(cross posted at New Economic Perspectives)

As I reported here and over at Great Leap Forward, a new study by two UMKC PhD students, Nicola Matthews and James Felkerson, provides the most comprehensive examination yet of the Fed’s bailout of Wall Street. They found that the true total cumulative amount lent and spent on asset purchases was $29 trillion. That is $29,000,000,000,000. Lots of zeros. The number is quite a bit bigger than previous estimates. You can read the first of what will be a series of reports on their study here. I want to be clear that this is a cumulative total—and for reasons I will discuss in this post it is the best measure if we want to understand the monumental Fed effort to restore Wall Street to its pre-crisis 2007 glory.

It is certain that no government anywhere, ever, has committed so much to benefit so few. Wall Street owes the Fed a big fat wet kiss. That’s a kiss Chairman Bernanke apparently does not want.

Last week he extended the Fed’s veil of secrecy over its bail-out of Wall Street by trying to counter a recent Bloomberg analysis of the extent of the Fed’s largess with a fog of deceit. Apparently the Chairman forgot the lesson we learned from Watergate: the cover-up is always worse than the original indiscretion.

Bloomberg had found that the Fed committed $7.77 trillion to the biggest banks. Bernanke provided a memo that claimed the real total was only $1.2 trillion. The memo went on to argue that much of the Fed’s lending benefited small banks, recipients of student loans, and even manufacturing firms like Harley Davidson. Finally, it claimed that throughout the bail-out, the Fed’s actions were transparent, with Congress continually updated on the Fed’s actions.

It was quite a performance, reminiscent of the kind of misleading statements the previous Chairman, Alan Greenspan, made before the House under interrogation by the late, great, Representative Henry B. Gonzalez. Gonzalez—trying to shine a bit of light into the Fed’s secret meetings—asked whether the Fed kept tapes of its FOMC meetings (shades of Watergate). Greenspan fibbed, answering “no.” Realizing that it is not a good idea to lie to Congress, he went back to the office, convened a conference phone call of Fed officials and warned them that they likely all would be called before Gonzalez’s committee. He said it would be up to them to decide to tell the truth, or to continue the charade.

You see, the Fed did tape every meeting and had been doing so since the days of Watergate; but the tapes were transcribed and then (supposedly) erased and used for subsequent recordings. In the end, the Fed decided to tell Congress the truth, and agreed to release edited transcripts within 5 years. So on some generous interpretation, Greenspan’s fib was not a lie. You can now read the transcripts on-line. (See the FOMC transcripts for the period from October 1993 to May 1994 for discussions surrounding the wisdom of operating with greater openness—and for fascinating internal discussions about how to deal with González and Congress; see also my article.)

However—and this is a real scandal—the Fed is routinely shredding the original transcripts (only the edited versions are available). You see, the Fed claims that because it is “independent”, it is not subject to normal “sunshine laws” that require maintaining government records. And its meetings that discuss monetary policy and bank supervision are also exempt from sunshine, according to the Fed.

But that is a topic for another day even though it should be infuriating to Congress.

Let us get back to Bernanke’s 29 trillion dollar fib. continue reading…

Micah Hauptman of Public Citizen has drawn from the work of the Levy Institute’s Marshall Auerback and Randall Wray to put together a concise piece that lays out five core critiques of credit default swaps.  Among the basic problems he highlights is a flaw-riddled process for determining when a CDS pays off:

… there are no bright lines to determine when a CDS payment is triggered. The system for determining when payments should occur is murky, unregulated, and replete with conflicts of interest. For speculators to cash in on their bets and receive CDS payments, there must be a “credit event.” Failure to pay when due is the most common credit event, however a “credit event” can also occur through bankruptcy, a change in interest rate, a change in principal amount, or postponement of interest or principal payment date. But even within these occurrences, there is considerable legal debate over what constitutes an “event.”

Consider the current financial crisis in Greece. The country has experienced distress due to mounting government debt. European officials recently reached a tentative restructuring agreement. Under the agreement, Greece will undergo a strict austerity plan to regain solvency and Greece’s creditors will receive a reduction in their interests. Whether this restructuring agreement constitutes a “credit event” will likely be contested.

Decisions like this as to whether a “credit event” has occurred are made by the International Swaps and Derivatives Association (ISDA) Determinations Committee—but as Hauptman points out, the ISDA committee includes representatives of financial institutions (some of the largest banks and hedge funds) that often have a stake in whether payments are triggered.

Read Hauptman’s piece here.

For those who are paying attention to the meltdown in Europe, credit default swaps are likely to make a dramatic reappearance.  Bloomberg reports, for instance, that European banks are selling CDS on their own member-nation’s debt (via Zero Hedge).  Banking on failure indeed.

OK, anytime one criticizes the Fed or Wall Street there will be some push-back by the professionals who serve their masters. (By contrast, Barry Ritholtz understood the argument, see here.)  My original piece on Friday got picked up by a number of blogs and generated a lot of hostile responses. I expect that. It is obvious from their comments that many of them did not bother to read the post very carefully, or, if they did, that they stuck to talking points. And it looks like many of them deal in obfuscations that would make Chairman Bernanke proud.

But let us presume they were not hired by the Fed and Goldman and instead assume good intentions. I will have a longish post over at New Economic Perspectives tomorrow that addresses several issues that were not adequately covered in my post on Friday. But here I will deal with the main topic of a number of the comments—which centered around the proper way to measure the Fed’s intervention: stocks or flows.

Several commentators presume I cannot tell the difference between stocks and flows. No long-time reader of this blog or of NEP would be confused about this. I know the difference, and indeed have been using Wynne Godley’s stock-flow consistent approach for a very long time.

As I said on Friday, we can choose any of three different measures to ascertain the size of the Fed’s response. First, we can look at peak lending at an instant; more practically, we could choose end-of-day lending by the Fed. We can measure this by looking at the Fed’s balance sheet, adding across the assets associated with the emergency lending facilities (a Fed loan to a bank shows up on the Fed’s balance sheet as an asset; a Fed purchase of an asset from a bank moves that asset to the Fed’s balance sheet.) This is the measure the Fed chooses, and it comes to a peak of $1.2 trillion on a day in December 2008.

(It will miss any off-balance sheet commitments. For example, if the Fed extends a guarantee that does not get triggered, it will never show up on the Fed’s balance sheet, meaning that a measure that includes only assets on the Fed’s balance sheet will miss some of the ex ante exposure to risk. We’ll ignore that here. Much like Bernanke’s claim that the lending turned out OK—because most loans got paid back—that is 20-20 hindsight and does not count when it comes to ex ante risk.)

OK, the peak instantaneous lending is a useful measure. I have never denied that. The analogy is to the six shot glasses poured by the bartender. If we want to tally up the Fed’s exposure to losses, that is a relevant measure. But note that my piece was not focused on risk to the Fed. To be sure, $1.2 trillion is a big exposure. It merits some concern. To my mind, this is a second order issue, although it is highly probable that Congress will be very concerned with Fed exposure to losses. continue reading…

Lessons from the bankruptcy of MF Global — the 8^th largest in US history

Yesterday, CEO Jon Corzine of MF Global appeared before the House Agricultural Committee. The hearing was a reminder that despite well intended legislation, including the Dodd-Frank Act, the speculative behaviors that brought down AIG and Lehman are still considered fair business deals in the financial sector.

Recent reports on the financial crisis in Europe confirm that MF Global was not an isolated case. The extent of speculative positions among banks have reached mind-boggling proportions, with OTC derivatives now standing at over $700 trillion (!) and increasing rapidly.  Banks in Europe are currently scrambling for funds as their regular sources of funds are rapidly drying up. Several analysts point to the fragility of the shadow banking system as a key determinant of the ongoing liquidity crisis, where virtually unlimited leverage seems to be the norm rather than the exception.

According to a Reuter’s report yesterday, the bankruptcy of MF Global shows how the London OTC market has been used by AIG, Lehman, and now MF Global to accumulate layers and layers of leverage on only a tiny bit of capital. The process of re-hypothecation is behind all of this, with especially lax rules in London permitting, for example, the finance arm of AIG—AIG Financial Products—to run up a CDS position of $2.7 trillion just before the firm collapsed in 2008.

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations, much to the chagrin of hedge funds. 

Over the years regulators gradually relaxed the quality requirements for such re-hypothecation, from initially only treasuries, to eventually money market funds, and now foreign sovereigns. This was the legal basis for the legitimate trades MF Global was engaged in, buying AAA European sovereign paper, despite their hedge fund clients probably shorting the whole sector. Eventually MF Global lost trust in the market and couldn’t meet the liquidity run when clients wanted their money back all at the same time (“classic bank run”). This then led to a scramble for cash, in the process also compromising client accounts. But, as several commentators have pointed out, the basis for their implosion was speculative trades on the basis of this process of re-hypothecation, leading up to a leverage ratio of close to forty. continue reading…

Michael Hudson has an article appearing in the Frankfurter Allgemeine Zeitung on the history of debt and democracy.  For those who can’t read German, Hudson has produced an abbreviated English version.  An excerpt:

The idea of an independent central bank being “the hallmark of democracy” is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations.

Read the English version here.

In the course of an interview by Alan Minsky from a couple of weeks ago, Michael Hudson discussed a proposal for setting up a public option for banking (following the “Chicago Plan” of the 1930s and, says Hudson, Dennis Kucinich’s recent NEED Act):

Instead of relying on Bank of America or Citibank for credit cards, the government would set up a bank and offer credit cards, check clearing and bank transfers at cost. …

Providing a public option would limit the ability of banks to charge monopoly prices for credit cards and loans. It also would not engage in the kind of gambling that has made today’s financial system so unstable and put depositors’ money at risk. …

The guiding idea is to take away the banks’ privilege of creating credit electronically on their computer keyboards. You make banks do what textbooks say they are supposed to do: take deposits and lend them out in a productive way. If there are not enough deposits in the economy, the Treasury can create money on its own computer keyboards and supply it to the banks to lend out. But you would rewrite the banking laws so that normal banks are not able to gamble or play the computerized speculative games they are playing today.

Hudson also argues that distortions in our tax system that encourage debt leveraging are contributing to the fragility of the financial system and worsening inequality:

Over the past few decades the tax system has been warped more and more by bank lobbyists to promote debt financing. Debt is their “product,” after all. As matters now stand, earnings and dividends on equity financing must pay much higher tax rates than cash flow financed with debt. This distortion needs to be reversed. It not only taxes the top 1% at a much lower rate than the bottom 99%, but it also encourages them to make money by lending to the bottom 99%.

Read the whole thing.  An edited transcript of the radio KPFK interview can be found here at NEP (with Hudson adding some post-interview elaboration).

(Down 57.7 percent to be exact.)

Sure, Wall Street has returned to claiming its 40 percent share, or so, of all corporate profits, while receiving little more than a regulatory slap on the wrist (which lobbyists are currently working to bring down to a light effleurage), but at the very least, at the end of the day justice will be served for all those in financial institutions and all along the mortgage financing food chain who were engaged in fraud.  So there’s that.

What’s that you say, Syracuse University?  Oh, never mind:

Figure 1: Criminal Financial Institution Fraud Prosecutions over the last 20 years

(Via Catherine Rampell at Economix, who notes that this isn’t the result of some sort of generally more lax approach to federal criminal prosecutions over the last decade—prosecutions for other crimes have almost doubled over the same time span.)

Just to rub it in, read this paragraph from Randall Wray’s policy brief, “Waiting for the Next Crash,” and then take another look at that graph:

… policymakers must recognize that the activities leading up to and through the crisis were riddled with fraud. Fraud, at multiple levels, became normal business practice—from lender fraud and foreclosure fraud to the practice of duping investors into buying toxic securities with bait-and-switch tactics, while simultaneously betting against those securities using credit default swaps. Every layer in the home finance food chain was not only complex but also fraudulent, from the real estate agents to the appraisers and mortgage brokers who overpriced properties and induced borrowers into terms they could not afford, to the investment banks and their subsidiary trusts that securitized the mortgages, to the credit rating agencies and accounting firms that validated values and practices, to the servicers and judges who allowed banks to steal homes, and on to the CEOs and lawyers who signed off on the fraud. Once a bank has made a “liar’s loan,” every other link in the chain must be tainted. And that means every transaction, every certification, every rating, and every signature all the way up to that of the investment bank CEO is part of the cover-up.

Update:  Or, read Matt Taibbi.

There’s an interesting (and unsettling) section of Martin Mayer’s presentation at the Minsky Conference that I’ll quote at length in which he talks about the reception of Hyman Minsky’s work.  Add this to the growing “what’s wrong with the economics profession?” folder:

I have found my own explanation, rather a disturbing one, for Hy’s relative obscurity despite the importance and intrinsic interest of his work. Several people, some of whom consider themselves followers of Hy, have noted to me that there isn’t much published work, which is nonsense: there is a lot of published work. But relatively little of it is in the economic journals. It’s in the peer-review journals.

The most important person in Minsky’s career was Bernard Shull, who has also been at a lot of these meetings, and I talked to him the other day. . . . He was a young member of the research staff at the Philadelphia Fed when he read Hy’s original article on central banks and the money market in 1957. Shull moved onto the Board of Governors to conduct a study on how the discount window actually operated and how it should operate. It was through working on that study that Hy developed the financial instability hypothesis, which was published originally in detail as a Federal Reserve document. Hy’s important work for the Ford Foundation-sponsored Commission on Money and Credit was published as part of the report of the Commission on Money and Credit. His late and long and important article on finance and profits was published by the Joint Economic Committee of Congress. Other major papers appeared in Festschriften and textbooks.

In the world of the economics profession, these things don’t count. Efforts to explain problems to people who might be able to do something about them are hobbies for the professor. The real work, and what he is expected to turn out, is this goddamn gelatinous stuff with its borders of mathematics that gets published in the professional journals. It may be that Hy’s increasing salience will do something about that. There was only one Hy Minsky. Natura il fece, e poi ruppe la stampa. But other lone wolves may get more attention in the future because the economics world finally awakened to the importance of Hyman Minsky, and thus the importance of publications that are not right down the standard track. We hope so.

The 20th Annual Hyman P. Minsky Conference, organized by the Levy Institute with support from the Ford Foundation, featured a broad range of speakers, including Gary Gensler (CFTC Chairman—occasioning some interesting back-and-forth in Q&A regarding commodities speculation), Paul McCulley, Andrew Sheng, Phil Angelides, Charles Plosser, Gary Gorton, Charles Evans, Vitor Constancio (Vice President of the ECB), Sheila Blair (head of the FDIC), Martin Mayer (who is apparently writing a biography of Minsky), and more.  The proceedings, including Q&A sessions, can be found here; select audio can be accessed here.

There’s a lot of good material to mine, but I’d like to highlight one particular session:  “Financial Journalism and Financial Reform: What’s Missing from the Headlines?” (the title explains itself), moderated by John Cassidy of the New Yorker and featuring Jeff Madrick, Joe Nocera, Steve Randy Waldman, and Francesco Guerrera (see “Session 2” for the audio).  There’s a great quotation from Steve Randy Waldman here:  “Goldman Sachs is just an off-balance sheet special purpose vehicle of the United States government.  Lloyd Blankfein is either a civil servant or a government contractor.  It’s just [that] his pay is out of line.”

The context is a discussion (starting at the 9:50 mark of Waldman’s presentation) that jumps off from this Minsky quotation: “financial reform needs to confront the public nature of much that is private.”  Waldman argues that while financial writers talk about the heads of the big six banks as though they were captains of private industry, their institutions ought to be treated as pseudo-government entities (just as Citibank ultimately had to stand behind its SIVs, which were supposed to be legally distinct, the US government ultimately has to stand behind the big banks in cases of insolvency).

Thorvald Grung Moe, Visiting Scholar at the Levy Institute, delivered a lecture last week on fractional reserve banking and the landscape of alternative options.  He ended with a quotation from FDR that’s worth repeating, particularly in the context of the “We Are the 99%” movement and stories like this about a return to business as usual (+10% or so) on Wall Street: