The political problem

Several years ago, immediately post-crisis, I wrote a short article for Nature exploring new ideas about modelling economic and financial systems. I wrote about agent-based models and other similar ideas, nothing all that earth shaking really. In an early draft, I recall adding a section toward the end of the piece making the point that, of course, better models, better science, etc., would never be enough because ultimately policy making has an irreducible political element; financial crises can almost always be traced back to the political influence of powerful forces who shape policies to help themselves (or to try to do so), with little thought for the welfare of others. To my surprise, my editor at Nature took that section out saying something like "we'd like to stick to the science."

I thought that was unfortunate and hugely misleading. Corruption is real, and I really do think that no amount of better economics will eliminate financial and economic crises, because of the reality of politics. No avoiding it. Simon Wren-Lewis has a great post on this topic today, looking at why it would not actually be that hard -- conceptually -- to make the financial system more stable. The only barrier is the intimate connection between finance and politics ("quite frankly, the banks own this place" as U.S. Senator Dick Durbin once put it), which means that banks won't actually have to do things that might help the public good and the nation as a whole:

There is one simple and straightforward measure that would go a long way to avoiding another global financial crisis, and that is to substantially increase the proportion of bank equity that banks are obliged to hold. This point is put forcibly, and in plain language, in a recent book by Admati and Hellwig: The Bankers New Clothes. (Here is a short NYT piece by Admati.) Admati and Hellwig suggest the proportion of the balance sheet that is backed by equity should be something like 25%, and other estimates for the optimal amount of bank equity come up with similar numbers. The numbers that regulators are intending to impose post-crisis are tiny in comparison.

It is worth quoting the first paragraph of a FT review by Martin Wolf of their book:

“The UK’s Independent Commission on Banking, of which I was a member, made a modest proposal: the proportion of the balance sheet of UK retail banks that has to be funded by equity, instead of debt, should be raised to 4 per cent. This would be just a percentage point above the figure suggested by the Basel Committee on Banking Supervision. The government rejected this, because of lobbying by the banks.”

Why are banks so reluctant to raise more equity capital? One reason is tax breaks that make finance using borrowing cheaper. But non-financial companies, that also have a choice between raising equity and borrowing to finance investment, typically use much more equity capital and less borrowing. If things go wrong, you can reduce dividends, but you still have to pay interest, so companies limit the amount of borrowing they do to reduce the risk of bankruptcy. But large banks are famously too big to fail. So someone else takes care of the bankruptcy risk - you and me. We effectively guarantee the borrowing that banks do. (If this is not clear, read chapter 9 of the book here.  The authors make a nice analogy with a rich aunt who offers to always guarantee your mortgage.)

The state guarantee is a huge, and ongoing, public subsidy to the banking sector. For large banks, it is of the same order of magnitude as the profits they make. We know where a large proportion of the profits go - into bonuses for those who work in those banks. The larger is the amount of equity capital that banks are forced to hold, the more the holders of that equity bear the cost of bank failure, and the less is the public subsidy. Seen in this way it becomes obvious why banks do not want to hold more equity capital - they rather like being subsidised by the state, so that the state can contribute to their bonuses. (Existing equity holders will also resist increasing equity capital, for reasons Carola Binder summarises based on the work of Admati and Hellwig and coauthors.)

This is why the argument is largely a no brainer for economists. [1] Most economists are instinctively against state subsidies, unless there are obvious externalities which they are countering. With banks the subsidy is not just an unwarranted transfer of resources, but it is also distorting the incentives for bankers to take risk, as we found out in 2007/8. Bankers make money when the risk pays off, and get bailed out by governments when it does not.

So why are economists being ignored by politicians? It is hardly because banks are popular with the public. The scale of the banking sector’s misdemeanours is incredible, as John Lanchester sets out here. I suspect many will think that banks are being treated lightly because politicians are concerned about choking off the recovery. Yet the argument that banks often make - holding equity capital represents money that is ‘tied up’ and so cannot be lent to firms and consumers - is simply nonsense. A more respectable argument is that holding much more equity capital would translate into greater costs for bank borrowers, but David Miles suggests the size of this effect would not be large. (See also Simon Johnson here, John Plender here and Thomas Hoenig here.) In any case, public subsidies are bound to be passed on to some extent, but that does not justify them. Politicians are busy trying to phase out public subsidies elsewhere, so why are banks so different?

There is one simple explanation. The power of the banking lobby (and the financial industry more generally) is immense, from campaign contributions to regulatory capture of various kinds. It would be nice to imagine that the UK was less vulnerable than the US in this respect, but there are good reasons to think otherwise. [2] As a result, the power and influence of banks and bankers within government has hardly suffered as a result of the Great Recession that they played a large part in creating.

This point bears repeating -- indeed, it ought to be repeated every day for the rest of the year. All the technical and semi-technical articles now being published about measures for getting at systemic risk and improved schemes for weighting capital and so on, however clever and interesting they may be, actually only serve to draw attention away from this most serious problem, which is institutionalized corruption plain and simple. If every finance professor wrote one article on this topic -- after all, shouldn't this really be THE main topic in finance today? -- we might one day get somewhere with fixing the financial system.

The War on Reality

If you're at all disturbed (I am) by the various recent revelations over massive data trolling by government agencies, you should read this article in the NYT by Peter Ludlow. It looks at the vast and largely invisible ecology of private security and intelligence firms that are not only gathering information on ordinary people, but actively creating and spreading disinformation (otherwise known as "lies") to discredit opponents of their corporate clients. They're information mercenaries who are essentially shaping reality as we see it -- and not with benign motives, you can be sure. Ludlow:

To get some perspective on the manipulative role that private intelligence agencies play in our society, it is worth examining information that has been revealed by some significant hacks in the past few years of previously secret data.

Important insight into the world these companies came from a 2010 hack by a group best known as LulzSec  (at the time the group was called Internet Feds), which targeted the private intelligence firm HBGary Federal.  That hack yielded 75,000 e-mails.  It revealed, for example, that Bank of America approached the Department of Justice over concerns about information that WikiLeaks had about it.  The Department of Justice in turn referred Bank of America to the lobbying firm Hunton and Willliams, which in turn connected the bank with a group of information security firms collectively known as Team Themis.

Team Themis (a group that included HBGary and the private intelligence and security firms Palantir Technologies, Berico Technologies and Endgame Systems) was effectively brought in to find a way to undermine the credibility of WikiLeaks and the journalist Glenn Greenwald (who recently broke the story of Edward Snowden’s leak of the N.S.A.’s Prism program),  because of Greenwald’s support for WikiLeaks. Specifically, the plan called for actions to “sabotage or discredit the opposing organization” including a plan to submit fake documents and then call out the error. As for Greenwald, it was argued that he would cave “if pushed” because he would “choose professional preservation over cause.” That evidently wasn’t the case.

Team Themis also developed a proposal for the Chamber of Commerce to undermine the credibility of one of its critics, a group called Chamber Watch. The proposal called for first creating a “false document, perhaps highlighting periodical financial information,” giving it to a progressive group opposing the Chamber, and then subsequently exposing the document as a fake to “prove that U.S. Chamber Watch cannot be trusted with information and/or tell the truth.” (A photocopy of the proposal can be found here.)

In addition, the group proposed creating a “fake insider persona” to infiltrate Chamber Watch.  They would “create two fake insider personas, using one as leverage to discredit the other while confirming the legitimacy of the second.” The hack also revealed evidence that Team Themis was developing a “persona management” system — a program, developed at the specific request of the United States Air Force, that allowed one user to control multiple online identities (“sock puppets”) for commenting in social media spaces, thus giving the appearance of grass roots support.  The contract was eventually awarded to another private intelligence firm.

This may sound like nothing so much as a “Matrix”-like fantasy, but it is distinctly real, and resembles in some ways the employment of “Psyops” (psychological operations), which as most students of recent American history know, have been part of the nation’s military strategy for decades. The military’s “Unconventional Warfare Training Manual” defines Psyops as “planned operations to convey selected information and indicators to foreign audiences to influence their emotions, motives, objective reasoning, and ultimately the behavior of foreign governments, organizations, groups, and individuals.” In other words, it is sometimes more effective to deceive a population into a false reality than it is to impose its will with force or conventional weapons.  Of course this could also apply to one’s own population if you chose to view it as an “enemy” whose “motives, reasoning, and behavior” needed to be controlled.

Psyops need not be conducted by nation states; they can be undertaken by anyone with the capabilities and the incentive to conduct them, and in the case of private intelligence contractors, there are both incentives (billions of dollars in contracts) and capabilities.

Several months after the hack of HBGary, a Chicago area activist and hacker named Jeremy Hammond successfully hacked into another private intelligence firm — Strategic Forcasting Inc., or Stratfor), and released approximately five million e-mails. This hack provided a remarkable insight into how the private security and intelligence companies view themselves vis a vis government security agencies like the C.I.A. In a 2004 e-mail to Stratfor employees, the firm’s founder and chairman George Friedman was downright dismissive of the C.I.A.’s capabilities relative to their own:  “Everyone in Langley [the C.I.A.] knows that we do things they have never been able to do with a small fraction of their resources. They have always asked how we did it. We can now show them and maybe they can learn.”

The Stratfor e-mails provided us just one more narrow glimpse into the world of the private security firms, but the view was frightening.  The leaked e-mails revealed surveillance activities to monitor protestors in Occupy Austin as well as Occupy’s relation to the environmental group Deep Green Resistance.  Staffers discussed how one of their own men went undercover (“U/C”) and inquired about an Occupy Austin General Assembly meeting to gain insight into how the group operates.\

Stratfor was also involved in monitoring activists who were seeking reparations for victims of a chemical plant disaster in Bhopal, India, including a group called Bophal Medical Appeal. But the targets also included The Yes Men, a satirical group that had humiliated Dow Chemical with a fake news conference announcing reparations for the victims.  Stratfor regularly copied several Dow officers on the minutia of activities by the two members of the Yes Men.One intriguing e-mail revealed that the Coca-Cola company was asking Stratfor for intelligence on PETA (People for the Ethical Treatment of Animals) with Stratfor vice president for Intelligence claiming that “The F.B.I. has a classified investigation on PETA operatives. I’ll see what I can uncover.” From this one could get the impression that the F.B.I. was in effect working as a private detective Stratfor and its corporate clients.

Stratfor also had a broad-ranging public relations campaign.  The e-mails revealed numerous media companies on its payroll. While one motivation for the partnerships was presumably to have sources of intelligence, Stratfor worked hard to have soap boxes from which to project its interests. In one 2007 e-mail, it seemed that Stratfor was close to securing a regular show on NPR: “[the producer] agreed that she wants to not just get George or Stratfor on one time on NPR but help us figure the right way to have a relationship between ‘Morning Edition’ and Stratfor.”

On May 28 Jeremy Hammond pled guilty to the Stratfor hack, noting that even if he could successfully defend himself against the charges he was facing, the Department of Justice promised him that he would face the same charges in eight different districts and he would be shipped to all of them in turn.  He would become a defendant for life.  He had no choice but to plea to a deal in which he may be sentenced to 10 years in prison.  But even as he made the plea he issued a statement, saying “I did this because I believe people have a right to know what governments and corporations are doing behind closed doors. I did what I believe is right.”  (In a video interview conducted by Glenn Greenwald with Edward Snowden in Hong Kong this week, Snowden expressed a similar ethical stance regarding his actions.)

Given the scope and content of what Hammond’s hacks exposed, his supporters agree that what he did was right. In their view, the private intelligence industry is effectively engaged in Psyops against the American public., engaging in “planned operations to convey selected information to [us] to influence [our] emotions, motives, objective reasoning and, ultimately, [our] behavior”? Or as the philosopher might put it, they are engaged in epistemic warfare.

Secrets of Cyprus...

Just something to think about when scratching your head over the astonishing developments in Cyprus, which seem to be more or less intentionally designed to touch off bank runs in several European nations. Why? Courtesy of Zero Hedge:

...news is now coming out that the Cyprus parliament has postponed the decision and may in fact not be able to reach agreement. They may tinker with the percentages, to penalize smaller savers less (and larger savers more). However, the damage is already done. They have hit their savers with a grievous blow, and this will do irreparable harm to trust and confidence.

As well it should! In more civilized times, there was a long established precedent regarding the capital structure of a bank. Equity holders incur the first losses as they own the upside profits and capital gains. Next come unsecured creditors who are paid a higher interest rate, followed by secured bondholders who are paid a lower interest rate. Depositors are paid the lowest interest rate of all, but are assured to be made whole, even if it means every other class in the capital structure is utterly wiped out.

As caveat to the following paragraph, I acknowledge that I have not read anything definitive yet regarding bondholders. I present my assumptions (which I think are likely correct).

As with the bankruptcy of General Motors in the US, it looks like the rule of law and common sense has been recklessly set aside. The fruit from planting these bitter seeds will be harvested for many years hence. As with GM, political expediency drives pragmatic and ill-considered actions. In Cyprus, bondholders include politically connected banks and sovereign governments.  Bureaucrats decided it would be acceptable to use depositors like sacrificial lambs. The only debate at the moment seems to be how to apportion the damage amongst “rich” and “non-rich” depositors.

Also, much more on the matter here, mostly expressing similar sentiments. And do read The War On Common Sense by Tim Duy:

This weekend, European policymakers opened up a new front in their ongoing war on common sense.  The details of the Cyprus bailout included a bail-in of bank depositors, small and large alike.  As should have been expected, chaos ensued as Cypriots rushed to ATMs in a desperate attempt to withdraw their savings, the initial stages of what is likely to become a run on the nation's banks.  Shocking, I know.  Who could have predicted that the populous would react poorly to an assault on depositors?

Everyone.  Everyone would have predicted this.  Everyone except, apparently, European policymakers....
 

Strategic recklessness

Some poignant (and infuriating) insight from Chris Arnade on Why it's smart to be reckless on Wall St.:

... asymmetry in pay (money for profits, flat for losses) is the engine behind many of Wall Street’s mistakes. It rewards short-term gains without regard to long-term consequences. The results? The over-reliance on excessive leverage, banks that are loaded with opaque financial products, and trading models that are flawed. ... Regulation is largely toothless if banks and their employees have the financial incentive to be reckless.

For banks, nothing is illegal

This would be literally unbelievable, except that we've all become desensitized to the double standard of our justice system -- enforcement of laws against ordinary people, and systematic collusion with large banks and corporate offenders to keep anyone from going to jail. I think Matt Taibbi offers the most honest take on this shameful decision to slap HSBC with fines only, rather than pursuing what should have been slam-dunk prosecutions for money laundering and drug smuggling on a global scale:

Wow. So the executives who spent a decade laundering billions of dollars will have to partially defer their bonuses during the five-year deferred prosecution agreement? Are you fucking kidding me? That's the punishment? The government's negotiators couldn't hold firm on forcing HSBC officials to completely wait to receive their ill-gotten bonuses? They had to settle on making them "partially" wait? Every honest prosecutor in America has to be puking his guts out at such bargaining tactics. What was the Justice Department's opening offer – asking executives to restrict their Caribbean vacation time to nine weeks a year?

So you might ask, what's the appropriate financial penalty for a bank in HSBC's position? Exactly how much money should one extract from a firm that has been shamelessly profiting from business with criminals for years and years? Remember, we're talking about a company that has admitted to a smorgasbord of serious banking crimes. If you're the prosecutor, you've got this bank by the balls. So how much money should you take?

How about all of it? How about every last dollar the bank has made since it started its illegal activity? How about you dive into every bank account of every single executive involved in this mess and take every last bonus dollar they've ever earned? Then take their houses, their cars, the paintings they bought at Sotheby's auctions, the clothes in their closets, the loose change in the jars on their kitchen counters, every last freaking thing. Take it all and don't think twice. And then throw them in jail.

Sound harsh? It does, doesn't it? The only problem is, that's exactly what the government does just about every day to ordinary people involved in ordinary drug cases.

And people wonder why the US falls year after year a little further down the Corruption Perceptions Index? As of 2012, we're just slightly ahead of Chile, Uruguay and The Bahamas. 

What's going on in Greece

Numerian, one of the most insightful financial bloggers I know, gets to the bottom of the markets' surge in the wake of the Greek passage of the new "austerity" measures:

For now, stock markets are happy because they get their periodic injection of heroin – oops, make that “liquidity” – to keep the game going. The game is the one we have all lived through our whole lives – the one where capitalism continues to grow by taking on more and more debt, until now every country is at the point where only the government is big enough to take on the enormous amounts of new debt necessary to keep paying principal and interest on the old debt. At least some countries are: the United States, the UK, Germany, France. Greece of course lost that privilege several years ago, and now even big borrowers like Italy are allowed into the markets only for very short term maturities.

The game, in short, is about over, choking to death on too much debt, kept on a resuscitator by politicians and central bankers who know the public has no way to stop them from raising trillions of dollars or euros with new bond issues. Only the market can stop an out-of-control debtor. Greece has found that out, Italy and Spain and Portugal are close to finding that out, and the UK and the United States are on the list, being no more virtuous than the Greeks. Once the government can no longer borrow, default in some form is inevitable, and austerity follows. The Greeks have austerity handed to them by the Germans; everyone else will be able to choose their own forms of austerity, as different economic and social forces fight with each other in a country that has run out of borrowing capacity and must live off the taxes it is able to raise.

If the stock market had a long term view, it would think about these things. It would look at Greece as a combination horror story and warning sign. Instead, the stock market lives for the day only, and for now the debt binge continues, and the fix of easy credit is being pumped into the financial system once more. Let the celebrations continue.

Prosecuting Wall St.

By way of Simolean Sense:

The following is a script of "Prosecuting Wall Street" (CBS) which aired on Dec. 4, 2011. Steve Kroft is correspondent, James Jacoby, producer.

It's been three years since the financial crisis crippled the American economy, and much to the consternation of the general public and the demonstrators on Wall Street, there has not been a single prosecution of a high-ranking Wall Street executive or major financial firm even though fraud and financial misrepresentations played a significant role in the meltdown. We wanted to know why, so nine months ago we began looking for cases that might have prosecutorial merit. Tonight you'll hear about two of them. We begin with a woman named Eileen Foster, a senior executive at Countrywide Financial, one of the epicenters of the crisis.

Steve Kroft: Do you believe that there are people at Countrywide who belong behind bars?

Eileen Foster: Yes.

Kroft: Do you want to give me their names?

Foster: No.

Kroft: Would you give their names to a grand jury if you were asked?

Foster: Yes.

But Eileen Foster has never been asked - and never spoken to the Justice Department - even though she was Countrywide's executive vice president in charge of fraud investigations...

See the video and transcript here.

Central corporate control revealed by mathematics

If you haven't already heard about this new study on the network of corporate control, do have a look. The idea behind it was to use network analysis of who owns whom in the corporate world (established through stock ownership) to tease out centrality of control. New Scientist magazine offers a nice account, which starts as follows:

AS PROTESTS against financial power sweep the world this week, science may have confirmed the protesters' worst fears. An analysis of the relationships between 43,000 transnational corporations has identified a relatively small group of companies, mainly banks, with disproportionate power over the global economy.

The study's assumptions have attracted some criticism, but complex systems analysts contacted by New Scientist say it is a unique effort to untangle control in the global economy. Pushing the analysis further, they say, could help to identify ways of making global capitalism more stable.

The idea that a few bankers control a large chunk of the global economy might not seem like news to New York's Occupy Wall Street movement and protesters elsewhere (see photo). But the study, by a trio of complex systems theorists at the Swiss Federal Institute of Technology in Zurich, is the first to go beyond ideology to empirically identify such a network of power. It combines the mathematics long used to model natural systems with comprehensive corporate data to map ownership among the world's transnational corporations (TNCs).

But also have a look at the web site of the project behind the study, the European project Forecasting Financial Crises, where the authors have tried to clear up several common misinterpretations of just what the study shows.

Indeed, I know the members of this group quite well. They're great scientists and this is a beautiful piece of work. If you know a little about natural complex networks, then the structures found here actually aren't terrifically surprising. However, they are interesting, and it's very important to have the structure documented in detail. Moreover, just because the structure observed here is very common in real world complex networks doesn't mean its something that is good for society.

Hating bankers and the "Unholy Alliance" -- the long history

An excellent if brief article at Salon.com gives some useful historical context to the current animosity toward bankers -- it's nothing new. Several interesting quotes from key figures in the past:

“Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people. To destroy this invisible government, to befoul this unholy alliance between corrupt business and corrupt politics is the first task of statesmanship.”

Theodore Roosevelt, 1912

“We have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks. The Federal Reserve Board, a Government board, has cheated the Government of the United States and the people of the United States out of enough money to pay the national debt. The depredations and the iniquities of the Federal Reserve Board and the Federal Reserve banks acting together have cost this country enough money to pay the national debt several times over…

“Some people think the Federal Reserve Banks are United States Government institutions. They are not Government institutions. They are private credit monopolies, which prey upon the people of the United States for the benefit of themselves and their foreign customers, foreign and domestic speculator sand swindlers, and rich and predatory money lenders.”

Louis McFadden, chairman of the House Committee on Banking and Currency, 1932

I should have known this, but didn't -- the Federal Reserve Banks are not United States Government institutions. They are indeed owned by the private banks themselves, even though the Fed has control over taxpayer funds.This seems dubious in the extreme to me, although I'm sure there are many arguments to consider. Memory recalls reading arguments about the required independence of the central bank, but independence is of course not the same as "control by the private banks." Maybe we need to change the governance of the Fed and install some oversight with real power from a non-banking non-governmental element.

And my favourite:

“Banks are an almost irresistible attraction for that element of our society which seeks unearned money.”

FBI head J. Edgar Hoover, 1955.

In recent years, the attraction has been very strong indeed.

This is why knowing history is so important. Many battles have been fought before.

Matt Taibbi on OWS

Don't miss this post by Matt Taibbi on the Occupy Wall St. movement and its roots as an anti-corruption movement:

People aren't jealous and they don’t want privileges. They just want a level playing field, and they want Wall Street to give up its cheat codes, things like:

FREE MONEY. Ordinary people have to borrow their money at market rates. Lloyd Blankfein and Jamie Dimon get billions of dollars for free, from the Federal Reserve. They borrow at zero and lend the same money back to the government at two or three percent, a valuable public service otherwise known as "standing in the middle and taking a gigantic cut when the government decides to lend money to itself."

Or the banks borrow billions at zero and lend mortgages to us at four percent, or credit cards at twenty or twenty-five percent. This is essentially an official government license to be rich, handed out at the expense of prudent ordinary citizens, who now no longer receive much interest on their CDs or other saved income. It is virtually impossible to not make money in banking when you have unlimited access to free money, especially when the government keeps buying its own cash back from you at market rates.

Your average chimpanzee couldn't fuck up that business plan, which makes it all the more incredible that most of the too-big-to-fail banks are nonetheless still functionally insolvent, and dependent upon bailouts and phony accounting to stay above water. Where do the protesters go to sign up for their interest-free billion-dollar loans?

CREDIT AMNESTY. If you or I miss a $7 payment on a Gap card or, heaven forbid, a mortgage payment, you can forget about the great computer in the sky ever overlooking your mistake. But serial financial fuckups like Citigroup and Bank of America overextended themselves by the hundreds of billions and pumped trillions of dollars of deadly leverage into the system -- and got rewarded with things like the Temporary Liquidity Guarantee Program, an FDIC plan that allowed irresponsible banks to borrow against the government's credit rating.

This is equivalent to a trust fund teenager who trashes six consecutive off-campus apartments and gets rewarded by having Daddy co-sign his next lease. The banks needed programs like TLGP because without them, the market rightly would have started charging more to lend to these idiots. Apparently, though, we can’t trust the free market when it comes to Bank of America, Goldman, Sachs, Citigroup, etc.

In a larger sense, the TBTF banks all have the implicit guarantee of the federal government, so investors know it's relatively safe to lend to them -- which means it's now cheaper for them to borrow money than it is for, say, a responsible regional bank that didn't jack its debt-to-equity levels above 35-1 before the crash and didn't dabble in toxic mortgages. In other words, the TBTF banks got better credit for being less responsible. Click on freecreditscore.com to see if you got the same deal.

STUPIDITY INSURANCE. Defenders of the banks like to talk a lot about how we shouldn't feel sorry for people who've been foreclosed upon, because it's they're own fault for borrowing more than they can pay back, buying more house than they can afford, etc. And critics of OWS have assailed protesters for complaining about things like foreclosure by claiming these folks want “something for nothing.”

This is ironic because, as one of the Rolling Stone editors put it last week, “something for nothing is Wall Street’s official policy." In fact, getting bailed out for bad investment decisions has been de rigeur on Wall Street not just since 2008, but for decades.

Time after time, when big banks screw up and make irresponsible bets that blow up in their faces, they've scored bailouts. It doesn't matter whether it was the Mexican currency bailout of 1994 (when the state bailed out speculators who gambled on the peso) or the IMF/World Bank bailout of Russia in 1998 (a bailout of speculators in the "emerging markets") or the Long-Term Capital Management Bailout of the same year (in which the rescue of investors in a harebrained hedge-fund trading scheme was deemed a matter of international urgency by the Federal Reserve), Wall Street has long grown accustomed to getting bailed out for its mistakes.

The 2008 crash, of course, birthed a whole generation of new bailout schemes. Banks placed billions in bets with AIG and should have lost their shirts when the firm went under -- AIG went under, after all, in large part because of all the huge mortgage bets the banks laid with the firm -- but instead got the state to pony up $180 billion or so to rescue the banks from their own bad decisions.

This sort of thing seems to happen every time the banks do something dumb with their money...

 More at the link.

Studies confirm: bankers are mostly non-human at the cellular level

This is no joke. Studies show that if you examine the genetic material of your typical banker, you'll find that only about 10% of it takes human form. The other 90% is much more slimy and has been proven to be of bacterial origin. That's 9 genes out of 10: bankers are mostly bacteria. Especially Lloyd Blankfein. This is all based on detailed state-of-the-art genetic science, as you can read in this new article in Nature.

OK, I am of course joking. The science shows that we're all like this, not only the bankers. Still, the title of this post is not false. It just leaves something out. Probably not unlike the sales documentation or presentations greasing the wheels of the infamous Goldman Sachs Abacus deals.

Federal Reserve Corruption

Take a look at this on the transparency of the Federal Reserve (from Financeaddict) compared to other large nations' central banks. Then watch this, where Timothy Geithner tries very hard to slip sleazily away from any mention of the $13 Billion that went directly from AIG to politically well-connected Goldman Sachs. "Did you have conversations with the AIG counterparties?" Response -- waffle, evade, waffle, stare, mumble. After that, try to tell me that the US is not neck deep in serious political corruption.

And they wonder what Occupy Wall Street is all about!

Lobbying pays off handsomely -- visual proof

From an article in The Economist, a graph showing the performance of the "Lobbying Index" versus the S&P 500 over the past decade. The Lobbying Index being an average over the 50 most intense lobbying firms within the S&P 500. It's pretty clear that lobbying -- a rather less than honourable profession in my book -- pays off:

Of Idols and Crises

Here's a quote of the day, perhaps the best metaphor I've heard for where we are now in this financial and economic crisis, a few years downstream of the initial fractures, as authorities (and bankers) in Europe are still trying to duck necessary pain and loss through clever financial slight of hand. From novelist John Lanchester, quoted in Business & Finance:

"It's like there was a giant rumbling noise, the foundations shook, there was a crack in the altar and the golden idol fell down," he says. "And then there was a silence as they picked up the idol, polished it and put it back on the altar and now they're hoping that nobody had noticed. The fact is, we've had three or four supposedly unprecedented crises in the last couple of decades, and these events seem to be getting bigger and more frequent. That suggests to me that we really need to fix the whole architecture of world capitalism, but nothing I've heard suggests that anybody's doing that." 

Truly, nobody is doing that. For the moment, in Greece, in the US, and elsewhere, everything is patchwork, a few small repairs, even the illusion of repairs, and that's it.

Making markets (appear) safe -- through more vigorous lobbying

It's as predictable as the Sun rising not long after it sets -- financial firms rightly criticized for creating dangerous systemic risks will do what is natural to protect their turf. No, not by looking deeply at their practices and asking if they actually do create greater risk, but by hiring a slew of lobbyists and image consultants to change the debate and stop any potential regulation in its tracks. As this article in the New York Times describes, now it's the turn of the high-frequency traders to follow this time-honored path (thanks to Alex Bentley at the University of Durham, UK for pointing me to this).

I learned last year that writing about finance isn't like writing about science, which I've been doing for 15 years. Scientists get touchy if you criticize their work, but generally respond with reasons and try to convince you you're wrong. Financial firms respond with threats of lawsuits. I found this out last year when I wrote this article for Wired UK on high-frequency trading and its potential systemic perils. I sent an early draft to the then PR person for GETCO, one big HFT firm, asking for her comments and help so I didn't misrepresent anything. I often find that showing interested parties early drafts of articles gets them to voice their criticisms early, so I can take them into account in later drafts. In this case it didn't work, as the PR person didn't respond with any reasoned argument.. Instead, she went quite ballistic. Even though I hadn't criticized GETCO at all in the piece -- I merely mentioned them as HFT traders, and argued that HFT trading in general may present new kinds of systemic risks -- she threatened to get the lawyers involved if I mentioned GETCO in the article at all.

GETCO is one of the firms mentioned in the NYT article as now hiring lots of lobbyists to prevent any new legislation which might hurt their profits, to hell with the stability of markets as a whole.

To be clear, I don't think these people are evil in any sense. They're trading in a legal way, and what they do brings some clear benefits to markets -- it has lowered spreads over the past decade and has indeed made it possible for many smaller traders to compete with the larger banks. But the HFT traders ought to be honest about that fact that no one -- absolutely no one -- currently knows what kinds of new systemic risks enter a market when it becomes dominated by algorithms making thousands of trades a second. This is new territory, and human intuition just isn't up working out what is likely to happen. Paul Wilmott made this point quite eloquently in an NYT OpEd well before the Flash Crash of 6 May, 2010 proved his concerns to be valid.

Since then, as I've mentioned before, we've had lots of smaller flash crashes, and a really devastating one may strike any day and possibly bring deep damage to the larger economy. Personally, it would seem sensible to put in place a speed limit of one trade per second and be done with it. Do we really need to trade faster than that?

Stress tests?

I suspect that what goes on at the European Banking Authority is pretty much above board, in general, but still -- are the stress tests reported on here really designed to find points of potential weakness? I'm not reassured when the New York Times reports that the tests were designed in part to "restore confidence in the overall health of the European financial system." This sounds a little like a public relations angle.

Later, the article gets to the real issue: are these stress tests designed to test the banks against realistically severe scenarios, or instead to throw up some soft balls to be hit hardly so as to restore (misplaced) confidence? Kudos to the writer for including this illuminating quote:

“This year’s tests still did not include the impact of a formal debt default by a European government, which is the single greatest risk facing the European banking sector at present,” Marie Diron, an economist who advises the consulting firm Ernst & Young, wrote in a note. “The publication of these results will not assuage investors’ fears over the resilience of the E.U. banking sector,” she wrote, referring to the European Union.   

The Greek crisis made clear...

This is far and away the most clear explanation I've seen of what is happening in Greece and why it poses an existential threat to the European Union. (h/t The Agonist)