What We Really Should be Yellin About When it Comes to Who Runs the Fed
Effective regulation, and on that note, it is a positive thing that the Summers of our discontent can finally be laid to rest. After all the damage Larry Summers has caused in being one of the architects of this crisis, from boxing in Brooksley Born and ignoring her warnings with regard to derivatives which brought down Long Term Capital Management during the Clinton administration, to his sexism among everything else. He has now thankfully taken himself out consideration for the job.
It's a good thing he did. Rather than fighting for something or someone that helps people suffering from this economic crisis, President Obama strongly recommended and fought for Larry Summers to be Chairman of the Federal Reserve, a guy who lost a billion dollars as President of Harvard betting on interest rates. Yeah, let that sink in for awhile.
It's really not OK. This is why making excuses for everything the President does, as too many Democrats do without thinking of the damage, is dangerous, immoral, and unprincipled. Now it looks like the front runner to replace Ben Bernanke as Chairman of the Federal Reserve is going to be Vice Chairwoman of the Board of Governors of the Federal Reserve System and once President and Chief Executive Officer of the Federal Reserve Bank of San Francisco, Janet Yellin. Unlike Larry Summers, she at least saw the crisis coming as early as 2005.
That being said, she also thought the housing bubble, and the reverberations throughout the financial system, could be contained and thus didn't start worrying that drastic action should be taken until it was too late in 2007. Chris Hayes had an interesting discussion about all of this on All In with Heather McGee from Demos and my favorite member of Occupy Wall Street and Occupy the SEC, Alexis Goldstein. She makes the same points I just did, only better. It would be nice if we could be more creative about this pick rather than another layaway from the Clinton administration, though Janet Yellin is better than Larry Summers.
This is a problem, because unlike what Tim Geithner thought while he was President of the NY Fed — the most important regulator of the 12 regional banks — before the President hired that incompetent tool of Wall St to be his first Treasury Secretary, being a regulator is one of the most important responsibilities of everyone who runs all branches of the Federal Reserve. Therefore it matters that Janet Yellin did not know that the SF regional Fed had the power to act unilaterally to try and make moves to mitigate the bubble, but didn't, and instead followed the Wall St. bought Washington consensus.
Ms. Yellen told the Financial Crisis Inquiry Commission in 2010 that she and other San Francisco Fed officials pressed Washington for new guidance, sharing the problems they were seeing. But Ms. Yellen did not raise those concerns publicly, and she said that she had not explored the San Francisco Fed’s ability to act unilaterally, taking the view that it had to do what Washington said.
“For my own part,” Ms. Yellen said, “I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s — I didn’t see any of that coming until it happened.” Her startled interviewers noted that almost none of the officials who testified had offered a similar acknowledgment of an almost universal failure.
Chastened by the financial crisis, Ms. Yellen now favors stricter regulation. “This experience,” she told the commission, “has strongly inclined me toward tougher standards and built-in rules that will kick into effect automatically when things like this happen, that make tightening up a less discretionary matter.”
San Francisco is in CA, and California is one of the largest states hit by the housing bubble. The state had a housing bubble in the 70s before and again when the big one exploded, so any moves at all would have made a difference. It's not enough to recognize a housing bubble, but yet, then severely underestimate the damage of the bubble while expecting the said damage to be contained, if one is in the position to do something about it as she was at the SF regional Fed.
Now it is certainly possible that Janet Yellin has learned from these mistakes since she now favors stricter regulation stated above, but it would be nice to get some specifics as to just how much. There are a number of reasons this should be the case: for instance, I, like Simon Johnson who has written papers on this, have reason to believe that the political power of these banks with trump any living wills loosely defined in Dodd Frank (plans to unwind without causing systematic contagion assuming they go insolvent again from their risky bets) via untested resolution authority. The banks are 30% bigger after Dodd Frank and they are too big and globally interconnected to regulate, really, when it comes down to it.
This is why I wish we had more creative choices on filling Ben Bernanke's position as Alexis Goldstein said. For instance, why not consider Richard Fisher, president of the Dallas Fed?
Bloomberg reports that Fisher recently called for an international agreement to break up banks that are too big to fail. Here are some quotations, taken from the Bloomberg article (the full speech is here):
“The disagreeable but sound thing to do” for firms regarded as “too big to fail” would be to “dismantle them over time into institutions that can be prudently managed and regulated across borders.”
“Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size. If we have to do this unilaterally, we should.”
“The existing rules and oversight are not up to the acute regulatory challenge imposed by the biggest banks. Because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of troubles through the financial system if they falter.”
This is the stark reality that I would like to hear a directly acknowledged from Janet Yellin. This is especially important since she advocated for the repeal of Glass Steagall in the 90s as my friend TheMomCat lays out. And on that note, one might recognize that there is a pseudo intellectual cottage industry that villager Ezra Klein inhabits, among others at the WaPo and NYT. This cottage industry is dedicated to claiming that repealing Glass Steagall was no big deal. In doing so, they reference one of the worst so called financial analysts of all time, Andrew Ross Sorkin, as if doing so is a feat of strength.
Too bad for them, they don't understand the crisis at all, which is evident by Ezra Klein's bewilderment over Inside Job among other things. I guess I shouldn't be surprised since Ezra seems to need Michael Lewis (who denied there would be a crisis) to hold his hand and reaffirm everything for him. I answered this nonsense about a year ago, and I will add a chart to hopefully explain how bad mortgages made it into bundled up sub-prime Mortgage Backed Securities and into structured investment vehicles, commercial and investment banks' balance sheets, municipalities' public and private pensions, and in other non banking institutions' books.
Bottom line: the repeal of Glass Steagall had a lot to do with the originate to distribute model of the crisis which is a main factor behind this whole crisis.
They were able to distribute these bad mortgages across the financial system to be securitized and package up into (CDOs), sell them off, and didn't have to hold them(“originate and hold”) or be responsible for them like banks used to. They were sold to other institutions(and different kinds of institutions) that didn't have commercial banking arms which is also how they wound up poisoning public pensions in states across the U.S. causing them to go broke. What a piss poor uninformed, excuse. It's time to go back to school. Originate to distribute 101.
Research and consulting firm Celent released a study yesterday titled, “Pathology of the US Mortgage Crisis,” which examines the evolution of the credit crunch from its humble beginnings as a U.S. subprime mortgage problem to the subsequent global liquidity crisis that ensued.
The Boston-based firm noted that the global credit market saw a “flight of uncertainty” over the past nine months that led to billions in associated write-downs, the fall of investment banking giant Bear Stearns, and multiple emergency rate cuts by the Fed.
Essentially, most originating banks and mortgage lenders only held onto mortgages long enough to sell them off to investors, promoting a higher-risk environment for loan origination.
Under this system, mortgage brokers and originating banks had volume-based incentives that weakened underwriting standards, while investment banks and Wall Street firms worked on loan performance incentives.
This disparity caused scores of low quality loans to funnel through the system and find their way into structured investments that eventually spoiled as home prices began to stagnate and fall, and mortgage defaults began to surge.
Whether Bear Stearns, Lehman Brothers, or Merril Lynch had commercial banking arms or not is absolutely irrelevant to Glass Steagall. All it takes is a few originators with bad underwriting standards brought on by the slow repeal of Glass Steagall in the 80s and the final blow with Gramm Leach Bliley in 1999 to spread this junk everywhere. ALL of these investment banks were brought down by subprime mortgage backed securities losses.
So that pretty much sums up why people who deny the significance of the repeal of Glass Steagall do not understand how sub-prime infected the whole system; shadow banking, commercial banking, investment banking, and non banking institutions; a perverse incentive and process which couldn't exist without this repeal, just like Citigroup couldn't exist. Not to mention the repeal of GS means that our FDIC deposits are now used as collateral for bets, just as they were recently to backstop JP Morgan's over 5 billion loss in their disguised London Whale proprietary trade. This is not to say Glass Steagall is a panacea for everything wrong with Wall St as AIG and Credit Default Swaps would have still been a major fixture of this crisis because of the Commodity Futures Modernization Act, but the crisis would have been much less severe without GS repeal.
So as Lambert of Corrente alluded to, before we start thinking we've hit a grand slam, let's reevaluate the replay of this perceived base hit. We need to know how Janet Yellin's thinking has evolved over the years on this since the 90s, because her thinking was once very wrong along with everyone else on regulation and the significance of Glass Steagall. We need to know how Janet Yelen feels about Too Big to Fail, because the Fed now has the power to regulate and end TBTF as we know it, if pursued. The problem is that the TBTF banks and Congress are whipped, bought and coerced by the White House and their benefactors.
The President will work to defeat any proposal in Congress to break up the banks as he did Sherrod Brown and Ted Kaufman's amendment to Dodd Frank(showing he can get things done when he wants to killing the excuse about Congress). So since the Fed now has the power to break up the banks if it so chooses, as Alexis Goldstein said, it would be nice if the reality of our financial system being too big, too interconnected, and too politically powerful was acknowledged from the next likely candidate to run the Fed.
So one might be asking why I am focused solely on the Fed as a regulator instead of its dual mandate of fighting unemployment and achieving price stability? Well, here comes the bad news: the truth is that although I appreciate the sentiment from Janet Yellin and other progressives in Congress who have praised her general focus on unemployment as a problem instead of just inflation from the Fed's standpoint, the truth of the matter is that there's really not much the Fed can do by itself right now for normal working people who make their money or rely on work in the real economy on Main Street.
The only time the Fed can truly bring down unemployment alone is with recessions they themselves create with double digit interest rates driving up the unemployment rate in order to "break the back of inflation" like what happened when Paul Volcker was Chairman of the Fed (of course that campaign was overly brutal to the labor market here and abroad and not solely responsible for bringing inflation down) and then lowering rates to bring unemployment down again. We are no longer in an era of high inflation. We are in an era of private debt overhang and deflation. ZIRP today means interest rates cannot go lower to lower unemployment like in the early 80s not to mention the causation factors are a matter of day and night.
We are in an entirely different more severe economic crisis today from an 8 trillion housing bubble that we haven't seen since the Great Depression. This crisis has killed over $1.4 trillion in demand in addition to demand leakages from the trade deficit which continue while we try to patch up the hole with an inadequate stimulus package that didn't close that or the lost output gap. Net government spending has been going down since 2009. With a private trade deficit in our current account we have to raise public deficits to cover these gaps which we aren't doing.
So called Fed Stimulus cannot significantly bring down unemployment by itself. What is called Fed Stimulus mostly affects the economy of the 1% as the Fed buys US Treasuries and swaps reserves for them from Commercial banks. Those reserves do not go into the real economy and chase goods that are for sale in a real economy. Instead they float speculative investments. UMKC economist Michael Hudson explains:
Therefore, not enough people are hired in the real economy, because there is no significant amount of demand that would come from what would truly amount to what a fiscal stimulus would bring. Quantitative easing is good for some Wall St. investors and speculators making bets on bonds, interest rate movements, and different commodities, but besides raising GDP without the net benefit for all, this is hardly the stimulus we know provides demand and jobs for all. The only way that happens is if enough of this money is lent out, and that is not happening on a significant enough scale.
There's a clear reason for this, and that is because QE building up banks' reserves does not cause lending. Banks create loans whenever they want. Quantitative easing has nothing to do with it. This is the money multiplier myth that has been debunked so many times, I do not even feel like going into it anymore. And yet, we hear acknowledgement of this and other myths on every network by some commentators who consider themselves progressive but don't know any better. Some of them mean well, but are grossly misinformed about these matters when they pretend that this is the most important issue when it comes to the economy, sadly.
And now I have to reference another villager whose perverse obsession with this is almost pathological; enter Matt Yglesias at Slate where he constantly beats this dead monetarist horse. In addition to that folly, this obsession with inflation expectations and the signals from the Fed with regard to letting inflation happen at just the right boom time in the future, as if the lack of demand we are experiencing is a psychological problem instead of this bizarre obsession with inflation expectations. The lack of demand is very real. This inflation expectation fetish seems like more of a psychological disorder than something to take seriously. I mean how long has it been with very little significant results in lowering unemployment from this fetish?
There is no real consistent evidence of this phenomenon that we can observe and report on like the private debt overhang on consumers or the pernicious effect of reducing national income and paying off the deficit by reducing discretionary spending as this administration has done and are proud of it while claiming they are investing in our future. This compounds the fact that only fiscal policy from Congress can begin to fix fix our unemployment problem and start to turn back the tide of crushing income inequality where 95% of the income in this "recovery has gone to the 1%.
I'm all for loose and soft currency monetary economic policy, but you cannot really isolate it from the importance of aggressive fiscal policy and expect to get results that benefit 99% of the population. The White House could help by stop blaming victims of mortgage and control fraud and do whatever is possible to instruct and pressure the head of the FHFA to write down more mortgage debt. They could consider creating a job guarantee program to shrink the supply of labor and bring wages up as an idea instead of not having the stomach for it. Even if it doesn't pass, they could advocate for it until it does.
Of course that assumes they care one iota about the public they claim to represent. That's what real leaders have done in the past with Medicare among other programs. A deficit terrorist White House that created the sequester while working with a deficit terrorist Congress to terrorize the public by reducing discretionary spending to the lowest level as a share of GDP since the Eisenhower administration is not leading when it comes to anything good on these issues. They failed us while helping their 1% benefactors looking to privatize and cut Social Security and Medicare by establishing the precedent of a Congress that jumps from one debt ceiling and government shut down fight to another every few months ending in continual Faustian austerity bargains.
This is either outright incompetence or extreme corruption. There are no excuses for it. The people who make excuses for it have no shame or empathy. In addition to that, Harry Reid has created an Congressional oligarchy 3 times now by keeping the filibuster. This is obviously the Congress he prefers. This means we are all pretty much screwed, because only Congress with proper leadership from the White House on things that matter to the 99% can even begin to fix our economy.
As of right now, the White House as well as the crisis to crisis stop gap bipartisan austerian Congress, are showing extreme disdain for the public. Is it no wonder why we are in this predicament? So the best we can hope for is that someone is appointed who is a decent regulator as Chairman of the Federal Reserve. Whether that person is Janet Yellin remains to be seen, and there are doubts.
It would be better if we had more choices considering her background, but at least there are no more Summers of our deregulatory discontent on the horizon, for now. This administration won't go quietly at another attempt at hiring another Rubinite in the dismal future they created.