The policeman isn’t there to create disorder, the policeman is there to preserve disorder
— Richard J. Daley
Quis custodiet ipsos custodes? (Who will guard the guardians?)
— Juvenal
What is the biggest impediment in 2009 to mitigating the harmful effects of energy problems in the 21st century? The answer may surprise you—it is insolvent zombie banks and our entrenched FIRE economy (Finance, Insurance, Real Estate). Allow me to explain.
Another Tragic Misallocation of Capital
Last week I took the long view of the climate and resource challenges we face in coming decades. Common sense tells us that the longer we wait to address those problems, the worse the consequences will be. Replacing oil consumption with widespread adoption of plug-in electric hybrids in 2020 after world oil production is already in permanent decline—provided this goal is actually possible—is like closing the barn door after the horse has left. What we do now has stronger, longer-lasting effects than anything we do in 2015, 2020 or beyond. There is not a moment to lose.
On February 24 Bloomberg reported that U.S. bailout and stimulus guarantees now amount to $11.6 trillion dollars ($11,600,000,000,000). Of this money, about 90% has been directed or pledged toward “fixing” the broken banking system.
Two clear and mutually exclusive paths lie before us in 2009. I am sorry to report that as of March the Obama administration is going down the wrong one. In my example below I will focus on energy investment, but my remarks could just as easily pertain to health care, manufacturing or education. I’ll use a round number to make my point—I think $10 trillion dollars will do very nicely. We might ask how some of this money would be best spent in the energy arena.
- Yes, We Can! — spend the money on reducing oil consumption and transforming the power grid. This would include large expansion of public transit in metropolitan areas (electrified light rail, trolleys, buses), an expanded system of long-haul railroads for both freight and passengers, direct financial support for troubled American-built PHEVs and batteries, wind and thermal solar farms to replace coal-fired base-load capacity, long distance power transmission lines to hook those farms up to the grid, encouraging reorganization of work & living patterns to decrease energy consumption, etc.
- No, We Can’t! — spend the money propping up insolvent banks like Citigroup or insolvent insurance companies like American International Group (AIG), the very institutions whose irresponsible risk-taking wrecked the global financial system. Merrill Lynch’s John Thain approved an “accelerated pool” of $4 billion in bonuses at the same time that Bank of America (which acquired Merrill) was in Washington begging for an additional $20 billion in bailout money. What energy-related projects could have been built with $24 billion in funding?
What about the stimulus package? That contained some useful energy spending, right? Of the $787 billion in the bill, only $43 billion was spent on direct expenditures and tax breaks for “clean and efficient” energy. That amounts to only 5.46% of the stimulus and 0.37% of the grand total ($11.6 trillion) broken out by Bloomberg. That’s next to nothing in view of the climate and resource catastrophes on the farther horizon. We need to replace roads, not repair them.
Just today (March 2, 2009) the “federal government … is providing embattled insurer AIG with an additional $30 billion in capital on an as needed basis, but also exposing U.S. taxpayers to additional risk.” The new money, now added to the $150 billion already committed, comes from the Troubled Asset Relief Program, or TARP. AIG lost a record $61.66 billion dollars in the fourth quarter of 2008.
The latest results [the quarterly loss] included the restructuring charges and write-downs as the company continues to be slammed by credit-market deterioration, especially in its exposure to commercial mortgage-backed securities
“The company [A.I.G.] continues to face significant challenges, driven by the rapid deterioration in certain financial markets…. The additional resources will help stabilize the company, and in doing so help to stabilize the financial system,” the Treasury and Federal Reserve said in a statement.
The AIG funding eclipses the $50 billion that Citigroup Inc. has received from three Treasury programs, and the $45 billion that Bank of America Corp. has received, although each of those firms might receive additional funding in coming months, if necessary. The two banks also have commitments from the U.S. government to back potential losses down the road, putting hundreds of billions of dollars in public funds on the line.
The Federal Reserve (Chairman Ben Bernanke) and the Treasury (Obama’s Secretary Tim Geithner) have the temerity to lecture—in effect, threaten us—concerning why AIG is too big to fail.
Given the systemic risk A.I.G. continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high. AIG provides insurance protection to more than 100,000 entities, including small businesses, municipalities, 401(k) plans, and Fortune 500 companies who together employ over 100 million Americans. AIG has over 30 million policyholders in the U.S. and is a major source of retirement insurance for, among others, teachers and non-profit organizations. The company also is a significant counterparty to a number of major financial institutions. [emphasis added]
That last sentence looks almost like an afterthought, doesn’t it? On the contrary, it is the primary motivation behind government policy, not the threat to small businesses or 401(k) plans.
Under the inspired leadership of Maurice “Hank” Greenberg, the financial products division of AIG (AIGFP) sold credit default swaps (default insurance) on mortgage-backed securities and other derivatives to banks in the U.S. and all over the world, including many large European banks. Those are the counterparties referred to in the joint Fed/Treasury statement. The value of these derivatives went bust after the Housing Bubble collapsed. Consequently—
AIG almost collapsed in September, 2008 after ratings agency downgrades triggered demands for billions of dollars in extra collateral from firms that had bought derivative-based protection from the insurer on complex mortgage-related products known as collateralized debt obligations, or CDOs…
[firms making demands included Goldman Sachs, Merrill Lynch, UBS and Deutsche Bank]
By Nov. 5, the insurer had paid out $37.3 billion of that money to counterparties who had purchased a certain type of derivative-based protection from AIG called multi-sector credit-default swaps…
Since then, AIG and the Federal Reserve Bank of New York1 have unwound most of these contracts. To do this, they offered to buy the CDOs that were originally insured by the agreements. The counterparties sold these assets at a discount, but were compensated in full in return for allowing AIG to extricate itself from the obligations. The counterparties also got to keep the $37.3 billion in collateral…
Thus Joe Nocera explains why “a bailout of AIG is really a bailout of its trading partners—which essentially constitutes the entire Western banking system” (New York Times, February 27, 2009). Nocera exaggerates the situation. What about the healthy banks out there which were forced to take TARP money?
The $180 billion dollars committed to our charitable “AIG Relief Fund”—so far—amounts to 419% of energy-related spending by the Congress and the Obama administration to date. This astonishing, continuing misallocation of capital is a great tragedy in the making for Barack Obama. It is definitely not change we can believe in.
Will the broken banking system be Obama’s Vietnam, his Waterloo? Does Obama get it as he said in his State of the Union speech?
So I know how unpopular it is to be seen as helping banks right now, especially when everyone is suffering in part from their bad decisions. I promise you – I get it.
No, Mr. President, I don’t think you do. Most of us agree that Obama is among the best of men. So, what’s the problem?
Geithner Versus the American Oligarchs
Bill Moyers’ coverage of the financial crisis has been superb. On February 13, Moyers spoke to Simon Johnson, former chief economist at the International Monetary Fund (IMF). He is now teaching at MIT’s Sloan School. Moyers led off with a quote from Johnson’s High Noon: Geithner vs. the American Oligarchs.
There comes a time in every economic crisis or, more specifically, in every struggle to recover from a crisis, when someone steps up to the podium to promise the policies that - they say - will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains.
Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble? The form of these vested interests, of course, varies substantially across situations, but they are always still strong, despite the downward spiral which they did so much to bring about. And fully escaping the grip of crisis
really means breaking their power.
Our new economic strategist is Tim Geithner, Obama’s Treasury Secretary. In a series of articles at Baseline Scenario, Johnson, along with two other respected economists, Peter Boone and James Kwak, argues persuasively that powerful banking interests have hijacked our political system. I am not going to belabor their point, which seems obvious once you look at the situation. Rather, I will quote the Moyers interview once more to provide examples of conflict of interest and then give you a list of resources to consult if you would like to know more.
I have provided some links to document sources in the text below. These links are not from ParanoidLeftWingNut.com. They are from ABC News and the New York Times. Geithner himself is the former head of the New York Fed.
Bill Moyers: Geithner has hired as his chief-of-staff, the lobbyist from Goldman Sachs. The new deputy secretary of state was, until last year, a CEO of Citigroup. Another CFO from Citigroup is now assistant to the president, and deputy national security advisor for International Economic Affairs. And one of his deputies also came from Citigroup. One new member of the president’s Economic Recovery Advisory Board comes from UBS, which is being investigated for helping rich clients evade taxes. You’re probably too young to remember that old song, “Sounds like the Mack the Knife is back in town.” I mean, is that what you’re talking about with this web of relationships?
Simon Johnson: Absolutely. I don’t think you have enough time on your show to go through the full list of people and all the positions they’ve taken. I’m sure these are good people. Don’t get me wrong. These are fine upstanding citizens who have a certain perspective, and a certain kind of interest, and they see the world a certain way. [emphasis added]
There wasn’t enough time to list all the examples, but I would be remiss if I didn’t include this one from Frank Rich of the New York Times:
[Obama's chief economic adviser] Larry Summers and Geithner are both protégés of another master of the universe, Robert Rubin. His appearance in the photo op for Obama-transition economic advisers three days after the election was, to put it mildly, disconcerting. Ever since his acclaimed service as Treasury secretary in the Clinton administration, Rubin has labored as a senior adviser and director at Citigroup, now being bailed out by taxpayers to the potential tune of some $300 billion. Somehow the all-seeing Rubin didn’t notice the toxic mortgage-derivatives on Citi’s books until it was too late. The Citi may never sleep, but he snored.
[Rubin made $115 million at Citigroup over 9 years before leaving in January, 2009]
No conspiracy is required to explain the undue influence of former Citi bankers holding key posts in the Obama administration. The problem is that they can not think outside the FIRE economy box. They may indeed be good people, but they are the wrong people to oversee the dismantling of a banking system that benefited them. Thus we are told that Citigroup and Bank of America are too big to fail.
Here are some additional resources to consult.
It gives me no great pleasure to report that Simon Johnson believes United States financial policy is starting to resemble fiascoes in emerging markets like “Russia or Indonesia or a Thailand type situation, or Korea.”
A New Energy Regime?
Paul Krugman called the current policies voodoo on January 18, 2009 before it became obvious that nothing changed when Obama assumed power. Krugman suggested a way to fix things.
But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly [now definitely] members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking…
A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.
By February 24, Krugman, a Nobel Prize winner in Economics, was referring to mysterious plans that made no sense.
I’m trying to be sympathetic to the various plans, or rumors of plans, for bank aid; but I keep not being able to understand either what the plans are, or why they’re supposed to work. And I don’t think it’s me. [the link is to Geithner's mysterious "stress test"]
The key difference between now and 1987 when the Resolution Trust Corporation was implemented is the intervening 22 years in which FIRE economy oligarchs like Robert Rubin and his protégés acquired great political influence. Simon Johnson has also made suggestions for taking over Citigroup and other insolvent banks. For AIG, which is now 80% owned by we the taxpayers, the story would be the same.
… bankers may not have to worry about getting smacked around by the White House. What bankers do fear is “pre-privatization.” That’s a term MIT professor Simon Johnson applies to the Bush/Obama approach to financial bailouts, as opposed to the painful restructuring that real nationalization would bring. As Mr. Johnson put it on his website, The Baseline Scenario, “We have state control of finance without, well, much control over banks or anything else. Responsibility without power sounds accurate.”
Responsibility with power would likely require AIG and other financial wards of the state to write down their assets so good assets could be separated from bad and sold off to new investors. That’s a prospect that existing shareholders should fear, since their holdings stand to be wiped out in the process. And the managers responsible for the banks’ problems would follow…
[The term pre-privatization appears to come from the respected blog Calculated Risk. The term was half-jokingly introduced to avoid the stigma associated with the word "nationalization".]
In other words, we have options other than keeping these parasitic banks on an intravenous money drip. The latest Baseline Scenario forecast sums things up.
Ideally, global economic growth requires a rebalancing away from the financial sector and toward non-financial industries such as manufacturing, retail, and health care (for an expansion of this argument, see this op-ed). Especially in advanced economies such as the US and the UK, the financial sector has accounted for an unsustainable share of corporate profits and profit growth. The only solution is to invest in the basic ingredients of productivity growth - education, infrastructure, research and development, sound regulatory policy, and so on - so that our economy can develop new engines of growth. [Add energy to the list]
But this change in the allocation of resources is greatly complicated by the increased political power of the financial lobby. During the boom years, large banks and their fellow travelers accumulated ever greater political power. This power is now being used to channel government subsidies into the now outmoded (and actually dangerous) financial structure, and in essence to prevent resources from moving out of finance into technology and manufacturing across the industrialized world.
We have done considerable damage to our economies through a debt-fueled bubble. But it could get worse. If the financial sector can use its political power to generate a higher level of subsidies from the government, we will convert even more of our banking industry into pure rent-seeking activities (i.e., all the bankers will do is lobby, successfully, for more support in various forms). If public policy is captured by banks in the US, Europe and elsewhere, then we face much slower productivity and overall growth rates for the next 20 years. [emphasis added]
If we can get past these seemingly intractable political problems, we can try to rebuild our energy infrastructure. We will know one of two things as we look back on what happened in 2030.
- It was possible to reduce our oil and coal consumption over time to lessen the dangers from fossil fuel resource depletion and anthropogenic climate change.
- It was not possible to do these things to the degree required and our standards of living deteriorated over time.
If we do not overcome the political obstacles to changing how we allocate capital resources, we will know in 2030 that we never had a chance—we were stuck with #2 regardless of whether success was possible or not.
Contact the author at dave.aspo@gmail.com
Notes
1. The major counterparties to AIG have never been publicly disclosed and the Fed continues to protect their identity. Bloomberg has also sued the Fed (under the Freedom of Information Act) to disclose the names of banks getting loans from the central bank.
The Fed refused yesterday to disclose the names of the borrowers and the loans, alleging that it would cast “a stigma” on recipients of more than $1.9 trillion of emergency credit from U.S. taxpayers and the assets the central bank is accepting as collateral…
The Bloomberg lawsuit said the collateral lists “are central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression.”
Obama has consistently called for transparency in government handling of the financial crisis. Yet no one in his administration has pressured the Fed to disclose who it is giving money to.
