Sunday, September 21, 2008

WHEN WILL WE EVER LEARN?

“Good judgment is the result of experience, which is the result of bad judgment.”- Anon. “Those who cannot remember the past are condemned to repeat it.”-George Santayana. Nearly 80 years ago, our country entered a great depression which only World War II effectively ended; not his honor, FDR, with his alphabet social programs. In the roaring 20’s, one could buy stock on margin, by putting up only 5% of the purchase price and borrowing the difference. With stocks rising nearly that much per month, one seemed a fool not to participate. Then on October 29, 1929, Black Tuesday, it all fell apart; the result of “irrational exuberance.”
One of the lessons of that era was that banks, who are heavily regulated and who are supposed to keep our hard earned deposits safe, should be forever separated from investment houses, which are very loosely regulated and finance the stock market. The Glass-Steagall Act of 1933 established the FDIC to insure our bank deposits, and erected a brick wall between commercial banking and investment banking. There was a three week Senate filibuster before the Act finally passed, and I suspect the bank lobbyists were heavily involved in trying to stop it. Through the decades, there was growing support (from the financial industry) to repeal Glass-Steagall, and they gradually garnered help from within both political parties.
As an aside, remember the early 1980’s, and the Savings and Loan Industry. They had since the 30’s been heavily regulated, yet had been able to borrow short term, and still provide long term mortgages for homeowners. But, because of inflation, they faced borrowing short term at rates approaching 18%, while stuck with 30 year loans on the books at 6%. In a government effort to help, they were deregulated and allowed to make all kinds of commercial real estate development loans. You recall the oxymoron, “I’m from the government, and I’m here to help you.” As a result, over 1,000 Savings and Loans failed. They were absorbed by the government funded Resolution Trust Corporation, a total cost to taxpayers of over $1 trillion, including interest on bonds issued to fund the project.
Now, we return to investment banking. In December 1986, over Chairman Paul Volker’s objections, the Fed allowed Bankers Trust Co. to engage in commercial paper (unsecured credit) transactions, but only up to 5% of their revenue. The wall begins to crumble, through a supposed loophole in Section 20 of Glass-Steagall.. In March 1987, the Fed allowed Chase Manhattan Bank to engage in commercial paper, also. In August 1987, Ronald Reagan appointed Alan Greenspan, a former J. P. Morgan director, to head the Federal Reserve. In 1989, the Fed expanded the bank loophole to dealing in debt and equity securities, as well as municipal securities. Later that year, they expanded the limit to 10% of revenue. In 1990, Fed head Greenspan allowed former boss, J. P. Morgan Co., to actually underwrite securities. In 1995, Robert Rubin, formerly a Goldman-Sachs executive, who was President Clinton’s Treasury Secretary, signaled in testimony before Congress that the administration was ready to end Glass-Steagall.
In 1998, financier Sandy Weill of Travelers Insurance, convinced President Clinton, Fed head Allan Greenspan, and Treasury Secretary Robert Rubin; all to sign off on merging Travelers Insurance, Solomon-Smith Barney Investments, and Citibank into one entity in clear violation of the Glass-Steagall Act. “Unless Congress repealed Glass-Steagall,” the Fed declared, “the new entity, Citigroup, would have two years to divest itself of the insurance business.” One year later, on November 4, 1999, Clinton signed the repeal of Glass-Steagall. Citigroup spent around $100 million in lobbying efforts that year to bring it about. Shortly thereafter, Secretary Rubin, formerly of Goldman-Sachs; resigned to take a top job at the new Citigroup. According to the Center for Public Integrity, the pharmaceutical and health industry all together, has only spent $100 million per year for lobbying during the past seven years.
Then after September 11, 2001, Fed head Allan Greenspan kept the Fed funds rate at 1% interest for an abnormally long 18 months before beginning to raise it. This was the beginning of the current debacle. 1% was good for you and me who needed to borrow money, but the money men were crying, “You are killing us. Figure a way to get me 8-11% on my money and I will buy all you can produce.” The ever obliging mortgage brokers, backed by the investment banks, figured a way. Sub-prime mortgages, which would be collateralized into securities, sliced and diced and sold in pieces to banks and unwary investors.

By early in this century, one seemed a fool not to buy a house. After all, you did not have to qualify properly, and the price was going to continue to rise, right? More “irrational exuberance.”
In January of this year, there were 5 large independent investment banking houses, all of whom had invested in toxic sub-prime mortgage backed securities. Like the S & L’s of yore, they were borrowing short and lending long. Since then, Bear Stearns was picked up by J. P. Morgan Chase Bank, with $30 billion backing by the Federal Reserve. Lehman Brothers has just filed for the largest bankruptcy in US history. I am sure we heard from Japanese investors, who lost over $300 million, themselves. Merrill Lynch just sold out to Bank of America. Goldman-Sachs and Morgan-Stanley just reported quarterly earnings better than estimated, but their stock still fell 22% and 37%, respectively, before last Friday.
The sub prime problem was exacerbated because all the derivatives, such as credit default swaps, which the brokerage houses created and “swapped” with each other, and with insurance companies such as Ambac, MBIA, and even the giant AIG insurance, went bad. A “credit swap” is actually an insurance policy against mortgage backed securities defaulting because the underlying mortgages are defaulting into foreclosure. The last estimate of the total of the global swaps market in 2007 was some $42 trillion. That’s about 3 times the size of the entire US economy. Single line insurers like Ambac and MBIA formerly specialized in insuring the pay-out of municipal bonds, which very rarely fail, since municipalities can always raise taxes to pay debt. They started selling insurance on mortgage backed securities, charging low premiums because they expected the same kind of loss experience. All these mortgages will probably not fail, but because they were bundled and sold in pieces, their true value is indeterminable. When you can’t accurately price your assets, you have a major problem. This is why Paulson came up Friday with “the ultimate solution.”
One year ago, the Fed had assets of $800 billion in Treasury securities. Since then, they pledged $200 billion to the Term Securities Lending Facility, a project to provide the brokerage houses with liquidity, loans previously only made available to banks. They have rescued Fannie Mae and Freddie Mac with $100 billion each, and agreed further to buy at least $5 billion of their government backed securities. They provided $30 billion to backstop the sale of Bear-Stearns. They passed on Lehman Brothers and let it bankrupt. The result was so catastrophic, they decided to rescue insurance giant AIG, to the tune of $85 billion, in return for 79% equity in the company. Including this week’s currency swap with other central banks amounting to another $180 billion, money meant to infuse liquidity into the world economy, their balance sheet of assets is probably down to about $200 billion.
Friday, Treasury Secretary Henry Paulson, former Goldman-Sachs executive, announced further plans to save the economy. The government will now insure Money Market Funds, which pay higher interest because they are invested in commercial paper, and are also beginning to freeze up. Immediately, Fannie Mae and Freddie Mac will buy more mortgage backed securities, because the Treasury is going to buy more than $5 billion from them. Then the SEC is going to increase securities regulation, as they should have done years ago, before the debacle was allowed to begin.
Further, if Congress passes a new law Treasury is requesting, which I am sure they will; taxpayers will be funding another equivalent of the Resolution Trust Corporation to buy all those stinking mortgage backed securities, which are unpriceable. Hopefully, they will pay less than face value, because they expect to hold them to maturity, usually an average of only seven years.
Sure, they can always issue more money simply by loaning it to the government, but every time they do, the dollars in your pocket fall in value. New Fed head Ben Bernanke and Treasury Secretary Paulson are doing a good job of holding it together, but at what future cost? Unfortunately, no one in Washington agrees with me. Texas ex-Senator, Phil Gramm is co-chair for John McCain. Gramm co-wrote the bill abolishing Glass-Steagall in 1999. When asked if he would restore Glass-Steagall, candidate Barack Obama replied: “Well, no. The argument is not to go back to the regulatory framework of the 1930’s because, as I said, the financial markets have changed substantially.” Three of his top contributors just happen to be: Goldman-Sachs, J. P. Morgan, and Citigroup.

Who is getting rewarded by the bailout? The mortgage brokers got their money up front. The securities people who packaged the mortgages into securities got their money up front. The securities people who are still holding some of the paper, and the banks and investors who bought them, are getting bailed out.
The candidates will not tell you anything which they do not believe will buy your vote. FDR perfected this election method over 70 years ago. Since I am not running for President, I can suggest what really needs to be done by the next President. You won’t like hearing it, but I am saying it anyway.
First, the ceiling on Social Security tax at $102,000 must be removed. Second, the cost of the Medicare drug insurance program must be curtailed, and the tax probably needs to be raised. The Medicare fund is in worse shape than Social Security. Third, the 15% capital gains tax rate given to the managers of hedge funds who have added to this credit freeze problem must be increased. Hedge funds are largely unregulated investment pools of wealthy sophisticated people who must invest hundreds of thousands to even participate. These managers, without a requirement to invest their own capital, have been driving down the stock of financial institutions so they, themselves, can profit even more. These managers are given capital gains rates on ordinary income (even thought it is usually in the millions of dollars per year.) Why should they pay the 15% tax rate of the average garbage collector on millions of income, when the average middle income American pays 28 to 35%?
In terms of the stock market, I have got several more suggestions. There must be more transparency.
There must be more regulation. The use of options to either buy or sell certain stocks in the future at a set price must be severely restricted. The uptick rule, which the SEC removed July 6, 2007, must be restored. It stated that if you were going to sell a stock short (guaranteeing to deliver it at a given price at a future date,) you had to sell it for at least slightly more than the last recorded sale, not less. Further naked short selling must be absolutely forbidden and tightly regulated. (The rule was if you did sell a stock short for delivery in the future, you had to either already own the stock, or borrow it at interest.) With a wink of the SEC eye, sellers have been allowed to sell the future delivery of a stock at a set price, without knowing where it would come from or what it would cost. When they could not deliver, it was simply considered a “failure to deliver.” Meanwhile, a given company’s stock had been driven downward for no good reason.
I have been a voting Republican since 1956, and I am sick of the Republican Party thinking the answer to every Presidential election is just to preach cutting taxes. They are now no more concerned with cutting spending than the average Democrat. My national Republican Party has been taken over by Neo-conservatives. They are not really conservatives. They are not adverse to burgeoning Federal debt. They don’t want us to be an empire, they just want us to control every other nation. They want a larger military-industrial complex, and they are not reluctant to use it. After all, they are not usually 18 to 25 years old. They consider themselves “nation builders,” and they expect their new nations to toe their line. If you don’t know them, you need to do some investigating. Consider me a paleo-conservative. But don’t get the idea I have given up. I am just going to have to hold my nose when I vote. At the rate things are going, my vote is not going to count, anyway
Our government now belongs to the moneyed interests of this country. Until we rise up in righteous anger and demand accountability, we are due for more of the same. When is the last time YOU wrote your Congressmen and Senators and informed them you are aware of their chicanery and that you are “mad as hell and you are not going to take it anymore?” Remember, we are the boss, they are the employees! If we don’t exercise our management functions, we should not expect promising results.

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