A Regulatory System as a Competitive Advantage

One of the most central themes in how I think about the interaction between economics and politics is the importance of the rules governing capitalism, in order for capitalism to reach its full potential and serve society in the best way it can.


The case for a well regulated economy is quite simple when you look at the alternatives:


Socialism does not work because no one can ever know enough about human economic behavior in order to plan everything in advance, and an unregulated economy does not work because that leads to monopolies, oligarchies and crime, and makes a democratic process impossible.


The economic crisis has now reached a stage where the role of regulation is becoming apparent for the U.S. financial system. More specifically, I argue that U.S. financial companies are now doomed to failure in competition with foreign financial companies because they have not, and will not, be adequately regulated.


A recent article in the New York Times highlights this problem. The article explains that, as a result of the crisis, the influence of British, German, Swiss and Japanese banks is growing on Wall Street and in the U.S. in general. As Eugene A. Ludwig explains, this could have something to do with regulation:


“What worries me is the competitive edge that non-U.S. banks have vis à vis U.S. banks,” said Eugene A. Ludwig, the comptroller of the currency under President Bill Clinton, who now runs the Promontory Financial Group, a Washington bank consultant group. “Non-U.S. banks generally operate under more coherent regulatory structures than U.S. banks do, which creates imbalances that non-U.S. banks can exploit, especially at a time when their U.S. counterparts are operating under extraordinary constraints.”


In short, the U.S. economy has again reached a stage where it is a wild west-style economic system that is essentially unregulated. The little regulation that exists is highly fragmented, where different financial regulators oppose each other and where financial companies can choose their own regulator, invariably picking the one that enforces the least amount of regulation.


By contrast, financial institutions in the EU operate in a much more comprehensive economic framework in general. A lot of this has to do with the work that was done in anticipation of the introduction of the Euro as the common currency. More specifically, Germany refused to go along with the project unless the German brand of stable capitalism became central to the operation of the Euro zone.


Some of the best examples of this are:


- The European Central Bank has a single mandate: to fight inflation ONLY, and not concern itself with economic growth, and to be wholly independent from politicians. A very helpful international comparison of central banks can be accessed here: http://www.bis.org/publ/mktc01.pdf?noframes=1


- Antitrust laws and fierce enforcements of those laws are meant to ensure that the “too-big-to-fail” problem does not occur.


- Bank capital requirements are higher, and additional credit rating standards are imposed on complex financial products such as mortgage-backed securities.


In addition to these rules, several countries in the EU have other regulatory advantages over those that U.S. companies have, such as:


- A single financial regulator with clear, often internationally harmonized rules (such as Basel I and II, and multiple EU agreements)


- Unlimited liability instead of limited liability. In many countries in the EU, financial executives are personally liable for what happens in their companies. This obviously creates a different risk-taking climate.


- The right of the government to take over non-banking institutions such as mutual fund companies and hedge funds in order to protect investors, much like the FDIC takeover authority in the U.S..


What I have listed above under the heading of “regulatory advantages” may seem like a not so coherent list of issues, but what these things lead to in terms of the role of financial institutions in the economy is one central thing:


A focus on long-term profits instead of short-term profits


It would be very hard to argue that a focus on short-term profits is a good thing from a societal economic perspective, or indeed from any perspective other than that of the individual financiers.


A focus on short-term profits, I argue, leads to large-scale “looting”, which I explained in
this blog post on circular looting.


Needless to say, the focus that American financial institutions have on short-term profits, as a result of the inadequate regulatory framework, is the explanation as to why U.S. companies are being challenged by foreign ones now. U.S. companies are simply not equipped to compete in the long term. When the looting is done, the companies have nothing to show for.


What we are seeing right now is a failure of the central functions of capitalism. Because the system has been under-regulated, if not unregulated, the good dynamics of capitalism where efficiency, choice, competition and innovation are central components have been shoved aside, in favor of outright looting.


Presently, U.S. financial companies appear to be doing better, but make no mistake, this is only an illusion. The suspension of the mark-to-market rule has enabled them to grab numbers out of thin air and make it look like they’re profitable again. Also, because the federal government is lending money to them extremely cheaply, on a highly unsustainable level I might add, these companies are currently experiencing some short-term gains.


As soon as the government realizes that the enormous subsidies cannot go on anymore, U.S. financial companies will start to tumble once again. My guess is that that will happen within 1-2 years.


The New York Times article gives the example of the U.S. auto industry not being able to compete with the Japanese auto industry, which I think is an excellent example. Because the U.S. government failed to implement proper standards for automobiles there was seemingly no need to change anything, you just keep churning out new cars for quick profits.


One day, though, the confidence of the public was used up, and the U.S. auto industry as we knew it died. In a not so distant future, Bank of America will be the new GM, and Deutsche Bank will be the new Volkswagen.





Moreover, I advise that the winner-takes-all voting system should be destroyed.

Geithner's Lies - A Preview

The famous “bank stress tests” are in their final stages right now. On May 4, Geithner is going to present the results, and those are certainly rather predictable.


The tests were created in order for the Treasury to be able to paint as rosy a picture as possible, of the situation that the country’s banks are in. This has not been denied, and in fact, it has been confirmed, although using different words.


“The point of doing this is to avoid a panic, not cause one”, said Geithner recently.


What happens if the government finds something that is worthy of a panic (which it probably has)? That’s where Geithner’s lies and acting skills come in.


Early this week, results of the tests started to leak out. The rumor on Wall Street is that 16 of the 19 major banks are actually insolvent. If that shouldn’t cause a financial panic, I don’t know what should.


I don’t know if this is true, but it certainly could be. Like I said, it’s a rumor.


The government released the details of how the tests were conducted today. This is how the stress test works:


The banks have to figure out what would happen to them if:


1. unemployment went up to 10.3%,


2. home prices fell an additional 22%, and


3. the economy contracted by 3.3% and remained flat in 2010.


Note that the banks are conducting these tests themselves, and it is not exactly in their interest to tell anyone that they’re insolvent. Supposedly, if the government does not find the information coming from the banks to be credible, the banks will have to explain themselves.


In short, there is no independent auditor, only two vested parties who both want to paint a rosy picture and reveal as little as possible.


So, Geithner’s speech on May 4th is rather predictable, no matter what the government finds. In fact, I can give you the short version right here right now, so you won’t have to spend time listening to it on May 4th.


Dear members of the press, (this is Geithner speaking)


For three months, the U.S. government has been conducting stress tests on the nation’s major banks. I’m here today to present the findings of these tests.


The tests were conducted in the most stringent of ways, in order to make sure that the nation’s banking system can hold up in our current economic times. We tested the banks under fictitious, harsh economic scenarios that are very unlikely to become a reality.


Our findings show that despite continuing difficulties in our economic system, and even under a scenario of significant further deterioration, our nation’s banking system remains safe and well capitalized.


In recent months, the banks have taken unprecedented steps to shore up their liquidity positions by writing down legacy assets and by attracting new capital. This, along with an apparent improvement in the overall economic condition of the country, makes it clear to us that our financial system is on the road to recovery.


Blah, blah, blah, banks are great and Wall Street should love me…


Thank you, and no questions please.




I have a strong feeling that the actual speech that Geithner will give, is going to consist of absolute rubbish. Everybody on Wall Street knows he’s lying, but they don’t care, they only care about how convincing his lies are, because that is what will move the market in the weeks to come.


For ordinary people, all this means that even more vital information is being swept under the rug in order to preserve the financial oligarchy, which is the mission that Geithner seems to think that he was given by the American people.




Moreover, I advise that the winner-takes-all voting system should be destroyed.

Wall Street Calls Bank of America's Bluff

On Monday, Bank of America presented a fantastic first quarter result with a profit of $4.2 Billion! In the face of insolvency, losses that amount to 20 years of profits, and purchases of Merrill Lynch and Countrywide that very likely doubled the bank’s exposure to toxic assets, how is this possible??


With such great news, Wall Street must have gone crazy, because Bank of America’s stock went down by 24% the same day. What happened??


The answer is as simple as it is predictable: Bank of America’s report is utterly fraudulent.


I looked at the SEC report myself, and found that a little over $2 Billion of the “gain” is a result of the fact that Bank of America has decided, with no basis in reality, that its toxic assets are now worth a hell of a lot more than what they were only a few weeks ago. They can do this because the rule known as mark-to-market has been repealed.


Also, Bank of America makes reference to other new GAAP rules (rules that govern accounting), which apparently (according to them) enables them to put assets in “special purpose entities”, away from the balance sheet. This is what Enron pioneered, and it is what eventually brought down that company.


I could find no numbers concerning how much had been hidden away from the balance sheet this time, but the bank obviously doesn’t want that to be found. This makes me believe that the real number is very big.


Think of Bank of America as a regular guy. This guy has a yearly salary of $30,000. He has a credit card debt of $2,000. He also owes a loan shark a further $10 Million, and he lives in his aunt’s house.


The guy prepares a loan application to buy his own house, and in it he states that his income is $100,000, that he has a credit card debt of $2,000, and that he already owns his own home.


The only thing that’s accurate in his application is the credit card debt. The reason for that is that it can be checked by the bank. Everything else is pure fantasy.


It is the same way with SEC filings. You can bend the rules so much that SEC reports hardly mean anything anymore. You can’t trust ratings agencies or auditors either, because they get paid by the companies that they are supposed to be scrutinizing.


All this makes Wall Street look at a certain metric: quality of earnings.


“Quality of earnings” is not mentioned very often in financial journalism, probably because it seems to suggest that not all profits are actually a reflection of a company doing well. Quality of earnings describes to what degree the earnings of a company can be attributed to actual sales, as opposed to accounting wizardry.


I have over the last year argued that there has been an alliance between politicians, Wall Street, banks, regulators and the media to cover up the true extent of the financial crisis in order to preserve the financial oligarchy. By doing this, they have been able to uphold the illusion that everything is fine.


Even though Wall Street traders are not saying it out loud, they seem to be breaking ranks. They can no longer push up the prices of bank stocks and other financial stock in the face of such obvious and rampant fraud.


Expect stock markets to go much lower in the coming months.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

What the People Want - Crisis Management and Proportional Representation

One of the central premises of this blog is that the will of the people, the voters, is not at all realized in actual political policies in countries, such as the United States, that don’t have proportional representation.


One of the clearest examples of this in history can currently be seen in the differences in the economic crisis management between countries that have proportional representation and those who don’t.


The voters in The United States and Great Britain (which both have the winner-takes-all voting system) are outraged and disgusted by the taxpayer give aways to the financial oligarchy, whereas voters in countries with proportional representation, such as Germany and Sweden, are generally pleased with the political handling of the crisis, even though they suffer greatly in this crisis too.


The winner-takes-all voting system excludes all those voters, often more than 50% of the voters, who do not subscribe to the specific beliefs of the two only parties that exist in this country. By contrast, a system with proportional representation counts every single vote, and if a party gets 10% of the votes, it gets 10% of the seats, hence incorporating the will of all the voters, as opposed to a small number of them.


In addition to this, the United States allows huge political donations to individual politicians in a scheme that can only be described as a “policy purchasing program”. Money for policy; it’s as simple as that.


The Handling of the Economic Crisis in The United States and Great Britain


Since the current economic crisis began last year, the handling of it has been strikingly similar in The United States and Great Britain. It has been based on one central premise alone:


Protect the current financial power structure, and the individual players within it, at any cost to the taxpayers and no matter what the long-terms consequences to the economy are.


It really is as simple as that, because there is virtually no evidence to the contrary. With bailouts, loans, guarantees to AIG, Citigroup, Bank of America, Bear Sterns and many more, the U.S. taxpayers are on the line for over $10 Trillion at this point!


Enormous bailouts of Royal Bank of Scotland, Barclays Bank and many more in Great Britain will eventually cost British taxpayers Trillions of dollars too. All the while banks and other financial companies in both countries are continuing to pay enormous bonuses while successfully opposing financial regulation.


The American and British economies are at this point essentially unregulated. The people in both countries are outraged, and I personally don’t know anyone, nor have I heard anyone outside the corrupt media elite, voice support for the bailout and support of the financial oligarchy.


I don’t have any exact numbers for this, but if I, as a resident of Manhattan working in the financial industry, don’t know anyone who thinks that this is a good idea, I can only imagine what people around the country think about it.


Protesters in Britain have repeatedly smashed the windows of banks, and bank employees have had to hire body guards, so I don’t think the outrage is any smaller there.


The Handling of the Economic Crisis in Germany and Sweden


Although there have been bank bailouts recently in Germany and Sweden, it has been done on a much smaller scale. Banks in both Germany and Sweden had been over extending themselves in lending to Eastern Europe while that part of the continent was trying to re-join Europe after communism.


Both the German and Swedish governments have repeatedly stated that it would be immoral to throw away large amounts of taxpayer money, both for the immediate purposes of taxpayers and the long-term consequences to the economy.


The internal economies in Germany and Sweden were already sufficiently regulated, so in no way are the banks there causing as much of a domestic problem. One could instead look at an industry that is vital to the U.S., Germany and Sweden: the auto industry.


The U.S. has simply given away billions of dollars to companies that are clearly not competitive. Germany’s car companies are very competitive, but the car market in Germany is extremely slow nevertheless. Germany was creative in dealing with this, and gave taxpayers a few thousand dollar to scrap their old car and buy a new one. Sweden will most likely follow this idea.


Sweden refused to bail out SAAB, noting that the company had only been profitable for a handful of years during its 50-year existence. How would Sweden be able to turn around a car company when the biggest automaker in the world could not? It must be noted that the Swedish government in general is not opposed to state-owned companies.


The Swedish government owns many companies that it runs for profit, and created and maintained one of the most successful brands in the world: Absolut Vodka. Who said the government couldn’t run a business?


The Swedish and German governments have, throughout the economic crisis always had the taxpayers’ interests and the future of the country as their first and only priorities.


Small bailouts have occurred, and stimulus in the form of aid to local governments that have run short on cash because of job losses have been paid.


The public outrage that has occurred in Germany and Sweden has largely concerned bonuses, but the big difference is that those bonuses were paid by the companies themselves, not the taxpayers, as in the case of the U.S. and Great Britain.


The policy response to the economic crisis from the winner-takes-all countries has been disastrous, and I personally disagree with almost 100% of what the response has consisted of. The policy is based on the premise that the financial oligarchy must be preserved, taxpayers and country be damned.


The policy response to the economic crisis from the proportional representation countries has been deliberate, responsible, thoughtful with a long-term approach. I agree almost 100% with what has been done in those countries, even though I would not vote for any of the parties currently in power in either country.


This fact describes clearly that the will of the people is not translated into policy in the United States and Great Britain. These two countries are undemocratic and both need vast constitutional overhaul.






Obviously, I advise that the winner-takes-all voting system should be destroyed.

The Geithner Plan - Same Old Crap

Geithner’s new plan was presented with a complexity that seemed engineered to fool people into believing that it was not what it has always been: a direct continuation of Paulson’s original Wall Street give-away plan.


The CEO of an investment firm called “Fusion IQ”, Barry Ritholtz, said it best yesterday when he was commenting on the stock market rally:


“This is the free-money rally. Traders like the fact that there’s a boatload of cash headed their way”


At least he’s being honest about what’s going on. The “boat” is being loaded up with cash by docile American taxpayers, who have never stood up for themselves to claim their rights as citizens.


Now we're seeing the results. J.P. Morgan Chase is, again, planning to expand it's fleet of corporate jets while tent villages are growing across the country and the number of Americans without health insurance is nearing 100 million.


I would like to offer a condensed version of the plan for those who have not kept up with Geithner’s change of vocabulary (which is all it is). The plan has the following features:


- HUGE subsidies for hedge funds and other similar entities to buy toxic assets


- potential for these buyers to get almost all the gain if there eventually is one


- minimal potential for the taxpayers to get any gain if there eventually is one


- minimal risks for these investors if the investments don’t work out


- enormous risks for the taxpayers if the investments don’t work out


- borrowing from the FDIC to finance the hedge fund subsidies. This is a truly desperate move, and one which actually threatens the safety of money in everyone’s bank accounts. The FDIC is already under funded, and this move could be disastrous down the road


The government is really getting desperate. Borrowing from the FDIC is something I never imagined would happen.


By the same token, for the government to buy its own treasury bills, which was announced over the weekend, is a very desperate move, that has only happened in times of really severe crises before (like when the U.S. felt it was going to be attacked with nuclear warheads by the Soviet Union in the 60s).


I’ll make a few predictions: In a couple of years, we will have interest rates above 10%, housing prices 20% lower than today, a stagnant stock market, inflation above 5% and unemployment at sustained high levels.






Moreover, I advise that the winner-takes-all voting system should be destroyed

Gordon Brown's Proposals

Last Wednesday, the British Prime Minister Gordon Brown gave a speech to Congress, parts of which were very surprising to me. Brown expressed a need for countries to work together to solve the global crisis, and he also suggested two important new measures:


1. A “Global New Deal”, or “Economic Marshall Plan”, and


2. Making the “shadow banking system” illegal


These two suggestions are actually quite radical, but I have not come across many details of these two suggestions. I will nevertheless attempt to speculate around these ideas.


A Global New Deal is hard to imagine ever coming to fruition. What Brown means by this seems to be that countries should come together and inject vast amounts of money in markets, where needed, in order to save and re-build those markets. Brown also seems to be talking about more tangible investments in industries to spur future growth, hence the mention of the Marshall Plan.


I assume that it would involve many different countries putting large amounts of money into a big pot, and then trying to decide where the money would help the most. Alternatively, if the global new deal involves countries simply coordinating financial rescue actions, it’s a little less hard to imagine, but still unlikely.


The issue of “international bailouts” has come up recently in the EU. Eastern Europe has been attempting to free itself from the chains of communism by creating an entire “subprime economy”. They took loans in foreign currencies such as Euros, Swiss Francs and Swedish Crowns. As Easter European currencies plunged in value, the loans skyrocketed in value.


It was thought to be an understanding in the EU that Eastern Europe could act fiscally irresponsibly in order to re-join Europe as equals, and that Western Europe would help them in case they ran in to trouble. When a number of Eastern European countries, such as Hungary, Romania and Bulgaria asked for an actual bailout, Germany said no. Germany feels a lot of resentment for having given up its own financial stability in order to support stability in the Euro and EU zone, and the country has apparently had enough.


When it comes to trying to convince many different countries to act in solidaric ways during a crisis, I believe there must be a system set up in advance. Otherwise, a country will have to choose between international solidarity or feeding its own population, and the former will obviously take a back seat.


Making the shadow banking system illegal, is quite a radical proposal, especially for the economies of the UK and the U.S.. Brown did not specify what he meant by the “shadow banking system”, but it is clear that he was referring to entities such as hedge funds and investment banks that are providing capital for lending in the economy.


In a way, this is a strange proposal, considering the fact that governments around the world have actively been participating in creating the “shadow banking system”, setting up entities like Fannie Mae and Freddie Mac. Brown seems to be saying that the banking system needs to go back to basics, to the way it was before governments started subsidizing mortgage rates (back 60-70 years ago in most cases).


Whether or not you expressly make the shadow banking system illegal, it is in the process of disappearing anyway. Brown’s comments seem to stem from a newly found clarity in terms of the real role of various financial institutions in the U.K. and the U.S., a clarity that he, like U.S. politicians, did not have when he was Chancellor of the Exchequer.


What Brown is suggesting is, in my mind, sound. If entities other than banks would stop providing enormous amounts of capital for all types of speculation, societies would become less reliant on stock markets, and the housing market would experience less swings. Mortgage rates would definitely become higher. Mortgage rates of over 20% were not too uncommon a few decades ago.


With respect to mortgages, I have for a long time advocated a system of covered bonds for the banks, like the one Germany has. I also believe that the Federal Reserve needs to be made into a government-owned Central Bank with a single, inflation fighting, mandate.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Taxpayer Bonuses to Failed Bankers... Is Obama Serious??

Chris Dodd is s sneaky fellow. Towards the end of the stimulus package negotiations, he snuck a provision in, severely limiting bonuses for executives receiving taxpayer money through the TARP or in other ways.


Tim Geithner has filled his cabinet with ex-Wall Streeters, so he and the Treasury have been fighting, tooth and nail, against limits on executive pay, just like Paulson did. Dodd’s provision was meant to counter the Treasury.


Now Obama has sided with the Treasury, and is trying to come up with ways for taxpayer money to be paid to these executives.


On Fox News on Sunday, senior Obama adviser David Axelrod said that the administration will: “seek changes in the government's approach to executive compensation”. That can only mean one thing: Obama will refuse to implement to provisions that he will sign into law on Tuesday.


Obama is prepared to break the law in order to give failed bankers million dollar bonuses paid by taxpayers! As someone who supported Obama fully, I am now left speechless, only able to say: are you serious Obama!!??


If a corporation feels like its executives deserve multi-million dollar bonuses and is willing to pay that, I have no problem with that. And if that corporation keeps paying the bonuses even in the face of multi-billion dollar losses, that is also fine with me. It’s just stupid, and I don’t understand why the shareholders accept that.


However, when the corporation receives taxpayer money, it is very much my problem how that money is being spent.


This is a really, really serious crisis. In Florida, there are actual bread lines. In Nevada and California, local governments have designated and fenced in land for people who live in their cars, reminiscent of the “Hoovervilles” of the Great Depression. Food banks are out of food in the Northeast, and the beggars in New York City are no longer mostly made up of addicts.


The President of The United States is currently weighing these problems against the need for multi-million dollar bonuses to failed bank executives. You have to ask yourself if he has lost his mind.


The heat is turning up in the battle for taxpayer money and the continued roll of Wall Street in the American economy. On outlets for Wall Street employees like CNBC and Fox News, the rhetoric is really changing dramatically.


The financial sector seems united in a battle against taxpayers, eerily reminiscent of crises in countries with financial oligarchies and mafia control like South Korea and Russia. The gloves have come off, and the financial oligarchs seem to be winning. People on these networks, such as Larry Kudlow and Charlie Gasparino, are absolutely mocking efforts to use taxpayer money to help taxpayers, as opposed to giving it to individuals on Wall Street.


For decades, The United States has been dictating what countries receiving aid from the IMF should do during bank crises. The advice has always been the same when corrupt countries have been receiving aid: fire bank executives, nationalize banks, and under no circumstances give the banks money with no strings attached.


Now, The United States is going down the very road it has warned against so many times, and the results have already proven to be disastrous. Bankers and other Wall Street executives are demanding taxpayer money while hiding even the slightest hint of the extent of their losses. They have insiders from Goldman Sachs, Citigroup and many other firms in the Treasury, and they are even using TARP money to lobby for these things.


I don’t know what Obama is thinking at this time. What he’s actually doing, though, is taking food from the mouths of starving Americans and putting the money in the pockets of bank executives who have brought down the American financial system.





Moreover, I advise that the winner-takes-all voting system should be destroyed.

The Road to Sweden, or the Road to Japan

As I have mention before, this crisis is NOT unprecedented, which the U.S. government keeps claiming. The reason that they’re claiming this is partly that they don’t understand it, and partly that they won’t admit how much trouble the banks are in. I can understand the latter to some extent; admitting this would probably create a panic.


The two crises in Sweden and Japan in the 90s had the following attributes:


1. The banks became insolvent because of bad assets


2. The bad assets were hidden off their balance sheets, meaning that they could not be seen by the public or the government


3. The bad assets were made up of complicated financial products related to real estate speculation


Sound familiar? We have here three almost identical crises, and two different approaches in dealing with them: the Japanese way or the Swedish way.


The Japanese way resulted in “Japan’s lost decade”, with huge job losses, capital destruction and an immense waste of taxpayer money. A sustained weakening of the Japanese economy occurred, which harmed Japanese competitiveness greatly.


The Swedish way certainly created short term pain for the country, but the net result of the crisis was an actual profit for the taxpayers, a sustained budget surplus and an eventual lowering of the national debt. In short, the country came out of the crisis stronger than before.


Another thing that, by now, may sound very familiar to Americans, is how the Japanese dealt with their crisis. They did the following: gave the banks hoards of money with no strings attached, bought bad assets, attempted to have a public/private partnership in buying up bad assets (which Geithner just recently suggested), passed multiple stimulus packages and lowered interest rates to zero.


Japan did all this, and everyone now agrees that none of it worked, otherwise they would not have had a “lost decade”…. The country’s crisis was not resolved until they did what Sweden instead did. The Swedish government did the following:


- Ruthlessly combed through the books of the banks to weed out which banks could be saved, and which could not be


- Nationalized the ones that were deemed to be able to survive, and let the weak ones fail


- Wiped out all shareholder value and fired bank management


- The government had to actually learn all there is to know about the assets, so that they could be sold at the highest price. They did not simply let stock market “experts” dole out money to their buddies.


Prior to the rescue, the Swedish Parliament had passed a law giving it the right to do all these things if a bank’s equity in relation to its debts fell below 2%. Many U.S. banks are far below that threshold now.


So, the U.S. government has two very clear alternatives: one that has been proven to work, and one that has been proven to be disastrous. It doesn’t get much clearer than that.


The U.S. government is currently furiously pursuing the disastrous course.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

There ARE Solutions to the Banking Crisis

Treasury Secretary Geithner presented his new financial rescue plan on Tuesday, which impressed no one. The plan was confused, unfinished and intellectually contrafactual. In this posting, I will expand on my solution to the banking crisis, which involves a system of what are called “covered bonds” along with the creation of new banks.


After the plan was introduced and poorly received, Geithner defended himself by saying that there was “no historical precedent” to this crisis. Nothing could be further from the truth. Simply giving the banks taxpayer money to spend as they please, a.k.a. the “Bush/Paulson/Geithner solution” is what lacks a historical precedent, simply because it’s so infinitely stupid.


Geithner, along with what seems to be the entire American political and economic establishment seems to be completely in the dark in terms of economic research and economic history. I’m saying that there are many precedents to this crisis, and that there are many precedents on how to solve it.


There are 2 main, related problems that must be solved as soon as possible:


1. the banks are insolvent, and


2. the mortgage securitization market is dead


The banks are insolvent because they own worthless assets that nobody wants to buy. Geithner’s plan involves trying to convince private investors to buy these worthless assets, but the reason they’re worthless is that these same investors didn’t want to have anything to do with them in the first place.


The assets are like rotten apples in a fruit stand, and however much such apples are promoted, I think it’s pretty safe to say that few people will ever by them.


The mortgage securitization market is the market where banks sell off mortgages to private investors in the form of mortgage-backed securities, which is the same thing as the assets I mentioned above.


Nobody wants to participate in the mortgage securitization market anymore because housing prices have imploded, so the market is dead with little chance of being revived any time soon. In other words, if housing prices don’t go up, the mortgage securitization market will continue to be dead.


Now to my suggestions of solutions to these problems. In a catastrophic banking crisis, the solution has in the past been either nationalization or the creation of new banks.


Nationalization is the more common solution, but if a bank’s debts are five times its market value, what is the point of rescuing it by nationalizing it? Spending five dollars to make one dollar doesn’t make a lot of sense… In light of the banks’ situation, nationalization would be the least severe destiny awaiting them. It would, however, be extremely expensive for the taxpayer.


Because the U.S. Government is ideologically opposed to nationalization, my bet would be that Bank of America and Citigroup (along with many smaller banks) will have the same fate as Lehman Brothers.


Instead, I believe that the creation of new banks is the appropriate solution. This was done in the 1800s in the United States during a catastrophic banking crisis. Under this plan, the government would simply set up a new bank, inject it with money for lending and write strict rules on how it can operate. That would instantly create a stable, prudent and dependable bank.


The government would then sell off 49% of the shares to private investors and keep running the bank according to prudent standards until the crisis is over. At that point, the bank can be sold off completely.


Instituting a system of covered bonds would be a good solution for the mortgage market. This is a very stable system that has been used for hundreds of years in Europe. Basically, all the banks would get together and put all their mortgages in a giant pool.

As soon as one mortgage defaults, it is immediately taken out of the pool, and the loss is shared by all the banks at once. All the mortgages, meaning the investments that the banks have made, are hence “covered” by all the participants in the system.


Under this system, the mortgages remain on the banks’ balance sheets. It is a collaborative effort, as well as being a system where each bank has to take responsibility for its own lending practices. This system encourages prudent lending standards by all participants, stabilizes the housing market in general, and improves the trust in the financial system.


We need to think in new ways about the crisis, which Geithner acknowledged in his speech, but he is so ignorant that he does not know of any solutions like the ones I just described.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

What to do with the Banks?

Allow me to explain, in plain language, what the whole discussion about the troubled banks is about. A lot of the banks, most notably Bank of America and Citigroup, are already insolvent. The only reason that they haven’t had to file for bankruptcy is that they’re claiming that their assets are worth much more than they actually are.


The banks are saying: our assets are worth a lot, but nobody is willing to pay anything for them now, but the value of them will go up in the future, so give us money now.


The very foundation of a capitalist economy is that any asset, whether it’s a house, a painting or a complex financial product is only worth what someone is willing to pay for it. In a communist economy, the government decides what assets are worth, but that is not, as we all know, how things are done in the U.S..


The assets that the banks are claiming to be worth so much money are actually completely worthless, because nobody is willing to pay anything for them. They’re like houses in a ghost town.


According to financial regulation you have to “mark assets to market”, which means that you have to value them according to what people are willing to pay for them, which is in line with the capitalist economy. However, the banks are hiding all these assets away from sight of regulators, investors and the public, so that they can get away with not doing this.


They do this by putting worthless assets in what they call “special purpose entities”, which do not appear on the balance sheet. It’s as if someone were to have a secret credit card with a huge balance that they have hidden away from their spouse, while telling that spouse that they have no debts.


Currently, the U.S. government is trying to figure out how they can relieve the banks of these assets (of which the government actually has no idea how much there are, or of what they are made up). Tim Geithner will present a plan tomorrow at 11 a.m., and the most important factor in this plan is that the government will try to buy these worthless assets from the banks.


What they have to do, in actual fact, is to decide a price of the assets, just like communist governments used to do. It is strange for the government to engage in communist economic policies in order to save capitalism. The taxpayers will pay for the assets, but whatever price is above zero is too high, so the American taxpayer is without question being ripped off big time… again.


The money which is available for use in this plan is $350 Billion. That is nowhere close to being enough for the banks so that they can avoid bankruptcy. The only thing this does is to buy time. It buys time for these worthless assets to go up in value again, and that is the only way that the banks can remain in their current forms.


Will the assets recover the value that they used to have? Absolutely not. Using the analogy of the house in the ghost town again, the ghost town would have to turn into a boom town in just a few months. I’m not aware that something like that has ever happened.


To simplify things quite a bit, you could say that one of these bank assets is made up of 1,000 houses in a low-income area of Cleveland (where the sub prime crisis is extremely severe).


By now, all of them will have lost at least 50% of their value, 200 of them will have been torn down, and 500 of them are empty (and the empty ones have lost 80% of their value due to looting and other things).


If each house were worth $20,000 in the beginning, the bank asset would have been worth $20 million. After the value destruction that I outlined above, the face value of the asset would be only $5 million. In addition to that, such an asset is priced based on the future expectations of it, which I need hardly mention are not good. Hence, nobody wants to buy it, and it is in fact worthless.


This decrease in value from $20 million to $5 million in a short time is the essence of the banks’ problems. In many cases, the situation is far worse than what I have described above, but I’ll try to keep it simple for now.


Hence, this bailout, like the other ones, is totally misguided and has no prospects of working. Why are they doing this anyway? Because the prospect of nationalization is too ideologically offensive to American politicians. Nationalization would lead to all the shareholders losing their money, and the bank executives would be fired.


Several banks will have to be nationalized sooner rather than later anyway, regardless of further bailout attempts. As I said, the reason for this is simple: the value of the bank assets will not go back up. I don’t favor nationalization because I think that would be too wasteful and expensive, but instead, I favor the creation of new banks, as I wrote in January.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

The Good Bank Solution

One solution to the financial crisis that is currently being discussed is the so-called “bad bank solution”. What this means is that the government would set up an entity, and gather all the toxic assets that the banks have, so that the bank system can be freed of the bad stuff and move on. Sounds good, but where do the losses go? The answer is: to the American people.


This solution is no different from the original TARP plan, in that the American taxpayer simply gives banks money to cover all the mistakes those banks made, with no strings attached. I believe that the losses in the banking system are too great for a bailout like this one to have the potential to work, regardless of the moral implications. That is why we need a different solution.


First, a reality check to illustrate my point. Bank of America and Citigroup are the two large banks that are in the worst shape. Consider their market value in 2007 compared to today:


Bank of America’s market value in the second quarter of 2007: $228 Billion


Bank of America’s market value in January 2009: $33 Billion


Citigroup’s market value in the second quarter of 2007: $255 Billion


Citigroup’s market value in January 2009: $15 Billion


In addition to this, these banks have several times their market value in toxic assets, which means that they are effectively insolvent already. Consider also what Bank of America did after it received bailout money: it went and bought MORE mortgage-backed securities, creating even greater losses. When the bank found out that it was going to get a bailout, it started paying huge bonuses to its executives, in reality using TARP money for that. It’s definitely time to stop betting on the losing horses. It doesn’t matter how much money we spend on these banks, they’re not going to be able to continue in their current forms. The bad bank solution is nothing more than a bad solution.


I am instead proposing a Good Bank Solution, under which the government sponsors entirely new banks, completely untainted by the crisis and the toxic assets. Instead of trying to repair a complete wreck of a bank, a new one is constructed from scratch. The public could then safely put its money into those banks, investors could invest money in them, and the banks could immediately start lending with prudent standards. More specifically, the plan would consist of the following steps:


1. The government drafts a bank charter (the rules for the bank), and includes very stringent standards on lending, how much capital the bank must have, how the bank can invest, how much money the bank must lend, and so on.


2. The government puts money into the bank. We’re talking about billions of dollars, not billions in losses, but in investments in a new banking system with a clear potential for profit. The government owns 100% of the bank.


3. The bank opens for business, takes customer deposits and starts lending immediately. Investors will be able to buy 49% of the stock, but the government must remain the majority shareholder for a few years until the financial crisis has been resolved. By selling stock, the government may already have recouped half of the investment at this stage, potentially at a profit.


The government can create many of these banks, and in one fell swoop bring confidence and lending back. It is important to note that this is just a temporary solution. Once the crisis has passed, these entities can be sold completely, so that the government does not have to act as a banker.


Before that happens, the government will also have been given time to legislate the new financial regulation that is so direly needed. The “good banks” don’t need regulation, because they will have that written into their charters. This would be a big operation for sure, but it must be done, because the current system is broken.






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