In Defense of the Banks

The title probably makes the blood pressure go up for quite a few people. The banks after all are the villains that brought our economy down, and that is undoubtedly true.

But it overlooks one cogent and vital point and that is the nature of our capitalist system. Now some of my audience may react that this is exactly why we need to get rid of the capitalist system, but I say to them, nobody has as yet come up with a better one. China, India, the USSR and a number of other countries have tried planned economies, and all they got were shortages, a low standard of living, and more poverty than any capitalist system has ever seen.

So as far as I am concerned I am for a capitalist system, or more accurately, a mixed economy with regulations that prevent inappropriate risk taking, and unethical behavior. Regulations have been the US model going back long before Roosevelt’s New Deal, and as least as early as 1890, when the Sherman Anti-Trust Act was enacted. A mixed economy goes back to the founding of the Republic, when the Constitution mandated that certain businesses, such as the delivery of the mail shall be a government function. Since then the US government has taken on innumerable business functions, from building canals, to land grants, to subsidizing the railroads, building highways, developing a widely envied (at least it used to be) public education system, establishing our National Parks, creating unemployment insurance, Health Insurance in the Medicare, Medicaid, CHIP, and VA programs and Social Security, to name just a few.

But why would I defend the banks? Well, they did what all businesses do in a capitalist system. They try to make as much money as they can, and that is what the banks did. So where was their fault. They used overly risky, ill considered and even unethical means toward their end of maximizing profits. But as long as what they did was not illegal, they did nothing wrong under our system of laws or even ethics.

Some, particularly in Republican circles, joined to some degree by left wing organizations, such as moveon.org, decried the bank bailout, and felt that they should reap the consequences of their reckless behavior. On a level of pure theory they are right, but we live in a real world, and the consequences of a melt down of our banking system would have had disastrous consequences for the whole economy, indeed the whole world. The failure to save Lehman brothers, which shook the economy, gives some indication of the abyss, which we were facing. Let us remember that F.D.R. dealt first with the banking crisis when he was inaugurated and despite unprecedented actions still had a 22% unemployment rate after 5 years in office.

In my opinion the fault lay in a misconceived believe that the capitalist system is self-regulating. Some, despite all evidence to the contrary, still believe that. Fortunately, many, among them the great apostle against regulation, the former Chairman of the Fed, Alan Greenspan, have recognized that they were wrong, or as the conservative British newspaper, the Guardian, said:

“… Alan Greenspan has conceded that the global financial crisis has exposed a "mistake" in the free market ideology that guided his 18-year stewardship of US monetary policy.

“A long-time cheerleader for deregulation, Greenspan admitted to a congressional committee yesterday that he had been "partially wrong" in his hands-off approach towards the banking industry and that the credit crunch had left him in a state of shocked disbelief.”

Even former President Bush, in his last year in office recognized the crisis and urged a bailout of the banks which was authorized by the Congress in a display of bipartisanship not seen since, with both Presidential candidates, McCain and Obama, voting for it along with a majority of Democrats, and a minority of Republicans, who clinging to their faith that the markets would right themselves, were willing to risk a total meltdown in pursuit of their ideology, and now oppose regulating the banks, having learned nothing from this crisis, or for that matter earlier crisis, and the people who through their votes support such irresponsible behavior.

We now see similar behavior from the Toyota company who resisted recalls and an emphasis on safety for fear that it would have a negative effect on their bottom line and we saw it during the Savings and Loan crisis of the ‘80s and ’90 which like this crisis was caused by the removal of regulations that until then prevented the calamity and would have prevented it had they remained in force, or as About.com explained it:

“Savings and Loans were specialized banks that used low-interest, but Federally-insured, deposits in savings accounts to fund mortgages. In the 1980's, the popularity of money market accounts reduced the attractiveness of savings accounts, so the banks asked Congress to remove restrictions. In 1982, the Garn-St. Germain Depository Institutions Act was passed, which allowed S&L's to raise interest rates on deposits, make commercial and consumer loans, and removed restrictions on loan-to-value ratios. At the same time, the Federal Home Loan Bank Board regulatory staff was reduced thanks to budget cuts.

“In an attempt to raise capital, banks invested in speculative real estate and commercial loans. Between 1982 and 1985, these assets increased 56%. In Texas, 40 S&L's tripled in size, some growing 100% each year.

“By 1983, 35% of the country's S&L's weren't profitable, and 9% were technically bankrupt. As banks went under, the state and Federal insurance began to run out of the money needed to refund depositors. However, S&L's kept remained open, making bad loans, and the losses kept mounting.”

Unfortunately, the lessons of that crisis were not learned, particularly since that too resulted in an essential bailout under a Republican Administration. Or as About.com puts it:

“By 1989, Congress and the president knew they needed to bail out the industry agreed on a taxpayer-financed bailout measure known as the FIRREA provided $50 billion to close failed banks and stop further losses. It set up a new government agency called the Resolution Trust Corporation (RTC) to resell Savings and Loan assets, and use the proceeds to pay back depositors. FIRREA also changed Savings and Loan regulations to help prevent further poor investments and fraud.”

But why any of this should be a surprise is difficult to fathom. Sport analogies are so very popular in our culture, and here there is one that is at much on point as any could be. Our capitalist system works on competition. Competition is the heart and soul of sports. But can anyone imagine sports without regulations and umpires to enforce them. With the Super Bowl just behind us, can anyone imagine that game without rules, among them unnecessary roughness, holding or other tactics considered unfair.

          The President has introduced legislation that would begin to repair this situation. The banks and their protectors in the Republican Party want to block these. They are essential if we are to avoid endless repetition, but even they are not enough. We need to once again separate investment from commercial banking, by reenacting the Glass-Steagall Act, as ably set forth by Thomas Frank in the Wall Street Journal: We need to cap usurious interest rates, whether disguised as fees, or in the form of charging interest for a month when the loan is in fact for a day.

          The idea that competition, the heart and soul of our capitalist system, can function without regulations and strict enforcement should by now be self-evident. The villain is not the banks, but the government that fails to set up regulations, the agencies that fail to enforce them, and the people who through their vote create such a government.

Too Much Too Soon?

“Too much too soon” is increasingly the cry of those who like the status quo, and they have succeeded in raising doubts in the minds of some who don’t necessarily like the status quo, but who have been impressed with the argument that dealing with the economy should be first, foremost and the sole concern, and are frightened by the projected deficits.

Their concern is understandable but misplaced. First of all there is a basic principle here and it applies not only to government debt, but to private and business debt as well, and that is that borrowing to meet daily expenses over time, is a recipe for disaster. But borrowing for capital expenditure is not only wise but a necessary part of assuring the future. A business that does not borrow in order to be able to purchase more efficient equipment is doomed to fail in the the competition of the market place. The US is now in a position of such a business. It must modernize, and borrowing for that purpose is a legitimate and necessary exercise. Investing in an efficient health care system, in education and in stopping the inexorable advance of global warming by reducing noxious particles in the atmosphere, which incidentally also effect health, are investments that will pay dividends may times over. They are investments. they are not expenses.

Dealing with the economy requires action on many fronts, from dealing with the banking crisis, to regulatory reform. But a large part of it is to stimulate the economy by way of injecting government funds to grease its gears.

There are many ways to do this. We can give tax cuts to those who are fortunate enough to still have an income, in the hope that they will spend the money, thereby creating demand, which has fallen drastically in this recession. The enacted Stimulus Bill does this. However, this may or may not be effective, because past experience has shown that in a time of anxiety people spend as little as possible, and if they unexpectedly have an increase in their income, they tend to save it or pay of debts. Nevertheless, it is part of the package.

Spending, however, in ways that create or save jobs is far more effective because that puts money in pockets that might not have enough for the necessities of life, and when the means to meet basic needs becomes available, it will be spent. But this can be accomplished even without creating jobs, for we can pay extended unemployment insurance, and the bill provides for this, or we can create useless jobs which is better than simply distributing cash, if for no other reason than that people have far more self-respect when they are “gainfully” employed.

But as I set forth in my essay entitled The Stimulus Bill, we can get the greatest gain for the buck when we employ people to do useful work, because here we have a huge multiplier effect. I cited how even doing something as mundane as reseeding the Capitol lawn can have a very good multiplier effect.

But even better then seeding a lawn, are things that have a really long lasting benefit, such as repairing our infrastructure and improving it. The highway system built by the Eisenhower Administration has served the nation well for all these years, but it is now antiquated and in desperate need of repair. When bridges are falling down, it is obvious that something needs to be done, even if the stimulus were not needed.
But we can no longer depend entirely on highways and airplanes to meet our transportation needs. Most of our competitors in the industrialized world are well ahead of us in having high-speed rail. Our need for this is way overdue and the stimulus bill provides funds for getting a start on this. Unfortunately, like everything else that meets the needs of the Nation, the naysayer targeted this for denunciation, describing it as a boondoggle, for a train between Disney-Land and Las Vegas, and then going so far as to describe it as a train going to a brothel in Las Vegas. A look at the proposed train routes published by the Department of Transportation shows no such plans.

But this is not the only example of stimulating the economy and getting long-range benefits. We can get a start on Health Care Reform by immediately investing in computerizing our health records and in other aspects of Health Care Reform, which can be funded quickly. Other reforms, which may not be possible until later years, will make sense in one of two ways. If the economy has not yet recovered, the spending on such reforms will act as a needed continuing stimulus. If the economy has recovered, tax receipts will have increased and the money for such reforms will be available. But say its critics, even if the economy is on the mend, it is likely that the amount expended will not equal tax receipts, and the deficit may as a result endanger the soundness of the dollar. This is a legitimate concern, particularly if the deficit turns out to be as large as is projected by the CBO (Congressional Budget Office) rather than by the OBM (Office of Budget and Management). But what are the alternatives, to leave the present system, which is bankrupting the country in place? I am reminded of the Harry and Louise ads, which warned of dire consequences if the Clinton Health Insurance plan were adopted. All the consequences of which these ads warned, in fact happened because no health plan was adopted. As a result of the status quo our choice of providers has drastically declined, as many Insurance Companies require that we go only to in-network providers. Not only have more and more Americans become uninsured (nearly 46 million Americans, or 18 percent of the population under the age of 65, were without health insurance in 2007, according to the latest government data available, but even the insured often find that they are refused coverage when major expenses arise, with the insurance companies claiming pre-existing conditions. According to the journal Health Affairs, medical bankruptcies affected about 2 million Americans annually, -- counting debtors and their dependents, including about 700,000 children, as of 2001, and things have gotten much worse since then. “Surprisingly, most of those bankrupted by illness had health insurance. More than three-quarters were insured at the start of the bankrupting illness. However, 38 percent had lost coverage at least temporarily by the time they filed for bankruptcy.” The result is not only individual tragedies, but the cost borne by our whole economy, since far too many cases are handled in emergency rooms, which is far more expensive to society, as is the lack of preventive care. Corporations, who have until now borne the cost of health insurance for most working Americans, can no longer afford it. In other words doing nothing or even delaying is not an option. It is a recipe for disaster. Whatever the risks of moving forward may be, the failure to act is not a risk. It is a prescription for guaranteed disaster.

This applies to an even greater degree when it comes to global warming. Ice caps are melting at a faster rate than anyone predicted. If nothing is done much of Florida and other areas of the US will be under water and the total land mass wiped out will cause a refugee problem that would make today’s migration seem puny by comparison.

But even without the threat of global warming the way we generate energy today, with reliance on coal and other fossil fuels, is inefficient and a threat to our national security. If we are to be competitive in the world economy, we must be in the vanguard of this development. We will be the innovators, or others will be. We will be exporting this technology or we will be importing it. We will create jobs in developing, building, and using this technology, or we will ship jobs to other countries, which have overtaken us.

Ditto for education. We have been the successful economic powerhouse, which we have been, because we have had one of the most educated workforces in the world. If we fall behind, and we have already fallen behind, we will not be able to compete on the world stage, and in a globalized economy we must, more than ever, compete.

So the question is not, can we afford to do these things? The question is can we afford not to do them? The clock is ticking! We cannot fail to act. We dare not delay. There are risks in acting. There are certain disasters if we fail to!

Economic Dilemmas

We are in the greatest economic crisis in almost 80 years and attempts at saving the economy, not only in the US, but throughout the world, are being turned into a circus.

First we had a big flap about earmarks, which while deplorable, represent minutia, and now we have what can only be describes as a lynch mob after the heads of the bonus recipients at A.I.G (.mp3).

The outrage is understandable, but the bonuses represent less than 1% of the money used to shore up A.I.G. If this becomes the basis for stopping further aid to the financial industry, then we would be cutting off our noses to spite our faces.

We have not and will not invest money in A.I.G. or anyone else to help them or their executives or their stockholders, but in order to save the liquidity of our economic system, and in the process revive our economy. Any distraction from that task is a disservice, particularly coming from politicians who have for years protected and defended the system they are now denouncing.

We have much to learn from history. During the Revolutionary War the Continental Congress issued I.O.U.s (since it had no taxing power) in order to pay its bills, including paying the men of the Continental Army. By the time the war ended it was generally assumed that these I.O.U. were worthless and speculators bought them up for pennies on the dollar. With Washington President, and Hamilton Secretary of the Treasury, the question arose whether the I.O.U.s should be paid at their face value. (Bulls, Bears, Boom, and Bust by John M. Dobson, p.64) The populist response was that to pay these speculators the benefits of their speculation was unfair and rewarded those who had done nothing for the war effort, while defrauding those who did. Hamilton argued, however that the issue was the “Full Faith and Credit” of the U.S. which would be endangered by a failure to honor its I.O.U.s. Hamilton prevailed and the “Full Faith and Credit” of the U.S. has never been in doubt since.
The point is that sometimes we must hold our noses and let those reap who have not sown, for the greater good of our nation.
But there is a lesson to be learned. We have arrived at this cross road because our vaunted capitalistic system has turned into crony capitalism. The outrageous bonuses paid the execs at A.I.G. are but the tip of the iceberg and we need to address the greater problem. This from the Wall Street Journal of April 28, 2008:

“According to the Congressional Research Service, the average pay for CEOs was more than 180 times average worker pay, up from a multiple of 90 in 1994. Total direct compensation for CEOs was a median $8.8 million, counting salaries, bonuses and other incentives, as well as the value of restricted stock, stock options and other long-term incentive awards at the time they were granted, according to a survey by the Hay Group of 200 major U.S. companies.”

But what is even more outrageous is the severance pay that top execs in our corporate culture receive. As long ago as December 25, 2005, the NY Times discussed this problem. “In 2000, for example, after three years as chief executive, M. Douglas Ivester left Coca-Cola with almost $120 million jangling in his pocket. Included were a six-year consulting agreement, office space, furniture, home security service and country club dues. Steven J. Heyer, a former Coca-Cola president, struggled under the weight of a severance package worth $24 million when he left the company in 2004. He held his position for only three years as well. And Douglas N. Daft, a former chief executive, pocketed more than $36 million when he left Coca-Cola in 2004.”

When executives leave after a successful stint in their jobs with such outrageous severance packages it is bad enough, but often it is after they have all but destroyed the company under their tutelage and leave pursuant to severance agreements that amazingly enough provide that they are entitled to such rewards if they are fired. In other words they do even better if they fail then if they succeed. Talk about reverse incentives!

Thus for example, the CEO of the company I used to work for, Richard J. Kogan, departed Schering-Plough after wrecking the company, received $13.2 million in severance and $26.4 million in retirement payments. This was after Kogan had gotten the company into a war with the one government agency no drug executive can afford to antagonize, the Food & Drug Administration, by reducing quality controls to unacceptable levels in an effort to cut costs, causing the companies share price to fall from $50 to about $36 in a short time, and after he was charged by the SEC of giving insider information to a group of select investors.

But this is but one of many outrages. Other examples are set forth on the Obama website referenced above.

These abuses occur not because competition of the market requires it, but because of a system where neither the public nor even shareholders have any say, and when execs destroy a company it is the shareholders and innocent employees who bear the burden. Unfortunately, it is not shareholders who decide on compensation. It is the Board of Directors! And who chooses the Board of Directors? Usually the CEOs. To be sure Shareholders get a chance to vote at shareholder meetings for the Board, and whatever issues are placed before them, but the only choices they really have is to vote yes or no on whatever the management chooses to let them vote on. And increasingly, shareholder meetings are held at out of the way places so as to discourage shareholders from attending. God forbid, they might ask embarrassing questions. They are asked to send in their proxies to confirm what has already been decided. The Chinese communist voting system is not much different.

We should not ever consider government compensation controls. But changing the governance of American corporations so as to give shareholders a real say in the companies they invest in, is way overdue.

We must not learn the wrong lessons from the banking and liquidity crisis!

Congress’ Response To The Credit Card Outrage

In my last post I discussed some of the outrages perpetrated on the American public by a banking industry that appears to specialize in predatory lending, and that because it can get exorbitant profits by lending without regard to credit-worthiness, takes on increasing risk by lending to people who can ill afford such loans. This was true in the mortgage crisis and it is equally true in the credit card business.

I discussed some of these practices, which result in borrowers paying fees and interest out of all proportion to their debt, charging what, in any context, are usurious rates worthy of the Mafia, and enticing people into becoming victims with teaser rates and minimal monthly payments. Needless, to say this started to cause an increasing number of defaults even before the mortgage crisis exploded.

The banks had an answer to this rising tide of default and it wasn’t by becoming more responsible lenders. Instead they decided that their victims must not be allowed the customary means of discharging their debt through bankruptcy protection, which is provided for in the US Constitution, Article I, Section 8 which says, that Congress shall be empowered “To establish … uniform laws on the subject of bankruptcies throughout the United States and by Title I of the US Code.

But in 2005 after many years of lobbying they pushed through an amendment to the bankruptcy act that made it much more difficult, if not impossible for people to discharge their debt. The late, great, Molly Ivens, who wrote for the Fort Worth Star-Telegram until 2001 and as an independent syndicated columnist until her death in 2007, wrote in various publications, including Creators Syndicate, and I quote in part:

“The bankruptcy bill was a gift to big bankers and credit card companies to begin with, in return for copious showers of campaign contributions to our very own elected representatives in Congress. Same old, same old…

“According to a study by two associate medical professors at Harvard, published in Health Affairs, bankruptcies are indeed shooting up. Between 1981 and 2001, personal bankruptcies rose by 360 percent, but those caused by medical debts rose an astronomical 2,200 percent. Only job loss now slightly leads medical crisis as the reason for bankruptcy -- it's ahead of divorce.

“Another cause, as well the usual usury, is that the card companies push accounts on people whose credit is only marginal -- your teenager has doubtlessly been offered several. Ooops, it turns out many of those with shaky credit can't pay (!), so of course the banks want the law changed even more in their favor. Poor little card companies -- only $30 billion in profits last year.

“Elizabeth Warren, a Harvard law professor, pointed out in testimony before Congress that the bill assumes everyone is in bankruptcy because they're spendthrifts. “ A family driven to bankruptcy by the increased cost of caring for an elderly parent with Alzheimer's disease is treated the same as someone who maxed out his credit cards at a casino. A person who had a heart attack is treated the same as someone who had a spending spree at the shopping mall. A mother who works two jobs and who cannot manage the prescription drugs needed for a child with diabetes is treated the same as someone who charged a bunch of credit cards with only a vague intent to repay."

In the House the bill passed with 229 Republicans and 73 Democrats voting for it. Not one Republican voted against it. Opposing it were 125 Democrats and one independent, Vermont's Bernard Sanders. In the Senate it passed by a vote of 74 to 25. Not one Republican voted against it. Sadly, 18 Democrats voted for it. Even more sadly, among them was our V-P elect, Sen. Biden of Delaware, where most of these banks are incorporated, and Sen. Reid of Nevada, the Democratic majority leader. President Bush promptly signed it into law. President elect Obama, who voted against it, has his work cut out to get anything decent out this coalition.

On the other hand, reform was attempted in March of 2008 when two bills aimed at protecting consumers, especially young consumers were introduced by Senator Menendez D-NJ, entitled the "Credit Card Reform Act of 2008" S2753 and Representative Maloney D-NY HR 5244. Although both bills have there own nuances, a look at the Senate’s version reveals that it has the following provisions:

-Consumers under the age of 21 would be allowed to choose whether to receive credit card solicitations. Cardvissuers could only solicit young consumers if they receive affirmative consent in advance.

-Card issuers could not use the widespread practice of charging higher interest rates on balances incurred before a rate increase went into effect.

-Credit card issuers could not alter credit card agreements while they are in force without specific written consent from the cardholder. This will stop issuers from giving themselves the right in cardholder agreements to increase interest rates and fees at any time, for any reason.

-The bill would require that penalty fees be reasonably related to the costs that credit card issuers incur because of a late or over-limit transgression.

-Credit card issuers could not increase a cardholder's interest rate based on adverse information relating to other creditors they find on the consumer's credit report.

-Card issuers would be required to limit penalty interest rate increases to 7 percent above the previous rate if a consumer fails, for instance, to make a payment on time.

-The Act would prohibit late fees on payments that have been postmarked by a designated date.

-The bill prevents issuers from offering credit or raising credit limits to consumers unless they determine that the consumer will actually be able to make the scheduled payments based on their current income, obligations, and employment status.

-The bill requires lenders to make a firm offer of credit that includes specific — not deceptively low — terms, including the interest rate, fees, and credit line.

It appears that the bill dealt with a serious problem.

It passed in the House by a vote of 312 to 112. 228 Democrats and 84 Republicans voted for it. 1 Democrat and 111 Republicans voted against it. It never got out of committee in the Senate.

Yes, we really NEED CHANGE WE CAN BELIEVE IN. I hope and pray that our new President and our new Congress can and will deliver it.