Kevin Drum

Unleash the Fed?

| Fri Mar. 20, 2009 12:18 PM EDT
Over at our main site, James Ridgeway remarks that "the Federal Reserve seems to be catching remarkably little blame for the current economic crisis."  This doesn't surprise me.  After all, in a lot of ways the Fed seems to be practically the only institution in Washington actually capable of taking dramatic action these days.  And something is better than nothing.

More interestingly, James points to a Nation piece by William Greider, a longtime Fed watcher, in which he climbs down slightly from some of his previous criticisms.  It's not that he suddenly thinks the Fed is doing a good job, but drawing on the work of progressive economist Jane D'Arista he suggests that part of the problem is that the Fed now has too little authority:

When deregulation began nearly thirty years ago, some leading Fed governors, including [Paul] Volcker, were aware that it would weaken the Fed's hand, and they grumbled privately. The 1980 repeal of interest-rate limits meant the central bank would have to apply the brakes longer and harder to get any response from credit markets. "The only restraining influence you have left is interest rates," one influential governor complained to me, "restraint that works ultimately by bankrupting the customer."

....The central bank was undermined more gravely by further deregulation, which encouraged the migration of lending functions from traditional bank loans to market securities, like the bundled mortgage securities that are now rotten assets....In 1977 commercial banks held 56 percent of all financial assets. By 2007 the banking share had fallen to 24 percent.

The shrinkage meant the Fed was trying to control credit through a much smaller base of lending institutions. It failed utterly.

The problem, D'Arista argues, is that the Fed's control of short-term interest rates has less and less effect on long-term interest rates as the money supply moves outside the traditional banking system.  And fixed capital adequacy requirements, which require banks to slam the brakes on lending during bad times, make things even worse.

Read the whole thing.  I don't have the chops to fully evaluate what she says, but it's an intriguing argument and I'd be interested in hearing reaction from other blogospheric economists.  It's something to think about once we've put out the immediate fire.

Advertise on MotherJones.com

Indispensable?

| Fri Mar. 20, 2009 1:19 AM EDT
Is it really true that the traders who created AIG's CDS mess in the first place are also the only ones with the knowledge to unwind it successfully?  Do we really need to pay millions of dollars to keep them around?  Simon Johnson, who certainly has the experience to know, says no:

If A.I.G. wants to argue that complex transactions, hedging positions and counterparty relationships require employees who are intimately familiar with those trades, it should at least provide evidence that the arguments for doing so are sounder than the ones made in Indonesia in 1997, when leading bank-owning conglomerates claimed that only they understood their financing arrangements, which certainly were complex. Or the Russian bankers in 1998 who were convinced that only they and their friends could possibly close the deals that they had taken on. We heard variants of the same idea in Poland in 1990, Ukraine in 1994 (and in the Ukrainian crises subsequently), and Argentina in 2002.

Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way.

Charles de Gaulle said it best: “The cemeteries of the world are full of indispensable men.”  If the current crew isn't willing to work for anything less than a million bucks a year, I doubt that AIG will have much trouble replacing them with someone who will.

Bonus Babies

| Thu Mar. 19, 2009 1:13 PM EDT

Hilzoy comments on the terms of the bonus contract written last year for AIG's Financial Products division:

The introduction to the contract says that one of its aims is to "recognize the uncertainty that the unrealized market-valuation losses in AIG-FP's super-senior credit derivative and originally-rated AAA cash CDO portfolios have created for AIG-FP's employees and consultants." That certainly suggests that AIG-FP was aware that there might be significant losses, as does the fact that they got their compensation locked down in a way that made it independent of their profits or losses.

Of course they got their comp locked down when they saw the storm ahead of them.  This is what executives always do.  Back during the dotcom bubble, corporations handed out trainloads of cheap stock options even though the practice was heavily criticized.  Why?  Because the stock market was going up and it was a nearly guaranteed way to make lots of money.  After the bust, they suddenly took the criticisms to heart and largely stopped the practice.  Why?  Because the stock market was going down and it wasn't easy money anymore.

Likewise, in the financial industry, pay has long been heavily linked to performance.  Why?  Because the industry was going gangbusters and it guaranteed everyone a big payday.  Now, though, banks are all talking about increasing base pay and cutting back on bonuses.  Why?  If you think it's because they've finally taken public criticisms about short-term incentives to heart, I have a bridge right here in my backyard with your name on it.

What happened at AIGFP is standard practice throughout corporate America.  America's corporate titans like to talk endlessly about performance-based pay and how capitalism rewards risk, but in real life compensation packages are almost always constructed to avoid as much risk as possible.  If you work in a growing industry, your bonus depends on raw growth rates.  If you work in a declining industry, your bonus is linked to relative growth rates.  If the market is up, your bonus is paid in stock.  If it's not, suddenly deferred comp and increased pension contributions are the order of the day.  Heads you win, tails you win.

The AIG traders who got this sweetheart deal are nothing special.  Management probably didn't even think twice about it.  Of course you switch from performance bonuses to retention bonuses when the market looks stormy.  What else would you do?

I don't, frankly, care all that much about the AIG bonuses being slashed.  The only reason AIG isn't in Chapter 11 is technical (they're too big to fail!), so morally I don't see any reason not to treat them as if they were in Chapter 11 like any other failed company.  That means employees stand in line for their bonuses along with all the other creditors.  On the other hand, this whole thing really is small potatoes in the grand scheme of things, and Tim Geithner and the United States Congress have better things to worry about.

But the culture that brought this on?  That deserves to be dismantled brick by brick.  I may not care much about AIG, but if it's the spark that finally gets Americans to take the executive comensation racket seriously, then hallelujah.  If it's not, then it's just a carnival sideshow.

Hooray For Us!

| Thu Mar. 19, 2009 12:20 PM EDT
We don't have Academy Awards here in magazine-land, but we do have the National Magazine Awards.  Last Year MoJo won the award for general excellence in our circulation category (that's 100,000-250,000, if you're curious), and this year we've been nominated for three awards, the first time in our history we've gotten that many nominations.  One is for general excellence in print, one is for public service, and the third is for general excellence online, for which I take full credit, of course.

(Except, um, for the legion of other people who write, design, blog, administrate, and illustrate the 99% of it that has nothing to do with me.  But other than that, full marks, baby!)

The full list of nominations is here.  Congrats to everyone nominated, and special congratulations to Clara Jeffery and Monika Bauerlein, our co-editors here for the past three years.

Rough Justice

| Thu Mar. 19, 2009 11:50 AM EDT
The LA Times reports on an ad hoc bankruptcy proceeding in Israel:

First came the employees, shortchanged two months' pay and laid off by the supermarket called God's Blessing. They rifled through their shuttered workplace, helping themselves to crates full of groceries.

As word spread through the small town, the store's jilted creditors joined in. They dismantled the light fixtures, ripped out wiring and absconded with the cash registers, even as television cameras rolled.

Within hours the parking lot was jammed with ordinary shoppers. They left car engines running and brought their children to help pick the shelves clean. Finally even the shelves were hauled away, leaving latecomers to scrounge the floor for leftover fruit.

This is not what you'd call an orderly liquidation.  Is it a harbinger of things to come?

Quote of the Day - 3.19.09

| Thu Mar. 19, 2009 11:31 AM EDT
From Matt Yglesias, commenting on the fantastic amount of money we spend on the Pentagon:

It seems to me that if you told the man on the street that you had a plan to spend double on defense what China, Russia, North Korea, and Iran spend combined that said man would assume you were proposing to spend a healthy amount of funds on national defense. Such a standard would, however, imply very large cuts.

If you want to project power over thousands of miles, it costs a lot of money.  Most countries don't really want to do this.  We, on the other hand, are pretty seriously addicted to it.

Advertise on MotherJones.com

Helicopter Ben

| Wed Mar. 18, 2009 10:58 PM EDT
Ben Bernanke has long said that even with interest rates near zero, the Fed still has plenty of monetary ammunition left to stimulate the economy.  Today he put his money where his mouth is and announced that the Fed would be buying up a trillion bucks worth of treasury bills and mortgage securities.  This is known as quantitative easing, aka printing money.  The Wall Street Journal rounds up some reaction:

Guy LeBas of Janney Montgomery Scott provides the basics: "Even today’s announcement that the Federal Reserve plans on purchasing everything in America that isn’t nailed down raised relatively few eyebrows on our end....Effectively, the Fed is monetizing the Treasury’s debt, a strategy that appears in the encyclopedia under the heading 'how to trigger inflation.' "

David Greenlaw of Morgan Stanley says the purchase of mortgage securities is designed to drive down interest rates: "In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year."

Paul Dales of Capital Economics isn't sure that $300 billion of Treasury purchases is enough: "This could just be the opening salvo....Overall, no one knows whether these measures will work. Much depends on whether banks loan out the cash they raise from selling Treasuries and whether households and businesses spend, rather than save, any extra borrowing....At the least, no one can say that the Fed isn’t trying."

So there you have it.  $300 billion in new money, another $200 billion over time from lower mortgage rates, and a clear message that the threat of deflation is being taken seriously.

That's what the adults were up to, anyway.  Back in make believe land, meanwhile, it was AIG bonus time 24/7.  Gotta keep Congress busy with something, I guess.

Healthcare This Year?

| Wed Mar. 18, 2009 2:14 PM EDT
Jon Cohn's tick-tock in the New Republic about Obama's healthcare plan is mostly fairly ordinary stuff: some of Obama's advisors wanted to go slow, others wanted to seize the moment, meetings were held, etc. etc.  But through it all, Obama was Obama:

Health care, in the end, might have gotten pushed aside — except that one very senior official in the administration kept insisting that it stay on the agenda. That official was Obama himself. Repeatedly, the president made clear that he was not abandoning health care reform.

....By the end, the debate had coalesced around three options: investing around $1 trillion over ten years, offset by new revenue and some substantial reductions in Medicare and Medicaid spending; investing a slightly lower amount, in the neighborhood of $600 billion, which could be offset by more modest revenue increases and reductions in Medicare and Medicaid; or putting aside just $300 billion, offset mostly by changes to Medicare and Medicaid. A final decision wasn't made until Friday, February 13, as a deadline for setting the budget loomed. Rejecting the $1 trillion proposal, because the offsets it required seemed too severe, Obama went with the $600 billion option — $634 billion, to be precise.

This seems to be typical Obama: he really does know what he wants, and he really does insist on getting it.  At the same time, as long as things are moving in the right direction, he seems profoundly willing to compromise about how fast he gets there.  I haven't quite figured out yet whether I think this is good or bad, but it's what we've got.  We may have a liberal in the White House, but we don't have one who's temperamentally likely to knock heads and try to make history.

The Presidential Bracket

| Wed Mar. 18, 2009 1:36 PM EDT
Jeez.  Not much love for the Pac Ten from our hoops loving president.  A first round win for Washington is all he's got for us in his NCAA bracket.  Somebody needs to take this up with him when he shows up here in Orange County later today.

Essay Mills

| Wed Mar. 18, 2009 1:03 PM EDT
Alan Jacobs proposes a novel theory for the success of essay mills in cranking out low-cost papers for slothful college students:

It seems to me that the most noteworthy fact here is this: essay mills of this kind can succeed only because college professors all over the Western world assign precisely the same kinds of papers. No wonder some of the writers can turn out dozens of the damned things in a week — “I can knock out 10 pages in an hour,” one of them says. “Ten pages is nothing.” The assignments we professors give are so woodenly predictable that they positively invite woodenly predictable essays in response.

I can feel a contest coming on: Propose a topic that's truly essay-mill-resistant.  Better yet, propose a general algorithm that makes any topic harder to fake from a distance.  Remember: extra credit for originality!