The Endgame

Here is a simple description of what is driving the markets. It is basically a counter party risk situation involving the biggest banks in the Western financial system. If you keep this in mind most of the things that are happening will be more clear, even though the mind of the status quo rebels against it. People will believe what is in their best interests, long perhaps after it is beyond repair.

I think the endgame is well underway, and the outcome is not saving the public, but managing the transition to a new system, while hopefully keeping the same ruling class. That will not be disclosed while ‘the players’ jockey for advantage and position, ‘turf’ and the privilege of rents, if you will, well ahead of the crowd. –Jesse “Currency Wars: European Debt Crisis and the Next Phase of Global Finance

In the game of chess, the endgame is the stage of the game when few pieces remain on the board, when the end is in sight but its implementation is still unknown. Quietly, it seems we have entered the endgame of the current financial disaster we have been unknowingly involved in over the past few years. We cannot know exactly how it will play out but the best odds seem to be a market collapse in Europe which, because of Wall Street’s exposure to French and German banks, will roar across the Atlantic to the US. The ruling class is likely doing everything it can now to protect and ensure its continued survival in the coming years. The general public will be left to fend for itself.

Most of that same public has no idea how tightly we are tied to the ongoing disaster in Europe. Most Americans would probably say to let Greece default and be punished for their apparent financial sins. Unfortunately, because we stood by in 2008 and did nothing of meaningful reform to the financial industries in the US, we are practically tied to the hip of the European crisis. How is that possible? In the same way that we were nearly destroyed by the Lehman and AIG crises of 2008, the lowly derivative.

Currently, according to the BIS, Wall Street banks have lent Greece a mere $7 billion. In the grand scheme of things, that’s chump change. As recently as September 6th of this year, Ben Bernanke has said that the US exposure to Greek banks is small. Unfortunately, none of that is exactly true. Or more correctly, while that is true, it tells only a fraction of the story. The real issue is that while Wall Street banks haven’t lent much money to Greece directly, they have lent enormous sums to German and French banks. Guess who stands to lose the most if Greece defaults? If you guessed German and French banks, you win the $64 prize. Wall Street has total exposure to the eurozone at around $2.7 trillion and more than half of that is owed by German and French banks.

To make matters much worse, most or all of that total is likely insured in the same way that the mortgage backed securities were largely insured, e.g. through the use of derivatives. Because of this, Wall Street can say they have minimal exposure but as you likely recall, when the bill comes due at the insurance agency, if the bill can’t be paid, chaos happens. This is exactly what we had in the 2008 crisis and unfortunately, nothing has changed because we allowed almost all the players to escape scot-free at the expense of the taxpayers in America.

The French and German banks are scrambling to free up assets as the market starts to realize the Greek bonds they own are likely worth 50 cents on the dollar. If Wall Street has lent large sums to these banks that is insured through derivative contracts and if one or more of those banks goes under or starts to crack, the effects on our economy will be huge. This is why the US Administration is pleading with the Europeans to bailout their own banks.

All of this is possible because nothing was done to deal with the moral hazard of banks being let off the hook during 2008. Hardly anyone went to jail. Practically no banks failed. We didn’t take the opportunity to either better regulate or flat out nationalize the banks. So now, we have a situation where the banks rightfully think that nothing they do can hurt them since it comes with the implicit guarantee from the US taxpayer that we’ll bail them out. We have kicked the can down the road until we entered a dead end alley. The can can’t get kicked any farther and unless the Europeans suddenly find a way out of a particularly tricky mess, we’re going to have more chaos on our hands, possibly much worse than 2008. We have fewer tools at our disposal this time around and the effects could be much greater. Predicting how this will end is almost impossible but the chance for an orderly and fair solution is rapidly shrinking.

Further reading:
Robert Reich: Follow The Money
New York Times: European Banks Face Huge Losses

Geithner Says Europe Will Follow Our Lessons, God Help Them If They Do

This week, Timothy Geithner made comments in the financial media regarding how he thought Europe would get out of the mess they are in.

“I think you’re going to see them draw on the lessons of our crisis, draw on the lessons of things that worked here in the United States,” Geithner said in a Bloomberg Television interview today in Washington. “I think you’ll see that reflected in some of the choices they make.”

God help them if they do. Unless they learn by doing the opposite. Three years on after the 2008 meltdown in the US financial system, does Geithner really think anything has changed at all? Are the financial firms under any more regulation? Have the banks been restrained at all? If he thinks the answer to either of those two questions is yes, he’s more deluded than I thought. Or captured by the very industry he’s supposed to be regulating. Nothing has fundamentally changed the financial world since the crisis. Banks are still holding tons of bad debt on their balance sheets, praying the economy will turn around. Consumer credit is largely a joke. Housing starts are a disaster. The real economy of the US is stillborn. Any lessons the Europeans can learn from us would be examples of what not to do.

When Obama was elected, he had the mandate to make sweeping changes to how things are done. Coming into office during the crisis gave him almost carte blanche ability to fix the problem. Instead, we threw trillions of dollars down the tubes bailing out banks that have since resumed extravagant management bonuses and continued to chase yield in highly risky investments. Instead of nationalizing the biggest banks and treating them as utilities, Obama and Geithner and crew took the money of the real economy in the US and handed it to Wall Street. Three years later, we are seeing what that bought us: zero job growth, a financial industry that still makes up 30-40% of GDP and the rich of Wall Street getting richer while America languishes.

On top of that, the lessons of the US are so drastically different from what is going on in Europe that it’s ludicrous to suggest they learn from us. They tried to create a monetary union without a corresponding political union and have discovered that won’t work. Or if they haven’t admitted it yet, they soon will possibly by the force of the bond market. The issues of the countries in Europe are not unlike the issues of the states and municipal governments in the US where they are constrained in their response to financial catastrophe. To suggest Europe react in the way the US did to the 2008 crisis is to fundamentally misunderstand what is causing Europe’s troubles.

The United States can always pay off any dollar denominated debt at any time by printing more money. This gives us the flexibility required to negotiate when things go south. The countries of the EU do not have this luxury since they signed onto the monetary union of the euro. When the debts of Greece come due, Greek politicians can’t devalue their currency by printing more of it to pay off the debts. Their only possible response is the one we’re seeing, that of austerity and devaluation at the cost of decades of low wages and growth. The citizens of Greece rightly see this as a bad move. To fix the problems in Europe, the EU members will need to have some way of unifying their fiscal policy across member states. Based on the responses we’re seeing from Germany, good luck with that ever happening.

From the beginning, it felt like the members of Obama’s financial team were under-experienced and unable to see how to effectively navigate us out of this crisis caused by years of easy money. Now, those same team members are making suggestions to the rest of the world on how to handle their own problems, problems that are sufficiently different in kind as to make comparison unwise. Our only hope is that not only do they ignore our advice but find a way to solve their problems before the financial world solves the problems for them via a market collapse. These days, it’s seems like that hope is named either Slim or None and both are on their way out of town.

The End of The Euro For Dummies

Let’s start with a story. You and I are friends. You discover that you’re going to come up a little bit short on the rent this month and ask to borrow $100 from me. I agree, loaning you $100 at 10% interest (we’re just doing that to keep the math simple, I would never loan shark you that bad, you’re my buddy.) So you are going to get $100 this month to pay your rent and pay me back $110 next month when you get paid. That’s a tidy profit for me, relatively speaking, and you don’t get evicted (not that you would get evicted in the US, current averages are well over a year for a foreclosure to go through but that’s another story.)

I however, think that there is a chance, possibly small, possibly large, that you may not be able to pay me back next month and in fact will go into bankruptcy over this $100 I have loaned you. I don’t want to lose my entire investment. Luckily for me, we have another mutual friend who sells insurance on loans, loans he didn’t have any influence over originating. He does this because historically speaking, people like you don’t default on your debts and it’s thought of as an almost risk free way to make some cash.

So I go to this mutual friend and ask to buy insurance against you defaulting. I agree to pay $8 to this guy in return for an insurance policy that says if you default on your $100 loan to me, our little friend will pay me the full value of the loan, $110. This way, I am guaranteed to make money either way. If you pay me back, I make $2, $10 from you minus the $8 I paid for the insurance policy. If you default, I make $10 when our mutual friend pays me my full value, $110. This is a perfect situation for me and assuming I have deep pockets, I’d happily loan all the money I could possibly afford to you because I’m guaranteed to make money. In fact, because of the terms above, I actually make more money if you default. Anyone who believes in the incentives of the market has to see that I’m going to start loaning money regardless of risk because I actually make more money on bad investments. EDIT: As Wes notes in the comments, as described, the math is wrong. I added the risk analysis part and conflated how CDS are typically done where a long or short position is established with my simplified story. It should just say that I make $2 either way to keep things simple. It doesn’t materially change the story so I’m leaving it in.

Our mutual friend however is on the hook in a bad way, though he doesn’t think that. If you default, he has to pay me $110. Even if the risk is low, the punishment for misjudging the likelihood of you defaulting is very, very high. If you lied about your income and in fact have almost no chance of paying, he has badly mispriced the insurance he sold to me. This is not a very good situation.

On the smallest scale, and ignoring a ton of highly relevant but complicated factors, this is exactly what is happening in Greece right now. Banks, predominantly French and German, loaned money to Greece when things were going good. Greece didn’t look like the profligate wastrel now portrayed in the media then. But just in case, those banks sold credit default swaps to other entities just in case Greece didn’t make good on her promises. Suddenly, it’s starting to look like Greece can’t pay things back and may very well have to default. In reality, the prices on Greek debt are already saying Greece WILL have to default. And the kick in the pants is that the entities that sold the insurance policies to those banks for the Greek debt are largely unknown. That is to say, we don’t really have a solid clue who will be left holding the bag with the dead bodies in it if and when Greece defaults.

Here’s another kick in the pants: the people of Greece know that even though the media keeps calling this a bailout, it’s really a loan. They are being asked to accept draconian cuts in services and benefits now with the promise that they will have to pay all this back at some point in the not so distant future. The average Greek knows that their politicians have bent them over in a bad way for decades and that they are now being asked to shoulder the blame, not only for their ruling class’ bad behavior but for the behavior of the idiot banks who never should have been making these loans in the first place. This is why they are rioting and who can blame them.

The thorniness of this situation grows even more tangled when we start to think about what happens if Greek defaults. We really don’t know who is sitting there with billions of dollars in insurance policies against just such an occurrence. What if the Bank of Britain sold some of those swaps? Hell, what if the US government decided to get in the game? Remember AIG? Remember Lehman Brothers? This could be much worse. We’re talking about an entire country’s debts (not to mention Portugal and Ireland) and because the risk associated with that debt has been passed up and up the chain, we won’t know who has to pay back what until we get to the last man standing, currently a complete unknown. This is how a country like Greece, with a tiny 3% of the entire GDP of the EU, could very well cause a systemic crisis at least as large as what we saw in 2008.

On top of all that, we have the issue of the euro as a common currency across nation states that don’t share financial policy. What that means is that when something bad happens in a country in the EU monetarily speaking (say, a country is in terrible debt, has 16% unemployment and an angry populace), individual countries don’t control their own money and thus can’t solve problems in ways a country like the US can (by printing up a bunch of money to pay back the debt.) So all countries in the EU are on the hook for each other, a fact that doesn’t sit to well in Germany who may now have to “bailout” the Greeks (the Germans are not at all blameless in this fiasco but again, a post for another day.) What this means is that if Greece defaults, the risk for a contagion spreading throughout the EU is suddenly very high. If Greece defaults, suddenly the market will wonder if Portugal or Ireland can afford to repay their debts. The price of these bailouts/loans for the Greeks and the Irish are above 5%. Those are terrible terms given the fact that current interest rates in the US hover around 1%. If Greece goes under, no one is going to believe Portugal and Ireland can repay. If those countries go under, suddenly Spain is in line and Spain is a huge chunk of the GDP of the EU. There will be no bailouts for Spain. We’ll just have to kiss the EU goodbye at that point.

When you read the headlines about protests and riots in Greece over the austerity measures and think “Those dumb Greeks, they can’t have their cake and eat it too”, remember this. They are not receiving bailouts. A bailout is what we gave to AIG and GM here in the US. Tax-payer funded cash infusions are bailouts. What the EU is giving to Greece are loans, loans with horribly unfavorable terms. The average person in Greece knows this. That same person also knows that for decades, corruption and cronyism in Greece has been rampant. Rich people in Greece have never paid taxes and they have no plans to start now. This entire burden is being foisted on the lower and middle class Greek. He is being asked to take a pay cut, pay more in taxes and work real hard for the foreseeable future so that German and French banks can get their money back, money he never really saw in the first place because the ruling class of his country absorbed most of it. You can see how he might think that is an exceptionally shitty deal for him.

The only way the euro can continue to survive as a currency is if the German people continue to accept the necessity of the “bailouts” and agree to keep funding them. Germany has a large enough economy that they can do this without too much pain. The Germans benefit greatly from the current arrangement for a variety of reasons and rationally, it’s in their interest to keep the status quo. But electorates are rarely rational. If they stop funding the bailouts, and there is certainly plenty of evidence that they are tired of doing so, the euro is doomed. If Germany refuses to loan money to Greece, Greece defaults followed shortly thereafter by Portugal and Ireland. Then the big hairy elephant of Spain shows up in the middle of the living room and takes a dump on the coffee table. The euro will be gone because no one will be able to afford to keep the debts going.

These are exceptionally tricky times for the EU. What is going on is unprecedented and probably largely unplanned for. Oh sure, there were probably some theoretical games played about “What happens if some country defaults?” but based on how this is being handled, they weren’t very serious about them. The chance of the euro as a currency continuing to exist is falling on a daily basis. This will have huge effects, effects we can’t possibly begin to understand right now. The world economy is going to suffer regardless of what happens until some of the details start to shake out. This would all be a lot of fun to watch if we weren’t all so intricately involved in the result.

Thoughts On A Lecture

Last night, I attended the Jones Day lecture in the Tate series at SMU. The talk was given by Professor Joseph Stiglitz who’s CV/biography can be found here. It was an interesting talk and I thought it would be worth writing a synopsis of Professor Stiglitz’ ideas and views along with my thoughts 24 hours later.

The talk in general felt slightly rambling so I’m going to hit the points that I made notes about. He started off by discussing the causes of the financial crisis of 2008. I’m assuming there were more than one but I only wrote down the housing bubble as the main cause. One thing that he mentioned as a lost opportunity was the chance we had during and after the crash to reform our financial/banking industry. According to him, the banking industry exists to do three things: correctly allocate capital to fund economic growth, do so at a low risk to the economy as a whole and to incur a minimal cost while performing this function. Historically, this is what banks do. They loan money in an attempt to grease the wheels of capitalism by finding worthy borrowers who have both good ideas and a good ability to repay the loan.

However, the financial crash of 2008 was largely caused because the banking industry failed at all three of these functions. They grossly misallocated capital by engaging in non-traditional banking activities such as credit default swaps. They operated at an extremely high level of risk which is evident when banks began failing after the house of cards collapsed and they did all this at a very high cost which has since been passed on to the taxpayers instead of absorbed by the banks themselves. By passing up on the opportunity we had to reform our banking industry at the end of 2008 and beginning of 2009, our leaders did a terrible disservice to both the taxpayers and the economy going forward.

Professor Stiglitz spent a significant amount of his talk on unemployment and jobs. Over 40% of those who are currently unemployed have been without work for more than 6 months. Among certain worker groups, the unemployment rate is much higher. For example, while the overall unemployment rate is 9.6%, it’s 27% for teenagers, 15.7% for blacks and 12.6% for Hispanics. The unemployment rate for college graduates is also very high and this is a time when the prospects for jobs should be good, coming right out of college. He talked about how the longer a person was unemployed, the harder it was for them to get a job and that even if they did manage to find a job, the salary would likely be lower than it would have been originally. This is due to a degradation in skills and abilities over time.

He believed that the stimulus package did in fact help the economy and the unemployed. He felt that the Administration underestimated the severity of the crisis they were dealing with and did not make the package large enough. He felt that they had hoped unemployment would be around 10% without the package and 8-9% with it when in fact the crisis was much worse. He felt that without the stimulus, the unemployment rate would be around 12.5% which could easily cause a greater level of unrest in the society.

His general belief was that we are suffering from a lack of aggregate demand and that because of this lack of demand, the economic outlook was pretty grim. Lack of aggregate demand is showing up a lot lately as the reason for our current economic woes including as cited by Bill Gross of Pimco. This is of course true in a sense but not particularly helpful in my view as a way to fix the issues we face. We face a lack of aggregate demand because for the past 20 years, monetary and fiscal policy in this country has accelerated that demand into the present through the easy money policies of Alan Greenspan and the Fed. By doing so, it pushed the reckoning of that demand into the future, except that we’ve now arrived at that future. In the same way that the government tax break on buying a home pulled demand forward causing a much larger fall now, we are experiencing a lack of aggregate demand as the consumers and corporations in America now deleverage in an attempt to right the sinking ship of their personal balance sheets.

Professor Stiglitz believed that we needed more governmental stimulus to alleviate this lack of aggregate demand. Largely a Keynesian solution, he would strive to more accurately apply the stimulus to areas that would produce more good including infrastructure, education and technology. He does not believe that QE2 is going to be effective in lowering the unemployment rate because it will do little to increase demand. The reason for this is twofold though you’re only going to get the second fold because I didn’t write down the first. The second reason why it won’t help is because money always chases returns and because our economy and those of our trading partners is in the dumps, the money will have a tendency to be utilized in emerging markets where the growth is much higher and more likely to produce a return. He did feel that QE2 may increase stock prices some (Ben Bernanke will be happy to hear that since its his stated goal for QE2) but that overall, it will not be helpful in a meaningful way and could be highly detrimental to the country’s economic health over the long term.

From a monetary perspective, Professor Stiglitz feels like we are stuck. Interest rates can only go so low and even using QE2 to lower longer term rates will not appreciably increase employment which is the main issue causing the economic problems of today. He believes that fixing the economy through fiscal policy is largely a non-starter in that the current zeitgeist will prevent our politicians from using federal spending as a way to increase aggregate demand.

The effects of all this going forward are threefold (all of which I wrote down, aren’t you lucky?). First, we will have a weak economy for the foreseeable future. For Professor Stiglitz, I got the impression that foreseeable future was sometime into late 2012. The economy is largely stagnating, the unemployment rate is stubbornly remaining high and our politicians are constrained in the ways they can battle the problems. Second, the relative position of America on a global perspective will continue to decline as our power in the world lessens. This will make it hard for us to negotiate effectively. Finally, we will continue to see a more divided society from two standpoints: how we see the world and the inequality gap in income and wealth between the rich and the poor.

He believes that America does have some strengths. The main one he discussed was our secondary education system. He believes that we have a monopoly in the world on secondary education at the university level. He did not go into this in great detail but I think this is fairly well accepted.

Overall, the talk was thought-provoking and interesting. I would have liked to hear more detail regarding the viewpoint that lack of aggregate demand was causing our current growth malaise as it relates especially to the idea that our lack of growth is just the flip side of the coin of easy money policy over the past 20 years. By centering our economy on consumer spending and allowing manufacturers to offshore and outsource domestic production, I feel that a typical Keynesian solution to this abnormal recession will likely only kick the can down the road a little bit farther. Clearly, he disagreed with that thought and it would have been good to hear him talk more about his solutions. Basic Keynesian economics say that during a recession, the slowdown in spending by consumers and corporations must be offset by government spending. However, I feel like the cause of our current economic woes are the result of easy money policies already and that we will only exacerbate the problem by increasing governmental spending. On top of that, the Administration and the one before it showed precious little ability in directing the stimulus to those it would help most and instead have further empowered the financial oligarchy that largely caused the mess in the first place.

I’m sympathetic to much of Professor Stiglitz’ thoughts on the criminality of the financial oligarchy as it relates to the crash of 2008 but I’m not sure you can get from a position that easy money caused the crisis to a position of more easy money will fix it. Overall, I do agree with him that we are in for a long period of low growth and stagnation. The dollar will cease to be the reserve currency of the world, the European Union will likely face multiple sovereign defaults, large liberal states like California are likely to face great difficulty in paying their bills and our politicians are not equipped to handle these issues. All that’s a post for another time though.

Further Reading
Fiscal versus Monetary Policy
The latest employment stats

Marching Towards Another Depression

A fascinating article at New Deal 2.0 details the steps we are taking towards a likely second Great Depression. At a time when economies are teetering on the edge of recovery and a second recession, governments are starting to make noises, particularly in Europe, about reducing deficits as a model for responsible financial health. Unfortunately, this is the exact opposite response governments should be taking as reducing a governmental deficit will naturally result in deflationary pressures on the private sector because the two are necessarily related.

Governments have two main ways to reduce deficits, increase taxes and reduce spending, both of which are deflationary. Doing either at a time when unemployment runs at 10% in most First world countries would result in huge burdens on the private sector. Governments are currently running large deficits because we just came out of one of the worst recessions the world has ever seen. Unfortunately, the bigger problem is that a huge portion of the government spending during those recessions actually resulted not in job creation but in an amazingly brazen transfer of wealth from the middle class to the wealthy through paying bondholders at par value and keeping the oligarchs in the big banks solvent.

Bailing out the banks instead of the common people was a monstrous mistake but not one that needs to be compounded now by cutting spending which will necessarily affect the very same classes of people negatively that the bank bailouts did through reduction of public services and increased unemployment. The fact that our elites are even considering this shows how little they understand of the situation. Or playing more cynical, how little concern they have for the plight of the middle and lower class.

What we need are statesmen and leaders who can clearly explain why the current budgets deficits are necessary and then begin to formulate plans to redirect stimulus not to the oligarchs in power but to the people most affected by the economic disaster. Instead, we have captured men and cronies in power who will continue to rape the middle class until they no longer can, either because there is no middle class left or because they have been deposed. Until the system is reformed and our political leaders once again serve the interests of the many instead of the power of the few, I don’t see how we aren’t in for dark days ahead.

Can Civilization’s Birthplace Become Its Funeral Pyre?

Overreaching headlines aside, the Eurozone is a bit of trouble. Greece has been bailed out in an attempt to avoid a sovereign default. Those in the know think the Greeks are unlikely to be the last country in the Eurozone to require a bailout and the conditions the IMF are expecting Greece to conform with are likely to have unintended far-reaching consequences that we can’t possibly understand at this point. A lot of people I talk to seem to be of the opinion that the Greeks got themselves into this mess and that bailing them out serves little purpose. This is probably true though for reasons far more complicated than that.

A guest post over at Naked Capitalism outlines 11 points supporting the idea that the Eurozone will likely break down over the Greece bailout. One of the key points revolves around a basic accounting principle: if one entity has a deficit, some other entity must have a surplus. Fiscal accounting is essentially a zero sum game and this is very important in the Greek case. When thinking about this, it’s important to realize that Greece, being a member of the EU, does not control its own sovereign currency. Thus, for Greece to run a deficit, there had to have been complicity from within the EU, specifically from Germany. It’s the fiscally conservative Germans benefiting from their strong export driven economy who provide the opportunity for the Greek government to run a deficit.

This part about sovereign currency is important. Historically, countries that control their own currency have been able to inflate their way out of debt, at least to some degree. In Greece’s case, the country is unable to do this because their currency is the euro and is outside their control. Therefore, they essentially have two options: default or bailout and accept the draconian retrenchment terms the IMF is demanding. As the article above mentions, it is unlikely that these terms are created with the considerations necessary regarding the simple accounting fact above, e.g. if Greece successfully imposes financial austerity measures on its people (a HUGE if at this point, one that isn’t getting enough attention), this necessarily means that the export societies of Germany and other Eurozone countries will retract due to the cutbacks in spending in Greece and others.

On top of that, these austerity measures will likely have a deflationary effect on the Eurozone. The bailout of Greece is aimed at government debt and the austerity measures are aimed in the same direction. Based on the same simple accounting concept I talked about above, if Greek government debt obligations are reduced through austerity measures, the Greek private sector will see their debt obligations grow leading to more private defaults and less growth in the Greek economy. Shortsightedly demanding to lower government debt with no consideration of the interconnectedness of the government and private sector spending will lead to further pullbacks and lack of growth in Greece.

In the end, the issues that we are seeing with Greece and the like illustrates several problems with the Eurozone as it is currently existing. If the Eurozone collapses, as the article seems to think possible, the ramifications will spread out over a much bigger area than just Europe. My crystal ball is cloudy when it comes to the results of a Eurozone collapse but I can’t help but think it will be highly detrimental to our country as well. We should watch carefully how things play out in Europe since it’s quite possible we may have to deal with similar circumstances in the near future here at home as profligate states like California begin to encounter the same issues the Greeks are running into.

Not Out Of The Woods

JP Morgan Chase reported today and it sure sounds like everything is coming up roses for the banking behemoth. Income is up 85% over last year at 74 cents a share compared to 40 cents a share a year previous. Revenue is up as well. Of course, as with most financial reporting these days, you have to read between the lines a little. The Times article above reports that Chase is “still hemorrhaging money” from its consumer businesses. So if you do some minor math on that, they are hemorrhaging money from a line of business that is a strong indicator of the economy at large but are bringing in insane profits from investment banking to cover it.

This is a sign of where we really are in the recovery process and why so many smart thinkers out there are saying there’s going to be a double dip sometime this year. People don’t have jobs, they aren’t spending money, foreclosures are still high and the commercial lending problems are only just now coming into the light. JPMC is making money because the market is up, because they have privileged status with the US Treasury and Fed and possibly because they are manipulating the precious metals market. These are not the functions that one of the largest banks in the US should be undertaking to make profits.

Do not think for a minute that the all clear has been sounded. I expect most of the large financial firms to report better than expected earnings this quarter but that other industries will lag behind. That will likely catch up with us in the third quarter and it will become evident that this recovery is mostly smoke and mirrors. The path ahead is fraught with obstacles and given the heavy step of our government and financial industries in recent years, I do not expect them to be able to safely navigate the dangers ahead. Until the American consumer is part of the recovery process, we are just sticking a Band-Aid on a slashed artery. And he’s not going to be part of that recovery for a long, long time.

And The Rich Get Richer. . .

There is currently a movement underfoot in Congress to recompense investors in the Bernard Madoff and R. Allen Standford Ponzi scheme debacles. It is couched in the terms of people having lost their life’s savings being fairly represented and treated but is actually a disgusting reminder of how those in power control much of our government now, wheeling and dealing in the halls of Congress to enact hidden taxes on the American people. By and large, the investors in these schemes were wealthy individuals and families who enjoyed years of outstanding returns with little or no risk, something that should have immediately raised concerns for any normal investor. Instead, they are now trying to collect money from Wall Street firms based on returns they would have gotten in the schemes had they been above board.

Should this come into law, it will codify protections for imaginary gains in all kinds of investment schemes. These were investors, mostly all rich, who should have known that outlandish returns had to be highly risky. We should also realize that these investors weren’t left out in the cold like so many average Americans who have lost significant portions of their life savings over the last three years. People in these schemes were covered under the Securities Investor Protection Corp up to $500,000 towards legitimate claims. Claims that aren’t legitimate include instances where the individual withdrew more money than they paid in. These people are clamoring for imaginary gains when many of them actually made money on the schemes. This is ridiculous.

What this will turn into is a tax. If it becomes law, the brokerages will have to pay the fines but they will most certainly pass the costs on to the consumers, most of whom are average Americans who just happen to have accounts with them. To think that we have Senators who are gladly sponsoring legislation to defraud the public to reward the rich and connected is sickening. But I suppose that is exactly where we are these days. Millions of people are out of work and our elected representatives are trying to get imaginary returns granted to the already rich and wealthy. Some day, the people of America will get sick of this treatment. I have some fear that the response from them will not be quiet and civilized.

Baby Steps

This week, President Obama proposed regulatory changes that would limit big banks, implicitly those that received the guarantee of a government backstop during the crash last year, from investing for profits using their own hedge-funds or proprietary trading desks. This would be an excellent first step in reining in the power that the JP Morgans and Goldman Sachs of the world wield over our economy and political landscape. It is unfortunate that Obama waited 12 months before listening to Paul Volcker, losing precious political capital in the process. 12 months ago, the banks were beholden to the President and the American people. We essentially owned them and should have taken steps then to limit their power.

Instead, we let them pay back TARP and gain monstrously atrocious profits this year, making money by sucking cash from the tit of the Federal Reserve and refusing to then lend it out to the people who actually needed it. The banks are now emboldened to go right back to business as usual as they came through 2008 learning only the lesson that the government will make sure they do not fail no matter what the consequence. They have not been punished, not even reprimanded for behavior that sucked the life out of the American and global economy.

“While the financial system is far stronger today than it was one year ago, it is still operating under the exact same rules that led to its near collapse,” Mr. Obama said. “My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout.”

This is exactly right, something that is a direct result of not reining in the banks 12 months ago. Now, the regulation has little chance of emerging from Congress with any teeth. It will die a death of 536 pricks, bled to death on the floor of the institution created to represent the people.

Of course, proprietary trading wasn’t the cause of the financial collapse, at least not the root one and that is a point many on the right are making now. But this isn’t designed to fix the problem, it’s a first step down the road of reforming the entities that currently have all the power in the American economy. There are those on the right who will moan about frightening the stock market but the market needs to be frightened because it is currently nothing more than a Ponzi game played with our money. Rising from the depths of last year inside of 12 months during the worst economic collapse since 1929 is silly. The stock market gains are largely smoke and mirrors using money that the Federal Reserve has created out of thin air. It cannot continue and the longer it goes on, the worse the responding fall will be.

This regulation will be difficult to implement as Yves at Naked Capitalism details. But it would be a much needed baby step down the road of reform and true recovery. As long as the big banks can find comfort in explicit government backing while remaining unpunished for poor decisions and risky behavior, they will continue to act in exactly the same way they have been acting for 10 years. We cannot have true recovery until the Goldman Sachs of the world, parasites on true creation of wealth, have been reined in.

More reading: Jesse
Perhaps there is some hope