"Quantitative Easing??" Try, "Printing More Idiots"

Is the Fed Repeating
Wall Street's Sins?

Joe Nocera: At a certain point, Wall Street ran out of clients to sell [securitized debt] to. So the only way it could keep the machine going was to buy it themselves.

Jon Stewart: So, they infected themselves. At the end, they themselves became vampires.

[Which suggests] a new theory on the financial crisis: it occurred because of an idiot shortage. If I'm the Fed, I just print more idiots.

--Bethany McLean and Joe Nocera Interview; The Daily Show (11/16/2010)

That's it!

Instead of calling the Fed's current monetary policy something arcane like "quantitative easing," how about calling it "printing more idiots?"

At least, that's how I understand it.

Just like Wall Street ran out of "idiots" to sell securitized debt to, the U.S. Treasury has started to run out of investors to buy (more) U.S. debt.

China already stuffed to the gills with U.S. bonds?

Ditto for Japan, Singapore, South Korea, Saudi Arabia and all our trading partners on the other side of our yawning trade deficit?

No problem -- we'll buy the bills and bonds ourselves!

Two years, five years, ten years . . . you name it.

In fact, we -- the Fed -- will buy so much, we'll actually drive interest rates down.

Which is quite an accomplishment, given that long term interest rates have already collapsed, and short term rates are effectively zero.

Nothing could possibly go wrong with such a scheme . . . . right??

No (Financial) Cure Without Proper Diagnosis

"We ALL Caused This Mess??" Hardly.

Put me in the camp that says, without an accurate diagnosis, it's not possible to cure our current economic mess.

So, here are two competing narratives explaining how we got to this juncture, both courtesy of Les Leopold (thanks to Ned Krahl for forwarding the Leopold piece):

Narrative #1: 'We Are All to Blame'

"We Americans sank ourselves in debt. We consumed more than we produced. We bought homes we couldn't afford and used them as ATMs. Of course Wall Street did its part by offering us mortgages they knew we couldn't really afford. The government also contributed mightily by pushing Fannie Mae and Freddie Mac to underwrite "politically correct" loans to low-income residents who shouldn't have been buying homes at all. In short, we all are to blame.

--Les Leopold, "Why the Big Lie About the Job Crisis?"; Huffington Post (9/3/2010)

If the foregoing is correct, here's what logically needs to happen next:

The era of excess is over. We need to cut back on spending and borrowing. We need to reduce government debt by raising the Social Security retirement age and cutting social programs. We've got to streamline our public sector by laying off public employees and cutting back their lavish pensions. And all workers will have to adjust to an era of intense foreign competition: We've got to reduce our wage and benefit demands if our companies are going to compete globally. We have to live within our means.

In short, we gorged ourselves until the economy crashed. Now we've got to tighten our belts and accept less to get it going again.

--Les Leopold

Contrast that with Narrative #2, "An untethered Wall Street crashed the financial system (and broader economy) while engorging itself."

Starting in the late 1970s . . . the financial sector was liberated from its New Deal-era shackles. Freed from any limits on constructing complex new financial products, hedge funds and too-big-to-fail banks and investment houses created an alphabet soup of new securities with the sky-high yields. The rating agencies abetted the crime by blessing these flimsy products with AA and AAA ratings.

Wall Street built this flim-flam of finance out of junk debt -- like sub-prime mortgages -- which it could pool, slice, and resell for enormous profits. In fact, selling these bogus securities was the most profitable enterprise in the history of Wall Street. Wall Street wrapped credit default swaps and collateralized debt obligations into pretty packages so that they could literally sell the same underlying junk assets again and again.

The whole scheme worked just fine as long as the underlying collateral (our homes) appreciated year after year. But as soon as housing prices peaked, it was game over. The upside-down pyramid of debt and junk financial instruments came crashing down. The entire credit system froze, tearing a gaping hole in the real economy.

--Les Leopold

Guess which narrative I find more accurate?

Prescribing Cures

Only once the disease has been diagnosed, can a cure be promulgated.

Here is Leopold's:

Through steep progressive taxes on the super-wealthy, fair income taxes on hedge funds and transaction fees on Wall Street's proprietary trading, we can keep that bubble from reinflating -- and in the process raise the money we need to put America back to work. With the revenue we collect, we can hire millions of people to weatherize homes and buildings and rebuild our infrastructure. Instead of laying off teachers we can hire more, and provide them with better training and support. We can expand universities and colleges too, and allow people to go to college for free, which will improve our peoples' skills -- and keep young people off the unemployment rolls.

--Les Leopold

The only step Leopold omits is holding Wall Street accountable -- through appropriate civil and criminal remedies -- for its transgressions.

Michael Lewis' The Big Short: Diabolical Castles in the Sky

Voiding Credit Default Swaps

In a book stuffed with scathing insights and blockbuster revelations, here's perhaps the biggest one (courtesy of Michael Lewis, writing in The Big Short):

The reason Citigroup (amongst others) is considered "Too Big Too Fail" isn't because it holds over $1 trillion in ordinary Americans' savings in their vaults.

It's not because inflicting billions of dollars of losses on Citigroup's creditors and shareholders would jeopardize other financial institutions -- and by extension, the U.S. financial system and economy (domestic and global).

And it's not even because the U.S. would then have to step up and make good on its guaranties of hundreds of billions of Citigroup's crappy mortgages and other collateral.

The Real Reason Citigroup is TBTF

No, the real reason that Citigroup is considered to be TBTF is that it may be the object of billions -- maybe trillions -- in Wall Street bets, just like the housing market was before:

Citigroup's failure . . . would trigger the payoff of a massive bet of unknown dimensions: from people who had sold credit default swaps on it to those who had bought them. This is yet another consequence of turning Wall Street partnerships into public corporations: It turns them into objects of speculation. It [is] no longer the social and economic relevance of a bank that renders it too big too fail, but the number of side bets that have been made upon it.

--Michael Lewis, The Big Short (p. 263)

What to Do

If Lewis is right -- and I have no reason to think he isn't -- the appropriate policy response couldn't be more obvious, or necessary.

Step One: the federal government should void all such credit default swaps, immediately.

Aren't those private contracts?

So what?

So were millions of contracts (presumably unwritten) making human beings owners of other human beings.

What do you think happened to all those contracts on January 2, 1863? (the day after The Emancipation Proclamation).

Step Two. Break up the monster banks that ushered in this toxic, dysfunctional and highly combustible state of affairs (cue Warren Buffett's line about "financial weapons of mass destruction").

Step Three. Hold their leaders accountable for their epic greed, negligence and corruption* (vs. giving them, collectively, ongoing billions in bonuses).

No, that hasn't happened yet.

In fact, it hasn't even started.

*Let the courts figure out the proper weighting; mine would be 50% greed, 30% corruption, 20% negligence.