The Big School and Convertibility Lost

As described in The Partnership: The Making of Goldman Sachs: Coyne [CEO of J. Aron] learned that the central banks of many nations kept their currency reserves in gold bars stored in the vaults of the Bank of England in London or the New York Federal Reserve Bank. Taken together, all this great wealth of nations had what Coyne saw as one fascinating characteristic: It earned zero return. It just sat in the vaults. But Coyne knew that the time value of money always figured into any futures contract...so he called on the central bankers in one country after another and made what appeared to be a generous and innovative offer: "Lend me your sterile bars of gold bullion and I'll pay you a fee of one half of one percent every year!"

Why then was this forbid? Why but to awe,
Why but to keep ye low and ignorant,
His worshippers; he knows that in the day
Ye Eate thereof, your Eyes that seem so cleere,
Yet are but dim, shall perfetly be then
Op'nd and cleerd, and ye shall be as Gods
Milton: Paradise Lost

There are, it may seem to a new student of economics, more schools of thought in the field than stars in the sky. I sometimes wonder if David Bohm, author of, inter alia, The Qualitative Infinity of Nature, might have felt more comfortable as an Economist than a Physicist. While the physical sciences, according to Thomas Kuhn, exhibit totalitarian tendencies with violent revolutions, Economics is far more democratic, tolerating, albeit not without disputes, multiple coincident schools of thought.

Of late, however, one school of economic thought has become increasingly dominant in policy making circles. The Big School holds that the larger a financial institution becomes the more protected it should be, and vice versa, the smaller a financial entity is, the less protection it should receive.

As an example of this (somewhat) facetious claim, consider the views of JPM's David Lowman: Like all loans, mortgage contracts are based on a promise to repay money borrowed. Importantly, there is no provision in the mortgage contract, express or implied, that the lender will restore equity or reduce the repayment amount if the value of the collateral – be it a home, a car or a stock market investment – depreciates. If we re-write the mortgage contract retroactively to restore equity to any mortgage borrower because the value of his or her home declined, what responsible lender will take the equity risk of financing mortgages in the future? What responsible regulator would want lenders to take such risk?

In other words, the same bank (there were, of course, others) whose inability to meet its contractual obligations a few years ago was such that it needed loans from, and preferential swapping of toxic for performing securities with, the Fed, equity support from the Treasury, and a release from the onerous task of marking securities to market, NOW thinks contracts, regulations and agreements are sacrosanct.

I wonder if the issue up for debate was deriviatives regulation or marking toxic assets to market, would any person from a bank end a paragraph with "what responsible regulator would want lenders to take such risks?"

Big School Rules.

In a Jonathon Demme film appropriately (for our purposes) titled "Stop Making Sense", the Talking Heads' David Byrne asked, "Well, how did I get here?"

The Big School took its cue from Kuhn and engaged not in democratic debate, but totalitarian revolt. They appropriated Walter Bagehot's views on the Central Bank's Lender of Last Resort facility in times of crisis but perverted them in the process. Instead of the outline presented in Lombard Street of "very large loans at very high rates" which, in modern times, became, "lend freely at a high rate", the Big School preaches the doctrine of "lending freely (to the banks) at a very low rate" thereby relieving the Central Bank of its responsibility to enforce prudence.

I may, however, be wrong in assuming the Big School appropriated their "lend freely (to the banks) at a very low rate" doctrine from Bagehot (they may simply have thought "lots of free money would sure be nice"), because this implies a reading thereof. If they had read Lombard Street they would have found these lines of concern about big banks, and management practices obscured from review:

The second misgiving, which many calm observers more and more feel as to our largest joint stock banks, fastens itself on their government. Is that government sufficient to lend well and keep safe so many millions?

All that the best board of directors can really accomplish [in the largest joint-stock banks] is to form a good decision on the points which the manager presents to them, and perhaps on a few others which one or two zealous members of their body may select for discussion

There is no more unsafe government for a bank than that of an eager and active manager, subject only to the supervision of a numerous board of directors, even though that board be excellent, for the manager may easily glide into dangerous and insecure transactions, nor can the board effectually check him.

Our great joint stock banks are imprudent in so carefully concealing the details of their government, and in secluding those details from the risk of discussion. The answer, no doubt, will be, “Let well alone; as you have admitted, there hardly ever before was so great a success as these banks of ours; what more do you or can you want?” I can only say that I want further to confirm this great success and to make it secure for the future. At present there is at least the possibility of a great reaction. Supposing that, owing to defects in its government, one even of the greater London joint stock banks failed, there would be an instant suspicion of the whole system. One terra incognita being seen to be faulty, every other terra incognita would be suspected. If the real government of these banks had for years been known, and if the subsisting banks had been known not to be ruled by the bad mode of government which had ruined the bank that had fallen, then the ruin of that bank would not be hurtful. The other banks would be seen to be exempt from the cause which had destroyed it. But at present the ruin of one of these great banks would greatly impair the credit of all. Scarcely any one knows the precise government of any one; in no case has that government been described on authority; and the fall of one by grave misgovernment would be taken to show that the others might as easily be misgoverned also. And a tardy disclosure even of an admirable constitution would not much help the surviving banks: as it was extracted by necessity, it would be received with suspicion. A sceptical world would say, “Of course they say they are all perfect now; it would not do for them to say anything else”.

A read of Lombard Street would not have led to the Big School's conclusion that the Lender of Last Resort should, in times of crisis, lend only to the banks, and even insolvent ones.

Bagehot advised differently: A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to “this man and that man,” whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them.

In other words, Bagehot argued the Central Bank's responsibility was to "the market", not the banks.

Further, he argued: the majority to be protected, are the “sound” people, the people who have good security to offer. He also speaks to the issue of unsound people, perhaps using a bit of wishful thinking: No advances indeed need be made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimally small fraction of the whole business. That in a panic the bank, or banks, holding the ultimate reserve should refuse bad bills or bad securities will not make the panic really worse; the “unsound” people are a feeble minority, and they are afraid even to look frightened for fear their unsoundness may be detected;

While the fraction of business which is unsound today is likely larger than in Bagehot's England, I suspect most is sound. Unfortunately, the unsound elements, while small in practical classification (derivatives, mortgage backed securities, etc.) are huge in terms of currency relative to the whole economy.

Big School means Big Problems

Why, I wonder, did the other schools of thought so meekly submit to the Big School's totalitarian revolution? Perhaps the question might better be phrased, what problem(s) deemed intractable by most other schools of thought did the Big School solve.

My best guess; one of the problems the Big School solved is Triffin's Dilemma. Alternatively, a previous (temporary) "solution" of Triffin's Dilemma, the London Gold Pool, was brought back to life, a la Frankenstein's monster which begat Big School thinking.

Triffin's Dilemma states that when a national money is used as an international medium of exchange and international reserve there will be trade-offs between the national and global effects of the reserve currency issuer's monetary policy. Moreover, the reserve currency issuer nation would soon find that it had to run increasing current account deficits to provide liquidity to the rest of the world. This, in turn, would erode confidence in reserve currency convertibility, eventually leading to international currency instability and potentially a break down in world trade.

Robert Triffin forecast the breakdown of the Bretton Woods system based on this dilemma. Of late, his work has been cited by the PBOC.

Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries´ demand for reserve currencies. On the one hand,the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities on the other hand,they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists. Zhou Xiaochuan: hairman, Monetary Policy Committee of the People's Bank of China

Triffin, in the late 50s, called for the creation of a new global currency to act as international reserve, along the lines of Keynes' Bancor, or the IMF's SDR (deliberations for the creation of which were informed of his concerns), which, in my view, invites a whole new set of problems, but may still, barring a significantly large, in economic terms, country usurping the US$'s role, e.g. China (which invites similar problems, and leads to the US' loss of the exorbitant privilege), prove the best solution. A "free banking" system of competing moneys is another option.

As the US, not entirely without globally altruistic justification, did not want the Bancor in 1960 any more than it wanted it in 1945, the dilemma of convertibility fears was managed by illusion by way of intervention. The London Gold Pool was established in 1961 to keep the "market price" of Gold at $35 and thus reduce the incentive to demand promised convertibility from the Fed.

This worked until French demands for Gold were not satisfied. The cartel failed to maintain prices within the target and within a few years Nixon's closing of the Gold window ended US$-Gold convertibility.

I'll spare you the details of the 70s inflation and early 80s newfound stability. Suffice it to write that US$ reserves were accepted as semi-convertible- if not to Gold at a fixed price, at least to Gold and a basket of commodities with limited (until recently) fluctuations at new, higher prices.

In one (presumably easily accepted) respect, Big School banks that created and kept markets going in multiple new ($ based) investment vehicles helped sustain the sense of convertibility so long as those markets were trading.  Markets to spend one's $s, even if one never shops there, engender a sense of stability.

Also coincident with this new found stability was the beginning of a business deal between J. Aron (purchased by Goldman Sachs in 1981) and Central Banks around the world. As described in The Partnership: The Making of Goldman Sachs: Coyne [CEO of J. Aron] learned that the central banks of many nations kept their currency reserves in gold bars stored in the vaults of the Bank of England in London or the New York Federal Reserve Bank. Taken together, all this great wealth of nations had what Coyne saw as one fascinating characteristic: It earned zero return. It just sat in the vaults. But Coyne knew that the time value of money always figured into any futures contract...so he called on the central bankers in one country after another and made what appeared to be a generous and innovative offer: "Lend me your sterile bars of gold bullion and I'll pay you a fee of one half of one percent every year!" (pg. 258)

The book goes on to detail that J. Aron was actually making 8% on the deal with no money down, "it produced a nearly infinite rate of return." The book suggests they pulled a fast one on the central banks.

What Coyne may not have known was that at least some governments may well have done the deal for nothing. J. Aron offered to do what the London Gold Pool had done, and was willing to take the risk itself- a risk passed on in the merger to GS.  An added benefit, assuming the deal worked as described, no gold had to actually be sold on the market, paper gold would suffice.

GS was not alone in this game. By the mid to late 80s when I was at Chase (now JPM), our Gold desk (fortunately positioned right behind the options desk where I worked) was playing the same game. Paper gold flooded the market.

One of the reasons I began working with GATA a decade ago was my observation (shared by them) of Gold's stubborn reluctance to rise in price despite the rapidly increasing external US$ reserves. If Gold was, as Triffin asserted, undervalued in the early 60s, surely, I thought, it was a steal in 2000 at $275.

Global US$ reserves have done nothing but rise since, at an increasing pace.

In 1978, Triffin and Mundell were warning of a sudden collapse of the US$ due to the growth of those reserves. Back then they wrote in astonishment of US$ reserves in the few hundreds of billions. Now, such reserves are measured in the trillions.

Without concrete data I can only speculate as to the extent of Central Bank gold leasing, or its effect on the price. In the past few years, the price of Gold has risen above $1000. Interestingly the price broke above the early 1980s high of $800 when problems began appearing in large US banks. The mid 2008 dollar squeeze in international markets capped its advance at that time, only to bring the US banking system to the brink of disaster.

How causal the coincidence proves to be remains a mystery. What seems certain is that, if Central Bank gold leasing is a policy aimed at extending the life of the US$ as global reserve currency, the banks so engaged cannot be allowed to fail, or the game is over.

Thus, I wonder how much effect, if any, the Gold leasing practices of the big NY banks had on the decision to make them too big to fail.

Have we dodged Triffin's dilemma by trying to maintain the illusion of convertibility only to invite a banking collapse worse than Bagehot's worse nightmare?

How will the US respond if an economy as large as China's needs a boost in international liquidity?  How large might an IMF rescue package need to be to keep China from suffering a disastrous contraction?  Would the US, as is its wont, allow the current account to widen further to ensure China repaid the IMF?

What if Japan needs IMF support?

How far off might such events be?

Big Questions for the Big School

Forget Kagan and Clinton. Rakoff for Supreme Court.

Given the somewhat tortured background of these cases and the difficulties the motion presents, the Court is tempted to quote the great American philosopher Yogi Berra: “I wish I had an answer to that because I’m getting tired of answering that question.” Judge Rakoff in SEC vs. Bank of America

In what may prove to be a case of affirmative action run amok, media reports suggest that the short list of potential Supreme Court Nominees (replacing retiring Justice Stevens) includes Elena Kagan and Hillary Clinton.

While Mrs. Clinton seems an able politician (damning with faint praise) her record as a Judge (or even as clerk to a Federal Judge) is non-existent.

Ms. Kagan, by contrast, has a record. She clerked for, inter alios, Supreme Court Justice Thurgood Marshall.

As President Obama's Solicitor General, she lost the case of Citizens United vs. F.E.C., which cleared the way for corporations to stand on equal footing as citizens in the rights to political speech. 

While it seems to me this may have been a lost cause from the start given the current "bent" of the court, it may be that Ms. Kagan failed to anticipate the proper grounds for argument as Justice Stevens noted in his dissent, in particular, this view:  In the context of election to public office, the distinction between corporate and human speakers is significant. Although they make enormous contributions to our society, corporations are not actually members of it. They cannot vote or run for office. Because they may be managed and controlled by nonresidents, their interests may conflict in fundamental respects with the interests of eligible voters. The financial resources, legal structure,and instrumental orientation of corporations raise legitimate concerns about their role in the electoral process.

A subtle mind, in my view, is needed in the Supreme Court, if the intent is battle with Financial Concentration.

Enter Judge Rakoff. While the main qualification media reports suggest as supportive of Ms. Kagan's Nomination is "non-ideological", Judge Rakoff is a man of opinions. He loves baseball, and thinks the banks have gone too far. (Batting 1000 so far)

In SEC vs. Bank of America, the Judge demonstrates to me a subtle mind, waiting for (indeed begging for, and presenting clues thereof) the right arguments to be presented. To wit: An even more fundamental problem, however, is that a fine assessed against the Bank, taken by itself, penalizes the shareholders for what was, in effect if not in intent, a fraud by management on the shareholders. This was among the major reasons the Court rejected the earlier proposed settlement. Where management deceives its own shareholders, a fine most directly serves its deterrent purposes if it is assessed against the persons responsible for the deception. If such persons acted out of negligence, rather than bad faith, that should be a mitigating factor, but not a reason to have the shareholder victims pay the fine instead.

I don't have a say in the matter (besides this opinion) but if I did, I'd bench the starters and get Rakoff in relief (of us all).

The Tyranny of Financial Technicians (and its demise)

The people always have some champion whom they set over them and nurse into greatness. This and no other is the root from which a tyrant springs; when he first appears he is a protector. Plato - The Republic

One of the earliest civilizations of which we still have record, Ancient Egypt, was, in a sense, run as a Technocracy (rule by technical experts). Technicians of that period were revered as priests and studied not money or credit, but time. Their worship of the sun set them apart from other cultures which used the more frequent lunar cycles to track time. By tracking the sun's movement in the sky the priest-technician forecast the coming of the Nile flood on which Egyptian food production was based.

These days the reverence accorded the ancient priests of time seems silly. Children with a few years of school can explain how the earth's revolution around the sun, and the earth's axial tilt leads to seasonal change. The basic secrets of the temple of time can be known by any who wish.

In modern times, the secrets of the temple of money, however, despite demystification attempts by William Greider, et alios, are still considered secret. Financial Technicians are revered perhaps as much as were the Time Technicians of old. Just as the Pharaohs of Egypt thought twice about confronting his priests our rulers think twice about confronting ours.

The Passover season just passed commemorates, from one perspective, the freedom gained from the ancient technocracy of Egypt, who, in the story, weren't as prescient in their forecasting as they professed. In that light, the timing of this op-ed, taking a modern technocrat to task for his lack of prescience, was perfect.

In modern times, internet connectivity makes the secrets of the temple of money far more open than was the case in ancient times. The big secret of the temple of money is that there is no secret. Men like Blankfein, Paulson, Rubin, Dimon, Greenspan, Bernanke, and (perhaps especially) Geithner, are not possessed of intellect and wisdom not found in many thousands of others. Moreover, their judgments, even granting solid "market sense" might be detrimental to the people and corporations that make up the nation (and whose actions are the ultimate determinants of the market).

Louis Brandeis, in his Other People's Money: and how the bankers use it, speaks to this issue:  Prominent in the banker-director mind is always this thought: "What will be the probable effect of our action upon the market value of the company's stock and bonds, or indeed, generally upon stock exchange values?" The stock market is so much a part of the investment-banker's life, that he cannot help being affected by this consideration, however disinterested he may be. The stock market is sensitive. Facts are often misinterpreted "by the street" or by investors. And with the best of intentions, directors susceptible to such influences are led to unwise decisions in the effort to prevent misinterpretations. Thus, expenditures necessary for maintenance, or for the ultimate good of a property are often deferred by banker-directors, because of the belief that the making of them now would (by showing smaller net earnings), create a bad, and even false impression on the market. Dividends are paid which should not be, because of the effect which it is believed reduction or suspension would have upon the market value of the company's securities. To exercise a sound judgment in the affairs of business is, at best, a delicate operation. And no man can successfully perform that function whose mind is diverted, however, innocently, from the study of, "what is best in the long run for the company of which I am director?"

Like the Ancient Egyptians waiting for the flood, a critical mass of modern people, many of whom dream of a comfortable retirement, are willing to revere those who promise market prices supportive of their financial expectations, and ignore those who don't. The market concerns of the investment banker described by Brandeis have increasingly became a major factor on policy.

As one example, consider the changed IMF perspective of capital flows (and its analog in the 2008-09 US Financial Rescue package) detailed by Raymond Mikesell, who attended the Bretton Woods Conference: Both White and Keynes believed that the IMF's assistance to members should not finance capital flight. However, the IMF has not maintained this position. The IMF's loans in response to the financial crises in the East Asian countries during the 1990s were primarily for the purpose of helping members restore confidence in their securities markets and currencies, rather than for financing imports. Moreover, according to a recent statement by Secretary of the Treasury Lawrence E. Summers, emergency loans to countries facing currency crises should be the principal lending function of the IMF (Kahn 1999).

Ultimately the Tyranny of Financial Technicians is the Tyranny of the Markets. Admittedly, I've employed hyperbole to make my point. The object of people's fascination varies over time. Following WWII, the people revered war heroes and elected Eisenhower and Kennedy. Their Treasury Secretaries did not come from Wall St. (or even close) and finance was but one of many technical skills deemed useful, and not the most popular.

In all likelihood, the modern fascination with our Technocracy will fade when the promises are seen to be empty. And empty they will prove to be so long as finance is primarily concerned with the markets and not the real sector on which they are based.

** Late addition:  In further support of the Investment-Banking mind driving policy thesis, consider the following argument in favor of EU and IMF support for Greece, granted at below market rates:  Jean-Claude Juncker, the Luxembourg prime minister and eurogroup president, said he hoped the agreement would calm the markets and help to avert the crisis facing Greece and the single currency. "This is the step of clarification the markets are waiting for," he said. "It shows there is money behind this."

Financial Regulation: Then and Now (Busting TBTF)

Like the internet, finance would benefit from redundancy, and competition, not just in the sense of distributed shareholdings (which is already the case) but viewpoints (which is not helped when directors merely “rubber stamp” CEO opinion, and Fed, Treasury, and other financial regulatory officials are always on loan from GS and the rest of Wall Street). Like minded-ness, if you will, is the issue here and "restraint of trade" the lever. TBTF engenders the myopia which leads men like Greenspan to argue, “nobody saw it coming.” Quite a few did, but they were, in a sense, crowded out of the market.

Simon Johnson and James Kwak of 13 Bankers and The Baseline Scenario, urge President Obama, in a recent Washington Post Op-Ed, to channel Teddy Roosevelt’s defiance of Wall Street, exemplified by the break-up of Northern Securities in 1904 in order to clean up the US financial system.

I agree with Johnson and Kwak’s call to arms, and am sure their views are far more nuanced than a space limited op-ed can relate, however, my examination of the Progressive period in US history, of which the chapter on US financial regulation is but a part, suggests that repetition of that period is most unlikely, and hopefully unnecessary. While there are many similarities between then and now, both the context and issues of concern are, in certain key respects, different.

The Federal Government during the Gilded Age bore little resemblance to that existing today. As a financial entity, in the main, the government collected customs’ duties, which were more than half its receipts, paid interest on the debt, the bulk of which was incurred during the Civil War, and fought the Native Americans and Spain (wars were much cheaper then, additional Army and Navy costs for the 1898 Spanish American War came to $190M).

The malefactors of great wealth, as the industrial and financial titans of the day were known, controlled commerce and finance. They mined iron and made steel, connected the nation via railroads, telegraphs and telephones, and controlled the banks. They set prices and controlled the supply of money, credit and raw materials, which gave them the power to “shake down” people and firms of which they didn’t approve, competitors and frauds alike.

Unlike today, the leading banks which emerged at the end of the Gilded Age weren’t Too Big To Fail, they were Too Solvent To Fail. They owned much of the US gold stock, then the basis of money, and were seemingly immune from the Panics which shook the rest of the nation every decade or so, more often than not, it was claimed, at their instigation.

I’m confident if JP Morgan were running the Fed, credit growth would have been restrained long ago.  There is some merit to having someone "own" an issue- unlike Greenspan, Geithner, Rubin et alios, who claim no responsibility.  Thus, some believe we need more regulatory officials rather than better ones.

When the government was running dangerously short of gold reserves, in 1895, they went to Wall Street for help- call it a reverse bail-out- and had the Treasury supply replenished. A very small group of unelected men, in effect, owned the government.

This small group of men directed the transformation of America from a disconnected agrarian to a connected soon to be industrial society- from the states united to the United States. In the process, however, they paved the ground for the Progressives to use the power, not of money, but of public opinion, via the ballot box, to usurp their control.

The government that almost died in 1895, was reborn in 1901, when the assassination, by an anarchist (love the irony), of President McKinley, made Teddy Roosevelt President.

Teddy Roosevelt’s Trust Busting kicked off a vigorous 20 year period for the new government. Progressives, who had pushed potentially transformative legislation through Congress from 1885-1900 finally had an executive willing to use it, and his big stick, for change. The Rough Rider took the de jure power of the Interstate Commerce and Sherman Anti-Trust legislation, which had hitherto been used against labor, and prepared to make it de facto, against big business.

The Federal Government, as we know it today, was born. It was a small child about to battle grown men. US Federal Government receipts totaled $670M in 1900 (JP Morgan bought the Carnegie Steel Company around that time for $487M). In 1904, Northern Securities, a railroad trust owned by JP Morgan, JD Rockefeller et alios, was ordered to break up. The precedent, after appeal, was set and many other trusts followed. In 1911, after more than a decade of court battles, the Supreme Court dissolved Standard Oil, making JD Rockefeller, according to some, the richest man in the world, in cash.

He and the other Titans got rich, but lost control of their businesses.  Like the Titans of Greek Mythology, they are, for good or ill, only going to appear once.

The child was growing quickly. In 1913, the Federal Reserve was created and the 16th Amendment, which made income taxes Constitutional, was ratified. Four years hence, the US entered World War I. At war’s end, the child had given way to the man. By 1920, receipts had grown to $23B. The Federal Government was now the biggest guy in town.

On one level, this growth of government is like that of Gilded Age business-built on the destruction of competition. There are, however, two key differences: 1) government didn’t “swallow” competitors, they dissolved them into smaller pieces, diluting their control 2) Gilded Age businesses were dynastic and decision-making was concentrated into few hands, government officials were (and are) popularly elected, operate within a system of checks and balances, and change more frequently.

The context in which Progressives operated was, as I’ve hopefully made clear, very different from today. The Federal Government then was, at least in a critical mass of minds, like a Deus ex machina, come to save the day. It didn’t tax the average citizen, but was likely to tax the wealthy and promised to not only break up the trusts, but also to open the credit spigot much wider.   One hundred years hence, the bloom is off the Federal Government's rose.  Increased taxation to fund another government expansion seems most unlikely.

Back then, the “money question”, as the debate between those who favored deflation or inflation was called, was one which brought people to the ballot box (I can’t imagine President Obama giving a Cross of Gold type speech). Elastic money seems to me the deciding factor which cemented Woodrow Wilson’s support of the Fed’s take-over of financial regulation.

Before turning to the present period, a few words about the Fed’s creation. There were two competing visions for the proposed central banking system, the Aldrich plan, which kept bankers in control, but allowed banks, at their discretion, access to government created liquidity (thus the need, under either vision, for the government, as financial entity, to grow, via increased taxes), The Bryan plan wanted government totally in control of a Central Bank which regulated the banks, and, at its sole discretion, could also supply liquidity.

The creature, as some call it, which emerged, was a compromise: government top down control of some key board members, banker control of others, the controlling board would be in D.C., thus demoting NY bankers, banks had access to liquidity, but the national liquidity level was at the board’s discretion.

Fortunately, unlike Johnson and Kwak, I’ve had the luxury of virtually unlimited internet space to flesh out the history. Unfortunately, I’ve probably lost most readers in this exercise of pedantry.

For those few that remain, let’s soldier on.

A Progressive solution, for our era, would involve for the creation of an empowered, taxing, global government with its own central bank, empowered with regulating all banks. This is, in a sense, the Nietzsche solution, fight monsters by creating bigger monsters. The United Nations (which replaced the earlier League of Nations) could be seen, in a Progressive dream, as the US Federal Government during the Gilded Age, an institution that, under direction of charismatic individuals, should become the biggest monster on the block, and maintain world order.

In my view, such a solution would but buy time in the same way that, 100 years from the empowering of the US government, many of the old problems remain. Ideas and conviction, not power, seem to me the missing elements. Further, the newly empowered Federal Government of a century ago was battling individuals, not national governments with armies, which would be the objects to be brought under control of any world government. If national governments begin to collapse, or fail to restrain growth of their internal monsters, however, I wouldn’t be surprised to see this “solution” emerge.

Supporters of continued US sovereignty within our borders, and the big bankers themselves, who might win the battle against US regulation only to risk eventually losing the war to world regulators (as the NY banks won the battle against state regulator but lost the war to the Feds) should take note. Men like Rockefeller and Carnegie, who ultimately submitted to government restraint, financed legacy institutions like the Trilateral Commission and its ilk to lay the basis for these bigger monsters. For a preview, consider: The IMF and the EU are currently battling for control in Greece, which seems willing to trade sovereignty rather than restrain its appetites via default.

Today, as then, the issue of size is key in one sense. Our regulators were seduced by “economies of scale” arguments and allowed a few financial institutions to grow beyond the ability of an indebted government to restrain. The 1895 analog is striking and, in that sense, Johnson and Kwak’s call to channel Roosevelt seems right on the mark. Terms like charisma and force of personality are often used to explain Teddy Roosevelt’s ability to bend people, ostensibly possessed of more power, to his will.

In the event, it took more than Roosevelt’s charisma to beat Morgan and his crew (or his charisma, and fear of popular backlash, was such that he bent a critical mass of the Supreme Court, to his will). US vs. Northern Securities was decided 5-4, with Chief Justice Fuller and Justices White, Peckham and Holmes dissenting. From a financial perspective, David, in the form of the US Government, had slain Goliath, a Trust whose capitalization was almost 2/3 of US revenues.

The basis of the decision, which, after appeal, and modification, became unanimous, however, was not bigness, but restraint of trade, via the stifling of competition. As Justice Holmes wrote in his dissent, “Size has nothing to do with the matter.”

Justice Harlan, writing in the affirmative: The Government charges that, if the combination was held not to be in violation of the act of Congress, then all efforts of the National Government to preserve to the people the benefits of free competition among carriers engaged in interstate commerce will be wholly unavailing, and all transcontinental lines, indeed the entire railway systems of the country, may be absorbed, merged and consolidated, thus placing the public at the absolute mercy of the holding corporation.

Adding: it need not be shown that the combination, in fact, results or will result in a total suppression of trade or in a complete monopoly, but it is only essential to show that, by its necessary operation, it tends to restrain interstate or international trade or commerce or tends to create a monopoly in such trade or commerce and to deprive the public of the advantages that flow from free competition;

Having read both sides, I understand the dissenting view; until trade is restrained, monopoly, per se, isn’t a crime, and might even lead to reduced consumer costs. Should there always be at least two rail options for every possible route? I assume, however, that the objects sought by President Roosevelt were a precedent, and distributed control and profits, not a strict reading enforcement.

I dwell on the decision to suggest a legal challenge to the current concentration of financial control into very few hands. Contrary to the above, financial concentration has already restrained trade, and imposed additional costs to all. Financial support (and even the expectation thereof) of TBTF firms also restrains trade in that potential (and actual) competitors who avoided (or even profited by) the declines in certain asset markets were restrained in gaining increased market share. Surely one of the benefits of competition is the weeding out of the short-sighted.

Fortunately, I don’t think we need new legislation, we just need to enforce what’s already on the books.

Like the internet, finance would benefit from redundancy, and competition, not just in the sense of distributed shareholdings (which is already the case) but viewpoints (which is not helped when directors merely “rubber stamp” CEO opinion, and Fed, Treasury, and other financial regulatory officials are always on loan from GS and the rest of Wall Street). Like minded-ness, if you will, is the issue here. TBTF engenders the myopia which leads men like Greenspan to argue, “nobody saw it coming.” Quite a few did, but they were, in a sense, crowded out of the market.

The need for redundancy would become more apparent if we held as self-evident the belief that there is no magic cure for financial overextension (bubbles) and their dissolution (busts) in a fractional reserve banking system. It will happen, again and again. Mitigation, as should now be clear, is not just an issue of additional liquidity but also a financial industry comprised of smaller, and more numerous, competing firms. It might also help to examine the books of any firm (including the Fed) which promotes the notion that “this time is different.”

I hold no illusions about being the sharpest knife in the drawer, as the Brits say, and thus assume others have considered similar legal arguments against financial concentration. Given the obvious trade restraining effects of TBTF, why isn’t the Supreme Court hearing arguments?

Like the Federal Government in 1895, ours too needs a bail-out. While the big financial firms can no longer provide such support, they can keep the Feds afloat by selling bonds as Primary Dealers, and, if needed, increase their own holdings thereof (particularly after the Fed has graciously relieved them of toxic mortgage, et alia, assets). If the Federal Government is ever to restrain finance, they need to break this dependency, and prepare to take their lumps, so to write, for poor fiscal management. If they were crafty they would blame the firms they were about to break up…just a thought.

This will require either skillful diplomacy or a good deal of charisma from some in power, and a good deal of conviction that this problem cannot be fixed without radical solutions, and will only worsen if left to fester. The "break-up" strategy from the early trust busting days may well prove effective today, and increase the number of balance sheet managers in the bargain.  It will also, I suspect, require inflation ($ debasement) as a self-administered bail-out. President Obama might need to channel William Jennings Bryan, as well as Teddy Roosevelt to get the US out of this mess.

Perhaps President Obama can deliver a Cross of TBTF speech at the next Democratic convention.

A Fascinating Exchange on Pre-Fed Banking Regulation

Almost 100 years ago, the US Congress was investigating the Money Trust, as the concentration of money and power on Wall Street was then called.  The St. Louis Fed has documentation of the hearings of the House of Representatives Subcommittee on Banking and Currency into the matter, better known as the Pujo hearings, which make for fascinating reading.

Then, as now, people were concerned with the power of Wall Street, and the deceit (stock and commodity price manipulation, inter alia, has been around for a long time).  Unlike the current situation, however, big finance was largely self-regulated  (then, as now, there were laws, but then, it seems, big finance thought the government too lax, and slow to act), and the idea of a government bail-out would have been absurd to men like J.P. Morgan. 

Also unlike today, the then captains of finance were all in favor of closing down insolvent banks, and even temporarily solvent banks who might well be frauds, even before the government got involved, as this exchange between Samuel Untermyer, Esq.,  counsel for the committee and J.P. Morgan demonstrates.

Mr. Untermyer: Do you not think there ought to be some authority, in the State or Government somewhere, to give to a solvent bank the right of clearance through the association?

Mr. Morgan: Yes; but it depends upon in whose hands the bank is.

Mr. Untermyer: Oh, you think the competitors of a bank ought to determine into whose hands it should go?

Mr. Morgan: For instance, suppose I were the clearing house- I would not be in favor of allowing a man to be associated with me that I thought was a fraud, simply because he owned a bank which at that particular moment was solvent.

That's a powerful argument in favor of private owners policing their own industry, which, as an aside would not work today as the banks are all publically owned.  Perhaps the current regulatory problems are unintended consequences of breaking up the large privately held conglomerates. Nothing like fear of personal loss to keep one on the straight and narrow.  Would Goldman have taken a different path over the past decade if they had remained private?

The view above might also be a defense against claims that certain banks had "shaken down" others in the Panic of 1907.  It's hard to tell without all the accounts available.  It does make me wonder if JP were alive today, (and as good as his word) would he have instigated a panic before things got so out of hand, and wound down the offending banks (and gotten grief about it for having too much power).  As best I can discern he seemed to take the issue seriously. 

The exchange continued:

Mr. Untermyer:   The question I ask you is as to whether competitors should have the fate of another competitor entirely in their hands. to close it up or let it go on, without any review anywhere.


Mr. Morgan: If they are insolvent, I think they should be shut up at once.


Mr. Untermyer: But do you think the competitors should have the right to pass upon that without any review.


Mr. Morgan: There is no other review possible that I know of.


Mr. Untermyer: Do you not think a review on the part of the banking authority would be possible?


Mr. Morgan: Not unless there is time. The question of time comes in.


Mr. Untermyer: It does not take long to telephone, does it?


Mr. Morgan: It does sometimes.


Mr. Untermyer: It takes too long to give the bank a chance, Anyway?


Mr. Morgan: Yes. Sometimes some people have to step in and take the bank’s balance in order to get them cleaned, at that.


Mr. Untermyer: Have you known of other banks doing that and getting well paid for it?


Mr. Morgan: I have known of some people doing it without being paid at all.

For Mr. Morgan, the key question in banking was character.  The idea of keeping a failure in business, even with financial backing, made no sense.  To wit:

Mr. Untermyer: If that is the rule of business, Mr. Morgan, why do the banks demand, the first thing they ask, a statement of what the man has got, before they extend him credit?


Mr. Morgan: That is what they go into; but the first thing they say is, "We want to see your record."


Mr. Untermyer: Yes; and if his record is a blank, the next thing is how much has he got?


Mr. Morgan: People do not care, then.


Mr. Untermyer: For instance, if he has got Government bond or railroad bonds, and goes in to get credit, he gets it, and on the security of those bonds, does he not?


Mr. Morgan: Yes.


Mr. Untermyer:. He does not get it on his face or his character, does he?


Mr. Morgan: Yes; he gets it on his character.


Mr. Untermyer: I see; then he might as well take the bonds home, had he not?


Mr. Morgan: Because a man I do not trust could not get money from me on all the bonds in Christendom.

I'm still working on an examination of Fed goals that transcend their stated directives of maximum non-inflation growth and thought this might make interesting reading in the meantime.

GoldiSachs and the TBTF Banks

GoldiSachs and her friend MorganStanley were tired (of worrying about insolvency) so they went upstairs in the Banks' home and found a bed labeled TBTF that was just right. In contrast to the children's story, GoldiSachs and MorganStanley were welcomed into the club.

In March of 2008, years of poor investment decisions finally caught up to Bear Stearns, forcing the firm to accept a $2 per share bid (later revised to $10) from JPMorgan (financed by loans from the NY Fed). A once mighty financial firm which had survived the Great Depression was no more. Adding insult to injury, its final 5 year stock price chart, which depicted a dive from over $150 to the single digits could easily have been mistaken for that of a dead Tech firm which never generated a dime in profits.

Coincidentally, the Federal Reserve announced the creation of the Primary Dealer Credit Facility (PDCF) which allowed any Primary Dealer not already authorized to borrow at the Fed's Discount Window, to, in effect, enjoy the privilege of discounting their securities if they were cash poor.

Despite the new access to Fed liquidity, however, stock prices of Primary Dealers, who, inter alia, sell US government debt, were under assault within 6 months. Lehman Brothers did not survive the assault, declaring bankruptcy on September 15.

Perhaps due to the thinning ranks of Primary Dealers (in the previous 2 years, 5 Banks, ABN AMRO, CIBC, Nomura Securities, Lehman Brothers and the aforementioned Bear Stearns, had left the club or died) or some other reason (more on that in my next post) the Fed and Treasury made the hitherto unsaid policy of Too Big To Fail (TBTF), explicit, and welcomed GS and MS into the club (which, according to Simon Johnson and James Kwak, numbers 13), declaring the new entrants Bank Holding Companies (BHCs), for emphasis.

A recent check of the Fed's NIC (a wonderful resource on BHC data) demonstrates that GS and MS fit into the BHC club about as well as I fit into the crowd on my first visit to Beijing many years ago. Their source and use of funds are quite different as are their arenas of profit.  They are investment firms, more closely related to Hedge Funds than banks.  I'm all in favor of investment firms, however, I don't agree that, if TBTF is wise policy (which, at this stage, I doubt) they should be included in the protected group.

I still, on the topic of sticking out from the crowd, remember being asked to join a picture of a Chinese family during a visit to the Great Wall, because, I suspect, this rural family rarely saw white people and wanted to show the folks at home their great adventure.

Banks, as I recently argued, always and everywhere earn their money lending. As the table below demonstrates, however, the meaning of the term "bank" is being diluted at roughly the same pace as the US$.  Admittedly, the banks themselves, in their desire to be more like Hedge Funds, are helping the dilution of meaning.  This makes me wonder if the next GS to join the club will be George Soros. Perhaps if he becomes a primary dealer....

                   click for larger version

As you can see, GS and MS needed no help in provisioning against bad loans (one argument, with some merit, in favor of TBTF is that the banks provided more mortgage credit than they otherwise would have if the government wasn't promoting home ownership).  These investment houses earn money from, inter alia, Investment Banking, Brokerage and Proprietary Trading. 

Proprietary Trading is the arena one tends to find "rogue traders" like John Rusnak, Brian Hunter of Amaranth fame and this fellow from France.  A policy of TBTF might well bail out a "rogue bank"or the banks' creditors, perhaps it already has.  This isn't to suggest I'm against prop trading (it's one way I earn my keep) I just don't see the positives (if any) outweighing the negatives. 


A thoughtful reader at Seeking Alpha wanted a more explicit statement of TBTF effects which inspired the use of "scam" in my last post.

TBTF direct effects include, as he noted, creditors avoiding "haircuts" (reduction or total loss of investment), and, as I added, employees and owners equally avoiding "haircuts" (reduction in compensation and loss of investment).

I used the term "scam" in reference to the latter two effects.  Reductions in compensation and dividend outflow would go right to the bottom line, mitigating the need for equity and liquidity support.

TBTF rewards failure, which creates its own ill effects, and it will impose financial costs on families across the US as the effects of the changes in the Fed's System Open Market Account (latest data seen below) and growth in US Federal Debt manifest.  Further, supporting firms which failed to see the collapse coming, or minimally to adjust their exposure accordingly, removes from the list of positives the one social virtue of trading I needed to know to become licensed as a securities' dealer- price discovery.

While I agree with the reader that US financial authorities had trade-offs in mind (I didn't use "total" in my original title) when TBTF became explicit (some going beyond finance, as I'll discuss in my next post) some are taking advantage or "scamming" the public in the lax environment.

Take a good look at aggregated employee compensation in the first table.

The ultimate question of TBTF is not "if" it will end.  It will.  Such arrangements always end.  The Medici were known as God's Bankers, under the protection of the Vatican- the best shield going at the time- and they went under. Money, like water, eventually finds a way to flow around (or through) constraints. 

The question is, will we end TBTF or will it end us, in our current form?

TBTF isn't just Bad Policy, it's a Scam

Free money from the Fed, and bail-outs from various governments allowed US Bank employees to pull off a marvelous trick, thereby freeing them from the normal contraints of Capitalism. They paid out more in dividends than they made in each of the past 3 years: by $8B in 2007, $41B in 2008 and $30B in 2009. Net operating income (NOI) for the banks was $102B for 2007, $10B for 2008 and $17B for 2009. This is obviously unsustainable, and makes the crooks from the Tech Boom look like amateurs- while the Techies based their fraud on the greater fool theory, the Bankers simply paid off their owners, and gave themselves raises.

The streams here in the Northeast US today, following a solid 2 day rain, are akin to those of income enjoyed by US Banks- spilling over at record setting levels.

As promised yesterday when I detailed the obscene compensation of bank industry employees, today's musings will focus in more detail on US Banking sector incomes, expenses and the future of Too Big To Fail.

Banks always and everywhere make the bulk of their income from lending and the US sub-species is no exception to this rule. Bankus Americanus is, however, unique in a few regards. It is the only animal on the Endangered Species list whose dwindling numbers are a result of cannibalism. To wit, in just the past 15 years numbers have dropped from 12,604 to 8,012 but those that remain are fatter than ever. Additionally, (and somewhat more seriously) unlike most banks in history, in recent times non-interest income has risen to more than 50% of interest income, helped in part, by the termination of Glass Steagall restrictions.  Data: FDIC- all covered institutions, aggregated

Given the substantial compensation American Bankers receive one might expect the increased non-interest income to come via trading, investment banking or the recently allowed insurance and brokerage activities, but this is not the case. Service charges on deposit accounts earn US Banks more than trading, investment banking, insurance, or brokerage in every year for which I have data. The lowly paid back office workers, in other words, generate much more income than the highly paid traders.

Admittedly, as I learned at Chase, there are indirect benefits to having a trading desk (and other financial services). Trading, for example, requires a cash deposit which will not only generate its own set of fees but also increase lending by whatever multiple the bank deems prudent.

Regardless, in the aggregate, US bank trading profits (exclusive of employee expense) have never exceeded 10% of net interest income. And the banks haven't even begun to unwind their derivatives portfolios, an event which may well push the absolute value of trading income above that of interest income for a year or two. I suspect in the not too distant future the wisdom of bank trading will be seen as pure folly. The NIMBY (Not In My Back Yard) movement which drove, e.g. chemical processing, off to foreign lands will soon, I believe, drive trading from Banks.

Moving on to larger streams, the biggest line item in the FDIC's breakdown of non-interest income is obscurely titled "additional non-interest income." The FDIC defines this as:

 All non interest income of the bank not required to be reported elsewhere, including (but exclusive to): 

1. Income and fees from the rental of safe deposit boxes;
2. Income and fees from the sale of checks, money orders, cashiers' checks, and travelers' checks;
3. Income and fees from the use of the bank's ATMs;
4. Income from performing data processing services for others;
5. Earnings on or other increases in the value of the cash surrender value of bank-owned life insurance policies;
6. Rent and other income from Real Estate Owned.

Chalk up another win for the back office, and, better still, the electronic office. An inquiry with the FDIC informed me that ATMs (and related services) were some of the biggest earners at US Banks. How clever of Bankus Americanus. The advent of the computer and internet age led to price reductions in most industries, inspiring the then Banker in Chief Greenspan to proclaim a productivity miracle. Bankers, by contrast, increased their income.

Pause for a moment. Can you imagine the outrage if ATMs were outlawed and tipping a teller a few dollars each time one made a withdrawal became mandatory? Can you imagine how many people would suddenly get the urge to be a bank teller? Banks would then have no problem staying open 24 hours a day, just like the ATMs- and we might all enjoy a human voice saying, "Thank you for banking with us."

There's a lesson to be learned here. The aggregate data strongly suggests that bankers aren't smarter than they were 30 years ago, they are just more protected. Protection of the sector allowed a relatively small group of people to pay themselves huge salaries (and huger bonuses) while the bulk of bank income was derived not from their efforts but from normal bank services spared the ravages of tech sector cost cutting. The high priced guys are the one's who have generated the problems.

Returning to cash flows, income isn't generated for free. The network of ATMs required development (but shouldn't the patent protection for this have expired like those for pharmaceuticals?), installation, and continued service. Profits accrue only when incomes exceed expenses. Banks must borrow funds more cheaply then they lend them.

As interest income is the bulk of bank income, you would expect that interest expense (i.e. cost of funds) is the bulk of bank expense. Up until the past few years, this was true. In 1994, interest expense was $145B (interest income was $321B) while employee compensation was $70B. In 2009, interest expense was $145B (interest income was $541B) while employee compensation was $163B. Amazingly, less than 2 million bankers (actually the problem is caused by the top 10%) paid themselves more than they paid the 100s of millions of depositors for the use of their funds. They even paid themselves more than they paid the bank owners.

If this (taking new equity capital to pay off previous investors and line their pockets) sounds like a Ponzi scheme that dwarfs that of Mr. Madoff, then I've made my point.

This brings us to the bottom line. If the Banks are truly TBTF and Bank employees truly indispensible, Capitalism is well and truly dead and Banking no longer a job, but a religion. In Capitalism, shareholders, not employees are the ultimate arbiters of business. Once net income goes to zero or below, the business, in its current form, is on borrowed time.

Free money from the Fed, and bail-outs from various governments allowed US Bank employees to pull off a marvelous trick, thereby freeing them from the normal constraints of Capitalism. They paid out more in dividends than they made in each of the past 3 years: by $8B in 2007, $41B in 2008 and $30B in 2009. Net operating income for the banks was $102B for 2007, $10B for 2008 and $17B for 2009. This is obviously unsustainable, and makes the crooks from the Tech Boom look like amateurs- while the Techies based their fraud on the greater fool theory, the Bankers simply paid off their owners, and gave themselves raises.

Yesterday Paul Volcker said TBTF was "moral hazard writ large". He was wrong. It's a hazard before it happens. This has been going on for 3 years.

As with the Tech Boom, something has to give. The real sector in the US isn't recovering, in part because credit is just circling round in the financial markets, as was the case in the early 90s, but on a much larger scale today. Real sector borrowing rates (adjusted for tighter credit conditions) are still too high. Thus the residential mortgage problem is not going away, and likely to worsen now that the Fed is out of the game (for the moment at least) and a commercial mortgage problem is looming.  Unlike the early 90s, there is no RTC set up to recover money for the banks, and there's that problem of who really owns the mortgages to be solved.

At current price levels it will be years before the banks are back to whatever constitutes normal these days, and I don't think we'll have that much time. Unlike the 90s, we have a government debt roll-over problem. If Banking sector NOI is roughly zero again this year, will shareholders be willing to accept zero dividends? I doubt it. Absent a sudden recovery in the real sector, US Banks, like the Irish Banks, will soon find they need more money.

Barring an unlikely substantial reduction in employee compensation (a solution I highly recommend, rolling salaries back to 1999 levels would free up roughly $70B A YEAR for loan loss provisions), the banks could dilute their own shares (but only for so long) or try to raise more overseas equity, but the amounts would be limited, in the case of foreign investment, to less than a controlling stake. I can't imagine the US population or government allowing China to hold a controlling interest in Citibank or any other big BHC.

A $ devaluation policy would alleviate the mortgage problem but the subsequent rise in interest rates would likely ignite another, much larger problem in the 200+ Trillion dollar derivatives portfolios, and our foreign creditors would be none too pleased. Sadly for them, the Germen option of forced liquidation is that least desired by the powers that be. Devaluation, I suspect, is the only option- it just has to appear to be an accident.

Regardless, we'll likely soon discover that TBTF isn't just bad policy, it's a scam- the Tech Boom on steroids.

A note on aggregation: Sometimes this process makes it easy to miss the trees for the forest-some banks might have profitable trading desks but they get lost. Goldman Sachs comes to mind. Yet, during the crisis of 2008, GS would have gone the way of LTCM (for the same reason) but for their transformation into a BHC and the bail-out of other institutions (notably AIG) which kept payments flowing.  GS isn't much of a bank in the usual sense but an investment house.  They should not, in my view, have gotten the protection of commercial banks. 

A note on trading: This essay might leave readers with the notion that I'm against trading. I'm not. I trade.  I simply believe that for trading to provide the promised price discovery benefits, they must stand on their own as private sector businesses.

It's Good to be a US Banker (for now)

I remember the first time I saw a fellow trader get fired from Chase Manhattan. Sitting down at my desk in front of the green screens (this was before the invasion of computer terminals) I had my coffee in one hand and a phone in the other when a buddy sitting behind me whispered, "check out the security guards."

I looked around and saw two guys in uniform standing at attention near the elevators. I hadn't noticed them when I arrived, as I was reading the newspaper. "What's up with that?," I asked.

"Someone's getting fired," he responded.

The 35th floor of Chase was very quiet, I suddenly noticed.

A few minutes later another trader walked in, nose buried in his newspaper, on the way to his desk. The guards, one of whom carried a cardboard box, followed him and just before he reached his desk told him to pack his things in the box and come with them. He reached for a phone but the guard was quicker. "No calls," he said, "pack your stuff and let's go."

It was a scary scene, but on reflection, as I still had a job (I was later to be on the other side of this issue), it made me feel as if banking (at least on the trading side) was a place where Capitalism reigned. Perform and you get very well paid. Screw up, and you're fired.

Or so I thought.

I've spent much of the past 2 days downloading data from the FDIC (more on those details in my next post) and was amazed to discover the best uptrend in the financial markets is banking salaries and employee benefits. One look at the graph below and I realized Lloyd Blankfein must be right. Bankers are doing God's work (or at least being compensated as if).

the data is skewed somewhat higher from the late 90s on by the repeal of Glass Steagall

You might think, if Bank employees are doing well, the owners must be doing even better. If these banks were more privately owned I would agree, but they aren't. It's apparently much better to work for a big bank (smaller banks don't pay even their top guys that well, as I found drilling down in the data) than to own it, just ask the gang at Goldman. The graph of cash dividends isn't nearly as pretty (but you can't argue with any dividend for 2008 or 2009, given the recent crisis, if you're an owner).

If you aren't a bank share owner but simply a taxpayer hoping the Fed won't let the currency in which you're remunerated shrink in value, you can argue plenty.

Recent news headlines proclaiming the wondrous profit (of $7B, not enough to pay salaries and bonuses of the top men at the big 5 US Bank holding companies) ready to be realized by the government with the sale of Citibank (brokered by these same bankers) miss the point. The Fed's balance sheet exploded to ensure that the Bankers who approved the loans which fomented the crisis could provision (inadequately, I suspect, as I'll discuss next time) against the losses and get paid handsomely for their shoddy work.

We'll all pay the price for that down the road and it may not be that far ahead.  Irish banks have gone back to their government for yet another infusion of capital.  Back here in the US, Elizabeth Warren of the TARP Congressional Oversight Panel is warning of an impending commercial real estate loan crisis.

When the next crisis hits, (not too long now, I suspect) the Bankers won't need a TARP, they'll need some flak jackets.

As Paul Volcker said today, the banks must face a credible threat of closure.  Ultimately the failing firm should be liquidated or merged. In all... it is a death sentence, not a rescue at the hospital.

Capitalism is Dead: Keynesianism, Marxism and Communism are too!

The Obama administration is making final preparations to sell its stake in the New York bank (Citibank), according to industry and federal sources. At today's prices, the sale would net more than $8 billion, by far the largest profit returned from any firm that accepted bailout funds, and the transaction would be the second-largest stock sale in history.  WSJ

John Kenneth Galbraith was once asked what he thought Nixon meant when he said, "We're all Keynesians now." Galbraith responded, in part, "He probably didn't know himself."  This might have been a joke.

I'm no expert on his views, but here's my attempt to succinctly present Keynesianism: 1) Capital (the means of production) is not the ultimate driver of economic growth, Demand is. 2) Demand can be manipulated by changes in government taxing and spending. 3) Economic growth can (and should) be maintained, if necessary, by such manipulations.

This interpretation of Keynesianism contrasts with that of Capitalism, which, I believe, in an ideologically pure sense holds that privately owned Capital, regulated solely by adherence to hard money rules of profit, loss and bankruptcy, is the driver of economic growth. Within that perspective, "Supply Side-ism" (if you will, a "child" of Capitalism) adopts the latter two elements of Keynesianism- capital can and should be manipulated by government intervention.

Using those definitions, with which, I'm sure, many will disagree, Capitalism is a rarely seen model. Supply Side-ism seems the most prevalent model in the west historically, and, recently throughout the world. US so-called Capitalists at the turn of the last century are, due to protective tariffs, better termed, Industrialists.

Within the past 30 or so years, however, the long time model of Supply Side-ism (sometimes leavened with Keynesianism, more often not) has fallen into disfavor and a new model has become preeminent in the US-Speculationism.

I'll borrow from Friedrich Nietzsche to continue: Have you not heard of that madman who lit a lantern in the bright morning hours, ran to the market-place, and cried incessantly: "I am looking for Capitalism! I am looking for Capitalism!"


As many of those who did not believe in Capitalism were standing together there, he excited considerable laughter. Have you lost it, then? said one. Did it lose its way like a child? said another. Or is it hiding? Is it afraid of us? Has it gone on a voyage? or emigrated? Thus they shouted and laughed. The madman sprang into their midst and pierced them with his glances.


"Where has Capitalism gone?" he cried. "I shall tell you. We have killed it - you and I. We are its murderers. But how have we done this? How were we able to drink up the sea? Is there any up or down left? Are we not straying as through an infinite nothing? Do we not feel the breath of empty space? Has it not become colder? Is it not more and more night coming on all the time? Do we not smell anything yet of Capitalism's decomposition? Capitalisms too decompose. Capitalism is dead. Capitalism remains dead. And we have killed it. How shall we, murderers of all murderers, console ourselves? That which was the holiest and mightiest of all that the world has yet possessed has bled to death under our knives. Is not the greatness of this deed too great for us? There has never been a greater deed; and whosoever shall be born after us - for the sake of this deed he shall be part of a higher history than all history hitherto." (with slight modifications)

Nietzsche's madman ranted about God, but I think his form is useful in the current regard. For Nietzsche, God died because man stopped understanding the word (a pun for theologists) and believing in its intended sense. Those who followed after God's death would need some new more powerful (Nietzsche hoped to find something more fundamental, or was he just mocking the attempt, it's hard to tell sometimes) controlling idea or chaos would ensue.

While I feel Nietzsche's argument form seems quite apt for the purpose of this essay, I don't share his faith (if such was the case) that we will find any more powerful, fundamental, controlling idea....and thus chaos ensues.

Consider the opening news item. The government bought a corporation not with the idea of controlling it- i.e., contra right wing talk radio, Obama is no Marxist- but with the idea of profiting from the speculative purchase.

To paraphrase Nixon, "we're all Hedge Fund managers now."

Capitalism is dead. Long live Speculationism.

Speculationism is the belief that economic growth is a function of money flows- not the hard money of decades past but money of indeterminate value which allows its quantity to be increased almost endlessly. Like Keynesianism and Supply Side-ism, note the implicit coordination of the state's power to create money and the providers of economic growth, finance.

The above, as an aside, is but an observation, not a critique. I do, however, find it funny that in the same way US Industrialists, protected behind tariff walls, fancied themselves "capitalists" decades ago, so too do today's Speculationists, protected by the Fed's ability to create money. Who are they kidding?

To wit, the US seems increasingly comfortable allowing its capital to move where it will (and it seems to want to move away) so long as Speculators can profit, not by running the company- i.e. controlling the means of production- but by betting on changes in its "market set" value. In Speculationism the term widget can, in the new textbooks, apply equally well to the things produced and the means of producing them.  The term capital itself has morphed and is no longer a reference to the means of production but rather to the money (sometimes previously referred to as financial capital, but this became repetitious) which, presumably drives it. 

Economic growth in the US is less and less a function of what we make (and how efficiently we make it) and increasingly a function of speculative profit. Thus, argue the Speculationists, the foolishness of Volcker's idea of separating speculative activities from commercial banking: Industry is dying, commerce is a small thing. The business of America is Speculation.

And they are right. Whether this will prove wise in the future remains to be seen, but things don't look good from where I sit.  I think we will miss Capitalism, and the capital (in its old sense) which has moved away.

p.s. Yes I waxed hyperbolic and didn't do justice with my definitions. This is but an essay, a word which means, to try (in this case to throw some ideas into the internet ether)

Helping the Fed Solve the Problem of Excess Reserves

The key to the game is your capital reserves. You don't have enough, you can't pee in the tall weeds with the big dogs. - Gordon Gekko

Ben Bernanke and the brain trust at the Federal Reserve have been working overtime trying to solve the problem of excess reserves in the US banking system. "How," they wonder, "can we drain these reserves from the system without destabilizing the markets?" Their fears of destabilizing markets are, I believe, justified, which seems odd given that the Fed, in the past, has been able to drain reserves, although the quantity drained was admittedly much smaller.

To the extent there is no way to drain these reserves without upsetting the markets the solution to the problem might not be one of action, but of thought. As Norman Vincent Peale said, "Change your thoughts and you change your world." Instead of trying to drain the excess reserves let's admit that they are not, in fact, "excess", but rather, "prudent", or even, as I suspect, "insufficient."

How do we determine if reserve levels are prudent, excess or insufficient? The determination is a process of thought. If financial assumptions about the future are perfectly accurate, there is no need of reserves- correctly valued assets will, under that head, always generate income sufficient to pay liabilities.

Reserves, then, are a safety measure in the event assumptions about the future are inaccurate- if assets are, in fact, not correctly valued. The more inaccurate prior assumptions of future events prove to be the wiser it would have been to increase reserves before the inaccuracies come to light.

The apparently resolved crisis in Greece seems a case in point (as, it seems to me, was the US crisis of 2008). The Greeks didn't simply decide, out of the blue, to borrow an additional 50 or 100 billion Euros, they, at certain levels of government, knew their fiscal position. Why then the crisis?

Simple. They made poor assumptions about either the value of their assets relative to liabilities (what economists call the primary fiscal balance) or the duration of the deceit which, in part, allowed them to borrow in sufficient quantities at favorable rates. In their case the latter seems more of an issue, as tends to be the case when crises "suddenly" manifest.

Like the homeowner who lied about his income to get a home or the Ponzi schemer who claims to own more than he does, the Greeks had been living on borrowed time. The question in that case about a crisis is not if but when.

Deceit, of course, is a loaded term as it connotes intent. Bernie Madoff is in jail because he admitted to such. In other instances a more appropriate phrase would be willfully ignorant. Those in charge hope for an outcome more objective, but equally educated persons deem unlikely, or impossible. Traders call this, talking your book.

Regardless of intent, the effects are the same. Reserves bridge the gap between projected and actual income relative to liabilities whether the gap is a function of deceit or ignorance (willful or otherwise). Sufficiently higher levels of reserves (other things equal) would have kept Mr. Madoff out of jail and obviated the Greek crisis.

Gordon Gekko had it right.

Returning to the issue du jour- the proper level of reserves in the US banking system- the difficulty of imagining a plausible future scenario with the reserves drained strongly suggests to me that current levels are minimally prudent. That is, if draining reserves would cause rates to rise, decrease real sector activity, or some combination thereof such that bank incomes wouldn't cover required payments then they shouldn't be drained.

Why then does the Fed seem so intent on draining? Perhaps they aren't as intent on draining them as some might think. Perhaps their intent is simply to maintain the illusion that the reserves are considered excess. If they told the world the level of reserves was considered prudent this would likely send a message that the financial state of US banks is not as healthy as otherwise advertised. This, in turn, might exacerbate future gaps between bank income and outflow, requiring even higher levels of reserves than currently exist, or, as was the case in Greece and with Mr. Madoff, precipitate a crisis.

Perhaps the only way to keep the real sector operating such that bank assets perform is to increasingly dilute the currency (since any increase in reserves would most likely be "borrowed" from the Fed as happened during the last crisis). Perhaps Mr. Kinsley's nightmare scenario of impending substantial inflation and even hyper-inflation is much nearer that truth than the Fed or Mr. Krugman would have us believe.  Perhaps the classification of reserves as excess has more to do with what the Fed wishes others (i.e. those who lend money to the US) to assume than what they assume, which edges ever closer to Greek deceit.

The Fed could, of course, prove me wrong by draining the reserves deemed to be in excess without precipitating a crisis.

I won't, however, be holding my breath.

The Kins(l)ey Report (on Inflation)

One could, in a debate of US inflation prospects, discuss the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not (in this essay) a reasoned debate but a notice of the lack thereof.


If, like me, you're an official member of the pajama wearing blogger corps, you might be familiar with the recent debate over US inflation prospects between Michael Kinsley and Paul Krugman, et. al. If not, here's Kinsley's initial article, Krugman's rebuttal, Kinsley's retort, and Krugman's rebuttal of the retort.

Krugman's second rebuttal dripped with condescension, or so it seemed to me, recalling memories of school yard bullies. Those memories tempted me to begin this article with a quip about Krugman needing to pick on someone his own size......, but I'll use a different metaphor.

"Ouch!," you might be thinking, "that's a bit cruel."

True.

So's this line from Krugman to Kinsley: "I’m tempted to get into an argument about whether it’s “bullying” to suggest that if you’re going to write about an economic issue, you might want to study it first. But what I really want to do is..."

Don't you love the artful use of the non-statement statement?

Aside from my belief that future events are more likely to follow some variation of Kinsley's nightmare scenario than Krugman's Japan model (about which, more here), the element of the exchange that inspired this post was Krugman's nasty dismissal of an apparently serious inquiry from one who apparently admires his views.

Kinsley's initial article contains statements like: "am I crazy?", "Every economist I admire, from Paul Krugman and Larry Summers on down, is convinced that inflation will remain low for as long as we can predict", "I can’t help feeling that the gold bugs are right", and "My fear is not the result of economic analysis. It’s more from the realm of psychology."

These are the words of a humble student searching for wisdom to quell his fears.

The wise Professor Krugman begins his rebuttal with: "Mike Kinsley has an odd piece in the Atlantic in which he confesses himself terrified about future inflation, even though there’s no hint of that problem in the real world."

You can almost see the sneering Professor holding up the student's paper in front of the class as you read the words (at least I could).

Using the tried and true nasty Professor trick of tossing about a bit of relevant jargon and a counter-example, Krugman expects Kinsley to slink back into his seat.

To his credit, Kinsley doesn't flinch.... much. He almost falls for the Professorial misdirection (debating whether a sudden 100% inflation shock is better than a Weimar hyper-inflation is like debating whether losing both legs is better than getting killed- I see your point, but I'll take none of the above) but then gets back on point, telling the Prof (in effect), "you didn't answer my question."

Why not inflation?

As Kinsley argued, the 70s demonstrated the US is not immune to inflation and Gold has risen from $275 to over $1000 during the past decade. Perhaps Kinsley's main confusion lies in his focus on the future tense, instead of seeing it as an ongoing issue.

Kinsley's search for the truth on inflation reminds me of Alfred Kinsey's search for truth on human sexual habits, which led to the publication of two books on human sexuality known collectively as the Kinsey Reports. Like Kinsley (or so it seems to me) Kinsey's search for truth battled with popular conceptions of what should (in some views) be, but wasn't.

In a sense Kinsey reported on what everyone (collectively) knew, but was afraid to say. The fear (perhaps, with the benefit of hindsight, somewhat justified) among then current opinion shapers was, in part, that open discussion would release the genie from the bottle. Hugh Hefner, of Playboy fame, credits Kinsey with opening his eyes to human sexual experience.

Krugman, in my view, is too smart an economist to dismiss outright the possibility of another significant inflation episode in the US, which may or may not be followed by hyper-inflation.

To use his phrasing, for those dismissing prediction of substantial US inflation, what is it about the US now that looks different to you from Thailand, Korea and Indonesia in say, 1997 (or Russia in 1998, or Iceland just recently)? Substantial public and private sector debt? Check. Huge expansion in the monetary base? Check. Large external debts and ongoing external deficits? Check. Increasing difficulties rolling over ever shorter term debt? Check. And yet each of those countries suffered, not multi-year hyperinflation, admittedly, but a sudden substantial (50-100% or more) inflation shock.

There are, admittedly, differences. As I wrote, I was using his phrasing and argument form. One could debate the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not a reasoned debate but a notice of the lack thereof.

Mr. Krugman might snidely respond to my snidely put question that the issue was hyper-inflation. I lived in Asia during their crisis and such shocks are worth worrying about even if hyper-inflation is avoided (besides, his use of Japan- a nation which self-finances, which seems to me a critical distinction- as counter-point suggests even moderate inflation is unlikely). Moreover, as Kinsley notes, who knows what policy makers will opt to do when the next crisis erupts. The history of the Bernanke Fed is not one of monetary restraint in a time of crisis.

I suspect that Krugman, not the economist, but the opinion shaper is, like those Kinsey battled, trying to keep the genie in the bottle- thus the Professorial dismissal instead of reasoned discussion of the issue. Inflation has both psychological and real world causes- when the two unite, the fireworks begin.

Perhaps, in a limited fashion, the Kinsley Report on Inflation will have a similar effect as Kinsey's, (then again maybe both should be seen as catalyst instead of cause) by bringing the debate into the open.

I wonder who the Hugh Hefner of Inflation will prove to be- perhaps Bill Murphy of GATA?

My advice to Kinsley is to have the courage of his convictions and buy some Gold, the price of which may have been as suppressed as reasoned open debate on US inflation prospects appears to be- both actions aim at the same effect.  I did (at $275 for Krugman's information) and I'm still holding.

US Industry, A Dim Bulb

Wang Jianwei, a graduate engineering student in Liaoning, China, was recently surprised to learn that he had been described as a potential cyberwarrior before the United States Congress due to a paper he published last spring- “Cascade-Based Attack Vulnerability on the U.S. Power Grid”.

My first thought on reading this news was that China would likely only resort to such a tactic in the event of actual war given that China and Asia in general generate (I couldn't resist) great profits from the US grid. Asian electronics exports wouldn't be of much use without a functioning grid in the US.

Further reflection on this topic recalled my days as emerging market economist; specifically one of the key bits of data in that field, electricity generation and consumption. Back then (the 90s) higher electricity consumption was seen as one of the few unalloyed goods in emerging economies- the more electricity an economy consumed the more it would grow.

Applying that view to the US, the graph below paints a picture of wonderful growth.

Yet, looks, in this case might be deceiving. While US electricity consumption has been growing it is being used to power a different mix of activities.

Until the mid 80s US Industry was the biggest consumer of energy, as the graphs below depict. Since the era of financial deregulation and industrial off-shoring (among other changes) Residential (all those new electronics exports from Asia) and Commercial (all those new office towers filled with people and computers in cubicles) use have continued to grow while Industrial use has lagged. US Industry uses roughly the same amount of power today as it used in the early 90s.

Meanwhile China's electricity consumption has been growing by leaps and bounds. The CIA's World Factbook lists China's electricity consumption as a close second to the US.

However, Chinese Industry currently uses, according to their Statistical Yearbook, almost 2.5 times as much electricity as US Industry. Current (2008) Chinese Industrial Electricity Consumption of some 2500B KwH is up from 883B KwH in 1999.

Suffice it to write that, if this data is a guide, the US is no longer the industrial workshop of the world.

Will the US sell Manhattan?

Those who face insolvency, Mr. Schlarmann, a senior member of Germany's Christian Democrats, said, must sell everything they have to pay their creditors. Thus, he said, Greece, given its debt problems, should consider selling some of its uninhabited islands to cut its debt.

The headline in the Bild newspaper took the argument a bit further, "Sell your islands, you bankrupt Greeks - and the Acropolis too!"

I guess we might call this the Andrew Mellon approach to sovereign debt crises- liquidate, liquidate, liquidate, on a national scale. It's a strategy which, if Niall Ferguson's argument-which contains the wonderful line, US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941- that the US, and other western nations, may soon follow Greece into crisis, proves prescient, might inspire calls for the US to sell some islands, like Manhattan.

Perhaps selling the island outright might be a bit much. Yet, while the Chinese Government isn't a fan of the Dalai Lama it might appreciate the Karmic touch of leasing Manhattan from the US for, say, 99 years. Imagine the road signs, "Now Entering New Hong Kong."

In a sense, assuming Wall St. and the NY Fed were included in the lease, it would be the ultimate "pump and dump"- temporarily stabilize the financial system, in large part with money from Asia, and then dump it, and the derivatives portfolios contained therein, on China. Why wait for the next financial crisis to go hat in hand to Asia. Let's sell Citibank at $4 instead of waiting for it to fall under a buck.

The world might even benefit from such an arrangement. Yesterday, Paul Volcker told the House Financial Services Committee that regulators, like the NY Fed, are unlikely to rein in excessive Wall St. speculation. If the Chinese get the NY Fed, and thus oversight of financial markets, their no-nonsense approach to dealing with corruption, which includes the death penalty, might help finance get back on the "straight and narrow." I'd love to see Lloyd Blankfein testify to the Chinese Communist Party.

A man can dream, can't he? And who knows what the future will bring. I doubt the Ottoman, Mughal and Manchu Empires could have imagined that the West would take over administration of their territories.

Fortunately, at least for Wall Streeters wary of Chinese justice, the German proposal fell on deaf ears. Yet, the seemingly intractable problem of many western governments' unsustainable debt levels remains.

Niall Ferguson argues that the problem is the welfare state- perhaps he should take on Keynes with a new book, The Economic Consequences of the Welfare State. I suspect, however, improper- to the extent such policies are seen as wise means of avoiding social unrest- welfare state funding is but a symptom of an apparently widely held view by many in both public and private sector positions of power that, in the words of Dick Cheney, deficits don't matter. 

War finance and Wall St. bail-outs played at least as large a part as welfare spending in US Federal Debt doubling since 2001.   Those bail-outs, in turn, were made necessary by Wall St.'s take on Cheney's wisdom, which they express as, too big to fail.

Contra Mr. Cheney, deficits, which add up to debt over time, do matter.  Contra Wall St., no insitution is too big to fail.  Both views are, in my view, effects of a broader issue.  There is no agreed upon method, barring adoption of island sales, for sovereign debt resolution. In decades past when nations retained currency sovereignty devaluation was always an option, and fear of devaluation kept investors on their toes. The more recent desire for supra-national currencies turns countries like Greece into states like California with very limited options.

If current trends continue, nations like Greece and states like California might simply be absorbed into larger bodies. Greece could become a special administrative region of the EU and California could become a district of the US Federal Government. Yet this would simply buy time, making the ultimate sovereign debt problem that much harder to resolve.

If the world is ever to reform global finance it will need, first and foremost, to agree upon a method of debt resolution applicable to all large institutions, public and private.   So long as those running large institutions feel there are no consequences to deficits, debt problems will continue to mount.  If we are going to use money to drive the world, we need to take it seriously.

The Mask of Solvency

On reading the news of Goldman Sach's involvement in the Greek Government's heretofore successful plot to negatively obscure their fiscal position from the rest of the world (with the notable exception of Goldman Sachs, it seems worth noting) a vision sprang to mind. In it, a group of Greek Finance Officials are seated on one side of one of those over-long conference room tables found in the upper floors of modern office buildings facing two people from Goldman Sachs- Europe's Chief Institutional Derivatives Salesman and his mid 20s blond bombshell assistant.


After the obligatory pleasantries are completed the assistant distributes folders to the Greek Officials, bending over slightly in front of each man in the process. "As I was saying on the phone, Gentlemen," the GS salesman interjects, interrupting the not well concealed ogling, "we at Goldman Sachs can structure a portfolio of derivatives to hide your true fiscal position from both potential investors and the prying eyes of the European Central Government. We call it, 'The Mask of Solvency' portfolio."

Fade out.

What an interesting name, and notion; The Mask of Solvency- a means for the insolvent to appear to all but the most discerning observer as solvent as the best AAA credit, e.g. the US Government (irony intended).

The invented-but-still-possibly-accurate name of the GS ploy reminds me of a book on Psychopaths by Psychiatrist Hervey Cleckley, The Mask of Sanity. The depiction of Psychopathology seems to me a most useful prism through which to view current financial affairs.

To wit (from the book): It must be remembered that even the most severely and obviously disabled psychopath presents a technical appearance of sanity, often one of high intellectual capacities, and not infrequently succeeds in business or professional activities for short periods, sometimes for considerable periods.

More often than not, the typical psychopath will seem particularly agreeable and make a distinctly positive impression when he is first encountered. Alert and friendly in his attitude, he is easy to talk with and seems to have a good many genuine interests. There is nothing at all odd or queer about him, and in every respect he tends to embody the concept of a well-adjusted, happy person. Nor does he, on the other hand, seem to be artificially exerting himself like one who is covering up or who wants to sell you a bill of goods. He would seldom be confused with the professional backslapper or someone who is trying to ingratiate himself for a concealed purpose. Signs of affectation or excessive affability are not characteristic. He looks like the real thing. Very often indications of good sense and sound reasoning will emerge and one is likely to feel soon after meeting him that this normal and pleasant person is also one with high abilities. Psychometric tests also very frequently show him of superior intelligence. More than the average person, he is likely to seem free from social or emotional impediments, from the minor distortions, peculiarities, and awkwardnesses so common even among the successful.

The idea of a mask of solvency must have seemed like a stroke of genius to those whose masks of sanity had faded as far from conscious awareness as breathing. Successful arbitrageurs, after all, are well practiced in accepting the facsimile of a thing as the true thing itself. Thus, for most, the S&P 500 future is seen as identical to a portfolio of those 500 stocks, even though it only delivers (or takes) cash on settlement. As with the psychopath itself, only careful observation of behavior in all facets of life distinguishes the arbitraged facsimile from the true thing.

Usually, the distinguishing characteristics only manifest, i.e. the masks slips, as seems the case with Greek debt, when the damage has been done.

Or is damage done? Is there a difference in experience between merely the appearance of a thing, or quality, like solvency or sanity, and that thing or quality in truth?

It seems man has been pondering this question for Millennia, which is to write that it is a question each person apparently needs to answer for his or her self. In Plato's Republic Socrates asks if there is a difference between a man who appears Just but is not and a man who is truly Just. Athens too, it seems, had its share of Psychopaths in positions of influence inspiring such questions.

In our modern, financially centered system, Solvency, not Justice is the issue. Recasting Socrates' question, Is there a difference between a financial entity which appears solvent but is not, and one that is truly solvent? Would it not be better, as Socrates' listeners asked (about Justice) in the Republic, to enjoy the extra consumption afforded those who can mask their insolvency?

Socrates argued against such a view, while admitting that those so masked might reap temporary benefits. His reward for such truth-seeking views was death ordered by an Athenian Government which was in the process of devolution from the core of a great empire to a city with little sovereignty.

Whether the question has been answered accurately is up to everyone to individually decide.

One wonders if any of the Greek Finance Officials recalled Socrates' views when offered the Mask of Solvency. Regardless, I suspect Socrates' wisdom is now evident to them.