And the Oscar goes to… a bank?

The 2011 Academy Awards, hosted this year by acting ingénues James Franco and Anne Hathaway, was an attempt by the Academy of Arts and Sciences to reach out to a new, younger audience.  By that measure, the Academy failed miserably, reaching 12% less viewers in the 18-49-age bracket.   Ultimately, the Academy’s strategy, to reach all audiences at once, was baldly transparent and ineffective.  The projected image of Bob Hope, who produced the funniest lines of the night, represented the Academy jumping the shark.

While The King’s Speech, a film about a British monarch overcoming a speech impediment, took the biggest honors of the night, the most competitive and interesting race was for Best Documentary.  Presenter Oprah Winfrey said that, “It has never been more important for us to see these stories to help us try to make some sense of the world we live in.” Five strong films entered, including Sebastian Junger’s Restrepo and Josh Fox’s Gasland. Inside Job, Charles Ferguson’s searing inquiry into the roots of the financial crisis, took the Oscar.  As Ferguson accepted his Oscar, he started by saying, “Forgive me, I must start by pointing out that three years after our horrific financial crisis caused by financial fraud, not a single financial executive has gone to jail, and that’s wrong,”

One can’t help but think that JP Morgan Chase (JPMC) foresaw Inside Job’s victory and the speech by Ferguson, as no less than four times during the Oscar broadcast, their “New Way Forward” commercial appeared, promoting JPMC as a key driver of our ‘recovery:’

Conveniently, JPMC released their annual 10-K financial statement one day after the Oscars, so we can put their claims in perspective.  In 2010, JPMC held just over $50 Billion in wholesale commercial loans to United States businesses, a significant drop from their commercial commitments in 2007 and 2008.  While they are committed to making $10 Billion available to small businesses, that doesn’t mean that they will actually make the loans.  Additionally, their offer of a second review seems reminiscent of the situation when you aren’t getting the assistance you need on the phone and ask to speak with a customer service representative’s manager.  Why is this process necessary, and what does it actually offer to the small businessperson?  More importantly, why are small businesses having trouble getting access to money in the first place?

The quandary over small business loans goes to a larger question: what did the bailout of our financial institutions, through the Troubled Asset Relief Program (TARP) and FED actions, accomplish, if we don’t yet have a strong recovery?   After the financial crisis the Federal Reserve and the Treasury Department bailed out many of our largest banks, including investment banks, through funds from TARP and through access to cheap money from the discount window at the FED.  Many of the banks were overleveraged, and these programs allowed them to recapitalize.  In essence, the government allowed these banks to repair their balance sheet by printing money, and forcing the public to take the loss through devalued currency.  The actions in late 2008 and early 2009 by Hank Paulson, Ben Bernanke, and Tim Geithner certainly prevented a collapse of our banking sector.  The TARP program remains universally unpopular, despite reports that even losses from loans to AIG won’t top $14 Billion, a significant drop from earlier estimates.

During the last few years, banks like JPMC and Goldman Sachs have made tidy profits and made tidy bonus payments, but that hasn’t necessarily translated into an economic recovery.  We have stronger banks, but not a stronger recovery.  The Excess Reserves of Depository Institutions (EXCRESNS) is a valuable lens with which to view this quandary.  In 2009, after nearly 50 years of being near zero, meaning that banks lent out as much as they could based on their reserves, the data jumps to hockey stick proportions.  You don’t have to believe me, you can see the data yourself on the FED’s website.  Many banks are standing pat on reserves that they could be lending.

While JPMC isn’t actually saying much in their Oscar ad, they do sound earnest and committed to a recovery.  I wonder how much that ad cost?  JPMC paid to lobbyists $6.2 Million in 2009 to help make the Dodd-Frank Financial Reform Bill to their liking.  What if JPMC lent that money out to small businesses in 2009, instead?  In retrospect, I think the Oscar voters missed out on an award-winning acting performance by JPMC.

What can key an economic recovery?  Lets look at the stimulus efforts to date, made up of both tax cuts and direct government expenditures.  John Maynard Keynes argued that both tax cuts and government spending would help to increase the GDP, but that government investments were far more effective, driving a more powerful Keynesian multiplier.  In essence, the expenditures recycle themselves more directly into the economy and have a larger impact, whereas tax cuts are often put into savings or used to pay off debt meaning that less money gets recycled back into the economy.

Republicans often argue that tax cuts ‘pay for themselves,’ relying on the unsubstantiated and discredited ‘Laffer curve;’ for example, the Republican House does not require tax cuts to be paid for in regards to the deficit.  With Republican governors continuing to reject direct government stimulus, as Wisconsin and Florida governors recently did with high-speed rail money, this means that our efforts to stimulate the economy will still hurt the deficit, but they will not be very effective.

However, the recent ‘Obama’ tax cuts, the extension of the Bush tax cuts including those on the top 2% of wage earners, amounts to Supply Side economics redux.  Capital gains cuts are similar in their effect to tax cuts, as the windfalls go to wealthy taxpayers who won’t spend the money immediately.  Supply Side economists argue that by reducing tax rates and eliminating regulation, businesses will be able to hire more workers, and increase the GDP.  To date, after many rounds of tax cuts for businesses, unemployment (and more importantly, underemployment) remains high.   Looking at the big picture, the actions of our government in response to the financial crisis is a bit like the Academy – trying to please a lot of different audiences at once, without delivering a clear, concise, and effective message.

Financial reform at last – is it enough?

Former Federal Reserve Chairman Paul Volcker, Chair of the President's Economic Recovery Advisor Board, and author of the Volcker Rule

Last night, just before the clock turned to midnight, almost two years after the global financial system nearly collapsed, House and Senate committees reached agreement on reconciliation of their respective Financial Reform packages.  The bill should be headed for a successful vote.  What level of protection will we have going forward?

Looking back, the economy nearly collapsed because of too much systemic risk spread across financial institutions that are “too big to fail.”  At the 11th hour, after Bear Sterns nearly collapsed, and Lehman Brothers went into bankruptcy, the surviving financial institutions converted into bank holding companies and received access to the Discount Window at the Federal Reserve, which allowed them to reduce their leverage with basically free money.  In addition to that bailout, much of the toxic assets on the books of these institutions were bought or guaranteed by the Fed.

Would it be enough to require these institutions to hold more capital?  Simon Johnson points out that the targeted requirement of 10-12% is actually what Lehman Brothers had on the book before they collapsed.

One good aspect of this bill is the inclusion of a compromise Volcker Rule.  Paul Volcker, the former Federal Reserve Chairman who proposed the rule, intended to restrict the ability of banks whose deposits are federally insured from trading for their own benefit. Banks and large Wall Street firms, who view it as a major incursion on their most profitable activity, fiercely oppose the Volcker Rule.  The compromise would allow them to continue some investing and trading activity, no more than 3 percent of a fund’s capital; those investments could also total no more than 3 percent of a bank’s tangible equity.

The proposal by Senator Blanche Lincoln that would have banned banks from any derivatives activities was loosed to a requirement that banks and the companies that own them be required to segregate the activity.  In theory this would prevent depositors money from being traded in derivatives, but isn’t this just shuffling around the balance sheet instead?

The new Consumer Protection Agency is a good move.  If the President puts someone like Elizabeth Warren in charge, we will see standardized, consumer friendly credit card statements, along with many other sensible reforms.  Of course, an exception for Auto Dealers was negotiated at the last minute.  If you go outside any military base you will she signs that say “financing available for E-1 and above.”  What those signs don’t say is that the interest rates for those E-1’s will be 30%, and that those 18-year-old kids just want the shiny new car.  In the same vein, I hope payday lenders will be subject to the new Agency, though I don’t doubt that powerful legislators may have exempted them as well.

Ultimately, at the end of the day, while there are admirable measures in this Reform, and while it is better than the status quo, this bill does nothing to deal with institutions being too big to fail.  The Brown Kaufmann amendment, which was defeated by among other opponents, The White House, would have forced banks to become smaller and limited what they could borrow from the Fed.  We taxpayers will one day have to confront these massive institutions and bail them out again, with the proverbial gun to our head.  It is inevitable.

It is instructive to look at the history of Bear Sterns, as detailed in the excellent book, House of Cards.  When that firm became a stalwart after the Great Depression, the partners were all personally invested in each financial investment decision.  They had skin in the game, and they were much more conservative as a result.  Deregulation in the 1980s and the 1990s allowed firms like Bear Sterns to leverage, more and more, their clients funds, and engage in riskier and riskier behavior.  Without the personal investment, the people in charge of Bear Sterns were no longer worried about the long view, just the next quarter.  Much like politicians who are simply worried about re-election and not about proper governance, these denizens of Wall St. were now only concerned with rising stock price and short term gains.  We lost something along the way, and unfortunately, we are not going to get it back.

Indeed, the world is ruled by little else.

Economist Milton Friedman

John Maynard Keyes wrote in 1945 that “the day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems – the problems of life and of human relations, of creation and behavior and religion.”  In the United States, we have pursued a policy of unquestioned growth and expansion, following the recommendations of prominent economists with an ardor that borders on religiosity.  However, the economic problem, as Keynes described it, has not taken a back seat, but rather has the developed world in the grip of a severe recession.

In the United States we have always looked to economists for the magic to make our economy go.  Milton Friedman, winner of the Nobel Prize in Economics, believed that a free market economy could expand and prosper with minimal government interference. Alan Greenspan, an admirer of Friedman, was revered as an enabler of unending growth during his service as Chairman of the Federal Reserve; he received the Presidential Medal of Freedom, the inaugural Harry S. Truman Medal for Economic Policy, the inaugural Thomas Jefferson Foundation Medal in Civilian Leadership, and was named both a Knight Commander of the British Empire and a Commander of the French L’Egion D’honneur.  Presidents from Ronald Reagan to George W. Bush all trusted Greenspan with the keys to the economy.  During the same time period, Bill Clinton, a Democrat, trusted economist Larry Summers’ advice that deregulation of banking and finance would also lead to continued growth; that was the height of Milton Friedman’s influence.  Barack Obama appointed Summers to be Chairman of his Economic Council despite the fact that his policies were partly at fault for the current economic crisis.  Why do all of these Presidents, from Reagan on the right to Obama on the left, put so much faith in these economists?  Keynes, in The General Theory of Employment History and Money (1935), addressed this question.  He wrote that:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”

The economic policies of the United States have become more and more complex since Keynes’ time.  Over the decades, as the United States left the Gold standard, and created a dynamic economy reliant on the growth of consumption and continuous expansion, we have relied and trusted economists to make it all work.  Most Americans who do not work on Wall Street have trouble understanding even some of the basic terminology and concepts used in finance today.  Many of us learned what a Collateralized Debt Obligation was last year, and discovered how debt was securitized in such complex ways that even some of the old hands in charge of major firms didn’t really understand.  Americans trusted economists to drive our growth, and while many don’t understand the problems we face, they expect economists to create a deus ex machina to miraculously get us out of the recession and onward to unending growth.