So why did Lehman Brothers collapse? A 2,000-page bank examiner's report released yesterday places a lot of the blame on plain old fraud:

The examiner, Anton R. Valukas, also for the first time, laid out what the report characterized as “materially misleading” accounting gimmicks that Lehman used to mask the perilous state of its finances....According to the report, Lehman used what amounted to financial engineering to temporarily shuffle $50 billion of troubled assets off its books in the months before its collapse in September 2008 to conceal its dependence on leverage, or borrowed money.

....A large portion of the nine-volume report centers on the accounting maneuvers, known inside Lehman as “Repo 105.” First used in 2001, long before the crisis struck, Repo 105 involved transactions that secretly moved billions of dollars off Lehman’s books at a time when the bank was under heavy scrutiny.

According to Mr. Valukas, Mr. Fuld ordered Lehman executives to reduce the bank’s debt levels, and senior officials sought repeatedly to apply Repo 105 to dress up the firm’s results. Other executives named in the examiner’s report in connection with the use of the accounting tool include three former Lehman chief financial officers: Christopher O’Meara, Erin Callan and Ian Lowitt.

More here from the Wall Street Journal and here from Reuters' Antony Currie. And just for some additional background fun, here's a short document on the general subject of "control fraud" written by Bill Black. He wrote the book on the subject (literally: you can buy it here) and handed out this short summary at a conference I attended last year. Enjoy.

CJR's Ryan Chittum points us to the chart below, which compares S&P 500 stock market returns over the past 50 years (blue bars) to those same returns after accounting for trading and management costs, dividend and capital-gains taxes, and inflation (red bars). It's part of a Bloomberg piece by David Wilson summarizing a report prepared by David Bianco, chief U.S. equity strategist at Bank of America Merrill Lynch. Once you take into account all the adjustments, the annual average return of the S&P 500 goes from 9.5% to 1.3%. Chittum comments:

Just remember when those financial advisers tell you to expect 8 percent to 10 percent annual returns that in real money over the last 50 years, you took home a measly 1.3 percent. As I wrote in January: "You have to wonder if there’s a connection to be drawn between the low savings rate and the idea that took hold in the last three decades, which still hasn’t been extinguished even after this miserable decade, that investing in stocks means you’ll get big returns on your money."

Of course, your basic money market account is returning about 0% these days, give or take a few mils, so it's not as if we little guys have a ton of other great investment opportunities. Luckily, the Wall Street tycoon set is still doing well. It's not all bad news out there, my friends.

Charles Pierce has some questions for me about healthcare reform:

I am not unsympathetic to the arguments made by Kevin Drum or Matt Y. here, even though I think the opprobrium heaped on Jane Hamsher is wildly disproportionate.....Ask me what I'd do, and I'd probably vote for the ongoing POS that is the Senate bill. However, I would like both Kevin and Matt [] to explain the "stepping-stone" argument to me. Why, precisely, should I believe that, that once we pass the POS, any opportunity to improve it, largely by the process of political evolution, will remain?

....After all, it's unlikely that the new system proposed in the ongoing POS will become so wildly popular, and so seriously armored by public approval, that there will be a substantial political risk to having opposed it in theory, or to opposing it in practice. Not by next autumn, anyway....Why shouldn't the Republicans run on a promise to repeal the new system, and then follow through by doing exactly that?....Can somebody explain to me how the surviving Democratic politicians, even if they hang onto their majorities, will muster the will and skill to move toward "further reform in the future," as Mr. Drum puts it, given what we've seen of their performance with overwhelming congressional majorities?....Again, everyone, please show your work.

Obviously there's no kind of geometric proof for this, but let's take a crack at it anyway. There are two separate questions here.

First, if healthcare reform passes, what's to stop Republicans from repealing it if they get control of Congress in November? That one is easy: Barack Obama's veto pen. As it happens, I also think that Republicans will find that it's far more difficult to repeal an actual existing bill with a bunch of popular provisions (pre-existing conditions, subsidies for the poor, etc.) than it is to make cheap, stemwinding speeches about onrushing socialism to tea party crowds, but that's really secondary. They couldn't muster 60 votes for repeal, and if they did, they certainly couldn't muster 67 votes in the Senate and 290 votes in the House to overturn a veto.

Second, what's the argument for longer term progress? This isn't quite as black and white, but the historical evidence is pretty clear. Look at virtually every other advanced economy in the world. They started off with small programs and grew them over time. Germany spent over a century getting to universal healthcare. France started after World War II and didn't finish until 1999. In Canada, national healthcare started in Saskatchewan in 1946, spread to the other provinces over the next couple of decades, and became Medicare in 1984. The trend here is pretty obvious: once people get a taste of universal healthcare, they like what they see and they don't stop until the job is finished.

But the United States is different! Fine. Take a look at social programs in the United States. Social Security provided meager benefits and only modest coverage when it was first passed. Over the course of the next 40 years it became a full-fleged universal pension plan. Medicare passed in 1965 with a limited payment structure and has been improved ever since. Prescription drug coverage wasn't added until 2003. You see a similar direction for things like federal home loan programs, civil rights measures, S-CHIP, gay rights, and practically every other social program ever passed. Progress is uneven, and sometimes even goes backward, but the general trend is pretty clear.

Once healthcare reform is passed, everyone will breathe a sigh of relief and move on to other issues. Republicans will huff and puff, but they don't have the votes to overturn it and they know it. (Why do you think they're resisting it so rabidly? They know perfectly well that entitlement programs practically never go away once they've been passed.) Then, down the road, future congresses will start to make changes. Maybe a Medicare buy-in. Maybe bigger subsidies. Maybe a public option outside of Medicare. It won't happen overnight, but within 20 or 30 years the current bill will almost certainly turn into de facto national healthcare. It's likely to be based on private health insurers in some way, but that's how they do it in Germany and the Netherlands too, and it works fine. Eventually it'll work fine here too.

Shifting Into Neutral

Fair warning: I haven't paid a ton of attention to the whole Toyota sudden acceleration thing, so maybe this has all been discussed to death. But I keep wondering what's really going on. If your engine is racing and you stand on the brakes, your car will stop. Right? Or, at the very least, it will certainly slow down a lot. And while I understand why you might not want to turn off the ignition, since that can lock up your steering, you can always put your car into neutral and coast to a stop. Why didn't the drivers of runaway Toyotas do this?

Obviously panic is part of it. If my car suddenly started racing off at a hundred miles an hour, maybe I wouldn't be thinking clearly enough to put the car into neutral. But a couple of days ago a guy in San Diego got plastered all over my TV when his Toyota went crazy and eventually had to be stopped by a CHP patrol car. Today, someone asked him about his reaction:

Sikes called 911 on Monday to report that his gas pedal was stuck and his blue 2008 Prius was speeding at 94 mph down a freeway near San Diego. A CHP officer helped bring the car to a stop, but not before two calls to police dispatchers that spanned 23 minutes.

Asked why he didn't simply put his car in neutral, Sikes said: "You had to be there. I might go into reverse. I didn't know if the car would flip. I had no idea how it would react."

Seriously? His car was speeding at 94 mph for 23 minutes and he was afraid to put his gearshift into neutral? Or just turn the ignition off once he got to a relatively straight portion of the freeway? The linked story gives plenty of other reasons to think this whole thing might be a hoax too.

But even for the non-hoaxsters, what's the deal? A few seconds of panic I can understand, but your first reaction would be to jam on the brakes, and once that got you into non-heartpounding territory wouldn't you just shift into neutral and slow to a stop? Do I only think this way because I've spent most of my life driving stick shifts, where neutral plays a bigger role than it does in an automatic transmission? Does this have something to do with it? What am I missing here?

The Left and Healthcare

Matt Yglesias made a good and underappreciated point about the Democratic healthcare bill yesterday. There's a core group of lefties that oppose it for idiosyncratic reasons, "But the point I want to emphasize is that theirs is a pretty marginal point of view. 'The left,' in both its traditional institutional forms (unions, civil rights groups) and its online grassroots forms (MoveOn) is very firmly behind this bill." Greg Sargent amplifies:

Americans United for Change is set to announce a $500,000 ad campaign in the districts of multiple House Dems across the country, a source familiar with the plans says. The labor federation AFSCME is preparing a "significant push in the weeks ahead," according to an AFSCME official, who adds that ads could air before and after the House votes on the Senate bill, providing cover for Dems who find themselves under assault after voting Yes. Americans for Stable Quality Care, a pro-reform coalition which is working with the labor powerhouse SEIU, is finalizing plans for a major buy in multiple districts, an official familiar with the plans says.

So unions are spending heavily in support of the bill, MoveOn's members support it 83%-17%, Nancy Pelosi is putting the screws on her caucus members, Harry Reid is doing the same in the Senate, and President Obama is finally pulling out all the stops too — both in front of the cameras and behind the scenes. Among the netroots, Markos Moulitsas says it's time to stop screwing around and pass the bill, and virtually every liberal member of the wonkosphere favors it as well. Ditto for church groups and civil rights groups. That's an enormous amount of firepower, and that's why, despite all the last-minute posturing and kvetching and preening, I think this bill is going to pass. In the end, that's just too much pressure to bear. Nancy Pelosi is going to get her 218 votes.

But it'll be close! If you haven't called your member of Congress, do it today. For a full list of congressional names and phone numbers, go to Type in your representative's name and it will pop up an information page that includes a phone contact. Don't know who your representative is? Enter your zip code and it will tell you.

Yesterday I suggested that credit default swaps might make financial markets inherently less stable. If a bond issuer defaults on, say, a $10 million bond, the buyer of the bond is out $10 million. However, if a hundred people buy CDS protection on that bond, then when the bond defaults the sellers of CDS are out $1 billion. A $10 million event has turned into a $1 billion event. During an economic contraction, when there are lots of defaults, this has the potential to spark a full scale panic.

But is this a real problem? It's obviously not a problem for the buyers of CDS, who all make a bunch of money in the event of a default. But the sellers are a different story. During the financial bust of 2008, AIG, which had sold billions of dollars worth of CDS protection that it couldn't pay off, went kablooey and had to be bailed out by taxpayers. That's a problem.

Felix Salmon, responding to yesterday's post, notes that following the meltdown of 2008, "there isn’t a company in the world — not even Berkshire Hathaway — which can write CDS protection without having to put up collateral." And if new regulations put CDS on open, tradable exchanges, that will make collateral requirements even more standard. That's all good. Then he says this:

But the most important thing to note is that the true villain here is not CDS so much as it is leverage. If I buy a bond and it goes to zero, I lose money, but there are few systemic consequences. If I’m a leveraged institution, however, and I bought that bond with borrowed money, then the consequences can be dire. Writing CDS protection is essentially the same as buying a bond, and writing CDS protection while putting no money down — as AIG did — is just as dangerous as buying a bond on zero margin.

....Sensible CDS regulation can and should, then, put tight limits on how much leverage a net seller of credit protection can be allowed to have. And by all means, if you want to keep things symmetrical, apply the same limits on how much leverage a bond investor can be allowed to have. But the CDS market is more dangerous, just because it’s so much bigger.

Felix, you had me at "leverage"! But now I have two more questions. First, how likely is it that tight leverage limits will be placed on sellers of CDS? Right now, market discipline is taking care of things, but as memories of 2008 fade that won't be enough. And I don't think leverage limits on CDS sellers are part of either the House or Senate reform bill, are they?

Second, one of the benefits of the CDS market is that it provides liquidity and price discovery. As Felix says, "The CDS market worked, during the crisis, even as the market in corporate bonds failed: bonds weren’t pricing, and CDS were....People will invest in bonds if they believe they can exit their positions when they want. And the existence of CDS makes exiting a bond position much easier than it ever used to be — which in turn makes the bond market much more efficient. If you banned CDS, the price of credit would surely rise."

But to a large extent, the superior liquidity and price discovery of the CDS market is attributable to its greater size, which in turn is attributable to leverage. If you tightly limit leverage, don't you also constrain the size of the CDS market? And if you do that, will it still provide any noticeable liquidity benefits compared to the market in the underlying securities themselves?

So I'm still on the fence about this. However, for a more full-throated takedown of the CDS market, see the full-throated Dean Baker here. He doesn't believe it's likely that the CDS market will ever be properly regulated, and even if it is he doubts that the benefits of CDS outweigh their risks. And that's not even to mention the role of CDS in the great synthetic CDO debacle. What kind of regulation would it take to put a permanent end to that?

Grammar Police

Ezra Klein:

Like most bloggers, I'm not too fond of e-mails correcting my grammar.

Really? I like getting emails about grammar and spelling. I mean, don't be a dick or anything, but if there's a mistake to be corrected or a usage issue to be debated, bring it on. We strive for linguistic greatness around here.

Let's recap: If the current plan is for the House to pass the Senate healthcare bill followed by a small "sidecar" of amendments, exactly how is this going to be done procedurally? House Democrats, who don't trust the Senate to follow through on the sidecar, have been proposing ever more baroque methods for passing everything at one time, culminating yesterday with.....oh, forget it. You don't want to know. (But click here if you're masochistic.) And anyway, it doesn't matter, because the Senate parliamentarian has apparently ruled that their latest fanciful scheme violates Senate rules.

Frankly, it violates common sense, too, and probably the U.S. constitution, for that matter. Plus, it's just plain dumb. At some point, you have to trust that your co-partisans aren't going to shaft you completely. Steve Benen:

Sure, there are tensions between the chambers — a common phenomenon over the last 200+ years — but there is absolutely no reason whatsoever to think the Senate would promise to pass a budget fix, and then decide not to. Indeed, the leadership is not only putting this in writing, but let's also not forget that senators want to pass the budget fix — it makes changes the senators themselves want to see — and have no incentive to pull a fast one on the [House].

We know the upper chamber can obviously be dysfunctional, but Senate Dems aren't insane — why on earth would they want a budget fix, ask the House to pass a budget fix, declare their support for a budget fix, promise to pass a budget fix, and then decide not to vote for it? Knowing that it would make all future negotiations between the chambers completely impossible?

I get that the House is nervous, but this fear doesn't make sense.

I wouldn't go as far as Steve. There are some senators who probably like the Senate bill just the way it is and don't want to pass the sidecar. There are others in the centrist caucus who'd like to vote against it for other reasons. And even if 51 senators are on board, there's always the chance that Republicans can successfully gum up the works or that the parliamentarian will make some weird ruling that kills some provision of the sidecar. Who knows?

So House Dems do have some reason to be suspicious. Hell, I'd be suspicious. But I wouldn't be paranoid. At some point, if Harry Reid and the appropriate committee chairmen all sign on, and Barack Obama signs on, and the House leadership feels comfortable, then you pull the trigger. The odds of getting screwed aren't zero, but they're pretty damn small.

We've been at this for over a year, and at long last the time for posturing and gameplaying is over. The holdouts need to dig into their consciences and do the right thing. Let's get on with it.

This War is Different

Andy McCarthy thinks that lawyers who represent detainees who have been designated enemy combatants are guilty of "coming to the enemy’s aid during wartime." Orin Kerr counters that McCarthy "strangely overlooks the basic fact that much of the litigation for the Guantanamo detainees concerns whether they are in fact the enemy." (Italics mine.) To make things more concrete, Conor Friedersdorf recounts the story of Fouad al-Rabiah, a relief worker who was hauled into the American net in Afghanistan in 2001, eventually deemed innocent by interrogators, but kept in custody anyway:

Thus Mr. al-Rabiah. It isn’t just that he was an innocent man thrown into Gitmo, or that he was held even after a CIA analyst concluded that he was innocent, or that National Security Council Staffers were aware of his innocence and actively trying to bring about a review of his detention — Mr. al-Rabiah’s case is apt because after the CIA’s 2002 determination of his innocence, he spent another seven years wrongly imprisoned, regaining his freedom and seeing his children only after retaining the help of American attorneys.

Ms. Cheney, Mr. Kristol, Mr. Thiessen and Mr. McCarthy assert that American lawyers who represent Guantanamo Bay detainees are helping the enemy in a time of war. Here is a case, however, where the Guantanamo Bay detainee was innocent, languished for years in custody without a lawyer despite official knowledge of his innocence, and ultimately achieved his freedom with legal help. Ms. Cheney, Mr. Kristol, Mr. Thiessen and Mr. McCarthy have no answer for people like Mr. al Rabiah and his attorneys — their poorly reasoned McCarthyite rhetoric is bankrupt because they are unable or unwilling to acknowledge the distinction between being accused of being an enemy of America in war time, and actually being an enemy of America.

The Andy McCarthys of the world endlessly lecture us about how this war is different because it's fought on one side by non-uniformed terrorists. And there's some truth to that. It is different. But one of the ways it's different is that it's not always simple to know who's a real enemy combatant and who's not. And if that decision is left entirely up to the executive branch, you're practically begging for the same kinds of abuses that you get if you let the executive branch operate without oversight in any other area. Thus, lawyers and judges have a role to play. They aren't aiding the enemy during wartime, they're trying to figure out who the enemy really is. Even Andy McCarthy ought to be interested in that.


Matt Yglesias comments on an op-ed about the misuse of PSA screening for prostate cancer:

A kind of odd piece of conventional wisdom has hardened that it’s dishonest of Barack Obama or Matt Yglesias or anyone else to suggest that there are some free lunches to be had in the realm of health reform....[But] in the health care domain, in particular, a mix of weak science, bad economic incentives, and poor mathematical understanding leads to a fair amount of over-treatment. And over-treatment for cancer isn’t just an issue of spending money that didn’t need to be spent — treatment for prostate cancer normally has very unpleasant side effects and it’s really cruel to inflict it on men who don’t actually need the treatment. And as far as cancers go, that’s totally typical. Reducing over-screening and over-treatment would probably save money (though it’s always hard to know what the long-term impact will be since everyone eventually gets sick and dies) and will definitely spare patients a lot of pain and suffering.

True enough. The problem is that it's not just doctors and pharmaceutical companies pushing these tests, though that's part of it. It's also patients who demand this stuff, and if you withhold it because "researchers" or "bureaucrats" say it's not cost effective, they go nuts. And they'll be goaded along in their hollering by whichever political party thinks it might gain them a momentary advantage.

I'm not sure what the answer is. Better patient education? I guess I'm not very hopeful about that. Economic incentives? Maybe, but when it comes to cancer that probably won't do the trick either. More rigorous approval procedures for this stuff? Perhaps, though there's an obvious tightrope to walk in order to get this right.

In any case, this is one of those topics that I have a hard time figuring out because my own temperament is so obviously different from most people's. I don't really like seeing doctors, I prefer the lightest treatment possible, and I dislike trying anything that hasn't been around for at least a decade or two. But most people just aren't wired this way. They see their doctor at the first sign of trouble, demand as much attention as they can get, and insist on whatever the latest and greatest treatments are. I just don't get this. But it's the reality, and the cure — pardon the pun — is hard to figure out.