The Deregulation Era

Just a note that I saw the term "deregulation era" for the first time just now. That does not mean it is the first time it has been used, just the first time I noted it.

It is used by New York Times business columnist Floyd Norris in a article called A Trading Tactic is Foiled, and Banks Cry Foul. Floyd pins the ear as lasting from 1980 until 2008.

Note this was an era where sometimes the Democrats controlled Congress, and sometimes Republicans. It covers the following presidencies: the last year of Jimmy Carter, then all of Reagan, Bush I, Clinton, and Bush II. As far as I know the most important piece of deregulation, the killing of the Glass-Steagall Act, was engineered by Bill Clinton and his Treasury Secretary Robert Rubin.

I Hope You Don't Mind Greek

Riots in Greece, riots in Spain. Greece of course, was the cradle of civilization over well over 2000 years ago. Spain built the world's first global empire in the 1500s before being muscled out by the Dutch, English, French, and eventually we Americans.

Americans have already gotten a taste of Greek Tragedy, starting with the burst of the housing bubble in 2007. It's complicated: there are a lot of characters in our tragedy. No one thought they were doing anything wrong, they just thought they were honestly trying to get rich, or richer. The key criminal mastermind, Robert Rubin, was U.S. Treasury Secretary under President Bill Clinton. Few remember he engineered the repeal of Glass-Steagall, a banking reform act from the early days of the Great Depression. It was like letting all the felons out of prison at once, on promise of good behavior.

From the Great Depression until about the turn of the millennium it was well understood by economists, politicians, and even the public that government spending could act as a counterbalance to the natural, chaotic cycle of pure free-market economies. Free market capitalism tends to boom then collapse. By increasing spending during recessions the federal government could prevent depressions. It borrowed to do that, which was alright as long as it also damped booms by cutting spending and increasing taxes. Bboom-year surplusses then reduced the national debt to tolerable levels.

The resurgence of the "greed is good" crowd, with its bizarre idea that taxes on the rich should be minimized, was a long time coming. In a normal nation the Internet Stock Bubble that burst just in time for the presidency of George W. Bush would have served as a sufficient warning against the new, faith-based economics. Instead the foolish just switched asset classes. After a brief recession, unregulated lending led to the Housing Bubble.

During the bubble tax revenue skyrocketed, especially for local governments that have real estate taxes as their primary source of income. Politicians like to be generous when they can, it tends to get them reelected. They doled out the real estate tax revenue to local, county, and state employees, and promised generous pensions.

Meanwhile, we had the Bush Tax Cuts, not just on income, but on inheritances and capital gains. While the national economy was in a bubble, that seemed fine to most people. We also increased military spending for the "War on Terror." That led to federal deficits during the bubble greater than we would normally have during a recession.

When the bubble burst unemployment skyrocketed. Construction workers and bankers lost their jobs first. Some stimulus was provided by automatic government mechanisms, like food stamps and unemployment benefits, but it was not enough to break the fall. Local governments, suddenly running big deficits, laid off workers. Pretty soon, by late 2008, just about everyone was either out of work or afraid they would be laid off. Barack Obama was elected President.

Up until 2000 or so the government would have fixed the post-bubble mess by borrowing money and spending it until the economy recovered. The additional debt could be paid back when the economy recovered by adjusting taxes. Federal and local spending would have decreased during the recovery because there would not be so much money needed for food stamps, etc. If a recovery were strong enough, and the tax system had not been gutted by the Bush Tax Cuts (which, you should recall, Democrats in Congress went along with at the time), tax increases might have been minimal. But not this time around.

Now we (and don't just blame the bankers and politicians) are up sh-- creek without a paddle. We, the United States, are still running huge deficits, and have a rather significant national debt. If there is a recovery, and interest rates climb, the interest on the national debt would quickly become the largest item in the national budget. There is still stimulus: the annual federal deficit. But sooner or later bond buyers will wise up, as in Greece in Spain, and refuse to buy. Then there can be no stimulus. Even if the economy is growing at that point we would need to raise taxes to pay off the debt and interest.

Taxing the rich, within reason (say up to 70% on incomes or capital gains or inheritance over $1 billion) does not hurt the economy. Keeping taxes on the rich low is like giving welfare checks to the poor. It demotivates them. They are people who need to make and spend money; that is their identity. If someone needs to make a million dollars after taxes to be happy, if they only pay 10% taxes they will hustle to make $1.1 million and then loaf. Increase their taxes to 50%, and they will hustle to make $2 million, so they would still have a million to spend.

The only way out of the current mud trap requires getting people back to work. That will only happen if taxes on the rich are increased. Rich people do not make their own money. They make money by exploiting their workers. To make more money, to compensate for tax increases, they will need to hire more workers. They say it ain't so, but they are lying because they are, as a class, really quite lazy.

But increasing taxes significantly on the rich won't happen, because both major political parties are controlled by the rich and the nearly rich. What will happen is military spending will be increased, because while that is the stupidest economic policy, it is the most politically defensible. As interest rates rise the government will issue more bonds to fund the interest payments, until the bond buyers rebel.

I think U.S. government bonds are worthless, or nearly so. They pay no interest, and if they did start paying interest the government would not be able to redeem them without essentially closing down.

If, like me, you did not get any or much pie during the feeding frenzy, you should be mad. But you should also prepare for Greek style austerity. Don't expect to slide by on unemployment or disability or even Social Security during the next economic downturn. The Tea Party Republicans have been chewing at the public safety net, and the next time it is heavily weighed it will simply disintegrate into chaos.

Robert Rubin: Exposed

Many citizen activists have tried to inform the public about the criminal activity of Robert Rubin during the Clinton administration. Today, finally, the "paper of record," The New York Times in an article on why Citigroup (aka citi, Citibank, Citicorp) is melting down titled, "The Reckoning – Citigroup Saw No Red Flags Even as It Made Bolder Bets”, (dated November 22, 2008) set out the basic facts for all to see:

"When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

" And since joining Citigroup in 1999 as a trusted adviser to the bank’s senior executives, Mr. Rubin, who is an economic adviser on the transition team of President-elect Barack Obama, has sat atop a bank that has been roiled by one financial miscue after another."

What the New York Times failed to mention (and the journalist had much to cover in the article, and limited space), was that Rubin and Alan Greenspan openly engaged in criminal activity. They violated their oaths of office by letting Citigroup and other banks know that they could go ahead and act as if they were already deregulated, even before Congress actually passed the laws that Rubin was pushing. Bill Clinton, of course, was complicit (as were leading Republicans and other leading Democrats including Vice-President elect Joe Biden (the Senator from Mastercard).

Rather than repeat myself, I'll refer you to my earlier postings:

Gramm-Leach, Glass-Steagall, and Bill Clinton

Housing, the Credit Squeeze, and Glass-Steagall Act

You can get some somewhat-sanitized information on Robert Rubin at Wikipedia.

Can we recycle crooks from past administrations to be Barack Obama advisors? Yes We Can!

Gramm-Leach-Bliley, Glass-Steagall, and Bill Clinton

In the last couple of weeks some of the nationally known pundits, and the Barack Obama campaign, have started talking about how the Gramm-Leach-Bliley banking bill, which overturned the Great Depression-era Glass-Steagall act, has played a major part in the mortgage finance disaster of 2007-2008. I posted an article, Housing, the Credit Squeeze, and Glass-Steagall Act, back on February 4, 2008, when no one wanted to talk about the subject.

During an election, if the economy is bad, there is a tendency to blame everything on the party in power. Senator Obama's attacks on Senator McCain about Gramm-Leach-Bliley are not unjustified. However, Obama's party, the Democratic Party, was just as responsible for repealing Glass-Steagall as the Republican Party. Given Barack's spineless political career we can surmise that he would have voted for Gramm-Leach like everyone else, had he been in the Senate or House of Representatives at that time.

At the shallowest level, we are simply seeing the usual political-economic cycles that have been taking place since the first flint ax was traded for the first sea shell. Mixing ordinary banking (taking deposits, making loans) with Wall Street style banking (creating and trading stocks, bonds, and more complex financial instruments) was clearly a cause of the Great Depression. So Congress built a firewall with Glass-Steagall. At the time the bankers were bankrupt and unable to bribe their way out of the situation.

But when no fire transited from banking to brokerage houses, or vice-versa, for a number of decades, pressures began to build. That firewall did not just prevent fires, it prevent people from making quick bucks. Flexible politicians were found, particularly new ones who did not remember the Great Depression. One of the most flexible modern politicians was Bill Clinton, a Democrat. He named Robert Rubin to be his Secretary of the Treasury, and he kept Alan Greenspan as Federal Reserve Chairman. Think of these men as voracious predators with no respect for anything put power and money. Together they put in place the key "reform" that allowed the rapacious mortgage and derivatives frenzy of 2004-2006. Now taxpayers will be further burdened to clean up the mess.

So what is Senator Barack Obama going to do about it if he becomes President? What will Senator McCain do about it if he becomes President? The standard answer seems to be: make the Federal Reserve more powerful. None of the old "power to the people" solutions are even conceived of, except perhaps by Green Party candidate Cynthia McKinney. But it was the Federal Reserve that helped pressure Congress into repealing Glass-Steagall.

Politicians will say anything to get elected. Congress, not the President, is supposed to write the laws. Most American citizens vote without knowing anything about their representatives in Congress. Until people are better informed and more able to exercise power directly, don't expect any major changes in our system.

Housing, the Credit Squeeze, and Glass-Steagall Act

The current United States economic crisis is a direct consequence of the repeal of the Glass-Steagall Act [passed as the Banking Act of 1933]. While restoring the act's provisions will not end the crisis, it would go a long way to preventing future economic near-meltdowns.

The Glass-Steagall Act was enacted in 1933 after Congress had looked into the causes of the Great Depression. It was a wise law and did much to protect the American economy until it was effectively repealed by the passage of the Gramm-Leach-Bliley Act in 1999.

Before Glass-Steagall a bank was a bank and could even be a stock brokerage house. We can categorize banks into three varieties. Retail banks mainly take deposits for checking and savings and make loans for housing, consumer items, and business needs. You can include Savings & Loans and Credit Unions in this broad category.

The second type is an investment or merchant bank. A merchant bank deals mostly with businesses and mostly lends out its own capital. It may take ownership stakes in businesses, or speculate in stocks. It may arrange for corporations to raise money by selling bonds. It do other services for fees, like arranging mergers and acquisitions.

The third type of bank is usually called a brokerage house. It might do some things a merchant bank does, but its principle business is buying and selling securities for clients for a fee. If it helps launch new stocks or bonds for companies, or speculates with its own money, it may become more of a merchant bank.

In many cases as a brokerage house or merchant bank grows it adds functions and the two categories start resembling each other. Before Glass-Steagall a banking corporation could legally function as all three types of banks, though many banks, especially smaller ones, kept to their specialties. So, for instance, a bank could take retail deposits from customers, lend money out for residential house mortgages, run an internal brokerage operation, and even originate stock and bond offerings.

There were many reasons for bank failures during the depression, and economists still argue about what made the stock market and economy collapse. The congressional committee that wrote the Banking Act of 1933 concluded that a major cause of the economic collapse that followed the stock market collapse was the blending of functions in banks. Basically, instead of taking non-business deposits and lending them out as mortgages, some banks had used those funds to speculate in the stock market in the late 1920's, or had loaned them to investors (margin loans) who speculated in stocks. When the market crashed these banks then were unable to repay their ordinary depositors. In addition Citibank's brokerage arm had advised clients to buy stocks that it knew were overpriced and at the same time shorted those stocks so as to profit from the downswing.

Glass-Steagall forced banks to chose between being what we now call a bank, an institution that takes retail deposits, and a brokerage house or merchant bank that specialized in stocks, bonds, and related activities.

In the 1990's a concerted effort was made to overturn Glass-Steagall. While the banks and brokerages pushed at Congress and the Clinton Administration, the Federal Reserve led by Alan Greenspan and other regulators looked the other way while retail banks started merchant bank activities and vice-versa. Leading the charge was Robert Rubin, U.S. Treasury Secretary from 1995 until 1999 (he was a former Goldman Sachs partner). Having done the dirty deed, he joined Citigroup and still serves as its chairman.

Citigroup has been highly involved in the mortgage-based economic meltdown of 2007. Citigroup now consists of a retail banking arm, a merchant banking arm, and a stock-brokerage arm, an insurance arm, etc. Other large banks such as Bank of America, and JPMorgan Chase, all engage in multiple activities that would be prohibited by Glass-Steagall if it were still a law.

So has does that figure into the current credit and liquidity shortage resulting from the deflating of the housing bubble?

Banks, that is retail or consumer banks, used to hold mortgages. They took in deposits and made loans including mortgages. However, back in the 20th century mortgages started to be resold. After a bank lent money to buy a house, it had less money to lend. By selling the mortgage the bank received its money back and could make another loan. When this happened a bank was acting more as a mortgage broker than in its old capacity of lending out its deposits and making a profit from the difference in interest rates.

Next came repackaging. The idea was to spread risk and allow the lenders to select a level of risk, and of return on investment, that they liked. This is also called the securitization of mortgages. Mortgage origination companies suddenly had a new economic role. They originated mortgages and made their money on the transaction fees. The mortgages were repackaged by banks, which also repackaged their own mortgages. The mortgages were blended and sliced and diced to be sold as securities. Often the end holder of the mortgage-backed security was a pension fund, a financial institution, or a wealthy individual or family trust looking for higher returns (interest) than could be gotten by buying U.S. treasuries or corporate bonds.

It all smelled so sweet while the bubble was inflating. People got houses. Rich people got high-dividend securities that were AAA rated because, after all, housing prices always go up so all that risk was more theoretical than real.

Or you could look at it this way: what appeared to be a security was actually a loan. They people who borrowed the money don't know who the lenders are and would not care about them anyway. And loans don't always get paid back.

The problem for the banking system, beyond individuals failing to make their mortgage payments, is that the very credibility of the system was endangered by combining retail and merchant banking. Many of the mortgages were made with some fraudulent misrepresentation to the buyers. At the other end banks minimized the risks involved when selling the mortgage securities to the end lenders. Citicorp and Merrill Lynch, among others, came out looking particularly stupid because they bought their own sales pitch.

Some banks lost a lot of money quickly because they had speculated in the securities they had created. They also had become dependent on the fees generated at each stage of the process.

So the banks became illiquid in 2007 and had to be bailed out by the Federal Reserve. Now we are in February 2008 and many people can't get the loans they need to buy houses, even if they have downs and good credit records. So banks that made foolish loans two years ago can't make good loans today.

Citicorp's retail operations, its banks that take in deposits, have been endangered by its merchant arm that created and held mortgage-backed securities. We are really lucky that there is federal deposit insurance to reassure depositors. If Citicorp depositors had decided to more their deposits to other banks in 2007, we might be in a Depression already today.

We need a clear firewall between retail banking and the securities market. Hopefully the current hard weather will convince people to fix this problem instead of waiting for another Great Depression.

I believe the criminal behavior that led to the passage of the Gramm-Leach-Bliley Act needs to be investigated and punished. But that is a pipedream given how corrupt America's political and economic systems have become.