Relevant and even prescient commentary on news, politics and the economy.

It’s official – Icelandic bankers have been jailed

If you’ve been following my posts over the last few years, you know that Iceland took the dramatic step of prosecuting top officers at the country’s big 3 banks, all of which were allowed to go bankrupt in the wake of the 2008 financial collapse. Unlike Ireland, it did not turn bank debt into government debt, which increased Ireland’s debt by close to 100% of gross national product (GNP) overnight. Though hit hard by the 50% drop of the krona, Iceland has managed a remarkable, though still incomplete, recovery marked by its renewed ability to borrow in foreign currency with less than a 1% risk premium and by achieving unemployment rates that Eurozone countries can only envy.

What you wouldn’t know, if you just been looking at the headlines (Google “Iceland jails bankers” and you’ll see what I mean), is that Iceland had not actually been jailing bankers. Here’s a typical one from the BBC, “Iceland jails former Kaupthing bank bosses” (12 December 2013). In fact, nobody went to jail at that time: They were convicted, but all four Kaupthing officials appealed their sentences. If you search similarly titled stories, you will see that headline “jailings” were either convictions, or an affirmation of these lower court decisions by the Icelandic Supreme Court, neither of which actually led to immediate jailings. Indeed, one of the “Kaupthing Four,” as they are now called, was living in Luxembourg (he had headed Kaupthing’s Luxembourg branch), and I wondered to myself if could even be compelled to return to Iceland to serve his sentence.

Now I am happy to report that the Kaupthing Four are finally in jail in a minimum-security prison with only one road connecting it to the outside world, including the former CEO of Kaupthing’s Luxembourg unit who was outside Iceland when his conviction was upheld. There have been an additional 22 convictions now at various stages in the appeals processes, and special prosecutor for the banking crimes, Olafur Hauksson, indicted five more bank officials for fraud and manipulating stock prices just last month.

As Kaupthing was Iceland’s largest bank before the crash, jailing its top officials sends a reassuring sign that the rest of those convicted will eventually follow suit. Iceland thereby establishes a precedent we should continue to urge in the United States, United Kingdom, and elsewhere that bankers are not too big to jail.

A note to readers: Bloomberg reporter Edward Robinson had not replied to a request for some clarifications at the time this story was published. If any of you know when the Kaupthing Four reported to prison, whether there are other bankers already in jail, or other useful news, please send along the information and I’ll be happy to credit you. Thanks!

Cross-posted from Middle Class Political Economist.

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A oh, Some in Europe can’t take the pressure

Seems the austerity thingy is starting to hurt where it really counts. Just read via the AP:
… and amid growing concern in Europe that austerity aimed at cutting ballooning deficits may also be choking growth.
A dozen European Union leaders, including British Prime Minister David Cameron and Italian Premier Mario Monti, called Monday for an open-markets strategy to stimulate growth and jolt the region out of its economic doldrums.
“We meet in Brussels at a perilous moment for economies across Europe,” the leaders said. “Growth has stalled. Unemployment is rising. Citizens and businesses are facing their toughest conditions for years. ”
Of course their solution is “Free the Kraken!*“: 
The letter urges European nations to deregulate their service, research and energy sectors, forge trade ties with growing markets including China, Russia and South America — and even contemplate a free trade agreement with the United States.
How scared are they? They are this frightened: 
“Implicit guarantees to always rescue banks, which distort the single market, should be reduced,” the letter said. “Banks, not taxpayers, should be responsible for bearing the costs of the risks they take.”
Be still my beating heart, be still.

Of course, all of this is related to Greece. I found that the British paper, the Daily Telegraph is liveposting daily on the Debt Crisis:
“Live coverage of the international debt crisis and rollercoaster financial markets in the eurozone and US.” From today’s postings:
20.06 Jeremy Warner [financial editor] writes that the US has proved that the brutality of hire and fire really does work:
It is a simple fact of life that business is more prone to hire if it is allowed to fire. The major risk to business investment, which is that of an ongoing workforce liability, is thereby removed.
Vince Cable’s proposed shake-up of employment law is in truth of much more importance to the future of the UK economy than faffing around either with credit easing or squandering £12bn on a temporary tax cut. It’s vitally important that the task is not ducked.
And yet, considering the 12’s concern about austerity to cut debt and banks taking the hit, there was this today: 
22.02 Here we go. Eurozone ministers agree on ways to cut Greek debt to 123/124pc of GDP by 2020, aiming to go close to 120pc. Eurozone in talks with representatives of private sector about finding further debt relief. Issue of ECB forgoing profits on its holdings of Greek bonds remains a sticking point.
Coming soon to a theater near you!  The Son of Austerity.
*Kraken: In modern German, Krake (plural and declined singular: Kraken) means octopus but can also refer to the legendary Kraken.

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Michael Hudson on Greece

Greece and what is happening to it is not getting enough attention.  What is happening there, in my opinion is an example of the human race at it’s worse.  I do not see the implementation of austerity as an experiment.  I see it as just one more step by those in the world controlling banking to mold the world into its self image.

This is a link to an 11 minute interview of Michael Hudson:  Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Distinguished Research Professor of Economics at the University of Missouri, Kansas City… 

In this interview, Prof. Hudson suggests that Greece is the test to see how far the world’s money people can push in preparations for further advancement within the EU.  Interestingly he notes, that in the US, because we privatized our utilities years ago, we are not seeing the same drive of austerity as we are seeing in Europe, including England.  Though we should not be complaisant.

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Interview of Mr. John Reed regarding banking fixing the game

In case you are not aware, Bill Moyers is back and he doing his best work to date concentrating on our the changing of the rules regarding the economy. This episode where he interviews John Reed, former Citi Bank CEO and current MIT chair is most telling as it relates to the issue of why we as a nation need to do what is required by law: investigate and prosecute as the investigations dictate.

First, let me just say, you need to watch the interview. What is most telling for me is the denial that still exists in Mr. Reed. Sure, he acknowledges that it all went wrong, but it is done in the temperance of “mistake”: 

1. an error in action, calculation, opinion, or judgment caused by poor reasoning, carelessness, insufficient knowledge, etc.
2. a misunderstanding or misconception.

Here, in the interview is what puts the delusion of self preservation in applying the word “mistake” to the decisions that lead to what we have today, and I’m not just talking recession:

Setting up the question to Mr. Reed by showing a video clip, SENATOR BYRON DORGAN: (Speaking on Senate Floor) What does it mean if we have all this concentration and merger activity? Well, the bigger they are, the less likely this government can allow them to fail.
BILL MOYERS: Were you aware of the few senators who raised real concerns about removing Glass-Steagall, about what would happen?
JOHN REED: No one that I’m aware of it saw it clearly. You point out to some Senators and Congressmen who did, but somehow we described them peripheral. And I simply said, “They’re wrong.” Turned out they weren’t.
SENATOR BYRON DORGAN: (Speaking on Senate Floor) I think we will in ten years’ time look back and say, “We should not have done that, because we forgot the lessons of the past.”

The issue of calling it a “mistake” becomes even clearer when you watch the interview of Senator Dorgan which follows Mr. Reed. This is why you need to watch it. Mr Reed knows what happened. He knows why it happened. I am certain he knows where the culpability lays. But, as they say in our neck of the woods: He wouldn’t say “shit” even if he had a mouthful.

What happened and what these people did was not a benign experience as the word “mistake” implies and as Mr. Reed is using it. It was intentional and wanton action taken on behalf of money. (See below: Where their heads were at)

Explaining Glass Steagall’s importance beyond not letting commercial banking marry investment banking.

JOHN REED: Well, that and even more importantly, or equally importantly, since the FDIC came into existence at approximately a similar time where the government was guaranteeing deposits so that people didn’t lose if a bank got into trouble.

But not only did they want to keep the banks from the business for reasons of not risking the money. They didn’t want them to use the guarantee that the government provided for those deposits to leverage their position. Because, you know, if you have a deposit base that’s guaranteed by the government, it sure puts you at a great advantage in terms of going into the market and playing around.
Regarding the take down of Glass Steagall

JOHN REED: When Sandy approached me on the merger [Travelers/Citi] I knew that it was right on the forefront of the legal thing. … And what we basically were told was, “If you all want to do this within the two years we’ll get the law changed.”
BILL MOYERS: But you got the blessing in this two-year period of President Clinton, of the Fed, of–
JOHN REED: We had that blessing prior to.
JOHN REED: Yes. In other words, I went with Sandy to call on Chairman Greenspan. We told him we were contemplating this merger. But that it would required that the Fed would be prepared to grant us permission. And we were assured that they would.
We went and saw the Chairman of the House Banking Committee, the Chairman of the Senate Banking Committee. And we said we’re talking about this merger but it could not take place if we were not assured that it would be approved at the Congressional level. We talked to the Secretary of the Treasury, I don’t recall–
BILL MOYERS: Robert Rubin? He was the Secretary of the Treasury at the time.
JOHN REED: Yeah, we would’ve spoken to him, I’m sure. And had Bob Rubin said, “No, the Treasury feels this is wrong,” we would’ve been careful. Because obviously, the Treasury recommends to the President on an issue of this sort. And there was no argument. No one said, “We’ll have to think about it.” And so a consensus built up. I don’t think it started in the Fed. I would guess it started in the industry, it certainly got into the Congress.

Regarding where their heads were at

JOHN REED: Which happened, yeah. I mean if you had asked me under oath, what probability I would have given that you would have gotten the whole group of Wall Street participants to get it wrong so to speak, I would have said zero.
BILL MOYERS: What do you think they saw that Wall Street didn’t see?
JOHN REED: They simply didn’t participate in the exuberance.
But I do think that, you know, this setting up the deck of cards so that we could produce what we currently are trying to withdraw from. Turns out to have been something that the word disaster is maybe not strong enough. (“Criminal” is the word we all know he is resisting.)
JOHN REED: We were carried away by the enthusiasm. And like everything else, you know, once you start you probably go a little further than you should have.
JOHN REED: Sandy Weil. I mean, his whole life was to accumulate money. And he said, “John, we could be so rich.” Being rich never crossed my mind as an objective value. I almost was embarrassed that somebody would say out loud. It might be happening but you wouldn’t want to say it.
JOHN REED: Yeah, Sandy Weil. And I sort of say, “Sandy, you know, we didn’t do very well.” And he’s not comfortable with that conversation at all. I think he would still defend that it was a good merger, it just went off the tracks afterwards. I —

Regarding the economics of it

JOHN REED:No, no. It’s not something you’d like to end your career with. That is for sure. No, look. We got carried away.It wasn’t any small group, it was a consensus that reached the press, it reached the political world. It certainly had reached the intellectual world. I’m now, as you know, at MIT,and I say to some of my academic friends that the intellectual underpinnings of this was created at MIT and places like that, I mean—
BILL MOYERS: With the technology of the computers?
JOHN REED: Well, no. It’s all of this mathematics of finance and the presumption in much of this mathematics that you can capture risk by looking at historical volatility and so forth and so on.
BILL MOYERS: Are you saying, suggesting that — the chairman of the board of MIT’s suggesting –that human intelligence no longer runs our financial system?
JOHN REED: Well, it’s a little wisdom balance that judgment wouldn’t hurt.

The Criminality of it (at least as I see it): See: Regarding the take down of Glass Steagall above

Showing an historical video clip, Mr. Reed speaking with Sandy Wiel

JOHN REED: Sandy called his friend the President last night and invited me to join in on the conversation and we had a good talk. So the President was in fact told last evening about what was going to happen.

JOHN REED: Well, they originated and sold into the marketplace things that should never have been originated.
BILL MOYERS: Derivatives, unregulated derivatives?
JOHN REED: Well, it was the excess mortgages, the no-doc, low-doc mortgages. And then the derivatives were a byproduct. Once you had those, then you could chop ’em up and so forth. And of course they had changed their mindset. They were in the business to make money, period.

The psyche that is protecting the conscience: Note his choice of words

JOHN REED: You’re– I mean, a consensusdeveloped. The fact that we took it [regulation, Glass Steagall] out was a byproduct of this mistaken beliefin this modern financial system that was, quote, “more efficient,” was very lucrative for the United States and the U.S. economy in global terms.
And which was supposed to handle risk better. In fact, it handled risk worse. I mean, this is what the facts are because there was a much greater concentration of risk created. And so we got it wrong.
But the restraint of the government and it’s agencies disappeared in the enthusiasm. (Yeah, just a “byproduct”)
And so it was this combination of the participants getting carried away, the normal checks and balances that should exist against participants.
And the thing that is astounding, frankly, and there’s a lesson here that we probably haven’t yet learned, is that the system can get it so wrong. It wasn’t–
BILL MOYERS: So wrong?
JOHN REED: It wasn’t that there was one or two or institutions that, you know, got carried away and did stupid things. It was, we all did. And then the whole system came down. You know, it became illiquid, the government stepped in. Had the government not stepped in, it really would have come to an end.

 

BILL MOYERS: But they left in place the very people who had driven the ship into the iceberg.
JOHN REED: I’m quite surprised at that. It clearly has not been a clean sweep. In other words, those of us who made mistakes, and so forth and so on, are still floating around the system. And–
BILL MOYERS: Floating it? You’re running it.
JOHN REED: Well, I am not, but —
BILL MOYERS: You’re not running it, they’re running it.
JOHN REED: But there are many who are. I wasn’t involved, obviously. I had retired in the year 2000. We’re now talking 2008. So I was a knowledgeable spectator, but certainly not a participant. I was quite surprised because, frankly, the worst thing that can happen to a businessman is to go bankrupt. (Shades of Greenspan confessions?) That’s the sign of ultimate failure. You ran a business and it was unable to succeed under the terms and conditions of private capital. Namely, you went bankrupt.
It’s not a crime. But it certainly is a mistake. And these companies, even though they didn’t have to file for bankruptcy, de facto went bankrupt. And so the managements and the boards and the regulators should have, in my mind stepped aside.
BILL MOYERS: Sounds to me like you’re calling the Glass-Steagall Act back from the grave.
JOHN REED: I think I am. (At this point, he still could not say it “shit”.)

There is more in the interview. You need to see and hear it to understand. I think Mr. Reed is struggling with his conscience and wanting to clear it versus what I believe he feels is a real risk of getting tied up with the Justice Department. It has to be working on him. Though I interpret an air of feeling protected in Mr Reed do to his own wealth. As much as he knows wrong and not a mistake was done, he has no experience of the anxiety as what those in the labor economy are experiencing. He is still in denial to an extent which stops him from using his position to truly work to correct this wrong. Or maybe he just is not of the character to participate on the just side of the fight.
Mr. Reed does get one thing correct:

BILL MOYERS But when the financial community can buy the rules they want —
JOHN REED: Then you’ve got an unstable situation. That’s an intolerable situation. I mean, obviously.

He knows.  He knows that regulation is a necessity. As the head of MIT, he could be doing so much more.
Come-on Mr. Reed, destiny is calling you.

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Greece is not Argentina

I politely disagree with the conclusions of the article written by my Angry Bear colleague, Kash, where he envisages Greece defaulting in 2011 similarly to Argentina in 2001.

I do agree, that the macroeconomic initial conditions in Greece scream default (actually, if you focus just on the measurable factors, like the current account, debt levels, or fiscal imbalances, Greece is much worse than Argentina in 2001 – see Table 4 of this IMF paper to see Argentina’s initial conditions and compare them to Greece in 2009 using the IMF World Economic Outlook Database).

Where I disagree, arguing that Greece is not like Argentina, is that the debt crisis in Argentina didn’t bring down the banking system of Latin America overall. In contrast, the default of Greece has the potential to do just that in Europe.

Update: see David Beckworth’s Macro Market Musings includes Rebecca’s thoughts on ECB

In Argentina, the Latin American banking system (and sovereign bonds, for that matter) was quite resilient in the face of the sovereign default in Argentina. Uruguay was the exception, whose two largest private banks, Banco Galicia Uruguay(BGU) and Banco Comercial (BC), which account for 20% of the country’s total, saw near-term liquidity pressure and an ensuing banking crisis in 2002 (see this IMF paper for a history of banking crises). All else equal, the IMF reports only minor impact to the region as a whole:

With the possible exception of Uruguay, economic and financial spillovers from the Argentine crisis appear to have been generally limited to date—as indicated, for example, by the muted reactions of bond spreads in most other regional economies and their declining correlation with those of Argentina, together with other favorable trends in financial market access and the general stability of exchange rates over recent months.


In contrast, the European banking system is highly interconnected. For example, according to the German Bundesbank, Germany’s bank exposure to Spain was roughly 136 bn euro in December 2010, where most of it is held in the form of Spanish bank paper, 56.4 bn euro, and Spanish enterprises, 58.3 bn euro; the rest is in sovereign debt. Furthermore, German banks are sitting atop 25 bn euro in (worthless) Greek paper, primarily in the form of sovereign debt. Euro area countries are exposed to other banks AND the sovereign; but more importantly, the ones that save (run current account surpluses) are the ones holding the worthless (in some cases) bank and government debt. (read more after the jump)

Bank risk is a big risk in Europe. Based on the consolidated banking data at the Bank for International Settlements (BIS), German banks hold 22% of the Greek external debt load i.e., bank debt + sovereign debt + corporate debt), while French banks hold 32% (see Tables below). Furthermore, German banks accumulated 20% of all Irish external debt, 14% of Italy’s, and 21% of Spain’s.

So the question is, not what will happen if Greece defaults, per se; but will a Greek default set off a chain reaction liquidity crunch that challenges asset valuations in the other Euro area banking systems (for bank paper and sovereign paper)? I suspect that it will, since the European banks are still building their capital buffers.

My point is, the Germans are partial to NOT letting Greece default. All fiscal austerity aside, the Germans have demonstrated that they’d rather write a check than take the writedowns, at this time. Therefore, from this perspective, I find it very unlikely that Greece defaults this year (or next, really).

Now, you’re probably thinking: well, it’s in Greece’s best interest to default. Willem Buiter calls Greece leaving the Euro area ‘irrational’. An irrational chain of events must be put in place in order to presage such a disorderly default (see 8. ‘Break-Up Scenarios for the euro area’ in the publication). We’re not there yet, since Greece is still in asset-selling austerity mode.

It’s political repression.

BIS data representation I: in Shares of external debt outstanding (click to enlarge)

BIS data representation II: in levels of external debt outstanding (click to enlarge)

Rebecca Wilder

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Too Big to Fail? Wall Street and Main Street: How Big Are They

Guest post by Steve Roth
crossposted at Asymptosis

Too Big to Fail? Wall Street and Main Street: How Big Are They

People are forever talking about banks that are too big to fail. But you rarely hear about the larger issue: The financial industry is too big to fail. Click for larger graphic.)

Note that “Main Street” here includes government expenditures — 20% of the total. Remove those, and Wall Street money flow is 58 times the size of Main Street.

I haven’t pulled these numbers for past years,* but it’s clear that this disparity has grown hugely since the 80s, driven by credit issued by the financial industry, to the financial industry, with the money circulating in the financial industry. From Dirk Bezemer:


(FIRE is finance, insurance, and real estate.) The financial industry has spent the last 30 years inflating its own bubble.

So much for the flows. What about the stocks? This is harder to compile, and it’s also difficult to compare Wall Street and Main Street. I’ll explore this in future posts. But here are two numbers worth pondering:

The red bar on the left is the one I’m concentrating on here. (It’s probably a big understatement, because it doesn’t include assets held by financial corporations; see “tally stick,” below.) Divvy these financial assets between every household in America, and each one gets half a million dollars. Yow.

Think of that pool of financial assets as stored money. While they couldn’t all be turned into actual “money” at one time, they constitute the pool of money held by people and businesses, which money flows into (from personal savings and undistributed profits) and out of (for consumption, fixed investment, and tax-paying). This pool is also expanded by new credit/money creation, and increases in asset values. It is shrunk by loan payoffs and declines in asset values.

Now here’s the key point to understand: everything of value to humans is created by the people and businesses on Main Street producing, buying, selling, and investing (in productive assets and housing). Yes, Wall Street produces and sells some of that value: vehicles for investing business and personal savings in a variety of real assets (“intermediation”), safe storage (compared to your mattress), convenience, bookkeeping, advice, etc. That’s all paid for via fees and commissions, and those Wall Street fees and commissions are counted as part of GDP (aka Main Street). As they should be.

But you have to ask: did Wall Street deliver 35% or 45% of the human value of all American businesses in the 2000s? That was the “financial services” share of business profits — the reward received for value created. (I’ve seen some variance in this number, but 34% is the lowest number I’ve seen.)

Whereas the financial sector claimed less than 15 percent of total U.S. corporate profits in the 1950s and 1960s, its share grew to 25 percent in the 1990s and 34 percent in the most recent decade through 2008. Testimony by Sheila Bair, January 14, 2010.

Here’s a picture:

You don’t have to imagine “evil actors” (though there is some proportion of those on Wall Street) to understand why a massive financial sector could be really, really bad for the real economy.

Imagine one of those super-hot racing sailboats that let you pump water from side to side as you switch tacks, to keep the boat upright, stiff, and stable. Now imagine all that water leaks out into the bottom of the boat, so it’s sloshing around with the wind and wave action. Every time you run into a big wave, all the water flows to the front of the boat. A big gust of wind heels you over, and all the water flows over in the same direction. It makes the boat really unstable.

That water is the money swirling and sloshing around in the financial economy. In the short term, those flows are are driven largely by people trying to predict what other people are going to do, so they can go in the same direction. Sound like our sailboat? With $55 trillion of financial assets in the U.S (4 x GDP), and those assets trading hands maybe twelve times a year, that’s a lot of sloshing.

It’s no wonder the sailboat gets knocked over periodically.

Now imagine that a whole bunch of your best and brightest crew members are spending their time with buckets pouring more water into the boat, and moving the water around from place to place (while furiously collecting as much as they can in little bottles in their pockets). Do you think you’re gonna win the race?

But here’s what’s weird: neoclassical economics basically ignores the motive effects of financial sector, treating it like a transparent, frictionless, and inert tally stick or bookkeeping system — like the bank in Monopoly. As Dirk Bezemer has pointed out, the model that the Fed uses to predict our economic future does not include the financial sector as an active entity.

The boxes indicate the variables included in the model. In the present context, the important observation is that all are real-sector variables except the money supply and interest rates, the values of which are in turn fully determined by real-sector variables. In contrast to accounting models, the financial sector is thus absent (not explicitly modelled) in the model.

Paper (pdf). A very nice summary here. You may take issue with Bezemer’s statements, but it’s certain that the Fed’s model does not consider the spectacularly large and highly variable flows within the financial economy, or model their effect on the real economy beyond the rather static notions of money supply and interest rates.

This is especially strange since the Fed is explicitly tasked with compensating for the business cycle. And the business cycle is largely driven by … the financial sector. (Main-street businesses’ cash flows, profits, and losses don’t display anything like the volatility of financial assets.)

Aside from those destabilizing money flows, which are pretty much inherent to financial economies (though their effects on the real economy depend crucially on plain old quantity), what other pernicious effects might we expect to see when a self-inflating financial sector does a very good job of inflating itself?

Moral Hazard. Because the financial economy is so massive, government has no choice but to bail it out if it gets in trouble. Financial-industry players know that, and they act accordingly.

Stagnant Growth in the Real Economy. As the pool of new financial assets (many of which are fabricated using finance-industry-issued credit) increases in value (in a boom or bubble), we see:

rising commitments for the real sector to finance asset transaction out of wages and profit, and rising actual debt levels. When the asset was sold at a profit, someone else bought the asset at the new, higher price. He or she financed this either by diverting liquidity away from real-sector transactions, or by borrowing – at higher levels than did the first buyer. Therefore asset price booms are accompanied by rising debt and by a slowdown in real-sector nominal growth.

Government Capture. Unlike welfare payments, for instance, which distribute money widely and hence are difficult to bring to bear on lobbying etc., the financial sector concentrates wealth, so it can be effectively used to capture government — which further benefits the financial sector, in a self-perpetuating cycle.

Misallocation of Resources. Since the financial industry provides rewards to employees and shareholders that are well in excess of the human value it produces (even considering its role as an intermediary delivering financial capital to the real economy, and its resulting second-hand contribution to delivering things that humans value), both financial and human capital are diverted away from the real economy that produces stuff we want.

I can think of several others (without even starting on things like fairness), but I’ll leave it to my gentle readers to fill out the whole set.

Supply siders, conservative politicians, and freshwater economists are fond of referring to financial capital as the “fuel” of the real economy. But if anything, labor, sales, innovation, or maybe natural resources constitute the real economy’s “fuel.”

Financial investments in business — whether in the form of equity or credit or some weird hybrid — are more like lubrication. A flow of financial capital is crucial to keep the machine running, but you don’t need all that much flow relative to output (43x? 58x??). (And Fama and French showed us long ago that it takes very few traders or trades to create an efficient market with reasonably accurate price signals.) This especially as business owners consistently tell us that investment is dead last on their list of business constraints.

Too much lubrication, in fact (I’m repeating my own line here), and the shop floor starts to get very, very slippery.

Truth told: we have truly oceanic quantities (both flows and stocks) of money, credit, liquidity — whatever you want to call it — far in excess of what’s necessary to lubricate the real economy. When somebody tells you that we need more savings to augment those quantities (and that we should, for instance, tax the rich less so they can provide those savings), I suggest that you go directly to Go, and look at the first three graphics in this post.

If I am correct, the financial sector is much larger than is necessary to lubricate the real economy, and as a result delivers far greater downsides than are necessary to fulfill its valuable purposes.

Is there anything we can do about that? Monsieur Pigou gave us the solution long ago: If you want less of something, tax it.

* It amazes me that these Wall Street figures are so hard to compile, and in fact are never compiled. (Google “financial industry profits” site:wsj.com. One useless hit.) The ratio between the financial economy and the real economy is not part of the everyday language of economic discourse. A kudos to Dean Baker and the folks at CEPR for putting these Wall Street numbers together.

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Irish Bailout–impact on taxes uncertain

by Linda Beale

Irish Bailout–impact on taxes uncertain
crossposted with Ataxingmatter

As plans for the $100 billion bailout of the Irish economy and banking system by the European Commission, International Monetary Fund and European Central Bank continues, Ireland’s downtrodden prime minister (who will call elections after the budget is finalized) has said that it “will not” change its corporate tax haven status–its corporate tax rate of 12.5 percent will remain for now.  At the same time, however, Daily Tax RealTime reports this evening comments today by Eurogroup President Juncker that discussions about Ireland’s low corporate tax scheme are ongoing, Both France and Germany would like to see Ireland raise its rate closer to the average 25% EU rate.

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TARP, Neil Barofsky, Rep. Alan Grayson and Transparency

by divorced one like Bush

Via Glenn Greenwald and his article The war being waged on the TARP watchdog’s independence comes an interview with Neil Barofsky the man charged with over seeing TARP. It appears the White House is not keeping true to the President’s campaign of a more transparent government.

…the Obama administration is now attempting to induce the Justice Department to issue a ruling that Barofsky’s office is not independent at all — but rather, is subject to, and under the supervision of, the authority of Treasury Secretary Tim Geithner.

Seems Mr. Barofsky’s latest report states that the grand total of all money currently paid out and pledged totals $23.7 trillion.

This is the original article to go along with the interview.
Click here to download and listen.

Via Naked Capitalism comes Rep. Alan Grayson asking Ben Bernanke who got the 1/2 trillion in US dollars as part of a swap. He notes $24 billion in 2007 is now $553 billion yr end 2008. Who got the money? “I don’t know…the loans go to the centeral banks and they then put them out…We are lending to all US financial institutions in exactly the same way.” That is, the fed is making no distinction between our nation and the rest of the world. Bernanke notes the law gives them the right to do this. (Sec 14 of the Federal Reseve Act.) Rep. Grayson issue is; at what point is using this “power” to move 1/2 a trillion dollars is infringing on Congresses control of the Treasury.

(Rep. Grayson has further comment at the link regarding this video.)

Transparency. The Federal Reserve and the Treasury say this money can’t be traced after it passes to the first receiver. Mr. Barofsky has shown that it can be by simple sending out a questionnaire. Bernanke is treating the lending, regardless of recipient as all the same and thus none of it can be traced and that they have a right and authority to use the Peoples Money as they see fit. Rep. Grayson thinks they are overstepping Congress.

Who was it here that noted we had not bailed out the banks, but instead the banks just bought the Treasury?

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There is a difference between then and now?

By divorced one like Bush

The following from Robert’s post got me thinking about railroads.

“There have been three big banking booms in modern U.S. history. The first began in the late nineteenth century, during the Second Industrial Revolution, when bankers like J. P. Morgan funded the creation of industrial giants like U.S. Steel and International Harvester. The second wave came in the twenties, as electrification transformed manufacturing, and the modern consumer economy took hold. The third wave accompanied the information-technology revolution.”

I talked about what was the same in the “second” wave then as today in my Taxation Rhetoric posting. As far as I’m concerned it had little to do with financing great industrialization and more with our first big flirt with financialization which is why we got the financial regulation in the 30’s.

As for the third wave, I believe there was the reporting of stupid money chasing anything with a dot com skirt on. Before that, in the 80’s we had “greenmail”, a smaller housing bubble and Milken et al. This got me thinking about the railroads and stories about how people would start building parallel lines just to get the big boys to buy them out. Early versions of greenmail? Stupid money chasing anything with a train. This was the biggy of the “first” wave.

So I went looking in order to write up something real to respond to Robert’s post and found that today is just like yesterday except that yesterday we actually got something when the people’s money was being used to line a private pocket.

Historical Handbook Number Forty
1969

This publication is one of a series of handbooks describing the historical and archeological areas in the National Park System administered by the National Park Service, U.S. Department of the Interior. It is printed by the Government Printing Office and may be purchased from the Superintendent of Documents, Washington, D.C., 20402, Price 60 cents

Both companies therefore resorted to a favorite device of 19th-century railroad builders—a construction company with interlocking directorate free of Government regulation…

The 1864 Act made the United States “virtually an endorser of the company’s bonds for the full amount of its own subsidy,” and now both the U.P. and the C.P. could draw on double the amount of subsidy granted for each mile of completed road.

The Union Pacific’s construction company was the Crédit Mobilier of America. In 1864 Durant bought the Pennsylvania Fiscal Agency, a corporation loosely chartered by the Pennsylvania Legislature to engage in practically any kind of business, and renamed it the Crédit Mobilier. The directors and principal stockholders of this company were virtually the same as those of the Union Pacific. Greatly simplified, the process worked like this: The Union Pacific awarded construction contracts to dummy individuals, who in turn assigned them to the Crédit Mobilier. The Union Pacific paid the Crédit Mobilier by check (i.e., cash, for the benefit of Congress), with which the Crédit Mobilier purchased from the Union Pacific, at par, U.P. stocks and bonds, which it then sold on the open market for what they would bring. The construction contracts were written to cover the Crédit Mobilier’s loss on the securities and to return generous profits. In this manner the directors and principal stockholders of the Union Pacific, in their opposite role as directors and stockholders of the Crédit Mobilier, reaped large profits as the rails advanced.

The Big Four used an almost identical device to build the Central Pacific. Although in practice continuing to share in the management of the Central Pacific, Crocker resigned from the directorate and formed the construction firm of Charles Crocker and Company, in which Stanford, Hopkins, and Huntington were the only stockholders. The connection between the two companies was too obvious, and in 1867 the Big Four organized the Contract and Finance Company, with Crocker as president. Acting for the Central Pacific, they awarded to this company the contract for building the road from the California line to the junction with the Union Pacific, as well as for supplying all materials, equipment, rolling stock, and buildings. The chief advantage of the Contract and Finance Company over the Crédit Mobilier, as railroad historian Robert E. Riegel pointed out, “was that it was able to get its accounts into such shape that no one has ever been quite able to disentangle them.”

It all sounds so deja vu. But, unlike our $1 trillion and climbing paranoia driven military program we invested in today, these guys got us a real asset that paid dividends and they did it in 4 years instead of the 10 years planned for while lining their pockets.

Such techniques not only pushed the railroad to completion in record time, but also made its financiers extremely wealthy men. The Union Pacific cost about $63.5 million to build, of which about half represented the Government s loan. The best estimate of profits gained is about $16.5 million, although the enormity of this figure emerges only when it is understood that at no one time did invested capital exceed $10 million. Profits thus amounted, not to 27-1/2 percent, but to more than 200 percent. The Central Pacific’s figures are more difficult to arrive at, mainly because many of its books were “accidentally” destroyed by fire during the Congressional investigation of the Crédit Mobilier, The best authority, however, places the cost of construction at $36 million. The company received land grants and Government bonds valued at $38.5 million, while Stanford admitted that $54 million in Central Pacific stock transferred to the Contract and Finance Company in payment of construction contracts represented virtually net profit.

Alas, there was a price to pay, a lesson that should have been learned. It took 1929 to actually learn it.

There was an inevitable reckoning. Both railroads were burdened with inflated capitalization that meant decades of high rates and operating losses. The Crédit Mobilier investigation in 1872, moreover, brought the railroads bad publicity that strained relations with the public and the Government for many years and produced hostile legislation. Nevertheless, almost all railroad historians, while deploring the financial buccaneering of the Pacific Railroad builders, agree that only through such methods could the railroad have been built without far more liberal Government aid.

Did you catch that? We either put up the money or we let the private sector do it at a higher cost? Another lesson we seem to not want to learn (health care anyone?).
And, how did our governmental department view all this creative financing in 1969?

Their methods were those of the 1860’s, employed by most of their contemporaries in business—practices condemned as thoroughly unethical by today’s standards. Thus the truly great achievement of hese men has been tarnished by the judgment of a later generation. They were, in fact, the first victims of the revulsion against such methods that swept the country during the early 1870’s.

It’s just heart breaking that they only got 200% on their money.

See, it’s always there. ALWAYS, THERE. And, just like 1969, we hear cries that the perpetrators are victims. Just simple mistakes made. Of course, that would imply some lessons were learned. That we are repeating again today, yesterday, puts the lie to the entire argument of victum and mistake. Yet, as I said, we got something for all this personal self interest with the peoples money in the past, unlike today’s privatization of the: military, health care, schools, roads, utilities, environment. All failing, all in need of major capital investment. All representing investment made, value lost.
Munsey’s Magazine 1903 reprint:

The money invested in the railways that we had in operation in 1880 was comparatively a few millions. Today the railway systems of the United States represent an investment of three billions and a yearly earning capacity of hundreds of millions.

In today’s money, that 1903 railroad investment has a value of:

$757,220,398,593.20 using the Consumer Price Index
$604,412,640,969.90 using the GDP deflator using value of consumer bundle
$3,333,116,883,116.90 using the unskilled wage
$4,369,728,261,008.50 using the nominal GDP per capita
$16,503,666,443,504.30 using the relative share of GDP

What a shame we let ourselves be talked into the “creative destruction” of the rail system, an asset that represents $3.3 trillion dollars in unskilled wages. That’s a lot of labor just gone. It represents a relative share of GDP bigger than our actual current GDP! It makes you think about who has managed their wealth better; the US? or Europe who did not creatively destroy their original investment, but built upon it and thus saved themselves from having to generate as much income as we have had to in order to have our now killing us (war for oil?, pollution, resource waste, etc), personal transportation system. I guess that is why we don’t get to have 6 weeks vacation for all, we have to work to rebuild what we had. Can you say Rat Race?

Can we broaden the discussion now?

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