Putting the incentives in the wrong place

At Slate.com, Eliot Spitzer argues that the BP disaster and the Wall Street disaster have something in common:

The law of incentives is what links the Wall Street cataclysm and BP's ongoing eco-disaster: In each case, we socialized risk and privatized gain, creating an asymmetry that created an incentive for private actors to accept and create too much risk in their business model, believing that at the end of the day, somebody else would bear the burden of that risk, should it metastasize into a disaster.

He mentions the astounding fact that in their current risk analysis of the too-big-to-fail banks, the Wall Street agencies assume that the federal government will come to the rescue with future bailouts. What we have is amazing. Public risk and private gain don't begin to pass the smell test. We are doling out corporate welfare where it is not needed and where it is not in the best interest of the taxpayers. And somehow, this catastrophic system passes as "the free market" among many modern-day free market fundamentalists. Spitzer points out that there are two ways to deal with businesses that engage in dangerous activities, tort liability and regulation, and that the public will be protected only if we have at least one of these.

A regime of full tort damages and recoveries is one way to balance safety and exploration, or investment and risk, or whatever economic activity we are discussing. But there is another way: meaningful and vigorous oversight to impose safety standards that are dictated not by the market for insurance but by the judgment of serious experts in a regulatory context.

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Finally, a politician talks straight about the need for Wall Street Reform

In an impassioned speech this morning, Sen. Ted Kaufman (D-Del.) called for the break-up of megabanks and a firmer separation between Main Street banking and Wall Street trading. At the above link video excerpts are available. OK, now we need 99 more senators and hundreds of representatives to get on board.

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Joseph Stiglitz weighs in on the Federal Reserve

Joseph Stiglitz is one of the greatest economists in the world. He's held professorships at Yale, Stanford, Duke, Princeton and Oxford Universities, and now teaches at Columbia University. He was the chair of the president's Council of Economic Advisors under Clinton. He served as Senior Vice President and Chief Economist at the World Bank from 1997 to 2000. He was awarded the Nobel Prize in Economics in 2001. There should be no disputing that he is eminently qualified in the field of economics, which is all the more reason for you to pay attention to what he says about the Federal Reserve. Speaking at a conference held by the Roosevelt Institute, he said that if a country had come to the World Bank under his tenure seeking aid, while maintaining a financial regulatory system like the Federal Reserve, it would have raised very big alarms:

"If we had seen a governance structure that corresponds to our Federal Reserve system, we would have been yelling and screaming and saying that country does not deserve any assistance, this is a corrupt governing structure," Stiglitz said during a conference on financial reform in New York. "It's time for us to reflect on our own structure today, and to say there are parts that can be improved."

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How do Wall Street banks make their money?

In the March 4, 2000 episode of Rolling Stone, Matt Taibbi answers a question on many peoples' minds: To exactly does Wall Street make so much money that it could hand out multi-billions of dollars in bonuses last year and this year? The story of Taibbi detailed article is that the Wall Street banks use at least seven major scams to make their money, and most of them involve taking advantage of American taxpayers. The seven scams can be summarized in one principle: "the answer . . . is basically twofold: they raped the taxpayer, and they raped their clients." Taibbi's entire article is available online. If the extremes, the corruption and the opacity of Wall Street have angered you, you'll appreciate Taibbi's facts, as well as his colorful descriptions. The first of the seven major cons described by Taibbi is the "Swoop and Squat," by which Taibbi is referring to the fact that AIG should not have been able to hand over big chunks of cash to a single creditor like Goldman when AIG was about to go belly up. Taibbi correctly refers to this maneuver as a "fraudulent conveyance." That money accounts for $19 billion in cash that Goldman would not have had without the massive intervention by the United States. As Taibbi asks: "To is that $13.4 billion in 2009 profits looking now?" Taibbi cautions that these numbers don't even include the direct bailouts of Goldman Sachs and other big banks. I'll mention one more of the seven major Wall Street cons described by Taibbi: "The Dollar store." Less than a week after the AIG bailout, Goldman and another investment bank, Morgan Stanley applied for and received permission to become bank holding companies, which made them available for increased federal financial support. Why would they do that? You probably won't read this anywhere in your local newspaper, because it's real news.

Institutions that were, in reality, high risk gambling houses were allowed to masquerade as conservative commercial banks. As a result of this new designation, they were given access to a virtually endless stream of "free money" courtesy of unsuspecting taxpayers. The $10 billion that Goldman received under the better-known TARP bailout was chump change in comparison to the smorgasbord of direct and indirect aid it qualified for as a commercial bank.

When Goldman Sachs and Morgan Stanley received those expedited federal bank charters, they were given permission to go to the Fed to borrow huge amounts of money at 0%. Taibbi points out that without this federal gravy, these banks would've totally collapsed, because they had no other way to raise capital at the time. Consider what the banks did with this taxpayer money, however.

Borrowing at 0% interest, banks like Goldman now have virtually infinite ways to make money. In one of the most common maneuvers, they simply took the money they brought from the government at 0% and went it back to the government by buying treasury bills that pay interest of three or 4%. It was basically a license to print money--no different than attaching an ATM to the side of the Federal Reserve.

Taibbi writes that that "The Dollar Store" goes a long way to explaining the enormous profits of Goldman Sachs last year. The entire article is well worth reading. Taibbi has once again done a terrific job of describing the corrupt ways of Washington and Wall Street.

Continue ReadingHow do Wall Street banks make their money?