• Here is a site which lets you find local credit unions

• Here is a site which rates the safety of banks, thrifts and credit unions

• And here is another site which rates the safety of credit unions

As USA Today pointed out in August 2008:

Credit unions are regulated by the National Credit Union Administration, or NCUA, or by state agencies. The NCUA oversees the safety and soundness of all credit unions.

If you want to check up on your credit union, make sure it’s federally insured by the NCUA and look at its finances, you can do that any time. Go to the NCUA’s website at www.ncua.gov, click on the “Credit Union Data” link on the left-hand side of the page below where it says Data and Services. Next, click on the Find a Credit Union link, type in the credit union’s name and click the Find button.You can then choose to view the Financial Performance Report or the official regulatory document, called the 5300 report. This report will tell you how well capitalized the credit union is and even let you see how many of the loans are going bad.

What about your asset protection? Credit unions are backed by the NCUA, through the NCU Share Insurance Fund, which is backed by the U.S. government. Individual accounts are backed up to $100,000, with additional coverage up to $250,000 for certain retirement accounts. Joint accounts may qualify for coverage of up to $200,000.

For example, economist L. Randall Wray writes:

Here’s the opportunity, Wall Street’s newest and bestest gamble: there is a huge untapped market of some 50 million people who are not paying insurance premiums—and the number grows every year because employers drop coverage and people can’t afford premiums. Solution? Health insurance “reform” that requires everyone to turn over their pay to Wall Street. Can’t afford the premiums? That is OK—Uncle Sam will kick in a few hundred billion to help out the insurers. Of course, do not expect more health care or better health outcomes because that has nothing to do with “reform” … Wall Street’s insurers… see a missed opportunity. They’ll collect the extra premiums and deny the claims. This is just another bailout of the financial system, because the tens of trillions of dollars already committed are not nearly enough.

Wray points out that — with the repeal of Glass Steagall — the financial sector and the insurance businesses (the “f” and “i” in the “fire” sector) are somewhat merged.

Wray is no conservative. He is Ph.D. is Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute — which focuses on inequality in the distribution of earnings, income, and wealth.

Dr. Andrew Coates describes the bill as “a guarantee of insurance industry dominance and the continued privatization of health care in every arena.”

Dr. Coates is no conservative. He is a medical doctor, a member of the Public Employees Federation, AFL-CIO, secretary of the Capital District chapter of Physicians for a National Health Program, and teaches at Albany Medical College.

And — as I have previously pointed out — progressives such as law school professor Sheldon Laskin, anti-war activist David Swanson, and Miles Mogulescu are calling the bill authoritarian and unconstitutional because the government cannot legally force people to buy private health insurance.

Indeed, given Wray’s point that this is just another bailout in disguise, the bill should more properly be called a “wealth reform” bill than health reform legislation.

•    The Wall Street Journal – Fed Proposes Tool to Drain Extra Cash
The Federal Reserve on Monday proposed selling interest-bearing term deposits to banks, a move the U.S. central bank would make when it decides to drain some of the liquidity it pumped into the economy during the financial crisis. The new facility is intended to help ensure that the Fed can implement an exit strategy before a banking system awash with Fed money triggers inflation. Fed Chairman Ben Bernanke has described term deposits as “roughly analogous to the certificates of deposit that banks offer to their customers.” Under the plan, the Fed would issue the term deposits to banks, potentially at several maturities up to one year. That would encourage banks to park reserves at the Fed rather than lending them out, taking money out of the lending stream.The central bank said the proposal “has no implications for monetary policy decisions in the near term.” “The Federal Reserve has addressed the financial market turmoil of the past two years in part by greatly expanding its balance sheet and by supplying an unprecedented volume of reserves to the banking system,” it said. “Term deposits could be part of the Federal Reserve’s tool kit to drain reserves, if necessary, and thus support the implementation of monetary policy.” Michael Feroli, an economist at J.P. Morgan Chase, said “it’s another step forward in the exit-strategy infrastructure, but it’s been well flagged in advance, so it’s not a surprise.” When Fed officials decide to tighten credit, they would likely use the term-deposits program ahead of — or in conjunction with — adjusting their traditional policy lever, the target for the federal funds interest rate at which banks lend to each other overnight. The Fed also said Monday that its balance sheet rose slightly to $2.2 trillion in the week ending Dec. 23. The Fed’s total portfolio of loans and securities has more than doubled since the beginning of the financial crisis. As part of its efforts to fight the downturn, the central bank is buying $1.25 trillion in mortgage-backed securities, a program it says will end in March. The Fed now holds $910.43 billion in mortgage-backed securities, it said Monday.

•    Bloomberg.com – Fed Proposes Term-Deposit Program to Drain Reserves
The Federal Reserve today proposed a program to sell term deposits to banks to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  The plan, subject to a 30-day comment period, “has no implications for monetary policy decisions in the near term,” the central bank said in a statement released in Washington. Fed Chairman Ben S. Bernanke is preparing tools and strategies to shrink or neutralize the inflationary impact from the biggest monetary expansion in U.S. history. Central bankers are also conducting tests of reverse repurchase agreements and discussing the possibility of asset sales. Term deposits may help the central bank “assert operational control over the federal funds rate” once officials decide to lift the overnight bank lending rate from the current range of zero to 0.25 percent, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Excess cash “would be locked up” rather than put downward pressure on the federal funds rate, he said.The Fed won’t begin raising interest rates until the third quarter of 2010, according to the median estimate of 62 economists surveyed by Bloomberg News in the first week of December.

•    The Financial Times – Fed to offer term deposits to banks
The US Federal Reserve plans to offer term deposits to banks as part of its “exit strategy” from the exceptionally loose monetary policy used to fight the recession. In a consultation paper released on Monday the Fed said it planned to change its rules so that it could pay interest on money locked up at the central bank for a defined period. The Fed added that the well-flagged rule change – designed to allow it more influence over the $1,100bn in excess reserves held by banks – was part of “prudent planning. . . and has no implications for monetary policy decisions in the near term”. It is one of a number of measures that has been outlined over the past few months by Ben Bernanke, chairman of the Fed, as an option to drain liquidity from the financial system in a manner that protects the economic recovery while heading off the threat of inflation.

•    The Federal Reserve – Notice of proposed rulemaking; request for public comment.
The Board is requesting public comment on proposed amendments to Regulation D, Reserve Requirements of Depository Institutions, to authorize the establishment of term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances. Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks (”eligible institutions”) could hold term deposits and receive earnings at a rate that would not exceed the general level of short-term interest rates. Term deposits would be separate and distinct from those maintained in an institution’s master account at a Reserve Bank (”master account”) as well as from those maintained in an excess balance account. Term deposits would not satisfy required reserve balances or contractual clearing balances and would not be available to clear payments or to cover daylight or overnight overdrafts. The proposal also would make minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board’s Policy on Payment System Risk to address transactions associated with term deposits.

Comment

We believe the proposal of this new tool signals the Federal Reserve is still flailing around trying to look busy so everyone is assured they have a plan.  The fact is they have no plan and are still throwing everything on the wall to see what sticks. From the November 4 FOMC minutes:

Participants expressed a range of views about how the Committee might use its various tools in combination to foster most effectively its dual objectives of maximum employment and price stability. As part of the Committee’s strategy for eventual exit from the period of extraordinary policy accommodation, several participants thought that asset sales could be a useful tool to reduce the size of the Federal Reserve’s balance sheet and lower the level of reserve balances, either prior to or concurrently with increasing the policy rate. In their view, such sales would help reinforce the effectiveness of paying interest on excess reserves as an instrument for firming policy at the appropriate time and would help quicken the restoration of a balance sheet composition in which Treasury securities were the predominant asset. Other participants had reservations about asset sales–especially in advance of a decision to raise policy interest rates–and noted that such sales might elicit sharp increases in longer-term interest rates that could undermine attainment of the Committee’s goals. Furthermore, they believed that other reserve management tools such as reverse RPs and term deposits would likely be sufficient to implement an appropriate exit strategy and that assets could be allowed to run off over time, reflecting prepayments and the maturation of issues. Participants agreed to continue to evaluate various potential policy-implementation tools and the possible combinations and sequences in which they might be used. They also agreed that it would be important to develop communication approaches for clearly explaining to the public the use of these tools and the Committee’s exit strategy more broadly.

The Federal Reserve first hinted at term deposits almost two months ago, although exactly what they were talking about was left vague until now.

Remember that the Federal Reserve has to withdraw over a trillion dollars of excess liquidity.  The easiest way to do this is to sell hundreds of billions of MBS, Treasuries and agencies.   As the bold highlighted passage above implies, they are scared to death of doing this, so they propose complicated schemes to withdraw liquidity like reverse repos and now term deposits.

We have argued that these schemes will not work.  They cannot be done in the sizes necessary or enough to even matter.  The Federal Reserve could possibly drain tens of billions of dollars via these schemes, but collectively that will amount to a rounding error when the goal is to withdraw over a trillion in excess reserves.

The Federal Reserve does not want to admit defeat, so they continue pursuing these strategies that will not make a difference.  We believe they also do it to “look busy” as they are taking measurements and notes as to how to withdraw all the liquidity they have pumped in.  They think this will give the market comfort that someone is on the case and that inflation expectations will not get out of control.  The market is not buying this.  Inflation expectations, s measured by TIPS inflation breakeven rates, are going vertical.

Reinvestment Risk

As to term deposits, the Federal Reserve is proposing an illiquid short term instrument for banks to invest in.  Banks would buy these instruments and “lock up” the excess reserves they now have.  This would have the same effect as draining excess reverses.  The maturities of these instruments would be as long as one year.

It is unclear if there will be a secondary market for these instruments, and if so, how liquid it will be.
Without a secondary market, buyers of these instruments face huge reinvestment risk.  The future course of short term interest rates is arguably to the most uncertain it has been in decades.  Will the Federal Reserve stay near zero until 2012 or will they be forced to raise rates in the first half of 2010?  Given all this uncertainty, who wants to lock up money in something that cannot be sold before maturity?  This is especially true given the Federal Reserve’s statement that the “maximum-allowable rate for each auction of term deposits would be no higher than the general level of short- term interest rates.”

The general level of short-term interest rates is set on known instruments that have generations of history and active secondary markets.  If the Federal Reserve wants to introduce a new, and wholly unknown instrument with an uncertain secondary market and offer no interest rate premium, then we cannot see how this will work beyond a token amount after some arm twisting to get them sold.  The Federal Reserve will have to offer a premium for uncertainty and illiquidy to make this fly in any major way, something they said they will not do.

Complicated Is Simple

The Federal Reserve owns 80% of AIG.  With each passing day it looks like the Federal Reserve is adopting AIG Financial Product’s business practices.  That is, when faced with a financial problem, they create complicated tools (like CDS).  When critics says these new products will not work, tell them they do not know what they are talking about and create even more complicated tools to dazzle everyone.  Once the tools are so complicated that no one understands them, you will be hailed as an expert with no peer.  You might even be named TIME’s Person of the Year.

As we head into the New Year, I am trying to look back at the last one with some semblance of a coherent interpretation of events that leads to a strategic vision of the future.  I have already touched on stimulus, kleptocracy and crony capitalism as dominant themes for the year 2009. 

These posts have been critical of the economic vision presented by the Bush and Obama Administrations. I would stress that I see a lot of overlap in the two Administrations’ economic policies, which is why I use the phrase “the Bush and Obama Administrations” instead of focusing just on Obama.

But, now is the time to offer a review of alternative policy solutions. Bashing policy without pointing to an alternative doesn’t add value. I also believe quite strongly that this exercise will demonstrate that alternative policy solutions did exist – and that they were pointed out at the time. One can only assume that alternative policy solutions were rejected because the Bush and Obama Administrations preferred the solutions they crafted to these. And while, I am most concerned with outcomes, this juxtaposition between what could have been and what is points to the kleptocracy and crony capitalism I mentioned in my last two review posts.

Before I go into my spiel, I want to stress a point I made at the outset of a November post “The less optimistic view of Treasury’s handling of the crisis”:

one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry.

I will probably end up flexing my confabulatory muscles like every other pundit out there – making direct or unconscious assumptions about motives, agendas or intent. This is all just speculation – much of it false. It is outcomes that matter, not intentions. And it is the outcomes that leave me unsatisfied with the present policy course.

Change you can believe in

The key issue, in my view, is the desire for change in 2008.

For years, the U.S. had been lecturing others how to run a successful economy. The Mexicans needed to sell their banks to foreign behemoths to succeed. The Asians and the Argentines needed to take their depressionary medicine and eliminate crony capitalism. The Russians also needed to eliminate gangsterism and crony capitalism or no one would invest there. The Europeans were overly regulated and the state was too big.  And so on.

Then, after a quarter-century of apparent economic success (1982-2007), the U.S. economic and financial system was close to collapse. The masters of the universe were seen to have brought the economy to its knees because there were vulnerabilities at the core of American-style capitalism.  This was an ugly surprise for many – and it was humiliating, just as 9/11 had been on national defense. Change was the watch word.

What kind of change? Last month, I said:

If you asked 1000 people in those exit polls from November 2008 – or even last week, “what would make you know America was headed in the right direction,” you probably would have gotten 700 different answers.

But, one thing is clear: Since January 20th, a lot of people are saying to themselves, “I know change when I see it and this is not it.” That’s what all polls are saying. So, whatever Obama and the Democratically-controlled Congress are doing, it’s not working.

So, people wanted fundamental change and they felt Obama could deliver it. What the specifics were was less important. The key was that whatever changes were made, it reflected a more proportional connection between economic contribution and financial gains as well as elimination of the core vulnerabilities of our system.

More of the same

So, when Tim Geithner says:

I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9-to-1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives.

this is either cynical propaganda or self-delusion. People did not elect your President to do deeply unpopular things. They elected Obama to make the fundamental change that he is not delivering. You may think this is change we can believe in, but polls show Americans do not. This quote encapsulates why you can’t have people who created the mess clean up after it. They are prone to defend their prior policies tooth and nail to vindicate their actions. As I said when reviewing a recent Matt Taibbi piece:

What happens when a company is nationalized or declared bankrupt is instructive; here, new management must be installed to prevent the old management from covering up past mistakes or perpetuating errors that led to the firms demise. The same is true in government.

And Geithner and Summers do not represent change in the least. They were at the center of many of the past decade’s policy mistakes: Lehman, OTC derivatives, and anti-regulation of money center banks.

It’s not difficult to see what’s going on. For Obama, it’s kind of hard to get change when you surround yourself with insiders who have vested interests in the status quo.

Credit Crisis Options

A quote from “America needs a pre-privatization plan” is my jumping off point because it does a good job of framing the policy choices at the time.

To my mind, there are three ways to deal with an insolvent financial institution:

• Bankruptcy. Allow the  institution to collapse (like Lehman Brothers)
• Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)
• Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.

As you can see, governments have tried all three solutions.  However, there are vast differences between the three.

The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere.  It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions.  It also acts as a subsidy, which favors domestic institutions over foreign rivals.  Bailouts increase moral hazard by rewarding risky and reckless lending practices.  And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.

As you know, the Bush and Obama Administrations chose the third option. Here are a few posts from the crisis detailing the Bush response (for which Geithner as New York Fed Chair shares responsibility). Paulson wanted to allow failed firms to fail. But, he quickly learned the same lesson that the Brits learned during the run on Northern Rock, namely this is a very risky strategy unless you have a well-thought out process to limit contagion (see the first post below).

After the post-Lehman panic, I see the policy as bailouts that are “a naked attempt to preserve status quo” as I say in the Dead on Arrival post below (and I present a coherent policy alternative there). Congress was asleep at the wheel, as usual.

• Lehman’s bankruptcy: putting the cart before the horse? – Sep 2008
• The $700 billion Paulson Plan is dead on arrival – Sep 2008
• The Paulson Bailout Plan is unconstitutional crony capitalism – Sep 2008
• The Paulson plan is not going to make it – Sep 2008
• Congress does need to act on the Economic Patriot Act – Sep 2008

So, when Obama was elected, there was an enormous opportunity to change course. I had pointed to Paul Volcker’s presence in Team Obama as encouraging in October 2008 (Paul Volcker: Obama’s other economic advisor) and November 2008 (Volcker warns how serious things have become).

However, after the election, Obama immediately put Geithner and Summers in charge despite their complicity in the policies that led to crisis. I will sheepishly admit to putting a positive spin on things pre-inauguration (see Crony capitalism in U.S. banking bailout should end from January). But, Geithner and Summers consolidated power over time as infighting begins within Obama’s team forced Obama to cast his lot with Geithner-Summers or Volcker. By March, Marshall Auerback was asking Where’s Volcker? as it became obvious he was being shunted aside.

The path not chosen

So, to sum up, we had an economic and financial crisis of a lifetime. The Bush Administration and the Fed were in disbelief and failed to make enough preparations for the obvious coming failures. An almost religious belief in market mechanisms and an incoherent policy led to disaster with Lehman – after which the Bush Administration got religion about bailouts and crony capitalism.

When Obama came to town, you might have thought his policies would be substantively different. But they were not – not on regulatory reform, auto bailouts or bank bailouts. His was the neo-liberal prescription of the Clinton era – substantively the same as the Bush policies. When I wrote Seven reasons to be skeptical of Obama’s economic plans already in January, this was why.

That’s how things panned out.

Since I detailed some of the policy choices in my review post on crony capitalism, I won’t cover that ground here. I will point out just a few March 2009 posts from Credit Writedowns which I did not mention in the last review posts. They all point to problem’s with Team Obama’s solution in terms of wealth transfers and sustainable outcomes as pointed out by leading economists.

• Is Obama considering nationalisation? – Mar 2009
• Geithner’s Plan: one of the most regressive wealth transfers of all time – Mar 2009
• Roubini: Nationalization “fully on the table” in Geithner’s Plan – Mar 2009
• Krugman: Geithner Plan “won’t work” — Mar 2009

I will use this as a natural place to stress how motives and intent are irrelevant.  Think Obama is a bad guy all you want. Think Larry Summers has an alternative agenda all you want. Think the perennial public servant Tim Geithner doesn’t want to do good all you want.  Motives and intent don’t matter; outcomes matter.

And here are the posts I feel best represent a number of potential alternative solutions to what we have witnessed from pre-Lehman through March.

• The Swedish banking crisis response – a model for the future? – Aug 2008
• How to tackle systemic malaise – Sep 2008
• The global economy has crashed: we need a comprehensive credit crisis plan – Sep 2008
• The problem with comprehensive banking crisis solutions – Nov 2008
• Seven reasons to be skeptical of Obama’s economic plans – Jan 2009
• What is an economic depression? – Feb 2009
• A conversation with Bridgewater Associates’ Ray Dalio – Feb 2009
• Yves Smith: Nationalization is what the FDIC is doing every week – Feb 2009
• America needs a pre-privatization plan – Feb 2009
• Did Sweden really nationalize its banks? – Feb 2009
• Lessons from Swedish bank resolution policy — Mar 2009
• A few thoughts about the banking crisis response in the United States – Mar 2009
• What would an alternative to bailouts have looked like? – Nov 2009

Likely outcome

I’ll finish this off by quoting from my third post “The US Economy 2008” which points to over-indebtedness and a purge of malinvestment as the problem which politicians will refuse to tackle:

The global economy, now supported in the main only by the overextended U.S. consumer, finds itself at stall speed, susceptible to any number of potential exogenous shocks. Ultimately, the economic malaise created by this confluence of events will take years to unwind. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.

This process will be extremely painful in the short term, but will lead to a healthy economy long-term. Unfortunately, experience shows that these painful steps will only be taken as a last resort. Moreover, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. Protectionism is a natural outgrowth of nationalist economic policy as it transfers wealth from foreign producers to domestic producers by cutting off access to lower cost excess capacity in the goods in service sectors. However, this also serves to transfer wealth from domestic consumers to domestic producers by increasing the price of goods in the protected sectors, ultimately reducing consumption demand.

For these reasons, I am cautious about the long-term outlook for the global economy and the U.S. economy in particular. The likely outcome for the next decade is one of sub-par global growth with short business cycles punctuated by fits of recession.

Could it be any different?

Yesterday, I indicated I would write a few thematic posts as a look back at some of the more important economic topics that this credit crisis has uncovered. Tying posts together in a theme definitely gives a better holistic view of a the themes than the posts do in isolation. But I also enjoy writing this because the review process gives me a better perspective of where we have come from and helps judge where we are headed.

Yesterday, I wrote about economic stimulus. My conclusion was that while stimulus may have helped avert crisis, the process made clear that crony capitalism is alive and well. So, the second topic I wanted to address today was crony capitalism. However, in writing this post, the lead in describing kleptocracy became so long that I decided to cut this into two bits; this first one is on kleptocracy and a later one will be on crony capitalism.

The first post I wrote related to kleptocracy was in March of 2008 called “A populist interpretation of the latest Boom-Bust cycle.” At the time, I wasn’t really blogging very seriously. I had just started two weeks earlier and wanted to flesh out some ideas that I had long considered germane to the understanding of the credit crisis. But, in retrospect, the thesis I developed in this post has become central to my thinking about how the American and global economy have evolved in the fiat currency era.

Kleptocracy defined as the status quo

The thesis was this:

[Jared] Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies. Thus, all ‘advanced’ societies with high levels of GDP are complex and hierarchical.

The problem is: these more stratified, more complex societies are in essence Kleptocracies, where those in power re-distribute societal wealth to themselves. Those at the bottom of the society’s pyramid accept this unequal, non-egalitarian state of affairs because they too benefit from their society’s relative advancement. It’s a case of a rising tide lifting all boats.

In short, the playing field in all modern day nation states is by definition unequal. The question is whether this should be tolerated, mitigated or eliminated. An unwritten assumption I made when I wrote the post is that humans are genetically programmed for fairness. My understanding is that scientific studies have convincingly demonstrated that human beings will actually consciously disadvantage themselves to seek revenge as a means of restoring justice and fairness.

This would suggest that a major flaw in neoclassical economic models, especially as regards a self-equilibrating economy, is the focus on rational expectations and efficiency at the expense or fairness and/or irrationality. A neoclassical economist might tell you that a rising tide lifts all boats and it is rational self-protection for economic agents (aka real human beings) to accept inequality for this very reason. But, in the real world, fairness and justice are important as well. And when an economic system is deemed unfair, people will go so far as to hurt themselves economically in order to level the playing field.

Stability of status quo leads to overreach and instability

So, my thinking is this: because of the natural state of inequality endogenous to any stratified society, over time the natural tendency of any ruling elite is to deploy the state’s coercive power for greater and greater self-benefit. I liken this to Hyman Minsky’s instability of economic stability theorem. The stability of power leads to overreach and overthrow. This is a view largely consistent with Paul Kennedy’s themes of imperial overstretch in his book The Rise and Fall of the Great Powers.

In the post I expressed these sentiments saying:

Diamond says the Kleptocrats maintain power using 4 different methods:

“1. Disarm the populace, and arm the elite.”

“2. Make the masses happy by redistributing much of the tribute received, in popular ways.”

“3. Use the monopoly of force to promote happiness, by maintaining public order and curbing violence. This is potentially a big and underappreciated advantage of centralized societies over noncentralized ones.”

“4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.”

Kleptocracy in America?

The obvious corollary of this theory is that most successful modern societies are, in fact, kleptocracies. The key is to use the four methods to gain popular support in order to re-distribute as much wealth to the ruling class as the populace will support. If the ruling class takes too much, it will be overthrown and replaced by a new ruling class (which in turn will re-distribute wealth to itself using the same four methods).

How the status quo maintains the status quo

Let me take these points one by one. I will preface this by saying that, as the stability of the economic status quo disintegrates into instability via economic depression, you should expect the ruling elite to step up uses of these methods of retaining power.  So when I wrote in my Depression piece about “more muscular forms of government,” this is part of what I was referring to.

As Libertarians see it, the right to bear arms is an essential in stopping the elite from maintaining power unjustifiably. Obviously, which arms, when they can be borne and how is a constitutional issue that goes to the heart of American democracy.

The second issue is about “bread and circuses” or what I call the anesthetizing of the populace as ironically demonstrated in this Star Trek “Bread and Circuses” from TV, our own modern-day agent of mental anesthesia.

The third issue is about totalitarianism.  Civil libertarians like myself see the permanent war state as promulgated by the Bush administration post 9/11 — and now maintained by the Obama Administration — as a clear sign that the state’s use of the monopoly of force to promote order is rising and will continue to do so. Eisenhower’s military industrial state warnings were warranted. You can see some of the articles on that very topic here in my bookmarks. And you should note Obama’s poor record on civil liberties.

The last (and perhaps most important) issue, in my view, has to do with the unabiding faith in free markets that many now have. It is with religious zeal that these so-called Libertarians defend the primacy of markets over all else when in reality common sense would tell you that those with the greatest influence and money will always be at an advantage without some check on that influence and power.

How ideology is central to retaining the status quo ante

I think this last point is important. Think of how Diamond phrased this:

The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.

The important thing to realize here is that ideology is a tool used to control the masses while those in power re-distribute to themselves. Diamond was probably talking here about ancient societies: the Mayans, Incas, the Greeks, the Romans, Easter Island. But, it does apply quite well to the modern-day. After all, in the U.S. average hourly earnings peaked more than 35 years ago. And we can see that most of the economic gains of the last two decades has been an illusion masked by gobs of debt.

But freshwater economists have this view that the economy is always self-equilibrating and this means government must be held at bay any- and everywhere lest it reduce the efficiency of the free market. This is an extreme ideological position which gained sway in the aftermath of the disaster of the 1970s. Fed Chairman Alan Greenspan was an adherent of this ideology despite holding a central planning position as Federal Reserve Chairman which was antithetical to the views he espoused.

Markets are wonderful. A largely market-based economy is certainly more ‘efficient’ than a non-market based one (ask the Soviets). But, markets are not self-regulating. They fail – and catastrophically so. But no manner of real world experience seems to shake ideologues’ free-market zeal. To give you an example of the mindset, Alan Greenspan is reported to have thought that markets could even self-regulate fraud – no regulatory oversight necessary. 

See the video in Frontline – The Warning: Who Knew About the Looming Financial Crisis for this particular revelation and Ms. Watkins, why does Charlie have lit dynamite? for why this is absurd. Even when you think Greenspan has learned something, he proves time and again that he just doesn’t get it. And don’t think he is alone in officialdom. Former Fed official Frederic Mishkin has shown he doesn’t get it either.

Not only is the freshwater view of rational economic agents and efficiency completely ignorant of the role of fairness, it also disregards the very real tendency for power to consolidate over time and to lead to crony capitalism. This is what I refer to as “deregulation as crony capitalism.” I see it as central to the causes of the crisis.

I will pick up on this theme in a later post. Next up on my year in review is a post on crony capitalism in action and how the credit crisis solutions reveal that the ruling elite want to return to the status quo ante. Overreach has been the order of the day and will ultimately invite an opposing response.

As we approach the new year, I have decided to write a few thematic posts as a look back at some of the more important economic topics that this credit crisis has uncovered. The thinking is that tying posts together in a theme might give a better holistic view of a few themes than the posts do in isolation.

The first topic is this: does fiscal or monetary stimulus work? That has been a consistent theme at Credit Writedowns.  And given my recent post backing away from fiscal stimulus as a policy tool, I thought it an opportune moment to explore the subject a bit via a full scale review of previous posts at Credit Writedowns.

Broadly speaking, the policy choices in a deep downturn are the ones I outlined last month in “Stop the madness now!.”

You have four options:

1. No stimulus. Let the chips fall where they may. Yves Smith calls this the ‘Mellonite liquidationist mode.’ The thinking here is that trying to avoid the inevitable bust only makes it that much larger. And the economic policies during recessions in 1991 and 2001 seem to bear that out. The Harding Recession of 1921 is commonly seen as gold standard response.
2. Monetary stimulus only. Quantitative easing mania. My understanding is this is what Ambrose Evans-Pritchard has been advocating.   The thinking here is that the flood of money and the low rates will eventually jump start the economy. No deficit spending needed.
3. Monetary and fiscal stimulus.  Full tilt Keynesian. This is the Krugman view. The thinking here is that one needs to credibly commit to higher inflation and close the output gap to avoid a deflationary spiral. If that is insufficient, then one needs to go full bore on fiscal stimulus aka deficit spending. And if that doesn’t work, subsidize jobs. The New Deal is commonly seen as the gold standard response.
4. Fiscal stimulus only. Deficit spending. I have been talking up this view. The thinking here is that we need to both close the output gap to prevent a deflationary spiral and revive private sector savings in order to promote deleveraging.

There is no magic bullet here.  We are living through a situation unique in time with few historical precedents. And there are a lot of competing ideas being tossed about. So policy makers are groping around, desperately seeking the holy grail of depression-busting economic policy.  In that regard, I don’t envy them. They are certainly going to make a lot of mistakes. It may seem at times that I don’t realize this given the harshness of my critiques, but I do.

When I started writing about the financial crisis, I took the first view, best exemplified in my pre-Lehman posts on the origins of the credit crisis and precedents in Japan and the Great Depression. My thinking at the time was that if policy makers recognized the full extent of the crisis and stayed ahead of the curve, we could get through this with a short but very sharp downturn.

• The US Economy 2008 – Mar 2008
• Credit deflation and the Japanese problem – Jun 2008
• The Japanese Problem is now ours – Jun 2008

However, policy makers were woefully behind the curve.  A recent article in the Washington Post highlights how Ben Bernanke and the Federal Reserve were blindsided by the crisis. So, when the panic that resulted from the Lehman crisis struck, I felt that the jig was up. We had been catapulted overnight into a seriously debt-deflationary economic environment in which monetary policy was ineffective. Option number two was out as a policy tool. Quantitative easing was not going to work.

The following posts outlining our thinking on these topics.

• Quantitative easing: printing money like mad to ward off deflation – Nov 2008
• Nouriel Roubini: Will massive stimulus ward off stag-deflation?  — Dec 2008
• Quantitative easing and inflation expectations – Dec 2009

As I saw it, the Lehman failure marked a clear change in possible policy paths. As I outlined yesterday:

when Lehman Brothers collapsed in a heap, it was clear to me that we faced a stark choice.  One choice was a deflationary spiral and the associated economic dead weight loss of a non-equilibrating global economy in Depression.  The other choice was a soft depression cushioned by fiscal (and monetary stimulus). About a year ago I wrote an ode to Keynesian economics called Confessions of an Austrian economist in which I said that I choose fiscal stimulus to cushion the downturn and prevent a depressionary spiral.

And this is the line I stuck to. I think the real debate about whether or not to try fiscal stimulus revolves around the role of government and its limitations. Ideologues on one side see government as a parasite which interferes with the free market.  On the other side, ideologues see government as the only way out of a crisis of this magnitude.  The key sticking point is not just the size of government, but also its effectiveness – the political will to effect change rather than to favor constituents as recent research suggests bailout money was used.

I have tried to outline this debate with a few posts that point to both sides of the issue.

• What does Mises say about trying to stimulate the economy out of recession – Dec 2008
• A brief philosophical argument about the role of government, stimulus and recession – Dec 2008
• Peter Schiff: “Government is a burden on the economy” – Jan 2009
• Marc Faber: The economic crisis is a consequence of U.S. government intervention – Feb 2009
• The choice is between increasing or decreasing aggregate demand – Oct 2009
• A few thoughts about the limitations of government – Nov 2009

The majority of Americans fall in neither of the two ideological camps.  I would argue that the reason Barack Obama was elected was his message of hope and the promise of “change you can believe in". That had many of us – including me – thinking government can add stimulus while simultaneously encouraging saving and deleveraging, reducing dependence on asset prices, and allowing zombie companies to fail.  This is government dispensing with crony capitalism. The posts below are an ode to that reasoning. You can see Buffett, Kasriel, Gross and Galbraith all taking this line.

• Congress ready with second stimulus package – Sep 2008
• Bill Gross: This economy requires a check from the government – Feb 2009
• Some tidbits about stimulus, recovery, and the Great Depression – Feb 2009
• Jamie Galbraith: Stimulus not enough – Feb 2009
• Galbraith and Buffett think a second stimulus is necessary – Jul 2009
• Does the US need a second stimulus package? – Jul 2009
• Japan does not demonstrate the failure of stimulus – Nov 2009
• Are we pushing on a string or crowding out? – Dec 2009

So, how has this worked out in practice? Not so well. From the very start, Obama’s lead by negotiating with oneself approach led to a weak and poorly crafted stimulus package.  My comments in “Obama takes middle road on stimulus and taxes that leads nowhere” from February sum up what was likely to happen (emphasis added):

In my view, it has become ever more apparent that the Obama administration is caught in some sort of muddle, trying to fudge between the calls for fiscal discipline from conservatives and the calls for stimulus from liberals.  Obviously, it is in Obama’s nature to lead by consensus, and he has looked for an inclusive political and economic strategy since he came to office.  However admirable these intentions may be, this middle path is unfortunate because it will leave no one satisfied.  Moreover, taking this middle path on the economic front — some stimulus but not massive stimulus, some tax cuts but also some increased spending, increased spending now but tax increases or budget cuts in a few years – is the worst of all outcomes; the economy will not gain enough traction to get the desired ‘jump-start’ and stimulus will ultimately be seen as ineffective.  If the Obama Administration later attempts to return to Congress for more of the same after a failed stimulus bill, it will find a more skeptical response…

My view here is that Obama is forging a middle path that leads to a dead-end. The stimulus is not nearly enough by half to get the job done. The proposed deficit reduction measures for 2013 are outright scary as they risk repeating a mistake from the 1930s. And the banking sector and mortgage plans, both of which I failed to mention, are dubious half-measures as well. One needs to act aggressively and proactively or not at all.

This is exactly what has transpired.  To make matters worse, his team’s lack of accurate economic forecasting has led to an Armageddon scenario at the state and local level, where even unemployment benefits are not adequately funded. All of this was predictable as evidenced by these two posts from early in the year.

• Obama’s stimulus bill is a tough sell so far – Jan 2009
• Will federal largesse be countered by state and local cutbacks? – Jan 2009

The President has effectively discredited fiscal stimulus as a policy tool. What’s more is the bailout of the too-big-to-fail institutions without strings, the apparent cronyism in how these bailouts were done, and the gutting of financial reforms by the financial lobby has also discredited government as an agent to level the playing field for struggling households and taxpayers. See Blodget: Obama suffers because “taxpayer always finishes last” for now, but I will take this subject up in another thematic post.

I certainly underestimated the degree to which cronyism and special interests ruled the roost in Washington. I no longer believe government can be an effective agent of change in the U.S any more than it has been in Japan (see “Japan: stimulus without reform leads to a policy cul de sac”).   As I wrote in “Stop the madness now!

If you are going to deficit spend you need to do it in a big way. You need to stop the deflationary spiral.  That means hitting the reset button by promoting private sector savings and deleveraging and purging all built-up malinvestments. The risk in addressing the situation this way, of course, is replacing the imperfect invisible hand of markets with the imperfect hand of politicians and legislative fiat.

This is a risk I no longer see as worth taking. I have bailout and deficit fatigue just like most Americans. It is abundantly clear that this Administration has absolutely zero intention of purging any malinvestment or promoting any deleveraging. All they want to do is continue business as usual and go back to the asset-based economy that caused this mess. This is why we have seen bailout after bailout coupled with easy money. It makes for record profits on Wall Street but it does nothing for the unemployed.

Moreover, the political process in the U.S. is such that any stimulus money will be diverted to pet projects and used to pay off political constituents. While this may increase aggregate demand, it does so at the risk of serious social unrest as the outrage will certainly spill over into populism.

So, I have developed a case of big government revulsion as I suspect many Americans have done. I will let Marshall Auerback argue the case for fiscal stimulus and its role leading to a sustainable recovery.  I am moving away from stimulus happy talk to focus on malinvestment.

Comments are appreciated.

Are financial markets a direct reflection of the overall health of a nation? I wish they were not, but I fear they are.

I wonder at times if our nation has entered a state of purgatory –
all of us mulling around in the waiting room to Hell, anxiously
counting the minutes until the grim reaper saunters through the door
sickle in hand his mission to send us off to eternal damnation.
Unfortunately, there is little time to close this door so that we may
stave off this potential fate that looms so near. What we need to alter
this course is a procession of men who possess moral fortitude and
common sense, men of rationality and reason. Men of action who will set
in motion the dismantling of institutions that bleed this nation dry.

Hope is not a strategy. This present state of manufactured optimism
emanating from the White House and our news outlets is contemptible. We
are in dire need of new reformist leadership and of new voices that
will speak the truth. A national purification is long overdue. Time is
not on our side. Look at the track record this nation has racked up
over the last few decades and this economic and moral purgatory in
which we find ourselves might very well mark the beginning of our walk
of death down the long road to Hell.

I make this analogy of a national state of purgatory not in jest,
but rather in practical terms. This nation has gone the way of an
absolute meltdown of morality and ethics. We’ve reverted to a sort of
Wild West where anything goes. From the halls of congress to our
corporate boardrooms our collective morality bar has sunk so low we
cannot go any lower without disconnecting from the great past this
nation is starved to regain. We stand dangerously close to the point
where immorality begets our undoing.

Personally, I am father to a daughter of fourteen years. Brett, my
co-author, is father to a twenty-month old daughter and an
eighteen-year old son. We desperately want to create for our children a
better world. But we are fallible men, and certainly not saints. The
paragraphs you are about to read are not written from some moral high
ground, or a Holier-than-thou pulpit, but rather from saddened hearts
when we see that by walking our own moral tightrope, if we were to
allow ourselves to slip below the bar, however slightly, we would be
just as guilty as the worst perpetrators of our nation’s moral
destruction. Also, when witness to greater moral transgressions, by our
own inaction, we become part of the problem. And we are just two men.
Amplify this by fifty million, one hundred million, or three hundred
million fold and it is no wonder immorality permeates our society.

This article is our personal effort to call people’s attention to
the truth. The brevity of our circumstance is immeasurable by past
reference. Economically, we have never been so challenged. Over the
past few decades a gullible US population cheered the halls of congress
and the Oval Office alike as the incestuous bedfellows of money and
politics ushered in a financial Coup d’état – co-opting our public
trusts with the greed and excess of Wall Street. Profits are now had at
any cost – damn the long-term consequences. Instead of being exposed as
the obvious fraud he was, Bernie Maddoff was coddled by the SEC – an
institution whose role as regulator is a complete failure. As Wall
Street and Washington raped an entire nation, employees of the SEC were
too busy surfing porn on the Internet and running private businesses
instead of doing the jobs taxpayers pay them to do. All the while,
young girls were selling their virginity to the highest bidder in
public cyber-forums where grown men (not hormonally charged teenage
boys) seek out their sexual fantasies in the netherworld of Internet
pornography. What of the wives, children, and even parents of these
men? Do they approve of such questionable actions?

Think of our children turning on the television to see people eating
bile, cow blood, and live bugs for money on game shows like Fear
Factor, or Flavor Flav and his hit reality show where he maintains a
stable of women all of whom physically fight each other to have sex
with him because he’s a celebrity – and a damn ugly one at that. And
finally, there’s always Survivor, the ultimate demonstration of all
things wrong with modern human interaction. A reality show that pits
person against person in a deceitful game of moral destruction where
lack of ethics are rewarded, instead of punished. Survivor, this is
what our nation’s leadership has become. Win at any cost. Damn the
future of anyone but myself.

Morality is in great part the measure of a nation. Have we unlearned
morality? Is this why we find ourselves staring down the abyss?

We are allowing ourselves to become more corrupt by the minute. We
stare into the face of our future being raped, but we do nothing. We
are as corrupt as the corrupters. We accept the unacceptable. We fail
to understand that absolute power, corrupts absolutely. In what will go
down as the greatest financial heist in history our leaders have chosen
to reward corrupt individuals and their hollow corporations for what
are arguably criminal levels of risk behavior by the moneyed elite of
this country. What message does that send to our children, or to anyone
for that matter? Be as corrupt as possible in the US and you will be
rewarded? Be the biggest failure jeopardizing the fate of others then
stand in the corporate welfare line with all the other wealthiest
institutions of the world, your greedy hand extended for a government
bailout check while you simultaneously foreclose on an entire nation?
Talk about the rich corralling the masses. It’s no wonder someone
coined the term “The Sheeple.”

The path we traveled to this purgatorial limbo is both easily
understood and misunderstood. The answers to understanding are
sometimes right in front of us. What are seemingly benign things or
actions, those everyday judgments or decisions we make to do one thing
or another, are not always benign. Tell a little white lie to make that
one sale that will put us into our bonus. Rig the game in our favor so
that we might enjoy a little more opulence for the few decades we have
remaining on this planet. Look the other way while the Federal Reserve
and Wall Street blow economic bubble after economic bubble and in the
process create a six-hundred trillion dollar shadow banking system that
plays by no one’s rules but its own. In the case of Goldman Sachs, and
Wall Street in general, lie, cheat, and steal their way to
profitability at the expense of three hundred million taxpayers. The
fact is that we have become an uncooperative nation willing to take
advantage of anyone for the sake of profit. The idea of building a
cooperative future where everyone wins has been sacrificed at the altar
of short-mindedness.

It might be this purgatorial limbo I speak of is simpler than it
appears. It could be that we are collectively suffering the
consequences of the “Peter Principle”, or getting to the job of
failure. This principle supposes that an individual rises in a
corporate hierarchy to their first level of incompetence. An assembly
worker gets promoted to supervisor then to assistant manager, then
manager, until he next gets promoted to an upper management job for
which he is ill equipped and subsequently gets promoted no further as
he can no longer demonstrate the competence required for the task at
hand. He rather relies on subordinates who are then stuck with an upper
manager who cannot carry out his own duties. Could this be the state of
our nation? Have we been promoted as far as our competence allows? Are
we in fact incompetent to handle our future? Have we now elected a man
just incompetent enough for the Presidency who is being manipulated by
Goldman Sachs, the Federal Reserve, and a circle of (previous) Wall
Street insiders now on the government payroll as cabinet members and
high-ranking advisors? The saddest thing is that we sit idly by whilst
our virtue is being stolen. We do nothing.

A view of the world through rose-colored glasses does no one, any
good. We are not as resilient as we think we are. Instead, we exist in
a world of synthetic productivity where multi-tasking renders us
incapable of doing anything effectively or with any level of
competence. Multi-tasking, that art of simultaneous ineffectiveness is
a counter productive weapon that to a large degree has contributed to
the potential failure of this nation. If you were to listen to Alan
Greenspan however, you would believe that multi-tasking through
technological gains by way of the “new paradigm” was the gold at the
end of the Information Superhighway and that exotic mortgages and the
burgeoning spending class paved the road to riches. We now know these
premises to be empirically wrong.

It can now be argued that what would seemingly be advancements in
productivity are proving to be setbacks. The Information Superhighway
has led us to an era of technological arrogance. In reality all we have
accomplished is to dilute our ability to carry out simple tasks as we
click from a quarterly sales report due in an hour, to Facebook, to
on-line solitaire, to writing an email explaining to our boss why the
quarterly report will be delayed this day. We are a nation of excuse
makers. We look for someone else to keep us one step ahead of our
accumulating debt that smothers the potential of what could have been
an equitable future. Ironically, it is our technological arrogance that
impedes our ability to produce and manufacture our way to prosperity.

Craftsmen who used to flock to this country to fulfill the needs of
a manufacturing base flock here no more. “Made in the USA” used to mean
something. It meant quality. It was the definition of industrial
capitalism. But now through the wonders of globalization we have
exported our craftsmanship through an outflow of jobs to China and
India as we turned everyone in the USA into real estate agents,
mortgage brokers, and web designers – a perfect playground for bankers
to ply their craft, lending money in every creative manner both
thinkable, and unthinkable. “Made in the USA” has been reduced to the
status of punch-line – synonymous only with “Mortgage Backed
Securities” and other “Toxic Derivatives.”

Is it any wonder we have evolved into the ‘entitled society’? If we
weren’t on the government payroll, or subsidized by the US taxpayer
through social welfare then we were borrowing our way to prosperity.
Enter the God-fearing middle class. Just dumb enough to buy into the
scam a couple hundred million people began signing over their
paychecks, selling their future for the enjoyment of having things now.
We were transformed into non-productive Sheeple, selling our souls for
an easier life in lieu of a better future for our children. At our
current rate of productive attrition we will soon be a nation of
declawed housecats, possessing no skill-set whatsoever to survive in a
world where the ability to produce real goods still reins supreme. Yet
we remain the ‘entitled society’, when we are entitled to nothing.

We forget (through economic amnesia) that throughout history all
societies fail. Nicolaus Copernicus maintained that civilizations
failed when bad money, controlled and understood by an elite few, drove
out good money. The same can be said for morality. Bad, drives out
good. This is a reality of which we should all be acutely aware but
rather are immune to its possibility. We dangerously believe we cannot
fail. That, in fact, is the greatest gamble of all. A roll of the dice
against history, a bet against all natural laws of the universe, all
things are in a state of entropy. All things eventually wither away to
nothing. To possess longevity is to be ahead of the universe. Sadly, we
have constructed a fragile world that produces material things that do
not last. The fiat money we use as the currency of our production is by
design, destructive itself. The Federal Reserve prints greed, nothing
more. But still we covet it. We pursue it as if it had value. And in
this pursuit we destroy earth’s resources as if the laws of nature have
no relevance. We believe there is only now.

We, the entitled society, morally and fiscally bankrupt have borrowed,
spent, and bailed our way into a historical corner. Nero should be so
proud. Our public trusts are nothing more than government sanctioned
check-kiting operations shifting liabilities from one credit card to
another faster than our creditors can say “Federal Reserve.” The
Ponzi-scheme that is our fiat currency system is about to go the way of
what was for a time the symbol of American superiority, General Motors.
It used to be said that what was good for General Motors was good for
our nation. As I claimed in 2005 that GM would go bankrupt I will now
guarantee that the US government is soon to follow. How our ultimate
entropy will take form I cannot say, but form it will. We will default.
We will restructure. It will be at this point our arrogance will end.

In response, the Fed says that an audit would interfere with its “independence”.

However, the Constitution does not empower a central bank. And Congress — which created the Federal Reserve in 1913 and which has the power to create credit and money — certainly has the power to audit, dissolve, or do whatever it likes with the central bank (including stripping it of the power to create credit).

I have previously demonstrated that the Fed has done a terrible job of managing the economy, keeping unemployment low, and regulating banks.

And I have previously pointed out that the the independence argument is a red herring.

Indeed, the whole idea of independence means that the Fed should be shielded from political pressure to artificially pump up the economy with easy money right before elections. Congress never intended Fed “independence” to mean independence from Congressional oversight to ensure that the Fed is acting within its mandate and in the best interests of the country. These are two totally different concepts, and the Fed and its boosters are being disingenuous when they argue that an audit will interfere with independence from pressure to pump up the economy right before elections.

Now, in an interview this weekend with Der Spiegel, Paul Volcker — while trying to support the Fed’s argument for independence — actually undermines it:

SPIEGEL: Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.

Volcker: I think the loss of independence and authority of the Federal Reserve would be a very serious matter for the United States. Not just in terms of monetary policy but in terms of our place in the world. People look to strong, credible institutions and I think the Federal Reserve has been such an institution. If that’s lost or too hamstrung by legislation I think we will regret it.

SPIEGEL: But is the Fed still the same kind of institution as during your tenure as chairman? Or is it now more of a governmental instrument? The Fed is managing the TARP program and is also buying government bonds.

Volcker: In some sense the Federal Reserve is always an instrument of the government. It is a government body but it is independent within government. But you are right in the sense that part of the concern is that they have involved themselves quantitatively in entering markets and in that process, you are supporting some markets and not others. That is an area in which the Federal Reserve has never wanted to get into and one that most central banks don’t want to get into. If you are going to maintain your independence you have to avoid that. To intervene in particular sectors of the market is not the proper role for the central bank over time. It could be justified only by extreme emergency.

Intervening and supporting some market players (Goldman, AIG, etc.) and not others (Lehman, etc.) is precisely what Bernanke has been doing. Whatever can be said for the Fed in the past, picking winners and losers is “not the proper role for the central bank”, in Volcker’s words. Without an audit, we will never know which “winners” were saved and which “losers” were left to die, or why. Nor do we really currently know which bailouts and other actions were truly performed under emergency conditions — to stave off catastrophe — and which were done to help out financial companies for other reasons.

Moreover, Bernanke gave many billions to private foreign banks and foreign central banks (and see this). Has the Fed been picking winners and losers among countries? Among private banks?

As former Federal Reserve economist William Bergman wrote (he sent me this by email; it was previously published in article form, but is not available on the Web):

One of the principal laws governing audits in the Federal Reserve was passed in 1978, the Federal Banking Agency Audit Act. This law established audit authority in the Comptroller General of the United States, who leads today’s General Accountability Office (GAO). The GAO conducts audits and surveys for a wide range of Federal Reserve activities, with over 100 conducted since 1978. Audit authority also resides in the Federal Reserve Board’s Office of Inspector General, who can audit Board programs as well as Reserve Bank operations when carrying out functions delegated by the Board.

The Federal Reserve’s financial statements are audited every year. The Board of Governor’s financial statements are audited by an independent auditor selected by the Board’s Office of Inspector General. The Reserve Banks’ statements are also subjected to outside audits, conducted by firms retained by the Board of Governors. These latter audits must have been an interesting exercise this year, given the massive expansion in Reserve Bank balance sheets in 2008. In turn, more generally, the Board of Governors conducts a wide range of reviews of Reserve Bank operations as part of its mandated oversight authority.

In this brief review of the Fed audit landscape, it’s worth noting that things haven’t always been this way. From the early 1930s to the early 1950s, for example, one of the shoes was on the other foot, as audit teams from the Reserve Banks examined the Board of Governors books. The GAO was actually precluded by law, law passed by Congress, from audit responsibility for the Fed, at least until the 1978 act referred to above. The main lesson here is that the structure of reporting and audit authority has changed in the past, and it can change again in the future.

But today, authority for auditing the Fed is in place. So why do so many people think we need an Audit the Fed Act?

Well, for one thing, the appearance of extensive auditing authority doesn’t mean audits are effective. Good auditing requires the willingness and ability of auditors to do their jobs. Some people view the Inspectors General, generally, and the Federal Reserve Board’s Office of Inspector General, specifically, as less than effective or independent in pursuing their mandates. In turn, some people question whether the Board’s oversight of the Reserve Banks, including the Federal Reserve Bank of New York, might be less than arms-length. More fundamentally, from the point of view of the supporters of the recently introduced legislation, there are a variety of restrictions on the ability of the GAO to audit the Fed. There are significant exceptions for monetary policy and transactions with foreign central banks and international organizations like the Bank for International Settlements and the IMF. The law proscribes GAO inspections of ‘deliberations, decisions, or actions on monetary policy,’ for example, as well as ‘transactions made under the direction of the Federal Open Market Committee.’ The proposed legislation under H.R. 1207 and S. 604 would remove those exceptions.

Why are the exceptions there in the first place? Well, a widespread mantra has it that Federal Reserve independence is crucial in allowing it to effectively pursue the statutory goals of maximum employment and stable prices. If we let politicians start mucking around in that arena too much, Fed leaders and supporters stress, we aren’t going to see very effective monetary policy. At a ‘town hall’ meeting last weekend, while addressing the audit issue, Fed Chairman Bernanke said ‘I don’t think people want Congress making monetary policy.’ But these audit bills don’t call for the Congress to make monetary policy. They call for broader authority for an independent audit of the Fed, from the General Accountability Office. Supporters feel it this authority would allow the Congress to do a better job of overseeing the performance of an entity to which the Congress has delegated the authority to ‘coin money, and regulate the value thereof,’ under Article I of the U.S. Constitution.

How independent is the Fed, right now, to begin with? The Fed is not an apolitical beast. It has had politicians working there in formal leadership positions as well as staffing roles. The Fed’s regulatory performance matters for the conduct of monetary policy, and the Fed’s relationships with the banks it regulates and bails out deserve scrutiny. Recently, we’ve been through a financial calamity, and have endured the biggest spike in the unemployment rate since World War II. Investment returns crumbled in 2007 and 2008, and Federal Reserve monetary and other regulatory policy played a significant role in this calamity. Looking back a little further, how effective has the ‘independent’ Fed been as source of stable prices? Congress passed the law first mandating ‘stable prices’ as a goal for Fed monetary policy in 1977, and the CPI has tripled since then.

The debate over curtailing the current legal restriction on GAO audits for ‘transactions made under the direction of the Federal Open Market Committee’ makes for a good case in point. This provision, on the surface, helps insulate monetary policy from Congressional oversight and/or second-guessing, promoting independent policymaking. But the FOMC conducts monetary policy under authority delegated by the Congress. It seems reasonable to allow for some form of stronger inquiry in this area, especially after the worst financial and economic crisis since the Great Depression. One facet of a possible future investigation could deal with individual monetary policy ‘transactions.’ Under the quantitative easing posture adopted by the Fed in recent years, with a wider range of financial instruments bought to liquify the banking system and promote monetary and credit growth, the question arises – at what price were those instruments bought? Were they ‘market’ prices, or were they another way to apply public resources to overpay for bad assets and help large financial firms that got into trouble?

That may or may not be a valid avenue of inquiry, but it seems like we could benefit greatly from learning about the broader range of issues that could be tackled.

Audit the Fed? Sounds good to me.

In Missouri, about 100 percent who were eligible [for food stamps] that year took advantage of the program, the highest rate in the nation, followed by residents of Maine and Michigan, at 91 percent and 89 percent, respectively …

Things have gotten much worse since 2007:

As the New York Times notes, “one in eight Americans and one in four children” receive food stamps.

Many economists and financial experts have said that we are in a depression. See this, this and this.

I hope they are wrong, or that — if we were in a depression — we’re out of it now.

But it is indisputable that the unemployment numbers are still grim. Specifically:

• More people will be unemployed than during the Great Depression

• Some of the top economists say that America has suffered a permanent loss of jobs

• By some measures, unemployment is worse than it was during a comparable time-frame in the Great Depression

• Vice President Biden said recently: “It’s a depression for millions of Americans”

Given the above, Stacy Herbert’s question of today is compelling:

The food stamps story seems to be one that keeps popping up; I guess food stamps are the soup lines of this Great Depression?

Note: At least some economists say that food stamps give more bang for the buck in stimulating the economy than just about anything else. And see this. But economic, political and moral questions surrounding food stamps are beyond the scope of this essay.

I am not sure I buy Meredith Whitney’s assertion that the government is “out of bullets” in its quest to prop up the economy. It’s a matter of political will more than anything else. Nevertheless, I do agree with her basic premise in the CNBC video below that the financial sector is likely to see a more unfavourable economic climate in 2010 than it has done in 2009.

In particular, a looming crisis at the state and local government level, coupled with continued distress at regional and local banks will mean a deadly combination of higher taxes, fewer jobs and less credit for households and small businesses. Unless we see a change in the political climate in Washington, now oriented toward deficit reduction over jobs, we are likely to see a double-dip recession late in 2010 or 2011.

Whitney says “the component parts don’t add up” in addressing the Obama Administration’s conflicting rhetoric on jobs, stimulus and deficit reduction.

What’s so frustrating is you have an administration that is arguing such a populist [rhetoric] and not appreciating all the unintended consequences that the consumer and small businesses have far less credit.

I have said Barack Obama gets it because we have confirmation that he understands that raising taxes or cutting spending is what leads to a double dip recession.

I will accept that not everyone believes we should avoid recession if it means more government spending because of the enormous debt loads in the private sector and the unfunded liabilities in the public sector. Fair enough. I have my own doubts due to concerns about crony capitalism. That is an ideological debate about the role of government.

But in executing actual policy, I believe the President’s words and actions are at odds in part due to the political landscape and the wishes of the corporate interests to which he is beholden.

Witness the duelling headlines today where Joe Klein points out a speech with elbows that the President delivered today.  Michael Tomasky was equally impressed. But, this was just a speech. When it comes to actual policy, Robert Reich was less impressed.

Barack Obama is trying once again for balance. On the one hand, he wants enough government spending to offset the timid spending of consumers and businesses. Otherwise, the jobs and wage recession could drag on for years. On the other hand, he doesn’t want to set off more alarm bells about the budget deficit. Otherwise, conservative Democrats might join forces with Republicans to block heath care. So what does he do? A little bit more stimulus spending, but stimulus spending that doesn’t look like more stimulus because it’s not really adding to the deficit. It’s coming out of savings from money already authorized to be spent on the bank bailout. Hmmm?

No president in modern times walks a tightrope as exquisitely as this one. His balance is a thing of beauty. But when it comes to this economy right now — an economy fundamentally out of balance — we need a federal government that moves boldly and swiftly to counter-balance the huge recessionary forces still at large.

States and cities, for example, are estimated to be $350 billion hole this year and next. They can’t run deficits so they’re wildly cutting spending, cutting jobs, cutting contracts, and raising taxes and fees. That’s a huge anti-stimulus package roughly as big as the remaining direct spending in the old federal stimulus package. Which means, Obama’s "new" stimulus, announced today, is about all we have, and it’s not nearly enough.

I am hearing a figure of $70 billion for a jobs initiative – a pathetically small number in an economy of nearly $15 trillion.  In my view, it is better to do nothing than to do something insignificant that acts to discredit your policies.

Returning to the bank world, Whitney’s recent bearishness has been on target (and one CNBC presenter mentions Goldman Sachs as an example). When asked pointedly whether she was making a general market call, Whitney says no. But she does rightly point out that distress in financials does have a spillover effect on the wider economy via restricted credit and this cannot be positive for shares.

As for TARP, Whitney makes an important point when she says the TARP repayments can be seen more as political calculation than an affirmation of banking sector health.  She believes the government needs the TARP funds to help states in severe budgetary distress because no funding will be forthcoming via legislative approval.

I see this as a textbook Larry Summers play and a continuation of the executive branch’s end-run around Congress to affect fiscal policy. In March I wrote:

The political realities of solving a financial crisis have often meant circumventing legislative approval to meet the exigencies of a particular situation. This was certainly the case in 1995 during the so-called Tequila Crisis in Mexico. And I believe it is the case again today in 2009.

Read that post to see how the Clinton Administration was able to bail out Mexico without legislative approval.  They are clearly seeking to exercise the same tactics in this case again.

The fact that this post has been all about government when I intended to write something about financial services should tell you something is seriously wrong.

The video of Whitney is below. It runs eight minutes.

As for Whitney’s comments on people without access to credit, see also Millions in US lack bank access from the Financial Times.