Michael Moynihan's blog

New York City--It is better than not that the bailout package passed and is now law.  However, as U.S. Sen. Barack Obama noted in his statement about its passage, this is no time for rejoicing.  Rather it is a time to get serious about addressing the issues that caused the crisis in the first place--lack of regulation, excessive debt and, above all, the failure of the underlying U.S. economy to deliver real improvement in living standards for Americans--and what we must do to put it behind us.

It was stagnant wages and falling living standards for the middle class over the last eight years, as much as anything else, that drove Americans to try to compensate with their own version of structured finance in the form of questionable mortgages and home equity loans on their homes.  And more generally, it was a preoccupation with financial engineering over real engineering that drove our society, especially our financial sector, to mortgage itself to the hilt. 

Going forward, America must first stimulate the economy by investing in clean infrastructure.  Measures that will put money on the street and also address our long-term energy challenges include a national clean infrastructure bank, a full court press to modernize our electricity grid, aid to states and localities for clean mass transportation and measures to retire our old energy efficient plant and replace it with energy efficient buildings. 

We must also provide meaningful relief for homeowners to keep people in their homes by replacing unsustainable, non-performing loans with sustainable ones as suggested by Alan Blinder, Hillary Clinton and others. Wall Street has gotten its bailout.  How about the American people?

Finally, America must move forward to accelerate the development of a full-fledged 21st century economy.  We must invest in our people, our ingenuity and our future through investments in education, clean infrastructure and the new clean energy technologies likely to power prosperity in the coming century.

There was one unambiguous bright spot in the legislation passed today.  Congress extended the Investment Tax Credit for solar energy which NDN has been arguing is vital to building a clean energy future, for eight years.  With a credit in place that will now span the period that solar needs, on its current cost path, to fall below the cost of fossil fuels, solar energy is likely to become an increasingly part of our energy future.  The production tax credit for wind, equally important, was extended by the bill for one year. 

New York City -- Stuff happens, but in dissecting financial disasters, more often than not, it turns out that some singular event--usually regulatory--not mere chance, opened the gates to abuse.  In the S&L fiasco in the 1980s, one such event was the success by lobbyists in winning a rule change that allowed them to take unlimited brokered deposits, ie deposits not from you and me opening accounts, but through financial markets. From that point on, many banks bid for deposits with little thought of the interest rate, lent the money without oversight and, when markets turned downward, a disaster ultimately occured.

This time around, while there is still a sense that our current crisis just happened, the New York Times reports today that, once again, it was not an accident.  As revealed in the article, in 2004, in an obscure meeting held in the basement of the SEC building, Commissioners voted to approve a proposal by lobbyists of Wall Street's biggest firms, led by Goldman Sachs, to change the rules to allow the firms to increase their rates of leverage on equity up to 33 to 1. As long as their returns were greater than the cost of borrowing, this allowed them to juice their returns.  However, one or two bad investments at this leverage--for example in sub-prime loans--had the ability to go diastrously awry, wiping out the firm's entire equity.  This, in essence, is what has happened to the entire financial industry. It turns out there is a smoking gun in this crisis, a rule change secured by lobbyists--that had disastrous effects.

The Times goes on to report that in exchange for the unprecedented leverage, the firms promised to monitor their risk and the SEC set up an office to monitor risk as well.  Unfortunately, the office never became functional.  A software consultant and MBA who designed software used by banks to monitor risk was the lone dissenter in a letter to the SEC.  However, his letter and advice were ignored and the rule was approved unanimously.

Had the SEC followed through on the oversight it was supposed to perform, the consequences might not have been so dire.  But dergulation combined with abdication of all responsibility by the regulator, the SEC, provided fatal.  And we are now seeing the consequences. 

In the common law, there is a saying that when the facts are clear, you get bad law.  When the facts are murky, you get good law.  Mike Bloomberg's bid to serve a third term by repealing term limits on the grounds that he alone can shepherd the city through the Wall Street emergency  falls into the category of clear facts but terrible precedent. Bloomberg has been a good mayor, for the most part.  As a successful businessman and billionaire on good terms with fellow businessmen whose decisions about where to locate a business may be important to the city's weathering the Wall Street crisis, there can be no doubt.  In all likelihood, Bloomberg, if he succeeds in repealing the term limit law, will do as good a job in a currently forbidden third term as he has in his first two.  Conditions will be far worse but his skills and contacts seem better suited than most to the likely challenges.

That said, however, there is a reason that term limits were installed.  In an era when incumbency creates its own rewards, term limits are an additional public check on bad behavior and therefore can be an important part of public governance.  For every good long term mayor, such as Chicago's Mayor Daley, there have been numerous terrible ones from Mayor Berry in Washington, DC to Sharpe James in Newark, who used the power of incumbency to win re-election despite atrocious records.  While Mayor Bloomberg may appear to be different than these, law in the United States cannot be about one man.  Suggesting that repealing term limits on account of one person, no matter how much money he has, or what sort of record he has compiled, opens up a slippery slope.

Further, one thing we know for certain is that Mayor Bloomber won't be mayor forever and one day, he will have a successor. How would conservative Republicans feel about term limits, if Al Sharpton, for example, won the election?

In the election that placed Mike Bloomberg in office in 2001, delayed because election day in 2001 happened to fall on September 11th, initially the then mayor, Rudoloph Giuliani suggested that he remain as mayor because the ciy required his steady hand during the emergency that followed.  People rightly viewed this as an unacceptable power grab inconsistent with America's tradition of putting law above any individual no matter how qualified they might seem to be.  One of the people arguing against Mr. Guiliani remaining mayor indefinitely was ironically, Mike Bloomberg who was then elected. 

While New Yorkers may wish to have an open debate about the value of term limits at some future point, this important law should not be abandoned because of one man's desire to extend his rule. 

There are plenty of other ways Mike Bloomberg can serve the public, for example, by running for another office.  And there are plenty of other people who would make good mayors. 

Term limits should not be abolished to accomomodate Mayor Bloomberg and if he cares deeply about American democracy, he should drop his call to end them and retire gracefully at the end of two successful terms.

New York City--The defeat of the bailout plan yesterday--and the fact that the House is now out of session for two days making any action impossible--provides lots of time for everyone concerned to panic.  But in the spirit of shoring up confidence, consider the bright side:

The bailout plan and its defeat overshadowed Wamu's collapse, the largest bank failure in history and its subsequent transfer to Chase.

Ditto, Wachovia, aquired by Citi in a deal which included an assumption of billions in liability by the FDIC--again with people barely noticing.

The bailout drama overshadowed the Fed's pouring an estimated $660 billion in credits--almost the same amount of the bailout--into credit markets in a sort of off balance sheet rescue, proving that this crisis is all about confidence and psychology, not actual dollars and cents.

And, of course, Secretary Paulson's bailout plan of Wall Street that ignored the underlying mortgage crisis wasn't all that great to begin with. 

So cheer up (easier if you don't own any stocks).  When the House gets back, maybe they'll pass something better. And at this rate, by Thursday, there may be even fewer banks left for the government to have to save!

New York City -- With the terms of the historic $700 billion bailout of the U.S. financial system now evidently fixed, it is appropriate to offer some reflections on what we know, what we may surmise and what we don't know.

What we know is as follows:

• As noted by Wolfgang Munchau, Daniel Gros and Stefano Micossi in the Financial Times, banks in some countries are now too big for their governments to bail them out and, in the United States, the overall financial sector is too big for the government to bail it out.  This is an important sea change in finance.  For this reason, the bailout offers a reasonable chance of stabilizing the system, but not is not a guarantee.
• Other countries from our allies in Europe to our enemies elsewhere are already crowing in glee at the U.S. comeuppance as the penalty for our previous hubris.
• The failure of the U.S. financial sector -- and it is a systemic failure -- will humble U.S. exceptionalist claims for some time to come.
• The United States is in need of radical redesign of its financial regulatory and bank supervisory regime.  Congressional hearings and a blue ribbon commission to study this and come up with recommendations -- rather than a clubby insider process run by Wall Street -- should be at the heart of overhaul of the system.

We may surmise that:

• The bailout will work and that the recovery will occur more rapidly than, say, that in Japan in the 1990s.  Our chief advantage here -- and let us hope we retain this advantage, is the flexibility of our more capitalist system.  The mark to market rules for troubled holdings that arguably accelerated the onset of the crisis but may also acclerate working through it.
• Treasury will use the cryptic authority granted it by Congress to minimize foreclosures.  As the eventual holders of much of the non-performing paper, the government should have the ability to alter loan terms to keep families in their homes.  However, it is up to Treasury and Congress to determine whether this happens or not.

What we don't know is as follows:

• Whether and how quickly the bailout will restore calm to financial markets.  While the promise of debt relief is designed to restore trust in the markets, how quickly that trust returns remains to be seen.  It is not entirely inconceivable that we may see further runs on vulnerable institutions.
• What Treasury will pay for securities and what securities they will buy.  The goal of the plan is to make banks solvent.  This means Treasury will have to pay more than market value for securities.  As they will have to allocate the $700 billion across numerous financial institutions and classes of securities, the devil is in the details.  The possibilities for abuse and simple incompetence are immense.  (This is why many economists favored direct government investments in the firms with equity rather than overpaying for bad assets.)
• Whether the plan will work long term.  A key flaw identified immediately in the Paulson plan but never resolved is that the plan leaves the system largely unchanged and has no explicit method to replace the bad debt with good.  What is to prevent banks from making more bad loans?  How can we be sure that other loans don't go bad if the economy tanks  And why should we expect non-performing loans to ever begin to perform if loan terms are not altered?  In accepting the Paulson plan, Congress rejected proposals by Alan Blinder, Nouriel Roubini and Hillary Clinton to create a Homeowner's Loan Corporation that would have issued affordable mortgages in place of predatory or unaffordable ones.  This, in my view, would have not only turned bad loans into good ones but helped people stay in their homes.
• How the crisis will impact the real economy.  Last quarter, the economy grow by a respectable 2.7%.  Most analysts now expect a recession.  How long and deep the recession goes is unknown.  However, with interest rates already as low as they can go, judicious fiscal stimulus in the form of investments in clean infrastructure, as I have argued, and other worthwhile spending, are the only real option for limiting the depth and duration of the recession.
• How the crisis will affect the willingness of foreigners to buy our debt and the dollar's role as a reserve currency. While this crisis has been difficult, it is nothing compared to what it would have been like if the United States did not have the luxury of borrowing in our own currency and continually selling the new debt we accumulate daily due to our deficits to overseas investors, a luxury we enjoy thanks to the dollar's position as a reserve currency  Some would like to see the Euro replace the dollar as a reserve currency just as the dollar replaced the Pound after the Suez crisis. 

These are all critical questions and how the government manages the use of the $700 billion authorized will be critical to determining whether this crisis ends up being a footnote in history or a painful chapter.

New York Ciy--Felix Rohatyn used to remark, in telling the story of the New York City bailout,  that the Latin root of the word credit is credo, to believe.  When people believe they will get repaid they lend.  When they no longer believe, credit dries up.  This is what has happened in recent weeks as one financial institution after another has fallen victim to runs, most recently Washington Mutual.  In some cases, investors pulling their money were fellow firms as in the case of the runs on Bear Stearns and Lehman Brothers.  In these cases, some investors may have first shorted the stock, then pulled their money from the firm, news of which caused the stock to drop, and then covered the short to make sizable profits.  In the case of Wamu, ordinary savers pulled their deposits based on rumors of collapse.  While most of the discussion of the crisis has centered on bad loans, it is important to keep in mind that what has actually precipitated the collapse of the failed firms so far are runs on the bank. 

The air of desparation created by Hank Paulson with his emergency plan announced last Friday (after Goldman Sachs, his alma mater, was itself the victim of shortselling, dropping from 170 to 108 in about a week) and the desparate effort of President Bush and Ben Bernanke to sell the plan on the basis of fear, have, themselves, fueled the panic.

Had Treasury put forth a careful plan to deal with the mortgage crisis six months ago that included homeowner relief such as a proposal endorsed by Senator Clinton yesterday that has been floating around for some time to create a new Home Owner's Loan Corporation, similar to the one created in the 1930s to buy up bad mortgages and replace them with good ones and a mechanism to liquidate bad loans, this crisis might very well be over.

Instead, the release of a three page plan that gave sole authority for spending $700 billion to one man, the Treasury Secretary, and explictly barred judicial and other review, the clumsy effort to speed it into law, and exhortations by the sober stewards of our financial system, Mssrs. Paulson and Bernanke to pass this or else face doomsday, have if anything hastened doomsday.  At yesterday's White House meeting, the New York Times reported that Secretary Paulson actually got down on one knee to implore Speaker Pelosi to save the deal.

In finance, perception is a large portion of reality.  The crisis is navigable but only if our financial stewards take a deep breath, step back and provide a plan that addresses the real issues. 

What are the real issues?  They are twofold.  First, a number of large financial institutions have ended up holding large quantitites of depreciated paper that they acquired using leverage or borrowed money on their books.  They owe the money they used to buy the paper.  But the paper has declined in value.  They thus resemble homeowners that borrowed money to buy a house that has declined in value.  They may actually have negative equity.  What they need therefore is a capital infusion in the form of more equity--or equivalently for the government to buy the paper for more than its market value--what the Treasury plan proposes to do.  Overextended as they are, they are susceptible to runs--or investors taking back their money.

The second important issue is that millions of Americans are saddled with mortgages they can't afford.  The answer to this problem is what in commercial real estate is quite common and is called a workout.  Workouts amount to making a deal where the loans terms are modified so that the bank does better than it would through foreclosure but the borrower is able to make the payments.

The plan introduced to date is a form of creditor relief but offers no corresponding debtor relief.  It simply authorizes a transfer of funds from taxpayers to Wall Street.  As the New York Times said, it is shocking that so far, Secretary Paulson is unwilling to give bankruptcy judges the right to modify loan terms for mortgages when they have this right for other types of debt.  Missing from the deal is a meaningful plan to modify onerous loan terms to keep people in their homes.  A further deficiency of the deal is its extension to include any trouble assets such as credit card receivables as opposed to mortages, particularly in the absense of meaningful credit card reform.

There is time to resolve this crisis.  The Republicans who blocked the deal may well have done every one a favor by slowing down a proposal that does not go far enough to keep Americans in their homes.  There is time to develop good legislation but only if the principals stop their fear mongering and agree to something that works for Main Street as well as Wall Street.

New York City -- What did it mean when oil prices today spiked by their largest amount in history, $16 in one day?  It means something is seriously wrong with the oil price market.  Analysts had no obvious explanation for the rise other than to say that it may have had something to do with the October contract expiring.  But a price spike of this magnitude --oil prices have now traveled from lows in the $90s last week to $130 today --is alarming. And oil price volatility of this magnitude in the absence of any magic changes in supply or demand is frankly unacceptable over the long term for a commodity on which so much of our economy depends.

A hint into the source of this volatility was provided at the U.S. Senate's recent summit on energy.  The fireworks commenced when Senators Bill Nelson of Florida and Maria Cantwell of Washington asked Goldman Sachs' COO, Gary Cohn, about the need to reign in speculation in the oil markets.  The Senators cited a recent study by Michael Masters, manager of a hedge fund and a trader himself, blaming volatility on speculation on indices. 

Northwestern CEO Doug Steeland echoed his belief that speculation was responsible for the bulk of volatility in the price of oil. Cohn answered that Goldman's position was that market prices were set by supply and demand and, in support, he cited a recent CFTC, trade by trade analsysis, that showed no outright market manipulation.

However, Cohn also noted that in setting up the index market, Goldman and others' goal was to create a buy side among pension funds and other long term investors for oil futures to balance the supply side of oil producers seeking money for exploration.  And, indeed, pension and others have become large players in the index market as energy futures have become another investment "class."

Today's volatility showed signs of institututions or traders shifting large blocks of money into an asset class to balance chaos in other markets.  This is not outright market manipulation.  But the emergence of oil futures indices as an asset play for huge non-energy investors, chasing yield, may be responsible for the unacceptable volatility in these markets. 

Congress and the CFTC should be examining whether this is the case and, if so, devise measures to reduce the the exposure of this nation-critical market to large shifts in money and what hedge fund traders like to call, cross market correlation.  

New York City -- As the Fed, in exchange for its granting of unprecedented amounts of credit to the financial industry, places more of it under its regulation, two reasonable questions might be 1) How is the Fed going to manage this vast expansion of its mission and 2) Why is the organization chartered by Congress to control our money supply and prevent panics better qualified than any other to regulate financial institutions?

The answer to these questions is 1) with great difficulty and 2) the Fed is not better qualified than other organizations.

In fact, the Fed already a large complex organization comprised of regional federal reserve banks, an open markets committe that must manage the twin goals of controlling inflation and promoting growth, a lending operation and a supervisory organization is now being asked to become an uber regulator.  Its role in regulation may well come in conflict with its other duties.  While the repeal of Glass Steagall in 1909 in may have made the old system of bank regulation on one side by different regulators corresponding to the type of bank and securities regulation on the other by the SEC in need of an update, placing our entire financial system under the regulation of the Fed in the middle of a financial crisis raises obvious concerns.

During the 1998 financial crisis, the Clinton Administration often said that the middle of a fire is no time to re-organize the fire department.  That is exactly what is happening today without anyone really paying attention.

New York City -- Wall Street and the financial industry got two huge gifts over the weekend, the promise of a $700 billion bailout fund to take bad assets off their books and permission from the Fed for Goldman Sachs and Morgan Stanly to borrow from them directly in exchange for those venerable Wall Street Insitutions becoming banks subject to the rapidly mushrooming oversight of the Fed.  Are they grateful?  Apparently not.

The Wall Street Journal reports that financial industry lobbyists and Republicans are rushing to block Democratic-sponsored efforts to keep Americans in their homes as part of any deal that bails out Wall Street and also block efforts to undo some of the more draconian bankruptcy and debt law changes carried out by the Bush Administration that make it virtually impossible for many average Americans, including GIs, to ever pay off or escape their debts. 

Not surprisingly, Barack Obama's numbers are up and McCain's are down as Americans see the injustice of their having to bail out Wall Street without receiving any relief themselves.  Democrats should stick to their guns on insuring that any deal keeps Americans in their homes and includes provisons for family debt relief as well as Wall Street debt relief.  If Republicans do not agree to measures to keep Americans in their homes, they will be the ones blocking legislation.  Democrats should send fair legislation to the President whose duty will be to sign it.

The passage last night by the House of Democratic-sponsored legislation to extend renewable tax credits and impose a national renewble electricity standard in exchange for expanding drilling is good news.  Crafted specifically to appeal to Republicans with the inclusion of generous drilling provisions, but also including incentives for renewables which ostensibly enjoy bi-partisan support, this comprehensive legislation should have garnered many Republican votes.  Instead, only 15 Republicans voted for the legislation and President Bush has threatened to veto it.  Given the reluctance of the Bush Administration to take yes for an answer, one has to ask, what exactly does it want?

The answer appears to be legislation entirely favorable to oil without support for renewables, or else, no legislation at all.  While the legislation thus faces significant hurdles to eventual passage, it at least serves to call the Republican leadership out on their real view toward building a low carbon energy future.