Confidence Game
Some time in the next two weeks, the Treasury will report on the result of "stress tests" conducted on 19 major banks. But you don't have to wait to learn the results. It's already clear that no major bank will be declared insolvent. The administration's economic assumptions about the worst conditions banks will face err on the side of rosy. In fact, much of the stress testing will be done by the banks themselves. There is no army of examiners poring over bank books. At worst, some banks may be asked to raise additional capital or accept additional aid from the government.
The difference between a "stress test" and the process of a government receivership is that the former allows the government to disguise how bad things are, while the latter forces the issue and gets on with the cure. But receivership is what the administration hopes to avoid. Hence the need for rosy test results.
Originally, the stress tests were billed as rigorous examinations of the balance sheets of the banks, under various possible scenarios. The idea was to see whether additional government capital was needed, and to determine whether any of the major banks might be deemed too weak to continue in its present form. But taking banks into government receivership has been ruled out in advance. Instead, government will string along the weakest banks with dollops of aid -- risking a needless prolonging of the crisis.
Contrary to the implication, the stress tests are not true comprehensive, rigorous bank examinations to determine the condition and value of the banks' balance sheets. Any such exercise just became a lot more difficult, since the Financial Standards Accounting Board gave in to political pressure and rescinded its rule requiring assets to be marked down to their current market value. So in principle toxic securities can now be carried on banks' books at whatever valuation the bank chooses while it waits for markets to revive -- a revival that may never come. If we truly believe that the big banks actually booked normal profits in the first quarter, as all of them claimed, then we have learned nothing from the era that began with Enron.
The stress tests are best understood as part of a broad confidence-building offensive, one that may well be premature. Ever since the stress-test exercise was first announced, Treasury has kept moving the goal posts, rather like states or school districts that dumb down proficiency tests so that they can get high rankings under No Child Left Behind.
Some weeks ago, it dawned on the Treasury that if a couple of large banks, say Citigroup and Bank of America, were given failing grades, there would be hell to pay. Treasury might have to go back to Congress for more bailout money. Congress might start asking nosy questions about how Treasury has spent the $700 billion that Congress gave it last fall. And the government might have to take one or two banks into receivership.
The Treasury, rather, hopes to release as few details as possible, lest markets gain information at odds with the increasingly rosy scenario that the administration, the Fed, and the banks themselves are painting. In recent days, both the government and financial analysts affiliated with banks have been on a concerted campaign to talk up the economy.
Last week, I attended the annual conference held every year on honor of the late economist Hyman Minsky, the man who presciently warned that a market economy, absent strong government regulation, is vulnerable to period bouts of financial excess and collapse. The conference included dozens of eminent economists and other experts on finance, ranging from Nobel Laureate Joseph Stiglitz to analysts Henry Kaufman and Martin Mayer, as well as senior officials of the Federal Reserve. For the most part, the appraisals of the condition of the nation's banking system were sober, if not dour. But when it came time for the representatives of the banks to present, you'd think there was only sunshine ahead.
Bruce Kasman, the chief economist of Morgan, saw housing starts improving, the corporate bond market and the commercial paper market returning to normal, pent up consumer spending picking up, and a recovery starting in the second half of this year, with unemployment peaking at 9.4 percent. James Paulsen, of Wells Capital Management, had an even rosier assessment, seeing 3 percent economic growth in the second half of this year. "We have lacked not stimulus, but patience," he told the conference.
I'd sure like a hit of whatever these people are smoking. The fact is that the entire financial economy is still on life support from the government. And the government is asking precious little in return.
While it's true that the Fed's policy of keeping short term interest rates at zero, and trillions of dollars ladled into financial markets by the Fed, plus $787 billion in legislated stimulus spending, and a budget deficit that will be around 12 percent this year, cannot fail to have some impact, the whole economy will still be dragged down by wounded banks. Nearly every responsible economist projects the economy to lose jobs at the rate of at least half a million jobs a month for much of 2009. The authoritative OECD projects that the unemployment rate will still be in excess of 10 percent in 2011.
Top officials of the Obama administration, meanwhile, hit the Sunday talk shows to crow that they would not need more money from Congress, because some banks will be paying back the government ahead of schedule. White House Chief of Staff Rahm Emanuel told George Stephanopoulos Sunday that the Treasury had the resources to provide any financial aid.
EMANUEL: We believe we have those resources available in the government as the final backstop to make sure that the 19 are financially viable and effective.
STEPHANOPOULOS: Without coming back to Congress?EMANUEL: Right. The resources that we have on hand, we believe -- and it's not just that, George, is that we have those resources; we have a facility to buy these troubled assets off their banks. If they need capital, we have that capacity.
Emanuel added that "we have a facility to buy these troubled assets off their banks. If they need capital, we have that capacity," and that the Treasury would proceed without any need for "nationalization."
The administration's plan for the banks might be described as "kick the can down the road." If we can just disguise the truly dismal condition of major banks' balance sheets for a few months, until more of the stimulus and the Fed's trillions kick in, maybe we can wish them back to life. Suspending accurate accounting helps. So does the kind of creative accounting that allowed even the most wounded banks to report profits for the first quarter. Treasury Secretary Tim Geithner's latest plan allows investment banks and hedge funds to gamble in distressed securities, in the hope that a massive amount of government subsidy will bid up their value.
The trouble, however, is that some things just cannot be disguised. On Monday, the Wall Street Journal did its own calculation of bank lending between October 2008 and February 2009, and found that lending was continuing to fall.
The financial press has also identified the heroic bookkeeping that allowed some of the most damaged banks to claim a return to profitability. (Curiously, the original headline on Eric Dash's NYT piece was "Sharp Pencil Lets Citigroup Declare Profit." By the time the piece made it onto the Times website, the headline was softened to, "After a Year of Losses, Citigroup Finds a Profit.")
As long as unemployment continues to rise, and even people who have not yet lost jobs worry about becoming jobless, consumer spending will not power a recovery. And while the stimulus package spends a lot of money, state and local governments are continuing to lose revenue at about three times the rate that Washington replaces it.
At the heart of this mess is the severely impaired banking system. Administration officials go out of their way to disparage a more direct and orderly way of recapitalizing the financial system, deliberately using terms like "nationalization," and contending that the government is not very good at running banks. But the fact is that ever since the Reconstruction Finance Corporation was originated (not by FDR but by Herbert Hoover), and the Resolution Trust Corporation of the 1980s was legislated to clean up the Savings and Loan mess (under that Bolshevik Ronald Reagan), government from time to time takes over failed banks, replaces management, and recapitalizes them with public funds. The FDIC does it several times a year.
This process, known as resolution or receivership, is not the same thing as long-term nationalization. And it is just what the government is planning when it comes to the auto rescue. The same Treasury department did not hesitate to fire GM chief Rick Wagoner. But it seems determined to keep zombie banks and their zombie managers intact at all cost. And all cost, in this case, could be trillions.
(Watch for two important Tuesday hearings. Tim Geithner will testify before the Congressional Oversight Panel, and leading critics Joseph Stiglitz and Simon Johnson will appear before the Joint Economic Committee.)
Ironically, the administration seems to keep bumping into its own contradictions. In a story carefully fed to the New York Times, unnamed senior officials Monday declared that they would need no more money from Congress because they could always convert the government's existing investment in zombie banks into common stock. However, as the story by Ed Andrews points out, this would leave the government as the largest shareholder -- in other words nationalization by another name.
Little is accomplished by putting a happy face on what is likely to be as difficult period, except prolonging the agony. Of course, it does save a lot of bank executives' jobs, and it does pump up the bank stocks, at least in the short run. Cynics might be forgiven for suspecting that this is the true intent.
Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His book is "Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."
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If Obama thinks he can be all things to all people he is mistaken. he will have to make tough decisions eventually.
Most people curse inflation when the price of their groceries increases yet praise it when the price of their homes increases. The capitalist mindset that asset price inflation should be high and consumer price inflation should be low lies at the heart of the financial crisis.
Asset prices can come unglued from consumer prices in the short term in the presence of a bullish financial market in combination with a bearish labor market. The competitive devaluation of labor associated with globalization permitted the devaluation of currency with respect to assets without a similar devaluation with respect to consumer goods.
But over the long term, asset prices are supported by labor and consumer prices. When earned income doesn't keep pace with investment income, the returns on those investments eventually fail to materialize and asset prices must come back in line with consumer price inflation.
The administration's plan is to re-inflate the asset bubble to protect the dollar amount of accumulated wealth. This can produce one of two outcomes: it can reset the stage for another asset bust in the future, or it can induce consumer price inflation to bolster past investments (i.e. stagflation).
Our savings have lost a great deal of purchasing power due to large-scale malinvestment by financial institutions. The administration can do little more than decide how to present this devastating news to the American people, and they've clearly chosen to spread the shock over many years to come.
"We need not to concentrate on the mistakes from the past, but concentrate on moving forward" is chilling. The Great Depression revealed that the banks during those times were anemic, they had very little power. The past would demonstrate that the Big Banks would fail during a 2nd Great Depression anyway even if they did start this 'recession'. If the major banks are going to fail anyway, let's take them over now and minimize taxpayer losses.
One of these results seems perfectly plausible: The monopolistic banking oligarchs will collapse (which will not foretell the end of American civilization, as claimed). The American currency will collapse which will spell the end to American governance as we know it. Our present leaders will be replaced.
The third possibility of a Japanese style lost decade is highly unlikely because of the enormous bankruptcy proceedings we are up against.
The first result, I believe, would allow us to come out of the depression with our self-respect, self-confidence and an intact Constitution (maybe).
More 1Q numbers tomorrow.
Can't wait to see what the over-compensated Overlord of the Sun has to say about HIS bank.
Why, they might even have to give up their racing sponsorship!
President Obama is not easily intimidated, but I am beginning to suspect that the Financial Oligarchs have succeeded where all others have failed. The problem is his peception that major disruption of major banks would endanger the entire business system of the country. This is a serious threat in the short term, but perhaps we need to look at this long term.
I perceive the Financial Sector as a giant vampire sucking the lifeblood out of main street. The excessive credit card charges that so many middle class families face consumes an increasing percentage of income leaving less and less to spend on main street. Sixty Minutes reported last Sunday how the Financial sector siphons off significant amounts from the 401Ks of unsuspecting savers.
These ill gotten gains enable the Financial Sector which produces nothing of value to pay extravagant salaries attracting into their ranks some of the brightest minds produced by our universities. The sectors that actually produce stuff are thus deprived of their creativity. Instead of devising revolutionary auto engines and medical treatments these guys devise creative ways to rip off the rest of the world.
This sector that should serve as a facilitator of productive economic activity has become an evil end in itself. Perhaps a complete collapse of some of the major players is required to change this situation. Perhaps that would be better for the nation as a whole in the long run.
How much did the collapses in the fall of 2008 cost? And you want to double down?
You make some excellent points.
Absolutely correct that Obama is spellbound by these guys who actually understand finance.
But to my perspective, and I think the IMF still is off by a couple of Trillion, what we really need is a separation of the monetary powers that exist within the FRS. Put the surviving banks back to banking, and put the government back in charge of creating the nation's money supply where that power belongs.
Like Lincoln did when the bankers failed the needs of the country.
Obama is spellbound by Geithner's claim that without the public bailout, the economy will crash for lack of liquidity. OMG, the sky is falling. And, I'm the guy who's falling it.
That is easily remedied, if Obama has the moxie to restore soundness and stability to the nation's money system.
The Chicago Plan for Monetary Reform called for separation of these two monetary functions so that private bankers do not have the power to create and destroy the nation's money system.
We are a sovereign nation, a nation of a sovereign people, and that means we have the right to any money system that we choose.
We had this private fractional-reserve experiment for about a hundred years.
It is done.
Mr Taleb said there are ways to ensure we never come back here again.
"Do not let those who drove the School Bus blindfolded and crashed have another school bus."
The Chicago Plan.
Greenbacks.
Public Credit.
monetary.org.
webofdebt.org
That's revolutionary enough for me.
Then, let's have some really free enterprise.
Some economic democracy.
Like that commercial where banks actually do compete for your deposits.
And your deposits go to banks that you want to put your money into.
Which is the bank that lends according to the needs of the depositors.
Banking.
The money creation part must meet FDR's test:
"The only sure bulwark of continuing liberty is a government strong enough to protect the interests of the people, and a people strong enough and well enough informed to maintain its sovereign control over the government."
Something for something.
Think Chicago Plan.
Peggy Noonan says we must just walk away from this crises. We need to look to the future and not dwell on the past. Keep the mystery going in the way Wall Street works.
When political operatives are all out of excuses, they do that future/past "turn the page" thing.
It’s all a question of confidence, don’t cha know? There is no reality, it’s all perception management! Bring out the Treasury Stress Testing Team. Pay the piper? — ha, ha that’s for the little people. Parties never end! Create more debt through derivatives than the amount of monetary value existing in the world? — Brilliant! Conmen do best when unregulated! Welcome to our still sociopaths-gone-wild economy.
Yawn. Thanks for disproving your own strawman.
When "everyone knows quite plainly what 'the truth' is," the longer you spend squirming-around about the matter, the more of a liar you yourself become.
Face it: it's over.
For more than ten years, a handful of "uber-banks" grew large and fat ... by means of securities fraud, usury, swindling and more.
They had help. The SEC looked the other way... Congress removed protective laws, and passed other ones specifically intended to block enforcement action.
In this way, trillions of phony dollars were injected into the world's financial system. Other nations discovered that they had no protection at all against what had just happened to them. Their "sovereignty" meant nothing under these circumstances. Hundreds of millions of Americans had no protection either, and today, hundreds of thousands of them are jobless (and homeless, or nearly so) because of it.
The bankers have been pulling on all their political strings, but not even "their men in Washington" can forestall these consequences.
These banks ... all of them ... are not only "utterly insolvent," but they have become "organized criminal enterprises." I do NOT say this casually.
We have no choice: this is crime and high-crime, and we MUST as a society confront it. We can't coddle it, can't parley, mustn't bargain. Crime like this, destroys without remorse.
I'm just curious, do you know what insolvency means in a recession and or depression?
What is over? People shopping at Target and Best Buy? Couldn't see any "being overs" the last time I went to the mall. It's still buzzing as if it were 2004. Not quite like it was buzzing in 2006 and 2007, but it's still buzzing. Nothing is "over". Things have simply returned to "halfway normal".
Thanks for writing this. I hope the administration is listening.
If we truly believe that the big banks actually booked normal profits in the first quarter, as all of them claimed, then we have learned nothing from the era that began with Enron.
Or even Madoff. It seems we like being conned. I think it makes us feel special... that w/ little to no effort... we can reap huge rewards. That if I we believe it to be... it will.
So we will keep on believing that these banks and government are doing what's rightt. That all it took was a little cash and good times are right around the corner. That soon we will all be back on the road to prosperity and the American Dream... If only we believe.
"That all it took was a little cash and good times are right around the corner. "
Errr... maybe you wanted to believe that. Most rational observers knew for a long time that these were not "good times" but simply irrational exuberance. OK, so the drunken monkey has fallen off the tree now. That's not the end of the world. It might actually be a rather good new beginning of it. Because once the monkey sobers up, he will be smarter. Or, at least, he could be. Your choice.
Mr. Kuttner, if you knew, what everyone else seems to know, you wouldn't be taking the sun on the roof of a burning building. You'd at least have an umbrella!
Dear Robert Kuttner:
You have the credentials to not only tell the whole truth without fear of being called a conspiracy theorist or loose a popular popularity contest.
So when you say:
"At the heart of this mess is the severely impaired banking system."
Why not identify the specific malignancy and let MAIN STREET know what it is truly up against.
Allowing these miscreants to continue operating in secrecy when you can make a difference is disappointing.
Knowing the truth may not set us free, but neither will cursing the darkness.
However, as the story by Ed Andrews points out, this would leave the government as the largest shareholder -- in other words nationalization by another name.
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Not so sure. Nationalization is a government controlled bankcruptcy procedure that gives government full controll over management, assets and which liabilities to pay. The government as a shareholder, however, does not control anything. The only clout government has is because it holds the purse.
What the administration is doing is simply backing up all losses of the banks and giving the managers free reign to do whatever it takes. Emmanuel has just admitted to this.
Now, you have government as a partner in crime. Indictments will go all the way up now.
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