The Fourteenth Banker Blog

August 31, 2010

New Banks Needed #2

Filed under: Running Commentary — thefourteenthbanker @ 8:30 AM

I posted New Banks Needed #1 on Huffington Post also, and was disputed by someone who was in denial about the status of the industry. He said, quote, “There are over 10,000 financial institutions in the United States today, the vast majority with ample capital, and a huge desire, to lend.”

Here is some analysis to put that statement to the test.

The gist of what I am saying is this and is really not controversial.

  • Banks have embedded losses on their balance sheets
  • These imbedded losses impact profitability and capital
  • Because risks in the economy are large, banks are exceedingly careful about lending.
  • On an individual bank level, this is appropriate.
  • In aggregate, this reduces growth or recovery potential
  • This is in line with the “Zombie Bank” discussions that were all over the place during the depth of the financial crisis, which predicted just what we have going on today.
  • The Fed policy of low rates and other regulators complicity in “extend and pretend” does not solve this dilemma. It simply prevents the clearing of the market for financial assets and the development of new robust financial institutions that are capable of taking on risk.
  • New banks with new capital are needed. They would not be encumbered by imbedded bad assets or dependent on a super low rate environment.

New banks would also provide the opportunity to shed the predatory financial model that imperils our future. The ability of bankers to be in denial about the state of affairs and to argue for the status quo is not a reason to believe them. That’s it.


August 29, 2010

Report on the Third Estate

Filed under: Running Commentary — thefourteenthbanker @ 11:03 PM

This report summarizes the situation of the Third Estate very well. From the Findings of the Working Group on Extreme Income Inequality, these key points:

  • Percentage of U.S. total income in 1976 that went to the top 1% of American households: 8.9.
    • Percentage in 2007: 23.5.
  • Only other year since 1913 that the top 1 percent’s share was that high: 1928.
  • Combined net worth of the Forbes 400 wealthiest Americans in 2007: $1.5 trillion.
  • Combined net worth of the poorest 50% of American households: $1.6 trillion.
  • U.S. minimum wage, per hour: $7.25.
  • Hourly pay of Chesapeake Energy CEO Aubrey McClendon, for an 80-hour week: $27,034.74.
  • Average hourly wage in 1972, adjusted for inflation: $20.06, In 2008: $18.52

Please click on the link for much more including fascinating statistics on CEO pay and the real value of the minimum wage today. Of course, the argument that increasing the minimum wage that much would result in more unemployment must hold true, because the above minimum wages have slumped to below real constant dollar “old minimum wage” levels. (that was a mouthful)  But really, think about it. If the real incomes of the top have increased so much, and the rest have done nothing so as to have fallen below the real value of the 1972 minimum wage, then a lot of somebodys got screwed.

How the Rich get Richer

Filed under: Running Commentary — thefourteenthbanker @ 3:29 PM

Presented in its entirety is a blog post from Bronte Capital. I have been reading John Hempton at Bronte for some time. This post is particularly interesting in that it discusses financial regulation from the perspective on one who makes it his business, among other things, to search out frauds. Here he analyses the Marc Rich saga and finds that regulation played a role in creating opportunity for fraud or something close to it. Certainly obvious from this is that people of no conscience have an edge in a capitalist society if there is no mechanism for what I referred to in a previous post as prosocial sanctions.

A deregulation conundrum

I have just read Daniel Amman’s excellent biography of Marc Rich – the oil trader notoriously pardoned by Bill Clinton.  I don’t want to get into the politics and ethics of the pardon other than to note that few things in it are black-and-white when you finished reading the book.

But the way Marc Rich made his money is fascinating and says a lot about the current re-regulation debate.

Marc Rich exploited price fixing/import/export controls to make simply unbelievable profits trading oil.  Marc Rich & Co (the Swiss vehicle) was started with just over $1 million in capital and a couple of years later was making in excess of $200 million in profit.  This level of profitability exceeds – by far – any other trading operation I have ever seen – and was probably the most profitable trading operation in history.  Marc Rich & Co (since renamed Glencore) is possibly the most valuable business in Switzerland within the lifetime of its founder.

A typical Marc Rich & Co trade involved Iran (under the Shah), Israel, Communist Albania and Fascist Spain.  The Shah needed a path to export oil probably produced in excess of OPEC quotas and one which was unaudited and hence could be skimmed to support the Shah’s personal fortune.  Israel – a pariah state in the Middle East – wanted oil.  Spain had rising oil demand and limited foreign currency but was happy to buy oil (slightly) on the cheap.  Spain however did not recognise Israel and hence would not buy oil from Israel – so it needed to be washed through a third country.  Albania openly traded with both Israel and Spain.  Oh, and there is an old oil pipeline which goes from Iran through Israel to the sea.

So what is the deal?  The Shah sells his non-quota oil down the pipeline through Israel and skims his take of the proceeds.  Israel skim their take of the oil.  Someone doing lading and unlading in Albania gets their take and hence make it – from the Spanish perspective – Albanian, not Israeli oil.  The Spanish ask few questions.  The margins are mouth-watering – and they all come from giving people what they really want rather than what they say they want.  We know what the Shah wanted (folding stuff).  We know what Israel wanted (oil).  We know what Spain wanted (cheap oil).  Who cares that Spain was publicly spouting anti-Israel rhetoric.  [Similar trades allowed South Africa to break the anti-Apartheid trade embargoes.]

It also helped that Marc Rich & Co was a (highly) multilingual firm.  Rich is fluent in Spanish (it is the language he talks to his children in).  He speaks English, German, Yiddish and presumably Hebrew.  His business partner (Pincus Green – pardoned the same day as Rich) speaks Farsi amongst many other languages.  They could do this deal because they could negotiate it and – deep in their heart they hold the Ayn Rand view that trade is a moral virtue and hence they do not need to be concerned with other morality.  [The only line that matters is the law – and then it might not be the law of his adopted country – Switzerland – rather than the United States where he was resident.]

And when the Shah fell?  Oh well – Pincus Green – an American Jewish businessman – gets on the plane to Iran and does a similar deal with the Mullahs – who – despite their rhetoric will sell oil down a pipeline through Israel – and will allow Israel to skim their take.  Trading through the American embargo – well that is just another instance of getting around restrictions and profiting (very) handsomely.  [Rich would argue that the trades were done by the Swiss company which was not subject to the American restrictions.]

The regulatory regime for domestic American oil was also perverse.  Old oil (meaning wells drilled before the first oil crisis) received one price.  New oil (wells drilled after the crisis) received a higher price.  Squeeze oil (oil that was extracted from wells that ran less than 10 barrels per day) received a higher price still.  The oil could be chemically identical and the price difference over $20 per barrel.  Obviously a trader with a method (any method) of changing the oil source could make a fortune.  Again I am not commenting on legality or morality.  That was just plain fact.  Ayn Rand applies – you give a value and you receive a value.

What all this regulation did was that it allowed people to make simply grotesque profits by thwarting regulation.  The regulation thus worked less well and it was socially unfair.  Pincus Green was good at negotiating in Farsi.  He was astoundingly brave going to Iran immediately after the Shah fell.  He was good at organising shipping.  He worked really hard – but he did not invent something that changed the world and he wound up a billionaire.   Traders make money by intermediating real business solutions – but these were real business solutions to problems made by legislation.  Bad regulation, moral indignation about “trading with the enemy” or “trading with Israel” or with racists in South Africa made people with Ayn Rand morals exceedingly wealthy because you could arbitrage your way around any of these regulations.

If you read the Marc Rich book you will understand why lots of people who were generally left-of-center became ardent deregulation advocates.  Plenty written by Krugman look like it advocates deregulation. (Not convinced: see his review of Laura Tyson’s book on trade theory inPop Internationalism.  Indeed see most of Pop Internationalism as favorably reviewed by – of all people – the Cato institute.)

Crank forward to the current crisis: what we see are the problems of deregulation and complexity.  We see traders and investment bankers who get rich – not as rich as Marc Rich and Pincus Green – but still frighteningly rich.  And they get there by taking risks that are ultimately absorbed by taxpayers or mutual fund holders (particularly taxpayers).  We see agency problems everywhere – where management enrich themselves at the expense of others – and they do so by capturing upside but (in part) socializing the downside.  Regulation in this case is about controlling agency problems – about stopping people privatizing the profit and socializing the losses.

A plea

As a plea then I want a debate about the right form of regulation – a regulation that controls agency problems but does not allow arbitrage opportunities to people with “Ayn Rand morals”.

We are not going to get that from the current Tea Party Republicans.  They simply argue that regulation (they say but do not mean all regulation) impinges on “freedom” (something that is clearly a good but hard to define).  However many of the same people want planning regulations to ban a mosque in downtown New York because it is an insult to the victims of 9/11 (and banning mosques is not a restriction on “freedom”).

If that is the level of debate we are not going to get good re-regulation – we are just going to get pandering to whichever lobby group manages to garner most support.  And that is a real risk because we will leave agency problems in place (they benefit the rich and powerful) and we will introduce the same sort of (dumb) regulation that made Marc Rich and Pincus Green astoundingly wealthy.  That sort of regulation also benefits the rich and powerful – especially those with “Ayn Rand morals”.  [The rich and powerful – if you have not noticed – are good lobbyists.  Unless we are careful many amongst them will get their way.]

I don’t know how to do this well – but I thought I would state the obvious.  The most obvious things that need regulation are things with a government guarantee (implicit or explicit).  If you have an implicit guarantee (as we now know almost all large financial institutions have) then regulation really matters.  If there are large agency problems (small shareholders, large management) then regulation should be deliberately biased to put power in the hands of shareholders not managers (eg banning staggered board elections).

Likewise other agency problems should be strongly policed and the regulation should be of the form that allows that policing.  When Elliot Spitzer found that Marsh – a large insurance broker – was participating in bid rigging against schools buying insurance that was shocking – and is precisely the sort of thing in financial markets that should be policed strongly.  But it took Elliot considerable effort to find and prove his case.  The rules should be established so that sort of behaviour is really difficult to hide.

And I do not think that I need to explain to anyone how much mortgage brokers contributed to the crisis by (a) deliberately misleading borrowers about conditions on their mortgage and (b) participating in the faking of borrowers income/assets/education level when they on-sold the loans to Wall Street.  Agency problems were at the core of the crisis.

On the other side if there is no agency problem then deregulation should remain the order of the day.  Trade restrictions create arbitrageurs – and the arbitrageurs ensure the trade restrictions don’t work anyway.

There are obviously going to be extensions to this rough rule – and this post is really to garner discussion.  But for a start I expect agents who benefit from their agency (and the abuse of their agency) to join the Tea Party.

It is difficult to get policy right.  And when and if the policy is got right we are in for a very long fight to implement it.


The Marc Rich saga is about power. Powerful people will fill vacuums. They will take up the space for themselves. They will breathe all the oxygen. They will privatize gains and socialize losses. This is a large part of our problem.

August 27, 2010

More on Regime Change

Filed under: Running Commentary — thefourteenthbanker @ 3:48 PM

Here are several perspectives from the last few days that deserve highlighting. This first piece discusses what has happened with our economy over the last several decades and what we should be acknowledging as the problems that need to be addressed.

Income: Average Real Weekly Earnings, (read: incomes adjusted for inflation), are below what what what they were in 1973. Income wise the average American family is worse off now than they were 37 years (4 decades) ago.

The Dollar’s Value: And it isn’t like we have a stronger dollar now. If we did perhaps we could get buy with less money. No, Uncle Buck is worth 95% less than he was 84 years ago when the “Creature From Jeckyll Island” (read: the “Fed”) came into existence.

Money is supposed to be a store of value. When you boil economics down to it’s core you are left with one law: Supply and demand. Increase the supply of anything and it’s value goes down. Our monetary system is flawed because if it isn’t expanded it collapses and when it is expanded the store of value is obliterated. The Fractional Reserve System is another example of a moronic idea created by greedy lunatics, It was doomed to failure upon inception. Debasing a currency only creates an addiction to debt.

Employment: In 2008 there were about 150 million workers. Today (U3-U6) unemployment is at 22%. The largest problem plaguing unemployment is the fact that most of the jobs lost were jobs that were created because of consumers binging on credit. For instance, in 2008 Americans tapped their home equity for stupid purchases. The best example of this is from Jim Quinn’s 2008 article: Consumers borrowed $9,000,000,000.00 (9 billion) dollars (from home equity loans) JUST to blow it on 4 dollar coffees at Starbucks, which has since closed 900 stores. Debt to expand a business or debt to purchase a home is sound debt for an economy. Debt to buy expensive coffees at “Fourbucks” won’t be economically sustainable (as proved by 900 closed stores).

Note that the first two points are not cumulative. The first, that real wages are stagnant, already considers the effects of inflation, though I suspect it is using a CPI deflator rather than change in the value of the dollar itself versus other currencies or commodities.

Further in the post the writer identifies several contributing factors including:

Corporatocracy: In a nutshell: Corporatocracy has replaced capitalism. I wrote about this in my last article “Why We Are Totally Finished”. Corporatocracy has permitted corporations to influence (bribe and control) the government which then rewarded select sectors for criminal activity. Fraud that led to our economy blowing up. The sectors which literally blew up the economy in 2008 was saved when they should been left to fail. TBTF translates to not regulated correctly to begin with. Nothing holds a gun to our head. Too big means too unregulated to be permitted to grow too big.

Which leads to the next piece and its main point, which is reminiscent of my rant of several months ago.

the entire profit recovery has been predicated not on GDP growth (which explains the constant skittishness about macro events), but on declining labor costs, and as the following JPM report points out, “the latest profit recovery (the three red dots) is reliant on declining labor costs like none before it.” What investors really want to know is how much more wage deflation can America take before it all collapses into a huge stinking deflationary mess?

Companies have brutally cut costs in order to produce profit growth. We have come to the point that each company acting individually in its interest is doing the same thing. They are all cutting headcount, health care benefits, pensions, 401K matches, etc. Management will say it is about competitiveness, but it is really about profit. The firms could accept less profit in given quarters with a view towards the long run. If all companies capable of doing so did, aggregate consumer demand would increase and perhaps the companies themselves would achieve better market valuation.

A profit recovery whose foundation is so reliant on sustained high productivity and low real wage growth should not command a very high P/E multiple.

Finally, this piece discusses the Bernanke speech today and the conditions tending towards revolutionary impulses. Fascinating how this keeps coming up. The title is The Elites Have Lost The Right To Govern. Of course, I agree with this. I’m not sure what to do about it. We need a revolution of justice, new corporate governance, new consumer and small business activism, elimination of the disparities between public sector and private sector benefits (meeting in the middle somewhere), an end to our predisposition to war, etc… to restore balance.  From the linked post:

One of my favorite quotes is from Joseph Schumpeter who said “everyone has elites the important thing is to change them from time to time.”

This is the United States not some sort of petty monarchy.  There is no divine right of any family or group of families to rule.  When this starts to happen you get the disaster we are now faced with.  That said, the bigger point is this.  What Obama has attempted to do is to wipe a complete economic collapse under the rug and maintain the status quo so that the current elite class in the United States remains in control.  The “people” see this ploy and are furious.  Those that screwed up the United States economy should never make another important decision about it yet they remain firmly in control of policy.  The important thing in any functioning democracy is the turnover of the elite class every now and again.  Yet, EVERY single government policy has been geared to keeping that class in power and to pass legislation that gives the Federal government more power to then buttresses this power structure down the road.  This is why Obama is so unpopular.  Everything else is just noise to keep people divided and distracted.

So the situation is intolerable and more and more bloggers are coming to the same conclusion, which is that there must be a realignment of power. How do we do that peacefully?

August 26, 2010

NY Elites Worried about French Style Revolution

Filed under: Running Commentary — thefourteenthbanker @ 8:11 PM

Yves at Naked Capitalism reported today on some conversations with New York acquaintances that would either fall into or be familiar with the “elite” classes.  Here is the post in its entirety.

Normally, I don’t report on anecdotes from my immediate circle, but a set of conversations in less than a 24 hour period suggests that even those comparatively unaffected by the crisis are bracing themselves for the possibility of sudden, large-scale, adverse changes. And that sort of gnawing worry seems to be growing in New York despite being buoyed by TARP funds and covert bank subsidies.

When out on my rounds the day before yesterday, I ran into an old McKinsey colleague, who had subsequently had impressively titled jobs in Big Firms You Heard Of before semi-retiring to manage family money. He and his very accomplished wife were big Bush donors and had been invited to both inaugurations.

He made short order of niceties and got to the point: “We need more fiscal stimulus. Obama did too little and too much of what he spent on was liberal pork. We could and need to spend a lot on infrastructure. This is looking a lot like 1936. I’m afraid it could get really ugly. And I’m particularly worried that the Republicans will win big this fall. They’ll cut even deeper, that’s the last thing we need right now.”

No I am not making this up, and yes, this is one of the last people I would have expected to express this line of thinking.

Next day, I had lunch with a two long standing, keen observers and participants in the New York scene, as in very involved in some of the city’s important institutions. Both have witnessed the shift in values over the last thirty years and the rising stratification, particularly at the top end (New York has always been plutocratic, but it formerly had a large upper middle class and a much smaller and much less isolated upper crust).

They started by commenting on my Bill Gross post, which had mentioned the appalling Steve Schwarzman contention that taxing private equity overlords more on their carried interest was like HItler invading Poland. Schwarzman is not only not retreating from his remark, he is convinced that the reason the economy is so lousy is that rich men like him are not getting their way (this is if anything an understatement of their account. Both men expect his head to be the first on a pike).

The conversation turned to whether the US was going towards revolution or fascism. One argued for the a continuation of trends underway: that the continuing weakness of the Obama Administration (and the discrediting of other members of the elite) meant there was a power vacuum. The obvious group to exploit it is the most strident, uncompromising opportunists, an area where the extreme right has a monopoly. The other, who has ben reading up on the French Revolutions. took issue with the conventional idea that a revolution is impossible in America: “In France, the trigger was that people were hungry. We are close to that point than most think.” He stressed the desensitization to violence (video games, more and more violence) plus widespread gun ownership. And he pointed to rising and underreported crime in the city, for instance, assaults of cab drivers.

He also noted that he believed that there were a lot of people (and he meant in the upper income strata) who were barely holding on, keeping up appearances, and hoping something would break their way. Some might get lucky, but most will hit the wall financially.

This was an engaging and lively conversation, but it you stepped back, the content was grim. Another thread was the decay in values, that there has been two generations of parents not setting boundaries for their children. One lives next to one of the elite private schools and likes children, but called those in his ‘hood as “monsters,” describing how a boy was beating up on his nanny and he had to intercede.

These data points don’t converge neatly, but they suggest a deep-rooted anxiety that economic and social structures are near a breaking point, and whatever comes next is not likely to be pretty.

That these types of conversations are going on is a good thing. Admitting you have a problem is the first step to solving it.

August 25, 2010

New Banks Needed #1

Filed under: Running Commentary — thefourteenthbanker @ 1:43 PM

This week news flow continues to indicate an economy that is significantly weakening from an already anemic activity level. There are wide-ranging destructive effects on every sector of the economy, households, businesses, and government. Some of these effects threaten to spiral into negative feedback loops causing further destruction and unpredictable outcomes from economic depression and attendant extreme unemployment, to deflation, to hyperinflation, to currency devaluation. All of these are possibilities. So what to do about it?

The current state of the society reflects the nature of society. I have posted before on the stratification of society into various interest groups which I have compared to the conditions before the revolution in France. We have profound ethical issues confronting us at every turn. There is a lack of trust. Cronyism here in America is alive and well.

Until we attack these underlying causes and conditions in a meaningful way, it is foolish to expect that we will have sustained economic recovery and general prosperity. The seriousness of the situation can be measured by our hopes. What we hope for is a little stimulus, a little inflation, a shift in exchange rates that will make exports more competitive, a return of the consumer to excessive spending, credit expansion. Are these the things that prosperity is made of? No!

Getting much attention in the news these days is the asset price cycle. The immediate manifestations are the recent sharp declines and possible further declines in the prices of residential and commercial property, the manic-depressive stock market, bond price bubbles and collapsing interest rates.

Amid this backdrop, one of the critical factors in an economic recovery will be the availability of credit to worthy businesses and investors. Already there are high net worth investors buying distressed property. Credit terms are tight and buying distressed property is still a risky investment. It is high risk with high potential reward. Facilitating these purchases are record low interest rates for super qualified borrowers. The opportunity for such returns, as usual, is for the rich. Those with idle cash have the opportunity to profit on the distress of others. Further stratification of wealth will be the inevitable result.

One blogger this week sought to find deeper solutions. Eric Haseltine suggests that we quit reacting to the panic of the moment and focus on building up our people in aggregate to create conditions for creative expansions.

Unless we overcome our temporal myopia, we’ll continue to put band-aids on this economy and it will continue to deteriorate: in other words, we’ll continue to treat symptoms and never go for a complete cure.

And what would such a cure look like? Let’s start by looking at disease that afflicts us. The fundamental problem with America’s economy is a decline in the capabilities and motivation of our workforce. True economic growth — not the artificial kind spurred by fiscal policy — stems from innovations such as Google’s search engine that create entirely new businesses and markets. Such innovations grow out of technological advances, which in turn emerge from earlier scientific discoveries.

Alan Greenspan, former Chairman of the Federal Reserve Bank, reinforced this idea when he said “Capitalism expands wealth primarily through creative destruction — the process by which the cash flow from obsolescent, low-return capital is invested in high-return, cutting-edge technologies.”

Ingrained in this approach is the requirement that creative destruction must be followed by investment in new technologies. That requires a functioning financial sector.

John Hussman agrees and fleshes out the arguments further in a previous market update.

If we as a nation fail to allow market discipline, to create incentives for research and development, to discourage speculative bubbles, to accumulate productive capital, and to maintain adequate educational achievement and human capital, the real wages of U.S. workers will slide toward those of developing economies. The real income of a nation is identical its real output – one cannot grow independent of the other.

Again, note that we must accumulate productive capital. This is a function of effective financial intermediation. Too much financial intermediation has been directed to speculative activity benefitting from market volatility and to the creation and sale of complex and opaque financial instruments that allow high profits from the lack of developed competitive markets and exchanges and frankly the ignorance of the buyers of these instruments. This is exploitative and is not productive capital formation.

So do we regulate such banks or do we start new ones? The first question is, can the banking sector, if it even chose to, provide for the capital needs of the economy. This point/counterpoint article addresses just that, among other topics of the day.

Mish Shedlock in citing the Jerome Levy Forecasting Center and agrees with but refines these particular points in the linked article.

There are various theoretical reasons given for the liquidity trap, but let’s just focus on what is happening now and what is likely to happen in the years ahead. Presently, excess reserves are not inducing lending for several reasons, and adding to them further will not make much difference.

  • First of all, banks are capital constrained, not reserve constrained.
  • Second, interest rates could not fall far enough during this business cycle to enable troubled debtors to refinance their way out of trouble, so now banks remain worried about the volumes of bad debt they are carrying and how future loan losses will impinge on earnings and capital.
  • Third, deflationary expectations are beginning to work their way into banks’ loan evaluation process on a micro level; in more and more areas, loan officers are looking at households with shrinking incomes and firms with deflating revenues.
  • Fourth, the private sector has too much debt, and many households and firms are trying to reduce debt, especially as more of them worry about deflation in their own incomes or revenues.

Point numbers one and two above are key factors in the financial intermediation part of this economic problem. Banks are capital constrained. Balance sheets are loaded up with problem debt. Future losses are embedded in booked exposures. The banking sector is not sufficiently healthy to support economic expansion or to reverse deflationary pressures.

So the question is how do we evolve? The government has propped up the banking sector, believing systemic impacts of bank failures would trigger a tidal wave of further liquidity contraction and trigger depression. The propping up has not worked. Yes, it has prevented a massive financial system collapse, but it has not supported economic growth. We need creative destruction in the banking sector. Let these existing banks reap the rewards of their policies. Create new banks with new fresh capital, unencumbered by toxic assets, headed by wise risk managers, but ready to lend. The FDIC may not like this because they do not want new competitors to pressure earnings of existing institutions. But the piddling cost of bank resolutions is nothing compared to the destruction of value in a squeezed economy. Fund up the FDIC and let these banks trickle towards failure. If new institutions are in place and ready to go, asset prices will reach clearing level and new investment will recycle assets into productive use. Many assets are already at or near clearing levels. As I said before, high net worth individuals are buying distressed assets. If you combine this recycling with vibrant human capital and a new sense of optimism, now there is something to work with.

The new banks could also have new business models that are supportive rather than exploitative. But that is for another post.

August 23, 2010

Rethinking Homeownership

Filed under: Running Commentary — thefourteenthbanker @ 1:11 AM

It has been a rough three years. Most Americans have lost a lot of their financial security. Small investors are abandoning the stock market. The assumption that homeownership is a great investment is out the window for now. Regardless of whether home prices resume their upward climb, Americans may choose to be more conservative in how much house they choose to buy. These are perfectly rational choices to make given recent history. However, people should think twice before choosing to be long-term renters. Why? First, the Federal Government has pushed interest rates to multi decade lows. The Federal Reserve is actively buying bonds out the yield curve in order to push borrowing costs down even further. Home prices had adjusted sharply downward and these two things combined have made homeownership more affordable. But that is not the prime reason to own a house today.

Here is my fear. I fear that the people who were really hurt in this stock market and housing bust will end up getting hammered again. Choosing not to invest in stocks may be wise. However, anyone who piles into bonds at this point risks really losing a lot of value when rates rise again. Note this NYT piece about a potential bond bubble, like the bubble or the housing bubble. Bubbles burst. If you are buying bonds you are basically betting that either the US is going into Japanese style long-term stagnation or that you can outsmart Wall Street and sell the bonds again before they do. That is playing with a loaded gun. When they sell their bonds, you will lose.

From the article:

Those who are now crowding into bonds and bond funds are courting disaster. The last time interest rates on Treasury bonds were as low as they are today was in 1955. The subsequent 10-year annual return to bonds was 1.9%, or just slightly above inflation, and the 30-year annual return was 4.6% per year, less than the rate of inflation.

Furthermore, the possibility of substantial capital losses on bonds looms large. If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?

This does not project what will happen if we move into a dollar devaluation scenario or if buyers quit purchasing the mass issuance of government debt. Rates can move much more dramatically.

Renting is a pretty good deal right now and may be for several years. But, if inflation comes, renters will not be spared. Many economists, and I trust the bloggers the most, believe we will suffer a period of deflationary pressures and then the debt burden on the US Government will become so large and the structural deficits so uncontrollable that there will effectively be a devaluation of the dollar through money supply creation and inflation in prices. If this happens, it will drive up interest rates as well as  home prices. Rents will follow. If, on the other hand, the deficit is not as large as expected, that will primarily result from an economy that is stronger than expected and therefore has driven tax revenues up. In either case, interest rates rise. In either case, bond investors take capital losses from today’s levels and the price of either home ownership or rent goes up, perhaps dramatically.

So what to do? If you are in that group that was already in bond funds prior to the last few weeks, you have some profit built-in. For those investing in bonds today, beware. The math does not work in your favor unless economic growth stays down long-term and the government can negotiate through its high debt levels without the markets reacting. To me those combined scenarios are low probability. Not impossible, but low probability.

From a housing standpoint, if you are one that currently does not own and has lost confidence in home prices, and would be a long-term occupant in your particular circumstances, think about the range of possibilities. What if inflation was 5% per year, mortgage rates went back to the 6-8% historical range, and the cost of your rent (probably artificially low in most places right now, went up 10% then 5% per year. Then five years from now you were looking at buying a house. How much would your payment be compared to if you bought today? How much would your future rent be compared to a payment locked in at today’s low interest rates. How much would having your long term cost locked be worth to you in a day of fiat currencies? Try to assign probabilities to the different scenarios and make your decisions. Maybe it is still worth staying flexible. Just know the risks.

Don’t just go with the flow.

August 20, 2010

Finance as Dictator

Filed under: Running Commentary — thefourteenthbanker @ 3:18 PM

This very insightful piece from Naked Capitalism resonates.  The source for Yves comments is a new book, out in two weeks, titled A Call for Judgement, by Amar Bhide of Harvard Business School. Yes, some good things do come out of Harvard Business School, just not in the years that produced most of today’s CEOs.

Yves titles her piece the Stalinization of Finance. I did not want to copy that title exactly, but did want to echo the essence. Finance occupies a unique space in our culture. It has often been a force for good, generally when it exercises good judgement. It can be a force for harm when it becomes unbalanced, unwholesome. Was it ever really wholesome? I don’t know. But I know it was more wholesome than it is today. Generally speaking, Finance has the promise of allocating resources more efficiently than if there were no Finance. It serves an intermediary function. That function should display attributes of moderation. As an intermediary, the profits should be moderate and stable. When the expectation is that Finance intermediates and “greases the gears of commerce”, it behaves in a certain manner. When causes and conditions are such that it becomes an ends in itself, rather than a fairly compensated means for the greater society, it behaves in a different, less civil manner.

One of the ways this occurs is discussed in the Naked Capitalism introduction and the Harvard Business Review article referencing the book. The grasping for ever-increasing revenue with ever decreasing costs created a system of centralization of decision-making, standardization of product around the dictates of the securitization market, and a dependence on statistics and assumptions to make all that work. Which, in case you didn’t notice, failed.

So back to the titles. Stalin was a dictator, governing a land that was supposed to be class-less and in which all were to have an equal voice. In fact, the class-less-ness and equal voice parts were an illusion, much as US democracy has become an illusion. We do not have a Stalin in power, but we do have oligarchs and kleptocrats.

Oligarchs become oligarchs by the concentration of power. Developments in Finance served to facilitate that concentration of power, sometimes in surprising ways. For example, why should the failure of the financial system increase the concentration of power in the financial system? Simply because Big Finance controlled the refs. When Finance was down on the mat, instead of counting them out in 10, the boxing ref gave them an adrenaline shot, B-12, a cold towel, a boost up, a seat in the corner, put the mouth guard back in, winked and said, “go get ’em, tiger!”

I digress. Perhaps we should address the dehumanization of finance. Here is Yves:

I’ve decried the fact that shifting lending from loan officers in branches to standardized, score-based templates resulted in considerable loss of information: face to face assessment of the borrower (does he understand what he is getting into? Does he regard the loan as a serious commitment?) and knowledge of the community (How healthy is his employer? What is the outlook for the local economy?)

Not specifically mentioned but  implicit in this description is the loss of relationship between borrower and lender and the corresponding loss of considerations of the best interests of the borrower. All that is left is the grasping part of the exchange, sometimes on the part of all parties.

From Bhide is a description of the mechanisms by which all this is done:

Over the past several decades, centralized, mechanistic finance elbowed aside the traditional model. Loan officers made way for mortgage brokers. At the height of the housing boom, in 2004, some 53,000 mortgage brokerage companies, with an estimated 418,700 employees, originated 68% of all residential loans in the United States. In other words, fewer than a third of all loans were originated by an actual lender. The brokers’ role in the credit process is mainly to help applicants fill out forms. In fact, hardly anyone now makes case-by-case mortgage credit judgments. Mortgages are granted or denied (and new mortgage products like option ARMs are designed) using complex models that are conjured up by a small number of faraway rocket scientists and take little heed of the specific facts on the ground….

and consequences at the individual level:

The replacement of ongoing relationships with securitized, arm’s-length contracting has fundamentally impaired the adaptability of financing terms. No contract can anticipate all contingencies. But securitized financing makes ongoing adaptations infeasible; because of the great difficulty of renegotiating terms, borrowers and lenders must adhere to the deal that was struck at the outset. Securitized mortgages are more likely than mortgages retained by banks to be foreclosed if borrowers fall behind on their payments, as recent research shows.

and the systemic consequences:

When decision making is centralized in the hands of a small number of bankers, financial institutions, or quantitative models, their mistakes imperil the well-being of individuals and businesses throughout the economy. Decentralized finance isn’t immune to systemic risk; individual financiers may follow the crowd in lowering down payments for home loans, for instance. But this behavior involves a social pathology. With centralized authority, the process requires no widespread mania—just a few errant lending models or a couple of CEOs who have a limited grasp of the risks taken by subordinates.

So this will be a book worth reading to see if it provides clues to the way out of this morass. I suspect it may. Whatever that may be, we as people need to realize that by our own grasping we have laid the axe at our own root. Whether it is buying the cheapest goods from China in place of US produced goods, or finding the cheapest loan regardless of any relationship we have with a bank, , or eating inexpensive but heavily processed non nutritious foods, we have in the end paid a far greater price than the dimes we saved in the process. The ultimate solution will require more discriminating consumers, who exercise choice based on their values. Liberating.

August 18, 2010

Somebody is Waking Up on the Legal Front

Filed under: Running Commentary — thefourteenthbanker @ 7:55 AM

Finally the Judicial system, the lone branch of government that does not have to sell-out for its job security, is waking up. The decision highlights the relatively innocuous headline on Bloomberg, “Barklays Follows Citigroup With Court Rejection of US Accord”.  What the heck does the mean?  I nominate that for worst headline of the day.  Here is the meat:

In yesterday’s hearing, Sullivan said the Barclays settlement “concerns the court.” Unlike the London-based firm, the average American caught robbing a bank doesn’t get deferred prosecution and the option of returning ill-gotten gains, he said.

Let’s hear it for the judge! Someone “gets it”. There is a trend, still timid, towards “getting it”. These are small but meaningful steps. The courts are starting to reject the sweetheart deals that allow banks and other firms to pay back a small portion of their ill-gotten profits from illegal activities. In some cases the settlements are obscene and are met with celebration by the guilty parties. But perhaps the days of those celebrations are ending.

Perhaps the days of hiding behind the corporate shield will be ending soon as well. Individual prosecutions must follow corporate prosecutions.

U.S. agencies and prosecutors, taking note of the decisions, will begin trying harder to deliver the executives responsible for misconduct, Doty said.

In one of the more obscene settlements, a former Citigroup CFO, still in a lucrative position with the firm, paid back a measly $80,000 in fines for deliberately misleading investors.

Former Chief Financial Officer Gary Crittenden, who left New York-based Citigroup last year, agreed to pay $100,000 to settle claims he didn’t disclose the risk after getting internal briefings.Arthur Tildesley, Citigroup’s former head of investor relations, will pay $80,000 to settle claims that he helped draft disclosures that misled investors, the SEC said. Tildesley now heads cross-marketing at Citigroup, according to the agency.

The matter was administrative, not criminal. See the SEC filing for details. The penalties for robbing the people must be stepped up with greater individual accountability and in appropriate cases, where there would be many, jail time. As highlighted in this prior post, the current criminal system remains biased against smaller property crime and in favor of major white-collar crimes that are clearly larceny on a greater scale.  Note also this, and this, and this.

August 16, 2010

More Talk of Revolution

Filed under: Running Commentary — thefourteenthbanker @ 8:44 PM

Outside the beltway, members of both major parties agree, America is bust. Both liberal and conservative principles have been completely obliterated by the current First and Second Estates, who have no loyalty except to their own interests.  This is the stuff of revolution. Paul Craig Roberts of the Reagan years describes the conundrum accurately, adding his voice to David Stockman’s, then drives home the emergency measures to prevent an implosion. What is interesting on both cases is that while some vestiges of their prior political leanings remain, the crisis of today rises above political philosophy and traditional party lines. The class war is against the American people who I refer to as the Third Estate. It is a war for plunder. Roberts:

To borrow from Lenin, “What can be done?”

Here is what can be done. The wars, which benefit no one but the military-security complex and Israel’s territorial expansion, can be immediately ended. This would reduce the US budget deficit by hundreds of billions of dollars per year.  More hundreds of billions of dollars could be saved by cutting the rest of the military budget which, in its present size, exceeds the budgets of all the serious military powers on earth combined.

US military spending reflects the unaffordable and unattainable crazed neoconservative  goal of US Empire and world hegemony. What fool in Washington thinks that China is going to finance US hegemony over China?

The only way that the US will again have an economy is by bringing back the offshored jobs. The loss of these jobs impoverished Americans while producing oversized gains for Wall Street, shareholders, and corporate executives. These jobs can be brought home where they belong by taxing corporations according to where value is added to their product. If value is added to their goods and services in China, corporations would have a high tax rate. If value is added to their goods and services in the US, corporations would have a low tax rate.

This change in corporate taxation would offset the cheap foreign labor that has sucked jobs out of America, and it would rebuild the ladders of upward mobility that made America an opportunity society.

If the wars are not immediately stopped and the jobs brought back to America, the US is relegated to the trash bin of history.

President Obama continues under the influence of the mystic Rasputian trio, Ben Bernanke, Larry Summers, and Timothy Geithner. When will Obama realize that he has been beguiled?

His first act of independence can be to appoint Elizabeth Warren and tell her to “sic em”.

August 14, 2010

You Can’t Hide Those Lying Eyes

Filed under: Running Commentary — thefourteenthbanker @ 10:24 AM

This Stanford Paper is absolute gold.  The full paper is attached as Stanford Paper on Deceit.  Huffington Post summary is here.

The paper is brilliant work in its own right.  It focuses on what CEOs say in investor conference calls and how they say it.  How they say it provides psychological linguistic clues into whether they are lying or not.

But that is not what immediately struck me about this paper. What struck me is that the described behavior also happens in a thousand staff meetings throughout the organizations. And is encouraged. Now that is not to say that in organizations such as big banks the use of such lying is pervasive. The subtleties of the question have to do with what is versus what is becoming.

Almost every big organization is run as if it were the sum of its component internal financials. Since management is inspecting these results just as closely as investors inspect the firms consolidated numbers, draw their perceptions and dole out the rewards on that same basis, would not the same deceitful dynamics occur in those contexts as well? In fact, would certain organizations that were more likely to make judgements and determine rewards on the basis of such internal financials be more likely to have deceit in the ranks, effectively making it viral? Might this be part of the answer to the great “WHY” of the financial crisis?

In the classic investor conference call, the CEO and CFO and perhaps on or two others are clearly in charge of the call and dispense the right to question to specific reporters much like the President at an East Wing press conference. Lower in the organization, in the hypothetical staff meeting, the meeting CEO is the inquisitor. They ask the question about divisional performance and have the opportunity to cross-examine, should they choose to do so. In this format the requisite skill is exactly the same. If a divisional manager is skilled at producing deceitful numbers and skilled at lying about the substance behind those numbers, they are rewarded with a higher personal “share price”. The actual deceit can take many forms. In the case of a BP, the on site managers might have adopted deceitful practices that were not officially sanctioned by upper management, but were unofficially mandatory with the financial reviews being the mediating mechanism.  Cutting corners, dumping fluids, falsifying reports, taking risks…. When the project financials rolled up these things would have created better numbers than otherwise, and if the manager could declare it was their excellent management practice that produced such better results, then they have achieved the same as the lying CEO has attempted.

Work such as this analysis, properly used, might provide the foundation for correction of certain behavioral aspects of systemic risk by deconstructing the dysfunctional corporate management systems in place today. Elizabeth Warren and other regulators should take note of the need to address such matters in their Financial Regulation implementation.

August 11, 2010

Uncounted Human Cost of Food Speculation

Filed under: Running Commentary — thefourteenthbanker @ 7:27 AM

As the market prepares another nose dive today, the world just becoming aware of the potential for Crisis II, we should not forget the costs of Crisis I. Crisis I was preceded by unprecedented asset speculation across all classes of assets including agricultural commodities. In the United States, that meant paying and extra dollar for a gallon of milk, a loaf of bread. In the third world, that meant poverty and starvation. While traders on Wall Street drank their daily success at the swanky New York watering holes, and followed up with dinner at 5 star restaurants, those impoverished by the resultant cost of food grieved their dead. This is no exaggeration.  Please read or watch the interview captured in this link.

August 10, 2010

Not a Good Corporate Soldier

Filed under: Running Commentary — thefourteenthbanker @ 6:36 PM

This article illustrates what is wrong with corporate America today.  If you don’t support the corporate instinct to gouge, you are not a good soldier.

Leslie Margolin, who recently resigned as president of Anthem Blue Cross in California, isspeaking out against a plan put forth by the health insurance company earlier this year to increase the cost of individual coverage plans by as much as 39 percent.

Margolin claims she urged the insurance giant to reconsider its intention to spike its rates and to explore alternative solutions to lower the cost of care, the Los Angeles Times reports.

“I thought the rates were too high,” explained the former Blue Cross president. “I thought the impact on our membership was too significant.”

We need more executives to speak up, then speak out.  Assuming these facts are correct, thanks are due to Margolin for being a good citizen, if not a good soldier.

“Her undoing was that she rocked the boat and wanted to do things a different way,” said the individual, who spoke on the condition of anonymity. “She wasn’t a good corporate soldier.”

Second Estate Issues

Filed under: Running Commentary — thefourteenthbanker @ 7:53 AM

The Second Estate, government, has de-linked itself somewhat naively from the Third Estate, the broader private sector public.

This is the situation we find ourselves in according to Mish.  Public Pensions are becoming such a burden on the state and taxpayers and are so disproportionate with taxpayer retirement security that conflict is sure to erupt.

I’m not saying that trusting government employees are any less screwed than the rest of us. They depended on future promises that are contingent on general prosperity. The politicians squandered the money in the good years and over-promised to curry favor. What is new?

Further Alarm Bells Ringing Faintly

Filed under: Running Commentary — thefourteenthbanker @ 7:32 AM

Yahoo posted an article today.  Nothing new.  Just a rehash of the situation of income and discretionary resource concentration at the top.

The data may be a further sign that the U.S. is becoming a plutonomy–an economy dependent on the spending and investing of the wealthy. And plutonomies are far less stable than economies built on more evenly distributed income and mass consumption. “I don’t think it’s healthy for the economy to be so dependent on the top 2% of the income distribution,” Mr. Zandi said. He added that, “In the near term it highlights the fragility of the recovery.”

In fact, the recent spending of the wealthy may be unsustainable. Their savings rate has gone from more than 26% in 2008 to a negative 7% in the first quarter of 2010, according to the Moody’s Analytics data. They still have lots of savings. But the massive draw on that in the past two years is unlikely to continue at the same pace.

“I think we’re already seeing a slowdown in spending by this group,” Mr. Zandi says.

And that should be a worry for all of us.

August 8, 2010

Big Problems Require Out of the Box Thinking

Filed under: Running Commentary — thefourteenthbanker @ 3:26 PM

This week, very late in the game, the big banks revised down their economic growth forecasts. Bloggers (which many times means economists that are not on the paid staff of corporations or the government) have been predicting this for perhaps six months. Of course, getting people to buy financial instruments generally requires a certain optimism.

We are at a point where ordinary policy prescriptions seem fruitless. Take for example this post by Gonzalo Lira, which points out exactly that fact. After a long and commendable preamble, Gonzalo has some suggestions for drastic steps. For example:

If I were absolute dictator of the United States, I would ignore both of these policy “choices”. Instead, for the sake of the long term health of the American economy, and the other world economies intimately connected to it, this is what I would do:

•Allow interest rates to float at the whim of supply and demand. The Fed would provide liquidity, but only at market rates, never subsidized.

•Impose a flat tax across the board of 15% for individuals earning any income over the minimum wage, 25% for corporations, a 20% national VAT, and impose a capital gains tax of 40%, with no loopholes, subsidies, tax breaks or tax write-offs—not even amortization or depreciation.

•Cut government spending to the bare bones, until the budget is balanced. Cut military spending to 10% of what it is today.

•Eliminate Social Security and Medicare/Medicaid, and impose a private but highly regulated pension and health care system, like the ones here in Chile (which are damned good, BTW, and which were also, unsurprisingly, imposed by a dictator—but are still going strong 20 years after he left)

•Cut the Fed’s life-support of the Too Big To Fail banking system, and let those zombies die already. While we’re at it, prosecute the banksters.

•Finally—and this is the tough part—let the economy crash: Let the asset prices collapse to sustainable levels, and let aggregate demand collapse to sustainable levels.

If the above measures were imposed, and the U.S. economy were allowed to crash quickly, harshly, unemployment as measured by U-6 would spike to 50% or 60%, and hang around 35% for a good six months before slowly settling to 20% in a year or so—which is where we are now. Half the S&P and all the Too Big To Fail banks would go broke. Imports would evaporate. The idea of America as a consumer society would be gone almost overnight. There’d also be riots and general civil unrest for a year or two, but nothing that terrible—Americans are a remarkably docile people.

What would happen after that? What would the U.S. get for this short-term pain and suffering?

The two thing needed for true long-term prosperity, from where the U.S. economy is today: Asset price levels would collapse. And aggregate demand levels would also collapse.

It would mean that trading—in whatever assets—would cease to be financially beneficial, and instead production would reassert itself as the form of social wealth creation.

It would also mean that mindlessly consuming would also cease to be a macroeconomically beneficial policy priority, much less a personal goal. It might even lead to a truly Green economic mentality—true conservation, as opposed to the pseudo-brand, where buying more and more “green” stuff is supposed to be “helping the environment”, when of course it isn’t.

These measures would all be very painful—adaptation always is. But this approach—what I would call Free Market Redux—would be the healthiest way to rebuild the U.S. economy, and frankly American society.

While these particular prescriptions are just some of many options, what strikes me is that to implement them requires a disregard of the current powers that be, the First and Second Estates. There would be fallout and it would hit those classes.

Our own Jerry J made another suggestion in a comment a couple days ago, which also strikes at the heart of the current power structure, albeit in a different way.

I am surprised that there were no comments on the obsolete character of the American Third Estate. This relates to the link by 14th to a Salon column by Michael Lind titled ” Are the American People Obsolete” by Michael Lind.

Lind sees that Americans will allow outsourcing of employment to their absolute detriment and that Americans no longer have the ability to sustain marketing of goods and services in the US. He is correct but omits a massive parameter. What are the per capita parameters of all US sourced claims on persons , corporations, states and state units? Similarly, what are the same parameters applied to other states that would replace future marketing of goods and services sought by the US population?

No matter what, first estate wealth survival requires the generation of personal income to amortize the claims on these US persons and groups over and above some personal income level to enable the desire to amortize the claims over a number of generations.

The elites destroy themselves. In doing so, they collapse the existing system. If the third estate is obsolete, then the third estate could politically cause all debts to be forgiven as well. Our kind of Terror could be via currency. Easily done constitutionally. Probably as easy as the Weimar Enabling Act of 1933. Congress may grant sums to the citizen. Congress say, authorizes United States Notes again. Grant each citizen United States Notes as universal legal tender. Pick up the money at the post office. How about a grant to natural citizens of $2 million each. The posting of the money at a central point forces issuance of say a mortgage release. The elites and their institutions then have all cash in the form of US Notes they can spend. Almost all are free and clear and own their assets outright. Obsolete is obsolete. Ha Ha, I could not resist this one. Sounds ludicrous? Why, if the natural person American national is obsolete from a discussion point? For years now, the right wing has been saying the US government cannot pay back it’s debt when , in point of practical fact,government debt functions as a currency form at the top. All that prevents full circulation is the fact that Treasuries are registered. Registry is only around 35 years old. Before that most Treasuries were bearer as were corporate debentures. Amend the IRC and remove the registry requirement.

Seriously, the always ignored aspect in these types of commentary is that elite wealth almost totally depends on claims from other Americans. Indeed, the shoe is on our foot because we owe trillions to the other nations who would wind up with legal tender too!

The elites are simply destroying themselves in the US: In a fashion that is remarkably close to broad spectrum Marxist expectations.

Comrades come rally…………..?

Again, this prescription defies conventional wisdom. To sum it up, everyone is given a pile of cash with which they then use to repay in full all their indebtedness to the elites. The elites then have a pile of worthless money and everyone else is debt free and has no more house payments. Instead of the Feds inflating its way out of its debt in a way that is carefully formulated to preserve the First Estate, it does so in a way that liberates the Third. Interesting thought experiment. In the resultant turmoil a lot of people get hurt, but it is not only the Third Estate. A lot of people are helped. The reformulation of the economy would create enormous economic activity.

I put these thoughts out only to point out that we have self-limiting economic beliefs that foreclose almost any option other than the slow rot of our system by the protection of the status quo. Economic suckers all, we realize not that our prosperity has already been outsourced by the very transnational companies and their executives that cry out, “Free Enterprise, Free Enterprise!”, a sort of revealed wisdom myth that they use to their advantage while ensuring their personal security by looting the system.

Nothing should be done in haste. But Washington should adopt a new credo. Listen to the radicals. Listen to the people. Listen to the elites and then give their point of view no more credence than the others. Standing in the way? Our system of non-representative government where gerrymandered incumbents don’t really have to deal with free elections. From our Declaration of Independence:

That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness.

Our system of government could restore its promise. In gerrymandering districts our states have done a huge disservice to the people of this nation. The trading off of one minority seat for five majority seats may have once served a purpose, now it has been abused.  Brave judges should throw out the principle underlying the design of congressional districts by elites. Every seat should be up for grabs in free and fair elections. If the populace had the opportunity to drive major change in the House of Representatives, perhaps 200 new members instead of 50 with party shifts in 150 districts, then the government would be more responsive to the people. That was how it was designed to be. The Senate provided the term stability. The House was responsive to the current mood of the country. The White House and Judiciary provided checks and balances. Now seats are sold out. Further, hindrances to third and fourth parties should be abolished. A multi party system would bring greater diversity of thought to Washington.

August 3, 2010

Qu’est-ce que le tiers-état?

Filed under: Running Commentary — thefourteenthbanker @ 9:20 PM

During the Ancien Régime, prior to the French Revolution, society was divided into these three classes (or Estates).

First Estate

The first Estate comprised the entire clergy, traditionally divided into “higher” and “lower” clergy. Although there was no formal demarcation between the two categories, the upper clergy were, effectively, clerical nobility, from the families of the Second Estate. In the time of Louis XVI, every bishop in France was a nobleman, a situation that had not existed before the 18th century.[1] At the other extreme, the “lower clergy” ( about equally divided between parish priests andmonks and nuns) constituted about 90 percent of the First Estate, which in 1789 numbered around 130,000 (about 0.5% of the population).

In principle, the responsibilities of the First Estate included the registration of births, marriages and deaths. They collected the tithe (dîme, usually 10 percent); served as moral guides; operated schools and hospitals; and distributed relief to the poor. They also owned 10 percent of all the land in France, which was exempt from property tax.[1] The church did however pay the state a so-called “free gift” known as a don gratuit, which was collected via the décime, a tax on ecclesiastic offices.

The French inheritance system of primogeniture meant that nearly all French fortunes would pass largely in a single line, through the eldest son. Hence, it became very common for second sons to join the clergy. Although some dedicated churchmen came out of this system, much of the higher clergy continued to live the lives of aristocrats, enjoying the wealth derived from church lands and tithes and, in some cases, paying little or no attention to their pastoral duties. The ostentatious wealth of the higher clergy was, no doubt, partly responsible for the widespreadanticlericalism in France, dating back as far as the Middle Ages, and was certainly responsible for the element of class resentment within the anticlericalism of many peasants and wage-earners.

The first estates had to pay no taxes to the second and third estates.

Second Estate

The Second Estate (Fr. deuxieme état) was the French nobility and (technically, though not in common use) royalty, other than the monarch himself, who stood outside of the system of estates.

The Second Estate is traditionally divided into noblesse de robe (“nobility of the robe”), the magisterial class that administered royal justice and civil government, and noblesse d’épée (“nobility of the sword”).

The Second Estate constituted approximately 1.5% of France’s population. Under the ancien régime, the Second Estate were exempt from the corvée royale (forced labour on the roads) and from most other forms of taxation such as the gabelle (salt tax) and most important, the taille (the oldest form of direct taxation). This exemption from paying taxes led to their reluctance to reform.

Third Estate

The Third Estate was the generality of people which were not part of the other estates.

The Third Estate comprised all those not members of the above and can be divided into two groups, urban and rural. The urban included the bourgeoisie 8% of France’s population, as well as wage-laborers (such as craftsmen). The rural includes the peasantry, or the farming class (about 90% of the population). The Third Estate includes some of what would now be considered middle class—e.g., the budding town bourgeoisie. What united the Third Estate is that most had little or no wealth and yet were forced to pay disproportionately high taxes to the other Estates.

So what does this have to do with America today?  As a free post revolutionary society we have cast off the notions of nobility. While the clergy are influential, they are not a class of their own with greatly disproportionate power and privilege as during the Ancien Régime. Nor are they homogeneous in their points of view. Yet, it seems to me that this basic class structure is taking shape. For some time I have been trying to determine in our modern society which would be most analogous to the First and Second Estates of France. Here is my go at it:

The First Estate consists of the individuals that control the entrenched large corporations, including banks, that dominate the modern economy. These are a priestly class. This Estate bears resemblance to the First Estate of the Ancien Régime in the following ways. The individuals are often from America’s entrenched wealth and the continuation of their power is contingent on maintaining the established order with minimal changes. They use their power to grant special privileges, such as the low tax rates owed by Hedge Fund managers, the evasion of criminal consequences for their conduct, and their special influence over the Second Estate. Further, like the clergy of old, they are often held up as role models, moral guides, and chief benefactors of many charities and political candidates. The First Estate are also the keepers of the mystery of Neo-Liberal Economics. All threats to their power are shrugged off as socialism, a form of heresy. The First Estate is also supported by most vocal and politically organized of the clergy in the West.

The Second Estate consists of the government. This is fitting in that the government originally had a role of benevolent rule combined with special obligations and sacrifices.  In early France, the nobles were entrusted with governing authority, but it also fell on them to raise armies and fund wars from their own purse. So with authority came sacrifice. The nobles owned much of the land and had the power to extract rents and levy taxes on other landowners. But in return they had to provide sound local administration. By the eighteenth century the nobles had either left for Paris or those left in the country had degenerated into petty oligarchs. At one time the nobility had lived among the ordinary people, related to them with both empathy and responsibility and felt their fates tied to the fate of the Third Estate. Today’s US Government is a second part of the power axis, hand in hand with the First Estate in ruling over the average citizen.  The Second Estate is becoming more and more corrupt as shown in innumerable headlines and this insightful piece today. The Second Estate shuns those that would return the government to its rightful role in society, such as Elizabeth Warren. It heeds not the calls of the Third Estate for such a reformer.

The Third Estate consists of the rest of us. As in the Ancien Régime, this largest of classes includes academics, writers, most professionals, laborers, craftsmen, etc. As during the Ancien Régime, this class pays a disproportionate share of the taxes and receive no special benefits.  W-2 wage-earners get creamed. Most have no defined pension plan, pay ever more for their health care, and have little political clout. Like before the French Revolution, these citizens are divided and do not know their common interests. They are becoming impoverished by the deflation of their most important assets, declining personal income, and inflation in staples. Further, The Third Estate is becoming obsolete at the whim of the First, which is a dangerous mix, because like the French Third Estate, we have an inextinguishable hatred for inequality.

These are only some similarities and are meant to provide a paradigm for thinking about the structure of power in this country. Some will point out that there are huge and obvious differences that historians can comment on at length. It is not the differences that concern me, it is the similarities. One of the differences is that this is so large and diverse a country that it may not be possible for the Third Estate to assemble in any meaningful way. Of course, that is what the nobility thought in France as well. De Tocqueville, no supporter of the Revolution, stated that:

When the middle classes has thus been isolated from the nobleman and the peasant from them both, when a similar process persisted at the heart of each class itself and small individual groupings had formed in the Center of each of them, almost as isolated from each other as the three classes were between themselves, then it was found that the whole nation was no longer anything more than one homogeneous mass whose parts were, however, no longer linked together (paradoxically) Nothing was arranged any longer to hinder the government any more than it was to shore it up. The result was that the whole structure of the King’s greatness could collapse together and at once, as soon as the society which served as its foundation started to tremble.

So the question in the title is translated, “What is the Third Estate?” from a pamphlet of the time that argued that the Third Estate was a complete nation and did not need the dead weight of the privileged classes. The government should not allow this idea to take hold. To prevent it more bold steps are required, including the appointment of Elizabeth Warren.

August 2, 2010

The Last Export

Filed under: Running Commentary — thefourteenthbanker @ 4:06 PM

Several prominent leaders convened to address the problem of lost US jobs and the perfect solution, which is to restore exports to their ancient prominence in the American economy. Attending the meeting were President Barack Obama, Governor Jan Brewer, Treasury Secretary Tim Geithner, Fed Chief Ben Bernanke, former Governor of Alaska Sarah Palin, and head of Goldman Sachs, Lloyd Blankfein.

Discussion was held:

Obama: “As a nation we have a huge problem. Persistent joblessness, a faltering economy, and the endless war in Vietnam, Afghanistan are producing annoying headlines and threatening the agenda I promised to deliver when I was elected.”

Brewer: “Mr. President, I believe we should start with the Mexicans. They are only drug mules anyway. They make no meaningful contribution to society, they bring in drugs, drink our water, use our toilets instead of cleaning them, and generally are the lowest class of immigrant population we have had in the history of this nation. And then Mr. President, we should export our values. America is the land of the free and the home of the brave, and we should export that to the world. They would gladly pay us for it. Mr. President, would you support us in court?”

Obama: “Jane…”

Brewer: “It’s Jan”

Geithner: “Mr. President, I believe we should export the dollar. I can print these at almost zero cost. If we export enough dollars, the rest of the world would have enough money to travel to the US and support our tourism business. It would give a boost to the cheap Arizonian hotels that used to house Mexicans.”

Obama: “These are really great ideas. But I have an even better one.Let’s export guns. This is the one competitive manufacturing industry we have left. My supporters at Boeing, Raytheon and Northrup say they can sell guns out the whazoo.”

Palin: “It’s wazoo, Mr. President. I know that one.”

Brewer: “Perfect Mr. President! To spur demand we should export hate! With enough hate there will be endless demand for guns”.

Obama: “Genius Ms. Brewer! What a great meeting!”

Geithner: “Mr. President, I was not done! At the Treasury we also have a lot of gold, tons of it! I believe we should export our gold.”

Bernanke: “Timothy, you are on to something, but if you export the gold how will they pay for it. If they buy it with dollars, you will have immunized your dollar export program and prevented the necessary increases in the money supply. Let’s hoard the gold and instead we can export bonds. I have even more bonds than you have gold!

Blankfein: “I can help with that”

Geithner: “No you don’t! I have more gold!

Brewer: “I have a lot of xenophobia we can export. xenophobia helps with hate and that helps with guns!”

Palin: “You guys are on the wrong track. We should export oil. In my home state of Alaska we have more oil than you have bonds. All we have to do is drill for it and build a pipeline across the Bering Straights to Russia. You can see Russia from Alaska you know. As I said before, “Alaska has a very narrow maritime border between a foreign country, Russia, and, on our other side, the land-boundry that we have with Canada. It’s funny..”

Obama: “Sarah!

Palin: “our next-door neighbors are foreign countries..”

Blankfein: “We love foreign countries!”

Palin: “As Putin rears his head and comes into the air space of the United States of America, where do they go? It’s Alaska. It’s just right over the border. When he comes in we can just shove that oil pipeline us his bum and crank the spigot. Kill two birds with one stone, you know. I love to kill birds. And when we drill, we can kill moose too. I love to kill moose!”

Bernanke: “We just marked up our bonds. Now is the time to dump them. If we export the bonds, we won’t have to tell them about the Red Roof Inns we have in Arizona, they will just be lost in the pool of assets.”

Blankfein: “That’s how we do it.”

Obama: “So that settles it. Here is the battle plan. First we export xenophobia to prepare foreign nations for hate. Then we sprinkle on the hate and sell them guns. Geithner exports dollars for them to buy the guns. We use Blankenfein..”

Blankfein: “It’s Blankfein, sir”

Obama: Sorry Blankenfein Blankfein, we use Blankfein to dump the bonds but that is a side operation. The next big operation is the oil pipeline through Putin, er Alaska, WHATEVER! THE DAMN PIPELINE THROUGH RUSSIA! JESUS!

Brewer: What about the Mexicans, sir? You forgot the Mexicans!”

Obama: “We don’t need the Mexicans! Let me finish!… Where was I…oh wait.. I didn’t mean that…”

August 1, 2010

Who is for Small Business?

Filed under: Running Commentary — thefourteenthbanker @ 1:20 PM

The American Bankers Association is chipping away at the Small Business Bill to protect the entrenched interests in Commercial Banking.

One amendment to the bill would allow credit unions to move more aggressively into this market. Here is the ABA rooting its members on:

Credit unions were given a tax exemption to serve people of modest means, not to aggressively go after business loans.  If you are concerned about the expansion on unfair credit union competition in business lending, we need to you write your Senators immediatelyand ask them to oppose the Udall credit union business lending amendment.

The bill is a sound bill. It provides a relatively small amount of capital to go to financial institutions that will increase Small Business Lending. The current state of affairs in the industry is that there are some giant banks that do Small Business Lending in a cookie cutter way and this limits lending on character and capability and instead directs money to only those small businesses that meet strict underwriting guidelines that are primarily based on long-established trends. This is fine if that is the business model they want. Then you have many smaller banks that are hamstrung by credit problems created by over exposing themselves to builders and commercial real estate loans. They have limited capital and are being directed in many cases to concentrate on reducing risk. This is also OK. What we need is new lenders that have adequate capital, a clean enough balance sheet, and a willingness to do judgmental lending based on their knowledge of the local business conditions and the owner operators of the businesses. This bill addresses just those issues in a modest way.

Maybe credit unions are not the very best vehicle to do this. But the money is not directed to credit unions. Any qualifying bank can access the funds and make the loans. In a time of economic stagnation, all banks should welcome any lender that will improve the economy and create jobs. This may help right some of those sorry loans currently on the books. So by taking a protectionist stance, the ABA serves its constituency and not the general economy.

Banks have an inherent advantage over credit unions in regards to business lending. They have market share, expertise, systems and branding. If they cannot compete with those advantages, they do not deserve to win.

The Apocalypse According to the NY Times

Filed under: Running Commentary — thefourteenthbanker @ 12:49 PM

In this Op Ed piece by David Stockman, the NY times hits on four deformations of the US economy created by policy mistakes of the last 40 years, and where they leave us today. Remember David Stockman? He was director of the Office of Management and Budget under Ronald Reagan. So this gives him a measure of credibility in placing blame squarely on his own party for their particular failures. His four deformations are:

  • Failure to balance international accounts and the resulting $8 trillion accumulated trade deficit
  • Explosion of government debt which will take it to Greek style levels
  • The vast unproductive expansion of the financial sector
  • The hollowing out of the larger American economy.

To focus on this one just a bit more:

The fourth destructive change has been the hollowing out of the larger American economy. Having lived beyond our means for decades by borrowing heavily from abroad, we have steadily sent jobs and production offshore. In the past decade, the number of high-value jobs in goods production and in service categories like trade, transportation, information technology and the professions has shrunk by 12 percent, to 68 million from 77 million. The only reason we have not experienced a severe reduction in nonfarm payrolls since 2000 is that there has been a gain in low-paying, often part-time positions in places like bars, hotels and nursing homes.

I will soon be posting on the similarities between the current American system of Political and Economic power concentrated in the hands of few today and how that compares to pre-revolutionary France.  The current manifestations of those power imbalances are different than they were then. We do not have either a dominant church or nobility, but we have power groups that act in a similar fashion. My post, perhaps later today, is intended to cautionary and certainly no endorsement of the type of revolution that occurred in France. Yet, if the Powers-That-Be do not heed the interests of the vast Third Estate, a revolution they will get. Hopefully a revolution at the ballot box. For no nation can stand an apocalypse and keep all measures of civility.

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