naked capitalism

From Veneroso Associates’ US Economy October Employment Report, ” Huge Discrepancy Between the Payroll and Household Surveys:

Executive Summary

1. According to BLS, payrolls fell at a 188,000 a month rate over the last three months. But their own household survey says employment fell at a 589,000 a month rate.

2. Why the discrepancy?

3. Chris Manning of the BLS told us last month that payrolls were overestimated in the twelve months ending March by 824,000. The source of this error was the birth/death model. BLS used “plug” numbers for the number of births and deaths. These “plug” numbers were wrong. They led to estimated positive contributions to employment that were too high. Most of the error (675,000 out of a total 824,000 jobs) occurred in the first quarter of this year. The birth/death model was adding significantly to payrolls when all other payrolls were falling. In reality the contribution from net births and deaths was in fact negative.

4. Manning told us that the faulty birth/death model was still being used for the months after March of this year. The implication was that the faulty birth/death model would continue to overstate payrolls and understate the payroll job losses in the months since March.

5. And, in fact, the BLS is doing just that. For the last three months they are assuming net birth/deaths have added 18,000 jobs a week. Last year over the same period they assumed it added 17,000 a week, the year before 18,000 a week, and the year before smack in the middle of the economic boom 18,000 a week.

6. It is obvious what BLS is doing. They are simply plugging in an extrapolated figure with zero adjustment for the most severe labor market contraction in three generations. And, worse yet, they know the birth/death number they are using is pure baloney.

7. NUTS!

8. Therefore, reality probably lies somewhere between the payroll survey monthly rate of job loss of 188,000 and the noisy household survey rate of job loss of almost 589,000. A best guess would be that jobs continue to be lost at a rate of 300,000 a month or more.

Payrolls were down 190,000. A slightly larger decline than the consensus. But prior payrolls were revised to show a lesser decline in August and September combined of 91,000. Payrolls with revisions declined only 99,000.

From a payroll survey perspective employment conditions are improving significantly. Not so from a household survey perspective.

The unemployment rate rose by .4%. I expected a rise, but only because I expected the sharp drop in the labor force in recent months to be partly reversed. In fact the labor force fell further by 31,000. The increase in the unemployment rate came entirely from another huge decline in the household measure of employment of 589,000. This followed declines of 785,000 in September and 292,000 in August. That is an average monthly rate of decline in employment of 589,000. That is as bad as it has been for the entire recession adjusted for population discontinuities.

The household survey of employment is a very noisy series. I was absolutely certain that, after the huge declines of August and September, we would see a much lesser decline in household survey employment in October. I thought that a decline of 200,000-300,000 would still signal serious employment weakness because of the huge declines in the prior two months.

No matter how noisy we think the household survey is, we have to take these household survey employment declines seriously. The three month decline may not be close to 1.8 million; it may be half that. It does not matter. A 300,000 a month rate of employment decline is very serious.

How can there be such a huge divergence between the household survey which now shows almost 600,000 job losses a month and the payroll survey which now shows average job losses of under 200,000 a month? Part of it, of course, is data noise. But part of it must be a continued overestimation of net positive job creation arising from the notorious birth/death model….

Therefore, reality probably lies somewhere between the payroll survey monthly rate of job loss of 188,000 and the noisy household survey rate of job loss of almost 589,000. A best guess would be that jobs continue to be lost at a rate of 300,000 a month or more.

Is this consistent with anything else? Yes. Though the manufacturing ISM showed a huge increased in its employment index, the non-manufacturing ISM showed a significant decrease to a low level. The vast majority of employment is in the non-manufacturing sector.

Also, if the rate of job loss was seriously contracting the work week should be rising. A move to a longer work week is often the first move by employers when labor conditions start to improve. The payroll survey shows a decline in the work week over the last three months and no improvement in the last month.

The latest initial and continuing claims suggest that there is some recent abatement in job losses. But they have probably continued at a significant rate and income destruction probably continues at a rapid pace….

As for the markets, they are so clueless at reading the fundamentals I have no idea how they will react to this data.

As readers probably know, the health care reform bill passed the House tonight, by a thin margin and with the Democrats offering a large concession by limiting reimbursements on abortions.

Thomas Frank has a good piece in the New York Times tonight, in which he argues that health care reform might lead more doctors to be salaried rather than in an entrepreneurial format in a system that is piecework and therefore rewards more procedures, and therefore encourages doctors to run tests and procedures, adding to healthcare costs.

If you don’t think this happens, I have a bridge I’d like to sell you. I had had a very good doctor before I went overseas for two years, but when I came back, he was no longer practicing (he had taken an job with a small drug company). I had surprising trouble finding a doctor I liked remotely as much as him (and I found doctors I liked in Syndey pretty readily, so I don’t believe I am unduly fussy). I also have a a good insurance policy, it allows me to see anyone with a 20% copay. I can go directly to a specialist, no gatekeeper nonsense. But a 20% copay is also enough to make me sensitive to overtesting.

One doctor I was referred to had his own townhouse. Bad sign. Decorated like that of a plastic surgeon. Second bad sign. He interviewed patients (by then in a gown) in a surprisingly cavernous office for a townhouse behind a large desk that I swear reminded me of Nazi Gemany (and I am a WASP and therefore not inclined to that line of thought). It read to me as an effort to intimidate, and he confirmed that by looking at my file and sneering, “XXX [my address] That’s a rental, isn’t it?”

Even though I am basically healthy, he proceeded to order $2000 worth of bloodwork and have me take an highly sensitive echocardiogram in his office (a $1300 test). Now mind you, my last doctor, a board certified cardiologist, said, “You would be immortal based on your heart.” There was not reason to run a costly test on my heart, but I didn’t know it was costly until I got the bill. I did have an idea what the damage on the bloodwork would be, though, and refused to have that done.

I also had an incident earlier where an orthopedic surgeon was particularly eager to operate on my knee despite a pretty ambivalent radiologist’s report on an MRI. Even though the report said, “possible false positive” his reaction was, “Oh, I’ll just go in, have a look, clean whatever I find up, you’ll be in on a Friday and walking by Monday. ” A second opinion (by a team of radiologists on the same MRI) found my knee was “perfectly normal.”

I hate to give personal anecdotes, but if as a pretty healthy person who does not see doctors often, I have had two clear experiences of doctors pushing to overtreat (and a few borderline cases too), how often does this happen to the average Joe, who might not be in as good general health and less of a constitutional skeptic than me?

Most patients are not able or wiling to buck their doctors if they order unnecessary tests or procedures. Frank describes the general case:

Most doctors undoubtedly recommend only those tests and procedures that they sincerely believe to be in their patients’ best interests. Yet those interests are seldom completely clear. And when doctors know that their incomes will be higher if they recommend additional procedures, many may tilt in that direction.

Physicians, like everyone else, are also subject to herd behavior. If some doctors in a given city begin prescribing additional procedures, others may feel pressure to follow suit — not just because patients expect it, but also to keep pace with colleagues’ incomes.

Yves here. There are most decidedly national as well as regional differences in practice. I noticed when I was in Australia, doctors were up on the current research, but were not inclined to swallow it hook, line and sinker. They were, far more than US doctors, very cognizant of the limits of recent studies (for instance, if it was a small sample size, or was a particular population, and thus not necessarily generalizable). And they were much less eager to operate and prescribe drugs.

Frank does point out that some approaches to cutting the test-happiness of US medicine have yielded positive outcomes:

In an article in The New Yorker, for example, Atul Gawande described an entrepreneurial medical subculture in McAllen, Tex., in which doctors prescribe roughly half again as many tests and procedures as those in otherwise similar Texas communities. McAllen, he argued, is where American health care is heading.

Current reform bills do little to curtail such spending, and all include subsidies to help meet insurance mandates, which would shift substantial existing health spending onto the federal budget. So enacting one of these bills would intensify pressure to cut costs.

The good news is that Dr. Gawande also identifies at least some health plans, like that of the Mayo Clinic in Minnesota, that have sidestepped the incentive problem by putting doctors on salary and operating their own hospitals. Such plans, which provide superb care and high patient satisfaction at significantly lower cost than conventional fee-for-service plans, would become more attractive under the proposed legislation.

But Frank asks the obvious question, and provides his own answer:

But that raises a puzzling question: If the Mayo model is better and cheaper, why hasn’t it swept the market like wildfire?

Part of the answer lies in the so-called adverse selection problem, a market failure that explains why so many Americans remain uninsured. When the decision to buy insurance is left to individuals, the young and healthy often opt out, thinking — generally correctly — that their premiums are likely to far exceed any reimbursement they will get.

But that means that the remaining members of the insured pool, on average, are significantly less healthy, so premiums must rise further. This puts pressure on the healthiest remaining members to drop out, causing still further increases in premiums, and so on…

But adverse selection can’t explain why the Mayo model hasn’t gained ground faster in the employer-provided health insurance market. That market doesn’t suffer from adverse selection, because insurance is tax deductible only if insurers accept all employees on equal terms.

Dr. Gawande reports that Mayo has recently opened a clinic that serves employers in the high-cost Florida market. But given how bitterly businesses complain about rising health care costs, we might have expected much more movement.

One explanation may be residual prejudice against the for-profit H.M.O. wave of the 1990s, which entailed a conflict of interest of a different sort. Patients paid a fixed annual fee, which meant that H.M.O.’s made more money each time they avoided prescribing a procedure. Because clinics like Mayo’s are nonprofits, they may avoid this conflict.

Another factor militating against quick expansion of the Mayo model is that many current doctors chose their profession hoping to earn lucrative pay, which they might not be able to do in a nonprofit clinic. But across the economy, we see talented professionals whose career choices are driven by concerns far broader than pay. Many top graduates from elite law schools, for example, turn down lucrative positions in corporate law to work for public-interest groups paying a third as much.

I suspect Frank is right on the pay issue, but for the wrong reasons. I am always staggered when I hear of law school and business school graduates being in debt to the tune of $100,000, even $200,000. I have no idea what the level for MDs is, but I imagine it is even worse.

And you cannot discharge student debt in a bankruptcy. You have no choice but to pay it (or I suppose flee the US or go underground, there are always extreme options). So the fee for service model may remain intact despite the fact that it produces poor outcomes for society as a whole because the current generation of doctors needs high incomes to so they can service their debts.

By Edward Harrison of Credit Writedowns

The Obama Administration is captured. To understand why it has acted as it has, one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry. One need merely read the last post I wrote on this topic.

In their wildly optimistic view, the banking industry is solvent and always has been. All that was needed to ‘solve’ than banking crisis was a lot of liquidity, government backstops and, most importantly, time. This blinkered view sees a looting of taxpayer money to bailout the banking industry as necessary to save banks whose credit is the ‘lifeblood of our economy.’

They are wrong. The banks did not need to bailed out. The banking industry industry needed to made solvent again. There is a big difference between those two sentences (banks versus banking industry and liquidity versus solvency) that goes to the core of the captured and politically damaging world view we have seen on display by the Obama Administration.

Change you can believe in

Think back some 18 months when Senator Obama was in a horse race with Hillary Clinton to see who would go up against John McCain in the Presidential election. If you asked any reasonable individual who had the least experience and the thinnest political resume of the three, he or she would have said Barack Obama. If Americans wanted someone long on inside-the-beltway experience, they would have chosen John McCain – or, at a minimum, Hillary Clinton, not Barack Obama.

So, Barack Obama did not best both Hillary Clinton and John McCain and get to the White House because Americans felt him more qualified for the job.  Rather, Americans believed the U.S. was on the wrong path and wanted a qualified person to lead the country who would also change course. They believed that person was Barack Obama.

And when it came to the economy, the presence of two men, Paul Volcker and Warren Buffett, born some 80 years ago, gave one the sense that, despite Barack Obama’s perceived relative youth or inexperience, he had the ablest of wise old men who would be his and our counsel in resolving this crisis.

Bailing out the banks

So when Barack Obama took office, it came as a rude awakening for many that he chose to bail out the too big to fail institutions with little or no strings attached, allowing them to later make record profits and pay record bonuses, while the economy was in a deep slump and ordinary Americans were being bankrupted and losing their jobs and homes at record rates. This was not change you can believe in.

What could or should the Obama Administration have done?

If you had listened to the chatter inside the beltway early this year, you would realize that Obama’s team believed it was not politically feasible to ‘nationalize’ Citigroup or Bank of America and force top executives to resign as was done at RBS, Bradford and Bingley or Northern Rock in the UK. This was a blinkered view which can only be described as captured (if not outright disingenuous).  We need look no further than Fannie Mae and Freddie Mac to see that nationalization was an option.

But this is not the kind of solution we needed.  What we needed was a solution by the Administration to take prompt corrective action in seizing bankrupt institutions, dismissing management, punishing any misdeeds and setting up a timetable to sell off the institution’s assets. That is change you can believe in.

I laid this out fairly comprehensively in February in my post “America needs a pre-privatization plan.” So I am not going to cover that ground here except to quote the key relevant passage in that post:

To my mind, there are three ways to deal with an insolvent financial institution:

• Bankruptcy. Allow the  institution to collapse (like Lehman Brothers)
• Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)
• Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.

As you can see, governments have tried all three solutions.  However, there are vast differences between the three.

The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere.  It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions.  It also acts as a subsidy, which favors domestic institutions over foreign rivals.  Bailouts increase moral hazard by rewarding risky and reckless lending practices.  And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.

So what we have here is a case of crony capitalism and kleptocracy, plain and simple – whether by design or not is immaterial. And the American people are on to this. That is why people are resistant to other changes this Administration has put forth.

Don’t let the media’s spin fool you: Washington insiders are on to this too. Politicians in Congress realize that Obama’s bailouts have cost him political capital  and they are challenging his policy agenda as a result. This is why the health care bill, which Obama wanted passed before the summer recess, may not see the light of day before year’s end.

Are we home safe?

I would advise the Obama Administration not to run any victory laps about having slayed the beast. The lingering effects of crisis are still there. The Fed’s liquidity is still liquid. Impaired assets are still impaired. And zombie banks are still zombies. As I indicated in my depression piece:

In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized.

Since I covered this ground in that article, I will leave you to read my further thoughts there. What I want to turn to now is the ‘why.’

The Cheney-Rumsfeld replay

Now, I am not writing off Barack Obama’s presidency. I do worry he still could see a recessionary relapse which would cause him to seem more Herbert Hoover than Franklin Roosevelt.  But, despite his Nobel Prize, it is much to early to know what his legacy will be.

Nonetheless, I believe he has wasted a lot of political capital and this will make ushering through a meaningful legislative agenda very difficult.

Why did Obama throw it all away?

Here’s my answer: I call it the Cheney-Rumsfeld replay.

When historians look back at the Bush 42 presidency, it will be defined by 9/11 and the wars in Iraq and Afghanistan.  While George W. Bush was politically pre-disposed to the Neo-con world view, it was really advice from Dick Cheney and Don Rumsfeld which made Afghanistan and Iraq possible. George W. Bush was famously not well-versed in foreign affairs, having almost never travelled abroad.  He was completely dependent on Dick Cheney and Donald Rumsfeld to make foreign policy (although he could have listened more to Colin Powell, his actual Secretary of State; again it goes to predisposition).

So, I see George W. Bush’s presidency as having been defined by foreign policy and the War on Terror and, by extension, on Rumsfeld and Cheney.

Fast-forward to Barack Obama’s presidency and you have an almost identical situation, this time with the economy instead of foreign policy and Tim Geithner and Larry Summers instead of Donald Rumsfeld and Dick Cheney.

But, as with George W. Bush, it goes to pre-disposition. Paul Volcker was a critical member of the Obama 2008 campaign. He also was a key member of Obama’s economic policy team. But, he has been speaking a very discordant message that is not in sync with team Obama. So, as with Bush and his marginalization of Powell, one has to believe Barack Obama has chosen to side with Geithner and Summers over Volcker.

The obvious conclusion, therefore, is that Barack Obama shares the blinkered and captured view of his policy makers and that this is why he has decided to go down this chosen path. And when it comes to Obama’s other ‘change’ decisions on the Guantanamo closure, torture, rendition, state secrets, and health care, the same logic also applies.

Is this change we can believe in? I will leave that for you to decide.

It should come as no surprise that those at the top of the food chain get preferential treatment on all levels. But this still stinks to high heaven. Employees of the Goldman, the Fed, Citigroup, and other banks are getting H1N1 vaccine allotments out of proportion to what can be justified from a public health standpoint. In particular, Goldman has gotten more than Lenox HIll hospital, which needs it not just for the sick but more important, for workers (not only does the public need to keep front-line health care workers in as good shape as possible, but if they get the infection, they become disease vectors fast, given the number of people they see).

Then again, banks have become parasitic, so why should we expect anything different? And although Business Week broke the story, it did it press release style:

To the list of hundreds of schools, hospitals, and community health centers that have received limited allocations of the H1N1 swine flu vaccine, you can now add some of New York’s largest employers. In the past week or so 13 companies, including Citigroup (C) and Goldman Sachs (GS), have begun receiving small quantities of the vaccine, according to city health authorities.

Citigroup has been supplied with 1,200 units and Goldman with 200, says Jessica Scaperotti, press secretary for the Department of Health & Mental Hygiene. The agency has so far approved orders by 29 employers—including 16 that have yet to receive any vaccine—after they were cleared by the U.S. Centers for Disease Control & Prevention (CDC). Big employers that have received or are scheduled to receive vaccine so far include Time Warner (TWX), JPMorgan Chase (JPM), Memorial Sloan-Kettering, New York Presbyterian Healthcare System, and New York University.

Health-care workers at those employers are bound by the CDC to distribute the vaccine only to populations deemed to be at high risk of developing serious complications from swine flu: pregnant women, children and young people aged 6 months to 24 years, people who live with or provide care for infants under 6 months (who cannot be vaccinated), people aged 24 to 64 with medical conditions that put them at higher risk for flu-related complications, and health-care workers and emergency medical personnel.

Yves here. Welcome to the class system in action. If you don’t work for a big, influential company, go to the back of the queue. Why should companies be the nexus of distribution for vaccines? I guarantee no Goldman MD gets much of his routine medical treatment from the GS health workers on staff (emergencies or a fast diagnostic like a strep test are different). But if you work for a less privileged employer or are self-employed or between jobs, tough luck, go to the back of the queue, you have to try to get yours (assuming you can) from vaccination centers in New York City. How easy do you think that will be? The difficulty and queuing are certain to be much worse than for any of the big financial players.

And please, it strains credulity to think that someone on the payroll at these companies won’t bend to pressure to make allotments at the margin according to who is most powerful. Do you think if Lloyd Blankfein or another member of the management committee was in a risk category that he would be denied it, assuming the firm did not have enough to go around? (and that is likely). Now given the brouhaha, Goldman may bend over backwards not to abuse this overmuch now that there is media pushback. But this serves to illustrate how the system has been suborned on just about every front. To wit, Goldman is getting 200 doses of the vaccine, the same number as Lenox Hill Hospital.

By Edward Harrison of Credit Writedowns

I was reading Kid Dynamite’s account of the recent Treasury – Finance Blogger meeting after having read a bunch of others (see them all in Abnormal Returns’ Nov 4th links). And I was struck by his characterization of the thinking at Treasury in regards to the financial crisis. I want to highlight two points and ask the question: didn’t the Treasury plan work as designed?

I will try not to editorialize and let you draw your own conclusions based on my (hopefully neutral) narrative of their stated goals.

Here is point #1 I want to highlight:

The first point that caught my ear was the description of the stress tests as having been designed to restore a level of confidence in the banking system.   The STO mentioned that the focus was now on reducing the footprint of economic intervention cautiously, quickly and prudently…

a number of STO’s present in the room, who quickly banded together to clarify that no one knew the results of the stress tests before they happened, and that they were designed to restore confidence by identifying the levels of capital needed by the banks, and requiring them to raise such capital.  I said that if they wanted to restore confidence, they should require banks to mark assets to market, and depict the true financial situation.

As I read it, Treasury wanted to show that it had a credible plan to identify any capital shortfalls amongst our biggest banks and to take corrective action.  Their belief is this would restore confidence.

Here is point #2 to highlight – why the need for secrecy:

I [Kid Dynamite] mentioned that the problem was that even if we had a “Counterparty Risk Czar” who somehow managed to magically quantify the exposures of each firm (which may be quite a difficult task in itself), we’d see the same problems we saw when the government went to give out the TARP funds. The government didn’t want to “bail out” select firms (ie, BAC and CITI) because they feared that the stigma attached to such assistance would create panic and runs on the bank – so they asked a large pool of financial institutions to take the money to hide the truly sick cows.

I read this to say that Treasury feared identifying ‘loser’ institutions would have a negative impact and cause bank runs (think Washington Mutual). therefore, they had to hide the ball, so to speak.  The same philosophy is behind the Fed’s refusal to release more information to Bloomberg on the Fed’s emergency lending counterparties.

The overall gist of the strategy was that Treasury wanted to identify the weak, give them time to grow stronger, and, in so doing, allow the panic phase to subside so that corrective action could be taken in a more normal economic environment.

Wasn’t the plan wildly successful? Blogger Accrued Interest thinks so.

Now, before you give a knee-jerk response, please read the following from a post I wrote in April called “Channeling my inner Larry Summers,” which was my attempt to read the intentions of Obama and his economic team (in the voice of Larry Summers). I think it dovetails nicely with what Kid Dynamite says were the actual goals of Treasury.

the question is how do we deal with this crisis.  The first priority must be  to forestall a deflationary spiral because that induces a dead-weight loss and extracts a cost of incalculable consequences.  The best way for government to end the spiral is to temporarily increase spending or temporarily induce more private sector spending.  Is this re-flating the bubble?  No, because deflationary forces will continue to extract a price even with these measures in place.  The key is to avoid a negative feedback loop, a spiral downward, and the easiest way for government to do this is to increase spending.

But, spending alone won’t get it done.  Ultimately, we will need to increase credit availability.  Just because people are spending more, does not mean the economy will grow.  Growth depends critically on increasing credit in line with the growth of the economy.

I am not one for nationalization of banks or other coercive, non-market based mechanisms of getting lending flowing.  The concept that nationalizing banks and re-privatizing them should be a first port of call for a government imperiled by a weak banking system is contrary to the need for limited government.  What we need to do is put a number of government-assisted programs into play — cognizant of that healthy tension between limited government and necessary government — and get credit flowing this way.

Let me enumerate some mechanisms:

• First we should try bank re-capitalization.  Our first priority must be to have an adequately-capitalized banking system. Absent that, increases in lending are impossible and the system will continue to be doubted. So that’s number one. We can do this through preferred equity so that the government is senior to common equity and receives some compensation for taxpayer money.  What’s more is it limits government interference. Remember – most of these institutions are having temporary problems.  With enough capital, they can weather the storm.  There is no need for heavy-handed government interference.
• If re-capitalization proves inadequate because of depreciated legacy assets, we will need to remove those assets from banks’ balance sheets in a way that promotes price discovery, increases asset liquidity and respects the tension between government involvement and government’s limitations. The PPIP and TALF can help achieve this.
• Moreover, by allowing financial institutions to borrow with a government guarantee, we can ease the funding liquidity constraints as well.

Ultimately, the jump start from stimulus and quantitative easing will start to kick in while all of this is ongoing. The result will be a growing economy and healthier banks. Nevertheless, we should implement some stress tests on institutions to gauge how much capital each institution would need in a worst-case scenario. Those banks faring poorest will need to take remedial action as soon as possible. However, under no circumstances should we ever imply that any individual institution is insolvent. This creates doubt and during times of stress it is not the wisdom of crowds, but the panic of crowds that is on display. Doubts about one institution are likely to have knock-on effects for others creating a systemic problem. This must be avoided at all costs.

So have Geithner and his team not avoided the pitfalls and accomplished their goals?

By Edward Harrison of Credit Writedowns

Yves is tied up in the never-ending ordeal that is writing a book, so I will fill in a few gaps by posting on NC today. Let’s wish Yves well in getting this thing sorted.

The power grab at the Federal Reserve is a topic I first broached back in February when the Federal Reserve was creating its alphabet soup of liquidity programs to pull us back from the brink of financial disaster. I was troubled about Fed policy then and I am still troubled today.

I am equally disturbed by what is happening in shift in the balance of power to the executive branch. The Obama Administration seems to be following in the footsteps of the Bush Administration and making its own power grab and Congress has only just begun to wake up to this and start to push back.

At the risk of making this post overly broad, I want to make a few general comments about how executive power in government operates before I take on the specifics of the cases at hand. Everyone who has studied political science is aware that dictators and oligarchies use crises to invoke fear that allows them to usurp power using the cloak of ‘national security’ as a Trojan horse to consolidate power.

I would argue, this is what has just happened in the U.S. post-9/11 and again after the Panic of 2008. I see these developments undermining Americans’ faith in the political process and I hope an appropriate restoration of the checks and balances laid out in the Constitution can be restored. Having made my editorial statement, let me move to the specifics.

Executive Branch power grab

In September, after Lehman Brothers failed, US Treasury Secretary Hank Paulson asked for and received a blank check to disburse $700 billion to former colleagues and rivals in the financial services industry as he and his staff saw fit. In a brilliant act of cunning, Paulson had gotten approval to do anything he wanted from a gutless Congress more interested in loading the bill with sweeteners. This bill was not unlike the Patriot Act, passed after the 9/11 attacks, in that it increased the executive branch’s ability to intervene in the economy as they saw fit. I called it the Economic Patriot Act.

Originally, the Economic Patriot Act was about marking to market. However, once Gordon Brown started recapitalising Britain, Paulson made an about-face and proceeded to dispense the money in a similar fashion (albeit with much fewer strings attached than in the UK).

When the Obama Administration came to town, the modus operandi were not much different. Other support programs were forthcoming and bailouts at Citi and BofA ensued.

With the economy and banks on sounder footing and much of the money returned to taxpayers, the Obama Administration has turned to regulatory reform – and, what do you know – they are looking for a blank check again to do as they please in resolving too big to fail institutions that run into trouble. Again, as with Bush in 2002, if Congress gives the executive branch any blanket authority, it will be used and Congress will be cut out of the process. This is NOT how the American system of government is supposed to be run.

The Fed is grasping for the brass ring too

Enter the Federal Reserve. The Fed has been engaged in a policy of acting in concert with the Executive Branch in a non-arms length fashion since this crisis began. All of the liquidity programs and backstops the Fed has implemented are not just about liquidity, they are subsidies that lower the cost of capital and increase profits in the banking sector. As such, these subsidies are actually a part of America’s fiscal policy – stimulus, if you will. It is a clear no-no for the Federal Reserve to inject itself into fiscal matters. And to top it off, the Fed is refusing to be transparent about the process. Why would we make it the Systemic Risk Regulator?

Willem Buiter says it best so I will just quote him verbatim from his article, “Should central banks be quasi-fiscal actors?”:

Any action going beyond that, such as the recapitalisation of insolvent banks through quasi-fiscal subsidies, ought to be funded by the Treasury.  The central bank should be involved only as an agent of the Treasury – an expert assistant.  It should not put its own conventional or comprehensive balance sheet at risk.

The two arguments against the central bank acting as a quasi-fiscal agent are, first, that acting as a quasi-fiscal agent may impair the central bank’s ability to fulfil its macroeconomic stability mandate and, second, that it obscures responsibility and impedes accountability for what are in substance fiscal transfers.  In the US such actions subvert the Constitution, which clearly states in Section 8, Clause 1, that the power to tax and spend rests with the Congress: “The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.”.

If, as happened in the USA on a vast scale, the central bank allows itself to be used as an off-budget and off-balance-sheet special purpose vehicle of the Treasury, and refuses to provide to the Congress some of the information essential for the quantification of the fiscal transfers it has made, the central bank not only subverts the constitution.  By attempting to hide contingent commitments and to disguise de-facto subsidies by not divulging relevant information on the terms on which the central bank has offered financial assistance, it undermines its own independence and legitimacy and impairs political accountability for the use of public funds – ‘tax payers’ money’.  It is surprising that a country whose creation folklore attributes considerable significance to the principle of ‘no taxation without representation’ would have condoned without much outcry such a blatant violation of the equally important principle of ‘no use of public funds without accountability’.  This indeed amounts to a quiet usurpation of the power of the legislature by the central bank.

Qualitative easing, or whatever you call it, must end.  With the FOMC starting its two-day meeting tomorrow, and with the Reserve Bank of Australia having already hiked twice, it will be interesting to see if the Fed retracts its “extended period” language as many of us expect. While I think it premature in regards to the robustness of the economy, the Fed needs to show it is an independent actor.

Once lost, independence will not be easily restored.

One week ago, I put up a post on the plight of a family that was at the end of its rope financially due to a lack of savings prior to the firing of the main income provider at the start of 2009. They had started using credit cards to pay for necessities, had paid on time until the previous month, and Bank of America stopped approving charges on the card.

This is the start of their story from last week:

Just like most everyone I know, my husband and I are in big debt with our credit card companies. My husband was laid off on New Year’s Eve last year. We were in total shock. I am retired from the USAF and receive a small monthly check, and my husband began collecting a meager unemployment check. He searched all over the US and made several trips out west knocking on doors and handing out his resume. NOTHING. Anyway, we had no saving and a little bit of stock which was cashed in at an all time low. No help there. Then we started living off our credit cards. Without them, we would have not made it, period. Our daughter and her family moved in upstairs and her husband was working of a whopping $8.50 an hour. No help there. So basically we were supporting them as well.

Two surprising things happened. First, one reader, a T. Rex Bean of Honolulu, offered to send the family $1000 if other readers would contribute. I said I would and encouraged others who were interested to ping me.

Second, that act of generosity seemed to particularly incense those inclined to take a dim view of those in debt, and some responded with vitriol, their comments having no grounding in anything more than prejudice, on why this family was having trouble making ends meet. Quite a few of the comments also reflected a considerable lack of understanding as to how the bottom half, income-wise, lives (for instance, saying that the couple “should” have several hundred thousand in savings plus that much in their home equity). A different theme was the couple should be on food stamps and the adult children and their kids should be on Medicare. One reader who rebutted that in comments, pointing out that the thresholds for assets and income were very low, was ignored, and a longer-form discussion came via e-mail:

In the US most aid programs for the poor are not oriented at all to the temporary poor. The way they are set up they don’t seem to treat “poorness” as a condition you are in but more as an identity. Prove you’re one of “them” and you’re all set. But the hassle of proving your poor identity is generally huge, so you want to do it only once. Once you are officially poor, you don’t want to be moving in and out of that designation and facing the paperwork blizzard over and over. It’s a real problem with the system. Treating “poor” as an aspect of identity makes people both reluctant to start getting help and then to stop getting help. The people I’ve known on Medicaid always took care to avoid a job that paid a little too much, lest they lose coverage.

There was also an assumption that the wife was on a full military pension. Note she said “small monthly check”. You need to do a full 20 years to get the inflation adjusted full pension; anything from 10 to 20 years is a % of final year pay.

This is a selection from comments:

What a whiny welfare biatch. I wonder how many Iraqis, Serbs, and Afghanis she killed at the USAF. You wanna do charity, give it to Iraqis, not American military welfare deadbeat crybabies. Dumb bitch.

Sounds like someone doesn’t know how to manage their money. I would bet they are making car payments and eat fast food at least 3 times a week. Probably have cable T.V. and deluxe cell phone plans. They probably get a new car like every two years. What happened to her reenlistment bonuses?

I think the family is at odds with the definition of ‘essential’, as are most Americans. Americans eat out often and call that essential. The food prepared at home is packaged in boxes for convenience: essential. Cell phones, well of course, they’re essential. Cable television? Ditto: essential, after all the cable is cheaper than Blockbuster late fees. Large hummer type transport? Essential: fought a war for that one. Sodas and chips? That’s called lunch.

And one she was a grifter:

I notice this story asking for ‘advice’ and not a hand-out managed to hit all the emotional triggers: military service, lay-off, always paid their bills before, adult son-in-law working valiantly at a low-paying job, grandchildren, no medical insurance…

I am aware that hard times happen to honest people. However the calculated pull for pity in this letter reads like a professional beggar.

Additionally, the letter implies it’s these older parents responsibility to help support the daughter’s family. It isn’t.

So what transpired? The couple is in the rural South, Georgia to be precise.

Even though quite a few readers sent payments (some wrote cover notes encouraging them to accept their offer), the checks were rejected. She only wanted help in dealing with Bank of America and was very grateful for the credit counseling leads some readers also sent along to her.

From her messages:

I’m such an idiot. We are not asking for ANYTHING but some advise on what ideas you might have to save us. My problem is the rising B of A bill, the extra charges being added on when I can’t make the minimum payment, the over the limit fees, late fees and that interest rate moving up and up. It’s got to stop and I don’t see an end to this madness. I just can’t understand why these banks that are being bailed out by us, the tax payers, are trying to bring everyone crashing down so they can collect their big bonuses or whatever they get. We have had it with banks and bonuses and the whole financial crisis. Thanks for all you help and the offer, but there are folks who have already defaulted on their cards and loans and have lost their homes and jobs. At least my husband did finally get a job last week after 10 1/2 months of looking from Baltimore to Berkeley, but the damage has already been done. Someone, somewhere must listen to the people because we are all going down, friends, neighbors, relatives, you name ‘em, we know ‘em….

From another message:

We haven’t eaten out in years, never pick up fast food, ever, don’t walk the malls, never received any public assistance, have a 2000 Tundra and a motorcycle to save on gas, make everything from scratch (even my own homemade laundry soap!)… frankly, I don’t know many folks around here that have saved for a stormy day. Saved? That’s a joke to most of us. We’ve gotten our phone disconnected and share a cell phone, we plan each and every trip to the store with a list of necessities, haven’t had a vacation in over 15 years, and up until my husband got a job last week, we were selling everything we could sell in the house on ebay. At least I am cleaning out the closets that haven’t been cleaned in years.

And this one:

We had lentils and cornbread last night…yum yum, and we’ll heat them up tonight as well. I did mention that my husband got his first paycheck last Friday. Sent from Heaven. We celebrated with brats and homemade kraut and hard rolls! Beats a t-bone any day in our book. Hubby is from Austria, so he can make some great kraut.

I should mention another little fact that goes along with all of this. Someone mentioned, maybe you, about proud folks in the south and everywhere. Well, my brother, who has an English degree from the University of GA and is a struggling wallpaper hanger, invited us in June to his son’s wedding in Savannah. He is my one and only nephew and I love him dearly, but we just could not afford to go. Savannah is about 4 hours from here, so gas to get down and back, hotel for a night, food and such…we just did not have the money. But instead of telling them the real story of why we could not make it, I gave them the BS excuse, hurt their feeling like you would not believe, and they haven’t spoken to us since! People just don’t want others, especially family, to know what kinds of problems they are going through.

Our neighbors across the street are struggling as well, but always have a cheery smile and something nice to say. Their son, who is a firefighter and his bride of one year just moved back in with them in September. Just couldn’t make it on their own. BUT, that’s the European way of life and we like it. Parents, grandparents, great grandparents, kids, grandkids, and maybe even great uncle Bernhardt live together. They help each other, eat out of the same pot, know each other’s ups and downs and so on. I was criticized for allowing my daughter, son-in-law and granddaughter to move in by some moron on the blog. Maybe they live in an adult only condo at Palm Beach and absolutely hate it when the grandkids come to visit. Interrupts their golf and bridge games perhaps. So those who criticize over half the US population for “over spending” and “living high on the hog” with credit cards are so out of touch with real America. They are a pathetic bunch of idiots.

I spoke with my son last night in Chicago who knows how we have been struggling. He told me to please hang in there for a few more months and his family has decided to move down to North Carolina out in the foothills somewhere. He wants us to all to pool our resources, get an old farmhouse we can fix up, and live off the land. Of course we will all have to find jobs, any jobs, but everyone is willing to work together for a common goal…the survival of our family and our community….

Now if only those jokers in Washington will pass the government option healthcare proposal, crack down on the credit card companies for their outrageous practices, and get us out of that war that the Bush regime got us into, maybe things will improve for the whole country, not just the top 3%.

I think quite a few readers owe her an apology. But I am also sure those readers are so locked into their Calvinist mindset that they will find some basis for criticizing this family. Some people seem constitutionally unable to admit that success and prosperity are not the result of hard work alone. I know plenty of people who are hardworking and talented. Some are making a fraction (and I mean less than 1/10) than people I know who strike me as less talented, often less natively intelligent, and certainly worked less hard. I know others who took considerable reversals through no fault of their own (including one in particular, a former high flier who has had to move back to his parent’s home, with the reasons including that he gave a lot of money to struggling relatives). Luck also plays a big role, what family you were born into, what breaks you got along the way, what landmines you avoided. It is part of the human condition that we lack foresight. Things that look like a logical choice can turn out badly for reasons beyond one’s control, and many people lack the luxury of choices to begin with.

This from another reader:

I am astonished at how many readers you have who have no idea whatever how the financial bottom fourth or fifth of America lives. When I was a kid in western Kentucky I had a few classmates who lived in unpainted old clapboard houses out in the country, in some cases
former slave quarters and so a century old. I remember one such house that even had a dirt floor. When I was little my mom’s parents lived in a tiny mountainside house in Appalachia that had no indoor
plumbing. They hand pumped water from a well and heated it on a coal stove, and for a toilet across the dirt road there was an outhouse that hung out over and dumped onto the weeds on the descending slope. Stunk to high heaven, of course, and there were lots of bugs. At eight years of age, having to go in the middle of the night armed only with a flashlight was a character-building experience.

Things are a little better in the rural south now, but they sure aren’t good, now that the small farms are gone. In my adult life I’ve seen one relative living in a broken-down trailer with a caved-in roof
and a goat tied up in the yard. And I’ve seen my cousin, with a small-college degree in math no less, getting by for a good while in the middle of nowhere, south Carolina on $9,000 a year from intermittent and part-time jobs. We can be all snooty about the poor not working hard enough, but I’ve also seen a sister quit a job pulling visibly diseased tissue off of Tyson chickens on a production line rather than get campylobacter one more time. We demand they live and act all middle class, but as a society we honestly don’t give them half a chance.

These guys who talk about saving hundreds of $thousands in small-town rural America are particularly irritating. How do you do that on $9K/year or $12K/year exactly? The US Census Bureau says in 2007 the bottom 20% of US households earned less than $19,178, so these are not trivial numbers of people. We never won our war on poverty really. We just forgot about it when the conservatives become obsessed with the hordes of welfare queens (and drag queens) that they imagined were filling our cities.

One of my big shocks when I started traveling more was to discover that compared to a lot of places a large part of the central and southern US (including parts of the upper Midwest) was actually what used to be called a third-world country, with way more poverty, illness, and and borderline illiteracy than Europe et al. Re literacy I remember in Turkey seeing Chekov plays for sale at a truck stop in the middle of nowhere. My Turkish friends thought it odd that I’d find that odd. To them it was perfectly reasonable that a truck driver might want something interesting to read.

One of the big lies about the poor or the struggling lower middle class is “surely they could have made something of themselves.” If you local school is lousy, how are you going to do that? I hate to say it, but from the time I have spent in Alabama, the level of education among average people (and I don’t mean poor, I mean average) is not hot at all. Multiply that across quite a few lower-income states.

McClatchy, the only major US news organization to question the Iraq war until is was obvious to all that it was a misguided exercise in neocon hubris, has started a series on Goldman’s famed “short subprime” exercise. While the timing and overall outline are not new (as to when and allegedly why the investment bank went short), it delves into some details that have heretofore not been examined, as to how much subprime paper it dumped onto investors during this period, whether this duplicity was permissible, and what sort of damage was visited on foolhardy borrowers.

Unfortunately, for my taste, the series does not appear to be getting enough into the nitty gritty (and it indicates clearly that Goldman has successfully kept mum about the details of how it executed its short). I am keenly interested, because my understanding is that any simple subprime index short would have blown out spreads and thus been very costly to execute.

Goldman used another route….and the road, not surprisingly, was through AIG. From an e-mail over the summer:

This also points out a *VERY* good nugget re: banks who used CDOs/AIG offensively as opposed to as a hedge. This is likely what bothered me most about the AIG debacle. The trades GS had on with AIG were generally *not* super senior CDOs GS was long simply because they had
underwritten CDOs and were “stuck” with the AAA risk as a result. Rather, GS had a whole program of issuance — something they called “Abacus” — which were deals they put together with the sole purpose
of getting short subprime/CDO risk. Their sole purpose in doing the deals was to get long protection/short risk on the underlying collateral. AIG was simply the vehicle they chose to moneitze that PnL. Call me crazy, but I put the AIG counterparties in two different camps: guys like SocGen, who bought bonds in good faith and then hedged the credit risk by buying CDS from AIG, and guys like GS, who used AIG as their lottery ticket for offensively constructed trades to capitalize on mispriced subprime risk. The former, to me, seem much more deserving of a bailout than the latter…

DeutscheBank had a broadly similar program called Start.

This of course makes complete sense. There simply was not enough insurance capacity (the monolines plus the volume on the Markit indexes) to account for the big names that went short (Paulson, Goldman, one other large but secretive player we are aware of). That road had to go through AIG as well.

And bear in mind another fact: asset backed securities CDOs (and the subprime kind were that type) were managed rather than passive. That mean when the collateral paid down, the manager would go and find new collateral. Again from an e-mail:

AIG got out of subprime in 2005/2006 – whenever – but it didn’t matter.  Why??  Because the same crappy borrowers that made it into 2005/2006 subprime RMBS refinanced and ended up in the 2007 vintage.  Guess who had to buy the 2007 subprime RMBS paper when the 2005/2006 paper repaid?  You got it – the 2005/2006 CDOs.  CDOs have reinvestment periods (4 yrs for SF CDO) whereby they have to continue to be fully invested rather than letting their liabilities get repaid.  The liability buyers don’t want their valuable paper to be repaid early – or, do they????

Readers who know the terrain, and Abacus and Start in particularly, are very much encouraged to comment or ping me at yves@nakedcapitalism.com.

Now to McClatchy:

McClatchy’s inquiry found that Goldman Sachs:

Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they’d misled borrowers or exaggerated applicants’ incomes to justify making hefty loans.

Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.

Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.

Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.

The article continues here.

By George Washington of Washington’s Blog.

Preface:  Please read to the end to see the humorous quote.

I have previously debunked numerous false arguments used to defend the too big to fails. See this and this.

But the apologists for the TBTFs are now arguing that breaking up the beached whales … er, giant banks … will harm America’s ability to compete with foreign banks.

Joshua Rosner (managing director of an independent financial services research firm), has written an important essay debunking this argument:

Those who argue against a more proactive reduction in risk and size of TBTF institutions will, as always, revert to an argument that strikes a natural chord in every American’s heart: ‘Doing so would create an unleveled international playing field for our institutions relative to their international competitors’. Level playing fields are a worthy goal, but this is not a relevant argument. Instead, this tired bromide must be resoundingly dismissed on several counts:

• Those countries with the largest banks as a percentage of GDP (Iceland, Ireland, Switzerland) demonstrated that a concentration of banking power can cause significant sovereign risk and tilt global economic playing fields away from that country.

• The likely breakups of ING, Lloyds and KBC suggest that it is we who seek to support an unlevel playing field where we subsidize our TBTF banks while other nations recognize the policy failures of moral hazard. If we continue down this path we will likely be at risk of violating international fair trade regimes.

• When the “unlevel playing field” argument is cited, keep in mind this reasoning supports the disadvantaging of 8000+ community banks relative to our largest banks, all in the name of protecting big banks from governmentally- subsidized international competition.

• There is no longer any evidence that, beyond a cost of capital advantage that comes with implied government support, there are sustainable and tangible economies of scale arising from being the largest. The financial supermarket concept has been proven a failure. The only ones who benefit are the high-level executives.

• We must demand that our legislators no longer allow unelected officials at the independent Federal Reserve to sign international accords created by the TBTF banks through supra-national bodies like the Basel Committee.

• Are we to believe that if we did not have such large and globally dominant firms, US borrowers might be paying more that the 29% interest that several of the TBTF firms are now charging on their card accounts? Perhaps we should think about what advantage our population has gained as a result of our financial institutions being such a large part of our economy or being globally dominant.

• Since when did we accept a national strategy of following rather than leading? When we do what is right, others follow. As example, consider the bank secrecy havens – they made money for a bit. Now, even the Swiss and the Cayman authorities are coming around to our view.

• We are already at a disadvantage given that the largest foreign banks operate in the US without any tier one capital requirement and yet mostlarge foreign banks have not built a bricks and mortar presence here. Nobody screams about their undercapitalization nor has that undercapitalization caused deposits to migrate to foreign banks.

What fake excuse will the apologists for the TBTFs throw out next?

That breaking up the giants and letting small and mid-sized banks, credit unions and state public banks compete fairly will shift the Earth’s gravitational field as deposits shift away from the money centers?

Note: Rosner has a funny and potentially effective idea for putting pressure on Congress. He suggests that we all call our representatives and ask how much the lobbyists have paid them to destroy America’s economy by propping up the too big to fail banks.

Rosner’s actual language is somewhat over-the-top:

Harper’s Magazine has written up the lengths to which the authorities will go in censoring views that dissent with what is the unstated official policy: that no demand of the banking industry is too unreasonable not to be catered to.

The object lesson is the gutting of the falsely-branded derivatives reform bill. It arrived with a loophole so large you could drive a truck through it, namely that customized derivatives were not covered. So this bill will do nothing to impede the growth of complex opaque products; in fact, it encourages it, since banks will have no oversight if they tweak a product so that is can be deemed “customized.” It was further weakened by excluding most of the banks in America and by excluding a whole swathe of end users. The final insult was making the derivatives clearing house self-regulating.

The hearings on the bill had testimony scheduled only from what amounted to industry flacks. Someone apparently realized at the 11th hour that that might not go over with the correctly angry public too well. So less than 24 hours prior to the session before the House Financial Services Committee, an invitation was issued to Rob Johnson, a former managing director at Bankers Trust Company and former economist at the Senate Banking Committee and Senate Budget Committee.

So what transpired? As Ken Silverstein recounts:

Johnson, who came last, offered the only serious critical viewpoint… After about five minutes of his testimony, Congresswoman Melissa Bean—another industry-funded committee member who chaired the hearing because Frank was absent—had heard enough. “I’m just going to ask you to wrap up because we’re running out of time,” she told Johnson.

Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.

“I do need a final comment,” Bean interjected seconds later.

That put an end to Johnson’s testimony. “I was just called to this hearing last night, so I will provide detailed comments on your bill and a statement for the record that will finish my comments,” he concluded.

So what happens next? >The House Financial Services Committee has refused to publish his testimony, offering “the dog ate my homework” level excuses, first that they hadn’t gotten it, then that it was in the wrong format, then that their IT department was experiencing difficulties (always a good one when real reasons are running thin). The last one was pure Catch-22: that he had gotten his written testimony in too late.

You can read his statement, which is obviously too offensive to powerful interests for it to see the light of day in any officially-sanctioned venue, at the Roosevelt Institute.