratch that.  No one is taking credit for it yet.  I think we can be pretty confident that it wasn’t one of the presidential nominees because they would be strutting around to every media outlet they could find to crow about it.

Well, no matter what happened, it was the right thing to do but that doesn’t mean we’re out of the woods.  The financial system is international and so is the spreading problem.  The solution is also going to have to be international in scope.  There will be some big meetings going on in Washington this weekend and no doubt the various members of the G7 are going to want to strangle George Bush and the other players that got us into this mess.  But if there is too much tension and acrimony, they may not hammer out a deal.  So, let’s hope that everyone uses their words and not their hands, and figures out how we get out of this.

In the meantime: