Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

20 April 2016

Hillary and the Banks

[For more analysis of Hillary and bankers, click here. For a recent post on the failed Doha oil meeting, click here.]

“Know thyself!” That was a motto of the ancient Greeks. After decades in politics, Hillary is still trying to know herself. “I’m not a natural politician,” she recently confessed, “in case you haven’t noticed.”

No, she’s not. Her instinctual and inveterate reaction to conflict is to triangulate, to find the middle ground. She smooths things over. She tries to see all sides. She acts like the mom with several fighting kids, who doesn’t have time to find out who hit whom first, and anyway doesn’t want to play favorites.

Sometimes that approach works well. It certainly does in the “identity wars” involving African-Americans, Hispanic immigrants and Muslims in America, including our own citizens. It would do no good to tar their antagonists as racists, xenophobes and bigots, although many of them self-evidently are. To call them out would only exacerbate their hatred and the victims’ grievances. It would give Fox more grist for its propaganda mill. And it might cost her votes.

So the best approach may be to soft pedal the conflict, tell soothing stories about American tolerance and our “melting pot,” and push for greater tolerance and equality behind the scenes. At least that’s what the President has always done, and he’s in a hated group himself. Although accused of racism himself innumerable times (for no good reason), he has never, to my knowledge, called anyone a racist.

But triangulation only goes so far. When it comes to public hatred that is nearly universal and well justified, it makes Hillary look weak. Worse yet, it can make her look bought.

There’s an interesting sidelight to Hillary’s solid victory yesterday in New York. According to the Washington Post, Hillary lost to Bernie by 12 points among voters who think Wall Street hurts more than helps our economy. Among voters who said it helps more, she won by more than 50 points. The only problem for Hillary was that Wall Street’s skeptics outnumbered its supporters by more than two to one. And that was in New York—a state whose economy depends heavily on Wall Street.

States far from Wall Street begged to differ. In states that sit on or West of the Rocky Mountains, Hillary lost every primary or caucus but two: Nevada and Arizona. Only in Arizona was her victory decisive. In other Western states, her losses were catastrophic. Here they are, in descending order of Bernie’s percentage margins: Alaska (63.2%), Utah (59%), Idaho (56.8%), Washington (45.6%), Hawaii (39.8%), Colorado (18.7%), and Wyoming (11.4%). (Note that these numbers are not Bernie’s percentages of the vote, but the percentage of total votes by which Bernie beat Hillary. Except for Wyoming’s, they are all far north of LBJ’s landslide victory over Goldwater in 1964.)

In addition, three of the six states next east (ND, SD, NE, KS, OK & TX) preferred Bernie by significant margins. They were: Kansas (35.4%), Nebraska (14.2%), and Oklahoma (10.4%). If states west of Texas’ eastern border (excluding Texas itself) were the measure, Bernie would be routing Hillary decisively.

There are several possible explanations for this phenomenon. Some of these states are solidly red, so the Dems there are small in number and perhaps more left-wing, in reaction to their environment. Some states had closed primaries, others did not; in open-primary states, independents could vote, and Bernie has won independents “by 62 percent to 36 percent across previous contests this year in which exit polls were conducted.”

But there’s another, simpler explanation that no one should discount. The farther you get from Wall Street, the more Hillary’s apparent coziness with it hurts her. Alaska, Hawaii and Washington are all solidly Democratic states, and Bernie buried Hillary in all of them. As for the red states, could Hillary’s stunning loss there be a portent of the general election?

You can argue whether Wall Street caused the Crash of 2008. You can argue whether our big banks and their executives wholly escaped the market discipline and the punishment that they richly deserved. You can argue whether Wall Street and its lobbyists whittled Dodd-Frank down to a dulled, single tooth’s worth of regulation. But you can’t deny that the vast majority of Americans think it did.

Both Bernie and The Donald have succeeded beyond anyone’s expectations at the outset of their campaigns. Although they represent vastly different parties and have incomparable character, their successes have stood on the same three pillars. They are: (1) exploding economic inequality, (2) the hollowing of American manufacturing and the consequent loss of good jobs, and (3) the Crash of 2008 and Wall Street’s role in it and its aftermath.

Of the three pillars, the last may be the strongest. Why? Because it’s the clearest. You can fuzz up inequality by calling the 1% “job creators” and touting the myth that every American who works hard can get rich. You can muddy the waters of manufacturing losses by talking about globalization and “free trade” (with which the offshoring of 60,000 American factories in fact has little to do). But it’s much harder to “spin” the Crash of 2008 and its aftermath, including the massive bank bailouts.

Sure, government regulation was lax. Why wouldn’t it have been, under a Republican administration? But the direct actors and causative factors were rogue bankers, who took enormous, highly leveraged risks, and should have known that the bad mortgages underlying them massively violated the issuing banks’ own credit standards. The culprits escaped not only without going to jail; they didn’t even lose much money, because the government bailed them out.

Much of the public senses how the banks and their lobbyists have watered down Dodd-Frank and the crucial regulations that enforce it. Many know that the only thing that stands between us and another crash is our Fed. And many have heard that the Fed, just recently, declared five of eight largest banks systemically risky and still too big to fail.

So Americans believe that the banks caused the Crash and have not only escaped punishment, but are still playing, with impunity, the very same games that caused the Crash. Is it any wonder that Bernie’s consistent, clear call to break them up strikes resonant chords?

Take me, for example. As a young lawyer I actually represented banks for a time. I worked for a big San Francisco firm (Morrison & Foerster), representing Crocker National Bank—then a regional powerhouse long since gobbled up by Wall Street. I even managed to work up some sympathy for its complaints about regulation. For example, two separate California statutes once required that two separate provisions in required disclosures had to be set in type two points larger than anything else—a requirement logically impossible to fulfill. But I also witnessed the federal elimination of state usury laws and the takeover of Congress by the banks, leading directly to the “let’s all get rich quick” party that eventually caused the Crash.

More to the point, as a law professor I know two dirty little secrets about punishing rogue bankers. First, it’s almost impossible to convict them of crimes because criminal charges require proof of mens rea (criminal intent) beyond a reasonable doubt. Even if banking executives weren’t circumspect in what they write down and whether they rat on each other—and they are!—it would be almost impossible to prove their bad intent. After all, none of them intended to defraud their customers or to crash the global economy; it just worked out that way. All they were intending was to make more money, albeit stupidly and greedily.

The second dirty little secret involves civil suits. For reasons buried in the history of Anglo-American law, there is no such thing as civil negligence for economic wrongs. You can be liable if your stupidity or carelessness kills or injures someone on the highway or in an industrial accident, but you can’t be liable for mere economic losses—even if your stupidity, negligence and carelessness destroy the global economy.

So, much more than the general public, I know how little chance there was, and still is, to punish individual bankers for their misdeeds and force a course correction. As a result, I firmly believe that regulation and breaking the banks up is all we’ve got to forestall the next crash. It’s the Fed or a breakup, or a good chance of another Great Depression.

Now the Fed is an independent agency. It must be, else the president, who is virtually never an economic expert, could jigger interest rates and tank our economy for political reasons. So the only way a president, by himself or herself, could forestall another Great Depression is to have independent authority to regulate or break up the banks. To my knowledge, the president doesn’t now, except (very indirectly) by appointing the Fed Chief.

What this means is that it’s all up the Fed. If another Great Depression threatens, the President can do nothing but watch and cheer from the sidelines.

But that’s still not all. I taught antitrust law for a number of years. While doing so, I read case after case teaching that, when economic concentration becomes too great, the only effective remedy is breakup. Trying to ride herd on clever, well-paid men (they are always men) who have accumulated enormous economic power, and whose motivations have devolved to self-interest alone, is a losing proposition. The only thing that really works, let alone has staying power, is breaking up their empires and reducing their power.

We did that over 100 years ago, when our Supreme Court broke up the Standard Oil combines. Under newer laws, our Justice Department, FTC and our courts have since prevented a number of anticompetitive mergers and acquisitions. But those same new laws have made our courts and antitrust enforcers reluctant to unwind menacing combines after they have formed.

So the banks got too big too fail, but big enough to threaten our national and the global economy. The Fed says that’s still true. But no one except Bernie (and former Republican presidential candidate Jon Huntsman, Jr.) wants to do what we know will work and might solve the problem for the foreseeable future. Hillary just wants the Fed to do it under Dodd-Frank, when it’s highly likely that Fed won’t until it’s too late.

So now do you begin to understand what a huge political liability is Hillary’s refusal to disclose transcripts of the three speeches she gave to Goldman Sachs for $675,000? Most working people take a dozen years to earn that much money. They wants to know what she said, and whether they can trust her. But she stonewalls.

I know, I know. Hillary is a ‘fraidy cat. She fears the spinmeisters will go over every phrase of the transcript and find nefarious ways to put her in Wall Street’s pocket. But isn’t it better to know than not?

Whatever she said then, she can say she’s changed her mind now. She can actually change it. She’s already done that on Iraq. In so doing, she avoided Jeb’s fate. Why not do the same thing on Wall Street, if need be?

And if there’s really nothing incriminating in those speeches, why stonewall? Doing so just makes her seems haughty, aloof and imperial. Maybe she’s waiting until she’s beaten Bernie decisively, so she’s free of challenges from her left. The Donald is not going to beat her up with Wall Street after saying he loves it; nor is Cruz.

The thing that rankles almost everyone about Hillary—even people like me who will vote for her with enthusiasm against the likes of Trump and Cruz—is her tin ear. Her first instinct seems to be to hide and cower behind secrecy and unspecified “comprehensive plans.” At the moment, she leaves the impression that her presidency will be more secretive than most in memory. The public doesn’t want that at all, not after the Snowden disclosures, the Panama Papers, Emailgate, and the fading memory of an economic cataclysm caused by secret pools of financial derivatives.

If Hillary is really as politically awkward as she confesses and she seems, she’d better get some savvy advisers on her staff. She’d better get some folks who remember the Tylenol poisoning disaster and how the truth and prompt action fixed it.

If not, she may still become the first female president, but she will forfeit the chance to take the Senate and House with her. She will miss the chance to win by the landslide that her historic achievement and the abysmal quality of her likely GOP opponents deserve. And she may end up judged by history, just as she was after Hillarycare, as the “woman who tried.”

Why “we the people” hate some bankers

Hillary Clinton doesn’t like conflict. She shies away from it and tries to smooth it over. That’s her instinctual and inveterate approach.

It’s not always a bad approach. Many conflicts are unnecessary, pointless and downright stupid. The current conflict between Saudi Arabia and Iran is destroying the Middle East for no good reason that anyone but mullahs can discern. The Cold War between the US and Soviet Union nearly extinguished our species and accomplished nothing but piling up world-destroying weapons. The Little Cold War between the US and Iran has produced mindless enmity and near-war, but may soon burn itself out. The ideological and propaganda war between right and left among us Yanks has left our ship of state dead in the water for about a decade and counting.

But some conflicts are worth fighting. World War II was the most horrible conflict in human history, but our species had to stop the hyper-aggression and appalling atrocities of Nazi Germany and Imperial Japan. NATO’s 1990s bombing campaign in the Balkans killed a lot of people but stopped an incipient genocide. FDR’s campaign against the clueless plutocrats who had caused the Great Depression and were dragging their heels in fixing it was absolutely necessary. That’s what FDR meant to say when he said “I welcome their hatred.”

Hatred is seldom justified. Most of the time, it’s just a product of our species’ worst trait—tribalism—which we must overcome with social evolution. But sometimes it has a rational basis.

So what about bankers today? Many Yanks hate them for destroying the global economy eight years ago and getting off scot free, and for subjecting us to a continuing high risk of doing so again. How justified is that hatred?

To answer that question, we first must analyze what bankers do. In essence, they do three things. They store money, transfer money, and invest money, charging fees or interest for each service.

No one has much of a problem with the first two functions. Today’s banks do a good job of storing and transferring your money. They can do it all online, from your desk or a mobile device. Most of the time they can do it in less than a day. You can transfer money globally, across international boundaries, with currency conversions at reasonable market rates. And you can get your money back, 24/7/365, in cash in the local currency, at tens of thousands of automated teller machines (ATMs) worldwide.

There are a few small problems. Some central banks now have negative interest rates: in order to encourage money’s circulation, they charge you to park it. Some banks still charge $25 for a wire transfer, in the digital age yet. But so far negative interest rates affect only other banks, not consumers, and you can usually circumvent the wire-transfer fee by using other electronic means.

The reason why people hate bankers today has to do with their third, most sensitive and most important function: investing other people’s money.

No one hated bankers when they took deposits and lent them out so that people who could not otherwise afford homes could buy them. That business put more people in homes of their own and jump-started a booming construction industry.

No one hated bankers when they made commercial loans to businesses. They made short-term loans to meet payroll, medium-term loans to buy inventory (of parts and material to build or things to sell), and long-term loans to build plants and finance other big projects. They even made loans to start whole new businesses—a thing known as “capital formation.”

No one hated bankers even when they invested money in risky start-up ventures, providing so-called “venture capital.” No one hated bankers when they financed mergers and acquisitions, allowing businesses to buy and sell each other and keep markets and the deployment of capital fluid. People only started hating bankers when their “investing” went far off the reservation and roamed way beyond these sensible and often boring tasks.

Take Goldman Sachs (GS), for example. It’s emblematic of the big so-called “investment banks.” But what does it invest in? To my knowledge, it makes no home loans, or short- or medium-term business loans. It rarely invests even in equities directly, except temporarily, when it “floats an issue,” that is, finances an issue of stock or bonds and brings it to market so others can buy it.

Have you even seen those ubiquitous GS ads on PBS’ website? You have to run through them in order to see non-current news programs. They try convince you that Goldman Sachs is a venture capital firm and pillar of your community, funding new businesses and new projects of old ones.

Maybe GS actually does a little of that. But that’s not what has made GS and the other big banks infamous.

To paraphrase Lloyd Bentsen’s classic putdown of Dan Quayle, I know venture capital. I used to work in Silicon Valley, doing venture-capital deals from the legal side. I used to drive by Kleiner, Perkins, Caulfield & Byers—one of the foremost venture capital firms in California—on my way to work. And GS is no venture capital firm. It isn’t even a public venture-capital firm like like Blackstone and the half-dozen others that have gone public.

So how do GS and the other huge “too big to fail” banks make the vast majority of their money? They do it by speculating on future events. They do it by writing, buying and selling second- and third-order securities, including bundled mortgages, bundles of bonds and other securities, plus what amounts to financial insurance (although it’s not actually called by that name). They deal in put options, call options, futures, options on futures, collateralized debt obligations (CDOs), “swaps” and other complex financial derivatives.

Apart from bundled securities, nearly all of these “investments” have two things in common. First, they are entirely abstract. You can’t point to any piece of property, plant or business that they represent. They require pages of dense legal prose just to describe them accurately and fix their terms. Second, they are speculative. Their value depends on the course of unknown future events, such as defaults by mortgagors, businesses or nations, or the vagaries of fluctuations in prevailing interest rates or the relative values of foreign currencies. Their relationship to real commerce and industry is, at best, indirect and tangential; but they can make bankers a lot of money, or so it seems.

To put it simply, the big investment banks these days do a lot of gambling. They “invest” huge sums of money in high-level abstractions that never find their way down to the world that ordinary workers inhabit. And sometimes the bankers don’t just gamble: they also swindle. At least that was what GS was accused of doing before it settled the case and paid a big sum without admitting guilt.

To get a sense of the scale of this gambling, you only need to know one number: $600 trillion dollars. That’s the face amount of interlocking derivatives outstanding when the whole house of cards began to collapse in the Crash of 2008 and the government had to bail the “too big to fail” banks out. And the right-wing blowhards squeal about a national debt of $19 trillion!

Before leaving the subject of derivatives, let’s see what Warren Buffet thought of them. He’s getting on in years now. But he’s a consummate capitalist whose “keep it simple, stupid” approach to investing and to life has made him the world’s most successful and most beloved investor. He once called derivatives “weapons of mass destruction.” And here’s what he said about them in his annual newsletter after the Crash:
“Improved ‘transparency’—a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks—won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them.”
Put simply, Buffet is saying that some banks are “too big to fail” because the huge portfolios of derivatives they hold is too complex and risky to exist.

If bankers want to bet their own money on this junk, that’s their business. It’s still a free country, and a consummately capitalist one. But don’t delude yourself that their doing so does the rest of us any good. The truth is quite the contrary: this junk destroyed our own and the global economy less than eight years ago. And it still threatens us today. Less than two weeks ago, the Fed informed us that five of the top eight banks are still “too big to fail” and present a systemic economic risk.

We still have two more points, which are often overlooked. “Investing” money in this junk drains big resources from real investment that might actually improve people’s lives and advance our species. It also drains the brains, attention, know-how and experience of sophisticated financial professionals that could be applied to real investment in real businesses.

No one knows exactly, because much trading in derivatives is still secret, in so-called “dark pools.” The total face value today is probably north of $700 trillion. Of course that number represents risk, not real money. But that’s just the point. Even if the real money behind it is only 5%, think about how much $35 trillion could help us convert to sustainable energy, repair our dilapidated infrastructure, pay down our national debt, start new businesses, do needed medical and scientific research, or simply make our poor less miserable.

The second overlooked point is how tiny a clique of men (they are nearly all men) engages in this useless gambling and occasional swindling. Excluding the peons and underlings, the principal bankers—the ones who got and stay obscenely rich by playing with this stuff—probably number no more than 250 worldwide. That’s a pretty small special-interest group, isn’t it? Almost any real industry, such as beef or fossil fuels, utterly dwarfs that number.

So there you have it, and there you have the enigma of Hillary. There’s a tiny special-interest group that destroyed the global economy less than eight years ago and still threatens to do so again. It engages in obscure, highly risky activity that does the rest of us little or no good, and its members get obscenely rich in so doing. Because they are rich and live in a rich man’s bubble, they get self-righteous to boot. Lloyd Blankfein, the CEO of GS, once referred to the junk that brought down the global economy down as “God’s work.”

Whatever else these folks may be, they are a pol’s dream. They are worthy objects of derision and hate. That’s why FDR said of their 1930s predecessors, “I welcome their hatred.” They constitute a tiny tribe that threatens the rest of us, wastes enormous resources, and accumulates obscene wealth and power while doing so.

If Hillary would just call them out, recite what they’ve done, and place blame where it belongs, her standing among Bernie’s supporters, independents and people who’ve lost their homes, jobs and/or self-respect since the Crash would skyrocket. But she hasn’t yet.

Why? The notion that she’s in their pocket is much too facile. Hillary is not consciously corrupt. But sometimes it seems that she still considers bankers—even the worst of the lot—part of her family’s children. Whether and if she changes her mind on that point may yet fix the fate of the Democratic party, the progressive left, and our nation.

Footnote: Goldman Sachs has been having trouble lately. Its profits are down, and it’s laying people off. The main problem seems to be market volatility. The enormous overhang of derivatives and high-frequency trading that firms like GS helped create are making markets chronically unstable. China, too, is growing increasingly unstable, and its authoritarian government and reflexive secrecy makes it hard to see how and when.

As the Yogi Berra once said, “The future is one thing that is hard to predict.” If bankers want to gamble on it with their own money, that’s their business. But they shouldn’t hold the rest of us hostage as they do, and they shouldn’t come to us for help when they lose. Only their obscene riches and power have let them and have animated the insurgencies of Bernie and The Donald. If anyone on Hillary’s staff has any savvy, she should be able to tap into this angst as the two insurgents have done.

Endnote on insuring the future. In bare theory, the idea of insuring the future against every risk might seem a good one. We all have home and car insurance, and (thanks to Obama) nearly all of us now have health insurance. So why not insure against every conceivable financial risk, such as the collapse of Greece’s economy, major-power involvement in Syria’s civil war, a US default (caused by Congress), a “hard landing” in China, or an abrupt devaluation of the yuan or yen?

The primary answer is Occam’s razor: simpler is better. Some risks are too complex to evaluate and insure against.

For example, when the financial jocks created their derivative house of cards in the runup to the Crash of 2008, they thought they could get a handle on the individual risk of a single firm’s default. But they had no way to evaluate the risk of a “domino effect,” in which one firm’s default triggers another’s. They probably had no way even in theory, because derivatives were secret and there was no central data base. So the government had to bail them all out collectively.

A second answer is experience. Insurance companies have decades of experience on which to base statistical estimates of the likelihood of your car crashing, your home burning, or you getting lung cancer. But how much experience is there of a Greek default impairing the Euro, China letting the yuan float, or China melting down just as it’s on track to become the world’s largest economy? No actuary or database can help predict these things. “Quants” who think they can predict these things are just kidding themselves and scamming their bosses with mumbo jumbo.

The final rap against trying to insure every risk is practical. If you run an airline, what’s the smartest thing to do to protect yourself against rising jet-fuel prices? hedge against them, keep your own pricing flexible, buy more efficient airplanes, or invest in renewable and therefore more price-stable fuels? Hedging just promotes short-term thinking and putting your head in the sand. It also takes your eye off the ball: the relationship between your pricing and your costs.

Of course drawing the line between insurable and uninsurable risks is always a matter of judgment. There is no formula, computer program or economic model that can draw that line for you. But if nothing else, the Crash of 2008 has proved convincingly that how much money you can make in the short term by writing complex insurance is not a particularly good criterion for evaluating its medium- and long-term risks.



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