Archive for December 20th, 2010
I wrote recently about the Bank of England sowing the seeds of their next banking crisis by deciding to reduce bank examinations. Spencer Bachus (R. Ala.), the incoming Chair of the House Financial Services Committee, told the Birmingham News: “In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.”
Ron Paul (R. Tex.), asked to comment on Bachus’ statement, said: “I don’t think we need regulators. We need law and order. We need people to fulfill their contracts. The market is a great regulator, and we’ve lost understanding and confidence that the market is probably a much stricter regulator.”
These comments share several characteristics. First, they demonstrate that many people in positions of power have not only learned the necessary lessons from the ongoing crisis – they have learned the worst possible lessons. Second, the comments reprise disastrous approaches that allowed the crisis to occur. Third, the comments represent the continuing triumph of ideology over facts. Fourth, the comments rely on false dichotomies that are the enemy of reasoning and good policy.
1. The U.S. and much of Europe have suffered a crisis of great proportions after they adopted deregulation, desupervison, and the de facto decriminalization of financial firms. For the U.S., this is our third major financial crisis in 20 years brought on by those triple “de’s.” The incoming chairs’ response to these crises is increased deregulation and desupervision (and no mention of prosecuting the control frauds driving the crises). What would it take to discredit policies that produce recurrent, intensifying crises?
2. The bipartisan “Reinventing Government” movement of the 1990s (championed by then Texas Governor Bush and Vice President Gore) led the senior leaders of the banking regulatory agencies to order their staff to refer to the industry as their “clients” or “customers.” It became a major agency priority to make those clients happy with the regulators. That policy became even more destructive during the Bush administration, which chose regulatory leaders based on the intensity of their opposition to vigorous supervision. SEC Chairman Pitt’s first major speech was before a group of accountants. He expressed his regret that the SEC had not always been a “kinder and gentler” place for accountants and blamed his agency for not showing accountants more love. The Office of Thrift Supervision’s (OTS) head, “Chainsaw” Gilleran, posed with the three major banking lobbyists and the number two guy at the FDIC (who was Gilleran’s successor) over a pile of federal regulations. Everyone held pruning shears, except Gilleran, who demonstrated the indiscriminate nature of his hate for regulation by holding a chainsaw. It is no surprise that among insured depositories the largest accounting control frauds were regulated by the OTS (where “regulated by” translated into “not regulated by”). The OTS went so far in its efforts to “serve the banks” that it encouraged or knowingly permitted several insolvent banks to file false financial statements relying on backdated entries.
The federal banking regulatory agencies “serve[d] the banks” by preempting state efforts to regulate abusive, predatory, and fraudulent lending. The federal banking regulatory agencies even tried to preempt State Attorney General lawsuits against the leading mortgage frauds.
Similarly, the SEC “serve[d] the [investment] banks” by creating the Consolidated Supervised Entities (CSE) program for the purpose of protecting them from serious regulation by the European Union. The CSE program was a sham. The SEC staff assigned to examine the largest investment banks in the U.S. were not examiners and did not examine the investment banks. No one believed they could because the staffing level was farcical.
Banks do not need regulators to “serve” them? There is no appropriate function in which we serve banks. There are many destructive ways in which anti-regulators would serve the interest of fraudulent banks.
3. Representative Paul’s claims epitomize the triumph of ideology over fact: “The market is a great regulator, and we’ve lost understanding and confidence that the market is probably a much stricter regulator.” No, the “market” is not a “great regulator” and the ongoing crisis is only the latest example of that point. Efficient, non-fraudulent markets would be a very good thing. Inefficient, markets with fraudulent participants can be a catastrophically bad thing. The “market” also does not deal effectively with externalities (and they can be lethal) and with market power. The neoclassical claim that cartels cannot persist and that potential entry solves prevents all serious ills proved false in the real world. Here, however, I will discuss only why control fraud turns “markets” perverse. Accounting control frauds are guaranteed to report high profits in the early years. This is why Akerlof & Romer (1993) agreed with white-collar criminologists that such frauds were a “sure thing.” I’ve explained why the four-part recipe for optimizing fictional accounting income maximizes executive bonuses – and real losses. In the interest of brevity I will merely mention four ways in which accounting control frauds make markets, and “private market discipline” perverse.
a. The fictional profits fool creditors and shareholders – they are eager to lend to and invest in firms reporting record profits. Rather than discipline accounting control frauds, creditors and shareholders fund their massive growth.
b. The fictional profits and the large bonuses they drive create a “Gresham’s” dynamic in which bad ethics tends to drive good ethics out of the marketplace. The CFO that fails to emulate the fraud recipe will report far lower profits in the near term and will fear losing his job. More junior executives whose compensation is based on the firm’s reported income have perverse incentives to engage in accounting fraud to ensure that the firm “hits the number” and have reduced incentives to blow the whistle on frauds.
c. Lenders engaged in accounting control fraud create “echo” epidemics of fraud. They use their powers to hire and fire and create compensation systems to create perverse incentives in other fields: among their employees, “independent” professionals, and agents (e.g., loan brokers).
d. When several large lenders follow similar fraud strategies they can hyper-inflate financial bubbles.
Anti-consumer control frauds can also turn markets perverse by creating Gresham’s dynamics. Chinese infant formula provides a good example. Dishonest firms drove honest firms from the market – maiming hundreds of thousands of infants’ health.
In the case of nonprime loans, for example, both principals (the borrower and the lender) typically lost utility as a result of the loan – reverse Pareto optimality. The unfaithful and fraudulent agents, however, won big.
Even when private market discipline did finally kick in it did not perform as advertised. Instead of differentiating between good and poor credit risks and honest v. fraudulent actors it simply shut down hundreds of markets.
Rep. Paul’s comparative statement – implying that the markets were tougher regulators than the regulators – fails on two bases. One, as pathetic as the anti-regulators were, they were commonly better than the market, e.g., warning about concentrations in commercial real estate well before the crash. Two, claiming that regulation is a failure because the ideological foes of regulation controlled the agencies and so completely desupervised the financial sector so completely that they created a self-fulfilling prophecy of regulatory failure is an act of chutzpah.
4. Rep. Paul’s other remark, however, illustrates the false dichotomies that underlie the ideological assault on regulation. He notes that we “need law and order.” He thinks that proves we don’t need regulation, but it proves the opposite. The banking regulators are the “cops on the beat.” We have nearly a million police and guards that deal almost exclusively with blue collar criminals. Control fraud creates a Gresham’s dynamic because it means that cheaters prosper. As regulators, we do “serve the [honest] banks” by taking away the ability of the cheaters to prosper – when we regulate effectively. The OCC and the OTS did zero criminal referrals during the current crisis. We did thousands as regulators during the S&L debacle. We prioritized the most severe frauds (the large control frauds) and made the support of criminal prosecutions a top agency priority. The result was over 1000 priority felony convictions of S&L elites. Without the regulators’ expertise the FBI cannot possibly stop an “epidemic” of mortgage (FBI House testimony, September 2004).
In the ongoing crisis, the Department of Justice, denied regulatory support and relying instead on the Mortgage Bankers Association – the trade association of the “perps” – has secured zero convictions of any senior officers of the large lenders specializing in nonprime lending/securitization. Effective regulations and regulators are not the enemy of private markets or private market discipline, but rather one of the essential requirements for efficient, honest markets in a modern economy.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
You are not going to believe some of the things that the U.S. government is spending money on. According to a shocking new report, U.S. taxpayer money is being spent to study World of Warcraft, to study how Americans find love on the Internet, and to study the behavior of male prostitutes in Vietnam. Not only that, but money from the federal government is also being used to renovate a pizzeria in Iowa and to help a library in Tennessee host video game parties. These are just some of the examples in a new report on government waste from Senator Tom Coburn entitled “Wastebook 2010“. Even as tens of millions of American families find themselves suffering through the worst economic downturn in modern history, the U.S. government continues to spend money on some of the craziest and most frivolous things imaginable. Every single year articles are written and news stories are done about the horrific government waste that is taking place and yet every single year it just keeps getting worse. So just what in the world is going on here?
It almost seems as though Congress actually enjoys inventing new ways to waste U.S. taxpayer money. It seems nearly inconceivable that anyone could keep a straight face while trying to justify spending money on many of the things in the list below.
At a time when the U.S. national debt is closing in on 14 trillion dollars, government waste just seems more out of control than ever. The following are 20 of the craziest things that the U.S. government is spending money on….
#1 A total of $3 million has been granted to researchers at the University of California at Irvine so that they can play video games such as World of Warcraft. The goal of this “video game research” is reportedly to study how “emerging forms of communication, including multiplayer computer games and online virtual worlds such as World of Warcraft and Second Life can help organizations collaborate and compete more effectively in the global marketplace.”
#2 The U.S. Department of Agriculture gave the University of New Hampshire $700,000 this year to study methane gas emissions from dairy cows.
#3 $615,000 was given to the University of California at Santa Cruz to digitize photos, T-shirts and concert tickets belonging to the Grateful Dead.
#4 A professor at Stanford University received $239,100 to study how Americans use the Internet to find love. So far one of the key findings of this “research” is that the Internet is a safer and more discreet way to find same-sex partners.
#5 The National Science Foundation spent $216,000 to study whether or not politicians “gain or lose support by taking ambiguous positions.”
#6 The National Institutes of Health spent approximately $442,340 to study the behavior of male prostitutes in Vietnam.
#7 Approximately $1 million of U.S. taxpayer money was used to create poetry for the Little Rock, New Orleans, Milwaukee and Chicago zoos. The goal of the “poetry” is to help raise awareness on environmental issues.
#8 The U.S. Department of Veterans Affairs spent $175 million during 2010 to maintain hundreds of buildings that it does not even use. This includes a pink, octagonal monkey house in the city of Dayton, Ohio.
#9 $1.8 million of U.S. taxpayer dollars went for a “museum of neon signs” in Las Vegas, Nevada.
#10 $35 million was reportedly paid out by Medicare to 118 “phantom” medical clinics that never even existed. Apparently these “phantom” medical clinics were established by a network of criminal gangs as a way to defraud the U.S. government.
#11 The Conservation Commission of Monkton, Vermont got $150,000 from the federal government to construct a “critter crossing”. Thanks to U.S. government money, the lives of “thousands” of migrating salamanders are now being saved.
#12 In California, one park received $440,000 in federal funds to perform “green energy upgrades” on a building that has not been used for a decade.
#13 $440,955 was spent this past year on an office for former Speaker of the House Dennis Hastert that he rarely even visits.
#14 One Tennessee library was given $5,000 in federal funds to host a series of video game parties.
#15 The U.S. Census Bureau spent $2.5 million on a television commercial during the Super Bowl that was so poorly produced that virtually nobody understood what is was trying to say.
#16 A professor at Dartmouth University received $137,530 to create a “recession-themed” video game entitled “Layoff”.
#17 The National Science Foundation gave the Minnesota Zoo over $600,000 so that they could develop an online video game called “Wolfquest”.
#18 A pizzeria in Iowa was given $60,000 to renovate the pizzeria’s facade and give it a more “inviting feel”.
#19 The U.S. Department of Agriculture gave one enterprising group of farmers $30,000 to develop a tourist-friendly database of farms that host guests for overnight “haycations”. This one sounds like something that Dwight Schrute would have dreamed up.
#20 Almost unbelievably, the National Institutes of Health was given $800,000 in “stimulus funds” to study the impact of a “genital-washing program” on men in South Africa.
In light of all this, is it any wonder why the approval rating of Congress recently hit another new record low?
According to the most recent Gallup poll, only 13 percent of Americans approve of the job that Congress is doing.
Just think about that – only 13 percent!
Our politicians seem very confused about why there is so much anger in the country today. Well, there are certainly a lot of reasons for it, including the fact that the U.S. economy is on the verge of collapse, but it certainly doesn’t help that our government is basically flushing our tax dollars down the toilet and spending them on some of the most wasteful things imaginable.
It would be bad enough if the federal government was swimming in money, but the truth is that all of this waste is being committed at a time when the U.S. government is nearing bankruptcy.
Over the last 30 years, the U.S. national debt has gotten 13 times larger. We have accumulated the largest debt in the history of the world and there is no end in sight.
In fact, we are rapidly running out of people to borrow money from. According to the Wall Street Journal, in order to repay maturing bonds and finance the exploding budget deficit, the U.S. government will have to borrow 4.2 trillion dollars in 2011.
Eventually the rest of the world is going to lose confidence in the ability of the U.S. government to repay all of this debt. Once confidence in U.S. Treasuries is totally gone, and there are already signs this is starting to happen, the game will be over and the U.S. financial system will collapse.
But the U.S. Congress just continues to act like it is “business as usual” and the wasteful spending just continues to get worse. Someday historians will look back and think that we must have been a nation full of idiots and morons.
For decades our politicians have been spending us into oblivion, yet we keep sending the vast majority of them back to Washington D.C. every time an election rolls around and the mainstream media keeps assuring us that our “respected leaders” know exactly what they are doing and that everything is going to be okay somehow.
It is almost as if some sort of collective insanity has overtaken most Americans. The path we are on inevitably leads to national bankruptcy and the destruction of our financial system, but only a small percentage of the population seems to care.
Well, in the end we will reap what we have sown. Unfortunately, the economic pain that is coming is going to be devastating for all of us – including those of us who are awake and are trying desperately to change things.
Federal Reserve is the primary tool of the new financial oligarchy – The ultimate banking clearing house with zero oversight from the people still holds over $2 trillion on its balance sheet.
The Federal Reserve system (the Fed for short) is the US central banking system. The Fed was created in 1913 with the enactment of the Federal Reserve Act. In the beginning the Fed had limited powers and its mission was limited. According to the Fed its mission today is to conduct monetary policy, supervise and regulate banking institutions, and maintain stability in the financial system. If this is the mission of the Fed, it has radically failed and the American people should audit the Fed to see what went wrong. The problem with the Fed is that it is independent within the government since it does not need to seek legislation for actions. Yet the authority of the Federal Reserve is derived from the US Congress. Yet we have recently seen when a push to audit the Fed was issued in Congress a major backlash hit from the Fed and we have yet to conduct a full audit of the Federal Reserve. The Fed has conducted and put at risk the US currency to protect the banking interests of its member banks. The unstated mission of the Fed is to protect its banking allies even if it means destroying the economic structure of its host nation so long as wealth is stabilized in the new financial oligarchy.
Even as the Fed gloats that the economy is on a mends, we see that the Fed balance sheet hasn’t really shifted since the financial crisis hit:
Source: Wikipedia, chart
The Fed currently has over $2 trillion in “assets” on its balance sheets. We have documented that within this enormous amount of assets, there are questionable loans and items including shadow bailouts of the imploded commercial real estate market. The Fed has bailed out shopping malls in Oklahoma that have no adequate traffic to justify their existence all the way to luxury hotels. Do you think the American people consider this a solid way of managing the nation’s financial health?
Yet let us go back to one of the stated items listed on the Fed’s mission statement, that of financial stability. In the last decade the US financial markets have seen some of the worst financial volatility since the Great Depression. The Fed did not sit idly by as we now know with the released lending notes during the crisis. The Fed made $9 trillion in short-term loans to 18 of the largest financial institutions in the country. It also made loans to corporate entities like McDonalds for example. The Fed of course did not want this information to be released since it showed favoritism to the largest organizations in the country all the while lending tightened up to smaller businesses and organizations. Individuals certainly have felt the credit freeze and nowhere in the notes do we see the Fed making a solid effort to bolster lending to the American public. They were concerned about the biggest institutions and the rest were left hanging on a shingle.
During the banking crisis of the Great Depression many banks failed in a system setup under unit banking:
Source: Mortgage News
Yet the big problem today is that we have a handful of banks holding over 50 percent of all total banking assets ($13 trillion and half with 19 banks out of 7,700+). So the raw count of bank failures is deceptive. We can have 100 bank failures costing $1 million each or have one giant failure like IndyMac costing $8 billion. The era of too big to fail is just as dangerous as one in which banks are isolated. In fact with the data released from the Fed we see the insidious problem of a system in which the worst performing banks with the most deceptive practices not only are bailed out but are given more capital to remain in business. All this does is solidifies their actions and makes them grow even bigger, the side effect of moral hazard. Think of JP Morgan taking over Washington Mutual and now they are going to charge customers $10 a month for what used to free checking for life. Think of Bank of America swallowing up Countrywide Financial. This is the kind of banking consolidation that the Fed has orchestrated since the crisis started with no accountability to Congress or the American people.
The Fed would like you to believe that they are using their own money but this is a lie. The Fed was instrumental in creating the housing bubble with their low Fed funds rate:
Most Americans carry a large part of their net worth in real estate. So the fact that the Fed turned what used to be a stable asset into a highly volatile commodity that encouraged Wall Street banks to develop CDOs and other instruments of financial destruction was a method of siphoning off wealth from most Americans to their banking overlords. Again, the Fed is designed to maintain financial stability but the actions of the last few decades demonstrate that their mission should read:
“To aggregate as much wealth into the banking system while eliminating the American middle class by a slow systematic dilution of their currency and financial well being and standard of living.”
This is exactly what has happened in the last decade. The average American makes roughly $39,000 a year or less. 72 million Americans make $25,000 or less each year. Yet at the same time wealth at the top is getting more and more consolidated. So now we have a system where giant bank failures don’t happen but we have a slow destruction of wealth for the remainder of the American public. The Fed only cares about stability for its member banks. Ben Bernanke, the current Fed chief went on 60 Minutes claiming that Americans would be better off if they just got more educated. Oh really? So you mean with the current higher education bubble Americans should borrow more money from banks and the government so they can go into massive debt for a degree that may not help them land a job? We all know that the cost of college has far outpaced the cost of most items including healthcare costs. Yet the solution to our current crisis is to get into deeper debt and become slaves to banks yet again? Sounds like Alan Greenspan being a champion for adjustable rate mortgages.
The Fed has given horrible advice over and over. It wouldn’t be such a problem if they were a pundit on a radio show. But this is our central bank! This is the institution that made $9 trillion in short-term loans and fought Congress to keep it hidden from the American people. This is the institution that has over $2 trillion in “assets” and doesn’t want to say what it is because the American people will find out that junk mortgages on failed real estate deals will show up. The Fed has failed on its explicit mission and it is time to fully audit the Fed.
Six of the biggest banks in the nation have been told by New Jersey’s Supreme Court Chief Justice that unless they can prove otherwise, they will have to stop tens of thousands of foreclosures in the Garden State.
“This is something we have focused on for a number of months,” Chief Justice Stuart Rabner told NBCNewYork in a conference call with reporters Monday afternooon.
New Jersey‘s action follows similar moves in other states where lawyers for homeowners have found bankers using so-called “robo signing” to process the paperwork of foreclosures, when court rules require the banker involved to have specific knowledge of each case.
The banks involved include Bank of America, Ally (formerly GMAC), JP Morgan Chase, One WestBank (formerly Indybank), Citibank, and Wells Fargo.
Together, they filed 29,000 foreclosure notices so far this year, nearly half of the 65,000 to date.
In addition, the Court is demanding that two dozen smaller lenders prove that they are on the up and up with all of their foreclosure actiions, and must provide proof to a Special Master that they did not use any shortcuts in moving people out of their homes.
In New Jersey, a lender can begin foreclosure action only after four months of a homeowner being in arrears.
But the process of getting people out of their homes has to go through the courts, and while it is usually up to a Judge to decide, he or she normally relies on affadavits by banking officials that in New Jersey, require some detailed personal knowledge.
Legal Services of New Jersey, apparently following up on reports of sloppy foreclosures elsewhere, began a multi month investigation that formed the basis of today’s action by Chief Justice Rabner.
In all, three fourths of the 65 thousand foreclosure filings made so far this year are being questioned by this action, with the six big banks being told to appear in a Mercer County courtroom January 19th to prove they’re not guilty as charged.