Category Archives: L. Randall Wray

Health Reform.Gov

Posted on March 24, 2010 by admin | 6 comments

HEALTH INSURANCE “REFORM”: IS A BAD BILL BETTER THAN NOTHING?
By L. Randall Wray

Many who supported health care reform are celebrating passage of the Health Insurers Bail Out Bill (HIBOB) and the argument that something–no matter how fundamentally flawed–is better than nothing. Fine. That is a point that Michael Moore as well as Dennis Kucinich make–and they are far more politically astute than I am. How can I criticize them?

A lot of my friends do not want to hear any criticism about the flaws. They ask for a few days to bask in the glorious victory. They think my critiques of the HIBOB are “annoying”. I take that as my job description.

Oh, alright, celebrate. But don’t you think that someone ought to point out what the flaws are, so that we might move forward? Even if the bill were a marginal improvement over what we have, and even if it allows the Dems to claim a victory, no one should be fooled into thinking this was healthcare reform. Health insurance reform? OK, maybe a bit-—but more on that below.

I think that any legislation that forces people against their will to turn over their paychecks to the FIRE (finance, insurance and real estate) sector is a mistake–it does not take too much thought to foresee the kinds of problems this will generate down the road. Also note that the government is going to start taxing and reducing Medicare funding BEFORE anyone gets the “benefits” of the legislation. What a great policy to introduce in the midst of this great depression! (Sound like 1937 deja vu all over again—when government started collecting payroll taxes before Social Security payments started, throwing the economy back into the Great Depression? You betcha.)

There is very little in the bill that requires health insurers to actually pay for the provision of any additional services–and most of the small improvements in that area do not kick in until 2014 or 2018. Read the fine print. Existing insurers are not subject to new requirements–only new insurance providers. The “legacy” firms get grandfathered–business as usual for them, and time to fight the provisions to ensure they never take effect.

Yes more people will get INSURANCE. Will they actually get more CARE PAID FOR? Not necessarily. They will get hit with deductions, co-pays, annual limits (for several more years), exclusions, out of pocket expenses. This will ensure that health CARE remains too expensive to actually take advantage of their new INSURANCE. And many currently insured people are going to get higher taxes. Premiums will rise. Government is going to shovel more of the costs to you. Wall Street needs your money.

There will be revolts of uninsured who do not like the mandates. We might need more riot police and prisons. More costs to bear to keep Wall Street insurers flush.

Exactly how it all turns out will take years to determine. I expect that insurer abuses will increase significantly; there will then be a regulatory reaction–as in Massachusetts. We will try to impose regulations, restrictions, fees, fines, taxes, and what-have-you on the insurers to force them to do what they do not want to do. Indeed, we will try to force them to do what no insurance company ought to do. That is because health insurance is fundamentally at odds with healthcare. Always has been, always will be. It is a crazy way to pay for healthcare.

So ultimately, that is what the problem with the HIBOB really comes down to: the insanity of running healthcare through the for-profit private health insurance industry, and thus an attempt to increase the insanity by running more healthcare through the insurers. This is a pro-Wall Street bill, by design. That is why the focus of the HIBOB was mostly on finance/insurance and not really on any (mostly minor and unintended) healthcare benefits that come out of the bill. And if we had actually had a HEALTHCARE bill, it would have been mathematically impossible to have one with fewer benefits than the HIBOB that passed—which by design was just a bail-out for Wall Street.

Many supporters say that this bill was the best we could do under the circumstances, and that in coming years we will make improvements to it. So, we will take the small benefits now and work for bigger ones incrementally. I am sorry but I do not buy the “incrementalist” defense of the HIBOB.

This is not incrementalism. It is a huge and unprecedented mandate to benefit private insurers. Fifty million people are being told they must turn over their paychecks to private companies. Protests and lawsuits have already begun. States are trying to change their constitutions. here If we had wanted incremental improvements to HEALTHCARE there are infinite combinations of small policy changes we could have pursued—without involving insurers at all. And celebrations by Dems of this great victory by Wall Street are laughable. I think Robert Prasch is right—it is the biggest giveaway to the GOP the Dems could have managed. here (But hold on, they are now preparing to turn Social Security over to Wall Street—the debates are just now getting underway.)

Here is what the whole HIBOB “reform” was all about (and Prasch suggests this was candidate Obama’s plan from the beginning; I have no strong reason to doubt him): health insurers were losing premiums because employers were dropping coverage (in part because they could not compete since no comparable country uses private insurance to provide health care); healthy individuals were dropping because no reasonable calculation could show insurance to be good value for the money. And it is not just the healthy young people who were dropping coverage. If you are single and have no chronic conditions, you are far better to pay out-of-pocket (UNLESS your employer pays most of the premiums and will not give you wages instead). 80% of healthcare costs are due to the 20% of the population that is unhealthy and perhaps unlucky. If you can make it to age 65 without chronic conditions (you don’t smoke, are not obese, were not born with too many preexisting conditions, and so on) it is quite rational to avoid health insurance. And if you get extremely unlucky, you do not have to have health insurance to get some kind of health care. Sure it is probably going to be inferior—but it could well be adequate. And in any case, you might not have that much faith in traditional medical approaches, anyway.

But the insurers were terrified. They could see the writing on the wall–they were losing the healthiest members from their pool, forced to raise rates, and that pushed more healthy people out in a vicious cycle. Hence, they went after Hillary Clinton and later Obama to get a HIBOB to force healthy people back into the pools so they would pay premiums. Yes, insurers knew there would be a trade-off because they’d have to take some unhealthy people. But giving them insurance IS NOT THE SAME THING AS paying for their care. So insurers agreed to accept some pre-existing conditions but never agreed to actually pay for treatments for those conditions. And they won’t.

I hope that those who are interested in this topic will actually read the Policy Brief I wrote with Marshall Auerback. here The point is that healthcare is not insurable. There is a fundamental conflict between provision of healthcare and insurance.

Compare it to auto insurance. When I was young and poor and perhaps somewhat foolish and irresponsible I drove without car insurance (it was not mandated at the time). I managed to drive for about two decades with only 2 accidents—both caused by drunk drivers who ran over me. Their insurers were more than happy to pay me to avoid a law suit. Actually these were not accidents (random Acts of God)—they were criminal infractions. The perps lost their insurance and licenses (and I believe one went to jail because he had already lost his license—he was driving his firm’s car, and it was his firm’s insurer that paid me). Later I started buying insurance. Last fall while driving home from OK at a rather high rate of speed (but within the limit, I hasten to add!), I was struck by an Act of God. She had a large buck leap in front of my car. $10k and 4 months later my car was almost repaired. I paid $1k deductible and my fellow insurance premium payers paid the other $9k (thanks guys!).

Now, we do not know why God did it. Maybe the deer blasphemied, or God hated my car, or she wanted me to stop begrudging the thousands I have paid over the years to car insurers; or she wanted a bit of stimulus for the local body shop. In any case, we do not know her Plan and for all intents and purposes it appears random to us. So we insure against Acts of God. On average of course, car insurance is a very bad deal. But for those of us targeted by God it is a good deal; and none of us really knows who will be chosen next. Further, by basing premiums on individual behavior and by charging large deductibles, we induce safer driving. I avoid speeding—mostly not due to fear of the fine but rather to the higher premiums to be paid for years. Ditto safer driving in parking lots (given that I made the decision—actually now mandated—to purchase insurance). And speaking of mandates, of course you can always avoid paying premiums by not driving. No one is mandated to hand over a paycheck to auto insurers.

Ok, turn to health “insurance”. For reasons discussed in detail in our Brief, health is not insurable. Every infant is a bundle of pre-existing conditions. You cannot provide insurance against a house already afire. After you hit a deer, you cannot go buy insurance. NOR WOULD YOU WANT TO BUY IT! Because the actuarially sound premium would exceed the cost of repairing your car. You cannot insure a pre-existing condition—and would only insure it if you could hide it from the insurer (that is of course called fraud). God already acted. She chose you, and nobody would even think about insurance: you don’t want to pay for it, the insurer doesn’t want to provide it, and your potential pool of fellow premium payers do not want you to be added to their pool.

An insurer cannot sell insurance against diabetes to a person who has diabetes; nor would that person want to buy the insurance; nor does any pool want that person included.

So what we do is pool the people with diabetes with people who do not have it and who are extremely unlikely to get it, then we have the healthy people subsidize the diabetes care. That is not insurance—it is an expensive way to take money away from the healthy and give it to the sick. You could make the argument that from the vantage point of society as a whole, these Acts of God are sort of random (not really, since obesity results from individual behavior as well as public policy) so if we get everyone into the pool we have got insurable risks. OK, sort of. But for the aggregate, it is always a bad deal—we have to pay the costs of running the insurer, plus profits. But there is no way you can run this through competing private insurers because each one has strong incentives to exclude the expensive cases—and so do all of their relatively healthy premium payers. So the only way to do this is to have mandatory insurance, everything covered, and either only one insurer or multiple insurers operating with identical pools and coverage. That ain’t going to happen. And it ain’t incrementalism.

And, of course, most of the healthcare that most of us receive has nothing to do with Acts of God. We need well-child care. We get pregnant. We get old. We need our teeth cleaned. We want Botox and Tummy Tucks. Nothing random about it. Not insurable risks.

We don’t need more health insurance. We need less. We need health provision; and we need to get it out of the hands of Wall Street.

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This Is Not The Way To Do Healthcare Reform: Democrats Propose Windfall For Insurance Industry

Posted on March 18, 2010 by admin | 10 comments

By L. Randall Wray

It is beginning to look like Congress is going to vote to pass health care legislation on Sunday. According to the NYTimes, Democrats are practically celebrating already. (here)It is interesting, however, that no one is talking about providing benefits to the currently underserved.
Rather, the “good news” is that the bill is supposed to be “the largest deficit reduction of any bill we have adopted in Congress since 1993,” according to House Democratic leader, Rep.Steny H. Hoyer of Maryland. “We are absolutely giddy over the great news,” said the House’s number three Democrat, Rep. James Clyburn of South Carolina. (Of course, deficit hysteria is nothing new. See here)

Who would have thought that health care “reform” would morph into deficit cutting?

As Marshall Auerback and I argue in a new policy brief (here), the proposed legislation is not “reform” and it will not reduce US health care costs. I will not repeat the arguments there. But very briefly, the most significant outcome of this legislation is the windfall gain for insurance companies—who will be able to tap the wages of the huge pool of nearly 50 million Americans who currently do not purchase health insurance. Since many of these are too poor to afford the premiums, the government will kick in hundreds of billions of dollars to line the pockets of health insurers. This legislation has nothing to do with improving health services for the currently underserved—it is all about increasing the insurance sector’s share of the economy.

You might wonder how Democrats can call this a deficit reduction deal? Elementary, dear Watson. They will slash Medicare spending. No wonder—it stands as an alternative to the US’s massively inefficient private insurance system, hence, needs to be downsized in favor of an upsized private system.

There is nothing in the deal that will significantly reduce health care costs. At best, it will simply shift more costs to employers and employees—higher premiums, higher deductibles, higher co-pays, and more exclusions forcing higher out-of-pocket expenses and personal bankruptcies. As we show in our paper, the US’s high health care costs (at 17% of GDP, double or triple the per capita costs in other similarly wealthy nations) are due to three factors. As many commentators have argued (especially those who advocate single-payer) part of the difference is due to the costs of operating a complex payment system that relies on private insurers—resulting in paperwork and overhead costs, plus high profits and executive compensation for insurance executives. This adds about 25% to our health care system costs. Obviously, the proposed legislation is “business as usual”, actually adding more insurance costs to our system.

In addition, Americans spend more for medical supplies and drugs. Since the Democrats ruled out any attempt to constrain Big Pharma through, for example, negotiating lower prices for drugs, there will not be any savings there.

Finally, and most importantly, the biggest contributor to higher US health care costs is our American “lifestyle”: too little exercise, too much bad food, and too much risky behavior (such as smoking). (here) This is why we spend far more on outpatient costs for chronic diseases such as diabetes—40% of healthcare spending and rising rapidly. Ending the subsidies to Big Agriculture that produces the products that make us sick would not only do more to improve US health outcomes than will the proposed legislation, but it would also reduce health care spending—while reducing government spending at the same time. That would be real healthcare reform! But, of course, no one talks about this.

Interestingly, according to the NYTimes article, President Obama likened the legislation to fixing the financial system or passing the economic recovery act. “I knew these things might not be popular, but I was absolutely positive that it was the right thing to do,” he said. That is an apt and scary comparison. This legislation will do as much to “fix” the US healthcare system as the Obama administration has done to “fix” the financial sector and to put the economy on the road to recovery?

Of course, we have not done anything to “fix” the financial sector, or to put Mainstreet on the road to recovery.

I think the President’s comparison is uncannily accurate. So far the main thing his administration has done is to funnel trillions of dollars to the FIRE sector in an attempt to restore money manager capitalism. The current legislation will simply continue that policy—the trillions spent so far to bail-out Wall Street have not been nearly enough. Hence, the effort to funnel billions more to the insurance industry.

But what is the connection between Wall Street and health insurers? As Marshall and I argue in our brief, they are “two peas in a pod” since the deregulation of financial institutions. We threw out the Glass-Steagall Act that separated commercial banking from investment banking and insurance with the Gramm-Leach-Bliley Act of 1999 that let Wall Street form Bank Holding Companies that integrate the full range of “financial services”, that sell toxic waste mortgage securities to your pension funds, that create commodity futures indexes for university endowments to drive up the price of your petrol, and that take bets on the deaths of firms, countries, and your loved ones. (See also here)

Hence, extension of healthcare insurance represents yet another unwelcome intrusion of finance into every part of our economy and our lives. In other words, the “reforms” envisioned would simply complete the financialization of healthcare that is already sucking money and resources into the same black hole that swallowed residential real estate. (here)

Just as the bail-out of Wall Street was sold on the argument that we need to save the big banks so that they will increase lending to Main Street, health care “reform” was initially promoted as a way to improve provision of healthcare to the underserved. What we got instead is a bail-out for insurers and cuts to Medicare. Funny how that happens.

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Timmy-Gate: Did Geithner Help Hide Lehman’s Fraud?

Posted on March 15, 2010 by admin | 7 comments

Timmy-Gate Takes a Turn For The Worse: Did Geithner Help Lehman Hide Accounting Tricks?

By L. Randall Wray

Just when you thought that nothing could stink more than Timothy Geithner’s handling of the AIG bailout, a new report details how Geithner’s New York Fed allowed Lehman Brothers to use an accounting gimmick to hide debt. The report, which runs to 2200 pages, was released by Anton Valukas, the court-appointed examiner. It actually makes the AIG bailout look tame by comparison. It is now crystal clear why Geithner’s Treasury as well as Bernanke’s Fed refuse to allow any light to shine on the massive cover-up underway.

Recall that the New York Fed arranged for AIG to pay one hundred cents on the dollar on bad debts to its counterparties—benefiting Goldman Sachs and a handful of other favored Wall Street firms. (see here) The purported reason is that Geithner so feared any negative repercussions resulting from debt write-downs that he wanted Uncle Sam to make sure that Wall Street banks could not lose on bad bets. Now we find that Geithner’s NYFed supported Lehman’s efforts to conceal the extent of its problems. (see here) Not only did the NYFed fail to blow the whistle on flagrant accounting tricks, it also helped to hide Lehman’s illiquid assets on the Fed’s balance sheet to make its position look better. Note that the NY Fed had increased its supervision to the point that it was going over Lehman’s books daily; further, it continued to take trash off the books of Lehman right up to the bitter end, helping to perpetuate the fraud that was designed to maintain the pretense that Lehman was not massively insolvent. (see here)

Geithner told Congress that he has never been a regulator. (see here) That is a quite honest assessment of his job performance, although it is completely inaccurate as a description of his duties as President of the NYFed. Apparently, Geithner has never met an accounting gimmick that he does not like, if it appears to improve the reported finances of a Wall Street firm. We will leave to the side his own checkered past as a taxpayer, although one might question the wisdom of appointing someone who is apparently insufficiently skilled to file accurate tax returns to a position as our nation’s chief tax collector. What is far more troubling is that he now heads the Treaury—which means that he is not only responsible for managing two regulatory units (the FDIC and OCC), but also that he has got hold of the government’s purse strings. How many more billions or trillions will he commit to a futile effort to help Wall Street avoid its losses?

Geithner has denied that he played any direct role in the AIG bail-out—a somewhat implausible claim given that he was the President of the NYFed and given that this was a monumental and unprecedented action to funnel government funds to AIG’s counterparties. He may try to deny involvement in the Lehman deals. (Again, this is implausible. Lehman executives claimed they “gave full and complete financial information to government agencies”, and that the government never raised significant objections or directed that Lehman take any corrective action. In fairness, the SEC also overlooked any problems at Lehman. (see here) But here is what is so astounding about the gimmicks: Lehman used “Repo 105” to temporarily move liabilities off its balance sheet—essentially pretending to sell them although it promised to immediately buy them back. The abuse was so flagrant that no US law firm would sign off on the practice, fearing that creditors and stockholders would have grounds for lawsuits on the basis that this caused a “material misrepresentation” of Lehman’s financial statements. (see here) The court-appointed examiner hired to look into the failure of Lehman found “materially misleading” accounting and “actionable balance sheet manipulation.” (here) But just as Arthur Andersen had signed off on Enron’s scams, Ernst & Young found no problem with Lehman. (here)

In short, this was an Enron-style, go directly to jail and do not pass go, sort of fraud. Lehman’s had been using this trick since 2001. (here) It looked fine to Timmy’s Fed, which extended loans allowing Lehman to flip bad assets onto the Fed’s balance sheet to keep the fraud going.

More generally, this revelation drives home three related points. First, the scandal is on-going and it is huge. President Obama must hold Geithner accountable. He must determine what did Geithner know, and when did he know it. All internal documents and emails related to the AIG bailout and the attempt to keep Lehman afloat need to be released. Further, Obama must ask what has Geithner done to favor his clients on Wall Street? It now looks like even the Fed BOG, not just the NYFed, is involved in the cover-up. It is in the interest of the Obama administration to come clean. It is hard to believe that it does not already have sufficient cause to fire Geithner. In terms of dollar costs to the government, this is surely the biggest scandal in US history. It terms of sheer sleaze does it rank with Watergate? I suppose that depends on whether you believe that political hit lists and spying that had no real impact on the outcome of an election is as bad as a wholesale handing-over of government and the economy to Wall Street.

What did Timmy know, and when did he know it?

Point number two. Lehman used an innovation, “Repo 105” to hide debt. The whole Greek debt fiasco was caused by Goldman, et. al., who helped hide government debt. (here and here) Whether legal or illegal, Wall Street has for many years been producing financial instruments designed to mislead shareholders, creditors, and regulators about the true financial position of its clients. Note that Lehman’s counterparties in this fraud included JP Morgan and Citigroup (who actually precipitated Lehman’s final failure when they finally called in their loans). It always takes at least three to tango: the firm that wants to hide debt, the counterparty that temporarily takes it off their books, and the accounting firm that provides the kiss of approval.

Worse, after aiding and abetting such deception, Goldman and other Wall Street institutions then place bets (using another nefarious innovation, credit default swaps) against their clients, wagering that they will not be able to service the debts—which are greater than the market believes them to be. Does that sound something like insider trading? How can regulators permit such actions?

What did Timmy know, and when did he know it?

Third point. To the extent that debt is hidden, financial institution balance sheets present an overly rosy picture—of course, that is the purpose of the financial “innovations”. Enron did it; AIG did it; Lehman did it. What about Bank of America, Citi, JP Morgan, Wells Fargo and Goldman? We now know that the New York Fed subjected Lehman to three wimpy “stress tests”, all of which it failed. Timmy’s Fed then allowed Lehman to construct its own sure-to-pass “stress” test. (We know, of course, that the test was absolutely meaningless because, well, Lehman passed the test and then immediately failed spectacularly. Timmy then let the biggest banks run their own stress tests, which they (surprise, surprise) managed to pass.

What did Timmy know, and when did he know it?

As our all-time favorite Fed Chairman Alan Greenspan liked to put it, “history shows” that when financial institutions pass their own stress tests, they are actually massively insolvent. There is no reason to believe that this time will be different. Mike Konczal reports that there is every reason to believe the biggest banks are hiding huge losses on second liens. (here) These are second mortgages or home equity loans that amount to about $1 trillion of which almost half are held by the top four banks. Since the first principal of a mortgage is paid first, it is likely that much of the second liens are worthless. Yet banks are carrying these on their books at 86 to 87 percent of face value—which was necessary to allow them to pass the stress tests. Konczal shows that at a more reasonable loss rate of 40% to 60%, the four largest banks would have “an extra $150 billion hole in the balance sheet”. I won’t go into the policy conundrum implied for President Obama’s plan for principal reduction to help homeowners (the banks will not allow renegotiation of underwater mortgages because that would force them to recognize losses on the second liens).

Of greater importance is the recognition that all of the big banks are probably insolvent. Another financial crisis is nearly certain to hit in coming months—probably before summer. The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking. In the bigger scheme of things, this is only 1931. We have a long way to go before bank assets (and nonbank debts) are written down sufficiently to allow a real recovery. In other words, a Minsky-Fisher debt deflation is still in the cards.

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Interview with Randall Wray about Greece’s Debt Crisis

Posted on March 13, 2010 by admin | 5 comments

See below Prof. L Randall Wray’s interview for the Greek newspaper (Eleftherotypia) about Greece’s debt crisis.

By Chronis Polychroniou
*This is an english translation of the greek publication.

1.Goldman Sachs created financial instruments to hide European government debt and Greece is one of its first victims in the eurozone. In a recent article of yours, co-written with Marshall Auerback, you argue that Wall Street firms should not only be held accountable for such practices, but war should be declared on them. How can a small nation like Greece declare war on Wall Street’s financial institutions?

Wray: Of course the best strategy would be a coordinated investigation by all Euro member nations to get to the bottom of the financial manipulation perpetrated by these institutions on European soil. As we said, investigators should invade the offices and secure all files, internal memos, and emails. This is the only way to find out which laws have been broken and to prosecute guilty parties. In our article we focused on recent revelations about Goldman, but it is likely that other behemoth financial institutions, including some European banks, have engaged in similar practices.

Beyond that, it is important to send a message to these institutions that “business as usual” will not be permitted any longer. It is no stretch to say that the fate of European Union is in question. These institutions are testing whether they can bring down Greece. If they are permitted to do so, there is absolutely no doubt that they will set their sights on the next victim—Portugal, Italy, or Spain. It is not just that they helped to hide debt. They are placing bets on default, driving up credit default swap (CDS) prices, inducing credit down-grades, and hence raising finance costs. None of the Euro nations would be able to survive this onslaught—not even Germany.

This is why we have used the term “war” to describe the nature of this conflict. No country should sit idly by and allow financial institutions to bring it down. If Greece cannot secure the support of other Euro nations, it will have to unilaterally declare war on those institutions operating on its soil—those actively engaged in undermining its economy.

1.Why isn’t the Obama administration doing something about Wall street’s manipulation and destruction of the world’s economies?

Wray: That is of course a difficult question to answer because it is not possible to get inside the heads of administration officials. We can only look at this from the outside, and from the outside it stinks of scandal. I am beginning to think that this will go down in history as one of the worst scandals the US has ever seen. The triggering event will be seen as the AIG bailout—in which the NYFed led by Timothy Geithner gave billions of dollars to AIG that it funneled to counterparties like Goldman to pay off CDSs at one hundred cents on the dollar. There was and is absolutely no justification for that action. But far worse is the cover-up, in which the Fed and Treasury are still engaged. It is always the cover-up that brings down administrations. This one looks like it ranks with a Watergate cover-up. I repeat that we do not have the facts, so the appearances might be incorrect. But that is all the more reason for the Obama administration to come clean. It must release all internal documents, and all emails, and account for every dollar spent. It must name names and it must then prosecute all fraud—even if that goes right to the top of the Treasury and Fed.

2.How do you explain the hysteria against Greece by major European financial newspapers?

Wray: There is of course always some sensationalism in the press. And Greece looks on the surface like an easy victim. And there is some residual belief that “Mediterranean nations” need more discipline (I have lived in Italy and am aware that even some Italians welcomed the Euro on the belief that it would discipline their own government). But leaving all that to the side, this story of Greece has elements that are sure to grab the attention of the press. A “profligate” government that spends well beyond its means. Shady backroom deals with huge Wall Street firms who help to hide debt and deceive the public as well as the rest of Euroland. And then a turn-coat Goldman that bets against its client (a normal practice at Goldman). The government now proposes austerity, and the population predictably reacts against cuts to pay and services. Civil unrest always makes headlines.

I think there is probably also a fear that they may be next. When bullies beat up a hapless child on the schoolyard, a crowd circles and cheers them on—in the fear that one of them might be next. I repeat, no Euro country is safe. So there is no doubt some perversity in the financial press’s attack on Greece, a sort of marveling at how easy it is to bring down a nation and an uneasy recognition that a similar fate awaits their own.

Greece’s real problem is the set up of the Euro, it is not due to failings of national character. In a sense, the arbitrary unfairness of this is what makes the story so much more exciting for the press.

3.What’s your assessment of the Greek government’s fiscal austerity program?

Wray: It will fail. Austerity eliminates any possibility of growth, imposes deflationary pressures, reduces tax revenues, and results in a growing budget deficit. An estimated 40% of Greece’s GDP is already unrecorded, and more activity will go underground to escape taxes. Add to the mix the fact that with the major exception of China, the entire globe is in deep recession that is likely to last many years. That means there is no hope for Greece to export its way out of this predicament. Wages are falling all across Euroland (13 out of 24 nations had falling wages last year, and more will this year), so no matter how much pressure the government can put on wages, it will not be able to significantly lower wages relative to European wages. Some have remarked that Greece is the next Latvia—which is trying to use austerity to become the lowest cost country. It will not work—it is a competitive race to the bottom. No one wins such a race.

4.Aside from Greece seceding from the EE and defaulting on its euro debt, what other options may have been available to the government other than the austere fiscal measures it introduced last week?

Wray: Seceding is, I think, a last resort. It would be quite costly. If Greece does secede then of course it should default on its debt and reinstate its own sovereign currency. In the short run it will be painful; in the long run it would be the correct strategy only if there is no hope for changing fiscal arrangements in Euroland.
Some have argued that stronger Euro nations might bail out Greece. I do not think that will happen, for reasons discussed above. Greece is only the first victim. The stronger nations might take over Greece’s debt, but then they would need to take over Portugal’s, then Italy’s, then Spain’s. That is not possible as markets would then attack Germany and France.

So here is the best course of action. The ECB will purchase government debt of all Euro member nations with a view to settling markets, bringing down risk spreads, and reducing interest payments by governments. It will also provide an emergency package of fiscal stimulus equal to one trillion euros distributed among all Euro nations on a per capita basis. Individual governments will decide how to spend the euros. Finally, the configuration of Euroland will be changed to increase the fiscal authority of the European Parliament, to provide funding equal to ten or fifteen percent of Euroland GDP (up from less than 1% today). Some of this funding would be managed from the center, but most would be distributed among member nations.

This would help to resolve the main problem faced by Euronations—and the real cause of Greece’s current crisis. The set-up was flawed from the very beginning. The individual nations gave up sovereign fiscal power when they joined the Euro. All of the focus has been on setting up the ECB, and surrender of monetary policy to the center. This was a neoliberal policy—to put economic power in the hands of an independent authority whose one mission was to fight inflation. But there was never a countervailing fiscal authority, responsible for maintaining full employment and robust economic growth. Individual nations could not really fill the gap, because markets would punish deficits—just as they are now doing to Greece. It is time to throw out the neoliberal agenda and to reformulate the union along more sensible lines.

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Worst Revelation Yet in the On-going Goldman-AIG-NYFed Scandal

Posted on February 23, 2010 by admin | 3 comments

By L. Randall Wray

Richard Teitelbaum reported today (here) that Timothy Geitner’s New York Fed hid the smoking gun that proves Goldman played the key role in bringing down AIG. The only plausible explanation for hiding the document is that Geithner et.al. were protecting Goldman. Is this the worst scandal in US history? To ask the question is to answer it.

In brief, here is the story. Recall that securitization of mortgages was supposed to be a risk-reducing innovation that would move mortgages off the books of banks and into well-diversified portfolios of those better able to absorb risks. Mortgage originators would do the underwriting (verify credit-worthiness), securitizers would do the packaging, credit raters would do the rating, and investors would buy the securities and take the risks. Ah, but Wall Street was too clever for all that. So here is how it really worked. Banks owned mortgage lenders who made NINJA loans (no income, no job, no assets), then worked with credit raters to get the ratings desired. The raters did not actually examine any of the loans because the banks bought Credit Default Swap (CDS) “insurance” from AIG to guarantee safety of the Collateralized Debt Obligation (CDO) issued against the mortgages. Goldman and other banks would then either sell the CDO while using a CDS to bet on default; or they would hold the CDO and use the CDS bet against it to hedge risk. Of course, since Goldman had securitized toxic waste, the bet was not a gamble at all. It knew the CDOs would fail. But meanwhile, it got to book all sorts of fees and income so that it could reward its management with outsized bonuses.

As the subprime market began to crater—due to “unexpected” delinquencies and defaults on mortgages—AIG’s own financial situation was down-graded. This led Goldman and other banks to demand collateral from AIG against their CDS bets. Goldman, in particular, played hardball with AIG—ensuring it would fail.

Here is how bad those CDOs were: losses are running as high as 78% on the toxic waste underwritten by Goldman. No wonder the firm bet against it! Yet, when Geithner’s NYFed intervened to rescue AIG, it demanded that AIG pay Goldman 100 cents on the dollar—for the “insurance” AIG provided on the toxic waste created by—you betcha—Goldman. Timmy’s office then ordered AIG to engage in a cover-up—telling it in November and in December 2008 to keep bank names out of documents filed. As late as January 27 2010 “the New York Fed was still arguing that the contents of Schedule A shouldn’t be fully disclosed”, Teitelbaum reports. Schedule A is the damning document that not only names names but also details the CDO deals.

It shows that Goldman underwrote $17.2 billion of the $62.1 billion in CDOs that AIG “insured”—the most of any bank. Goldman, in turn, received $14 billion from AIG as its share of the settlement (second only to Societe Generale, which got $16.5 billion). If you do the math, Goldman was paid over 80 cents for every dollar of CDO it wrote that got AIG insurance ($14B/$17.2B). The government has poured $182 billion into the rescue to date and now holds much of the toxic waste created by Goldman and others.

Why did Timmy do it? Why does the NY Fed still insist on secrecy? “They must have been trying to shield Goldman” says Professor James Cox of Duke.

And here is the most outrageous part of the story. As Marshall Auerback and I wrote (here) Goldman’s top management was not only betting against the toxic waste they created, they also bet against Goldman:

top management unloaded their Goldman stocks in March 2008 when Bear crashed, and again when Lehman collapsed in September 2008. Why? Quite simple: they knew the firm was full of toxic waste that it would not be able to continue to unload on suckers—and the only protection it had came from AIG, which it knew to be a bad counterparty. Hence on March 19, Jack Levy (co-chair of M&As) sold over $5 million of Goldman’s stock and bet against 60,000 more shares; Gerald Corrigan (former head of the NY Fed who was rewarded for that tenure with a position as managing director of Goldman) sold 15,000 shares in March; Jon Winkelried (Goldman’s co-president) sold 20,000 shares. After the Lehman fiasco, Levy sold over $6 million of Goldman shares and Masanori Mochida (head of Goldman in Japan) sold $56 million worth. The bloodletting by top management only stopped when Goldman got Geithner’s NYFed to produce a bail-out for AIG, which of course turned around and funneled government money to Goldman. With the government rescue, the control frauds decided it was safe to stop betting against their firm.

Goldman appears to be the classic case of what my colleague Bill Black calls a “control fraud”. But the NY Fed and by implication the US Treasury (which is also captured by Goldman) is involved in the cover-up of the frauds perpetrated by Goldman’s top executives—those “savvy businessmen” President Obama has praised. And that, dear reader, is what makes this rank among the worst scandals in US history.

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Memo To Greece: Make War Not Love With Goldman Sachs

Posted on February 21, 2010 by admin | 3 comments

By Marshall Auerback And L. Randall Wray

In recent weeks there has been much discussion about what to do about Greece. These questions become all the more relevant as the country attempts to float a multibillion-euro bond issue later this week. The Financial Times has called this fund-raising a critical test of Greece’s credibility in financial markets as it battles with a spiraling debt crisis and strikes. (see here) The “credibility” of the financial markets is an important consideration in a country which has functionally ceded its sovereign ability to create currency, and thus remains dependent on the vagaries of the very banking institutions which helped create the mess in the first place.

Maybe Greece should secede from the European Union and default on its euro debt? Or go hat-in-hand to the International Monetary Fund (IMF) to beg for loans while promising to clean up its act? Or to the stronger Euro nations, hoping for charitable acts of forgiveness? Unfortunately, all of these options are going to mean a lot of pain and suffering for an economy that is already sinking rapidly.

And it is questionable whether any of them provide long term viable answers. Polls show that given the perception of fiscal excesses of Greece and the other countries on the periphery, the public in Germany opposes a bailout of these countries at its expense by a significant margin. Periphery countries such as Ireland that have already undertaken harsh austerity measures also oppose the notion of a bailout, despite—nay, because of–the tremendous pain already inflicted on their own respective economies (in Ireland’s case, the banks are probably insolvent as well). The IMF route is also problematic, given that Greece probably doesn’t qualify under normal IMF standards, and many euro zone nations would find this unpalatable from an ideological standpoint, as it would mean ceding control of EU macro policy to an external international institution with strong US influence.

The Wall Street Journal recently highlighted an article by Simon Johnson and Peter Boone, lamenting that the demands being foisted on Greece and other struggling Euronations would “massively curtail demand, lower wages and reduce the public sector workforce. The last time we saw this kind of precipitate fiscal austerity—when nations were tied to the gold standard—it contributed to the onset of the Great Depression in the 1930s” (see here). Where we disagree with Johnson and Boone is the suggestion that the IMF be brought in to craft a solution. Any help from this organization will come with tight strings attached—indeed, with a noose around Greece’s neck. Germany and France would be crazy to commit their scarce euros to a bail-out of Greece since they face both internal threats from their own taxpayers and external threats from financial vampires who are looking for yet another nation to attack.

Here’s a more appropriate action: declare war on Goldman Sachs and other global financial firms that created this mess. Send the troops, the planes, the tanks, and the ships. Attack every outpost of the saboteurs on European soil. Blockade the airports and ports. Make Wall Street traders and CEOs fear for their lives, or at least for their freedom to travel. Build some Guantanamo-like facility to hold these enemy financial combatants until they can be tried, convicted, and properly punished.

Ok, if a literal armed attack on Goldman is too far-fetched, then go after the firm using the full force of the regulatory and legal systems. Close the offices and go through the files with a fine-tooth comb. Issue subpoenas to all non-clerical staff for court appearances. Make the internal emails public. Post the names of all managers and traders on Interpol. Arrest anyone who tries to board a plane, train, or boat; confiscate their passports; revoke their visas and work permits; and put a hold on their bank accounts until culpability can be assessed. Make life at least as miserable for them as it now is for Europe’s tens of millions of unemployed workers.

We know that the Obama administration will not go after the banksters that created this global financial calamity. It has been thoroughly co-opted by Wall Street’s fifth column—who hold most of the important posts in the administration. Europe has even more at stake and has shown somewhat more willingness to take action. Perhaps our only hope for retribution lies there.

Some might believe the term “banksters” is too mean. Surely Wall Street was just doing its job—providing the financial services wanted by the world. Yes, it all turned out a tad unfortunate but no one could have foreseen that so many of the financial innovations would turn into black swans. And hasn’t Wall Street learned its lesson and changed its practices? Fat chance. We know from internal emails that everyone on Wall Street saw this coming—indeed, they sold trash assets and placed bets that the trash would crater. The crisis was not a mistake—it was the foregone conclusion. The FBI warned of an epidemic of fraud back in 2004—with 80% of the fraud on the part of lenders. As Bill Black has been warning since the days of the Saving and Loan crisis, the most devastating kind of fraud is the “control fraud”, perpetrated by the financial institution’s management. Wall Street is, and was, run by control frauds. Not only were they busy defrauding the borrowers, like Greece, but they were simultaneously defrauding the owners of the firms they ran. Now add to that list the taxpayers that bailed out the firms. And Goldman is front and center when it comes to bad apples.

Lest anyone believe that Goldman’s executives were somehow unaware of bad deals done by rogue traders, William Cohan (see here) reports that top management unloaded their Goldman stocks in March 2008 when Bear crashed, and again when Lehman collapsed in September 2008. Why? Quite simple: they knew the firm was full of toxic waste that it would not be able to continue to unload on suckers—and the only protection it had came from AIG, which it knew to be a bad counterparty. Hence on March 19, Jack Levy (co-chair of M&As) sold over $5 million of Goldman’s stock and bet against 60,000 more shares; Gerald Corrigan (former head of the NY Fed who was rewarded for that tenure with a position as managing director of Goldman) sold 15,000 shares in March; Jon Winkelried (Goldman’s co-president) sold 20,000 shares. After the Lehman fiasco, Levy sold over $6 million of Goldman shares and Masanori Mochida (head of Goldman in Japan) sold $56 million worth. The bloodletting by top management only stopped when Goldman got Geithner’s NYFed to produce a bail-out for AIG, which of course turned around and funneled government money to Goldman. With the government rescue, the control frauds decided it was safe to stop betting against their firm. So much for the “savvy businessmen” that President Obama believes to be in charge of Wall Street firms like Goldman.

From 2001 through November 2009 (note the date—a full year after Lehman) Goldman created financial instruments to hide European government debt, for example through currency trades or by pushing debt into the future. But not only did Goldman and other financial firms help and encourage Greece to take on more debt, they also brokered credit default swaps on Greece’s debt—making income on bets that Greece would default. No doubt they also took positions as the financial conditions deteriorated—betting on default and driving up CDS spreads.

But it gets even worse: An article by the German newspaper, Handelsblatt, (“Die Fieberkurve der griechischen Schuldenkrise”, Feb. 20, 2010) strongly indicates that AIG, everybody’s favorite poster boy for financial deviancy, may have been the party which sold the credit default swaps on Greece (English translation – here).

Generally, speaking, these CDSs lead to credit downgrades by ratings agencies, which drive spreads higher. In other words, Wall Street, led here by Goldman and AIG, helped to create the debt, then helped to create the hysteria about possible defaults. As CDS prices rise and Greece’s credit rating collapses, the interest rate it must pay on bonds rises—fueling a death spiral because it cannot cut spending or raise taxes sufficiently to reduce its deficit.

Having been bailed out by the Obama Administration, Wall Street firms are already eyeing other victims (and for allowing these kinds of activities to continue, the US Treasury remains indirectly complicit, another good reason why one shouldn’t expect any action coming out of Washington). Since the economic collapse is causing all Euronations to run larger budget deficits and at the same time is raising CDS prices and interest rates, it is easy to pick off nation after nation. This will not stop with Greece, so it is in the interest of Euroland to stop the vampires now.

With Washington unlikely to do anything to constrain Goldman, it looks like the European Union, which is launching a major audit, just might banish the bank from dealing in government debt. The problem is that CDS markets are essentially unregulated so such a ban will not prevent Wall Street from bringing down more countries—because they do not have to hold debt in order to bet against it using CDSs. These kinds of derivatives have already brought down an entire continent – Asia – in the late 1990s (see here), and yet authorities are still standing by and basically doing nothing when CDSs are being used again to speculatively attack Euroland. The absence of sanctions last year, when we had a chance to deal with this problem once and for all, has simply induced even more outrageous and fundamentally anti-social behavior. It has pitted neighbor against neighbor—with, for example, Germany and Greece lobbing insults at one another (Greece has requested reparations for WWII damages; Germany has complained about subsidizing what it perceives to be excessive social spending in Greece).

Of course, as far as Greece goes, the claim now is that these types of off balance sheet transactions in which Goldman and others engaged were not strictly “illegal” under EU law. But these are precisely the kinds of “shadow banking transactions” that almost brought down the global financial system 18 months ago. Literally a year after the Lehman bankruptcy – MONTHS after Goldman itself was saved from total ruin, it was again engaging in these kinds of deals.

And it wasn’t exactly a low-level functionary or “rogue trader” who was carrying out these transactions on behalf of Goldman. Gary Cohn is Lloyd “We’re doing God’s work” Blankfein’s number 2 man. So it’s hard to believe that St. Lloyd did not sanction the activities as well in advance of collecting his “modest” $9m bonus for last year’s work.

If these are examples of Obama’s “savvy businessmen” (see here), then heaven help the global economy. The transaction highlighted, if reported that way in the private sector, would be accounting fraud. Fraud – “Go to jail, do not pass Go” fraud. That senior bankers had no problem in structuring/recommending/selling such deals to cash-strapped governments should probably not surprise us at this point. However, it would be interesting to know if the prop trading desks of those same investment banks, purely by coincidence of course, then took long CDS (short the credit) positions in the credit of the countries doing the hidden swaps. A proper legal investigation by the EU could reveal this and certainly help to uncover much of the financial chicanery which has done so much destruction to the global economy over the past several years.

In this country, we have had a “war on terror” and a “war on drugs” and yet we refuse to declare war on these financial weapons of mass destruction. We all remember Jimmy Carter’s “MEOW”—the attempt to attack creeping inflation that was said to sap the strength of the US economy in the late 1970s. But Europe—and indeed the entire globe—faces a much more dangerous and immediate threat from Wall Street’s banksters. They created this mess and are not only profiting from it, but are actively preventing recovery. They are causing unemployment, starvation, destruction of lives, and even violence and terrorism across the world. They are certainly more dangerous than the inflation of the 1970s, and arguably have disrupted more lives than Osama bin Laden—whose actions led the US to undertake military actions in at least three countries. That should provide ample justification for Greece’s declaration of figurative war on Manhattan.

However, in an ironic twist of fate, it was just announced that Petros Christodoulou will take over as the head of Greece’s national debt management agency. He worked as the head of derivatives at JP Morgan, and also previously worked at Goldman—the firm that got Greece into all this trouble!

Dimitri Papadimitriou has recently made what we consider to be an important plea for moderation of the hysteria about Greece’s debt. Writing in the Financial Times, he complained that “The plethora of articles in your pages and others, some arguing in favour and other against a bail-out, contribute to market confusion and drive the country’s financing costs to record levels. It is not yet clear that a bail-out is even needed, but this market confusion is rendering the government’s ability to achieve its deficit goals ever more difficult.” Indeed, we suspect that the same financial firms that helped to get Greece into its predicament are profiting from—and stoking the fires of—the hysteria. He goes on, “what Greece really needs now is a holiday from further market confusion being created by contradictory, alarmist public commentary” (see here).

Greece, Euroland in general, and the rest of the world all need a holiday from the manipulation and destruction of our economies by Wall Street firms that profit from speculative bubbles, from burying firms, households, and governments under mountains and debt, and even from the crises that they create. Governments all over the globe should use all legal means at their disposal to ferret out the bad faith and even fraudulent deals that global financial behemoths are foisting on us.

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Wall Street Still Doesn’t Get It

Posted on February 16, 2010 by admin | 17 comments

Peasant Insurance, Greek Debts, and CLX Derivatives

By L. Randall Wray

Forget the bonuses. Sure, it is disgusting that Wall Street is funneling government bail-out funds straight to what my colleague Bill Black calls the “control frauds”—the top managers of financial institutions. And, yes, they are blowing the black hole of financial insolvency bigger day by day even as they thumb their noses at Washington while Timmy Geithner and Ben Bernanke look the other way. But what is even more disturbing is that Wall Street is still maniacally creating risk, inventing new ways to bet on the death of “peasants”, economies, and nations.

Previously, Marshall Auerback and I have written about the securitization of “life settlements” (see here). A Wall Streeter buys the life insurance policies of individuals with terminal illnesses, packages them into securities, and profits when the underlying collateral dies. In his most recent movie, Michael Moore documented the practice of taking out “peasant insurance” on employees. Now we learn that firms continue to carry life insurance on former employees, hoping they will die untimely deaths so that the firm can collect (see here). We know how devastating unemployment is for most people, ruining their marriages, mental and physical health, and social life. Hey, why not fire employees in the midst of the worst downturn since the Great Depression, when chances of finding another job are nil? That ought to hasten death. And if a firm can hold life insurance policies on former employees, why not take out policies on down-and-outers who never worked for the firm? Death is the new profit center, packaged and sold by Wall Street insurers.

Second, there is of course Greece. Goldman Sachs sold them financial products to disguise their budget deficits. Of course, Goldman argues that it was doing nothing unusual—it has been creating complex products to hide risk for decades (see here and here). Goldman gets huge fees, but of course the risks always come back to bite its suckers. However, in the case of Greece, Goldman might have bit off more than it can chew. From 2001 through November 2009 Goldman created financial instruments to hide European government debt, for example through currency trades or by pushing debt into the future. But not only did Goldman help (and perhaps even encourage) Greece to take on more debt, it also apparently brokered credit default swaps on Greece’s debt—making income on bets that Greece would default. We don’t know whether Goldman has placed its own bets on the death of Greece—nor is it clear what role Goldman has played in whipping up hysteria about the likelihood of default, but the bank is almost certainly benefiting by the booming business in default “insurance”. As CDS prices rise and Greece’s credit rating collapses, the interest rate it must pay on bonds rises—fueling a death spiral because it cannot cut spending or raise taxes sufficiently to reduce its deficit. And it is probable that other Euronations—perhaps Italy and Portugal—used similar financial products sold by Wall Street. While Washington will not do anything to constrain Goldman, it looks like the European Union, which is launching a major audit, just might banish the bank from dealing in government debt.

Finally, according to a report, Citi is going to launch a new derivative that will allow gamblers to bet directly on financial crises. here Rather than betting on the death of an individual, firm, or government Citi would create a tradable liquidity index, the CLX. Essentially this would allow one to place a bet that a liquidity crisis would occur. If funding costs spike in a run to liquidity the derivative sellers would have to pay. Recall that our current financial collapse began with just such a liquidity “event”: the commercial paper market dried up, which meant that holders of mortgage-backed securities could not continue to finance their positions. The CLX products are supposed to hedge the liquidity risk of a spike of funding costs. The problem, of course, is exactly the one faced by those who had bought CDS “insurance” from AIG: counterparty risk. As Cambridge Professor Chris Rogers says, “This is basically a kind of insurance product. The main issue is: how good is the party issuing it? If it’s going to be paying out huge numbers in the event of a crisis, will it be able to meet obligations? Insurers can buy reinsurance for their liabilities, but the buck has to stop somewhere—there’s a limit to how much a private insurer can pay out. Only the government can cover unlimited losses.” Hence, only the chosen few “too big to fail” sellers of this kind of insurance will be able to play the game. That is, folks like Goldman, J.P. Morgan, Citi, and Bank of America. And guess who will get stuck with the bill when the whole scheme crashes? You betcha, it will be the Treasury.

And that is what this whole Wall Street house of cards boils down to: risky bets, private profits, socialized losses. Worse, yet, it misaligns interests so that Wall Street profits are higher if there is economic and social instability—and Wall Street is powerful enough to generate exactly those conditions. Until Wall Street is constrained and downsized, it will continue on its path of death and destruction.

In spite of all the happy talk about the end of the recession and the successful resolution of the financial crisis, things are much worse today than they were two years ago. Commercial real estate is toast. Option ARMs (the toxic mortgages with low teaser rates) are resetting ahead of schedule because of clauses that allow mortgage holders to jack up rates as homeowners go underwater. Every class of consumer debt—much of it securitized—looks a lot like subprime mortgages. Euroland and Japan are cratering, the UK is going to try to reduce its budget deficit, and even China has decided to slow its growth to reduce inflation pressures. Note that all of these markets are linked, and for every debtor that goes delinquent there are numerous linked financial products that go bad. There are well over $500 trillion of those products still floating around. While it is true that every derivative has both a buyer and a seller—so that every “event” should be a zero-sum game, with the seller paying the buyer—that works only if bad bets can be covered. But we know that Wall Street institutions are not good counter-parties. So what happens instead is that there is a rush to liquidity as everyone tries to sell out positions in assets to cover their commitments, causing asset values to plummet. Be prepared for another global crisis by summer. And also get ready for another Washington bail-out of Wall Street, because the $23 trillion promised so far will not be enough.

So here’s the best policy. Unwind the $23 trillion committed by the Treasury and the Fed. Let the market operate. It wants to close down all the “too big to fail” institutions. The market is right—these institutions are not necessary, indeed, they represent the biggest problem facing the financial sector. Their CEOs instinctively recognize that these institutions serve no useful purpose—which is why their efforts are directed to creation of ever more dangerous and socially destructive financial products. As I have said before, Washington needs to get on the right side of the leverage ratio: for every dollar of real productive activity and income generated, there can be $30 or more of leveraged financial bets. Rather than trying to make all of those good, it makes far more sense to allow default to wipe out the bets, and then work to save the productive activity, jobs, and income.

I know that Wall Street’s protectorate, led by Geithner, Rubin, and Summers, will claim that failure of the behemoths will create an economic disaster. But that is not true. All real economic fall-out can be contained and the economy will emerge much healthier. Replace Wall Street’s life support with support for mainstreet. Start with a payroll tax holiday (don’t collect any payroll taxes from employers or employees for the next two years); add $500 billion for direct job creation to immediately get to full employment; add another $500 billion for relief of state and local governments distributed on a per capita basis; and give all mortgaged homeowners the option of immediate default with a “rent to own” plan. True recovery would begin immediately, and we’d be out of the mess by summer.

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Why Do Progressives Claim that Deficits Today Mean More Pain Tomorrow?

Posted on February 11, 2010 by admin | 20 comments

By L. Randall Wray

Yesterday I posted a blog here arguing that we should not conflate a sovereign government’s balance sheet with that of a household. One is the issuer of the currency, the other is a user. That makes a big difference. The currency issuer can spend by “financing” its purchases through credits to bank accounts, issues of new currency, or new issues of sovereign interest-paying debt that is considered to be the safest dollar-denominated asset in existence. Households cannot do that. I also argued that there is no “piper-paying” due date on which government needs to repay its debts, hence, no financial imperative to ever run a budget surplus (or even a balanced budget). Further, even if the government were to try to run surpluses to repay debt, that would (based on historical experience) throw the economy into a depression that would only increase budget deficits. Empirically, budget deficits are correlated with growth; budget surpluses precede depressions. Based solely on the historical record, only a fool would recommend budget surpluses as a policy goal. Yes, that implies that Robert Rubin and Pete Peterson advocate foolish policy.

Somewhat ironically (at least from my point of view) the shrillest critics come from the left. When I try to explain how government “really” spends, or why government is not like a household, or why the focus on budget deficits is misplaced, the loudest objections come from those who claim to be progressives. Indeed, on the matter of deficits, the only discernable difference between the “progressive” position and the “deficit hawk” position of a Pete Peterson is over the short run. Both agree that deficits today mean higher taxes and less government spending in the future—more burdens for our grandkids. Both agree that spending more now to relieve the pain of unemployment only means more pain in the future. The only difference of opinion comes down to the willingness to “party now” and “pay later”. Conservatives would forego the party to avoid the hangover; “progressives” would party like it is 1999, then deal with the migraines and stomach upsets later. I must say that if I had to choose between the two strategies, I would go with the conservatives: take the pain now and enjoy lower taxes later. Indeed, I cannot think of any justification for taking the party now and putting the burden of the aftermath on our children in the future—if that is what the choice really involved.

But here’s the deal. The “progressives” are wrong. Nay, they are dangerous. They are the worst enemies we face. At least with the Pete Petersons you know what you get: they oppose deficits precisely because they oppose any progressive policy that might help the average American today—the pain in the future is just a bogeyman to prevent progress today. Indeed, that is, by definition, the position of conservatives who want to return to the idyllic past when the poor suffered their deserved fate and the deserving enjoyed their privileges.

Progressives are supposed to be, well, progressive. But almost all of them constrain progressive policy to a Puritanical trade-off: anything that leads to improvement today is bought by more suffering later. They are far worse than the conservatives because no one who wants to improve the position of the average American would ever take the deficit hawk position of Pete Peterson seriously. We all know what he stands for. So the position of the progressives on deficits, which is identical in all important respects to that of the deficit hawks, is far more dangerous precisely because they appear to prefer progressive policy but warn that in the long run it will bankrupt us.

Why do they adopt a position that is fundamentally inimical to the progressive agenda?

Let me proffer an informed hypothesis. It is all politics. Back during the waning days of the Clinton administration, a high ranking economist of a major labor union laid it all out in public at an economics conference. Union surveys showed that voters trusted Democrats far more to protect Social Security than they trusted Republicans (a finding that is not surprising, given the efforts of Republicans dating back to the early postwar period to kill the program). As they have long argued, Republicans claimed that Social Security faces an Armageddon because when baby-boomers retire, payroll tax revenues will not cover Social Security benefit payments. This labor union economist assured the assembled crowd that this is not really a problem because Social Security is a government program, and as government is a sovereign issuer of the currency it can and will make all Social Security payments as they come due simply by crediting bank accounts. I was practically dumbfounded, having thought that I was just about the only economist who understood this.

But he went on. Democrats needed a campaign issue, he said, something candidate Gore the Bore could sink his teeth into. (Recall that this was before Gore had become the global warming messiah we all now love.) So the Democrats had decided that “save Social Security” would be his main campaign theme. Problem: Social Security did not and does not need saving because it does not and cannot face any financial problems. Solution: join the Pete Petersons and Senator Judds of the world, and claim that Social Security is going bankrupt. This would be a “two-for”. First, Gore could rise from the near-dead as savior of Social Security, garnering the support of voters fearing that Republicans would gut the program.

More importantly, Gore could collect the campaign contributions of Wall Streeters, who desperately wanted to privatize Social Security because the dot-com bubble was running out of steam. They wanted to manage a growing Trust Fund, charging huge fees from whence to pay Wall Street sized bonuses. And thanks to Clinton, the Democrats had become the official Protectorate of Wall Street’s cash flow (with Rubin and Summers the anointed minions). So Gore promised to save Social Security from the evil-doers on both the right and the left. The right wanted to slash benefits, the left wanted to use Social Security’s surpluses to finance other government spending. Gore would protect those surpluses by locking up Greenbacks in a safe, to be taken out later when the babyboomers retire. Not only that, he would have the federal government kick in some extra bucks by double counting Social Security’s surpluses. It was accounting nonsense, but Wall Street drooled in anticipation of obtaining access to the overstuffed safes.

But a funny thing happened on the way to the election: the population could not understand what the heck Gore was talking about, but it sure sounded scary. Baby Bush seemed to be a safer choice—he had lots of happy talk about making us all “stakeholders” in a new “ownership society”. That sounded a lot better than Gore’s scare mongering. Americans like to be scared about foreigners—immigrants, Reds, French fries—but they do not want to listen to incomprehensible plans to rescue near and dear entitlement programs to which they had become accustomed. Better to kill the messenger. (The same thing happened to Kyoto and cap-and-trade, but that is an issue to be left for another day.)

And so it goes. The “left” simply will not give up on the scare tactics. They want to terrorize the population about budget deficits, so they can propose some deficit-cutting policies in the distant future—preferably left for the next administration. More party today, more pain later. Who gets to party? Well, obviously, Wall Street—the main benefactors of the Democratic party and, no surprise, the main beneficiaries of bail-outs.

And what if Wall Street did not get its bail-outs? Armageddon, as Bernanke, Paulson, Rubin, and Geithner have been claiming for two years. In reality, there would have been no collapse, indeed, we would have been in far better shape had we simply closed down all of the insolvent financial institutions (which would have included all of the big ones). But the Wall Street rescue operation never had, and never will have, anything to do with saving the economy, dealing with retiring baby-boomers, or indeed with resolving any real world problems. It is all about stoking the flow of cash from Wall Street to Democrats.

Unfortunately, it is a strategy that will fail. Scaring voters and funneling money to Wall Street only generates distrust. Voters voted against Gore, against Kerry, and for change—that they thought they would get with Obama. They want honesty, not terror. They want action, not threats of deferred pain. They want jobs now, not excuses about “affordability” or “sustainability”. They don’t need nonsensical lectures about why the government can afford $23 trillion in promises to Wall Street, but it cannot afford to support Main Street. They want the sure recovery now, not scary talk about burdens this will place on future generations.

They will not accept the argument that because of some hypothetical revenue shortfalls 75 years from now, government cannot keep teachers employed and schools open now. They will not sit idly by as Haiti suffers from the same governmental near-paralysis that New Orleans experienced under the previous President. They want government to spend, now, on the necessary scale to deal with our problems, and those of our even less fortunate neighbors. They recognize that the problem is not one of “money”—something that costs the government nothing to create—but rather a failure of will to mobilize the ample and underused resources we now have to accomplish the tasks at a hand.

While more than two generations have passed, memories of WWII are still strong. Government ramped up its spending to 50% of GDP; its deficit reached 25% of GDP—almost twice as high as the ratio today. We shipped our highest tech products out of the country and we sent some of our most motivated and productive workers off to fight the war—many of whom never came back; we mobilized our labor force and went far beyond what anyone thought to be full employment—with the help of female workers that many had believed to be incapable of the work they successfully undertook; and we constrained our domestic consumption sector to preserve resources for the war effort. Still, living standards rose, inequality, racism, and poverty fell, and we emerged from the experience stronger than ever. The next generation experienced the “golden age” of US capitalism as we put resources to work producing for domestic consumption, and the rest of the world grew faster than it ever had before.

With the New Deal programs and constraints in place, the financial system played a secondary role, with no significant crises for a whole generation after the war. By design, Wall Street was tiny, and our financial institutions were simple, but they financed the most rapid and sustained growth of output and living standards our nation had ever seen. Over the course of the 1930s, we had downsized, strangled, and constrained Wall Street. It took a half century for it to fully recover—and once it did it returned to its old destabilizing ways. To make a long story short, finance gradually returned to the dominant position it enjoyed on the eve of the Great Depression—and duplicated the result.

In this current crisis, Wall Street refuses to downsize. It wants to emerge as the still dominate force that it had enjoyed before the crisis. Its biggest threat is the recognition that it is not needed, that it plays no important social function. Not only can the financial system be downsized by two-thirds or more without ill effects, the economy would actually perform better.

From Wall Street’s perspective, if government finance were truly understood, there would be little room left for the “financialization” that Goldman Sachs and others have been promoting. Securitization of mortgages and of other consumer debt is superfluous. Private pensions managed by Wall Street are unneeded–Social Security is safe and can be expanded as desired to provide decent and secure pensions. Health care insurance does not need to be reformed or expanded, instead, it needs to be eliminated and replaced by a single payer system. Government does not need to beg or bribe finance to fund efforts by entrepreneurs to create jobs because a federal job guarantee program can ensure continuous full employment. And Wall Street does not need to choose our candidates for us, as voters are perfectly capable of electing representatives of their interests. In short, it is difficult to conceive of any positive role for outsized finance to play.

Lest anyone think that I am advocating a bigger government, I want to make clear that I am actually arguing for less government intervention into the economy. The market wants to eliminate the biggest financial institutions. I think the market is correct. It wants to get rid of the riskiest financial instruments, such as credit default swaps and securitization. The market is correct on that score. The market would eliminate bonuses for Wall Street traders and CEOs—only Bernanke and Geithner stand in the way, providing government bail-outs that fund the outrageous rewards paid to the crooks and fools that created the crisis. The market would wipe out the mortgage debts of underwater homeowners—it is only the inducements provided by government that keep the mortgage servicers and first and second lien vampires afloat so that they can suck some more blood. And no rational market would have developed private employer-based pension plans or use of employment-related insurance as the dominant method of providing healthcare services. Both of these anomalies were created by partnerships of Government and Wall Street acting against the interests of the vast majority of Americans. I believe that we can have decent and rationalized retirements, health care, and jobs programs without increasing the size of government.

But the first step is to get beyond the deficit bogey. A government budget is not like a household budget. A government deficit—by itself–is neither good nor bad. And in any case government deficits are mostly not discretionary—they do not result from government policy but are largely “endogenously” determined by the nongovernment sector’s behavior. That is a topic for another blog. The most important thing to recognize that there is no “party today, pain tomorrow” trade-off. If government needs to spend more today to create jobs, provide healthcare, and support education, that simply means we can enjoy the benefits of fuller use of our resources. It does not impact our ability tomorrow to similarly use government spending as necessary to create jobs, provide healthcare, and support education. Indeed, it will make it easier because our nation will be in better shape tomorrow than it would have been if we had gone without jobs, healthcare and education today.

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Posted in L. Randall Wray, The Federal Government Deficit, The National Debt, Uncategorized

Tagged L. Randall Wray, The Federal Government Deficit, The National Debt

Let Banks Choose: Bonuses or Bank Charters?

Posted on February 4, 2010 by admin | 4 comments

L. Randall Wray

Now here is the best idea we have seen yet. Britain’s Financial Services Authority has come up with the ultimate response to bank claims that they must pay high bonuses to the geniuses who caused the crisis. Just as Timmy Geithner claimed, while trying to protect his Wall Street handlers, UK banks always say that contracts are contracts and so no matter how repulsive it might be, they have to pay out bonuses as spelled-out in their contracts. The FSA said fine, go ahead, but if you do you will lose your license to do banking in London. In other words, it is the bank’s choice: be a bank, or pay bonuses. You cannot have it both ways (see here).

So here is the deal. President Obama should direct his administration to offer our bankers the same choice: either forgo all bonuses until the US unemployment rate drops below 5%, or lose your bank charter. Indeed, he should go further. Banks are really public-private partnerships, and bank management and other employees should not receive pay in excess of civil servant pay. Assign the appropriate civil servant pay grades to our regulated and protected banking institutions. Any banks that wish to pay higher salaries than that to retain “rocket scientists” can do so, but they will give up their bank charters. They will slip into the dark “shadow banking” sector and will lose all access to government protection.

Then adopt a strict version of the Volcker rule. Should any of those shadow banks find themselves in trouble, they will not be bailed out. Instead, they will be “resolved”—that is, shut down, with creditors paid whatever the government can recover on assets. If that rule had been in place two years ago, no more Goldman Sachs. Instead, Goldman was handed a bank charter, which allowed it to stay in business, to hoover up manufactured profits, to manipulate government policy, and to pay out bonuses using government bail-out money.

As to the complaint that banks will not be able to retain all the geniuses that helped to create the crisis, Obama’s response ought to be: Goodbye and good riddance. Go find jobs in the Caribbean. Banking does not need rocket scientists. It is basically a simple business: assess credit worthiness, make loans that have a high probability of repayment, and issue deposits. It used to be known as the “three-six-three” business: pay three percent on deposits, charge six percent on loans, and hit the golf course at three p.m. That was good banking and it did not need high remuneration. Tens of millions of Americans bought homes, started businesses, and sent their kids to college. It was good enough.

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Posted in L. Randall Wray, Uncategorized

Tagged Financial system, L. Randall Wray, New financial structure

What President Obama Ought To Say In His State Of The Union Address

Posted on January 27, 2010 by admin | 4 comments

By L. Randall Wray

President Obama: Over the past year it has become amply clear that targeting most of the Federal Government’s assistance toward Wall Street rather than Main Street has done nothing to help pull our economy out of the deepest downturn since the Great Depression. I have become convinced that the single most important thing Washington can do to help America is to create jobs–and to create them on an unprecedented scale. I am talking about millions of jobs, maybe tens of millions.

So here is what I propose to do. I am directing my administration to come up with a plan that will guarantee a decent job at decent pay for any American who wants to work–regardless of race, regardless of gender, regardless of education or training, and regardless of previous work experience. I want these to be productive jobs–jobs that will enhance the well-being of everyone in our country. Among the areas that ought to be targeted I would include education, care for our aging population, cleaning up our environment and retrofitting buildings to make them energy efficient, and repairing and improving our nation’s infrastructure.

It is time that we take seriously the United Nation’s Universal Declaration of Human Rights, which guarantees the right to a job–which was actually one of the key components of the Second Bill of Rights proposed by my predecessor, Franklin Roosevelt more than 65 years ago. I am ashamed that our nation has not lived up to its commitment to human rights, and I aim to change that.

This program will be permanent, and it will ensure that from this day forward, the United States economy will operate with true, full employment. We will look to the New Deal job creation programs for inspiration, but we will go further because we will end forever the horror of involuntary unemployment. Eliminating the scourge of unemployment is good politics, it is good social policy, and it is good economics.

Now, I am not an expert in esoteric economic theories that are common in the ivory towers of some universities. But I can tell what is nonsense. And any economist who tells you that it makes sense to keep tens of millions of people unemployed is spouting nonsense.

Our nation faces many challenges, today and in the years to come. But we can solve these by working together–and it will take all of us, working, together, to meet those challenges. The truth is that we can no longer afford to keep people out of work. The job is too big. So I ask my administration, and I ask you, the American people, to put our minds together to create those jobs and I will commit the Federal Government budget to provision of decent wages for all of those who want to fill them.

Thank you.