(cross posted at EconoMonitor)

Government Sachs posted its second quarterly loss since it went public in 1999. No doubt that has sent Washington scrambling to try to plug the leak. (Wouldn’t it be fun to listen in on Timothy Geithner’s incoming phone calls from 200 West Street, NYC, today?)

Lloyd “doing God’s work” Blankfein blamed the “uncertain macroeconomic and market conditions”—conditions created, of course, by Wall Street. And since Wall Street refuses to let Washington do anything to improve those conditions, expect much more hemorrhaging among Wall Street’s finest.

The big banks are toast, as I’ve been saying for quite some time. There is no plausible path to real profits with the economy tanking. Only jobs—millions and millions of them, as well as comprehensive debt relief will stop that.

As I wrote a couple of weeks ago:

“US and European banks probably are already insolvent. When Greece defaults and the crisis spreads to the periphery that will become more obvious. The smaller US banks are in trouble because of the economic crisis. However, the biggest banks that caused the crisis are still reeling from their mistakes during the run-up to the crisis. They were already insolvent when the GFC hit, and are still insolvent. Policy makers have pursued an “extend and pretend” approach to hide the insolvencies, however, the sorry state of these banks will be exposed when the next crisis begins to spread. It is looking increasingly likely that the opening salvo will come from Europe, although it is certainly possible that it could come … The economy is tanking. Real estate prices are not recovering, indeed, they continue to fall on trend. Few jobs are being created. Defaults and delinquencies are not improving. GDP growth is falling. Household debt as a percent of GDP is only down from 100% to 90%. While declining debt ratios are good, it is still too much to service. Consumer debt fell from $12.5 trillion in 2008 to $11.4 trillion now. Total US debt is about five times GDP and while household borrowing has gone negative, debt loads remain high. Financial institutions are still heavily indebted—mostly to one another. At the level of the economy as a whole, it is still a massive Ponzi scheme—that will collapse sooner or later… No real economic recovery can begin without job growth in the neighborhood of 300,000 new jobs per month and no one is predicting that for years to come.
Isn’t it strange that Wall Street has managed to remain largely unaffected? continue reading…

Nouriel Roubini argues at Project Syndicate that widening inequality lends itself to both economic and political instability.  In his latest policy brief, “Waiting for the Next Crash,” Randall Wray connects some of these same dots, tying the rise of “financialization” and soaring household debt levels to stagnating median incomes in the US:

…as finance metastasized, the “real” economy was withering—with the latter phenomenon feeding into the former. High inequality and stagnant wage growth tends to promote “living beyond one’s means,” as consumers try to keep up with the lifestyles of the rich and famous. Combine this with lax regulation and supervision of banking, and you have a debt-fueled consumption boom. Add a fraud-fueled real estate boom, and you have the fragile financial environment that made the [global financial crisis] possible.

Partly inspired by the work of Hyman Minsky (the Minsky Archives here at the Levy Institute, incidentally, are in the process of being digitized), Wray recommends a set of policy changes that are aimed at righting this imbalance between finance and the “real” economy.  These include restructuring (shrinking) and re-regulating (with strict limits on securitization) the financial sector, and an “employer of last resort” policy that would offer a guaranteed job to everyone willing and able to work (federally funded, with decentralized administration).  The ELR would not just be aimed at addressing the catastrophic unemployment problems associated with a cyclical downturn like the one we’re in now, but at creating a force pushing toward full employment at all phases of the business cycle.  (You can read the brief here.)

Update:  Read the IMF’s recent contribution to the inequality debate here and here.

“Crises are an inherent feature of capitalism. Marx knew this only too well; so did Keynes and Minsky. Neoliberals, on the other hand, tend to believe that it is government action that causes market turbulence and economic instability.”  This is the opening salvo from a new one-pager by C. J. Polychroniou that takes on neoliberal doctrine in light of the global financial crisis (Read it here.)

Polychroniou also has a recent working paper that looks at the potential dissolution of the Eurozone as a failure of neoliberalism:

…the fact that EU’s leaders are having a difficult time getting a handle on the Greek problem and providing a comprehensive solution for the eurozone debt crisis is due to the very constraints of the neoliberal economic regime in which policymakers operate, and helped to create, and much less a question of political incompetence. The architecture of eurozone governance, combined with the asymmetries of European integration, severely limit quick, far-reaching political decisions for addressing the debt crisis, including Europe’s banking system that remains vastly undercapitalized.

The paper includes a detailed and compelling narrative of how Greece got to where it is today.  (Read the working paper here.)

Let’s look at the reasons to doubt that the big six are solvent.

1.The economy is tanking. Real estate prices are not recovering, indeed, they continue to fall on trend. No jobs are being created. Defaults and delinquencies are not improving. GDP growth is falling. Isn’t it strange that Wall Street has managed to remain largely unaffected? Finance is an intermediate good. It is like the tire that goes on a new Ford automobile. Auto sales are collapsing but somehow tire sales to auto manufacturers are doing just fine? Does that make sense? Banks are making no loans, yet, they remain profitable?

2.Not only are the financial institutions NOT doing any of the traditional commercial banking business—lending—they aren’t doing much of the investment banking business either (remember that the last two remaining investment banks were handed bank charters so that they could scoop up insured deposits as a cheap way to finance their business). How many IPOs have been floated? Corporate debt? Trading? Well, one of the two investment banks that survived, Morgan Stanley (the sixth largest bank—barely squeaking into my “dirty half dozen” biggest banks), just released a pretty poor trading outlook—blamed on “high costs, historically low interest rates and market volatility that has pushed clients to the sidelines”. (Reuters Global Wealth Management Summit News).

3.Europe is toast. US bank exposure to Euroland is huge. But US banks are doing just fine, thank you? Hello?

4.Commodities are tanking. Equities markets are at best horizontal. Other than making profits by cooking their books, these were areas open to banks to make profits. And, yes, both commodities and equities had been doing quite well—climbing back up from the depths of the crisis. This should be put in perspective, however, because at best they only recouped losses. Still, those bubbles are now history. Losses are going to pile up. Yes, I know financial institutions hedge their long positions in commodities with some shorts—but who do you short with? Does anyone remember AIG—the insurer of first and last resort? Hedges are only as good as counter-parties, and counter-parties are no better than you are when markets collapse. In a crisis, correlations reach 100%.

5.Hedge funds have not done particularly well over the past couple of years. And yet banks have? Even though all they are doing is trading (plus cooking books and reducing loan loss reserves), the banks are far more successful than hedge fund managers at picking winners? Does that make a lot of sense?

6.And, as mentioned above, they’ve got all these lawsuits—which requires hiring lawyers, paying fees and fines, and employing Burger King kids to falsify documents. The document shredding services alone must be crimping net returns.

Ok, is there any evidence that might cause one to question bank solvency? Real hard stuff? continue reading…

James Galbraith talks about the mechanisms by which obstacles are placed in the way of dissenting and original voices in economics, as well as the failure of most in the forefront of the profession to see the global financial crisis coming (via INET):

Galbraith has written about this before; surveying the work of those who got it right, as well as the narrow parameters of prevailing doctrine:  “This is the extraordinary thing. Economics was not riven by a feud between Pangloss and Cassandra. It was all a chummy conversation between Tweedledum and Tweedledee. And if you didn’t think either Tweedle was worth much—well then, you weren’t really an economist, were you?” (read it here).

“We’ve put this off for too long.  We need debt relief and jobs and until we get these two things, I think recovery is impossible”—Randall Wray, quoted in a Reuters article examining the possibility of negotiating massive consumer debt relief.

Although household borrowing has been declining, debt burdens remain sky high:

(from the latest Levy Institute Strategic Analysis)

“The problem is that we have way too much money chasing way too few good assets. The total amount of financial bets out there is way over $600 trillion around the world. There just aren’t enough good investments to absorb that amount of money. So, what happens is they blow up–one asset after another. Then, those inevitably crash.”  Jumping off from his latest post, Randall Wray was interviewed at Benzinga regarding his arguments about a commodities bubble and the potential for a new crash.

Wray suggests in this interview that, in the face of another crisis, Washington may be constrained in its ability to come to the rescue as it did in 2008:

The Dodd-Frank legislation makes it very difficult to repeat that performance. I’m not saying that they won’t find a way around the rules, or they won’t find a way to do it again. They might, but it’s going to be very politically unpopular. I’m not sure they are going to be able to do it again.

Once prices start tumbling, all of the asset markets are actually linked. Even though it’s not obvious, they really are. It will tumble across all of them. And it’s not clear that we will be able to stop it this time. At least, not as easily as last time.

Michael Hudson on the ECB and eurozone national central banks’ restricted abilities to purchase government debt:

Their banks have perpetuated the “road to serfdom” myth that a central bank runs the danger of fueling inflation if it creates money – in contrast to commercial banks, which supposedly run no such danger if they create money on their own computer keyboards. It is not considered inflationary for them to charge interest to the government, which then needs to pay by taxing the economy at large.

When you find this kind of distortion being popularized and even written into law, there always is a special interest at work. The supposed contrast between “bad” central banks and “good” commercial banks is a lobbying effort seeking to monopolize credit creation in the hands of commercial banks, by promoting a travesty of how central banks are supposed to act.

The reality is that commercial banks have fueled an enormous asset-price inflation in recent years. The debt they have created imposes an interest burden that deflates the economy – even while adding to the cost of living and doing business. Meanwhile, central banks monetize government deficits that are supposed to spur recovery, not simply be giveaways to financial institutions and other vested interests. …

Whether a bank is private or public, money and credit are created electronically on computer keyboards. So it is a myth that government money is more inflationary. But this myth has a political function reflecting private self-interest: it blocks the “public option” of creating money without paying interest to banks which have obtained the privilege of creating credit freely. They are not lending out peoples’ savings deposits, but are creating deposits much like they used to print bank notes. They then look for customers willing to pay interest.

Hudson, a Research Associate here at the Institute, was interviewed for the “Guns and Butter” radio program on the topic of debt deflation in the eurozone and the US.  (Transcript posted over at Naked Capitalism).

(Cross posted from EconoMonitor)

Greece’s Finance Minister reportedly said that his nation cannot continue to service its debt and hinted that a fifty percent write-down is likely. Greece’s sovereign debt is 350 billion euros—so losses to holders would be 175 billion euros. That would just be the beginning, however.

Nouriel Roubini has argued that the crisis will spread from Greece and increase the possibility that both Italy and Spain could be forced out unless European leaders greatly increase the funds available for bail-outs. The Sunday Telegraph has suggested that as much as 1.75 trillion sterling could be required. To put that in perspective, the US bailout of its financial system after 2008 came to $29 trillion. The 1.75 trillion figure will almost certainly prove to be wishful thinking if sovereign debt goes bad, because that will make the US subprime crisis look like a nursery school dispute. All the major European banks will go down—and so will the $3 trillion US money market mutual funds. (That probably explains why the US has suddenly taken a keen interest in Euroland, with the Fed ramping up lending to what Americans had formerly seen as “Eurotrash” financial institutions.)

It is becoming increasingly clear that authorities are merely trying to buy time to figure out how they can save the core French and German banks against a cascade of likely sovereign defaults. Meanwhile, they keep a stiff upper lip and demand more blood in the form of periphery austerity. They know this will do no good at all–indeed, it will increase the eventual costs of the bail-out while stoking North-South hostility. Presumably leaders like Chancellor Merkel are throwing red meat to their base for purely domestic political reasons.  If the EMU is eventually saved, however, the rancor will make it very difficult to mend fences.

There is no alternative to debt relief for Greek and other periphery nations.  But, they are not likely to get it, at least on the scale needed. Certainly not before a lot more pain is inflicted, and a lot more grovelling shown to Europe’s masters.

Indeed, the picture of the debtors that the Germans, especially, want to paint is one of profligate consumption fueled by runaway government spending by Mediterraneans. The only solution is to tighten the screws. As Finance Minister Wolfgang Schäuble put it: “The main reason for the lack of demand is the lack of confidence; the main reason for the lack of confidence is the deficits and public debts which are seen as unsustainable…We won’t come to grips with economies deleveraging by having governments and central banks throwing – literally – even more money at the problem. You simply cannot fight fire with fire.” You’ve got to fight the headwinds with more glacial ice.

While the story of fiscal excess is a stretch even in the case of the Greeks, it certainly cannot apply to Ireland and Iceland—or even to Spain. continue reading…

In the case of a major reform like the Dodd-Frank Act, the attention spans of most journalists and opinion-mongers inevitably peak around the legislative battle, pronouncements are made in the aftermath, and then everyone moves on.  But as articles like this remind us, so much of the action still remains to be played out, in the nitty-gritty of the rule-making process.  To wit, a draft proposal that fleshes out the “Volcker rule” prohibitions on proprietary trading was recently released.  The rule was intended to restrict banks’ ability to make bets with their own capital, but the draft language in question suggests those restrictions could end up being fairly weak (due in part to a broader interpretation of the sort of “hedging” that will be deemed permissible).

This is just the beginning of the beginning for Dodd-Frank.  Looking beyond these initial rule-writing stages, there is the further question of how the law and its provisions will hold up over time.  Rules are only as good as the regulatory and enforcement structures that shape and govern them.  That’s not much of a catchy slogan (worst-selling bumper sticker of all time?), but it contains some critical truth.

Jan Kregel (recently elected to the Lincean Academy) highlighted these dynamics in his investigation of the origins and eventual erosion of Glass-Steagall, the New Deal-era legislation that separated commercial and investment banking (some regard the Volcker rule as a kind of tame, second-best alternative to a return to Glass-Steagall).   In addition to tracing the history of the collapse of the 1933 law, Kregel argues that we cannot simply go back to a Glass-Steagall-style regime.  (Read the policy brief here; highlights here.)

While so much attention is paid to Gramm-Leach-Bliley (the Financial Services Modernization Act of 1999), Kregel demonstrates that the “end” of Glass-Steagall and of its restrictions on securities trading was a fait accompli well before the much-maligned 1999 law had passed.  All of the action had already taken place through a series of rulings and interpretations by the Fed, the SEC, the Supreme Court, and lesser known bodies like the Office of the Comptroller of the Currency (see Kregel, on pp. 9-11 of the brief, for a crisp summary of the key provisions that were weakened and effectively dismantled over time; particularly with reference to Section 16 of the 1933 law, the “incidental powers” clause; which Kregel refers to as the “Achilles heel” of Glass-Steagall).

At a deeper level, and of great policy relevance to current discussions (as well as post-mortems) of financial reform, Kregel goes on to argue that there are serious challenges to reinstating Glass-Steagall-type separations between banking and securitization. continue reading…