naked capitalism

Coffee producers ‘getting hammered’ by global climate change Raw Story (hat tip reader John D)

Wild bears back in Britain? Telegraph

Plastic rubbish blights Atlantic Ocean BBC

NYT Should Rely on Experts Who Are Not Employed by J.P. Morgan Dean Baker

In which Paul Krugman proves he is an academic snob who argues from his prejudice rather than the data John Hempton. In fairness, Hempton somewhat misconstrues Krugman’s assertion…by “great newspaper”, he was almost certainly not talking about circulation. And the success of the Financial Times counters his assertion that “prejudice sell media”. That is clearly an attractive model, but it is not the only model.

Elizabeth Warren on the Coming Commercial Real Estate Crisis; 3000 Community Banks at Risk Michael Shedlock

Nationwide: UK house prices fall 1.0% Ed Harrison

Mankiw at EEA Economists for Firing Larry Summers

Data breach disclose bankers and public officials’ salaries and bonuses in Latvia Associated Press (hat tip reader John M)

Pound under attack as debt worries grow Times Online

Details Emerges for Greece Plan Wall Street Journal but consider: If This Guy Is The Source Of Greek Bailout Reports, You Should Be Very Skeptical Cluserstock. There were many times during the crisis when one paper would have a story well in front of the others that ultimately proved to be wrong.

Persistence of bad governments Daron Acemoglu, Georgy Egorov, Konstantin Sonin VoxEU

Antidote du jour (hat tip reader Barbara):

From the Independent:

Chief executives from the world’s banks discussed the plans at a secret dinner held at Claridge’s, the London hotel, last October, at which several leading British bankers are said to have suggested that the sector should take greater responsibility for its part in the crash, and do more to reduce the vast bonuses paid to staff.

But the recommendations were met by stiff opposition from the US banks JP Morgan, Morgan Stanley and Goldman Sachs, according to one source. “Some of the US bankers were furious about attempts to reduce pay throughout the industry, arguing that any such move smacked of socialism and would be fiercely resisted,” the source said on Friday. “It’s not the way the Americans like to go about their business.”

Yves here. The evidence that US capital markets firms are firmly in the hands of hopeless sociopaths continues to mount.

The fact set is undeniable: the big firms in the industry engaged in a massive campaign of looting, of running enterprises in which the employees were consistently overpaid relative to the risks and true profits of the firms. The result was that they were overleveraged. The only reason the industry survived was due to massive public subsidies, from equity injections to special lending programs to super low rates to regulatory forebearance. By any right, the firms should have failed, and the bankruptcy course should have gone full bore after the pay earned in the bubble years as fraudulent conveyance.

The British bankers seem to understand:

1. The industry is responsible for the financial crisis and the toll it has inflicted on innocent bystanders

2. The industry should be very grateful indeed for all the emergency rescue, particularly since virtually nothing has been done to prevent the industry from resuming the same sort of profitable-looking reckless behavior that nearly drove the world economy off the cliff

3. Banks’ current profits are also due in significant measure to all that lovely cheap funding on offer from central banks, in effect an unexpected reward for having caused the crisis. Reader NYT pointed out:

GS [has] gone from a privately funded balance sheet to a government funded balance sheet since the October meltdown. They paid only $6.5B interest on only $500B of debt in 2009. That’s about 1.3%. Given that some of their debt is long term debt (e.g Buffet’s 10% loan etc) issued prior to 2009, they must have replaced almost all of the $500B in debt with loans from the Fed.

Looks like the financial crisis worked out very well for GS. They are paying $25B a year less in interest than they paid in 2008 and it looks like no one is even talking about why GS should not be given this huge and ongoing government subsidy.

4. The wisest course of action is to try to resume as much of status quo ante as possible while keeping a low profile so that the public and officialdom will not decide to interfere in this juicy little racket. That means avoiding in engaging in the most press and public annoying behavior, namely, paying lavish bonuses, is not a very good idea right now

5. But the US banks are convinced of their divine right to feed at the trough

The astonishing bit is that the US banking execs have the temerity to self-restraint on pay “socialism”. They are benefitting from what most would call socialism for the rich, but is more accurately termed Mussolini-style corpocracy or good old fashioned pilfering from the public purse.

A successful investor would often say, “Little pigs get fed. Big pigs get slaughtered.” A lot of people are waiting for these big pigs to get their just deserts.

I imagine that many readers will react as I did to the Washington Post story, “In China, Wal-Mart presses suppliers on labor, environmental standards” (hat tip reader Paul S): that this story, yet another tidbit supporting the Bentonville giant’s supposed conversion to the true green camp, has to make sense on a cold-blooded P&L basis, even if it isn’t obvious how.

Given Wal-Mart’s history in the US, it is just about impossible to imagine that the company has concern about the impact of its policies on the greater community. Wal-Mart’s low prices depend on super-low wages effectively subsidized by the public (for instance, it pays workers so poorly that they cannnot afford health insurance, so that it is a given that some will wind up getting their health care via their local emergency room, which then winds up recovering those costs from paying customers). And the company is the antithesis of a good citizen. Over 40 states filed lawsuits against Wal-Mart for failing to pay overtime when mandated by law; the Bentonville giant settled a Federal lawsuit over similar issues in 2007 and agreed to pay as much as $640 million to settle 63 wage and hours class action suits. Wal-Mart also has the largest sex discrimination lawsuit in US history pending, and has settled other suits charging discrimination.

Wal-Mart is also famous for squeezing suppliers. One attorney I worked with who had a lot of early stage companies would recommend strongly against them taking orders from Wal-Mart, for the simple reason that the retailer (if satisfied with quality) would quickly become their dominant customer, know it controlled their business, and would start pushing for lower prices and improvements on other terms.

That’s a long winded way of saying that Wal-Mart is the antithesis of an altruistic organization. In particular, Wal-Mart has a history of funding anti-environmental candidates. So why should we trust that its seemingly civic-minded action is all that it appears to be?

One interpretation is that there is indeed less here than meets the eye. Wal-Mart, according to the Post, is making impressive declarations that are not fully met in practice:

In October 2008, Wal-Mart held a conference in Beijing for a thousand of its biggest suppliers to urge them to pay attention not only to price but also to “sustainability,” which has become a touchstone for many companies.

“For those who may still be on the sidelines, I want to be direct,” Wal-Mart chief executive Lee Scott said sternly. “Meeting social and environmental standards is not optional. I firmly believe that a company that cheats on overtime and on the age of its labor, that dumps its scraps and its chemicals in our rivers, that does not pay its taxes or honor its contracts will ultimately cheat on the quality of its products. And cheating on the quality of products is the same as cheating on customers. We will not tolerate that at Wal-Mart.”…

Many critics argue that WalMart’s longtime commitment to “everyday low prices” fosters a disregard for labor and environmental standards. China Labor Watch, a New York-based organization devoted to workers’ rights in China, said in a report last Thanksgiving that “the case of Wal-Mart . . . shows that corporate codes of conduct and factory auditing alone are not enough to strengthen workers’ rights if corporations are unwilling to pay the production costs associated with such codes.”

China Labor Watch pointed to five factories where it said workers lived in overcrowded and unsanitary conditions and were forced to work excessive overtime without adequate pay. Moreover, it said, two of the five had plotted to deceive Wal-Mart auditors and had coached workers to lie during the audits.

Yves here. Wal-Mart says it is trying to do a more through job of auditing.

But there are reasons to think this push is more that a PR ploy with a few more teeth than usual (Wal-Mart is sufficiently heavily scrutinized that a mere campaign of words would not be persuasive).

First, the odds of increased protectionism are high, particularly directed against China. The US and China are engaged in a phony war, with action so far limited to tit-for-tat tariffs and some designed-to-irritate gestures, like having Obama meet the Dalai Lama. But the theater is being ratcheted up for a reason: unemployment is painfully high, and China refuses to revalue its currency. If these stresses continue (likely), politicians may feel compelled to take measures that apply more pressure to China. An obvious one, that allows the US to maintain that it remains committed to free trade, is to demand that importers meet certain minimum environmental and labor standards. Given China’s particularly poor record on environmental protection, any such effort would hit it harder than other exporters (although how one would measure adherence to this sort of standard is an open question). Wal-Mart may regard this as a real risk (as in even if the odds are only 15%, the consequences would be so disruptive that it is prudent to go down this path). This “insurance policy” approach would also be consistent with taking some steps but not going full bore until new measures looked to be imminent. But Wal-Mart did suspend 126 Chinese suppliers in 2008 and stopped dealing with 35 permanently, so some serious steps are being taken.

A second reason may be that Wal-Mart is increasingly involved in food production in China. China has industrial pollution so severe that it has cadmium and heavy metals in the soil in some areas. Wal-Mart may correctly regard establishing itself as a company that supplies food with consistent attention to environmental issues (as well as cost saving measures to prevent waste and loss) could give it an unassailable position in the Chinese market. So visible concern about environmental practices, as evidenced in its pressure on suppliers of all sorts, could be part of a long-term branding strategy (it seems odd to think of Wal-Mart aspiring to be the Costco of China, but readers have commented that its prices, ex food, seem high relative to local market levels, so Wal-Mart in China may be a more upmarket discounter than in the US).

A third possibility is that evangelical Christians are increasingly see stewardship of the earth as an important duty. If Wal-Mart does not take at least some measures that look environmentally responsible, it might risk a backlash from its core customers.

Wal-Mart seems to be less of a target of ire than it was a few years ago; its pro-environment posture and other progressive-looking measures seem to have appeased many of its critics. But I have little faith that Wal-Mart has really turned over a new leaf.

Free market capitalism is based on the idea that “the invisible hand” of the market will create the best possible outcome for the most people.

But as I noted a couple of weeks ago, the man who came up with idea of the invisible hand did not believe in unrestrained free market capitalism:

Americans have traditionally believed that the “invisible hand of the market” means that capitalism will benefit us all without requiring any oversight. However, as the New York Times notes, the real Adam Smith did not believe in a magically benevolent market which operates for the benefit of all without any checks and balances:

Smith railed against monopolies and the political influence that accompanies economic power …

Smith worried about the encroachment of government on economic activity, but his concerns were directed at least as much toward parish councils, church wardens, big corporations, guilds and religious institutions as to the national government; these institutions were part and parcel of 18th-century government…

Smith was sometimes tolerant of government intervention, ”especially when the object is to reduce poverty.” Smith passionately argued, ”When the regulation, therefore, is in support of the workman, it is always just and equitable; but it is sometimes otherwise when in favour of the masters.” He saw a tacit conspiracy on the part of employers ”always and everywhere” to keep wages as low as possible.

Moreover, as I pointed out in September:

One of the leaders of the new science of financial modeling – Rama Cont – points out that Adam Smith was wrong about the “Invisible Hand”.

Specifically, investors in financial markets rationally pursuing individual profit can produce outcomes that are bad for almost everyone.

As an article in City Journal notes:

Simple forecasts can also be mistaken if they fail to account for the actions of market participants themselves: investor strategies can influence prices, which in turn influence future strategies in a feedback loop that can cause considerable instability. Cont recalls the severe stock-market crash of October 1987, which seemed to strike out of the blue, since nothing significant was happening in the real economy. Subsequent research, though, blamed the crash in part on a new investment strategy, “portfolio insurance,” which a large number of fund managers had simultaneously adopted. Based on the famous Black-Scholes options-pricing model, this strategy recommended that fund managers reduce their risks by automatically selling shares whenever their values fell. But the approach didn’t take into account what would happen if many investors followed it simultaneously: a massive sell-off that could send the market plummeting. The 1987 crash was thus not provoked by events in the real economy but by a supposedly smart risk-management strategy—and the current downturn, of course, also derives at least partly from a global craze for a seemingly foolproof financial innovation…

Investors in financial markets rationally pursuing individual profit, then, can produce outcomes that are globally negative. Doesn’t that contradict classical economic theory? “Both theory and empirical facts do tend to show that, on the financial markets, the Invisible Hand does not always lead to welfare-improving general outcomes,” Cont replies.

Does this mean that free market capitalism is dead?

No. And I’m not sure that there is any better alternative.

But capitalism has to grow up and become less naive, relying less on a blind faith in “the invisible hand” and more on an understanding of human nature, including insights from the field of behavioral economics.

It must include sophisticated checks and balances to make sure that the system is not gamed, instead of childish ideas about the “inherent stability” of the market.

And it must make sure that the poker game doesn’t suddenly end when one of the players gets all of the chips.

Of course, with high-frequency trading dominating the market (and see this), frontrunning, permanent bailouts (and see this), government-sponsored credit rating scams and enterprises, the creation and maintenance by the government of banks so big that their very size warps the entire system, socialism for the big boys, and all of the other shenanigans going on, we don’t currently have free market capitalism.

Consider: if we are starting to see signs of resistance to austerity measures in the US, it would suggest that they are not going to go over too well in other countries that have debt overhangs either. Defaults and/or restructurings are usually more palatable, politically.

And before suggesting that bondholders won’t stand for it, guess what, they can and do. Our Chapter 11 regime is widely praised and admired among the economically orthodox. That is a system for organized partial default and restructuring. Banks and investors are happy to lend to companies post Chapter 11.

Note we are not endorsing violence, and perhaps more important to note, the destruction that occurred at UC Berkeley was not planned, but instead grew as tensions spun out of control.

The outbreak appears to result from two sources of discord: one, the student objections to tuition increases and program cuts, the second a series of racist incidents: first a “Compton Cookout” on President’ Day in protest of Black History Month, followed by a noose on display in the UC San Diego Library. Students objected to the university’s failure to respond to these incidents, which led to a series of dance parties to show solidarity being organized at other UC campuses to show support. The blog Occupy California claimed the dance parties were followed by the occupation of several university buildings t UC Santa Cruz.

The Daily Californian describes the outbreak at UC Berkeley and notes that the police believe that many of the rioters were not students (via Raw Story, hat tip reader John D):

A crowd of more than 200 people swarmed the streets of Southside early Friday morning in a riot involving seven law enforcement agencies, runaway dumpsters, flaming trash cans, shattered windows and violent clashes between rioters and police.

What began as a dance party on Upper Sproul Plaza led to an occupation of Durant Hall at around 11:15 p.m. Thursday to raise support for the March 4 statewide protest in support of public education…

UCPD Captain Margo Bennett said the occupiers “cut a lock to get into the construction area and then cut a lock to get into the building [Durant Hall]” before vandalizing the area.

“There were windows broken, there was spray painting and graffiti on the interior, there was construction equipment that was tossed around,” she said.

The occupation evolved into a riot as it moved onto streets south of campus…

Bennett said the occupiers were able to leave Durant Hall without police confrontation because UCPD did not have adequate staffing and the Berkeley Police Department had not responded to the scene per UCPD request before the occupiers left.

She added that UCPD believes many of the occupiers were not UC Berkeley students….

The tone of the gathering changed at about 1:55 a.m. when a dumpster was pushed into the center of the intersection and set on fire by members of the crowd. The Berkeley Fire Department responded as people danced on top of the dumpster and shouted, “Whose street? Our street!”…

Officers physically pushed the crowd back so that Berkeley fire personnel could extinguish the flames. Sporadic fights broke out within the crowd, causing police to advance their line on the growing mob and use batons to push it back…

Members of the crowd hurled glass bottles, plastic buckets, pizza and other objects at the police line. The crowd’s size and intensity fluctuated as the police and protesters clashed and multiple members of the crowd were detained by police..

Feed Pete Peterson to the Whales Alexander Cockburn, Counterpunch (hat tip reader Crocodile Chuck)

Hitler and Cloud Computing Security Gunnar and Marcus, YouTube (hat tip reader John Moore)

Two huge icebergs let loose off Antarctica’s coast Salon (hat tip reader Crocodile Chuck)

Reinflating the Bubble Ryan Chittum, Columbia Journalism Review (hat tip reader Doug S)

Rising Threat of Infections Unfazed by Antibiotics New York Times

Google taken to task over its objectivity Financial Times

“China buying IMF gold” story unfounded: author Reuters (hat tip Marshall Auerback)

Short Selling Restrictions “A Great Indicator of Imminent Market Crashes” Michael Shedlock

China insider sees revolution brewing Sydney Morning Herald (hat tip reader Sean)

Dollar/euro ‘money play’ follows Greek tragedy Financial Times

Is China trying to “lock up” the world’s natural resources? Theodore Moran, VoxEU

“The High Road Procurement Policy” Mark Thoma

Forget bipartisanship Obama: shoot for the moon Edward Luce, Financial Times. Today’s must read. Key paragraph:

American presidents with the greatest record of bipartisan legislative achievement, notably Franklin Roosevelt, Lyndon Johnson and Ronald Reagan, got their way by intimidating opponents, not by splitting the difference. As Machiavelli famously observed, it is better for a prince to be feared than loved. For all his intelligence, nobody fears Mr Obama.

BTW, a really big earthquake (8.8 maginitude) hit off the coast of Chile. Australia (and presumably New Zealand) is on tsunami alert.

Antidote du jour. This is a Bronx zoo sea lion pup. Go Bronx!

Bloomberg reports that former Treasury Secretary and Citigroup board member Robert Rubin will be summoned before the Financial Crisis Inquiry Commission in April, with Alan Greenspan and Chuck Prince likely to be tapped as well.

On the one hand, it’s a welcome sign that the FCIC will be interviewing many of the major figures responsible for the crisis. On the other, the Q&A format is almost certain to prove mighty unsatisfying. Although Angelides has been more effective a questioner than expected, none of the committee members is a litigator (as in practiced in dealing with witnesses in public forums) and it shows. Imagine what these hearings would be like if David Boies, who was devastatingly effective in the Microsoft antitrust trial, had a go at the likes of Bob Rubin, who bears far more responsibility for the crisis than most realize.

Greenspan, while a key actor, is unlikely to provide new information. He has been grilled repeatedly over his record; he has defended it verbally and in print; he therefore has already been subjected to every major line of attack and has practiced responses. Prince never seemed up to the task of managing Citi; a year into his tenure, he was having difficulty asserting control over the sprawling bank.

But Rubin was either the architect or the moving force behind so many of the flawed policies and practices that fed the crisis that it is difficult to come up with a complete list. For starters, he was an advocate of a finance-centric view of the economy and ultimately of US interests (notice how often trade negotiations have made opening financial markets a priority item. It’s due to the near certainty that American firms would easily secure a significant share. Just look at the inroads they made in the UK and Europe). He was a persistent advocate of a strong dollar policy (and he meant it; his stance represented a 180 degree change from earlier Clinton Administration efforts to weaken the dollar to put pressure on Japan). One of the reasons is that prolonged currency weakness was believed to be unfavorable to the standing of financial centers.

Rubin also pioneered covert banking bailouts. US financial firms were heavily exposed to the 1994 peso crisis. Congress rejected a rescue package for Mexico. Rubin then raided the Exchange Stablilzation Fund, a large kitty created in the Depression and under Treasury’s control, to do exactly what Congress had nixed, which was help the banks (a motive not openly discussed) by assisting Mexico.

Surprising as it amy seem, Rubin also bears considerable responsibility for global imbalances. In the 1997 Asian crisis, Japan wanted to lead a rescue effort within Asia, relying primarily on Asean. Rubin and his protege Larry Summers beat that back aggressively and insisted the IMF lead the rescue efforts (which by the way, all called for greater opening of capital markets, when hot money inflows had been the proximate cause of the Thai and Indonesian booms and busts). And the overly aggressive, inappropriate measures imposed on Thailand, Indonesia, and South Korea left a strong impression on all countries in the region: never never get in the position where you might need help from the IMF. That led them all to peg their currencies low in order to build up large foreign exchange reserves. If you look at charts showing the level of private debt to GDP in the US, the increase goes parabolic starting roughly in 1999.

Rubin was also famously the leader of the successful fight against Brooksley Born’s efforts to regulate credit default swaps.

Yet Rubin somehow has the aura of being untouchable. From Bloomberg:

Rubin, 71, has been perceived as “bullet-proof” because his Citigroup job was “framed as if he was only there to give advice,” said Charles Geisst, author of “Wall Street: A History” and a finance professor at Manhattan College in Riverdale, New York. “Unless they’ve actually got some stuff where he advised on some surreptitious deal that went bad or his advice was purposely misleading, they’re going to have a very difficult time with him.”

Yves here. Ahem, the problem isn’t that there probably isn’t dirty laundry, it’s that Rubin normally limits his interventions to those at a similarly lofty level who will therefore never rat him out. And no one will go in and demand a data/e-mail dump. Rubin did call Treasury to try to get it to intercede to avoid a downgrade of Enron, and the press for the most part politely ignored this hot potato. Similarly, Rubin repeatedly pushed Citi management to take MORE risk in the credit markets. So even the little we can see of Rubin’s record at Citi is far from clean.

Mind you, I am not suggesting he did anything criminal, and that it the problem with the standard that the FCIC and SIGTARP seem to be using. Reader Andrew Dittmer describes why “Were crimes committed?” is the wrong question to be asking:

A substantial fraction of financial services industry activity over the last couple of decades has been directed toward “financial innovation” in the sense of Martin Mayer: “finding legal
ways to do things that used to be illegal under the old rules.” The periodic blowups have been dealt with by producing a scapegoat whose misbehavior was so blatant that it could be punished under the criminal code. The result is actually to support a framework in which enormous rewards are granted to people
who devote their lives toward freeing corporate organizations from the pain of democratic supervision. I don’t think any compromise is possible on this point – if Congress resolves the tension through symbolically punishing a couple of egregious offenders, that would signify a step backwards on the road towards a non-predatory financial system.

The only way to get out of this trap is to focus attention on what it means to maintain a sector that is addicted to finding ways to turn the rules that bind it into dead letter, and to supplying this skill to others as a paid service.

Yves here. In other words, we need to come up with standards of what should be unacceptable behavior. Rather than focusing on what was legal, which gives an industry that devised overly lax rules an easy out, we need to identify what products and practices were destructive. If they happened to be legal, that is prima facie evidence that we need new rules.

Via e-mail:

1. Before Barrack Obama’s next televised speech, prepare your “Bullshit Bingo” card by drawing a square.  I find that 5″ x 5″ is a good size — and dividing it into columns –five across and five down. That will give you 25 1-inch blocks.  

2. Write one of the following words/phrases in each block: 

Restored our reputation 
Strategic fit
Let me be clear 
Make no mistake
Back from the brink
Signs of recovery 
Out of the loop
Benchmark
Job creation
Fiscal restraint
Win-win
Affordable health care 
Previous Administration
At the end of the day
Empower (or empowerment) 
Touch base 
Mindset 
Bipartisan
Trust
Inherited as in “I inherited this mess”
Relief for working families
Unprecedented
Accountable (or held to account)
Free market
Reform

Players can make substitutions to this list, but only one phrase can be used in any one block. Alternatives include:

Change (as in “change you can believe in)
Universal health care
Brought the economy back from the brink

3. Check off the appropriate block when you hear one of those words/phrases. 

 4. When you get five blocks horizontally, vertically, or diagonally, stand up and shout  ”BULLSHIT!”  

Testimonials from past satisfied “Bullshit Bingo” players: 

 ”I had been listening to the speech for only five minutes when I won.” - Jack W., Boston 

 ”My attention span during speeches has improved dramatically.” – David D., Florida 

 ”What a gas! Speeches will never be the same for me after my first win.” - Bill R., New York City  

“The atmosphere was tense in the last speech as 14 of us waited for the fifth box.” – Ben G., Denver  

“The speaker was stunned as eight of us screamed “BULLSHIT!” for the third time in two hours.” – Harry A. Chantilly

By Edward Harrison of Credit Writedowns

Over the past few days, a number of major European banks have announced earnings results.  Two of the most dismal results were registered at the British company Royal Bank of Scotland (RBS) and at Germany’s Commerzbank. However, the similarity ends there because, while Commerzbank investment bankers received no bonus, the bankers at government-controlled RBS received billions of dollars in bonuses. In my view, this differences highlight a cultural divide on compensation between financial services-dominated countries like the U.S. and the U.K. and industry-driven economies like Germany.

Large losses and zero bonuses at Commerzbank

Let’s start with Commerzbank. Yesterday, in yesterday’s links I posted a Bloomberg story “Commerzbank Doesn’t Pay Bonuses to Investment Bankers for 2009” which outlines the recent bonus and earnings numbers:

Commerzbank AG, Germany’s second- largest bank, isn’t paying investment bankers bonuses for 2009 after the company posted a 4.5 billion-euro ($6.1 billion) loss.

“We de facto didn’t pay variable compensation components in investment banking in 2009,” Chief Executive Officer Martin Blessing said at a press conference in Frankfurt today. Michael Reuther, Commerzbank’s head of investment banking, said the U.K. bonus tax will therefore have no impact on Commerzbank.

So Commerzbank’s stance is that, having lost billions during the financial crisis, it cannot pay bonuses. This is the second year in a row that Commerzbank has said they weren’t paying bonuses. See my post “No one gets a bonus at Commerzbank and no dividend either” from last February.

Large losses but large bonuses at RBS

At RBS, the results were similarly catastrophic but RBS is paying £1.3 million (Guardian) or £1.7 billion (Times of London) depending on which account you read.

Jill Treanor of the Guardian writes:

Royal Bank of Scotland faced renewed criticism over its decision to hand out £1.3bn of bonuses to its investment bankers this morning as the state-controlled bank reported a loss of £3.6bn.

Stephen Hester, the chief executive who has waived his £1.6m bonus, warned that "2010 will be a year of hard slog" as he battles to restore the bank, which is supported by up to £54bn of taxpayers’ money, to profitability.

The losses, an improvement on the record £24bn lost in 2008, were caused by impairment charges on loans which have turned sour to the tune of £13.8bn, although Hester said it now appeared that these may have peaked.

The underlying core business posted operating profits of £8.3bn, up 89% on 2008, but £5.7bn of these came from the investment banking arm, known as global banking and markets.

This explained the need to hand out bonuses to the staff in the investment bank, although chairman Sir Philip Hampton insisted he shared "the public’s concerns" about the need for the payouts.

Shadow chancellor George Osborne waded in to the row by saying "people will find it very difficult to understand" how RBS could pay out bonuses in the current circumstances.

"We have just got to look at the whole banking sector and try to bring this pay down. It has got to ridiculous levels," he told BBC Breakfast. Osborne, though, gave no clues how a Conservative government would have tackled the problem.

He told BBC Radio 4′s Today programme: "I do think the level of payment in the banking sector has got completely out of kilter with the rest of society. It is totally disproportionate to what doctors are paid, people working in industry are paid, teachers are paid and the like.

"We need to bring down pay across the sector – not just in one bank, across the sector – and things like a bank tax, internationally agreed, might help do that."

Treanor explains the crux of RBS’ bonus payments as coming from the divergence between catastrophic full-year results at RBS and a glorious operating result in global banking and markets. But, there is a different, more pressing rationale offered by RBS chief Stephen Hester, namely that staff are leaving in droves because of poor pay.

Philip Aldrick of the Telegraph writes:

Speaking after RBS unveiled a £3.6bn loss last year , chief executive Stephen Hester claimed a thousand top bankers quit in 2009 for better pay elsewhere, adding: "This year will look a lot like the last… The people who left us last year would have increased our profits by up to £1bn… [This year] we will lose uncomfortable amounts of staff."

The Telegraph goes on to reveal that more than 100 people earned bonuses in excess of £1 million at RBS – most of whom I suspect are on the investment banking side of the business where the operating results were fantastic.

The problem with large bonuses

Here’s the problem. While RBS’ global banking and markets business may appear to be firing on all cylinders right now, the fact is it is those same groups who caused the catastrophic losses and government takeover in the first place. Compensation at RBS rewards bankers for immediate results when, in fact, their investment decisions have longer-term consequences on the bottom line at RBS.

This is what we have witnessed during the financial crisis – bets that once looked brilliant and earned the too big to fail employee punter a shed load of cash went decidedly pear-shaped later, exposing RBS and UK taxpayers to tens of billions in losses. To my mind, it is wholly unjustifiable to pay large bonuses unless these are specifically linked to the longer-term outcomes of the specific investment decisions upon which those bonuses are based. You have to either do this, base bonuses on long-term company results, or institute some clawback mechanism.

Moreover, RBS, Commerzbank and other too-big-to-fail institutions like them which have benefitted from government largesse NEED more capital. Every dollar awarded in compensation is a dollar that could be used to bolster the capital base in order to promote the lending that is clearly not taking place in Europe right now.

If I were the American President Barack Obama, I might say something like:

I, like most of the American people, don’t begrudge people success or wealth. That is part of the free- market system.

Yes, some people most certainly deserve high compensation. But I do want there to be some semblance of reality in compensation structures. Hundreds of employees at companies like RBS that are wards of the state should not be receiving millions in bonuses for the simple fact that their jobs couldn’t exist had it not been for government intervention. The fact that the government had to bail the company out is de facto evidence that not all the performances to which these bonuses are linked justify millions in payout.

This should be patently obvious.

Instead, the executives pretend this isn’t true, relying on the spurious argument that they will lose staff unless they pay them millions. Have you done such an ineffective job of creating company loyalty that you would lose your best corporate citizens because they didn’t receive a large bonus in one particular year? A loyal employee would stick around for the long-term if you could effectively convince her that this was a one-off. Is salary so important to people that they would be willing to jump ship just for a bump-up in bonus?  Yes, of course it is.

But, that’s the price you pay for the reckless lending and dodgy investments which brought the global economy to its knees.

Culture plays a large role

The thing is the banking sector in the UK is enormous. I would argue that countries with outsized banking sectors like the UK, Ireland and the U.S. put undue emphasis on the importance of this sector. As I pointed out in my post “Inside the mind of an investment banker: Greece, Goldman and derivatives,” compensation is the most important yardstick now being used to validate achievement, success and self-worth in the industry. So naturally, the tendency is to make all manner of justifications for large bonuses.

There is something cultural here at work as well.  Let me give you an example from a high profile deal of yesteryear.

Remember, the huge brouhaha over compensation in the tech bubble-era takeover of Germany’s Mannesmann by Britain’s Vodafone (Airtouch)? Back then, the mobile phone market was a huge growth market, with the market doubling between 1997 and 1999 alone. As a result, Vodafone was a darling of technology investors. Buoyed by a bubble in valuation, the company went in search of acquisition targets abroad, quickly coming across Mannesmann, a traditional German industrial company that lucked into the goldmine that was mobile telephony.

Vodafone was rebuffed by Mannesmann management on the grounds that the deal made no strategic sense. Vodafone went hostile and launched a bid anyway. The German labour union IG Metall metal workers union immediately rejected the deal (remember, Vodafone was not a telecom company, but an industrial company with a large Telecom unit). The American labour unions actually supported the deal, highlighting the difference in cultures.

Eventually in 2000, the deal went through. But, the critical feature of the deal in the German press was the enormous bonuses awarded to Mannesmann management – 111.5 million deutsche marks ($77 million). Mannesmann group chair Klaus Esser alone pocketed more than 60 million deutsche marks (about $40 million).

Germans were outraged. The scale of the pay packages was unprecedented. And this was pay which, although technically for past performance at Mannesmann, was being awarded for people who weren’t likely to be a part of the new larger Vodafone enterprise for long. The feeling was that management had rebuffed the initial offer because they did not want to lose their jobs, but took Vodafone CEO Chris Ghent’s sweetened offer because they were effectively being bribed. So, they were sued. Although the men were eventually acquitted, the case has had lasting impact in Germany.

The defendants had argued that such large payments are common practice in other countries such as the United States and that sanctioning the executives would discourage any bold decision-making in German companies in future.

-All Acquitted in Mannesmann Trial, Deutsche Welle, 2004

That’s a long winded way of saying the Germans look askance at Anglo-Saxon pay practices because the Germans are much more sceptical of the large gulf in wealth and opportunity the practices create.

As an aside, one reason the mobile telephony market was so attractive had to do with low interest rates. Telecom companies needed huge investment in fixed capital, especially for the nascent mobile networks. When interest rates are low, it has the effect of shifting investment capital toward longer-term capital intensive businesses (think Enron, WorldCom or Qwest) because the low rates increase the net present value of distant cash flows. When interest rates normalized, the bubble in telecom stocks burst and the malinvestment became evident. Vodafone was forced to take the then-largest writedown in corporate history for the Mannesmann acquisition.

In the end, it isn’t clear to me the money that Mannesmann management received at the beginning of the last decade was any more justified than the money RBS bankers are getting now. Unless pay practices in banking are reformed, I suspect seriously onerous regulation on compensation is coming.

Source

Vodafone’s hostile takeover bid for Mannesmann highlights debate on the German capitalist model – European Industrial Relations Observatory Online

Germany charges six in Vodafone takeover case – Independent

Citibank Shuts Down Gay Entrepreneur’s Bank Account Over Blog’s Content Washington Independent (hat tip reader John D)

‘Zombies’ have free speech rights too, US court rules Raw Story

Lost Exile: The unlikely life and sudden death of The Exile, Russia’s angriest newspaper Vanity Fair (hat tip reader

Leaked Microsoft intelligence document: Here’s what Microsoft will reveal to police about you Computerworld (hat tip reader John L)

Emergency shipment of condoms headed to Olympic athletes CBC (hat tip reader John D)

Goldman vs. Grassley on Build America Bonds Ed Harrison, Credit Writedowns

Scientists find first physiological evidence of brain’s response to inequality Science Daily (hat tip reader Paul S)

Blue Cross parent hiked rates after paying out $39 million in bonuses Raw Story (hat tip reader John D)

Swiss shun untaxed cash, seek fix to “black money” Reuters (hat tip reader Bill)

Labour shortage hits China export recovery Financial Times (hat tip reader Paul S)

Satyajit Das: Paul Volcker’s Trojan Horse Business Standard (hat tip reader MichaelC)

Dodd punts on fiduciary requirement for brokers Investment News

Ten Wall Street Blogs You Need to Bookmark Now Wall Street Journal. Several readers remarked they thought we were not give the credit due by being “ranked” eight. But the listing was alphabetical. I don’t think rebranding the blog a “Capitalism, Naked” to boost our standing would be a net plus.

Antidote du jour:

The Wall Street Journal is not the first to comment on the magnitude of the wagers against the euro (the Financial Times took note nearly two weeks ago: “Speculators raise record bets against euro“). But the Journal offers a spectacle sure to inflame sentiment in Europe: that of major hedge funds feasting first on lemon-roasted chicken and filet mignon and later the euro:

During the dinner, hosted by a boutique investment bank at a private townhouse in Manhattan, a small group of all-star hedge-fund managers argued that the euro is likely to fall to “parity”—or equal on an exchange basis—with the dollar….

An SAC manager, Aaron Cowen, who pitched the group on the bearish bet, said he viewed all possible outcomes relating to the Greek debt crisis as negative for the euro.

Yves here. The article contains some comment that I consider to be misleading:

There is nothing improper about hedge funds jumping on the same trade unless it is deemed by regulators to be collusion. Regulators haven’t suggested that any trading has been improper.

Through small gatherings, hedge funds can discuss similar trades that can feed on each other, in moves similar to those criticized by some investors and bankers in 2008. Then, big hedge-fund managers, such as Greenlight Capital Inc. President David Einhorn, who also was at this month’s euro-dominated dinner, determined that the fortunes of Lehman Brothers Holdings and other firms were dim and bet heavily against their securities, accelerating their decline.

Yves again. The first paragraph gives the mistaken impression that foreign exchange markets are regulated. They aren’t. Spot and forward markets in foreign exchange in the major currencies are close to unsupervised (for instance, there is no mechanism for collecting transaction activity, which would be a critical way to look for odd transaction patterns and volumes), so the notion that there are growups that are supervising that trading or prepared to intervene is oversold. Now there are currency futures that trade on the IMM, Euronext, and ICE and these traders may well prefer to use exchange traded futures (options are largely traded OTC). Those trades would be subject to meaningful oversight.

Using Einhorn as an example in this context is also peculiar. First, Einhorn shorted Lehman’s stock, which meant he was operating in a highly regulated market, which is very different than some of the avenues open for wagering against the euro. Second, given his history (the SEC investigated Einhorn for possible market manipulation when he shorted Allied Capital, when Einhorn’s stance was ultimately vindicated, and the SEC later launched an internal probe in response to Einhorn’s charge that it mismanaged the situation, and appeared to discover some irregularities) my impression is Einhorn went to some lengths to make his case against Lehman in a highly public way. So while there is nothing inaccurate, narrowly speaking, about mentioning Einhorn, conflating his short of Lehman with a currency short is disingenuous. The standards for collusion in SEC-land are very different from those in the wild west of OTC markets.

But then we get to a more complicated dynamic. Truth be told, eurozone members should want a cheaper euro. A favorite crude measure, the Economist’s Big Mac index, suggests that fair value would be 1.1 versus the dollar, well below its current level of 1.35. Of course, the old nostrum that a cheaper currency is better for growth generally (by helping export competitiveness) does not mean that a shift would not be disruptive and leave many individuals worse off (particularly since energy imports in particular would become more pricey).

But a fall now, particularly a sudden one, would be seen a a repudiation of the euro. There is more at stake than just the level of the euro; many observers see this as a test that was inevitable when the euro was established, that a number of crucial issues were finessed and now have to be resolved. But some go further, and argue that while the eurozone will not break up, that it includes too many heterogeneous nation-stated to be viable. FT Alphaville (hat tip reader Richard Smith) quotes Paul Donovan of UBS:

That the Euro area is not an optimal currency area is generally agreed upon. The European economies are sufficiently diverse that external shocks hit different economies with differing degrees of severity. The asymmetrical nature of any shock is also likely to persist for longer. This is something that has been well understood for some time. Indeed, fourteen years ago UBS economists concluded that “a monetary union extending beyond the core six [European] economies would not work properly in economic terms.” The analysis identified those economies that could realistically be called an optimal currency area, those economies that could satisfy the Maastricht criteria (on a relatively liberal interpretation), and those economies for which there was a strong political will in favour of monetary union. The analysis suggested that Greece, Spain, Italy and Portugal failed to meet real economic or financial criteria. Ireland and Finland were felt to meet the financial and political criteria, but also failed to meet the real economic test. The Venn diagram UBS originally published is replicated [here], for the benefit of those with an interest in economic history….

The most optimistic scenario for the Euro probably lies in some kind of parallel to the experiences of the US in the 1930s. Then, a fragmented banking system, with powerful regional central banks, failed to deal properly with an asymmetric shock to the economy (and to the financial system). The problem fostered significant regional differences in economic performance. This motivated financial reform, and a greater fiscal transfer mechanism to turn a sub-optimal currency area into a sub-optimal currency area with the mechanisms to smooth the consequences of shocks.

Yves here. So see, it IS possible to be a “sub optimal currency area” if you can muddle through devising the right mechanisms. And the analogy to the US in the Great Depression is apt in another way: a complicating feature is that a sovereign default or restructuring will hit European banks, many of which have fragile balance sheets.

It is important to note that while the symptoms may show up as a “Greece problem” or a “Spain problem”, the root cause is a one-size fits all monetary policy (that is not to say that country-level monetary policy guaranteed good outcomes, individual governments can still make poor choices).

Reader Richard Kline’s remarks in comments yesterday illustrate the considerable variations among the eurozone members the top of most worry lists (and as some readers correctly point out, the UK also has a looming external debt problem, but is not in the firing line right now):

Protests: By whom and to achieve what? Those to me are the principle questions. It would appear that the protests were primarily organized by unions and in particular by public employee unions. That is understandable because theirs are the jobs most likely to be lost, but if they are protesting in isolation—and it would appear to be so—their cause is already lost. Without broader support in their countries, they can make a lot of sound and fury, but the flutter of a redundancy slip will have the final word. I take that as the undercurrent of some of the well-intentioned pushback in comments in this thread. Part of me wants to be sympathetic to part of the problem, but the fact is the context has changed, and strategy needs to change.

Greece’s problems aren’t a result of the financial crisis. Greece has run unsustainable deficits for decades, finally turning to accounting chicanery. Greece has had do-little public sector jobs as buy-offs for social peace, too many jobs, and these wealth-transfer posts can’t be funded, now. The political counterweight for those jobs was a tax system which more or less allowed there significant domestic wealthy elite to live in a domestic tax haven, paying virtually nothing. All of this was possible while phoney ‘growth’ was happening due to the credit bubble making Greece’s sovereign debt fundable on capital markets without qualm—once it was euro-denominated. (Greece had financial crises in the recent past before the currency union.) Greece’s problems have been, in fact, made in Greed. —So it would be a good thing if those who live in Greece got on the stick and came up with some solutions. The solutions at present appear to be, ‘Shaft the common man, and bill him for the surgery.’ That proposed VAT is brutal . . . but then that’s one of the few taxes which is relibably collected there. And the rise in the retirement age hits the poorest with particular force. What is not on the table are effective tax enforcement upon the wealthy, and at higher rates. This, too me, is what protestors should be protesting, not the evaporation of do-little jobs which the country can only afford if someone else is picking up the tab. Then too, another goal of a demonstration which would be reasonable would be to demand a ‘renegotiation’ of existing debt over longer terms at lower rates; ‘reasonable’ because the banks who snapped up Greek sovereign debt in the good times did it in full knowledge of the situation but were quite willing to leap in as ‘enablers’ as long as they got their money rent on it. French, Swiss, and German officials would find if hard to defend against a demand for renegotiation in a situation where they are insisting that the Greek citizenry work two, four, seven years more of their lives to pay that debt off. To me, the point is as you say, Yves, to keep the impacts of necessary changes from being excessively and unfairly taken out of the hides of the poorest.

Portugal’s problems are also not caused by the financial crisis. PJM above sums them up well. Portugal joined the euro, and this was both necessary and good as it brought cross-border investment from within Europe, gave increased access to markets there, and (in normal times) gave increased access to capital markets there. But the export sector, and overall productive sector there is too small yet to support services and government at a ‘European’ level, all efforts to expand them notwithstanding. Just as PJM says, remittances from abroad are still a very important part of the local financial system, a real indication of production imbalances. What has happened is not that Portugal has ‘overspent’ or ‘overborrowed’ but that the borrowing they have done was only possible at the excessivly low rates of the credit bubble: Portugal can’t afford a rate spike, and so services are squeezed with funding becoming dear. The alternative to that are long-term development funds from within the EU, but that was controversial (as a matter of competitive advantage) even before now, and will be very difficult if not impossible to get funded in present conditions. Portugal’s economy is small and weak relative to stresses around it, and is getting bruised. That is not their ‘fault,’ even if it is their pain.

And so on, and so on. The points to me are: a) the immediate crises are by-products of lending squeezes, and b) stink of predatory instigation by third-parties speculating against the weak countries involved. If the poor in the affected countries aren’t to take the hit for everyone, they need to get out in front with solutions rather than just saying no. I think most in those countries know this better than I do.

Update 3:30 AM: From Eurointelligence:

FT Deutschland leads the paper with the story that leading German banks announced that they would not be buying Greek bonds at a forthcoming auction (very unhelpful such an announcement, but this is what happens once a panic starts). Eurohypo, Hypo Real Estate and Postbank are the banks mentioned in the article, and Deutsche Bank will only get involved in its role as an investment bank. The paper quoted sources from two Landesbanken as saying that investments in Greece are hardly thinkable. So, these banks are already distrusting any possible guarantees they might receive from the German government as part of a rescue package. Die Hypo Real Estate is the German bank most exposed to Greek debt, with about €10bn.

Jean Quatremer says in his blog that a monetary union with full fiscal independence is not going to be sustainable in the long run. He also writes that Athens is threatening to borrow unilaterally from the IMF if the euro area is not helping – or attaching further pre-conditions – which would a massive embarrassment for the EU.

Goldman may have made a fatal mistake. Fatal not to the existence of the firm, but to its standing, reputation, legitimacy, and ultimately, to the thing it covets most, its profits.

Power is most effective when it is used as sparingly as possible. Niall Ferguson, in book The Cash Nexus, stressed the importance of financing to military success (he argues that England was able to punch above its economic weight due to its superior tax collection apparatus and more highly developed bond markets). The Rothschilds, which among other things financed governments at war, went to some lengths to underplay their influence so as not to threaten their state patrons/clients.

The problem is that the behaviors that contributed to Goldman’s commercial success have over time become unbalanced, and are putting it at odds with governments. It is one thing to abuse the likes of a Jefferson County, as JP Morgan has. As deplorable as that behavior is, they cannot retaliate. It is quite another to mess with bodies that really are, ultimately, bigger than you are.

When I was young and worked briefly at Goldman, the firm was a pig and let even the very junior staffers understand precisely how its pigginess worked so that they would improve upon it when they grew up. For instance, on the deals it lead managed Goldman managed its stock and bond syndicates so as to extract as much as possible, to the disadvantage of other members of the syndicate, who shared the underwriting risk. I was told that Goldman was far more aggressive than other firms in hogging the deal revenues than any other firm on the Street, but could get away with it as a major lead manager. Similarly, on another deal, I walked into the Syndicate department when one of the most powerful partners at Sullivan & Cromwell was on a conference call, instructing the younger members of the department what the right answers to questions would be when the SEC came in asking questions on what they were about to do on this particular transaction, an underwritten call (note: what made Goldman savvier than most firm was that everyone got the official rationale for technically legal but questionable behavior BEFORE they did it, which made it much easier to maintain party line, rather than after the fact, when some conversations and communiques might contain remarks that were decidedly unhelpful. Note that this practice was well established over two decades before e-mails became pervasive).

Anyone who has read Roger Lowenstein’s account of the LTCM crisis, When Genius Failed, will recall how Goldman’s lawyer is assigned to a key negotiating role, and proceeds to cut the transaction in ways that favor Goldman over the other rescue group members. It is almost an uncontrollable reflex, the sort you see a predator take when someone makes the mistake of standing between it and its kill.

Now this aggressiveness was tempered (somewhat) by the posture Goldman called “long term greedy”, which basically meant not bleeding customers too much. One of the corporate accounts I worked on was a very reliable fee generator, and the M&A bankers were desperate to talk it out of a deal (on which they would have earned a fee) because they were convinced it was a turkey.

But the Goldman of the new millennium has kept the same relentless focus on the firm’s financial interest, and has become utterly, hopelessly sociopathic, incapable of understanding right versus wrong. The firm’s defense strategies vary among priggish and legalists reports (a Lucas van Pragg speciality), insincere, non-specific apologies (Blankfein), or stony silence. But the truth of how the members of the firm see things comes out again and again, through the many ways the Goldmanites keep maintaining that they really deserve what they make (starting with the heinous Blankfein “God’s work” comment), revealing again and again their inability to see how sharp practices and numerous forms of government support are an integral part of their recent “success”.

Every generation seems to have at least one financial firm that abuses its priviledges and power to the point when their pathological behavior brings about their downfall: Drexel, Salomon, Bankers Trust, Enron (Frank Partnoy argues that Enron was a “highly profitable derivatives bank”). It is too early to say for sure, but Goldman looks to be at risk of joining their ranks.

Although the Fed is far from an aggressive investigator, the fact that is has taken interest in Goldman’s role in Greece is significant. And the FCIC is also probing Goldman’s too clever by half strategy of using collateralized debt obligations to tee up short bets, since the buyers of the CDO would assume that they were purchasing a legitimate investment, not something that Goldman would have an incentive to design to fail.

From the Financial Times:

The US central bank is looking into Goldman Sachs’s role in arranging contentious derivatives trades for Greece, which helped the country to massage its public finances, Ben Bernanke, chairman of the Federal Reserve, revealed on Thursday.

“We are looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece,” Mr Bernanke said, apparently referring to Greek currency transactions structured by Goldman….

Mr Bernanke said default swaps are “properly used as hedging instruments” and that “using these instruments in a way that intentionally destabilises a company or a country is counterproductive”.

The Securities and Exchange Commission is “examining potential abuses and destabilising effects related to the use of credit default swaps and other opaque financial products and practices”, said a spokesman.

Separately, Phil Angelides, chairman of the US Financial Crisis Inquiry Commission, told the Financial Times he was concerned about the practice of creating securities and “fully betting against them” – and about Goldman’s role in particular. Goldman declined to comment.

The US comments came as an official in German chancellor Angela Merkel’s ruling Christian Democratic Union party said the G20 nations were discussing whether a ban on the speculative use of CDS was workable.

By Marshall Auerback, a fund manager and investment strategist who writes for New Deal 2.0.

Usually, we dread the regular Congressional testimonies of the Fed Chairman. They generally constitute a mix of obfuscation on the part of Mr. Bernanke mixed with political grandstanding on the part of Congress. But occasionally, a glimmer of truth comes through, as occurred today in this exchange between the chairman of the Federal Reserve and Congressman Barney Frank:

Frank: Do you think there is any realistic prospect of America’s defaulting on its debt in the near future?

Bernanke: Not unless Congress decides not to pay….

So there you have it. If Congress doesn’t pass the debt ceiling, the Treasury can default. But this constraint is not operationally inherent in the monetary system. It is put there by the same Congress that could (and should) revoke the unnecessary constraints, much as the European Union could (if it chose to do so) could eliminate its arbitrary rules limiting government expenditure. This is a problem of “willingness to pay” and not “ability to pay”, as the government is at all times in control of its spending process. In short, here we have the Chairman of the Federal Reserve openly acknowledging that, short of voluntary political constraints, there are no financial constraints on the ability of a sovereign nation to deficit spend.

To anticipate the usual objections that we usually encounter whenever we point this out, please note that this doesn’t mean that there are no real resource constraints on government spending; this should be the real concern, not financial constraints. Government spending should be analyzed in regard to its effects on the real economy, which means that it should, like Goldilocks, be neither “too hot” (or else inflation will result), or “too cold” (as is the case today, where we have an economy characterized by high unemployment and significant resource underutilization) Debating whether the social losses due to operating below full employment are higher than economic losses due to inflation or currency depreciation, are germane discussions to POLITICAL debate, but totally separate from the issue of national solvency.

So what’s with the Fed Chairman’s obsession with fiscal sustainability, when Bernanke knows that there is no insolvency issue?

There’s obviously a degree of self-interest here. As head of the nation’s central bank, Mr. Bernanke (like any other central banker) is keen to assert the primacy of monetary policy over fiscal policy, despite the fact that the former’s impact on real economic activity is far more ambiguous. The manipulation of interest rates may be used to control inflation and that inflation expectations may have an influence on the spreads at the longer end of the yield curve. But the way in which interest rate manipulation (that is, monetary policy) impacts on inflation is unclear: rising interest rates certainly increase costs for borrowers and may choke of aggregate demand but equally they increase incomes for those with interest-rate sensitive portfolios which may add to aggregate demand. Fiscal policy, by contrast is far more targeted in terms of the impact it seeks to achieve.

There is also a political dimension: the financial class (whose views still reflect the predominant economic thinking at the Fed and on Wall Street), benefits from the deflationary bias imparted as a consequence of these artificial financing rules, which are remnants of the gold standard era. But in reality this is a denial of the essence of the fiat monetary system that we now live in and there is thus no economic basis for these constraints. Keeping unemployment high provides a strong means of disciplining wage demands and enhancing profits.

A stable ratio of federal debt to GDP may or may not be the right policy objective. But it is neither more nor less “sustainable,” under different economic conditions, than a rising or a falling ratio and Mr. Bernanke implicitly recognized that in his testimony today. We wish he had gone further. It is not, as Professor James Galbraith has argued, “a hidden evil. It is not a secret shame, or even an embarrassment. It does not need to be reversed in the near or even the medium term. If and as the private economy recovers, the ratio will begin again to drift down. And if the private economy does not recover, we will have much bigger problems to worry about, than the debt-to-GDP ratio”.

The public is told that government spending causes inflation and is warned that if we do not control the budget deficits that a Weimar Germany fate awaits us. Conveniently forgotten is that German production capacity was either significantly damaged by WWI, or redirected toward output required by the military. Additionally, Weimar Germany faced large foreign claims from war reparations, as well as exploding budget deficits. By 1919, it is reported the German budget deficit was equal to half of GDP, and by 1921, war reparation payments represented one third of government spending (the so-called London ultimatum required annual installment payments of $2b in gold or foreign currency, in addition to a claim on just over a quarter of the value of German exports).

Neither of these conditions remotely pertains to the US today. In the highly unlikely event that inflation started to accelerate in the US, a highly non-unionized workforce has neither the bargaining power nor the access to credit to keep up with rising prices. Household claims on real resources would wither under inflation as real wages would simply fall behind.

The reality is that all questions of “national insolvency” or fiscal sustainability go by the wayside whenever Wall Street or some other major corporate interest demands a hand-out from the government.

And if they don’t get satisfaction from one party, they’ll shift their support to the other, as Wall Street is doing today According to new data compiled for The Washington Post by the Center for Responsive Politics, the securities and investment industry went from giving 2 to 1 to Democrats at the start of 2009 to providing almost half of its donations to Republicans by the end of the year. Similarly, commercial banks and their employees also returned to their traditional tilt in favor of the GOP after a brief dalliance with Democrats, giving nearly twice as much to Republicans during the last three months of 2009.

The naked self-interest of the financial sector trumps all. All this talk about “free markets” and the virtues of “private market disciplines” go out the window should the actual discipline of markets impose losses on these institutions. Virtually the moment the handouts are made, in comes the discussion of national insolvency and the public mobilization against further government spending. Never do we step back and ask the question – what is the public purpose being served by net government spending? Perhaps this is the line of enquiry that should be directed at Ben Bernanke the next time he appears before Congress and lectures us on fiscal and monetary policy.

Australia summons Israeli envoy over Dubai killing BBC

Belief In Climate Change Hinges On Worldview NPR

Why Liberals and Atheists Are More Intelligent Reason (hat tip reader John D)

Noah’s ark was circular Guardian (hat tip reader John M)

Killer whale shakes trainer Dawn Brancheau to her death Times Online

New home sales fall to a record low CNN (hat tip reader John D)

Bernanke Transparency Offer May Not Defuse Calls for Audits Bloomberg

Banks Bet Greece Defaults on Debt They Helped Hide New York Times

Martin Wolf Makes Me Look Like Pollyanna Paul Krugman (hat tip Swedish Lex)

Financial Innovation Pt. 1: Two Problems and TRACE Mike Konczai, New Deal 2.0. This is a great case example, although Konczai does not hit the punch line hard enough (maybe that comes in Part 2). What Wall Street has defined as innovation is precisely the opposite of this sort of activity, which increased liquidity, transparency, and lowered dealer spreads. Heavens, we can’t possibly apply the positive brand of “innovation” to anything that reduces our profits!

Goldman Is Unpopular Because ‘It Brings Envy,’ Corzine Says Bloomberg. I had to resist the impulse to post on this. On the one hand, harping on Goldman seems to be getting a bit tired, and other parties were plenty culpable too. The high end of finance was a criminogenic environment. But then you read idiocy like this, and it demands a retort of some type. Goldman people are standing up and ASKING to be whacked thought their hopeless arrogance and astonishing capacity for denial

No, people are NOT mad at Goldman because it is “successful”. Americans love success, look at Steve Jobs, Oprah, any one of a dozen rags to riches stories. What they hate about Goldman is:

1. That the taxpayers rescued it at considerable expense, everyone there seems ever richer than before, there has not been an iota of shame, apology, change in behavior. The teeny weeny bit of restraint around bonuses was only due to a firestorm of protest. This is socialism for the rich, and the public has every reason to be upset

2. Goldman has again and again been the leader in shady behavior. Yes, it may not have been illegal, technically, but much of it OUGHT TO HAVE BEEN illegal. The fact that Goldman could get away with so much stuff that does not pass the smell test simply confirms the suspicions of favored treatment and special dealings (which is actually correct, but the only error is suspecting it happened on specific deals, as opposed to being the result of a concerted, long-standing lobbying effort by the industry to weaken regulations).

3. Goldman is persistently arrogant and tone deaf. They insist on rubbing your fact in 1 and 2, and add insult to injury by trying to assert that their profits are the result of “talent” when from 2006 to 2009, looting was a major source of earnings.

Antidote du jour:

The financial press has for the most part looked at the possibility of sovereign debt crises in Greece, Spain, and Portugal through a deal-making window: will Germany and other EU surplus countries back a rescue package, and if so, with what strings attached? There has certainly been ample speculation, particularly since a bailout of Greece would be wildly unpopular in Germany, but some have though various finesseses, such as having various EU members guarantee Greek debt, along with imposing austerity measures (in particularl, raising the retirement age in short order from age 61 to 67) might be workable.

But even if a deal could be brokered, will the citizens accept it? Citizens in Greece could be every bit as big a stumbling block as those in Germany. From the Globe and Mail (hat tip reader John D):

… threatened to turn into a wider social and political emergency this week as general strikes and protests paralyzed Athens and Madrid, and Greek leaders lashed out at their German rescuers amid dark economic projections.

Protesters in Greece battled police using rocks and bottles last night at the end of the second day-long general strike. The walkout closed schools, hospitals and most forms of transportation, shutting down the economy as the government prepared to freeze pay, increase retail taxes and raise the
retirement age to 63 to reduce a huge deficit and attempt to pay off €53-billion ($75-billion) in public debt owed this year.

As European leaders scrambled to find a way to prevent the continent’s troubled southern nations from defaulting and jeopardizing the euro, citizens and some political leaders in those countries fought back, badly fracturing Europe’s cohesion. Greece’s general strike, the second in two weeks, followed a shutdown in debt-crippled Spain on Tuesday, with a countrywide general strike scheduled in Portugal next week….

In a shocking gesture that seemed to transform Europe’s bailout tensions into an outright political crisis, Greece’s deputy prime minister Theodoros Pangalos on Wednesday lashed out at Germany, the only country able to provide the money to rescue the balance sheets of Athens…

Some European officials seemed to lose patience with Greece. Otmar Issing, a former European Central Bank executive, warned the German parliament against using the country’s funds to bail out the Greek economy.

“The crisis is made in Greece,” he told the Bundestag. “It is the result of bad policy, not outside forces like an earthquake.”…

While protesters and union officials demanded that Greece hold back on austerity measures and spend more on stimulus instead, European officials said that Greece is likely to have deeper austerity measures, including an increase in the value-added tax beyond its current 19-per-cent level.

Greece has until March 16 to deliver its austerity measures, or more may be imposed by Brussels…

Greece will need to cut spending – by 10 per cent of GDP over 10 years – while raising revenue and cracking down on its untaxed black-market economy, which counts for as much as a third of all financial activity in the country. This combination could provoke further unrest, and may foretell
similar tensions in Italy and Portugal.

If Greece’s crisis and accompanying political unrest were an isolated case, it might be more manageable, but this week the turmoil seemed to spread across the belly of Europe.

On Tuesday, Spain’s cities were shut down by unionized workers protesting its left-wing government’s plan to raise the retirement age to 67 and cut spending in order to deal with its own serious fiscal situation….

And on Wednesday, Portuguese unions announced that they would hold a general
strike on March 4 to protest similar austerity measures.

Yves here. Other reports claim the majority of the Greek population supports the austerity programs, but that may prove cold cheer if opposition continues to be able to conduct effective general strikes.

Update: Two readers from Spain disagreed with the Globe and Mail’s characterization of the protests, saying they not large scale by Spanish standards and did not “shut down cities.” Back to the original post

These protests may seem barmy to some observers. Did riots in Thailand and Indonesia during the Asian crisis cut any ice with the IMF? Well actually, yes, the initial plan was not only too severe, pushing subject countries into a deflationary spiral, but they used the same template that was devised for Latin American countries, and many elements were inappropriate to Indonesia, Thailand, and South Korea.

Moreover, the assumptions about industrialization, progress, and class differ between the US and Europe. Americans do not identify with the image that many Europeans have of the industrial era: of people who lived in small towns suffering downward mobility in the first half of the 1800s, as home craft workers (particularly in the English countryside) and guilds were displaced by automated manufacture. In addition, in some areas, conditions were made more acute as commons, which were typically shared pastureland, were privatized. The loss of grazing land often pushed self-supporting households into poverty. That in turn led to an influx into the cities. A series of uncoordinated revolutions in 1848 swept the continent, and while only one overthrew the government (in France), those uprisings are now credited with producing significant political shifts in other countries.

By contrast, the popular history of the US in the 1800s is dominated by geographic expansion, conquest and settlement of the heartland, with the role of urban immigrants (who often worked in sweatshops), Chinese labor (critical to building the railroads) and newly freed slaves in taking up many of the most difficult jobs of the US industrial revolution often gets short shrift. Laura Ingalls Wilder is more widely read today than The Jungle.

That is a long winded way of saying those who view the protests as a futile protest against the inevitable may be looking at the wrong metrics for success. While they seem unlikely to achieve their narrow objectives of forestalling budget tightening, they may succeed in making sure that the burden of compliance does not fall unduly on the working man.

And needless to say, the political drama is at a minimum going to make it much harder to craft an economic deal. IMF mandated reforms helped make the world safe for America’s finest investment bankers and multinationals; Germany and the other EU creditors in theory have little upside (although the exposures of their banks to Club Med members does put them at considerable risk, readers tell me that saving financiers is ever bit as unpopular as rescuing Greek wastrels). And the rising tempers on both sides are certainly not helping.