The (Non-)Political (Non-)Persection of JPMorgan Chase

The Washington Post tells us what some conspiracy theorists have to say about the prosecution of JPMorgan Chase for the London Whale fiasco and for the sins of its acquired companies leading up to the financial crisis:

We’re less impressed by the more backward-looking attack on JPMorgan for allegedly misleading investors about the quality of securities it marketed before the crash. Mr. Dimon reportedly is facing a demand for $11 billion in fines and other payments to settle the case, under threat of a Justice Department criminal investigation. Yet roughly 70 percent of the securities at issue were concocted not by JPMorgan but by two institutions, Bear Stearns and Washington Mutual, that it acquired in 2008. Among the investors supposedly ripped off were the sophisticated government-sponsored enterprises known as Fannie Mae and Freddie Mac. As was inevitable, some say the case is payback for Mr. Dimon’s criticism of Obama adminstration policy.

The editorial continues,

We don’t take that view; nor do we pity JPMorgan, which is still a lucrative business despite its legal woes and which purchased the institutions for their valuable assets mixed in with their massive liabilities. When it bought them, it bought their legal issues, too — known and unknown.

There's an obvious tension between the Editorial Board's whine, "70 percent of the securities at issue were concocted not by JPMorgan but by two institutions, Bear Stearns and Washington Mutual, that it acquired in 2008" and their subsequent statement, "When [JPMorgan Chase] bought them, it bought their legal issues, too — known and unknown". If they're responsible, then the percentage doesn't matter. Even if you buy into the subsequent "poor little rich boy" argument, "then-Treasury Secretary Henry M. Paulson Jr. told Mr. Dimon that doing so would help the country by stemming market panic. That gives the case a certain 'no-good-deed-goes-unpunished' quality", the companies' misconduct was not exactly a state secret at that point and potential liabilities were factored into the fire sale prices. Robert Pozen offers another version of the "poor little rich boy" stance, that admits as much,

If JPMorgan had purchased Bear Stearns under "normal" circumstances, JPMorgan's shareholders would have been a reasonable target of the lawsuit. Typically, if one corporation (call it A Corp.) buys another (call it T Corp.), A assumes all of T's former liabilities-its bonds, pension obligations, and, yes, its legal liabilities.

The transfer of legal liability relies on the logic that A could have performed due diligence prior to acquiring T, and reduced its offer price to account for any potential legal liability. Thus, the expected cost of future lawsuits flows through to T's shareholders, as it should in the normal case.

But JPMorgan's acquisition of Bear Stearns was different. JPMorgan purchased Bear Stearns at the behest of top federal officials-who needed JPMorgan to quickly announce a deal in order to quell a potential financial panic. Furthermore, the offer price was effectively set by these federal officials. There was no opportunity for JPMorgan to learn about Bear Stearns' legal liability, nor to adjust its offer price accordingly. Indeed, JP Morgan initially walked away from the acquisition because it did not have enough time for due diligence.

Thus, punishing JPMorgan's shareholders does nothing to align incentives-it merely punishes shareholders for acts in which they are blameless. Even worse, this fine discourages companies from engaging in "white knight" acquisitions at the request of federal regulators. In the future, company executives will demand broad guarantees against losses from the government before taking over any troubled institutions.

The short answer to that is that, while I feel some sympathy for a company that plays white knight and ends up with a worse deal than it anticipated, nobody forced JPMorgan Chase to say "yes". Pozen admits that they understood the risk and chose to go forward with the purchase anyway. As for their being a fixed price and no room to negotiate, clearly there were negotiations - JPMorgan Chase was free to walk away, did so, reconsidered, and came back to close the deal. Further, the facts belie the notion that the government presented JPMorgan Chase with a "take it or leave it" price - they had initially agreed to pay $2/share, and it was the threats of Bear Stearns shareholders to fight the sale that inspired them to raise their offer to $10/share. The total selling price was less than the value of Bear Stearns' Manhattan headquarters - you can't look at the negotiations or the purchase price without recognizing that JPMorgan Chase knew it was taking on potentially massive liabilities.

As for future "white knights" being afraid to step forward, let's be honest: JPMorgan Chase acted because it saw a business opportunity. Pozen and the Washington Post Editorial Board assume that JPMorgan Chase was unaware of the possible downside. I don't attribute that level of incompetence to its negotiators, and have little doubt but that they carefully considered outcomes far worse than the present proposed fines when they agreed to buy Bear Stearns at a stock valuation of 7.5% of its 52 week high.

But more than that, if the Board sincerely does not endorse the view of the conspiracy theorists, the unidentified "some" who "say the case is payback for Mr. Dimon’s criticism of Obama adminstration policy", why did Fred Hiatt and his crew choose to title their editorial, "JPMorgan Chase’s political persecution"? Was Hiatt trying to mislead readers into believing that the Post endorses the stance of the conspiracy theorists? Does he understand what the word "persecution" means? And why are they suggesting that holding JPMorgan Chase responsible for misconduct for which they acknowledge it to have assumed liability imperils the government's reputation for impartiality? How would it be impartial for the government treat JPMorgan Chase more favorably than it would treat another, similarly situated company?

Alas, these are the types of questions that Fred Hiatt's Editorial Board can never seem to find space to answer.

Ka-Ching! Tim Geithner Cashes In

Not that it's unusual for former government officials to cash in on their years of service, but it seems to me that it's worth noting when a guy who personifies "regulatory capture" cashes in:

Tim Geithner, the former US Treasury secretary, has been elevated to the highest rank of public speakers, alongside former world leaders Bill Clinton and Tony Blair, after receiving about $400,000 for three speaking engagements.

A speech at a Deutsche Bank conference last month netted him about $200,000, according to people familiar with the situation, underscoring the lucrative fees that former public officials can receive.

I'm not clear on why people would be particularly interested in Geithner's "take on topics including Federal Reserve policy and the state of the world three months after leaving the Obama administration", but then I have always been skeptical that this type of payment is actually for the speech as opposed to reminding other "public servants" of the riches that await them if they keep the industries they regulate happy.

AIG Suing the Government... Have Pity On the Orphan

Even if willing to excuse the incompetents, those who didn't want the criminals who helped take down the economy to avoid any consequence have been reminding us for years that the statute of limitations was running:

In the meantime, the statute of limitations, generally five years for securities fraud and most other federal offenses, is running out, precluding the possibility of bringing many new suits dating from the bubble years.

The result is a public perception that the big banks and their leaders will never have to answer fully for the crisis. The shameless pursuit of Wall Street campaign donations by both political parties strengthens this perception, and further undermines confidence in the rule of law. There may be more civil fraud suits related to the financial crisis, producing settlements and fines. But to date, those cases have rarely named top executives and the banks have rarely admitted wrongdoing. And the fines, even those in the hundreds of millions of dollars, have been small compared with bank profits and banker bonuses.

After all these years, what is still needed are cases with convictions and settlements severe enough to deter future bad behavior. If institutions operating at the heart of the economy really cannot be held to account, the solution should be to break them up, not give them and their leaders a pass.

In an editorial that reminds me of the joke about the lawyer defending his client, accused of murdering his parents, "How can you say such awful things about this poor orphan," David Boies makes the case for AIG's suing the federal government for having the audacity to bail it out:

Objections to AIG shareholders having their day in court to contest the terms of the government's takeover of their company are based on ignorance of the law and the facts.

Opening your argument by pounding the table? Not a good sign.

David Boies is the lead attorney representing Starr International in a shareholder lawsuit against the government. Starr's chairman is Maurice "Hank" Greenberg, AIG's former chief executive.

One statement I do not expect to be hearing from Boies,

This suit was not commenced at an earlier date because it was complex, not because my client has done anything wrong or has anything to hide, and my client happily waives the statute of limitations for any criminal charges or civil claims arising from his own conduct. Pure as the driven snow, he is.

Most of Boies' arguments, no offense to the man, strike me as the leavings of a ruminant. I am to believe that private investors were lining up to bail out AIG with sweetheart deals, but that the U.S. government scared them off? Care to name one, or should we refer to them for now as "Hank Greenberg's invisible friends"?

Remember all that nonsense about "the sanctity of contracts" from back in the day, when insurance executives were insisting that gargantuan bonuses be paid to the idiots who took down the economy, and that payouts be made in full with taxpayer cash, because insurance companies cannot survive unless their word is gold? (Ever make an accident claim only to be lowballed by the insurance company, or fight to get a medical procedure covered? Then odds are you weren't fooled.) Remember how we were instructed that it could even be illegal for AIG to try to negotiate reduced payouts to counterparties? Now Boies complains that AIG actually had to live up to its word, the so-called "back door bailout", because the government used taxpayer money to fully fund AIG's liabilities.

If Darrell Issa has a spine hidden somewhere beneath his suit coat, perhaps he'll stop peering unsuccessfully under the skirts of Obama Administration officials, in search of fake scandals, and turn his attention full bore on AIG. And perhaps he can rally his fellow Republicans to authorize a blank check for the defense of the lawsuit - enough of the excuse for failing to prosecute of, "It's just too complicated". You didn't want to take the war to AIG, fine, but now AIG has brought the war to you. If Hank Greenberg has a case to make, let him make it - but turn the heat way up.

Jeb Bush Flatlines in the WSJ

Jeb Bush seems to be trying to set himself up as the candidate people wish had run for the Republican nomination. It's a "Don't pay any attention to what I did as governor (or what my brother and father did as Presidents, or what my grandfather did as a Senator) - I've discovered Ron Paul and libertarianism, and regret "succumbing" to the temptation to "do something" about economic problems.

The short version is that Jeb has supposedly been moved by Ron Paul's allusion to "The right to rise" as a "core concept of economic freedom", and as a result wants to free businesses of regulation and to free individuals from any form of government assistance.

We have to make it easier for people to do the things that allow them to rise. We have to let them compete. We need to let people fight for business. We need to let people take risks. We need to let people fail. We need to let people suffer the consequences of bad decisions. And we need to let people enjoy the fruits of good decisions, even good luck.

You know, like being born to a family that has been fabulously wealthy and politically connected for more than a century. The sort of fortunate birth that many people confuse with qualification for public office, but that's apparently something we are now supposed to celebrate rather than regret in the wake of a duopoly of increasingly disastrous Bush presidencies. (Anybody wanna go for a trifecta?)

The primary target of Jeb's editorial is regulation, which he tells us "abridge our own economic freedoms". He paints with an incredibly broad brush, but fails to identify any actual regulation that he sees as harmful, or to identify any actual harm. I don't think that's because he could not identify a regulation in which the costs and benefits were out of balance. I suspect that it's because to do so would reveal that this is penny ante stuff - that he could not identify any significant impediments to big business arising from regulation and that people would very easily identify the need for the regulations he specifically described even if agreeing that they should be modified.

It is fair to say that regulation of business impairs the ability of small businesses to enter highly regulated markets, and to compete with larger businesses that have legal departments that allow them to navigate or bypass regulation. But it's also fair to observe that as much as businesses rail against regulation, they recognize that complexity can be their friend - a clear regulation must be obeyed, while labyrinthine regulations are inevitably full of loopholes. Simple regulation also doesn't serve as a barrier to entry, while complexity may deter competitors from entering their markets. A similar phenomenon can be seen with newer high tech companies complaining about patents as a barrier to their success, and then not seeming so bothered by them after they build their own catalog of patents to use to threaten or negotiate with competitors.

But Jeb is speaking about personal freedom, and he provides no link between the regulation of businesses and the freedom of individuals. Having supposedly been inspired by Ron Paul, perhaps he has been listening to some of Paul's inanities on libertarian markets. As much as a certain faction of right-winger would like to pretend otherwise, history's lesson is clear: In the absence of regulation, business and wealth run roughshod over individual rights and freedoms.

Jeb offers some stump speech-style rhetorical questions,

Have we lost faith in the free-market system of entrepreneurial capitalism? Are we no longer willing to place our trust in the creative chaos unleashed by millions of people pursuing their own best economic interests?

If you succumb to the temptation to answer the questions, they're easily revealed as simplistic and inane. But that's not the point. Jeb is suggesting that there's a horrible "other" at work in our government that is out to undermine "entrepreneurial capitalism" and individual economic freedom and, implicitly, that it's men like him who are the answer... that is, now that they're out of power and no longer "succumb" to the temptation to pass the regulations that they would not dream of passing if they are returned to power.

When Jeb says, "We see an industry dying and we demand it be saved," I expect that he's speaking of the domestic auto industry, more specifically of GM and Chrysler, that both his brother and President Obama thought necessary to save within the context of a massive economic meltdown. Except the auto industry was not going to fail - just two of the three domestic manufacturers. Do you believe for a second that, had Jeb been President, he would have stepped back and allowed GM to collapse rather than providing funding to keep it afloat while pushing it through a structured bankruptcy? I suppose he could be referring to the financial industry, as that industry might have collapsed pretty much in its entirety had it not been bailed out by the government, but the chance of President Jeb not stepping in with a bailout package would have been zero percent. Let's be real. The "right to fail" is an individual right, and provides a context in which Jeb would have no difficulty distinguishing large corporations from real people.

I liked this line:

The right to rise does not require a libertarian utopia to exist.

Have you ever paused to wonder what a libertarian utopia would look like? Were you to smoke opium you might dream up something along the lines of Ron Paul's fantasy:

The regulations are much tougher in a free market, because you cannot commit fraud, you cannot steal, you cannot hurt people, and the failure has come that government wouldn't enforce this. In the Industrial Revolution there was a collusion and you could pollute and they got away with it. But in a true free market in a libertarian society you can't do that. You have to be responsible. So the regulations would be tougher.

I once heard a sarcastic, but much more likely vision of a libertarian utopia: anarchy with lawyers. You only have rights to the extent that you can privately enforce them, meaning that you need lawyers and money (or guns) on your side to prevail. Once you start allowing the government to regulate such things as what you do with the toxic sludge you dump on your own land, such that it doesn't leach into the groundwater or create toxic runoff onto neighboring parcels, you're creating the "collusion" that Ron Paul assures us will only serve to ensure that the polluter will get away with it, or the "loss of personal freedom" that Jeb implies will inevitably arise from the regulation of industry.

Jeb, as a politician, saw his party cater to the legal drug dealers of his state - pain clinics that rake in millions of dollars legally selling pain medications to addicts from around the country - and failed to pass legislation that would have created a state system for tracking the prescription of scheduled medications. Such a database is an imperfect tool, but is one that can help the state track both doctor shopping by patients and the doctors who are most obviously selling prescriptions as opposed to practicing medicine. Perhaps, having seen the "folly" of such regulation, Jeb has come to believe that people should have the freedom to get intoxicated on the substance of their choice. More realistically, he came to understand that it's sometimes the most immoral, most repugnant businesses who have the deepest pockets for lobbyists and to find ways to buy off government officials who might otherwise limit their harmful practices.

Within that context, I have a difficult time not being cynical about Jeb's call for "Rules that sunset so they can be eliminated or adjusted as conditions change". The non-cynical interpretation is that he's proposing that we test how regulations work in practice and only renew them if they work as planned, and return benefits that exceed their cost. The cynical interpretation is that if you set a sunset period of, let's say, four years, every four years you get to return to the trough to be fed by the industry's lobbyists.

Meanwhile we are to pretend that regulations are never revisited, that nobody ever looks at costs and benefits, and that nobody can figure out how they work. Great hyperbole, and like any good lie containing a kernel of truth, but a lie nonetheless. Sure, there's always an element of uncertainty in the creation and passage of new regulations, and there are always regulations that continue long after their original goals are fulfilled. But it's absurd to pretend that industry doesn't figure out how to operate in a regulated environment, that its lobbyists are not consistently working to amend or revoke unwanted regulations, and that some of the zombie regulations live on because they benefit an industry, directly or indirectly subsidizing certain activities and operations. We can also easily look back on episodes of deregulation and see direct, negative consequences on industries, public welfare and the economy. For example, although Jeb would probably prefer that we not recall his brother Neil, whose reputation was shattered by his role in the Savings & Loan debacle, or how the more recent financial industry collapse was a repeat of the S&L collapse, on steroids, but it would take a fool to not see how deregulation played a significant role in both financial disasters.

With no apology for his hyperbole, Jeb tells us the horrors that will inevitably come from regulation:

We either can go down the road we are on, a road where the individual is allowed to succeed only so much before being punished with ruinous taxation, where commerce ignores government action at its own peril, and where the state decides how a massive share of the economy's resources should be spent.

You might believe from Jeb's first statement that, since his father was in the West Wing and Oval Office, taxes have been on the rise. But then there are those nasty facts - taxes went down significantly under big brother G.W., and have again been reduced under President Obama. If Jeb wants us to believe that we're on an inescapable downward spiral of regulation that can lead to nothing but higher taxes, the facts have a cruel way of raining on his parade. Now it is fair to say that our course is unsustainable - that the damage the G.W. Bush years, with their unfunded wars, entitlements and tax cuts, bloated budgets, stagnant wages and out-of-control spending did to the economy leaves us with no choice but to raise taxes. But none of that has a whit to do with regulation. And, as a good Republican, Jeb prefers to pretend that we can magic away all of that harm by eliminating regulations and cutting entitlements.

I'm not sure when we were last in a world in which commerce could avoid paying attention to government action. It appears that Jeb is unfamiliar with the U.S. Constitution and how it empowers the federal government to regulate interstate commerce, or how that regulation has facilitated commerce between the states. Or how he can be unaware that treaties and negotiations have facilitated commerce between nations. Even so-called "free trade" agreements are a form of regulation, not deregulation - rules and policies that both sides must follow in order to avoid tariffs. You don't believe me? Read NAFTA and... in a few hours, or perhaps tomorrow, when you're done, come back and explain to me how little it regulates.

As for Jeb's concern that the state "decides how a massive share of the economy's resources should be spent", well, let's take a look at the budget. The biggest expenditures are for Social Security and the military. Social Security is an insurance program, perhaps a redistribution of wealth but not the government deciding how the money is to be spent - the government may write the check but, as a beneficiary, you're free to spend your check as you please. (The same is true for income security programs such as unemployment). So is Jeb railing against military spending? Unquestionably, the government controls how every penny of the military budget is spent. But we know what would happen if we were to directly ask Jeb about military spending as the state deciding how a massive amount of money should be spent - we would get a word salad that boils down to "That's different."

But I'm (cough) beating around the bush. Jeb is talking about medical spending, and is implying that the Affordable Care Act's shifting around of the deck chairs on the Titanic amounts to deciding how the nation's healthcare dollars are spent. Never mind that for most people there will be no discernible difference between their health care or health insurance expenditures before and after 2014, or that the plan pushes money into the hands of private health insurance companies. Never mind that if "free markets" inevitably brought the efficiencies that people like Jeb promise, we would already have the cheapest, most accessible health care system in the world, while instead we have the highest costs in the world without a corresponding level of access or performance. Never mind that the ACA at least attempts to reign in medical inflation, and that without corrective action the present system will collapse.

The alternative to Jeb's imaginary parade of horribles is the "return" to a world that exists only in his imagination:

Or we can return to the road we once knew and which has served us well: a road where individuals acting freely and with little restraint are able to pursue fortune and prosperity as they see fit, a road where the government's role is not to shape the marketplace but to help prepare its citizens to prosper from it.

Would that be a road through which the son of a millionaire can become a millionaire Senator, and have a millionaire son who becomes President, and have a millionaire grandson who despite a track record of non-achievement can also become President while his more accomplished (but still not all that impressive) brother can become a governor who obviously hopes to also become President? Because the road is a lot tougher for the rest of us, and the Horatio Alger myth remains a myth. Jeb speaks of choice between "the straight line promised by the statists" (an allusion, perhaps, to equality?) that turns out to be "a flat line" and "the jagged line of economic freedom" (where you and I have our ups and downs, while brothers like Tripper and Tumbler - the Secret Service code names Jeb and George respectively earned as they staggered through their drunken young adulthood - emerge from their wastrel youth float into adulthood, buoyed by an inherited name, family fortune and political connections... but in fairness, Jeb did let us know, up front, that we need to let people enjoy "the fruits of... good luck".

So let's pretend that a return to the era of the robber barons, the age in which the Bush family fortune was first accumulated, will be an era of equal opportunity, of a rising middle class. Let's ignore that the greatest innovations in the world's history occurred in no small part through public-private partnerships of the modern era - NASA, ARPAnet, the Manhattan Project, military technology, etc. - and pretend that we would be better off in the era of child labor, violent union-busting, rampant inequality, and corrupt government. Because it would appear that to Jeb Bush, those are the good old days. Make the pie lower.

For the diminishing number of people who still believe that a new candidate can enter the Republican primaries and save the party from Mitt, sorry, it won't be Jeb. It's far too late for that. So why emerge from the woodwork now? To attempt to position himself as relevant and, should the economy stagnate for another four years, to point back on his essay with an "I told you so". Why offer an essay that is so lightweight, weakly reasoned, devoid of examples? For the same reason - in the event that the economy turns around, by leaving the meat off of the bones he's not making any statements that his future opponents might use against him.

David Brooks on the Work Ethic

I had intended to follow up my post, David Brooks vs. The Facts, by challenging his assertion that "nations like Germany and the U.S." are rich because we share "values, habits and [a] social contract upon which the entire prosperity of the West is based", to be distinguished from the European nations presently in crisis, but a flood of others have already done the job. I will grant that it's true, you will find commonalities between western democracies, but as those others have pointed out, when Brooks attacks nations like Greece and Italy and praises Germany he ignores Germany's higher social spending, lower average annual hours worked, high government spending, and embrace of social democracy.

Brooks states a basic philosophy that most people would describe as fair:

People who work hard and play by the rules should have a fair shot at prosperity. Money should go to people on the basis of merit and enterprise. Self-control should be rewarded while laziness and self-indulgence should not. Community institutions should nurture responsibility and fairness.

He's also correct that you can undermine that ethos, one of the obvious lessons we can draw from the communist experiment. But I think he's being both parochial and incorrect when he argues that there exists some form of Northern European / North American work ethic that simply doesn't exist in the rest of the world. I also think he misunderstands the genesis of the work ethic and what sustains it.

Let's start with Brooks' observations about the supposed decline of work ethic, something he believes is a new phenomenon,

Right now, this ethos is being undermined from all directions. People see lobbyists diverting money on the basis of connections; they see traders making millions off of short-term manipulations; they see governments stealing money from future generations to reward current voters.

Does Brooks believe that lobbyists are new? That historically they have not diverted money "on the basis of connections"? Such a belief would seem to be completely at odds with history. As for "traders making millions off of short-term manipulations", since when is that new? When we transitioned from Jimmy Carter telling us to tighten our belts to Ronald Reagan's ushering in the era of "Greed is Good", we witnessed the Savings and Loan debacle, insider trading scandals, and plenty of evidence of crony capitalism. Brooks' notion that workers have suddenly become lazy because "they see governments stealing money from future generations to reward current voters" seems absurd.

Although it's true that Medicare costs more than one would have anticipated when the system was created, and as it turns out Social Security is on the whole a good deal for most lower- and middle-earning workers (and not such a bad deal for workers who want some level of affordable disability insurance), does Brooks truly see that the nation's living up to its promises to workers who have paid into those systems over the course of their working lives constitutes "theft"? And if he does, why the praise for social democracies like "Germany and the Netherlands" that "steal" even more money to ensure that retirees avoid poverty and citizens have access to quality healthcare? It's simply not the case that the work ethic has materially changed since the housing bubble burst, or that it is weakened by offering workers the promise of eventual retirement or access to medical care.

Further, in speaking of nations that "have lived within their means, undertaken painful reforms, enhanced their competitiveness and reinforced good values," he explicitly omits mention of the United States. That's fair, given that by Brooks' measure we do not appear to have done any of those things. Yet there we are, in Brooks' mind, sitting at the top of the heap of exceptional nations due to our work ethic. What gives?

As with "kids these days" editorials, people have been writing about the decline of the work ethic pretty much since the time it was first conceptualized. Brooks seems to be asserting two contradictory thoughts - first, that the U.S. has a remarkable work ethic as compared to the rest of the world, and second that it is newly threatened by the scandals of the past six years.

I am reminded of John McCain's comments from a few years ago, suggesting that Americans are too lazy to perform hard physical labor, and wouldn't spend a season picking lettuce even at $50 per hour. If a willingness to pick lettuce or work in sweatshop conditions for wages that are a small fraction of that $50, it would see that Americans have nothing on the poor of the world - China has no shortage of workers willing to toil in factories for long hours under unpleasant conditions, Southeast Asia is full of factories producing consumer goods in what can reasonably be called sweatshop conditions, and we use thousands of Mexicans, both legally and illegally in the U.S., to harvest crops, clean houses, cut lawns, or work in the building trades. You could draw a comparison to the working poor of the industrial revolution, who also worked ridiculous hours in horrible conditions for meager pay. The commonality, of course, is not "habits, values and social capital" or a delusion held by the workers that their jobs will lead to "a fair shot at prosperity" - it's their lack of better alternatives, and fear of what will happen if they lose their meager remuneration.

Even though by historic standards, taxes are low, without presenting any evidence to support his claim Brooks contends that people are put off working by the notion that the government is "stealing" their money to support unworthy others. Can Brooks name one person who has "Gone Galt" due to the fact that our nation hasn't completely eliminated its comparatively meager social safety net, or because seniors get Social Security and Medicare? One person who has so much as slacked off at work over outrage over lobbying in Washington? When the Tea Partiers rose up against the financial industry bailout, did they quit their jobs? What am I missing?

The real lesson from financial crises is that, at the pit of the crisis, you do what you have to do. You bail out the banks. You bail out the weak European governments. But, at the same time, you lock in policies that reinforce the fundamental link between effort and reward. And, as soon as the crisis passes, you move to repair the legitimacy of the system.

Let's relate that suggestion to the U.S. - what did we do after the financial industry bailout to "reinforce the fundamental link between effort and reward" or "repair the legitimacy of the system"? The steps the government took would seemingly fall under Brooks' conception of "stealing money from future generations", with a huge reward going to a privileged special interest, well represented by lobbyists, as opposed to "current voters". But no, it's not stealing to take hundreds of billions of taxpayer dollars from future generations in order to ensure that bankers never miss a bonus - that's "necessary". But if you promise somebody approaching retirement, who has paid into Social Security and Medicare for their entire career, that you will fulfill the promise that it will be there when they retire, Brooks apparently sees an act of "theft". (Does Brooks endorse any financial industry reforms that will make that industry less of a lottery, help ensure that there won't be additional crises and tie pay to actual performance?)

Although taking away the social safety net, job security, decent wages, and the other factors that helped our nation develop its middle class may in fact be effective at creating a population desperate enough to take any work at any wage, it would seem to move us much more toward the ethos of China or Cambodia than that of Germany. The retort, "But we'll still have the Horatio Alger myth", seems like small solace.

David Brooks vs. The Facts

If Brooks doesn't know the facts, and after this much time he really has no excuse, one wonders how he keeps his job. Brooks prevaricates,

Over the past few decades, several European nations, like Germany and the Netherlands, have played by the rules and practiced good governance. They have lived within their means, undertaken painful reforms, enhanced their competitiveness and reinforced good values. Now they are being brutally browbeaten for not wanting to bail out nations like Greece, Italy and Spain, which did not do these things, which instead borrowed huge amounts of money that they are choosing not to repay.

Wheras in fact,

The story so far: In the years leading up to the 2008 crisis, Europe, like America, had a runaway banking system and a rapid buildup of debt. In Europe’s case, however, much of the lending was across borders, as funds from Germany flowed into southern Europe. This lending was perceived as low risk. Hey, the recipients were all on the euro, so what could go wrong? For the most part, by the way, this lending went to the private sector, not to governments. Only Greece ran large budget deficits during the good years; Spain actually had a surplus on the eve of the crisis.

Brooks is correct to observe that it's unfair to expect the people of the nations that are not responsible for the debt crisis to fund the bailout of those who are responsible. But it's exceptionally dishonest of him to pretend that they're bailing out governments, when the primary beneficiaries of the bailouts are going to be the financial institutions that made bad loans, largely to the private sector. It's easy to tut-tut the governance of nations like Greece, but why did Brooks omit Ireland from his list? You remember - Ireland, the nation that was a shining model of the success of conservative economic theory, low business taxes and the like, right up to the day the financial crisis hit, at which time it found itself lumped in with the PIIGS (Portugal, Ireland, Italy, Greece and Spain)? And in implying that the people of nations like Greece have not been asked to compromise, is he completely ignorant of Greek austerity measures, or the replacement of Greece's Prime Minister through a process that was anything but democratic?

It's more than fair to ask that governments looking for handouts revisit some of the policies that are likely to hamper economic recovery, or even viability. But it's quite another to wag your finger at governments that in fact borrowed responsibly while ignoring the elephant in the room, giving lip service to banks as being "far from blameless" while endorsing policies that will nonetheless leave those whose irresponsible lending practices are behind economic collapses around the globe, once again, whole or possibly enriched at the expense of ordinary, working taxpayers. If Brooks doesn't believe that's demoralizing, he somehow missed both the rise of the Tea Party and the Occupy Wall Street Movements.

Fees on Debit Cards

At The Atlantic, David Indiviglio complains that Congress is gouging consumers,

That WSJ article quotes one angry Bank of America customer, saying that she feels the bank is "gouging" her. That's not quite right: she paid this fee before -- she just didn't know it. It was incorporated into the prices of the goods and services that she purchased with her debit card. The fee was then paid to banks by the retailer where she shopped. Now Bank of America is just cutting out the middle man to collect a portion of the fees. This move isn't meant to create new revenue for the bank, but to replace the revenue that Congress forbid them to collect through their old fee policies.

I'm not sure if he's simply being contrarian or if he's not familiar with the terminology, but "gouging" doesn't involve putting money into somebody else's pocket. It's a reference to exploiting a consumer's position in order to sell products above their fair market value. The customer who feels gouged by Bank of America is actually correct - right now she has a lot of choices, and can go to banks that won't charge her similarly high fees on her debit card. If other banks respond by raising their fees the problem isn't Congress - it's oligopoly pricing. Which, come to think of it, is the same thing that led to the legislation that reduced maximum debit card fees from 44 cents per transaction down to 24 cents.

It's fair to observe that, at least from the coverage I've seen Bank of America is not claiming that its debit card operations will cease to be profitable at 24 cents per transaction, or even that they will cease to be immensely profitable. The complaint appears to be that the lower fees will result in lower profits and, implicitly, that the easiest way to make up the shortfall is to slap a new fee on debit cards. It appears to be a problem not of profits versus losses, but of profits versus the banks' feeling of entitlement to windfall profits.

I'm not sure where Indiviglio sits on "free market" issues, but if he's a fan of free markets he should be applauding the rule change. Rather than hiding exorbitant transaction costs in swipe fees, banks have to either forego that portion of their profits or be forthright with their customers. Does Indiviglio believe consumers are better able to make informed choices when fees are hidden from the consumer and a product is falsely depicted as "free"?

Indiviglio lectures,

In a perfect world, customers would end up paying the same amount in fees as they did before through this new approach. The only difference should be that they're paying more money directly and less indirectly. That means that the prices of the goods and services they purchase ought to decline accordingly.

Unfortunately, we don't live in a perfect world. As I pointed out on Wednesday, retailers aren't cutting prices. Instead, they're pocketing the $7 billion or so they'll save in fees. While this could theoretically change in the future, they have indicated that they aren't cutting prices at this time.

The thing is, I don't recall anybody claiming that we live in a perfect world, let alone that we should expect that merchants will lower prices the second that the new fee regime goes into effect. If you think about it, you will realize that not every customer uses a debit card, and that there is no easy way for merchants to translate lower swipe fees into a direct cost savings to debit card users. You will also recognize that most merchants aren't looking at the fees on a per transaction basis, but are looking at the total amount they pay in transaction fees over a given accounting period. A merchant that no longer needs to budget as much money for bank transaction fees might find that money to be better spent on something other than a price cut. Renovations, new locations, servicing debt, pay raises, increased health care costs, or even turning a small profit instead of going near or into the red in a difficult economic environment.... Even in a "perfect world", Indiviglio's claim would be simplistic.

Indiviglio also claims that "customers will end up paying more than they did before once this new law goes into effect", a claim that is only true for those customers whose bank imposes a new fee on debit cards, and who choose to stay with that bank, and who choose to use their debit cards so as to incur the fee. Most consumers won't pay a cent more than they did before, the only difference being that they might be paying with cash, a check, or a credit card instead of their debit card. Indiviglio's whine that "This financial regulation effort will amount to a gift to retailers, courtesy of Congress" is misplaced - he's really talking about a regulation that attempts to end a windfall to major financial institutions at the expense of retailers. (Indiviglio has worked for financial institutions, but it seems reasonable to infer that he has never worked at a retailer that struggles to maintain a reasonable profit margin after a bank takes its swipe fee.)

Indiviglio claims concern for the working poor, "this action by Congress will hurt low- to middle-income Americans more than wealthier Americans". The thing is, so did the old rules. The fact that banks, having been instructed that an old regulatory regime needed to be changed in order to avoid imposing an undue burden on low- to middle-income Americans, find a new way to impose an undue burden on low- to middle-income Americans is not so much a problem with Congress as it is SOP for banks. If gouging is going on, I would rather have it be transparent than take the form of hidden fees and charges.

What Caused the London Riots

David Cameron explains the riots in London and Manchester (and Birmingham, and Liverpool, and Bristol, and... Nottingham? I thought they had a Sheriff that made Arpaio look soft on crime):

For me the root cause of this mindless selfishness is the same thing I have spoken about for years: it is a complete lack of responsibility in parts of our society. People allowed to feel that the world owes them something, that their rights outweigh their responsibilities and that their actions do not have consequences. Well they do have consequences.

I personally would not have been so quick to blame the financial industry.

The Debt Downgrade Blame Game

Here's something that the nation's politicians should think about before pointing their fingers at the other party and saying, "This is your fault!" By making that accusation you're admitting that the debt downgrade is appropriate - and that our nation's debt is a riskier investment than S&P triple-A rated French debt. (Let's ignore the fact that it's French debt that's taking it on the chin after the downgrade, not U.S. debt.)

 I heard Tyler Cowen on the radio this morning arguing a position that, to me, sounded like "This is a good editorial statement for S&P to make to the U.S. government." That is, he seemed less concerned with the accuracy of the S&P debt as a rating of the risks of U.S. debt, as opposed to agreeing with the implicit political statement that the U.S. needs to start working toward a balanced budget involving both tax increases and entitlement cuts. Cowen explained his reaction, in advance, on his blog. Consistent with his support for tax hikes and entitlement cuts, he argues that the Republicans should have worked with the President toward the "grand bargain" that Obama proposed during the debt ceiling debate.  Cowen is correct that, at least if we want this country to be what we claim it is, a land of opportunity, an example to the world, a leader in technology and innovation, and all that, we will need tax increases to balance the budget.

Cowen also argues that "Democrats need to choose on entitlements", which apparently means that they need to support entitlement cuts. There are unquestionably some Democrats who are taking a "no cuts now, no cuts ever" stance toward Social Security and Medicare, and it's fair for Cowan to criticize that. But it's farcical to pretend that entitlement cuts don't occur because only the Dems are blocking them. I'm not attributing this whine to Cowen, but those who complain that it was the Democrats who magically stopped the Republicans from partially privatizing Social Security under Bush consistently ignore the fact that Bush couldn't get majority support for his plan from his own party, nor could he get them to back a different plan.

Had Bush backed away from privatization and proposed the type of tweaking that has been approved in the past, odds are that he would have succeeded with his reform. Similarly, it was Bush who advanced and signed into law Medicare Part D, the unfunded prescription drug benefit. It was the Republicans who screeched about "death panels" and "Medicare cuts" during the debate of healthcare reform. It was again the Republicans who howled that President Obama was offering to cut Social Security and Medicare after the recent debt ceiling debate.

 Don't get me wrong - I'm not suggesting that the Republican Party wants to preserve either Social Security or Medicare. But there is no question that they will preserve and even expand those programs if they perceive that doing so will help them win reelection. And there's no question that they will engage in demagoguery against the Democrats that makes it difficult for them to subsequently implement the cuts that they actually support. Their dream is for the Democrats to propose and pass the cuts or reforms that undermine the social safety net, such that they benefit both from the implementation of their policy preferences and have the opportunity to angrily accuse the Democrats of harming seniors. The difficulty is, you really can't have it both ways. (Hence David Frum's crying into his coffee about how, prior to Joe Lieberman's last minute sabotage, the Affordable Care Act threatened the future of the Republican Party.)

 Cowen suggests that the lesson history will draw from the economic downturn will not be "we should have had a much bigger stimulus" but will be "We needed a big dose of inflation, promptly, right after the downturn. Repeat and rinse as necessary." Cowen argues that didn't happen because "voters hate inflation and, collectively, we proved to be cowards." But do voters actually hate inflation? Would voters have hated seeing their long-term investments show a rate of return that reflected inflation, as opposed to flatlining? Yes, voters were upset by skyrocketing energy prices and gas prices contributed to the collapse of the auto industry and probably contributed to the timing of the bursting of the housing bubble. But for some reason we were supposed to view inflation in energy prices and in housing costs as a "good thing". We were supposed to view housing inflation as turning our houses into giant piggy banks from which we could withdraw tens or hundreds of thousands of dollars with no concern for the future. There are some forms of inflation that the U.S. public can be convinced are good, and a subset of those can actually be good for average citizens.

When inflation is tied to market realities and people aren't cashing every cent of equity out of their homes, it's actually a good thing for there to be some level of inflation. It's not a horrible thing, either, for there to be a reasonable return of interest on passbook savings accounts. Spikes in food prices, on the other hand, would be unpopular. I don't see much point in speculating as to which theoretical future we will ultimately wish we had chosen. But I disagree with Cowen's suggestion that it was fear of voter reaction that led to a policy decision to pursue a stimulus instead of imposing "a big dose of inflation". I suspect that the financial interests that we had just bailed out would have been apoplectic if the government took away the all-but-free money they've been enjoying since the bail-out, and instead imposed a policy that would require that they share the burden of the recovery by across-the-board inflation that had the effect of wiping out homeowners' negative equity. If the financial industry had wanted inflation, we would have had inflation. It wanted interest rates near 0%, so that's what we got instead.

If somebody was making the case for "a big dose of inflation" during the debate over the stimulus, they did a good job of keeping it a secret. One of the loudest voices in support of a larger stimulus was Paul Krugman. But I am recalling that he has also spoken about how higher inflation could help consumers, while repeatedly pointing out that the government spending that his political critics proclaimed would result in inflation has not done anything of the sort.

 Cowen argues against the biased sample, suggesting that it is unfair to point to S&P's poor track record on other matters when questioning its present rating of U.S. debt. The problem is, Cowen does not actually present evidence that the sample is biased - he asks us to take it on faith that S&P is good at rating government securities. I was thinking of Krugman's criticism of bond raters in general; but I see that Krugman has also responded to the criticism raised by Cowen:

Notice that what’s happening in the case of S&P is precisely that many people are giving them credence because of where they sit; it’s therefore highly relevant to point out that they may be a prestigious organization for some reason, but their track record is ludicrously bad.

It's unfair to pick out a few errors from an otherwise good track record to argue, "You should never take that guy seriously," but sometimes it actually is fair to point out, "You're asking that we follow the advice of the village idiot." If Cowen wants to establish that S&P has sound methodology and a good track record, the ball appears to be in his court.

 Will this be the wake-up call that Cowen hopes it will be? Something that "years from now today may well be seen as a turning point of significance"? I doubt it. If nothing happens - as appears to be the case - it could be worse than doing nothing. The boy who cried "wolf". Being able to say "I told you so", five, ten or twenty years from now? Worthless, even if you can make the after-the-fact case that this (of all things) should have been what woke our nation's leaders up to the need for real change.

Update: Yesterday I wrote,

If the financial industry had wanted inflation, we would have had inflation. It wanted interest rates near 0%, so that's what we got instead.

Today?

The U.S. Federal Reserve on Tuesday took the unprecedented step of promising to keep interest rates near zero for at least two more years and said it would consider further steps to help growth, sparking a rebound in stocks. 

The Fed painted a gloomy picture, saying that U.S. economic growth was proving considerably weaker than expected, inflation should remain contained for the foreseeable and unemployment, currently at 9.1 percent, would come down only gradually.

Whatever voters may think of inflation, we're suppressing inflation due to the financial industry and markets, not because of consumer sentiment.

"I Didn't See This Coming, Either"

In the past couple of months I've seen the documentary, Inside Job, a competent explanation of how the financial industry crisis arose, and of the ensuing collapse and bail-out. There are no big surprises for those who followed the crisis, but it's a good refresher course - and probably a good primer for those who are still wondering how the crisis occurred. I also saw the star-studded HBO dramatization of Andrew Ross Sorkin's novel, "I Love You, Hank Paulson" Too Big to Fail. That production offers a frenzied account of how the crisis was handled, but (in my opinion deliberately) omits mention of how the crisis arose or what has happened since Paulson "forced" the nation's biggest banks to accept billions of taxpayer dollars, no strings attached.

Two things struck me about the HBO production. First, if Sorkin's account is accurate, perhaps Henry Paulson's epitaph should be, "I didn't see this coming, either." Perhaps in order to maintain him as a sympathetic character, there's next to no mention of Paulson's background in Goldman Sachs, and what mention there is comes in the form of telling us how unfair it is that the government is viewed as being unduly influenced by the former Goldman Sachs employees who manage the treasury, or how hard Paulson worked to save Lehman Brothers (merely, we are told, the seventh largest investment banking firm in the country - why would Goldman Sachs care about such a minor player) and how it was that bank's intransigence and not Paulson's policy that resulted in its bankruptcy. There may be truth to that, but it's still very interesting how much effort Sorkin applies to salvaging Paulson's reputation as opposed to explaining how Paulson managed to avoid recognizing the perilous condition of the financial sector before we reached the crisis point. Seriously - thanks to Sorkin I now know Paulson's religion and that he has to be arm-twisted to take a sleeping pill (which he may or may not have actually taken), than I do about his history with Goldman Sachs.

The film ends with Paulson expressing a hopeful but concerned expectation that the banks would follow through on their implied promise to lend out the billions of "no strings attached" dollars to boost the economy, but unlike the rest of the film in which Sorkin's interpretations and conclusions are spoon-fed to the audience, you only "get" the ending if you already know that the banks did no such thing - but you're expected to believe that Paulson didn't see that coming. From Sorkin, you get no sense of any of the inside dealing and willful blindness that was behind the bubble or AIG's failure. This is stuff that just happened - a perfect storm, it would seem, of industry actions for for which nobody should be held accountable. You get no sense of regulatory capture - but as I've commented, Sorkin's coverage of the financial industry seems to me to be the journalistic equivalent of regulatory capture. The dramatization of his book reinforces that perception, and then some.

Some of the explanations for policy choices are left with the not-so-credible statements we've previously received. For example, we have no choice but to give the nation's biggest banks all those billions of dollars because if only the failing banks are given money everybody will know which banks are failing. The competing explanation, that it would not be fair to the non-failing banks if their incompetent competitors get that kind of boost and they do not, is omitted. But by the time of that cash infusion, everybody who was following the crisis knew or could easily determine which banks needed the money and which did not. The "we need to maintain a level playing field" argument would have been more credible; although I suppose that would have undermined Sorkin's explanation for why no strings could be attached to the money. You could achieve that level playing field by offering the money, strings attached, on equal terms to every bank. And not so much as a whisper about how your word is your bond in the financial and insurance sectors - maybe that's a rule only for insurance companies?

Timothy Geithner, on the other hand, gets no similar amount of love. When he's on screen the goal seems primarily to be to attribute to him some of the worst and least popular aspects of the bail-out - blank checks for the banks, "cash for trash".... That may be entirely fair. Whatever I can make of defenses of his intentions and integrity, I can't recall the last time I've heard a defense of his competence in relation to the management of this crisis. But really, given how a simple measure such as some form of bankruptcy cram-down for homeowners' first mortgages could have helped over the past two years, simplifying the process of getting people out of their upside-down homes without foreclosures or short sales, keeping struggling people in their homes, and in stabilizing housing prices, who could muster an energetic defense for a guy whose only concern was in shoveling as much taxpayer cash as possible, no strings attached, into the institutions most responsible for the nation's problems.

Groupon Deal: Buy Early Shares for $10 and Get $50 Worth of Investor Money

That's not intended to be a literal expression of Groupon's business model or IPO, but as Frank Reed notes, early investors have been doing very well on their Groupon shares:

And remember when Groupon raised $950 million not so long ago? Guess what that did? It simply paid out the early investors in handsome sums. It did little to build the business. You can get the details in the All Things Digital post.

If history should teach us anything, it's that the financial industry loves bubbles. It loved the profits it made during the first Internet bubble. It was ecstatic over its profits during the housing bubble. And now, having been bailed out, pampered, and guaranteed immense profits and compensation at taxpayer expense on the ground that they're "too big to fail", why not do it again? Besides, a few IPO's that result in pumped up valuation, enormous, easy profits for early investors, insiders and investment banks, and... well, quite possibly not much for ordinary investors in the longer term, if that counts for anything... don't make for a bubble, do they? It's just a few hundred billion, maybe a trillion. Chump change.

I am of the impression that Groupon's founders want to build a sound, dominant business. But that doesn't mean they don't want to cash in. Is that the new economy? Build a $billion business, a $5 billion business, a $10 billion business, a remarkable accomplishment in itself, take it public at a ridiculously inflated valuation, the bankers, and investors and founders get rich beyond fabulously rich. As for the ordinary people left holding the stock? Sure, they may have paid $50 for $10 worth of company, but they got the exact number of shares that they paid for. Whose fault is that?

"Conventional Valuation Models Don't Apply to Us"

I recall, back in the days of the first Internet bubble, how the popular wisdom was that there was incredible value in "eyeballs" - the volume of traffic to your site, and information you might glean from your users, was far more important than turning a profit... or even generating revenue. As it turns out, although there have been innovations in how traffic and information can be monetized, it is important to generate that revenue.

I commented recently (and cynically) on the LinkedIn IPO, taking the position that the argument that the bankers put one over on LinkedIn's owners was a stretch. It seemed, and still seems, more symbiotic. LinkedIn, its owners and the investment bankers who handled the IPO made tons of money. Whether or not LinkedIn ever generates enough revenue to justify a tenth of its present valuation, its owners and early investors will walk away with truck loads of money. Meanwhile, the businesses of the nation's proverbial "Main Streets" have difficulty obtaining financing. Wow. There's less risk in floating a multi-billion dollar IPO for a business that has no clear plan or path to justify its valuation, than in investing in traditional brick and mortar businesses. There must be, because you can see for yourself what banks are doing.

Groupon plans to be the next business to clean up through an IPO:

The IPO, which could value Groupon at $15 billion to $20 billion, prompted Richard Brenner, president and CEO of financial-advisory firm The Brenner Group, to say that he would tell would-be investors to “sit out” the IPO because Groupon “doesn’t appear to have a sustainable business model yet.”

“Why would the public support a company that can’t figure out how to be profitable?” Brenner said.

But Mark Lehmann, a Wilmette native who heads up JMP Securities in San Francisco, said investors are clamoring for a long-awaited IPO by a company that shows such terrific growth.

“Groupon has the brand and the first-mover advantage, and it is extremely well-regarded,” Lehmann said.

Groupon came into business with a simple but clever idea, and its latest efforts suggest that it is capable of innovation. But this type of thing makes me nervous:

We don’t measure ourselves in conventional ways.

There are three main financial metrics that we track closely. First, we track gross profit, which we believe is the best proxy for the value we’re creating. Second, we measure free cash flow—there is no better metric for long-term financial stability. Finally, we use a third metric to measure our financial performance—Adjusted Consolidated Segment Operating Income, or Adjusted CSOI. This metric is our consolidated segment operating income before our new subscriber acquisition costs and certain non-cash charges; we think of it as our operating profitability before marketing costs incurred for long-term growth.

A more sophisticated explanation, certainly, but why does the phrase, "We make it up on volume" come to mind?

Larry Summers and the Harvard C Students

They're probably his favorites:

The A, B and C alums at Harvard in fact could be broadly characterized thus, he said: The A students became academics, B students spent their time trying to get their children into the university as legacies, and the C students—the ones who had made the money—sat on the fund-raising committee.

I'm reminded of somebody else's observation:

“One of the speakers at my 25th reunion said that, according to a survey he had done of those attending, income was now precisely in inverse proportion to academic standing in the class, and that was partly because everyone in the lower third of the class had become a Wall Street millionaire.”

I reflected on my own college class, of roughly the same era. The top student had been appointed a federal appeals court judge — earning, by Wall Street standards, tip money. A lot of the people with similarly impressive academic records became professors. I could picture the future titans of Wall Street dozing in the back rows of some gut course like Geology 101, popularly known as Rocks for Jocks.

That article goes on to suggest that, as big bucks went to Wall Street jobs, so did the smart kids:

“When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

But apparently it was the C students who gave most generously to Harvard during Summers' Presidency, and who paid him (a grown-up smart kid) millions to... I guess help them understand derivatives? Something like that.

Payday Loans vs. Loan Sharking

Todd Zywicki is once again crying in his coffee for high interest rate lenders:

Look, I am no fan of payday lending and auto title lending, and I also wished I lived in a world where people could get copious access to low-cost credit which they always repaid diligently and responsibly, and that no one ever had to use payday lending and the like. But taking away other people’s choices based on wishful thinking that somehow we will conjure up something better for them out of thin air, especially those with limited choices already, strikes me as an irresponsible way to think about regulation and unintended consequences. Especially when at the same time regulations supported by so-called consumer activists are making better credit products, such as credit cards, more expensive and less available for responsible low-income consumers and driving them out of the mainstream financial system.

The article to which Zywicki links is entitled "Dodd-Frank and the Return of the Loan Shark", also by Zywicki, complains that new rules could cause holders of credit cards to pay higher rates and have lower credit limits. Despite conflating high risk credit card borrowers with those dependent upon payday loans, Zywicki offers no evidence that we're speaking of the same population. I expect that there is overlap, but my experience with those who go to payday lenders is that they have no credit to begin with - when it comes to cost to the borrower, even before the 2009 Credit CARD Act you were much better off using your credit card and might consider a payday loan only after you had maxed out every other source of credit. All you need to get a payday loan is a checking account, and it doesn't matter if it's empty - in fact, that's the lender's expectation.

Zywicki complains,

Nontraditional financial products serve an important role in the marketplace for the millions of consumers who count on them. Even pawn shops and loan sharks are more palatable and less expensive than the bounced checks and utility shut-offs that would result in their absence.

Zywicki doesn't appear to know much about payday loans, pawn shops or loan sharks. Let's say I have an item of value and I want money. I can take my item of value to a pawn shop and secure a loan against the item, which the pawn shop holds as security. (Some pawn shops might also offer to buy the item outright, for resale.) If I repay the loan with interest I get my item back. The material differences between a pawn shop and a payday loan are that I don't have to own anything of value to obtain a payday loan - I simply hand over a postdated check that everybody knows to be presently worthless - and I have less time to repay the loan at a significantly higher cost than the pawn.

Granted it may still be a better deal as compared to defaulting on the pawn and losing my item of value, but there's no reason to believe I would be cavalier about defaulting on a pawn and scrupulous about repaying my payday loan. Also, I can't deepen my hole by re-pawning my item, but in many states I can make my situation much worse by obtaining payday loans from multiple sources. Many states attempt to limit borrowers in the number of payday loans they can take out at the same time or over a specified period of time, but it's difficult to police if the borrower is going to multiple lenders including out-of-state entities offering payday loans online.

Also, pawnbrokers operate under state law limits for their interest rates. Those rates may still be high, but they don't approach the rates charged by payday lenders. Why not?

A 1978 Supreme Court decision affirmed the concept of rate exportation, by which federally chartered banks can offer financial "products"—read: small (generally under $1,000) loans, via credit cards or check-cashing partners—nationwide, but in accordance with the usury ceilings in their home states. Quick to recognize an opportunity, Delaware, South Dakota, and six other states scrapped their small-loan laws (which is why your MasterCard bill always seems to originate in Sioux Falls). So, a check casher in a tough state can team up with a bank in a loose state to offer a gargantuan APR—500 percent, 1,000 percent, even 5,000 percent—regardless of local usury statutes. Virginia, for example, caps small-loan APRs at 36 percent. But a savvy Virginian lender can partner with a bank based in Delaware and then "import" that state's unregulated banking laws. The store may be in Richmond, but the rates are pure Wilmington.

Loan sharks, of course, remain subject to state and federal laws, including usury laws and RICO.

Federal authorities [in 2001 were] prosecuting Nicodemo Scarfo Jr.—the 36-year-old son of jailed-for-life Philadelphia godfather Nicodemo "Little Nicky" Scarfo—for running a loan-sharking and gambling operation in New Jersey. According to a New York Times article, an FBI sweep of Junior's computer hard drive revealed that he was breaking federal usury laws by charging annual interest of 152 percent a year for his very illegal loans.

Yes, it would appear that the most notorious loan sharks in the nation aren't able to demand the interest rates of a payday loan store. What's more,

An April [2001] New York Times survey of the practice in immigrant enclaves—the sharks' current core constituency—included the tale of one bodega owner who receives a 20 percent APR from his shark, a reward for years of dependability. For a cash-only businessman whose murky immigration status or poor credit rating might get him laughed out of Chase Manhattan, that's a solid deal.

But surely they'll break your knees if you don't pay?

Sharks prefer to seize personal property from defaulters, or hold immigration documents hostage, since brutality is likely to attract police attention. "I've always understood that it worked pretty well," Daniel J. Castleman, chief of the Manhattan district attorney's investigations division, told the Times. "We don't get a lot of reports about intimidation."

In other words, loan sharks operate by assessing credit risk and, when they guess wrong, typically by bypassing judicial process (self-help execution against a debtor's assets) or similar non-violent means. Which makes sense not only because of the possibility of law enforcement attention, but because you can't repay a loan if you're injured or dead.

But let's say the loan shark wants to go legit. He has a pool of responsible borrowers, sees the rates charged to similarly situated borrowers by credit card companies and payday lenders, and figures "I can turn a profit while charging a lot less than that." So he sets up a corporation, starts offering loans at 30%, and... Oops. Not in Michigan:

The interest of money shall be at the rate of $5.00 upon $100.00 for a year, and at the same rate for a greater or less sum, and for a longer or shorter time, except that in all cases it shall be lawful for the parties to stipulate in writing for the payment of any rate of interest, not exceeding 7% per annum.

Our ex-loan shark hasn't successfully obtained an exemption from that law, as have banks and credit unions, so he's limited to an interest rate well below what Zywicki argues is fair. In fact, so are you. So am I. And the consequence of violating that law is serious - all payments of interest (as well as penalties, late fees, etc.) are credited to the principal balance, meaning the law transforms the loan into a 0% interest loan. Every year or two I encounter a case where a borrower, fully aware of this law, convinces a friend to loan them money on a promissory note with a higher-than-lawful interest rate, knowing that "They tricked me" won't get the lender anywhere in court if they try to collect. Moreover, if you charge more than a 25% simple interest rate, still a mere fraction of what Zywicki suggests is a fair compound interest rate for those most in need of the money, you're a felon.

Zywicki has previously lectured us,

So social engineers may want to be careful about "saving" the poor from the scourge of subprime lending, because by restricting those choices they are likely just pushing them into even less-favorable credit options.¹

Except the fact that people use pawn shops and loan sharks suggests that, for many, those options are more favorable than payday loans. Certainly being able to enter into a binding promissory note with a friend or family member at 15% APR (or that loan shark who was lending to good borrowers at a 20% APR) is superior to forcing people to go to payday loan shops. So why does Zywicki seem to care only when regulation affects high interest rate lenders who are in business primarily because they've lobbied their way around laws that restrict or criminalize their competition - competition that in many cases would be a better source of money? Isn't he supposed to be a libertarian?
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1. That lecture came in a defense of subprime lending to people with marginal credit, dated March 14, 2005. I'll grant that he's not the only smart person whose insight into the housing market bubble seems retrograde, but why does his pattern seem to be "If regulation hurts major financial institutions, any other facts are irrelevant."

... And It Will Happen Again

We can talk all we want about how new regulations or oversight will prevent another collapse of the major banking institutions or prevent the need for another taxpayer bailout. We can pretend that the taxpayers won't stand for another bailout. But when push comes to shove....

Paul Krugman writes,

I think this film [Inside Job] will stay with us; when you ask how the even worse crisis of, say, 2015 happened, the fact that these people got away with it will loom large.

I don't want to seem pessimistic, but "2015" feels all too possible.

Congress Fears the People? Please....

A few days ago CWD commented,

I still haven't figured out why everyone gives the Fed a pass when they are deliberately setting a policy that hurts a substantial number of Americans (anyone living on a fixed income/relying on savings and investments... like retirees). Don't get me wrong, there is an argument for the Fed's position, but no one even bothers acknowledging that the issue exits and that the costs should be considered...

The underlying point is that when interest rates are at or near zero, people who are relying upon their investments to help pay for their retirements have to either cut their spending or dig into their equity in an amount greater than they anticipated. The long-term consequences of overspending equity are self-evident, and are magnified when you're no longer earning wages.

The easy response to that is, "Who's paying attention"? The population that is largely identified as comprising the Tea Party movement, upper middle class, mostly white, largely male, would be a population you might expect to be attuned to the issue. But even if we assume that some tried to raise the issue, the supposedly Tea Party-friendly media - Rush Limbaugh, Fox News, etc. - ignored it. Glenn Beck was on the case well in advance, of course, but in a different way. He was paid handsomely to shill for overpriced gold coins as an investment. Yes, you too can undermine your retirement while lining his pockets.

Here's something that Matt Yglesias proposed as a serious argument for why we have this massive, poorly publicized subsidy of the financial industry that's hurting pretty much every wage earner who is trying to save for retirement, and pretty much every senior who is living in part on retirement assets affected by the return on those investments. You're asked to imagine that you're a public official who is terrified of letting even a single bank fail (presumably here we mean one of the handful of large banks, because small banks are allowed to fail with some regularity). You're presented with two choices:

One choice is that you force the banks in question to accept capital injections from the public sector. This will “bail out” the bank and save it as an institution. It’s also obviously better for the bank’s owners than the alternative of letting the bank fail. But for the owners it’s also not ideal since it means the value of their shares is being diluted. Indeed, if raising extra capital were a bailout of the shareholders they would have avoided this problem long ago by simply raising capital from private investors. But their reluctance to do this has helped bring us to the crisis point. They’d rather get public equity than fail, but they’d rather avoid getting public equity.

If the issue is that a bank will fail and wipe out its investors, but we're to accept that the bank could simply raise money from capital investors, it's going to choose not to fail. The bank only needs to be bailed out if its management was so incompetent that it chose bankruptcy over raising money, or if it's anticipating that the government will shovel money in its direction if it claims that it's going to otherwise fail. So we're in the position of being asked to bail out banks that are either led by incompetents who have destroyed the business they run, or to pay hundreds of billions of taxpayer money to banks run by people who planned to loot the treasury in exactly that fashion.

Further, if we look back at when we did inject money into those banks, the arrangements were made in a manner that protected shareholders and bondholders, even though that meant at best minimizing the return to taxpayers who were saving the banks from failure and potentially losing part or all of that money. So no matter what the public does, the bank and its investors come out just fine, thank you very much. And let's gloss over the fact that the taxpayer was asked in some cases to inject money meeting or exceeding the market capitalization of the financial institutions at issue - we can talk all we want about private investors, but if a private investor comes up with that type of money you can expect that when the transaction is done they'll own their investment, lock, stock and barrel.

A different option is to refuse to give “the banks” extra money. Instead you perform stress tests and proclaim that the banks are secure, implicitly signaling the existence of government guarantee of their operations. You have the Federal Reserve start paying interest on banks’ excess reserves, giving them a zero risk profitable investment parking cash with the Fed. Then you hunker down and wait for the regulatory forbearance to allow the profit-making process to generate sufficient capital to resolve the situation.

Wait - I have an idea! Why not do both - in fact, we did do both. Seriously, why is this being presented as a choice of options?

It's argued that the second approach, probably better described as "phase two" of the financial industry bailout, will take longer to work, prolong the suffering on Main Street, and is "wildly more favorable to the people who owned the banks, in a way that creates a massive problem of injustice" - that third point being what CWD noticed. But it's argued that this second approach may seem preferable because you don't need to get approval from Congress and the public would view it as "superior to a soft-on-bankers 'bailout'". Well, whose fault is it that this isn't being repeatedly and accurately characterized on by the media as a bailout?

Tim Fernholz at Tapped characterizes this argument as follows:

The long and short of it is that we ended up choosing a less optimal policy, because people were so angry about bailouts, and because Congress - and the incentives of political actors therein - drastically increased the challenges of implementing a better policy.

Except as is patent from the description Yglesias provides for the first option, the anger is justified. We made oversized investments in financial institutions that were designed to deliver undersized returns (or obscene losses), to bank managers whom Yglesias tells us could have prevented the need for a bailout had they been willing to dilute the value of their shares, and who forged ahead in apparent anticipation that they would be able to use a doomsday scenario to get that public bailout money. Now we have a disguised bailout in the form of low interest rates for those banks, because they still prefer to be undercapitalized than to dilute the value of their shares. I'm sorry, but if the private money is there to be invested as Yglesias suggests and Fernholz accepts, this is not a case of taxpayer anger causing Congress to fear making the better of the two choices - because there's a third choice that would also keep the banks from failing. It's another round of banker greed, incompetence, or both causing the economy to languish while taxpayers pick up the tab.

It's interesting, isn't it, that wiping out shareholder value was not such a big deal when the auto industry was involved. How Congress and the President had no problem demanding that, in return for being bailed out, auto makers come up with plans for long-term sustainability in down markets. How they insisted that worker wages be slashed and contracts rewritten. And, whatever people may have thought about the bailout itself, all of that was largely popular. But when it involved the oversized compensation packages and absurd "retention bonuses" of the people whose greed and/or incompetence caused the economic collapse, we were lectured on "the sanctity of contracts".

The reason we have a backdoor bailout is not because Congress is afraid of a direct bailout due to popular anger. It's because it knows that it can't get away with another "no strings attached" - no, that's too charitable - another open giveaway of taxpayer money without making some demands on the financial industry. So sure, you can get me to blame Congress for not approaching this in a way that brings a faster, more cost-effective and fairer end to the bailouts - but let's put the rest of the blame where it belongs, on the financial industry itself. It's fear of their wrath, not mine, that cows Congress.

Fixing the Mortgage Mess

An opinion column in the Times is skeptical that the mortgage documentation mess can be fixed with legislation:

The banks and other players in the securitization industry now seem to be looking to Congress to snap its fingers to make the whole problem go away, preferably with a law that relieves them of liability for their bad behavior. But any such legislative fiat would bulldoze regions of state laws on real estate and trusts, not to mention the Uniform Commercial Code. A challenge on constitutional grounds would be inevitable.

Asking for Congress’s help would also require the banks to tacitly admit that they routinely broke their own contracts and made misrepresentations to investors in their Securities and Exchange Commission filings. Would Congress dare shield them from well-deserved litigation when the banks themselves use every minor customer deviation from incomprehensible contracts as an excuse to charge a fee?

It may well be inevitable that some lawyers would attempt to challenge a federal law, but is there a reason to believe that the litigation would be successful? Federal law can bulldoze state laws - it's called preemption. For the most part, even now, homeowners don't seem particularly inclined to fight the foreclosure process. Legislation would further narrow the pool of people willing to litigate, and banks could redouble their efforts to document those transactions so as to moot their cases.

Perhaps the author is speaking of the potential litigation between the various financial institutions involved - attempts to force buy-backs of mortgages or securities, fraud actions, breach of contract actions.... But the players seem to know the risks associated with that game, which is why they're presently working through their lobbyists as opposed to their law firms.

There are alternatives. One measure that both homeowners and investors in mortgage-backed securities would probably support is a process for major principal modifications for viable borrowers; that is, to forgive a portion of their debt and lower their monthly payments. This could come about through either coordinated state action or a state-federal effort.

The large banks, no doubt, would resist; they would be forced to write down the mortgage exposures they carry on their books, which some banking experts contend would force them back into the Troubled Asset Relief Program. However, allowing significant principal modifications would stem the flood of foreclosures and reduce uncertainty about the housing market and mortgage securities, giving the authorities time to devise approaches to the messy problems of clouded titles and faulty loan conveyance.

Unless the documentation is in order, how do you know you're dealing with the correct party? Or is the author's assumption that, despite the irregularities and fraud in banks' attempt to document mortgages, they banks have it right in the vast majority of cases and eventually the paperwork will catch up?

Also, which is more likely to come out of the next Congress - a law making it easier for financial institutions to overcome deficiencies in their documentation of mortgages, or another bailout of the financial industry? It may be easy to forget now that the astroturfers have redefined the movement, but the Tea Party Movement grew out of popular disgust at the first bailout.

Update: Who could have seen this coming.

The Sanctity of Contracts, Revisited

Recall back in the days when we were being asked to hand out hundreds of millions of taxpayer dollars as bonuses to the incompetents at AIG who helped engineer the economic disaster? How many lectures we received about "the sanctity of contracts", even from an industry notorious for avoiding its contractual obligations?

Every time I hear bankers and financial industry insiders assure us that the current mortgage mess is "no big deal" - that we should shrug off forged documents, the failure to have properly conveyed mortgages, even the inability of a party asking for foreclosure to prove it has any legal right to do so - I am reminded of those earlier assertions. Contracts are sacred when scrupulous adherence will line the pockets of financial and insurance industry insiders. When they might work to the benefit of the little guy, they're "red tape" to be ignored.