Reader's Contribution

THE ABSURD TIMES

Absurd Times:

My name is Stephen Zill and I am an Economics Instructor at De Anza College, Cupertino CA (and sometimes San Jose State). For the last three quarters I have written a column for the De Anza school paper (La Voz). Inter alia, I attempt to keep it "student friendly", and to inject a bit of humor when possible-- lately this [dark-type, anyway] has been pretty easy. Anyway after hitting your blog a few times, I thought you might get a kick out the column I wrote about what was supposed to be the final bank/credit market- bail out plan. I would be interested in any comments you might have.

Cordially,
Stephen Zill
Economics Dept.
De Anza College

4) A discussion with the dark lord on the Fed's new deal (Pub. 10.27.08)

By: Stephen Zill

Posted: 12/1/08

It appears that the Federal Government has FINALLY settled on a plan - TARP II, or is it III? - that will be implemented in an effort to save our ailing credit markets and keep the economy from sliding into a deep and prolonged recession.

As a result, I have lately begun to immerse myself in a number of articles to learn more about the intricacies of the deal, and while doing my research, two things stood out: it seems that the Treasury is no longer referred to as THE Treasury, but simply "Treasury" (fascinating); and the other thing is, the cliché used most commonly when discussing the particulars of the plan is always, "the devil's in the details."

Thus, it occurred to me that, the Treasury thing aside, this "devil" fellow must know quite a bit about the present situation. So I figured I could save myself some trouble by simply giving the Prince of Darkness a call. (I have a direct line ... surprised? Come now, I'm an economics instructor!)

I put together a list of questions likely being asked about the Fed's new scheme and dialed up the beast to talk about it. I was put on hold, which seemed to last forever - probably due to the endless stream of Barry Manilow being pumped over the line - and then finally, ol' Mephistopheles picked up. What follows are the highlights of our little Q and A.

Beelzebub: Hell-o?

Me: You really need to work on some new material.

B: What do you want?

Me: It's about my weekly column in La Voz Weekly - Economics for Everyone? I figured it would be as good a time as any to give the details on what seems to be, more or less, the so-called "bailout plan" that the United States government has pieced together, as I am sure you've heard all about. And I figured, based on all the souls you've no doubt collected from Washington and Wall Street, who'd know more about this sort of thing than you? So can I trouble you for a few moments of your time?

B: I've got eternity. Shoot.

Me: Thank you. So, besides the much-publicized $700 billion that will be used to buy preferred bank stock, and to maybe purchase bad debt - aka "toxic paper" - what else is included in the plan?

B: According to last week's La Voz - yes, I read it; I'm a big fan - you've already told your readers about the dramatic scene where Treasury Secretary Henry "The Godfather" Paulson gave the heads of nine major banks "a deal they could not refuse". Having been chosen to volunteer for the program which features the $250 billion "capital injection" by way of preferred stock purchases, the banks - which include Bank of America, Wells Fargo, Citigroup Inc. and others - would, as long as they were part of the deal, have restrictions on their senior executives' pay, be forced to avoid compensation programs that "encourage unnecessary risks," and, of course, there will be no more of that "golden parachute" nonsense ... [here the phone is muffled; can hear voices but not what is being said].

Sorry about that. Just some new arrivals. Lawyers, sports agents, the usual. Where was I? Oh, and the FDIC will do their part by offering unlimited deposit insurance for non-interest-bearing accounts, and (for a fee) will back for three years some debts issued not only by banks, but thrifts and holding companies as well.

Me: Back to the $700 billion. Initially, Paulson was reluctant to take the "capital injection" approach, and instead hoped to free up credit markets by buying up all the bad debt that was clogging the system. Though the government will probably use some of our tax dollars to do just that, many believe the "capital injection" method is superior to the "cash for trash" method. Why?

B: Where do you want me to start? For one thing, it is considered to be more direct, hence more effective in getting banks to start doing business again. Another reason is that, due to their preoccupation with "moral hazards," the government instead created a "morale hazard," because whenever they stepped in for a takeover, or to facilitate a takeover, the stockholders got the short end of the stick. This contributed to the "run" on stocks, and created even more uncertainty and instability than we were already trying to deal with. And ideally, it is more likely that, by emphasizing that approach, the taxpayers could actually come out ahead.

Me: Do you really believe that?

B: [loud, prolonged diabolical laughter]

Me: Alright, what's so important about the LIBOR?

B: The LIBOR (London Interbank Offered Rate) is the rate of interest that banks charge each other for short-term loans. A lot of important lending rates are based on the LIBOR, such as adjustable-rate mortgages. It has been slowly moving downward lately, and the TED spread seems to be closing a bit. These are positive signs that maybe credit markets are starting to thaw.

Me: Maybe we should send the credit markets down your way.

B: Funny.

Me: Wait a minute ... TED spread? Is that something I can put on toast when I have my morning coffee?

B: No, you idiot. It's the difference between the short-term LIBOR and the interest rate on short-term U.S. Treasuries. It's a good gauge as to the health of the credit markets. Historically, the spread tends to be around 0.3 percent (or 30 basis points), while just a few days ago it went up to 4.65 percent (465 basis points). Scary!

Me: You should know.

B: Silence, mortal. Anyway, like I said, the gap has closed some, which is potentially a good sign.

Me: But everybody keeps saying we're already broke! $700 billion? Where's that coming from?!

B: Silly man. For one thing, like recent Economics Nobel Prize winner Paul Krugman (he owes me BIG TIME) said in an interview the other day, that is unlikely to be a problem. For one thing, you people have the largest economy in the world, and hence, the largest tax base. In addition, you can just simply keep on borrowing, because, believe it or not, foreigners are still very willing to keep buying up U.S. government securities.

Me: Okay, my phone is starting to get warm, so one last thing: do you think this plan is going to work?

B: All by itself, perhaps not. Already there are signs that banks have taken those first cash infusions and used them to pad their mattresses. They have also made little effort to debunk the notion that they may just use that cash to buy up their weaker competitors. As much as the Treasury has emphasized that the money they are getting is to be loaned, they have no legal right to enforce it. Therefore, consistent with the Government's "fling it at the wall" approach, I'm sure if this plan doesn't do the trick, other things will be tried. Already, the Fed has a plan to buy up to $600 billion in short-term debt, and there is talk of Congress putting together yet another fiscal stimulus package along the lines of the one that was passed last February. Anything else?

Me: No, I'm good. Thanks again. If I think of anything, I'll call you.

B: Feel free. Oh, and before I forget, be sure to take good care of that soul of yours. After all, we've a deal, you and I.

Me: Yeah, yeah. [click]

So there you have it - just in time for Halloween, the devil and the details.

Happy trick-or-treating, everyone.

---

© Copyright 2009 La Voz Weekly

Understanding McCain

THE ABSURD TIMES

Illustration: We welcome back our illustrator. He has escaped the wind swept deserts of the southwest, pulled the cactus pins out of his feet, returned to north of the Mason-Dixon line, eaten some real food and quenched his thirst and is ready for action.

About the only way to get an idea of what McCain stands for a believes is to quote him and paraphrase his own statements and those of his own trusted advisors.

We are only in an "intellectual depression."
The fundamentals of our economy are strong.
I don't know much about economics.
We are a nation of whiners.
The workers of the United States are the fundamentals of our society.
I am going to clean up Washington by kicking out the lobbists, except those who run my campaign (most of them).
Obama has been in Washington too long.
I am a Maverick -- just like James Garner.
Our economy is in a mess.
I know how to be President of the United States because I was a POW.
I will fire the head of the SEC. [That would be illegal]
Sarah Palin is the most qualified person in the United States to be President if something happens to me.
Bomb, bomb, bomb -- bomb, bomb Iran.
(Just kidding)
Al Kyda is trained in Iran.
Did I mention I'm a maverick?
I am going to learn how to use the google.
I will learn how to use the e-mail.
"John McCain helped invent the Blackberry for America." [One of his spokesman -- the product was invented in Canada.]
Yes, I have several houses, but when I was a POW I didn't even have a chair.

You know, this is getting pretty depressing, so I'll stop here.
Below is an article that makes a bit of sense out of our economic situation:


************************************************************************

Wall Street and Washington

How the Rules of the Game Have Changed

September 21, 2008 By Steve Fraser
Source: TomDispatch

Steve Fraser's ZSpace Page

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What is Washington to do as the financial system collapses? Clearly, stark differences in approach as well as in public policy have already emerged. Bail-out Bear Stearns and pump up the brokerage and investment business with new lines of credit. Nationalize Fannie Mae and Freddie Mac on the backs of the taxpayer -- but let Lehman drown. Tell the financial community to save itself, after which Bank of America salutes and buys Merrill Lynch. Then, the Fed gets cold feet and decides it can't let an institution the size of the insurance giant AIG go under as well. Washington is left staring into the abyss. The old rules no longer apply.

And that's the point. At moments of crisis since the mid-1980s, the relationship between Washington and Wall Street has changed fundamentally, at least when compared to anything that would have been recognizable in the previous century. As a result, the road ahead is dark and unknown.

During the nineteenth century, Washington was generally happy to do favors for Wall Street financiers. Railroad tycoons, who often used those railroads as vehicles of extravagant speculation, enjoyed subsidies, tax exemptions, loans, and a whole smorgasbord of financial fringe benefits supplied by pliable Congressmen and Senators (not to mention armadas of state and local officials).

Since the political establishment was committed to laissez-faire, legerdemain by greedy bankers was immune from public scrutiny, which was also useful (for them). But when panic struck, the mighty, as well as the meek, went down with the ship. Washington felt no obligation to rush to the rescue of the reckless. The bracing, if merciless, discipline of the free market did its work and there was blood on the floor.

By early in the twentieth century, however, the savage anarchy of the financial marketplace had been at least partially domesticated under the reign of the greatest financier of them all, J.P. Morgan. Ever since the panic of 1907, the legend of Morgan's heroics in single-handedly stopping a meltdown that threatened to become worldwide, the iron discipline he imposed on more timorous bankers, has been told and re-told each time an analogous implosion looms.

Indeed, last week's news carried its fair share of 1907-Morgan stories, trailing in their wake an implicit wistfulness. They all asked, in effect: Where is the old boy when we need him?

Back then, with Morgan performing his role as the nation's unofficial private central banker, Teddy Roosevelt's administration continued to keep its distance from Wall Street, still unready to offer salvation to desperate financial oligarchs. Not normally chummy with Morgan and his crowd, Roosevelt did cheer from the sidelines as the über-banker performed his rescue operation.

As it turned out, though, the days of Washington agnosticism about Wall Street were numbered. The economy had become too complex and delicate a mechanism and, in 1907, had come far too close to meltdown -- even Morgan's efforts couldn't prevent several years of recession -- to leave financial matters entirely in the hands of the private sector.

First came the Federal Reserve. It was established in 1913 under President Woodrow Wilson as a quasi-public authority meant to regulate the country's credit markets -- albeit one heavily influenced by the viewpoints and interests of the country's principal bankers. That worked well enough until the Great Crash of 1929 and the Great Depression that followed and lasted until World War II. The depth of the country's trauma in those long years vastly expanded the scope of Washington's involvement in the financial marketplace.

President Franklin D. Roosevelt's New Deal did, as a start, engage in some bail-out operations. The Reconstruction Finance Corporation, actually created by President Herbert Hoover, continued to rescue major railroads and other key businesses, while some of the New Deal's efforts to help homeowners also rewarded real estate interests. The main emphasis, however, now switched to regulation. The Glass-Steagall Banking Act, the two laws of 1933 and 1934 regulating the stock exchange, the creation of the Securities and Exchange Commission, and other similar measures subjected the financial sector to fairly rigorous public supervision.

This lasted for at least two political generations. Wall Street, after all, had been convicted in the court of public opinion of reckless, incompetent, self-interested, even felonious behavior with consequences so devastating for the rest of the country that government was licensed to make sure it didn't happen again.

The undoing of that New Deal regulatory regime, and its replacement, largely under Republican administrations (although Glass-Steagall was repealed on Clinton's watch), with what some have called the "socialization of risk" has contributed in a major way to the mess we're in today. Beginning most emphatically with the massive bail-out of the savings and loan industry in the late 1980s, Washington committed itself, at least under conditions of acute crisis, to off-loading the risks taken by major financial institutions, no matter how irrationally speculative and wasteful, onto the backs of the American taxpaying public.

Despite free market/anti-big-government rhetoric, real-life Washington has tacitly acknowledged the degree to which our national economy has become dependent on the financial sector (Finance, Insurance, and Real Estate -- or FIRE). It will do whatever it takes to keep it afloat.

This applies not only to particular institutions like Bear Stearns, or even to mortgage mega-firms like Fannie and Freddie, but to finance in general. When it seemed necessary, public monies were indeed funneled in the general direction of the banking/brokerage community to shore up the whole rickety structure. This allowed one burst bubble -- the dot-com debacle -- to be replaced by another, namely our late, lamented mortgage/collaterized-debt-obligation bonanza, just now dramatically going down the tubes.

Backstopping the present bail-out is the ever-credulous, put-upon American public with its presumably inexhaustible resources. Even while Washington was instituting the periodic "socialization" of bad debts, it was systematically abandoning the New Deal's commitment to regulation. That, of course, was in the very period when financial markets became ever more arcane, ever less comprehensible even to their Frankenstein-ian inventors, and ever more in need of monitoring. So the "socialization of risk" was accompanied by the "privatization of reward," which now is likely to prove a truly deadly combination.

That the crisis has now reached a newly terrifying stage is suggested by Washington's sudden willingness to depart from the new orthodoxy and let the huge investment bank, Lehman Brothers, go under. Some may see in this a steely return to a laissez-faire faith. More likely, it represents wholesale confusion on the part of Bush administration and Federal Reserve policymakers about what to do, even as all endangered businesses have come to take it for granted that Washington will toss them a life-preserver when they need it.

The times call for a new departure. The next administration, which will surely enter office under the greatest economic pressure in memory, must confront reality. The financial system is out of control and has led the economy into a wildly turbulent sea of heavily leveraged speculation.

It's time for a reversal of course. Stringent re-regulation of FIRE is not enough anymore. Washington's mission may, at this late date, be an even greater one than Roosevelt's New Deal faced. The government must figure out how to deploy its power to shift the flow of investment capital out of the mine-fields of speculative paper transactions and back into productive channels that will help meet the material needs of American society. Real value must be created in place of chimeras. In the meantime, we all have ringside seats -- in fact, far too close to the action for comfort -- as another gilded age is ending. What comes after is, in part, up to us.

Steve Fraser is working on a book about the two gilded ages. A TomDispatch regular and co-director of the American Empire Project series at Metropolitan Books, he is the author of, among other works, the recently published Wall Street: America's Dream Palace.

[This article first appeared on Tomdispatch.com, a weblog of the Nation Institute, which offers a steady flow of alternate sources, news, and opinion from Tom Engelhardt, long time editor in publishing, co-founder of the American Empire Project, author of The End of Victory Culture, and editor of The World According to Tomdispatch: America in the New Age of Empire.]