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.
When you talk with Conservatives about regulation, they will generally tell you that government regulation is too pervasive and ineffective; additional regulation is out of the question, and existing regulation should be simplified. Those same conservatives often blame the financial crisis and the Great Recession on government involvement, and claim that if only the markets were free of government interference, rational actors would allow the markets to regulate themselves. However, deregulation during the last three decades eliminated most of the protections put in place after the Great Depression, and put us in a hole we have yet to dig ourselves out of.
Simon Johnson and James Kwak, creator of The Baseline Scenario blog and authors of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, examine the long history of financial regulation and deregulation in their recent book. They show that, without question, the Wall Street banks continue to hold inordinate power over our government and the U.S. economy. They carefully trace the bipartisan financial deregulation that began under Ronald Reagan but continued through each successive administration, leading to the near collapse of the Global economy:
“Never before has so much taxpayer money been dedicated to save an industry from the consequences of its own mistakes. In the ultimate irony, it went to an industry that had insisted for decades that it had no use for government and would be better off regulating itself – and it was overseen by a group of policymakers who agreed that government should play little role in the financial sector.”
For example, Johnson and Kwak explain the SEC agreement of April 28, 2004 that allowed the five large investment banks (Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Sterns) to calculate their own net capital based on internal models, rather than using standard models, allowing them to expand their leverage extensively for the next three years. In fact, the regulation put in place by FDR after the Great Depression was systemically dismantled, and 13 Bankers shows how that dismantlement created massive financial institutions that were not only Too Big to Fail, but too powerful to control:
“The fact that their failure could entail the loss of millions of jobs gave the banks the power to dictate the terms of their rescue. If the government insisted on paying market prices for the toxic assets, or insisted on taking majority control, the banks could simply refuse to go along, secure in the knowledge that the government would have to come back to the table.”
13 Bankers examines many common assumptions about the financial crisis; for example, conservatives tend to blame the entire crisis on Fannie Mae, Freddie Mac, and the Democratic Party. However, Johnson and Kwak artfully disarm that claim:
“The riskiest mortgages, however – the ones that pushed the housing bubble to dizzying heights – were simply off-limits to Fannie and Freddie. The [Government Sponsored Enterprses] could not buy many subprime mortgages (or securitize them) because they did not meet the conforming mortgage standards… ultimately regulatory constraints prevented them from plunging too far into subprime lending. As housing expert Doris Dungey wrote, ‘the immovable objects of the conforming loan limits and the charter limitation of taking only loans with a maximum [loan-to-value] ratio of 80%… plus all their other regulatory strictures, managed fairly well against the irresistible force of innovation.’”
In short, the banks lobbied for years to remove the regulations that limited their size and scope; they developed complex financial instruments that were impossible to understand without a PhD from M.I.T.; they used those instruments to hide risk inside AAA rated securities that ultimately plummeted in value, and to move debt off their books; and finally, they had the nerve to complain about government interference after taxpayers backed up those risky bets.
Last summer, the Financial Reform Law was finally passed by Congress and signed by the President. On The Baseline Scenario, Simon Johnson quickly identified the missing ingredient in the new regulation: it does nothing to reduce the size of institutions that are Too Big To Fail. In 13 Bankers, Johnson and Kwak examine some common arguments about large banks, that they supposedly gain economies of scale, and that our large corporations require large, multi-national banks. In fact, those claims “suffer from a shortage of empirical evidence.” Johnson and Kwak provide good evidence to the contrary; for example, Johnson & Johnson used 11 different banks in their 2008 debt offering, and 13 different banks in their 2007 debt offering.
13 Bankers clearly identifies the systemic risk that TBTF banks offer, and warns of an even more dangerous crisis to come in the next financial cycle. One of the main reasons is that TBTF institutions are effectively subsidized by the government, getting money for lower interest rates than smaller competitors; this occurs because investors know the government will always bail out TBTF institutions; this competitive advantage will provide the TBTF institutions a strong incentive to take excess risk. Ultimately, until TBTF institutions are reduced in size, they will remain dangerous to long-term economic health. Johnson and Kwak propose that commercial banks be limited to 4% of GDP and investment banks to 2% of GDP. This would affect only six institutions: Bank of America (currently at 16% of GDP, JP Morgan Chase (14% GDP), Citigroup (13% GDP), Wells Fargo (9% GDP), Goldman Sachs (6% GDP), and Morgan Stanley (5% GDP). The goal would be to allow these banks to fail without taking down the entire economy with them.
13 Bankers will give you a good understanding of how bankers and the government have navigated the regulatory question over America’s history, and what caused the financial crisis. The book also provides an excellent prescription for tackling the TBTF problem. The Baseline Scenario is also an excellent resource, updated daily.