Category Archives: Banking and Finance

Following Europe’s Decline: The Dismal Failure of America’s Government

The United Kingdom based magazine The Economist, which endorsed Barack Obama for president last year, had this to say about the fiscal cliff deal:

The tax deal enacted this week, which leaves income-tax rates where they are for 99% of households while raising them sharply on the top 1%, was indeed a political victory for Mr Obama. For the first time in more than two decades Republicans had voted for higher taxes, by large numbers in both the Senate and the House of Representatives. The deal raised almost as much money from the rich as Mr Obama had first sought, and he made no meaningful concessions on spending in return.

It was less of a victory for the economy. It leaves in place significant short-term fiscal tightening, while doing almost nothing to arrest the escalating national debt in the long term. Mr Obama himself conceded that at the White House: “We still have deficits that have to be dealt with,” he said, surely his understatement of the year.

The problem with the fiscal deal is not so much what the bill accomplishes. Most Americans support higher federal income taxes on the richest 1% of taxpayers, and Congress earns praise for making most of President Bush’s tax cuts permanent. It was for this reason that former Republican vice-presidential candidate Paul Ryan joined most of his fellow partisans in the Senate and many in the House in voting for the bill. In a statement explaining his vote Ryan declared,

Will the American people be better off if this law passes relative to the alternative? In the final analysis, the answer is undoubtedly yes. I came to Congress to make tough decisions — not to run away from them.

I think Ryan made the right decision in terms of the vote itself. But fellow rising Republican star Senator Marco Rubio, one of the few Republican senators to vote against the bill, explained his vote in terms of lost opportunity. As the New York Times reports,

Mr. Rubio, in a statement explaining his vote, warned that “rapid economic growth and job creation will be made more difficult under the deal reached here in Washington.” He added: “This deal just postpones the inevitable, the need to solve our growing debt crisis and help the 23 million Americans who can’t find the work they need.”

In the final analysis Congress’s handling of the fiscal crisis, as well as that of President Obama, has been nothing less than abysmal. In the Washington Post Robert Samuelson highlights the inability of Congress to cut spending by pointing to the perpetuation, year after year, of annual subsidies for farmers in the territory of $10-15 billion. Such subsidies made sense in days when farmers faced unusually crippling economic and environmental uncertainty as well as market exploitation in the late 19th and early 20th Centuries. Today, as my own friends involved in farming confirm, the subsidies are largely unnecessary handouts. Samuelson concludes,

Farm subsidies are a metaphor for our larger predicament. We no longer have the luxury — as we did for decades — of carrying marginal, ineffectual or wasteful programs. We can no longer afford subsidies for those who don’t need them or, at least, don’t need so many of them (including affluent Social Security and Medicare recipients). If we can’t eliminate the least valuable spending, then we will be condemned to perpetually large deficits, huge tax increases or indiscriminate cuts in many federal programs, the good as well as the bad.

What makes all of this most disturbing is how similar the United States’s handling of its fiscal problems is to the recent record of the European Union. Though the problems are different, in both cases, politicians repeatedly pander to short-term fixes while avoiding long-term solutions, even while everyone involved admits that such an approach is unsustainable. We seem to be voluntarily committing ourselves to the laboratory experiment of determining whether or not Alexis de Tocqueville’s famous warnings about the demise of democracy (due to the inability of elected politicians to say no to the demands of the populace, and of unelected bureaucrats to relinquish their own power) are true.

In another article The Economist warily notes just how similar is the track record of the United States and Europe.

For the past three years America’s leaders have looked on Europe’s management of the euro crisis with barely disguised contempt. In the White House and on Capitol Hill there has been incredulity that Europe’s politicians could be so incompetent at handling an economic problem; so addicted to last-minute, short-term fixes; and so incapable of agreeing on a long-term strategy for the single currency.

Those criticisms were all valid, but now those who made them should take the planks from their own eyes. America’s economy may not be in as bad a state as Europe’s, but the failures of its politicians—epitomised by this week’s 11th-hour deal to avoid the calamity of the “fiscal cliff”—suggest that Washington’s pattern of dysfunction is disturbingly similar to the euro zone’s in three depressing ways.

The Economist rightly argues that Republicans and Democrats are equally to blame for the flawed fiscal deal, and that contrary to the view of some, the problem is not that politicians are insufficiently principled but that they are too unwilling to compromise in order to achieve the most important goals.

Viewed through anything other than a two-month prism, it was an abject failure. The final deal raised less tax revenue than John Boehner, the Republican speaker in the House of Representatives, once offered during the negotiations, and it included none of the entitlement reforms that President Barack Obama was once prepared to contemplate…. Democrats pretend that no changes are necessary to Medicare (health care for the elderly) or Social Security (pensions). Republican solutions always involve unspecified spending cuts, and they regard any tax rise as socialism.

There is only one way to prevent the deceptively slow-burning fuse of America’s debt from ending in calamity. Both sides need to remember that they represent the whole country, not just their relative ideological constituencies. Our goal is not to build the kingdom of God, whether as liberals or conservatives understand that kingdom. No one is going to get all of what they want here. We’re just trying to sustain the economic and political stability of the United States of America.


You didn’t build that, which is why I’m not concerned about the poor. A two-party problem.

Over at First Things Robert George, whose conservative credentials are not remotely in doubt, suggests that President Obama got a bit of a “bum rap” in the criticism over his “You didn’t build that” rhetoric. While George gratuitously qualifies his defense of Obama so as to clarify to his conservative readers that he utterly rejects Obama’s big governmentism and so thinks that Obama deserved the criticism anyway, his begrudging concession to the president makes a substantive point.

[E]xamined in context, I don’t think it is correct to interpret the “that” in “you didn’t build that” as referring to businesses.

Here, I believe, the President is telling the truth in saying that by “that” he meant the infrastructure (roads, bridges, etc.) that makes it possible for businesses to flourish, but which businesses do not themselves provide.

And of course, Obama is right. Government does far more to shape the context for productive business than many if his critics would like to admit, and even if they might wish things were different, in the real world of American politics and governance there are few sharp lines between the free market and political power.

Take, for instance, the Washington Post‘s recent report that one of the main reasons Obama has as much of an eight point lead over Mitt Romney in the absolutely vital state of Ohio is that the president has showered the state with the blessings of federal patronage in the past four years. To be sure, Ohio is no doubt a very meritorious state, and surely no president would ever use his political clout to sway the merit-based procedure of determining what states or business should receive government grants, loans or tax breaks. Yet, as the Post begins its report,

After President Obama pledged in March to create up to 15 manufacturing centers nationwide, the first federal grant went to a place at the heart of his affections: Ohio.

When the Obama administration awarded tax credits to promote clean energy, the $125 million taken home by Ohio companies was nearly four times the average that went to other states.

And when a Cleveland dairy owner wanted to make more ricotta cheese, he won what was then the largest loan in the history of the U.S. Small Business Administration.

And what about the Fed? In another recent article the Washington Post describes how Ben Bernanke has radically increased the role of the Federal Reserve in bolstering and guiding the U.S. economy.

In what might be his final years as chairman of the Federal Reserve, Ben S. Bernanke is transforming the U.S. central bank, seeking to shed its reclusive habits and make it a constant presence in bolstering the economy. The new approach would make the Fed’s policies more responsive to the needs of the economy — and likely more forceful, because what the Fed is planning to do would be much clearer….

Bernanke has already pushed the Fed far along this path. The central bank this month pledged to stimulate the economy until it no longer needs the help, an unprecedented promise to intervene for years. That’s a big change from the Fed’s usual role as a curb on inflation and buffer against financial crises.

That may have a calming effect on the economy, as the article notes, but it also threatens to politicize the Fed and possibly to increase the likelihood of inflation. Micromanaging the free market, as economic theorists know, is fraught with danger. And according to what principles will the Fed operate? Those of the Democrats or the Republicans? Keynes or the Austrian School?

Unfortunately the problem is not simply with the current administration, the current Federal Reserve chairman, or the Democratic Party. As Joel Kotkin wrote over a month ago, both parties are beholden to Wall Street and to big business, and the common man to whom Ronald Reagan was so committed finds himself with no advocate in the 2012 presidential campaign.

In a sane world, one would expect Republicans to run against this consolidation of power, that has taxpayers propping up banks that invest vast amounts in backing the campaigns of the lawmakers who levy those taxes. The party would appeal to grassroots capitalists, investors, small banks and their customers who feel excluded from the Washington-sanctioned insiders’ game. The popular appeal is there. The Tea Party, of course, began as a response against TARP.

Instead, the partynominated a Wall Street patrician, Mitt Romney, whose idea of populism seems to be donning a well-pressed pair of jeans and a work shirt.

Romney himself is so clueless as to be touting his strong fund-raising with big finance. His top contributors list reads something like a rogue’s gallery from the 2008 crash: Goldman Sachs, JPMorgan Chase, Morgan Stanley, Credit Suisse, Citicorp, and Barclays. If Obama’s Hollywood friends wanted to find a perfect candidate to play the role of out-of-touch-Wall Street grandee, they could do worse than casting Mitt….

Who loses in this battle of the oligarchs? Everyone who depends on the markets to accurately give information, and to provide fundamental services, like fairly priced credit.

And who wins? The politically well-situated, who can profit from credit and regulatory policies whether those are implemented by Republicans or Democrats.

Of course, there are those who believe the significant shift within the conservative movement of our time has been from traditionalist conservatism towards an infatuation with the utopian benefits a free market might bring, but as Joe Knippenburg points out (responding to David Brooks), the Republican Party has always been controlled more by the interests of business and economics than it has by thoughtful conservatism, whether of the traditionalist stripe or of the libertarian version.

In electoral politics, the business-oriented guys have always had the upper hand. The traditionalists … have never been major players in partisan politics.  They’ve always been more noticeable in various “ivory towers,” like the Intercollegiate Studies Institute and the editorial offices of First Things (if I may be so bold)….

In day to day politics, the pressing (the unsustainable size of government) crowds out the important (the state of our souls and our civil society). We should not stint in reminding our friends, colleagues, and fellow political disputants of what’s really important. But we have to recognize that the failure adequately and responsibly to address our pressing problem puts what we really care about at risk as well.

But Knippenburg is also wise enough to recognize that the Republican Party’s version of economic prosperity doesn’t always help the little guy and it is certainly not winning the hearts and minds of the working class.

A substantial majority (70 percent) of white working class Americans thinks that our economic system unfairly favors the wealthy…. Connected with working class doubts about fairness is a conviction held by almost half (47 percent) that the American Dream once held true, but does no more… One might ask why those people who mistrust the fairness of markets and society at large don’t turn to government to make things right. Surely they’re tempted to do so. And surely Barack Obama wants them to do so. Their hesitation for the moment might be due as much to the likelihood that government just seems to them to present unfairness in another guise.

But Republicans have to come up with a compelling way of talking about the opportunities provided by the marketplace. To be sure, they can offer a celebration of freedom and a critque of government intervention as “crony capitalism,”  but I’m not sure how far that goes with a working class person who doesn’t see an obvious path to prosperity for himself and his family.

I wish I had a magic bullet here, but I don’t. We have to recognize that in our economy, the opportunities for those who lack skills are very limited.

It’s easy to criticize government for being too big or for interfering with the economy too much. It’s even easier to criticize the Democratic Party and Barack Obama. Everything gets a lot harder when we recognize that the Republican Party is not offering very persuasive solutions, and in many ways it is simply another part of the problem.

The greatest public scam may be one hardly anyone is talking about: state pension plans

How big of a mess are state pension plans in today? It’s huge. As Walter Russell Mead writes in a recent essay:

As a new report from Boston College’s Center for Retirement notes: “there is a total of $2.6 trillion of assets on [the 126 public sector pension plans tracked by the study] but current liabilities under today’s assumption that they can grow by eight percent annually are $3.6 trillion. If the investment assumption is moved down to four percent (still high when compared to current returns), then the liabilities of those plans jumps to a staggering $6.4 trillion.”

For those of you not following this story, this may all be Greek to you. However, Mead offers a helpful explanation of how the public pension fund problem is related to the recent financial crisis and how it feeds off corrupt collusion between labor union leaders, politicians, and Wall Street. Mead explains it far better than I could so I am going to quote him at length. But you should really go and read his whole essay.

The biggest scam going in American financial life may be the collusive effort by Wall Street, the political class, and public sector unions to use union retirement money to prop up Wall Street speculation.

Step One: state politicians promise big pension and health care benefits to their unionized work forces, but don’t set aside enough money to fund those benefits when the bill comes due. This makes union leaders and unions look good, because they can point to the shiny new benefits they have negotiated with the politicians. Meanwhile, it makes the politicians happy because the unions support them with contributions and volunteers at election time, but because the unions don’t insist on full funding for the benefits, the politicians don’t have to raise costs or otherwise disturb the big majority of voters who don’t work for the government.

Step Two: Make aggressive assumptions about the rate of return on pension investment funds. This has two consequences: it covers the gap between promise and reality (for a while), thereby postponing the day when the politicians have to face the voters and the union leaders have to tell their members that those beautiful benefits were bogus from the start. But the other purpose, equally important, is that it forces America’s public sector pension funds into the deep end of the financial markets, leading pension funds to be major investors in hedge funds, derivatives and various other not-for-the-widows-and-orphans investments. If these work out, great — the funds hit their investment targets and the benefits, or at least some of them, get paid. If they go awry — as many did in the last few years — then the pension problem turns into a crisis.

But whether or not the investments work for retirees, they work very, very well for Wall Street. Fees from giant public sector pension funds played a significant role in creating Wall Street’s buccaneer culture and speculative frenzy that the left claims to hate.

Looking for examples? Head to Pennsylvania:

The Pennsylvania State Employees’ Retirement System, for example, has more than 46 percent of its $26.3 billion in assets invested in riskier alternatives, including private equity funds and real estate. Over the last five years, the system paid roughly $1.35 billion in management fees – over 5 percent of the total value of the fund over a five-year period – while realizing an annualized return of just 3.6 percent, well below the 8 percent it needs to meet its financing requirements and also lagging behind the 4.9 percent median return for all public pension systems.

There’s bad news for Pennsylvania’s teachers, too:

The $51.4 billion Pennsylvania public schools pension system…which has 46 percent of its assets in alternatives, pays more than $500 million a year in fees. It has earned 3.9 percent annually since 2007.

California is also struggling:

Fees for the $242 billion in California’s giant state pension system, known as Calpers, nearly doubled, to more than $1 billion a year, after it increased its holdings in private assets and hedge funds to 26 percent of its total in 2010, from 16 percent in 2006…

Calpers…has earned 3.4 percent annually over the last five years.

Compare that with Georgia, which is at the other end of the investment risk spectrum:

In Georgia, the $14.4 billion municipal retirement system, which is prohibited by state law from investing in alternative investments, has earned 5.3 percent annually over the same time frame and paid about $54 million total in fees.

Pension reform is about more than cutting benefits to realistic levels, and ensuring that politicians and union leaders have to stop the collusive scams. It is also about enabling pension funds to invest in safer investments and stop paying huge fees to hedge fund managers and investment banks — and because public pension funds are such large pools of capital, this would be an effective way to help bring Wall Street back down to earth.

Pension funds should not be aggressively invested. Retirement funds should be conservatively managed — and that means enough has to be paid into those funds so that with moderate investment results, retirees can be sure that their promised benefits will in fact be paid.

The key to this change is stronger regulation of government pension funds, to force them to observe the same requirements that apply to private sector pension funds as well. Amazingly, the same union leaders and lefty experts who call for tough regulations elsewhere in the economy want to keep government workers chained to the roulette wheel in the Wall Street casino: they are bitterly opposed to seriously prudential regulation of government pension funds.

The debt problem in this country is not just a federal problem. You, the taxpayer, stand behind a mass of financial commitments off of which public employees, politicians, and Wall Street have been winning big time. What do you think of that?

How sustainable is our money system? You should probably care.

From Via Meadia a few days ago:

In most western countries, central banks are, at least in theory, wholly divorced from the political process. Central bankers are selected to terms far longer than that of the average politician—and they are typically allowed to oversee numerous changes in political leadership during their time at the helm—in order to insulate them from the rough and tumble of everyday politics. In theory anyway, the central bank concerns itself purely with inflation rates and monetary policy; fiscal policy, tax rates, and other such matter are left up to the politicians.

At the end of the day, this is about the long term sustainability of a fiat money system. If monetary authorities get into the habit of excessively manipulating the money supply, a fiat money system gradually loses credibility. That loss of credibility was a factor in the inflationary wave of the 1970s, and the greater move toward political independence for central bankers was part of the response.

So what’s wrong? The constant state of financial crisis in which we seem to find ourselves is prompting just the sort of excessive manipulation the money system may not be able to handle long term.

The real worry is that the unconventional measures like quantitative easing that central banks have been using are politically motivated. To put it another way, there is so much pressure on central banks to keep the world economy from collapsing, that the banks have lost all autonomy over their policy. Instead of performing an independent function in economic policy, central bankers have blackmailed by politicians who refuse to take politically costly measures to stabilize the economy. Central bankers are faced with an impossible dilemma: do they let the economy and the financial system collapse, or do they take steps to insulate the economy (and the politicians) from the consequences of poor leadership?

As Mead says, all of this may lead to a crisis of confidence greater than the crisis of confidence in Wall Street or in European (or American) governments. The problem may be with the money system itself. The fiat money system has not been in existence long. In many ways it is still an experiment. The question is, can the West sustain it?

Corruption in the Banks: J.P. Morgan

At Via Media Walter Russell Mead draws our attention to corruption in the world of banking.

Bloomberg reports that J.P. Morgan has been sued by the Louisiana Police Pension Plan for securities fraud, and this charge only scratches the surface of the company’s misconduct.

FoxBusiness reports that in a “strictly confidential” report issued last year, J.P. Morgan admitted that underfunded pension liabilities amount to nearly $4 trillion—far worse than most observers believed…

So why did J.P. Morgan hide the report?

But people in senior management worried that the study’s stark analysis about the looming threat of unfunded pensions to state and local finances — and its recommendation on how to fix the problem — would offend the firm’s municipal bond clients, namely those cities and states that tap J.P. Morgan to underwrite their bonds.

With that, the firm decided that it would keep the study largely under wraps, according to people with direct knowledge of the matter. Only its best hedge fund clients and large institutional investors would receive the report. The cities and states at the heart of the analysis wouldn’t be informed, nor would most public investors. . . .

This is why so many people are suspicious of capitalism and the free market. The world of finance and banking is full of people who are more than willing to lie, cheat, and steal in order to advance their own ends. That’s why its so important to crack down harshly on corruption wherever it appears. There are few areas where government’s role is more significant and legitimate: ensuring that businesses and banks operate within the basic confines of law, order, honesty, and transparency.

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