Sunday, February 28, 2010

Ames: Polite libs like Krugman don't get it: Repubs like being Mean and Deceived

Judging by the great number of outright hoaxes aimed at Obama, Democrats, and liberals that are forwarded every week to my Inbox with a scarily long list of prior recipients, hoaxes which are easily debunked by Snopes, PolitiFact, UrbanLegends, TruthorFiction and other sites, I can only conclude that U.S. conservatives are unusually mean and want to be lied to.

Ames is right: debate and logical argument don't really matter. Conservatives want to live in their mean-spirited bizarro rabbitt hole; they just scream, kick you in the face, and burrow in deeper when you grab their ankles and try to pull them out of there.

By Mark Ames
February 27, 2010 | The Exiled

Stiglitz on bank reform: 'There's no question we'll get it wrong'

The Nobel Prize-winning economist argues the banking industry "failed in their core societal function," helping lead to the great economic crash of '08.
Interview by Zack Carter
February 25, 2010 | AlterNet
Zach Carter: How did we get here?
Joseph Stiglitz: Well, there are so many pieces that contributed to our getting here that it's hard to distill into something simple, but the bottom line is that the banks acted recklessly in their lending, in their gambling, in their management of risk. They made bad judgments about credit worthiness. In a sense, they failed their core societal function of allocating capital and managing risk. They misallocated capital and they mismanaged the risk. What I tried to do with the book is peel back the onion and ask – this is not the way capitalism supposed to work – why did things happen so badly?  And here there are a number of factors. One of them was that the bankers had the incentive to engage in short-sighted behavior and excessive risk-taking. You have to ask, "Why is that?" And the answer has to do with problems of corporate governance and a host of other problems that I try to delineate in the book.
On the other side, though, they were allowed to get away with it. And here the issue was deregulation. We stripped away the regulations that had worked so well in the quarter century before 1980. We'd known about the potential for these problems for decades and we had figured out how to stop them, but then we stripped away those regulations. Then you have to ask why we did that, and it had to do with the ideology and with financial interests. The bankers wanted to be unrestrained and they painted the political process, shaped it to make sure they could get away with it. The economists provided some arguments for why it would be a good thing.
ZC:  I want to focus on that word 'capitalism.' A lot of people who are advocates of financial reform are being described as 'populist' or 'socialist.' But it seems to me that one of the core thrusts of your book is that the system we had in place in the mid-'70s was a good system, and nobody was screaming about our socialist banking system at that time. What do you make of the current debate over the banks?
JSWhat we have now is not real capitalism. I give it the name "ersatz capitalism" because what we're doing is socializing losses and privatizing gains. That's worse than real capitalism, of course, because it means that there are distorted incentives. So the banks can write these credit default swaps and crazy derivatives knowing that if things go bad, the taxpayer is going to pick up the tab. So the first point I want to make is that today's system is not real capitalism. It's gambling at the expense of the taxpayers. 
The other point that I would make is about the use of the word "populism," which is used in a number of different ways. One meaning of populism is a government that responds to the concerns of the people. Of course, that is what democracy is supposed to be about, so reformers shouldn't worry about being labeled populist in that sense. But the other use of the word is much more negative in tone, and it describes a situation where political leaders promise things that are beyond the laws of economics.
In this crisis, I actually think of these bankers as being the populist figures in that sense. It was the bankers who tried to pretend that they could break the laws of economics. The things they were telling poor people -- borrow all this money, don't worry about your ability to repay, house prices are going to go up, you're going to be a wealthy person -- and by the way, you can share some of that wealth that you're going to get by giving us big fees -- well, that was unreality. There's no such thing as a free lunch and the bankers were promising a free lunch both for themselves and for everybody else. So the irony in all of this is that the people who ought to be most accused of that kind of populism, that out-of-touchness with reality, are the bankers themselves.
ZC:  Speaking of reality, one of the most astonishing aspects of the deregulatory movement has been the popularity of these 'off-balance sheet vehicles' in finance. The banks actually refused to account for a lot of transactions and regulators just shrugged it off. You won your Nobel Prize for work on information asymmetries – where did this bogus accounting come from and is there any defense for it?
JS:  One issue that I try to raise in my book Freefall is that good information is necessary for the functioning of a market economy. The banks' accountants were originally very clever in coming up with legal deceptions to avoid paying taxes -- you might call it "creative accounting." But then they discovered they could use some of the same techniques to deceive investors. And that's a lot of what all of this great, high-paid talent in the banking industry was up to over the last 20 years. They weren't trying to make our economy work more efficiently; they were engaged in what we call regulatory accounting and tax arbitrage. In other words, they were deceiving investors, deceiving the tax authorities and deceiving the regulators. 
ZC:  In Freefall there's a paragraph where you're talking about Henry Paulson coming to Congress with a three-page TARP bill and demanding the bailout money with no strings attached. You say it looked like a classic problem in developing nations where the financial sector basically uses the government to steal from the public. When has this taken place before and what does it look like?
JS: Oh, it's happened in many emerging markets. Mexico was one of the cases where it happened, and that was just before I arrived at the World Bank and we were seeing some of the consequences there. But what happens in the process of bailouts is that money goes from public purse to somewhere else. And you have to trace the money and what you discover is the money goes from the public, from the taxpayer, and it inevitably winds up in the hands of some of the same people who caused the crisis. And it's often done in a very obscure way, just like the creation of the crisis itself, into things that are hard to detect -- off-balance sheet transactions and the like.
What has absolutely amazed me about this crisis is the lack of transparency that created it is now being reflected in the lack of transparency in the bailouts. And the Federal Reserve is saying that it's not subjected even to the Freedom of Information Act. Here we have a public organization that is refusing to disclose where the money went.
ZC: The public's money, at that.
JS: That's right. Bloomberg [News] had to sue, Bloomberg won the suit and rather than saying, "We made a judgement call that wasn't right," the Fed said, "No, we're going to appeal because we don't want people to know." It's not like anyone has been advocating to have every scrap of information immediately available in the moment of the crisis. That obviously could cause a little bit of a turmoil. But now we're more than a year after Lehman Brothers. It's no longer a question of market stability but a question of accountability.
ZC: Are other central banks this secretive?
JS: This is part of the mentality of central banks. Remember, the central bankers are often people from the banking community, the same community that has been involved in the inventive, creative use of these off-balance-sheet kinds of non-transparent vehicles. So they know that information is money, and the best way to profit is to try and keep everything quiet.
ZC: 'Too big to fail' has become a household term, but how did things really play out when Lehman Brothers went under? If policymakers had just looked at Lehman's involvement in the commercial paper market, it's at least conceivable that the bankruptcy could have been managed without so much fallout. Could Lehman have gone through a prepackaged bankruptcy similar to what Chrysler and GM experienced?  And if so, what would it have looked like?
JS: Clearly, we could have managed an orderly resolution for Lehman. You know, there have been big financial companies – Continental Illinois – that have gone bankrupt without any trauma to our economic system. And so we know how to manage these things. There is a little bit of a question about whether there was legal authority to do it because Lehman was an investment bank not a commercial bank, so the ordinary FDIC process wouldn't apply. 
ZC: Well, Lehman was a lot bigger than Continental Illinois, but we still managed to come up with something for Chrysler and GM, and the FDIC process didn't apply to them.
JS: The point I was going to make is that everybody knew that there was going to be a problem with Lehman Brothers several months before it actually went under. If there really wasn't any legal authority to deal with it, Bernanke and Paulson should have gone to Congress and said they needed it. So the fact is, this legal authority issue was just an excuse for policymakers. The bailouts of AIG and Bear Stearns involved very unusual measures. These guys were willing to bend the law, and they could have done a lot more than they did on Lehman Brothers. But they were in the business of picking winners and losers. There were a lot of discussions about how they decided who to bail out and who to not, and the sheer recklessness of the process is just inexcusable.
ZC: But what do we do now? After Lehman, the government can say it will let these mega-banks fail, but the credit markets won't buy it. The big banks are still able to raise money at lower interest rates and take bigger risks because investors think the government will spare them from losses. Is there a way to establish a fair playing field in finance that doesn't involve breaking up these banks?
JS:  It's very difficult. You know, the studies have shown very clearly that the very big banks, the banks that we call too big to fail, have a competitive advantage not because they are more efficient, but because they can get access to capital at lower costs. Everybody knows that they're effectively guaranteed by the U.S. government. And that really tilts the playing field and leads to a very adverse dynamic in which the big banks actually get bigger. The bigger you are, the better the implied government insurance, and that accelerates the process of concentration in a few banks. It's very, very unhealthy from an economic standpoint. It undermines competition and drives up interest rates. We want low interest rates to get our economy recovering. This goes in exactly the opposite direction because it weakens competition.
So in my mind you have to do something. Both because of this distorted playing field, but also because the too-big-to-fail banks have this bias toward risk-taking.  If they gamble and they win they walk off with the profits. They lose, we, the taxpayers, pick up the losses. 
So something has to be done. Taxes can make a big difference, they can help level the playing field, and there have been proposals for that. I'm not sure, though, that that's going to be enough, and here's why. Those who run the banks have interests that are not necessarily coincident with the banks' shareholders and bondholders. We saw that over and over and over again. The bankers have done very well, but the shareholders and bondholders have not always done so well. So we probably need to go further than tax policy.
I argue that we need a three-pronged approach. Higher taxes and higher capital adequacy requirements to level the playing field are the first prong. The second thing we need to do is take serious structural measures like breaking them up. We should not allow banks that accept deposits to engage in proprietary trading. We shouldn't allow them to own insurance companies, and so forth either.  By forcing companies to focus on one thing rather than allowing them to conduct four different kinds of financial business, we will actually increase the efficiency of our economy. And finally, at the end, we have to make sure that they don't undertake excessive risk.
ZC: Paul Volcker wants to ban proprietary trading by commercial banks, but said recently that he's not in favor of bringing back the Glass-Steagall separation between commercial banking and investment banking. Is that enough?
JS: Well, I'm in absolute agreement that you have to ban proprietary trading and he's seen the risk of that. But I think you need to go a lot further than he seems to be willing to go at the current time. First, we have to do something about the too-big-to-fail investment banks. Goldman Sachs, we'll bail it out, AIG we'll bail it out. We need to make sure that our reforms don't just address the depository institutions, but all of the large financial institutions that pose the problem. Back in the 1990s we even engineered a bailout for the largest hedge fund, Long-Term Capital Management. So you have to go beyond the depository institutions, beyond traditional commercial banks. 
And secondly, there are lots of forms of risk-taking. Proprietary trading is one, but for instance, the big banks are issuing these derivatives, these credit default swaps that brought down AIG. And that means if they're issuing them, the U.S. taxpayer is underwriting them because we underwrite the commercial banks. That means we, ultimately, are bearing the risk.  We shouldn't be participating in this kind of gambling.
ZC: As soon as Goldman Sachs got its bank holding company status in 2008, the first thing it did was move all its derivatives operations under the commercial bank unit. It was very clear it wanted to use deposits to fund that business.
JS: Exactly.
ZC: We've talked a lot about banks so far, but there is more to the economy than banking. It's been a really bad year for American households. Do we need a second stimulus? If so, what should it look like?
JS: We clearly need a second stimulus. There are a couple of ways of seeing this. When the Obama administration first moved on the stimulus, it posed a scenario that was not really rosy, but one that proved a little too optimistic. It expected unemployment without the stimulus it would be around 10 percent, with the stimulus it would be brought down to 8 percent. Others like me thought things were going to be much worse, that without the stimulus, unemployment would be around 12 percent and with the stimulus, it would be about 10 percent. And the pessimists were right. Well, when the world turns out to be worse than you thought it would, you have to adjust what you do. 
But even a much bigger stimulus would have only brought the unemployment rate down to about 8 percent, which is still totally unacceptable. So right now I am very much in favor of a second round of stimulus. Hopefully, it will be better designed and more targeted to job creation and actually stimulating the economy. The tax cuts in the first round weren't designed really to stimulate the economy very much and didn't work very effectively. 
ZC: And what do you do to create jobs? Are we talking fiscal aid to states? Unemployment benefits? A new WPA?
JS The first thing I would do is aid to the states. The states have balanced budget frameworks. The revenues are down by around $200 billion because of the recession. If they don't get aid, they have to either raise taxes—which is very hard in the current environment—or cut back expenditures. And what they inevitably cut are teachers, nurses, firefighters and a whole set of crucial public services which are all the more important in an economic recession.
So the first thing is to provide states with money, and that spending goes right to the economy very quickly. You don't have to set up new programs and it really does save jobs. I would also do one of the things that Obama is pushing now which are job credits to encourage companies to hire more workers. Focus a little bit more direct attention on jobs. We don't know how effective these are going to be. There is some debate, but it seems to me that if we don't try we're not going to get anywhere.
The forecast right now is that it will be the middle of the decade before unemployment returns to normal—that should be very worrying. That kind of situation should be completely unacceptable because it creates severe long-term problems. If you have young people who remain unemployed for extended periods of time, they lose their job skills. Economic studies show very clearly that their lifetime incomes will be significantly lower than if they had been able to get jobs and enter the labor force.
ZC:  It's almost as if they aren't living in the same economy as everyone else. Changing gears a bit—how did every policymaker miss this? We had everybody at the Fed and the Treasury insisting as late as 2007 that everything was fine. How does the biggest credit bubble in history and the worst financial crisis in history just go unnoticed by every major public official? 
JS: They didn't want to notice it. And they didn't want to notice it for two reasons. One was this absurd notion that if you can just keep the markets optimistic -- be a cheerleader -- the economy will keep going strong. The normal hope at Fed and Treasury is that you will be viewed as a great economic leader because you cheered the economy on. So political leaders start acting like cheerleaders and not as economic analysts, which is dangerous.
But the deeper problem is that our public officials – the Bush administration and the Federal Reserve – were very wedded to a particular ideology that could not conceive that the markets were not efficient. They actually argued that there was no such thing as a bubble, or that even if there was, you couldn't tell when it was happening. They actually argued that it was less expensive to clean up the mess afterward than to try to interfere with the magic of the market. It was crazy, but that made it intellectually easy to dismiss all the smart people who were talking about the housing bubble.
But of course, underneath all of that is the third reason. Lots of money was flowing to lots of people who were friends of these politicians. And no one wants to be a party pooper when so many people that they knew were making so much money. And so they were under pressure to keep the party going. But they weren't deceiving the American people in a sense, in that they actually, I think, believed what they were saying, which is all the more worrisome. Their role as cheerleaders, their ideology, their view that their friends were so smart and deserved to get all this money because it was making the economy go – all these went together and served as blinders on their eyes. And unfortunately, those same blinders have impeded a design of an effective response.
ZC: It's interesting to see similarities between the Obama administration's response and that of the Bush administration. 
JS: Well, some of this is bipartisan. Wall Street is bipartisan. There are people in both parties that believed in deregulation. There were people in both parties that were making a lot of money. But there is a difference. The critics of the deregulation philosophy were much more vocal within the Democratic Party. When I was in the Clinton administration, there were several of us that were raising these issues very strongly. We didn't win out in the end, but there was at least a very vocal debate on the economic philosophy.
ZC: Can you go into that a little bit more? I think people are broadly aware of the conflict between Robert Reich and Robert Rubin on the budget deficit, but what was actually discussed when you were on the Clinton team?
JS: Well, the very issue that you were talking about before. The repeal of Glass-Steagall was one of those issues that was debated very extensively. And I described this in my book Freefall, that we had this big debate and I can say that I feel pleased that while I remained chairman of the Counsel of Economic Advisors the Glass-Steagall Act repeal wasn't approved, but I think it had more to do with Congressional politics than politics within the administration. The Treasury wanted it. Bob Rubin wanted it. And one can understand why.
ZC: He made a lot of money working at Citigroup after the repeal.
JS: I think there was genuine belief in this doctrine of deregulation, that markets could take care of themselves. Greenspan in his famous Congressional testimony, his mea culpa, he said that he thought banks could manage risk far better than they did. But what he didn't point out was that if I mismanage my risk, there are consequences for me and my family, but when a major bank mismanages risks, there are consequences for the entire economy. So it's not just an issue of risk management, it's an issue of catastrophic externalities. You shouldn't allow a bank to put the entire economy at risk
ZC: But the debate is still all about regulating banks as private sector, for-profit companies. Given the clear public purpose that banks serve, why don't we just make finance a public utility?
JS: There are actually several problems that carry a long history with governments trying to run banks. In many countries, they have not done it very well because of the potential politicization of the lending process. And that's why I'm actually fairly supportive of the approach that we took in the years after the Great Depression where we had private banks, strong incentives, but we made sure that they don't engage in excessive risk-taking, that they were regulated to serve the public purpose so that we try to shape their behavior.  This public/private interaction that I think has worked most effectively. 
There is no one today who believes the government should not be involved in finance. Even the bankers acknowledge this when they ask for bailouts, and they're also very protective of the Federal Reserve system. There would be no mortgage market today without the government. What we need to do is find the right balance, the right kind of government involvement in finance, because right now we clearly don't have that. And the bankers are doing everything they can to keep the balance out of whack.
ZC: Will we get it right?
JS: There's no question that we'll get it wrong, the question is how wrong we will get it. Right now, I am not very optimistic. We lost the political moment. Something will happen, it will have substance, but I worry that it will still be more cosmetic than substantive.

Saturday, February 27, 2010

Stiglitz: The Great Bank Robbery

The Great American Bank Robbery
How did the big banks nearly take down the entire economy and still continue to profit?

By Joseph Stiglitz
February 27, 2010 | AlterNet

The following is Part I of a two-part excerpt from Freefall: America, Free Markets, and the Sinking of the World Economy by Joseph Stiglitz ( W.W. Norton & Co., 2010). Read AlterNet's recent interview with Stiglitz by Zach Carter.

Bankruptcy is a key feature of capitalism. Firms sometimes are unable to repay what they owe creditors. Financial reorganization has become a fact of life in many industries. The United States is lucky in having a particularly effective way of giving firms a fresh start—Chapter 11 of the bankruptcy code, which has been used repeatedly, for example, by the airlines. Airplanes keep flying; jobs and assets are preserved. Shareholders typically lose everything, and bondholders become the new shareholders. Under new management, and without the burden of debt, the airline can go on. The government plays a limited role in these restructurings: bankruptcy courts make sure that all creditors are treated fairly and that management doesn't steal the assets of the firm for its own benefits.

Banks differ in one respect: the government has a stake because it insures deposits....The reason the government insures deposits is to preserve the stability of the financial system, which is important to preserving the stability of the economy. But if a bank gets into trouble, the basic procedure should be the same: shareholders lose everything; bondholders become the new shareholders. Often, the value of the bonds is sufficiently great that that is all that needs to be done. For instance, at the time of the bailout, Citibank, the largest American bank, with assets of $2 trillion, had some $350 billion of long-term bonds. Because there are no obligatory payments with equity, if there had been a debt-to-equity conversion, the bank wouldn't have had to pay the billions and billions of dollars of interest on these bonds. Not having to pay out the billions of dollars of interest puts the bank in much better stead. In such an instance, the role of the government is little different from the oversight role the government plays in the bankruptcy of an ordinary firm.

Sometimes, though, the bank has been so badly managed that what is owed to depositors is greater than the assets of the bank. (This was the case for many of the banks in the savings and loan debacle in the late 1980s and in the current crisis.) Then the government has to come in to honor its commitments to depositors. The government becomes, in effect, the (possibly partial) owner, though typically it tries to sell the bank as soon as it can or find someone to take it over. Because the bankrupt bank has liabilities greater than its assets, the government typically has to pay the acquiring bank to do this, in effect filling the hole in the balance sheet. This process is called conservatorship. Usually the switch in ownership is so seamless that depositors and other customers wouldn't even know that something had happened unless they read about it in the press. Occasionally, when an appropriate suitor can't be found quickly, the government runs the bank for a while. (The opponents of conservatorship tried to tarnish this traditional approach by calling it nationalization. Obama suggested that this wasn't the American way. But he was wrong: conservatorship, including the possibility of temporary government ownership when all else failed, was the traditional approach; the massive government gifts to banks were what was unprecedented. Since even the banks that were taken over by the government were always eventually sold, some suggested that the process be called preprivatization.)

Long experience has taught that when banks are at risk of failure, their managers engage in behaviors that risk taxpayers losing even more money. The banks may, for instance, undertake big bets: if they win, they keep the proceeds; if they lose, so what? They would have died anyway. That's why there are laws saying that when a bank's capital is low, it should be shut down or put under conservatorship. Bank regulators don't wait until all of the money is gone. They want to be sure that when a depositor puts his debit card into the ATM and it says, "insufficient funds," it's because there are insufficient funds in the account, not insufficient funds in the bank. When the regulators see that a bank has too little money, they put the bank on notice to get more capital, and if it can't, they take further action of the kind just described.

As the crisis of 2008 gained momentum, the government should have played by the rules of capitalism and forced a financial reorganization. Financial reorganizations—giving a fresh start—are not the end of the world. Indeed, they might represent the beginning of a new world, one in which incentives are better aligned and in which lending is rekindled. Had the government forced a financial restructuring of the banks in the way just described, there would have been little need for taxpayer money, or even further government involvement. Such a conversion increases the overall value of the firm because it reduces the likelihood of bankruptcy, thereby not only saving the high transaction costs of going through bankruptcy but also preserving the value of the ongoing concern. That means that if the shareholders are wiped out and the bondholders become the new "owners," the bondholders' long-term prospects are better than they were while the bank remained in limbo, when they were not sure whether it would survive and not sure of either the size or the terms of any government handout.

The bondholders involved in a restructuring would have gotten another gift, at least according to the banks own logic. The bankers claimed that the market was underestimating the true value of the mortgages on their books (and other bank assets). That may have been the case—or it may not have been. If it is not, it is totally unreasonable to make taxpayers bear the cost of the banks' mistake, but if the assets were really worth as much as the bankers said, then the bondholders would get the upside.

The Obama administration has argued that the big banks are not only too big to fail but also too big to be financially restructured (or, as I refer to it later, "too big to be resolved"), too big to play by the ordinary rules of capitalism. Being too big to be financially restructured means that if the bank is on the brink of failure, there is but one source of money: the taxpayer. And under this novel and unproven doctrine, hundreds of billions have been poured into the financial system.

If it is true that America's biggest banks are too big to be "resolved," this has profound implications for our banking system going forward—implications the administration so far has refused to own up to. If, for instance, bondholders are in effect guaranteed because these institutions are too big to be financially restructured, then the market economy can exert no effective discipline on the banks. They get access to cheaper capital than they should, because those providing the capital know that the taxpayers will pick up any losses. If the government is providing a guarantee, whether explicit or implicit, the banks aren't bearing all the risks associated with each decision they make—the risks borne by markets (shareholders, bondholders) are less than those borne by society as a whole, and so resources will go in the wrong place. Because too-big-to-be-restructured banks have access to funds at lower interest rates than they should, the whole capital market is distorted. They grow at the expense of their smaller rivals, who do not have this guarantee. They can easily come to dominate the financial system, not through greater prowess and ingenuity but because of the tacit government support. It should be clear: these too-big-to-be-restructured banks cannot operate as ordinary market-based banks.

I actually think that all of this discussion about too-big-to-be-restructured banks was just a ruse. It was a ploy that worked, based on fear-mongering. Just as Bush used 9/11 and the fears of terrorism to justify so much of what he did, the Treasury under both Bush and Obama used 9/15—the day that Lehman collapsed—and the fears of another meltdown as a tool to extract as much as possible for the banks and the bankers that had brought the world to the brink of economic ruin.

The argument is that, if only the Fed and Treasury had rescued Lehman Brothers, the whole crisis would have been avoided. The implication—seemingly taken on board by the Obama administration—is, when in doubt, bail out, and massively so. To skimp is to be penny wise and pound foolish.

But that is the wrong lesson to learn from the Lehman episode. The notion that if only Lehman Brothers had been rescued all would have been fine is sheer nonsense. Lehman Brothers was a consequence, not a cause: it was the consequence of flawed lending practices and inadequate oversight by regulators. Whether Lehman Brothers had or had not been bailed out, the global economy was headed for difficulties. Prior to the crisis, as I have noted, the global economy had been supported by the bubble and excessive borrowing. That game is over—and was already over well before Lehman's collapse. The collapse almost surely accelerated the whole process of deleveraging; it brought out into the open the long-festering problems, the fact that the banks didn't know their net worth and knew that accordingly they couldn't know that of any other firm to whom they might lend. A more orderly process would have imposed fewer costs in the short run, but "counterfactual history" is always problematic.

There are those who believe that it is better to take one's medicine and be done with it, that a slow unwinding of the excesses would last years longer, with even greater costs. Perhaps, on the other hand, the slow recapitalization of the banks would have occurred faster than the losses would have become apparent. In this view, papering over the losses with dishonest accounting (as in this crisis, as well as in the savings and loan debacle of the 1980s) would be doing more than just providing symptomatic relief. Lowering the fever may actually help in the recovery. A third view holds that Lehman's collapse actually saved the entire financial system: without it, it would have been difficult to galvanize the political support required to bail out the banks. (It was hard enough to do so after its collapse.)

Even if one agrees that letting Lehman Brothers fail was a mistake, there are many choices between the blank-check approach to saving the banks pursued by the Bush and Obama administrations after September 15 and the approach of Hank Paulson, Ben Bernanke, and Tim Geithner of simply shutting down Lehman Brothers and praying that everything will work out in the end.

The government was obligated to save depositors, but that didn't mean it had to provide taxpayer money to also save bondholders and shareholders. As noted earlier, standard procedures would have meant that the institution be saved and the shareholders wiped out, with the bondholders becoming the new shareholders. Lehman had no insured depositors; it was an investment bank. But it had something almost equivalent—it borrowed short-term money from the "market" through commercial paper held by money market funds, which acted much like banks. (One can even write checks on these accounts.) That's why the part of the financial system involving money markets and investment banks is often called the shadow banking system. It arose, in part, to circumvent the regulations imposed on the real banking system—to ensure its safety and stability. Lehman's collapse induced a run on the shadow banking system, much as there used to be runs on the real banking system before deposit insurance was provided; to stop the run, the government provided insurance to the shadow banking system.

Those opposed to financial restructuring (conservatorship) for the banks that are in trouble say that if the bondholders are not fully protected, a bank's remaining creditors—those providing short-term funds without a government guarantee—will flee if a restructuring appears imminent. But such a conclusion defies economic logic. If these creditors are rational, they would realize that they benefit enormously from the greater stability of the firm provided by conservatorship and the debt-to-equity conversion. If they were willing to keep their funds in the bank before, they should be even more willing to do so now. And if the government has no confidence in the rationality of these supposedly smart financiers, they could provide a guarantee, though they should charge a premium for it. In the end, the Bush and Obama administrations not only bailed out the shareholders but also provided guarantees. The guarantees effectively eviscerated the argument for the generous treatment of shareholders and long-term bondholders.

Under financial restructuring, there are two big losers. The executives of the banks will almost surely go, and they will be unhappy. The shareholders too will be unhappy, because they will have lost everything. But that is the nature of risk-taking in capitalism—the only justification for the above-normal returns that they enjoyed during the boom is the risk of a loss.

Joseph Stiglitz, a Nobel laureate, is a professor of economics at Columbia University.

Ames: Ayn Rand's crush on 1920's serial killer

Jeez, I didn't know Ayn Rand was this messed up.

I admit it, in my stupider adolescence I was an Ayn Rand fan... for a feverish few months. Pretty soon though I realized that only children with absolutely no idea what human beings were really like could write, or love, her novels. In Rand's universe, the only ill-gotten wealth was government tax revenue. All priests were deceiving hucksters. All rich people liked each other and got along because they recognized their fellow Supermen. There was one fascist standard of true art, (which Objectivist Supermen would immediately recognize), and everything else was trash. Family and friends were parasites distracting the capitalist gods from realizing their all-important productive work. Rape was sometimes OK. And "true" love could only result from an "objective" assessment of the paramour's productive value.

Her philosophy was just as cold, materialistic, fascistic, and anti-democratic as that of the Soviet Union which she escaped as a little girl. Only she turned Marx around by worshipping the capitalists and hating the proletariat. Both of these ideological extremes were absurd, wrong, and deadly when put in practice.

So it's amazing when you think that leading figures like Alan Greenspan and Clarence Thomas are Ayn Rand fans, because you realize that they must really hate and despise the America in which they find themselves, the government that pays them, and most of their fellow citizens. Ayn Rand would have found most of you literally disgusting and immoral.

Ayn Rand, Hugely Popular Author and Inspiration to Right-Wing Leaders, Was a Big Admirer of Serial Killer

Today her works treated as gospel by right-wing powerhouses like Alan Greenspan and Clarence Thomas, but Ayn Rand found early inspiration in 1920's murderer William Hickman.

By Mark Ames
February 26, 2010 | AlterNet


Friday, February 26, 2010

Study: Smart people are liberals, atheists

Well, I'm obviously a night owl (check the local time of this post), and I'm certainly liberal, but am I a statiscial outlier: a dumb liberal? I'll leave that to you, my esteemed readers, to decide. Regardless, science don't lie, so if you're a religious conservative, chances are, you're not quite as sharp. Sorry to break it to you this way. Here's some consolation though: you've still got Sarah Palin, Pat Robertson, and Glenn Beck to feel superior to... I hope.

Liberals and Atheists Smarter? Intelligent People Have Values Novel in Human Evolutionary History, Study Finds
February 24, 2010 | ScienceDaily

More intelligent people are statistically significantly more likely to exhibit social values and religious and political preferences that are novel to the human species in evolutionary history. Specifically, liberalism and atheism, and for men (but not women), preference for sexual exclusivity correlate with higher intelligence, a new study finds.

The study, published in the March 2010 issue of the peer-reviewed scientific journal Social Psychology Quarterly, advances a new theory to explain why people form particular preferences and values. The theory suggests that more intelligent people are more likely than less intelligent people to adopt evolutionarily novel preferences and values, but intelligence does not correlate with preferences and values that are old enough to have been shaped by evolution over millions of years."

"Evolutionarily novel" preferences and values are those that humans are not biologically designed to have and our ancestors probably did not possess. In contrast, those that our ancestors had for millions of years are "evolutionarily familiar."

"General intelligence, the ability to think and reason, endowed our ancestors with advantages in solving evolutionarily novel problems for which they did not have innate solutions," says Satoshi Kanazawa, an evolutionary psychologist at the London School of Economics and Political Science. "As a result, more intelligent people are more likely to recognize and understand such novel entities and situations than less intelligent people, and some of these entities and situations are preferences, values, and lifestyles."

An earlier study by Kanazawa found that more intelligent individuals were more nocturnal, waking up and staying up later than less intelligent individuals. Because our ancestors lacked artificial light, they tended to wake up shortly before dawn and go to sleep shortly after dusk. Being nocturnal is evolutionarily novel.

In the current study, Kanazawa argues that humans are evolutionarily designed to be conservative, caring mostly about their family and friends, and being liberal, caring about an indefinite number of genetically unrelated strangers they never meet or interact with, is evolutionarily novel. So more intelligent children may be more likely to grow up to be liberals.

Data from the National Longitudinal Study of Adolescent Health (Add Health) support Kanazawa's hypothesis. Young adults who subjectively identify themselves as "very liberal" have an average IQ of 106 during adolescence while those who identify themselves as "very conservative" have an average IQ of 95 during adolescence.

[Now I admit I would have identified myself as "very conservative" in my stupider adolescence, but you might say that my genes got the better of me, and my innate intelligence forced me to become a bleeding-heart, Marxist/socialist liberal in adulthood. - J]

Similarly, religion is a byproduct of humans' tendency to perceive agency and intention as causes of events, to see "the hands of God" at work behind otherwise natural phenomena. "Humans are evolutionarily designed to be paranoid, and they believe in God because they are paranoid," says Kanazawa. This innate bias toward paranoia served humans well when self-preservation and protection of their families and clans depended on extreme vigilance to all potential dangers. "So, more intelligent children are more likely to grow up to go against their natural evolutionary tendency to believe in God, and they become atheists."

Young adults who identify themselves as "not at all religious" have an average IQ of 103 during adolescence, while those who identify themselves as "very religious" have an average IQ of 97 during adolescence.

In addition, humans have always been mildly polygynous in evolutionary history. Men in polygynous marriages were not expected to be sexually exclusive to one mate, whereas men in monogamous marriages were. In sharp contrast, whether they are in a monogamous or polygynous marriage, women were always expected to be sexually exclusive to one mate. So being sexually exclusive is evolutionarily novel for men, but not for women. And the theory predicts that more intelligent men are more likely to value sexual exclusivity than less intelligent men, but general intelligence makes no difference for women's value on sexual exclusivity. Kanazawa's analysis of Add Health data supports these sex-specific predictions as well.

One intriguing but theoretically predicted finding of the study is that more intelligent people are no more or no less likely to value such evolutionarily familiar entities as marriage, family, children, and friends.

Wednesday, February 24, 2010

Obama break's W's record for awkward silence

Dude, like, um, be eloquent and stuff. Jeez, you're the best speaker we've had in the White House since at least Reagan and you only do Oprah-type "intimate" interviews with softball questions and Vaseline smeared all over the camera lens. What's the matter with you?

Like, for instance, you might say a peep or two about health care reform, and how you'd like to get it passed in your lifetime, and without the pages all stuck together from the pharma and insurance lobbyists who write the bills to enrich themselves.

Obama tops Bush at ducking reporters

No formal press conference in 215 days

By Joseph Curl
February 22, 2010 | Washington Times


Tuesday, February 23, 2010

FOX, NYT, others fell for O'Keefe's ACORN 'pimp' scam

Oh, whither the lib'rul media? What have we come to when FOX leads The New York Times by the nose?

Giles Admits O'Keefe, Breitbart ACORN 'Pimp' Story was a Lie: 'That Was B-Roll, Purely B-Roll'

Woman who posed as prostitute confirms repeated misreporting by NYTimes, many others

Why does 'paper of record' still refuse to retract, apologize?

By Brad Friedman
February 19, 2010 The Brad Blog


Friday, February 19, 2010

IRS: Richest 400 Americans pay 17% income tax

Gee, big surprise that Dubya would have hidden this annual IRS report from the public for the past 8 years. Good for Obama for publishing it once again.

You GOP/teabagger types accuse me of class envy or class warfare, but the numbers speak for themselves: our tax system has been distorted to favor the super rich. The top 400 richest Americans pay a lower effective tax rate than those making low 6 figures. How on God's green Earth is that equitable, fair, or rational? Especially since, with America's Third-World income distribution curve, the super rich are the only ones with any income (2007 average: $345 million)! The top 400 earn 1.59 cents of every dollar of U.S. income.

Those tax reforms that you brainwashed marks call "soaking the rich" would simply rationalize our tax system and return it to its progressive, post-WWII roots: you earn more, you pay more, both absolutely and relatively.

The top 400: Income way up and taxes way, way down
A new IRS report on the richest 400 taxpayers shows their income rose an average of $81 million -- in a single year

By Joe Conason
February 17, 2010 |

Before angry voters restore Republicans to power -- in the name of "tea party populism" -- perhaps they should consider just how well right-wing rule worked out for them during the past decade. Last fall a Census Bureau study found that real median household income had declined from $52,500 in 2000, the last year that Bill Clinton was president, to $50,303 in 2008, George W. Bush's final year -- a period during which Republicans dominated Congress as well. Millions of those median households lost their health insurance (and, since the onset of the Great Recession, many of those same families have lost jobs as well).

So most of those middle-class Americans who flock to the tea party demonstrations were big losers during the Bush era. So who were the winners? According to David Cay Johnston, America's premier tax journalist, newly released IRS data shows that the country's very wealthiest citizens -- the top 400 -- marked enormous income gains while paying less and less in taxes. For purposes of comparison, Johnston notes that the bottom 90 percent of Americans saw their incomes rise by only 13 percent in 2009 dollars, compared with a 399 percent increase for the top 400.

In a single year, between 2006 and 2007, the income of those top 400 taxpayers rose by 31 percent -- from an average of $263.3 million to an average of $344.8 million per year. Meanwhile, Johnston writes, "Their effective income tax rate fell to 16.62 percent, down more than half a percentage point from 17.17 percent in 2006, the new data show. That rate is lower than the typical effective income tax rate paid by Americans with incomes in the low six figures, which is what each taxpayer in the top group earned in the first three hours of 2007." He also notes that the IRS data probably understates the income of the top 400, because of deferral rules enjoyed by hedge fund managers (at least three of whom earned $3 billion or more in 2007).

Johnston's data comes from the latest edition of an annual IRS study of the top 400 taxpayers, which was first made public during the Clinton presidency. When Bush became president, unsurprisingly, he curtailed public access to the top 400 report for eight years. The Obama administration has made the report available this year, but such embarrassing statistics will no doubt be buried again as soon as the Republicans return to power.

MB360: U.S. middle class pays for all our sins

The Middle Class Two Income Trap – Two Breadwinners plus Extra Money to support the Banking Industry. How Middle Class Americans are losing Ground by Supporting the Financial Sector.

Posted by mybudget360

If it isn't enough that average Americans are contending with the rising cost of healthcare, education, and daily necessities like food now additional funds are going directly to the banking sector to keep them propped up like a money loving puppet. Since the Great Depression the rise of the middle class has been the envy of many people around the globe. The ability for hard working Americans to have access to an economy that supported them so long as they worked hard and followed an implicit guarantee with their nation. With this implicit guarantee it was assumed that the government would also protect people to a certain degree especially when it came to their financial well being. This did not assure a winning portfolio but it did mean we wouldn't turn our stock market into a giant game of casino where the connected had a loaded deck. Much of the strong regulatory arm that came from the Great Depression was because of the speculative gambling during the Roaring 1920s. Yet as time went on slowly Wall Street took these structures away and now we are finding ourselves once again with the middle class largely at risk in the United States. It isn't by accident we are in the situation we are in today.

The first important thing to understand is that yes, the income of middle class families has gone up since the 1950s but a large part of this was the rise of the two income households with women entering the workforce:

The above chart is disturbing in many ways because it bucks the nearly 50 year long-term trend of employment. Now, even with two income households many with rising job losses are finding they now have to make it with one income while inflation has eroded their buying power over the decades. In this recession 3 out of 4 job losses have been men. If you have any doubt regarding the insidious nature of inflation I put together a chart looking at various costs over the last few decades:

Part of this is due to the Federal Reserve and U.S. Treasury trashing the U.S. dollar over the decades. For example, in 1950 it took the median household income (which was largely a one income household) about 2 times the annual household income to purchase the median priced home. In 2008, it took the median household income (now largely a two income household) four times annual earnings to purchase the median priced home. In fact, the two income household has hidden a large part of how much the middle class has fallen behind in this country. Now with this recession, the deep cracks are now being exposed in the system.

Income inequality has also risen in this country and a large part of it is due to the financial sector. 1 percent of our population control 42 percent of all financial wealth. In fact, in the last decade the only segment of our population that has seen any sizeable gains in true wealth is the top 1 percent. Every other category has seen a loss of housing net worth, wage stagnation, and higher costs for daily items that consume a larger part of their budget. Just take a look at the chart below showing this change:

Source: CNN

The above is looking at a one income household in 1973 versus the two income household in the 2000s. It is interesting to note that in the 1970s Nixon took the dollar into a purely fiat system and since that time, the dollar has lost much of its actual value. This would be expected. The Federal Reserve with its banking lieutenants has been able to put our country so deep into debt that realistically we are in a position of never paying back all our outstanding obligations. The only way out is via inflation and with a fiat system that is the path we are heading down. This is important because when you look at the charts above prices rise for various reasons and inflation is a hidden tax. No need for higher taxes to bailout the banking sector when you can just destroy the purchasing power of middle class Americans by monetizing enormous amounts of debt as we have done.

That is why in the next decade, Americans are now working for someone else beyond their immediate household. A large chunk of their money is now going to the banking sector. This can be in absurd payments to credit card companies, loss of purchasing power because of the Fed, or other hidden methods of taxing the public. We are really at a crossroads for the middle class. If we dissect the data further we realize that even though things cost more, much of it has been financed through debt:

Ironically the family in the early 1970s had more discretionary income than the family in the early 2000s even with a dual income. Yet if you look around, it isn't immediately apparent because of the massive debt bubble financed by the banking sector. Sure people bought bigger homes and newer cars but all this was under a phony veneer of success and was financed with debt. All of it was built around a mountain of debt. Yet here is where the big divide hits. Middle class families are now losing their homes through foreclosure. Many are having their cars repossessed because they can't make their payments. Bankruptcy filings are soaring because people cannot service their debt. So middle class Americans are paying the price with the rules that are setup. Yet banks are not. They are sucking the American taxpayer for all their horrible bets and are not dealing with the ramifications of their actions. In other words, the bill is going to the middle class as the middle class is dealing with their own bad decisions. This is part of the system built around the corporatacracy model of government. Losses are socialized while gains are privatized.

And don't kid yourself, this entire game was financed on debt:

And the small group of banks at the top now control a large portion of all FDIC backed assets in our country:

Source: FDIC, Bank Financial Statements

Forget about the Republican or Democrat parties, we are being governed by the financial sector of this economy. It is amazing how hard it is to get sensible legislation even after this great calamity. To prove this point, in California an insurance company announced they are hiking healthcare premiums by 30 percent in the midst of this recession even though they pulled in billions in profits. The government will sit back and let the middle class get fleeced because they are part of the problem. They speak a good game but are bought by the industry. Prove us wrong if this isn't the case. Enough talk, time for action. From now on we need to focus on who is delivering results. If you can, take your money out of the big banks and put them in local regional banks. Let your local representatives know that their number one priority should be focusing on protecting our struggling middle class. Time to get some real reform or we really risk losing our middle class.

15% of Americans on Medicaid

Here's more evidence that hands-off government regulation of Wall St. combined with hands-on bailouts of TBTF banks has led by default to the growing socialist welfare state that laissez-faire, pro-business types wanted to avoid all along.

46.8 million Americans are enrolled in Medicaid, and growing.

Who needs socialist health care reform? The bad economy is forcing Big Guvmint's hand.

Medicaid enrollment rises nationwide, analysis finds
By Amy Goldstein
February 19, 2010 | Washington Post


Palin: Teabaggers need to pick a party...but which one???

"Now the smart thing will be for independents who are such a part of this Tea Party movement to, I guess, kind of start picking a party," Palin said at an Arkansas GOP fundraising event Tuesday, according to CBS News.

I guess Palin's kinda like, you know, right. I'm sure it will be an agonizing choice for all those independent-minded Tea Partiers. Which party? Which one??? It's so close, they could go either way! I can't bear the suspense.

February 17, 2010 | CNN

Thursday, February 18, 2010

Taibbi: How Wall St. turned a profit thanks to Big Guvmint

You lib'ruls will be with me on this, you don't need any convincing, you just need to know the "high-finance" mechanics of how greedy, lawless Wall Street SOBs used Big Guvmint not only to save themselves, but to become more profitable than ever in the face of a collapsing financial system. You know instinctively that Wall Street's recent profits stink to high heaven, but you have to educate yourselves on how they accomplished it.

It's you "pro-business" Republicans and teabaggers who need more convincing, although you Tea Partiers are ostensibly opposed to all bailouts, albeit the relatively measly bailouts of GM and Chrysler seem to rankle you much more, for the reason that Detroit has labor unions, whereas hotshot investment banks turned bank holding companies sucking from the Fed's teat interest-free didn't automatically raise any ideological red flags with you rubes. Do you suffer from what con men call "True Believer Syndrome"?

Read it and weep, you marks. Then get mad as hell. And then do something about it. Yes, Obama and Geithner have oodles of blame. Get over it. You're not voting for Democrats anyway. That's not a cure. The point is to fix it. Contact your Congressmen. Tell them you won't tolerate being robbed! Re-establishing Glass-Steagall would be a damn good start!

Wall Street's Bailout Hustle
Goldman Sachs and other big banks aren't just pocketing the trillions we gave them to rescue the economy - they're re-creating the conditions for another crash

By Matt Taibbi
February 17, 2010 Rolling Stone

On January 21st, Lloyd Blankfein left a peculiar voicemail message on the work phones of his employees at Goldman Sachs. Fast becoming America's pre-eminent Marvel Comics supervillain, the CEO used the call to deploy his secret weapon: a pair of giant, nuclear-powered testicles. In his message, Blankfein addressed his plan to pay out gigantic year-end bonuses amid widespread controversy over Goldman's role in precipitating the global financial crisis.

The bank had already set aside a tidy $16.2 billion for salaries and bonuses — meaning that Goldman employees were each set to take home an average of $498,246, a number roughly commensurate with what they received during the bubble years. Still, the troops were worried: There were rumors that Dr. Ballsachs, bowing to political pressure, might be forced to scale the number back. After all, the country was broke, 14.8 million Americans were stranded on the unemployment line, and Barack Obama and the Democrats were trying to recover the populist high ground after their bitch-whipping in Massachusetts by calling for a "bailout tax" on banks. Maybe this wasn't the right time for Goldman to be throwing its annual Roman bonus orgy.

Not to worry, Blankfein reassured employees. "In a year that proved to have no shortage of story lines," he said, "I believe very strongly that performance is the ultimate narrative."

Translation: We made a shitload of money last year because we're so amazing at our jobs, so fuck all those people who want us to reduce our bonuses.

Goldman wasn't alone. The nation's six largest banks — all committed to this balls-out, I drink your milkshake! strategy of flagrantly gorging themselves as America goes hungry — set aside a whopping $140 billion for executive compensation last year, a sum only slightly less than the $164 billion they paid themselves in the pre-crash year of 2007. In a gesture of self-sacrifice, Blankfein himself took a humiliatingly low bonus of $9 million, less than the 2009 pay of elephantine New York Knicks washout Eddy Curry. But in reality, not much had changed. "What is the state of our moral being when Lloyd Blankfein taking a $9 million bonus is viewed as this great act of contrition, when every penny of it was a direct transfer from the taxpayer?" asks Eliot Spitzer, who tried to hold Wall Street accountable during his own ill-fated stint as governor of New York.

Beyond a few such bleats of outrage, however, the huge payout was met, by and large, with a collective sigh of resignation. Because beneath America's populist veneer, on a more subtle strata of the national psyche, there remains a strong temptation to not really give a shit. The rich, after all, have always made way too much money; what's the difference if some fat cat in New York pockets $20 million instead of $10 million?

The only reason such apathy exists, however, is because there's still a widespread misunderstanding of how exactly Wall Street "earns" its money, with emphasis on the quotation marks around "earns." The question everyone should be asking, as one bailout recipient after another posts massive profits — Goldman reported $13.4 billion in profits last year, after paying out that $16.2 billion in bonuses and compensation — is this: In an economy as horrible as ours, with every factory town between New York and Los Angeles looking like those hollowed-out ghost ships we see on History Channel documentaries like Shipwrecks of the Great Lakes, where in the hell did Wall Street's eye-popping profits come from, exactly? Did Goldman go from bailout city to $13.4 billion in the black because, as Blankfein suggests, its "performance" was just that awesome? A year and a half after they were minutes away from bankruptcy, how are these assholes not only back on their feet again, but hauling in bonuses at the same rate they were during the bubble?

The answer to that question is basically twofold: They raped the taxpayer, and they raped their clients.

The bottom line is that banks like Goldman have learned absolutely nothing from the global economic meltdown. In fact, they're back conniving and playing speculative long shots in force — only this time with the full financial support of the U.S. government. In the process, they're rapidly re-creating the conditions for another crash, with the same actors once again playing the same crazy games of financial chicken with the same toxic assets as before.

That's why this bonus business isn't merely a matter of getting upset about whether or not Lloyd Blankfein buys himself one tropical island or two on his next birthday. The reality is that the post-bailout era in which Goldman thrived has turned out to be a chaotic frenzy of high-stakes con-artistry, with taxpayers and clients bilked out of billions using a dizzying array of old-school hustles that, but for their ponderous complexity, would have fit well in slick grifter movies like The Sting and Matchstick Men. There's even a term in con-man lingo for what some of the banks are doing right now, with all their cosmetic gestures of scaling back bonuses and giving to charities. In the grifter world, calming down a mark so he doesn't call the cops is known as the "Cool Off."

To appreciate how all of these (sometimes brilliant) schemes work is to understand the difference between earning money and taking scores, and to realize that the profits these banks are posting don't so much represent national growth and recovery, but something closer to the losses one would report after a theft or a car crash. Many Americans instinctively understand this to be true — but, much like when your wife does it with your 300-pound plumber in the kids' playroom, knowing it and actually watching the whole scene from start to finish are two very different things. In that spirit, a brief history of the best 18 months of grifting this country has ever seen:


By now, most people who have followed the financial crisis know that the bailout of AIG was actually a bailout of AIG's "counterparties" — the big banks like Goldman to whom the insurance giant owed billions when it went belly up.

What is less understood is that the bailout of AIG counter-parties like Goldman and Société Générale, a French bank, actually began before the collapse of AIG, before the Federal Reserve paid them so much as a dollar. Nor is it understood that these counterparties actually accelerated the wreck of AIG in what was, ironically, something very like the old insurance scam known as "Swoop and Squat," in which a target car is trapped between two perpetrator vehicles and wrecked, with the mark in the game being the target's insurance company — in this case, the government.

This may sound far-fetched, but the financial crisis of 2008 was very much caused by a perverse series of legal incentives that often made failed investments worth more than thriving ones. Our economy was like a town where everyone has juicy insurance policies on their neighbors' cars and houses. In such a town, the driving will be suspiciously bad, and there will be a lot of fires.

AIG was the ultimate example of this dynamic. At the height of the housing boom, Goldman was selling billions in bundled mortgage-backed securities — often toxic crap of the no-money-down, no-identification-needed variety of home loan — to various institutional suckers like pensions and insurance companies, who frequently thought they were buying investment-grade instruments. At the same time, in a glaring example of the perverse incentives that existed and still exist, Goldman was also betting against those same sorts of securities — a practice that one government investigator compared to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars."

Goldman often "insured" some of this garbage with AIG, using a virtually unregulated form of pseudo-insurance called credit-default swaps. Thanks in large part to deregulation pushed by Bob Rubin, former chairman of Goldman, and Treasury secretary under Bill Clinton, AIG wasn't required to actually have the capital to pay off the deals. As a result, banks like Goldman bought more than $440 billion worth of this bogus insurance from AIG, a huge blind bet that the taxpayer ended up having to eat. Thus, when the housing bubble went crazy, Goldman made money coming and going. They made money selling the crap mortgages, and they made money by collecting on the bogus insurance from AIG when the crap mortgages flopped.

Still, the trick for Goldman was: how to collect the insurance money. As AIG headed into a tailspin that fateful summer of 2008, it looked like the beleaguered firm wasn't going to have the money to pay off the bogus insurance. So Goldman and other banks began demanding that AIG provide them with cash collateral. In the 15 months leading up to the collapse of AIG, Goldman received $5.9 billion in collateral. Société Générale, a bank holding lots of mortgage-backed crap originally underwritten by Goldman, received $5.5 billion. These collateral demands squeezing AIG from two sides were the "Swoop and Squat" that ultimately crashed the firm. "It put the company into a liquidity crisis," says Eric Dinallo, who was intimately involved in the AIG bailout as head of the New York State Insurance Department.

It was a brilliant move. When a company like AIG is about to die, it isn't supposed to hand over big hunks of assets to a single creditor like Goldman; it's supposed to equitably distribute whatever assets it has left among all its creditors. Had AIG gone bankrupt, Goldman would have likely lost much of the $5.9 billion that it pocketed as collateral. "Any bankruptcy court that saw those collateral payments would have declined that transaction as a fraudulent conveyance," says Barry Ritholtz, the author of Bailout Nation.

Instead, Goldman and the other counterparties got their money out in advance — putting a torch to what was left of AIG. Fans of the movie Goodfellas will recall Henry Hill and Tommy DeVito taking the same approach to the Bamboo Lounge nightclub they'd been gouging. Roll the Ray Liotta narration: "Finally, when there's nothing left, when you can't borrow another buck . . . you bust the joint out. You light a match."

And why not? After all, according to the terms of the bailout deal struck when AIG was taken over by the state in September 2008, Goldman was paid 100 cents on the dollar on an additional $12.9 billion it was owed by AIG — again, money it almost certainly would not have seen a fraction of had AIG proceeded to a normal bankruptcy. Along with the collateral it pocketed, that's $19 billion in pure cash that Goldman would not have "earned" without massive state intervention. How's that $13.4 billion in 2009 profits looking now? And that doesn't even include the direct bailouts of Goldman Sachs and other big banks, which began in earnest after the collapse of AIG.


In the usual "DollarStore" or "Big Store" scam — popularized in movies like The Sting — a huge cast of con artists is hired to create a whole fake environment into which the unsuspecting mark walks and gets robbed over and over again. A warehouse is converted into a makeshift casino or off-track betting parlor, the fool walks in with money, leaves without it.

The two key elements to the Dollar Store scam are the whiz-bang theatrical redecorating job and the fact that everyone is in on it except the mark. In this case, a pair of investment banks were dressed up to look like commercial banks overnight, and it was the taxpayer who walked in and lost his shirt, confused by the appearance of what looked like real Federal Reserve officials minding the store.

Less than a week after the AIG bailout, Goldman and another investment bank, Morgan Stanley, applied for, and received, federal permission to become bank holding companies — a move that would make them eligible for much greater federal support. The stock prices of both firms were cratering, and there was talk that either or both might go the way of Lehman Brothers, another once-mighty investment bank that just a week earlier had disappeared from the face of the earth under the weight of its toxic assets. By law, a five-day waiting period was required for such a conversion — but the two banks got them overnight, with final approval actually coming only five days after the AIG bailout.

Why did they need those federal bank charters? This question is the key to understanding the entire bailout era — because this Dollar Store scam was the big one. Institutions that were, in reality, high-risk gambling houses were allowed to masquerade as conservative commercial banks. As a result of this new designation, they were given access to a virtually endless tap of "free money" by unsuspecting taxpayers. The $10 billion that Goldman received under the better-known TARP bailout was chump change in comparison to the smorgasbord of direct and indirect aid it qualified for as a commercial bank.

When Goldman Sachs and Morgan Stanley got their federal bank charters, they joined Bank of America, Citigroup, J.P. Morgan Chase and the other banking titans who could go to the Fed and borrow massive amounts of money at interest rates that, thanks to the aggressive rate-cutting policies of Fed chief Ben Bernanke during the crisis, soon sank to zero percent. The ability to go to the Fed and borrow big at next to no interest was what saved Goldman, Morgan Stanley and other banks from death in the fall of 2008. "They had no other way to raise capital at that moment, meaning they were on the brink of insolvency," says Nomi Prins, a former managing director at Goldman Sachs. "The Fed was the only shot."

In fact, the Fed became not just a source of emergency borrowing that enabled Goldman and Morgan Stanley to stave off disaster — it became a source of long-term guaranteed income. Borrowing at zero percent interest, banks like Goldman now had virtually infinite ways to make money. In one of the most common maneuvers, they simply took the money they borrowed from the government at zero percent and lent it back to the government by buying Treasury bills that paid interest of three or four percent. It was basically a license to print money — no different than attaching an ATM to the side of the Federal Reserve.

"You're borrowing at zero, putting it out there at two or three percent, with hundreds of billions of dollars — man, you can make a lot of money that way," says the manager of one prominent hedge fund. "It's free money." Which goes a long way to explaining Goldman's enormous profits last year. But all that free money was amplified by another scam:


At one point or another, pretty much everyone who takes drugs has been burned by this one, also known as the "Rocks in the Box" scam or, in its more elaborate variations, the "Jamaican Switch." Someone sells you what looks like an eightball of coke in a baggie, you get home and, you dumbass, it's baby powder.

The scam's name comes from the Middle Ages, when some fool would be sold a bound and gagged pig that he would see being put into a bag; he'd miss the switch, then get home and find a tied-up cat in there instead. Hence the expression "Don't let the cat out of the bag."

The "Pig in the Poke" scam is another key to the entire bailout era. After the crash of the housing bubble — the largest asset bubble in history — the economy was suddenly flooded with securities backed by failing or near-failing home loans. In the cleanup phase after that bubble burst, the whole game was to get taxpayers, clients and shareholders to buy these worthless cats, but at pig prices.

One of the first times we saw the scam appear was in September 2008, right around the time that AIG was imploding. That was when the Fed changed some of its collateral rules, meaning banks that could once borrow only against sound collateral, like Treasury bills or AAA-rated corporate bonds, could now borrow against pretty much anything — including some of the mortgage-backed sewage that got us into this mess in the first place. In other words, banks that once had to show a real pig to borrow from the Fed could now show up with a cat and get pig money. "All of a sudden, banks were allowed to post absolute shit to the Fed's balance sheet," says the manager of the prominent hedge fund.

The Fed spelled it out on September 14th, 2008, when it changed the collateral rules for one of its first bailout facilities — the Primary Dealer Credit Facility, or PDCF. The Fed's own write-up described the changes: "With the Fed's action, all the kinds of collateral then in use . . . including non-investment-grade securities and equities . . . became eligible for pledge in the PDCF."

Translation: We now accept cats.

The Pig in the Poke also came into play in April of last year, when Congress pushed a little-known agency called the Financial Accounting Standards Board, or FASB, to change the so-called "mark-to-market" accounting rules. Until this rule change, banks had to assign a real-market price to all of their assets. If they had a balance sheet full of securities they had bought at $3 that were now only worth $1, they had to figure their year-end accounting using that $1 value. In other words, if you were the dope who bought a cat instead of a pig, you couldn't invite your shareholders to a slate of pork dinners come year-end accounting time.

But last April, FASB changed all that. From now on, it announced, banks could avoid reporting losses on some of their crappy cat investments simply by declaring that they would "more likely than not" hold on to them until they recovered their pig value. In short, the banks didn't even have to actually hold on to the toxic shit they owned — they just had to sort of promise to hold on to it.

That's why the "profit" numbers of a lot of these banks are really a joke. In many cases, we have absolutely no idea how many cats are in their proverbial bag. What they call "profits" might really be profits, only minus undeclared millions or billions in losses.

"They're hiding all this stuff from their shareholders," says Ritholtz, who was disgusted that the banks lobbied for the rule changes. "Now, suddenly banks that were happy to mark to market on the way up don't have to mark to market on the way down."


One of the great innovations of Victor Lustig, the legendary Depression-era con man who wrote the famous "Ten Commandments for Con Men," was a thing called the "Rumanian Box." This was a little machine that a mark would put a blank piece of paper into, only to see real currency come out the other side. The brilliant Lustig sold this Rumanian Box over and over again for vast sums — but he's been outdone by the modern barons of Wall Street, who managed to get themselves a real Rumanian Box.
How they accomplished this is a story that by itself highlights the challenge of placing this era in any kind of historical context of known financial crime. What the banks did was something that was never — and never could have been — thought of before. They took so much money from the government, and then did so little with it, that the state was forced to start printing new cash to throw at them. Even the great Lustig in his wildest, horniest dreams could never have dreamed up this one.

The setup: By early 2009, the banks had already replenished themselves with billions if not trillions in bailout money. It wasn't just the $700 billion in TARP cash, the free money provided by the Fed, and the untold losses obscured by accounting tricks. Another new rule allowed banks to collect interest on the cash they were required by law to keep in reserve accounts at the Fed — meaning the state was now compensating the banks simply for guaranteeing their own solvency. And a new federal operation called the Temporary Liquidity Guarantee Program let insolvent and near-insolvent banks dispense with their deservedly ruined credit profiles and borrow on a clean slate, with FDIC backing. Goldman borrowed $29 billion on the government's good name, J.P. Morgan Chase $38 billion, and Bank of America $44 billion. "TLGP," says Prins, the former Goldman manager, "was a big one."

Collectively, all this largesse was worth trillions. The idea behind the flood of money, from the government's standpoint, was to spark a national recovery: We refill the banks' balance sheets, and they, in turn, start to lend money again, recharging the economy and producing jobs. "The banks were fast approaching insolvency," says Rep. Paul Kanjorski, a vocal critic of Wall Street who nevertheless defends the initial decision to bail out the banks. "It was vitally important that we recapitalize these institutions."
But here's the thing. Despite all these trillions in government rescues, despite the Fed slashing interest rates down to nothing and showering the banks with mountains of guarantees, Goldman and its friends had still not jump-started lending again by the first quarter of 2009. That's where those nuclear-powered balls of Lloyd Blankfein came into play, as Goldman and other banks basically threatened to pick up their bailout billions and go home if the government didn't fork over more cash — a lot more. "Even if the Fed could make interest rates negative, that wouldn't necessarily help," warned Goldman's chief domestic economist, Jan Hatzius. "We're in a deep recession mainly because the private sector, for a variety of reasons, has decided to save a lot more."

Translation: You can lower interest rates all you want, but we're still not fucking lending the bailout money to anyone in this economy.

Until the government agreed to hand over even more goodies, the banks opted to join the rest of the "private sector" and "save" the taxpayer aid they had received — in the form of bonuses and compensation.

The ploy worked. In March of last year, the Fed sharply expanded a radical new program called quantitative easing, which effectively operated as a real-live Rumanian Box. The government put stacks of paper in one side, and out came $1.2 trillion "real" dollars.

The government used some of that freshly printed money to prop itself up by purchasing Treasury bonds — a desperation move, since Washington's demand for cash was so great post-Clusterfuck '08 that even the Chinese couldn't buy U.S. debt fast enough to keep America afloat. But the Fed used most of the new cash to buy mortgage-backed securities in an effort to spur home lending — instantly creating a massive market for major banks.

And what did the banks do with the proceeds? Among other things, they bought Treasury bonds, essentially lending the money back to the government, at interest. The money that came out of the magic Rumanian Box went from the government back to the government, with Wall Street stepping into the circle just long enough to get paid. And once quantitative easing ends, as it is scheduled to do in March, the flow of money for home loans will once again grind to a halt. The Mortgage Bankers Association expects the number of new residential mortgages to plunge by 40 percent this year.


All of that Rumanian box paper was made even more valuable by running it through the next stage of the grift. Michael Masters, one of the country's leading experts on commodities trading, compares this part of the scam to the poker game in the Bill Murray comedy Stripes. "It's like that scene where John Candy leans over to the guy who's new at poker and says, 'Let me see your cards,' then starts giving him advice," Masters says. "He looks at the hand, and the guy has bad cards, and he's like, 'Bluff me, come on! If it were me, I'd bet everything!' That's what it's like. It's like they're looking at your cards as they give you advice."

In more ways than one can count, the economy in the bailout era turned into a "Big Mitt," the con man's name for a rigged poker game. Everybody was indeed looking at everyone else's cards, in many cases with state sanction. Only taxpayers and clients were left out of the loop.

At the same time the Fed and the Treasury were making massive, earthshaking moves like quantitative easing and TARP, they were also consulting regularly with private advisory boards that include every major player on Wall Street. The Treasury Borrowing Advisory Committee has a J.P. Morgan executive as its chairman and a Goldman executive as its vice chairman, while the board advising the Fed includes bankers from Capital One and Bank of New York Mellon. That means that, in addition to getting great gobs of free money, the banks were also getting clear signals about when they were getting that money, making it possible to position themselves to make the appropriate investments.

One of the best examples of the banks blatantly gambling, and winning, on government moves was the Public-Private Investment Program, or PPIP. In this bizarre scheme cooked up by goofball-geek Treasury Secretary Tim Geithner, the government loaned money to hedge funds and other private investors to buy up the absolutely most toxic horseshit on the market — the same kind of high-risk, high-yield mortgages that were most responsible for triggering the financial chain reaction in the fall of 2008. These satanic deals were the basic currency of the bubble: Jobless dope fiends bought houses with no money down, and the big banks wrapped those mortgages into securities and then sold them off to pensions and other suckers as investment-grade deals. The whole point of the PPIP was to get private investors to relieve the banks of these dangerous assets before they hurt any more innocent bystanders.

But what did the banks do instead, once they got wind of the PPIP? They started buying that worthless crap again, presumably to sell back to the government at inflated prices! In the third quarter of last year, Goldman, Morgan Stanley, Citigroup and Bank of America combined to add $3.36 billion of exactly this horseshit to their balance sheets.

This brazen decision to gouge the taxpayer startled even hardened market observers. According to Michael Schlachter of the investment firm Wilshire Associates, it was "absolutely ridiculous" that the banks that were supposed to be reducing their exposure to these volatile instruments were instead loading up on them in order to make a quick buck. "Some of them created this mess," he said, "and they are making a killing undoing it."


Here's the thing about our current economy. When Goldman and Morgan Stanley transformed overnight from investment banks into commercial banks, we were told this would mean a new era of "significantly tighter regulations and much closer supervision by bank examiners," as The New York Times put it the very next day. In reality, however, the conversion of Goldman and Morgan Stanley simply completed the dangerous concentration of power and wealth that began in 1999, when Congress repealed the Glass-Steagall Act — the Depression-era law that had prevented the merger of insurance firms, commercial banks and investment houses. Wall Street and the government became one giant dope house, where a few major players share valuable information between conflicted departments the way junkies share needles.

One of the most common practices is a thing called front-running, which is really no different from the old "Wire" con, another scam popularized in The Sting. But instead of intercepting a telegraph wire in order to bet on racetrack results ahead of the crowd, what Wall Street does is make bets ahead of valuable information they obtain in the course of everyday business.

Say you're working for the commodities desk of a big investment bank, and a major client — a pension fund, perhaps — calls you up and asks you to buy a billion dollars of oil futures for them. Once you place that huge order, the price of those futures is almost guaranteed to go up. If the guy in charge of asset management a few desks down from you somehow finds out about that, he can make a fortune for the bank by betting ahead of that client of yours. The deal would be instantaneous and undetectable, and it would offer huge profits. Your own client would lose money, of course — he'd end up paying a higher price for the oil futures he ordered, because you would have driven up the price. But that doesn't keep banks from screwing their own customers in this very way.

The scam is so blatant that Goldman Sachs actually warns its clients that something along these lines might happen to them. In the disclosure section at the back of a research paper the bank issued on January 15th, Goldman advises clients to buy some dubious high-yield bonds while admitting that the bank itself may bet against those same shitty bonds. "Our salespeople, traders and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research," the disclosure reads. "Our asset-management area, our proprietary-trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research."

Banks like Goldman admit this stuff openly, despite the fact that there are securities laws that require banks to engage in "fair dealing with customers" and prohibit analysts from issuing opinions that are at odds with what they really think. And yet here they are, saying flat-out that they may be issuing an opinion at odds with what they really think. To help them screw their own clients, the major investment banks employ high-speed computer programs that can glimpse orders from investors before the deals are processed and then make trades on behalf of the banks at speeds of fractions of a second. None of them will admit it, but everybody knows what this computerized trading — known as "flash trading" — really is. "Flash trading is nothing more than computerized front-running," says the prominent hedge-fund manager. The SEC voted to ban flash trading in September, but five months later it has yet to issue a regulation to put a stop to the practice.

Over the summer, Goldman suffered an embarrassment on that score when one of its employees, a Russian named Sergey Aleynikov, allegedly stole the bank's computerized trading code. In a court proceeding after Aleynikov's arrest, Assistant U.S. Attorney Joseph Facciponti reported that "the bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways."

Six months after a federal prosecutor admitted in open court that the Goldman trading program could be used to unfairly manipulate markets, the bank released its annual numbers. Among the notable details was the fact that a staggering 76 percent of its revenue came from trading, both for its clients and for its own account. "That is much, much higher than any other bank," says Prins, the former Goldman managing director. "If I were a client and I saw that they were making this much money from trading, I would question how badly I was getting screwed."

Why big institutional investors like pension funds continually come to Wall Street to get raped is the million-dollar question that many experienced observers puzzle over. Goldman's own explanation for this phenomenon is comedy of the highest order. In testimony before a government panel in January, Blankfein was confronted about his firm's practice of betting against the same sorts of investments it sells to clients. His response: "These are the professional investors who want this exposure." In other words, our clients are big boys, so screw 'em if they're dumb enough to take the sucker bets I'm offering.


Not many con men are good enough or brazen enough to con the same victim twice in a row, but the few who try have a name for this excellent sport: reloading. The usual way to reload on a repeat victim (called an "addict" in grifter parlance) is to rope him into trying to get back the money he just lost. This is exactly what started to happen late last year.

It's important to remember that the housing bubble itself was a classic confidence game — the Ponzi scheme. The Ponzi scheme is any scam in which old investors must be continually paid off with money from new investors to keep up what appear to be high rates of investment return. Residential housing was never as valuable as it seemed during the bubble; the soaring home values were instead a reflection of a continual upward rush of new investors in mortgage-backed securities, a rush that finally collapsed in 2008. But by the end of 2009, the unimaginable was happening: The bubble was re-inflating. A bailout policy that was designed to help us get out from under the bursting of the largest asset bubble in history inadvertently produced exactly the opposite result, as all that government-fueled capital suddenly began flowing into the most dangerous and destructive investments all over again. Wall Street was going for the reload.

A lot of this was the government's own fault, of course. By slashing interest rates to zero and flooding the market with money, the Fed was replicating the historic mistake that Alan Greenspan had made not once, but twice, before the tech bubble in the early 1990s and before the housing bubble in the early 2000s. By making sure that traditionally safe investments like CDs and savings accounts earned basically nothing, thanks to rock-bottom interest rates, investors were forced to go elsewhere to search for moneymaking opportunities.

Now we're in the same situation all over again, only far worse. Wall Street is flooded with government money, and interest rates that are not just low but flat are pushing investors to seek out more "creative" opportunities. (It's "Greenspan times 10," jokes one hedge-fund trader.) Some of that money could be put to use on Main Street, of course, backing the efforts of investment-worthy entrepreneurs. But that's not what our modern Wall Street is built to do. "They don't seem to want to lend to small and medium-sized business," says Rep. Brad Sherman, who serves on the House Financial Services Committee. "What they want to invest in is marketable securities. And the definition of small and medium-sized businesses, for the most part, is that they don't have marketable securities. They have bank loans."

In other words, unless you're dealing with the stock of a major, publicly traded company, or a giant pile of home mortgages, or the bonds of a large corporation, or a foreign currency, or oil futures, or some country's debt, or anything else that can be rapidly traded back and forth in huge numbers, factory-style, by big banks, you're not really on Wall Street's radar.

So with small business out of the picture, and the safe stuff not worth looking at thanks to the Fed's low interest rates, where did Wall Street go? Right back into the shit that got us here.

One trader, who asked not to be identified, recounts a story of what happened with his hedge fund this past fall. His firm wanted to short — that is, bet against — all the crap toxic bonds that were suddenly in vogue again. The fund's analysts had examined the fundamentals of these instruments and concluded that they were absolutely not good investments.

So they took a short position. One month passed, and they lost money. Another month passed — same thing. Finally, the trader just shrugged and decided to change course and buy.

"I said, 'Fuck it, let's make some money,'" he recalls. "I absolutely did not believe in the fundamentals of any of this stuff. However, I can get on the bandwagon, just so long as I know when to jump out of the car before it goes off the damn cliff!"

This is the very definition of bubble economics — betting on crowd behavior instead of on fundamentals. It's old investors betting on the arrival of new ones, with the value of the underlying thing itself being irrelevant. And this behavior is being driven, no surprise, by the biggest firms on Wall Street.

The research report published by Goldman Sachs on January 15th underlines this sort of thinking. Goldman issued a strong recommendation to buy exactly the sort of high-yield toxic crap our hedge-fund guy was, by then, driving rapidly toward the cliff. "Summarizing our views," the bank wrote, "we expect robust flows . . . to dominate fundamentals." In other words: This stuff is crap, but everyone's buying it in an awfully robust way, so you should too. Just like tech stocks in 1999, and mortgage-backed securities in 2006.

To sum up, this is what Lloyd Blankfein meant by "performance": Take massive sums of money from the government, sit on it until the government starts printing trillions of dollars in a desperate attempt to restart the economy, buy even more toxic assets to sell back to the government at inflated prices — and then, when all else fails, start driving us all toward the cliff again with a frank and open endorsement of bubble economics. I mean, shit — who wouldn't deserve billions in bonuses for doing all that?

Con artists have a word for the inability of their victims to accept that they've been scammed. They call it the "True Believer Syndrome." That's sort of where we are, in a state of nagging disbelief about the real problem on Wall Street. It isn't so much that we have inadequate rules or incompetent regulators, although both of these things are certainly true. The real problem is that it doesn't matter what regulations are in place if the people running the economy are rip-off artists. The system assumes a certain minimum level of ethical behavior and civic instinct over and above what is spelled out by the regulations. If those ethics are absent — well, this thing isn't going to work, no matter what we do. Sure, mugging old ladies is against the law, but it's also easy. To prevent it, we depend, for the most part, not on cops but on people making the conscious decision not to do it.

That's why the biggest gift the bankers got in the bailout was not fiscal but psychological. "The most valuable part of the bailout," says Rep. Sherman, "was the implicit guarantee that they're Too Big to Fail." Instead of liquidating and prosecuting the insolvent institutions that took us all down with them in a giant Ponzi scheme, we have showered them with money and guarantees and all sorts of other enabling gestures. And what should really freak everyone out is the fact that Wall Street immediately started skimming off its own rescue money. If the bailouts validated anew the crooked psychology of the bubble, the recent profit and bonus numbers show that the same psychology is back, thriving, and looking for new disasters to create. "It's evidence," says Rep. Kanjorski, "that they still don't get it."

More to the point, the fact that we haven't done much of anything to change the rules and behavior of Wall Street shows that we still don't get it. Instituting a bailout policy that stressed recapitalizing bad banks was like the addict coming back to the con man to get his lost money back. Ask yourself how well that ever works out. And then get ready for the reload.

[From Issue 1099 — March 4, 2010]