In financial news, Tim Geithner has at last unveiled the administration’s plans to deal with the toxic assets infecting bank balance sheets. The plan assumes, contrary to all evidence, that the problem currently facing the global financial system is one of liquidity, not solvency–i.e. if mortgage-backed assets were properly valued, they’d be worth much more than currently, so if we just make a market for them, banks will be able to sell them at good prices and thus recapitalize their balance sheets. In reality, as Paul Krugman was quick to point out, the mortgage backed assets really are crap, buying them (even at a premium) won’t render troubled banks solvent, and it’s not a certainty that people will buy them at a premium. Above all, in my mind, is the following human fact: if you give someone $100 to invest for six months and, at the end of six months, they give you back $0, you’d be unlikely to give them $100 again: the plan ensures current management isn’t fired–indeed, it seems to be designed expressly to avoid that possibility–whereas nationalization would. The problem of undercapitalized banks would be solved if they could raise capital, but who is going to invest money with the same people who burned it with such abandon?
In other news from my world, there’s been developments in the saga of my friend, Stoner Mark, who I wrote about below. To recap, Stoner Mark is a friend of mine who lives on the West Coast. To make a living, Stoner Mark deals pot in a nice provincial city. Recently, his head filled with dreams of a new cell phone and more vacation time, Stoner Mark made a large purchase of what was supposed to be high-quality greens, blowing through most of his savings to do so. Instead of the boon to his business he thought it would be, the pot turned out to be crap, and now he’s broke and his mortgage is coming due, so, like many of us, he’s in need of a bailout.
When all this happened, stoner Mark called me first for a loan, which I provided, and then for advice. Like a good friend, I told stoner Mark that his only real solution was to bite the bullet: sell the house, move back home with his generous parents, and get his life in order (i.e. figure out how to be something other than a drug dealer). He also had two deadbeat stoner roommates at the time; I suggested that, as hard as it would be, he needed to throw them out in the cold. Since then, Stoner Mark hasn’t called (and no one has answered my plea for advice to give to him!); I’ve learned that he’s been surviving on loans from his other friends and from his parents and is desperately trying to get rid of the bad greens.
Well, just yesterday, oddly at the same time I was absorbing the details of Geithner’s new plan, Stoner Mark’s parents called me in an angered state. It turns out that, not long after they first called me for advice, Stoner Mark got in touch with them and came clean about the situation. They were, of course, shocked and appalled to find that their son was a drug dealer; Stoner Mark’s brother, a lawyer named Todd, was in such a state of rage at what he saw as his parents’ subsidizing Stoner Mark’s deadbeat lifestyle that he had to get psychiatric attention. After much soul searching, however, they realized that it was both good for the family and the right thing to do to help him. Then, outrageously, he convinced them to help him in the most ridiculous way imaginable: they offered to just give him $5000 to cover his losses! I was so shocked by this I called Stoner Mark, trying to see what effect this would have on him. I tried to be casual, not letting on that I’d spoken to his parents.
What was he up to these days, I asked, was he still in trouble? No, everything was fine again, he managed to use the money from his parents (which he called a loan but they insisted they gave to him not expecting to be paid back) to essentially cover his living expenses while he dealt with the bad pot. He used the rest of the money to buy good pot to mix in with the bad, which is what I’d feared he’d do with the loan I originally gave him. He’s now getting his business back in order with the help of the loan; he’d lost a lot of customers from having the bad pot for so long. I asked him, diplomatically, if he had any plans to find a new source of income? His response: “of course not, man, this is the life!” I tried another angle: I asked him how good his suppliers were, if he’d be able to still buy good stuff and make a healthy margin down the road if he didn’t have money from his parents? Not to worry, he said; yeah, the new stuff was pricey, and yeah, the good stuff is more expensive these days, but he’s making bank again, he’d be able to afford it. It sounded like the same kind of dreaming that led him into the situation.
Maybe I’m just old-fashioned, but I find the whole thing maddening. If a drug dealer buys crap product, his business should go down, it’s just the American way. After I talked to Stoner Mark, and realizing that I was crossing boundaries, I called his parents back, I was just too livid. “You see what’s happening, don’t you?” I said to them. He’s just going back to drug dealing, you’ve enabled him to continue to be a drug dealer. Suddenly, they turned on me: “at least it’s something he does well”, they said. Can you believe that! They think he should continue to sell drugs, at least he can do SOMETHING. They’re little baby is destroying a nice West Coast community with bad ganj and they are proud of him; they’re even willing to subsidize his market!
It’s just amazing. Thank God the country isn’t ran this way.
Three sets of facts:
As reported in the Times and elsewhere, AIG is still paying bonuses and won’t disclose the recipients of their bailout funds, mainly counterparties to credit default swaps at large investment banks.
The Fed itself has resisted inquiries by Congress to disclose AIG counterparties who are receiving bailout money, and has denied past requests from the media for information on recipients of bailout money and the types of collateral they were accepting for emergency loans.
The Markets Group at the Federal Reserve Bank of New York is responsible for implementing monetary policy, pursuant to directives from the FOMC. They do this via trading relationships with the primary dealers, entities tasked with/empowered to trade government securities with the Fed.
The Federal Reserve Bank of New York is run like any private corporation: there’s a private board that appoints a CEO, the Bank President, currently William Dudley and previously Timothy Geithner. The NY Fed’s current board:
Class A
elected by member banks to represent member banks
Richard L. Carrión (bio) 2010
Chief Executive Officer and Chairman
Banco Popular de Puerto Rico
Charles V. Wait (bio) 2011
President, Chief Executive Officer and Chairman of the Board
The Adirondack Trust Company
Jamie Dimon (bio) 2009
Chairman of the Board and Chief Executive Officer
JPMorgan Chase
Class B
elected by member banks to represent the public
Jeffrey R. Immelt (bio) 2011
Chairman and Chief Executive Officer
General Electric Company
(two vacancies)
Class C
appointed by Board of Governors to represent the public
Lee C. Bollinger (bio) 2009
President
Columbia University
Denis M. Hughes (bio) Deputy Chair, 2011
President
New York State AFL-CIO
Stephen Friedman (bio) Chair, 2010
Chairman
Stone Point Capital, LLC
I.e. the CEO of a major investment bank, the CEO of a major corporation with a huge financial services arm, the chairman of a company that invests mainly in the financial industry (Stephen Freidman), and some other people (at least one of whom makes over a $1 million a year).
A simple proposal: how about a little more representation for the public on the Fed’s board, and maybe a little bit less for the financial industry? It is no doubt reasonable to have major member banks represented by their own, that’s cool. But in the world after The Fall, it may be better to start thinking of finance as a public utility, as Martin Wolf of the FT has suggested, and it’s various governmental supporting institutions as utility regulators. It should be easier for voters and the media to demand accountability on bailout funds if the public had more seats at the Fed’s table, and especially the NY Fed, given it’s special role in monetary policy implementation. Throw in a mayor, or an ex-governor, or maybe just a few average Joe Blow homeowner’s, and maybe the Fed won’t feel as skittish about asking for fuller disclosures of e.g. subprime mortgage exposures from major financial institutions.
This is a simple proposal for a slippery issue: In normal times, the Fed relies on the primary dealers to implement monetary policy via the conventional methods, mainly open market operations that move the benchmark interest rate up or down. Since the Fed relies on the primary dealers for this purpose, they try to make it nice for them: they don’t survey their activity, a fact that resulted from regulatory changes in 1992 which, according to the FRBNY website, were conducted partially to remove the false impression that the Fed regulated these institutions. (One change is that the primary dealer surveillance unit at the FRBNY was dismantled and a system of market-monitoring was developed.) Regulatory concerns such as whether they have enough capital to be operating properly are monitored not by the Fed, but rather by the SEC and the Treasury.
In abnormal times such as now open market operations to bring the interest rate down don’t work anymore because the rate is already at zero and can’t go down any further. In this case, the Fed has taken the extraordinary step of lending directly to major financial institutions (banks and non-banks), including the primary dealers (most notably through the Primary Dealer Credit Facility, but also through other “unconventional” lending programs). These new measures have created issues of accountability: many argue that some of these banks, including primary dealers such as Citigroup, are insolvent. I.e. someone wasn’t monitoring their capital adequacy properly, and now they are “zombie banks”–essentially failed institutions worth nothing that are propped up by government capital injections (institutions which, in turn, spread disease by undermining the incentive structure and margins in lending markets through highly-risky lending aimed at resurrection). Someone now needs to determine if they are solvent or not (the purpose of the Treasury’s “stress test”) and, if not, bury them. Lending needs to be restored to the economy, however, so for the time being the Fed is relying on the assumption that banks are solvent and that they simply need liquidity to get back on track, so they’re pumping them full of taxpayer money in the hope that these institutions will start lending again.
So, adding this all up, the primary dealers and their crony institutions are in a wonderful position to blackmail the Fed into preventing disclosures of where exactly all the taxpayer money is going. If the Fed or the Treasury start opening the institutions’ books to public scrutiny, they can simply stop participating in the lending facilities or use bailout money to de-leverage instead of starting to lend again at lower expected rates of return. As the economy falters further from lack of credit, the policymakers will be blamed for allowing Rome to burn and political pressure will lead, happily, to more bailout funds (and more ill-gotten bonuses). As zombie institutions are thus propped up the forestalled disclosures will, in turn, further delay the discovery of insolvencies by the public.
So how do we detonate this situation? One solution may be to give the public more say on the NY Fed’s board. Another (though historically fraught) solution may be to just place open market operations under the control of the public Federal Reserve Board, instead of the private FRBNY.