[p2p-research] FW: Tremble, Banks, Tremble

[Michael Gurstein]

Finally, someone talking sense about the current mess and some realistic
(except for the US politics) strategies for moving forward.

M

-----Original Message-----
From: moderator at PORTSIDE.ORG [mailto:moderator at PORTSIDE.ORG] 
Sent: Monday, July 12, 2010 6:20 AM
To: PORTSIDE at LISTS.PORTSIDE.ORG
Subject: Tremble, Banks, Tremble


Tremble, Banks, Tremble 
The key to financial recovery: restoring the rule of
law on Wall Street. 
James K. Galbraith 
The New Republic 
July 9, 2010 http://www.tnr.com/article/economy/76146/tremble-banks-tremble

The financial crisis in America isn't over. It's
ongoing, it remains unresolved, and it stands in the way
of full economic recovery. The cause, at the deepest
level, was a breakdown in the rule of law. And it
follows that the first step toward prosperity is to
restore the rule of law in the financial sector.

First, there was a stand-down of the financial police.
The legal framework for this was laid with the repeal of Glass-Steagall in
1999 and the Commodities Futures Modernization Act of 2000. Meanwhile the
Basel II process relaxed international bank supervision, especially
permitting the use of proprietary models to value complex assets-an open
invitation to biased valuations and accounting frauds.

Key acts of de-supervision came under Bush. After 9/11
500 FBI agents assigned to financial fraud were
reassigned to counter-terrorism and (what is not
understandable) they were never replaced. The Director
of the Office of Thrift Supervision appeared at a press conference with a
stack of copies of the Code of Federal Regulations and a chainsaw-the
message was not subtle. The SEC relaxed limits on leverage for investment
banks and abolished the uptick rule limiting short sales to moments
following a rise in price. The new order was
clear: anything goes.

Second, the response to desupervision was a criminal
takeover of the home mortgage industry. Millions of
subprime mortgages were made to borrowers with
undocumented incomes and bad or non-existent credit
records. Appraisers were selected who were willing to
inflate the value of the home being sold. This last
element was not incidental: surveys showed that
practically all appraisers came under pressure to
inflate valuations in order to make deals happen. There
is no honest reason why a lender would deliberately seek
to make an inflated loan.

Mortgages were made with a two-or three-year grace
period, with a low, fixed interest rate called a
"teaser." These were not real mortgages; they were counterfeits, whose value
would collapse when exposed. As with any counterfeit, the profits came
early, when the bad paper was first sold. After the grace period, rates
would reset, and the lenders knew that the borrowers, who were already
stretched by their initial payments, would either refinance or default. If
they refinanced, that would mean another mortgage origination fee. And if
they defaulted, well ... on to step three.

Third, the counterfeit mortgages were laundered so they
would look to investors like the real thing. This was
the role of the ratings agencies. The core competence of
the raters lay in corporate debt, where they evaluate
the record and prospects of large business firms. The
value of mortgage bonds depended on the behavior of tens
of thousands of individual borrowers, whose individual
quality the ratings agencies could never check. So the
agencies substituted statistical models for actual
inquiry, and turned a blind eye to the fact that the
loans were destined to go bad.

Fourth, the laundered goods were taken to market. The investment and
commercial banks transformed the bad mortgages into bonds, obtained the AAA
ratings, and sold the stinking mess to American pension funds, European
banks and anyone else who took the phrase "investment grade" at face value.
(Later chumps would include the Federal Reserve.) The European crisis now
underway is a direct result, as their banks and investors, stung by losses
on American mortgage bonds, are dumping their risky Greek public debt and
seeking the safety of U.S. Treasury bills.

When the crisis went public in August 2007, Henry
Paulson's Treasury took every step to prevent the final collapse from
happening before the 2008 elections, extracting billions from the Federal
Housing Authority and from Fannie Mae and Freddie Mac to relieve the
pressure on bank balance sheets. It worked until it didn't. In September
2008 the collapse of Lehman triggered the collapse of American International
Group
(AIG) and the steps that led to the Troubled Assets
Relief Program (TARP) and to the effective
nationalization of the commercial paper market, meaning
that the Federal Reserve has become the primary short-
term funder of major American corporations.

Upon taking office, President Obama had a chance to
change course and didn't take it. By seizing the largest problem banks, the
government could have achieved clean audits, replaced top management, cured
destructive compensation practices, shrunk a bloated industry, and cut the
banks' lobbying power and therefore their capacity to obstruct financial
reform. The way to write- downs of bad mortgage debt and therefore to
financial recovery would have been opened.

None of this happened. Instead the Treasury administered
fake "stress tests" and relaxed mark-to-market
accounting rules for toxic assets which permitted the
banks to defer losses and to continue to carry trash on
their books at inflated values. This reassured the banks
that they would not be permitted to fail-and so back to bonuses-as-usual
they went. The banks survived, and the administration today claims this
"proves" they didn't need to be taken over. But to what end did they
survive? The banks are bigger, more powerful, and moer obstructionist than
ever-and largely uninterested in making new commercial, industrial, or
residential loans.

Today the former middle class is largely ruined: upside
down on its mortgages and unable to add to its debts.
With housing prices low and falling, banks are delaying foreclosures because
they don't wish to recognize their losses; it is a sick fact that the cash
homeowners conserve by non-payment is one source of the anemic recovery so
far. But construction remains depressed, state and local budgets continue in
a death-spiral of spending cuts and tax increases, the stimulus will soon
end, and exports may soon fall victim to international austerity and the
rapidly declining euro. Meanwhile the deficit hysterics seem determined to
block unemployment insurance and aid to states today, and to cut Social
Security and Medicare tomorrow.

In this way, the financial sector remains a fatal drag
on the capacity for strong growth. And the financial
reform bills about to clear Congress will not cure this.
The bill in conference has some useful elements but it
is neither sufficient nor necessary to clean up frauds,
which have always been illegal. Nor will it clean up
private balance sheets and permit lending to restart.
Still less will it set a new direction for the financial economy going
forward.

What to do? To restore the rule of law means first a
rigorous audit of the banks and of the Federal Reserve.
This means investigations-Representative Marcy Kaptur
has proposed adding a thousand FBI agents to this task.
It means criminal referrals from the Financial Crisis
Inquiry Commission, from the regulators, from Congress,
and from the new management of troubled banks as they
clean house. It means indictments, prosecutions,
convictions, and imprisonments. The model must be the
clean-up of the Savings and Loans, less than 20 years
ago, when a thousand industry insiders went to prison.
Bankers must be made to feel the power of the law in
their bones.

How will this help the economy? The first step toward
health is realism. We must first stop pretending that
bad assets can be made good, that bad loans will someday
be repaid, and that bad people can run good banks. Debt
crises are resolved when debts are written down and
gotten rid of, when the institutions that peddled bad
debts are restructured and reformed, and when the people
who ran the great scams have been removed. Only then
will private credit start to come back, but even then
the result of bank reform is more prudent banks, by
definition more conservative than what we've had.

So yesterday's borrow-like-there's-no-tomorrow America
is done for in any event; there will not be another bank-sponsored private
credit boom. The housing crisis (and therefore the middle-class insolvency)
won't go away soon. There is no cure for falling housing prices except time
and patience; debt relief will at best stabilize the middle class. It
follows that the private banks and dealers and borrowing by households are
not going to be at the center of the next expansion.

We are in the post-financial-crash. We need to do what
the U.S. did during the New Deal, and what France,
Japan, Korea, and almost every other successful case of post-crash (or
postwar) reconstruction did when necessary. That is, we need to create new,
policy- focused financial institutions like the Reconstruction Finance
Corporation to take over the role that the banks and capital markets have
abandoned. Thus, as part of the reconstruction of the system, we need a
national infrastructure bank, an energy-and-environment bank, a new Home
Owners Loan Corporation, and a Gulf Coast Reconstruction Authority modeled
on the Tennessee Valley Authority. To begin with.

A reconstructed financial system should finance the reconstruction of the
country. Public infrastructure. Energy security. Prevention and mitigation
of climate change, including the retrofitting of millions of buildings. The
refinancing of mortgages or conversion to rentals with "right-to-rent"
provisions so that people can stay in their homes at reasonable rates. The
cleanup and economic renovation of the Gulf Coast. All of this by loans made
at low interest rates and for long terms, and supervised appropriately by
real bankers prepared to stay on the job for decades.

The entire host of neglected priorities of the past 30
years should be on the agenda now. That is the way-and
the effective path-toward prosperity.

_____________________________________________

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