@rblinne Twitter Blog

NY-20 Confirms Status Quo

There's been much twittering over the weeks of Rasmussen's generic congressional ballot being roughly tied. We had the first real test last night not with something generic but a real election. First, I need to introduce a concept known as PVI which is the registration advantage in a Congressional District. Nate Silver at fivethirtyeight.com gave the following handy table of moderately Republican districts and whether the Democrat or the Republican won:

NY-20 is a R+2 district and it came as close to a tie as possible with Murphy ahead by less than 100 votes with several thousand absentee ballots outstanding. We will probably be waiting weeks or months for a winner here. Looking at Nate's chart a tie is what you expect in the current environment. Is there evidence for stasis elsewhere? Why yes. Look at Obama's approval number on Gallup. It's stabilized at a high level.

Same with Congressional approval for both Republicans and Democrats:

The only thing that's changed is there is a modest uptick of consumer sentiment and spending that is following the rally in the Markets. I am also seeing similar trends in the all-important right-track/wrong-track numbers. 

So, for all the #tcotters out there I find no evidence for buyer's remorse. So, I predict your April 15th tea parties will be a giant bust. Nate Silver put it this way:

The status quo, in other words, was more or less preserved. But the status quo, of course, is a much happier place if you're a Democrat than if you're a Republican...

Who is the BIS and Why You Should Listen to Them

Just before the Bipart Report was created we had a conference call with Mike Leahy who runs the TCOT report. He mentioned he liked to see some investigative journalism. For example, he speculated that the current economic crisis might have been the result of manipulations by George Soros in October 2008. That's just plain nuts. The origin of the crisis came much earlier. Also, the economic experts who were not beholden to hyper-libertarianism saw this one coming from a mile a way. In particular, there is an organization of central bankers and regulators known as the Bank for International Settlements (www.bis.org) that look at things such as derivatives. If you read their reports like I do the proposals for re-regulating the financial markets that came this Thursday would sound eerily familiar. In fact, if they had been listened to earlier the housing bubble would probably have just caused a mild recession rather than this semi-depression (and we wouldn't have been literally 3 hours away from economic apocalypse in September 2008). 

Note what they said in 1998. http://www.bis.org/publ/ecsc08.pdf?noframes=1

Despite the widespread use of bilateral netting, OTC derivatives have become a  significant source of credit exposures between the global financial institutions that are the largest 
dealers. Consequently, if a major global financial institution were to fail, losses to other dealers on  OTC derivatives would be a potential channel for the transmission of systemic disturbances. The collateralisation of inter-dealer exposures in principle could greatly reduce the likelihood of these systemic disturbances being transmitted through that channel. However, as noted above, the use of collateral entails other types of risk, including legal risk and liquidity risk, which, if not managed effectively by dealers, could also pose threats to the financial system. With respect to legal risk, there is the risk that in the event of a counterparty’s insolvency collateral agreements might prove unenforceable in one or more relevant jurisdictions. Such a development could result in widespread losses, because many counterparties might have relied upon the enforceability of the agreements and incurred exposures that they would have avoided if they had suspected the agreements were unenforceable. With respect to liquidity risks, as the usage of collateral grows, dealers may become more vulnerable to liquidity pressures; large changes in market prices could produce significant demands for collateral. Thus, it will become increasingly important for dealers to conduct stress tests to estimate potential demands for collateral and to take whatever steps are necessary, including steps to allow effective reuse of collateral, to ensure that they can meet the estimated demands. If dealers fail to do so, collateral agreements could add significantly to liquidity pressures during periods of market turbulence.

What are these OTC derivatives? These are the CDOs and CDSs that AIG and other high fliers were selling. They thought the practice of bilateral netting also known as "netting out" would protect them from systemic risk. Note the recommendation of stress tests. In fact, policy makers went in the exact opposite direction with Gramm-Leach-Bliley in 1999 and the Commodity Futures Modernization Act in 2000. Because these are sold over the counter they become opaque and cannot be effectively regulated causing a risk to the entire world economy to be created. (More on that later.)  One of the major recommendations in 1998 was the creation of a clearing house under regulatory control because these unregulated OTC relationships were simply too risky. Gee, this sounds exactly like Tim Geithner's testimony last Thursday.

 Here's the specifics of the 1998 recommendations:

A development that the study group believes could significantly mitigate risks in OTC derivatives transactions is the rapidly expanding use of collateral. However, to ensure that the benefits concerned are realised, counterparties must effectively manage the liquidity, legal, custody and operational risks of using collateral. The study group recommends that counterparties carefully assess these risks and that prudential supervisors consider developing supervisory guidance in this area.

In the end, neither happened. The counterparties relied on bogus ratings from the ratings agencies and the Bush Administration had zero supervisory guidance because, hey, deregulation was the way to go.

Fast forward to the 2007-2008 time frame. http://www.bis.org/publ/work251.pdf?noframes=1 The potential became the actual. Starting in mid 2007, the BIS was sending alarm bells that something seriously wrong was happening. First, the explosion of these toxic derivatives: [Note: all that follows here was written in February 2008]

At a structural level in the financial system, recent years had seen an acceleration of financial innovation. The main manifestation had been the extraordinary expansion of credit risk 
transfer instruments, which permitted the transfer, hedging and active trading of credit risk as a separate asset class (Graph 4). Examples included credit default swaps (CDSs) and, in 
particular, structured credit products, through which portfolios of credit exposures could be sliced and diced and repackaged to better suit the needs of individual investors. This category included, in particular, collateralised debt obligations (CDOs), backed both by cash instruments, such as primitive securities, loans or asset-backed securities, and by derivative claims, such as CDSs and CDOs themselves (Graph 4). The expansion of these products had both contributed to, and been supported by, a strengthening of the originate-and-distribute (O&D) [Note: this market was expanded greatly under Gramm-Leach-Bliley] business model of financial intermediation. Increasingly, rather than holding the credits they originated, credit institutions would sell them off, possibly after having repackaged them, into the capital markets. 

Note the scale here. TRILLIONS of dollars. Then the credit shock happened in August 2007. Here's some graphical representations of how bad things were getting.

This gave the BIS much concern about the economy in the 2H of 2007. What was their going forward look as of February 2008?

At bottom, the characterisation of the dynamics of the financial turmoil is rather simple. The turmoil represented a sharp repricing of credit risk that, given the leverage built up in the system, led to, and was exacerbated by, an evaporation of liquidity in many markets, including in the interbank market. The repricing, which happened to have the US subprime mortgage market at its initial epicentre, followed a prolonged phase of broad-based and aggressive risk-taking. [Note: due to Gramm-Leach-Bliley allowing excess leverage.] It was amplified by the great opacity of new instruments [Note: due to Commodity Futures Modernization Act], such as structured credits, and of the distribution of exposures across the system. This led to a crisis of confidence in valuations, triggered by unexpected rating agency downgrades, and to a generalised distrust of counterparties, as market participants wondered about the size and character of their own exposures and of those of others. The crisis of confidence in turn  triggered an evaporation of market liquidity for the instruments concerned and of funding liquidity for those institutions suspected of being vulnerable to the market disruption. As time passed, the underlying asset quality weaknesses inevitably became more evident. 

In the end this mess was caused by deregulation and the BIS knew about and warned us about it. People like Phil Gramm who wrote the legislation that was behind this called our economy in June 2008 a "mental recession". What Tim Geithner presented last Thursday was in my opinion the most import leg of the recovery so that the deregulatory madness never ever happens again! 

The President is an Elitist (Except When He's Not)

The President's critics can't seem to get their criticism straight. The President goes on Leno and yucks it up. There's a crisis and he's making March Madness brackets. Earlier this month the President was too serious and talking down the market. Now he's not serious enough. Come on which is it?

What the critics don't get is that he's a smart person who relates to the average Joe who doesn't pretend to be a plumber. This drives them nuts. If he's smart and he went to an Ivy League school he must be an elitist. But he talks about sports so he's not Presidential. Here's a clue: smart people can have fun too.

I understand how frustrating it must be having gone through eight years of malapropisms. A President can be smart and articulate and do lots and lots of things simultaneously. And shockingly enough he can have a good time while doing it. Last night the President mentioned persistence in his press conference. Maybe he was thinking of Galatians 6:9.

Let us not become weary in doing good, for at the proper time we will reap a harvest if we do not give up.

Scripture also recognizes that being light-hearted and wise are not mutually exclusive categories, Prov. 15:13-14.

A happy heart makes the face cheerful,
       but heartache crushes the spirit.

The discerning heart seeks knowledge,
       but the mouth of a fool feeds on folly.

Maybe the next time that Ed Henry asks why the President was slow to speak and was not immediately outraged he should read his Bible.

In Defense of Tim Geithner

We've already looked at the substance of many of the economic recovery policies of the Obama Administration here(http://bipartreport.com/?p=233). I want to look at the whole "secret" bonuses to AIG kerfuffle. Staff for the Treasury Department wanted certain language added to the stimulus package. It's my contention that the added language was a good thing.

Until the stimulus package there were no restrictions on pay for employees of TARP recipients (except for union auto workers). There were bills in the Senate and the House that retroactively denied bonuses for TARP recipients. In the Senate was the Snowe Amendment. Here's how the vote went (http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=111&session=1&vote=00060). The only Republicans voting for this were the "traitors" Collins, Snowe, and Specter. In the House was the TARP Reform and Accountability Act (http://clerk.house.gov/evs/2009/roll026.xml). 242 Democrats and 18 Republicans voted for this. So, the House and Senate Democrats were on record for retroactive bonus clawbacks and the Republicans against.

What the Treasury Department did was to propose to only remove the retroactive part of the bill. If there was not a stimulus package there would be no restrictions on bonuses in either the past or the future. The amended language would prevent future bonuses. Let's take a look at the language of the stimulus package:

i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding

         ...

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

A number of Republicans have complained about the ex post facto and bill of attainder nature of the tax-based clawbacks. So, why are they complaining about what should be considered by them an improvement to the stimulus? Politics. Everybody is pissed and the finger pointing game is going on. In my opinion what's in the stimulus is a good compromise. It claws back the bonuses without the problems of retroactive taxation and preserves the integrity of contracts. It's time for the Washington crowd in both parties to stop being wusses and back our Treasury Secretary.

I'm a Special Needs Dad and I'm Offended

No, it's not about Obama's tasteless joke about the Special Olympics on the Tonight Show. It's something much deeper than a slip of a tongue in a self-deprecating joke. It's cynical hypocrisy of the basest kind. I'm the one Republican in the Bipart Report. Why have I changed my mind and am a supporter of the President? It started with the Palin nomination at the RNC. A friend of ours sent me an e-mail of how great Governor Palin was on special needs. This was my response.

Dear ****,
On September 17, you said:

Here is some interesting data about Palin’s increased budget for special needs kids in Alaska. Democrats have tried to make it look like she did nothing. In fact, under her, budget increased and services are free. Visit the website below where some democrats have to eat their words.

I understand you sent it because you care for **** and me, and our autistic son, ****. Even though Trig is Down Syndrome it was suggested at last night's debate it made Governor Palin an expert on ASD (or was it because she has a niece with ASD?)  It struck myself and a number of other special needs parents as pandering. Her small amount of experience betrays a total lack of understanding of what parents of teenagers or even adults with developmental delays are going through.

When developmentally delayed children get older and stop being "cute" they have intense needs that are not covered like they are in school. Even for those of us with a good deal of financial means it's a great burden. We rarely go out on dates and vacations along with running for Vice President are completely out of the question.  A good deal of my retirement savings was to fund living expenses for ****'s entire life. Now that's mostly gone.

Here's what Sarah Palin doesn't get. The most important issue to us is fully funding wait lists. This will fund ****'s ability to go to a group home or get training so that his social "quirks" keep him from getting a job in the awful economy. Even though Alaska has a surplus due to oil revenue it doesn't fully fund its DD wait list. See here:

http://www.hss.state.ak.us/dsds/dd/pdfs/WaitlistReport07_Final.pdf

Contrast this with Barack Obama's plan for kids with autism here:

 http://www.barackobama.com/pdf/AutismSpectrumDisorders.pdf

Barack Obama will appoint a Federal ASD coordinator that will make sure that people like **** will get all the help he needs. He will also make sure that the IDEA funding that currently benefits **** will actually be spent, not just if they get the $2000 diagnosis like we had to do but all people on the "spectrum". As was mentioned during the debate McCain's budget cuts would slash IDEA funds.

On a slightly different front, Dr. ****, informed us that the band director will be doing both band and orchestra at ****'s junior high. Music is so important to autistic kids and this will be yet another blow to our family. Please vote for Amendment 59 so that our kids can get the education they need rather than us getting useless $50  TABOR checks.
But this is not only about the presidential election and even if you plan on voting for John McCain there are still ways for you to support our son.  Sarah Palin's cluelessness is also a problem in Colorado. Please vote for Amendment 51 and County Referred Issue #1A. There is more information at www.endcoloradowaitlist.org and www.voteyeson1a.org or contact the Larimer County ARC at arcinfo@arcic.org.

Thank you for your love for our son. **** and I appreciate your support for our family and look forward to you working with us in making his life all that it can be.

On October 24, 2008 Governor Palin gave one of her only policy addresses and it was on special needs:

This is a matter of how we prioritize the money that we spend. We've got a three trillion dollar budget, and Congress spends some 18 billion dollars a year on earmarks for political pet projects. That's more than the shortfall to fully fund the IDEA. And where does a lot of that earmark money end up? It goes to projects having little or nothing to do with the public good -- things like fruit fly research in Paris, France, or a public policy center named for the guy who got the earmark. In our administration, we're going to reform and refocus. We're going to get our federal priorities straight, and fulfill our country's commitment to give every child opportunity and hope in life.

There's a problem with the earmarks. Fruit fly research is a key way genetic disorders like Autism are studied. For example this study done by the University of North Carolina which studied brain proteins using fruit flies. : http://uncnews.unc.edu/news/health-and-medicine/specific-brain-protein-required-for-nerve-cell-connections-to-form-and-function.html

Neurons, or nerve cells, communicate with each other through contact points called synapses. When these connections are damaged, communication breaks down, causing the messages that would normally help our feet push our bike pedals or our mind locate our car keys to fall short.

Now scientists at the University of North Carolina at Chapel Hill School of Medicine have shown that a protein called neurexin is required for these nerve cell connections to form and function correctly.

The discovery, made in Drosophila fruit flies may lead to advances in understanding autism spectrum disorders, as recently, human neurexins have been identified as a genetic risk factor for autism.

OK. That happened during the campaign. Why am I now offended? Because we see in what Governor Palin is doing with the stimulus shows us precisely the kind of "reform and refocus" her administration would have provided. So did she -- as my friend alluded -- use the stimulus to increase the special needs budget because of her love for Trig? HELL NO!!! http://www.adn.com/palin/story/729504.html 

The biggest single chunk of money that Palin is turning down is about $170 million for education, including money that would go for programs to help economically disadvantaged and special needs students. Anchorage School Superintendent Carol Comeau said she is "shocked and very disappointed" that Palin would reject the schools money. She said it could be used for job preservation, teacher training, and helping kids who need it.

So she will use her Down Syndrome son as a political prop but all she cares about is her own kid. The rest be damned. It's a good thing what my gut told me about her was correct.

Obama Recovering from Misstep

Obama made his first major misstep with the AIG bonus fiasco. Whether it was due to inattention or underestimating populist rage the Obama administration was caught flat-footed on the AIG bonus scandal. When SecTreas was negotiating with Congress he wanted to make sure that the stimulus was legally defensible and more importantly that contractual obligations were honored. If they weren't, they were concerned -- in my opinion legitimately -- that future public-private partnerships to get rid of the toxic debt would be hampered. They were also a concern that the retention bonuses which were intended to wind down operations would be confused with performance bonuses that would reward the bad actors.

Congressional Democrats had a better sense of the populist rage when they voted for the Snowe Amendment that would have blocked the controversial bonuses retroactively. The only Republicans voting for this amendment were the so-called traitors, Collins, Snowe, and Specter. In the House this took the form of the TARP Reform and Accountability Act. 242 Democrats and 18 Republicans voted for this. This exposes the Republican hypocrisy. They were never for restricting the bonuses until people with torches and pitchforks showed up in their offices yesterday. 

A compromise was worked out to remove the retroactive language. Except for that limitations on bonuses remained. Here's the language in question:

i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding

         ...

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

The Administration underestimated the populist rage for even past contracts being honored. A recent Gallup overnight poll showed this as follows:

This caused the vote in the House yesterday. As I was saying on Twitter last night this is not unconstitutional. The Heritage Foundation did an analysis of retroactive taxes (which they vehemently oppose). Their lawyers are too honest to note that retroactive taxes are constitutional. Their analysis can be found here. The Supreme Court has weighed in and has ruled that retroactive tax rate increases were constitutional in U.S. v Darusmont.

At this point some might ask why I think Obama is recovering from this? It's the pivot he did on the Tonight Show last night. When Jay Leno asked him about what Congress did, Obama replied it was closing the door after the horses left. Instead, he said a moderate approach is his less radical tax increases in his budget is a better way to go. He also noted that most of the things that Jay wanted to send people to jail for were perfectly legal. The President presented himself as the reasonable middle ground with common sense regulation and modest tax increases. This is in contrast of going pillar to post from complete deregulation to confiscatory taxation. Will the President be able to mollify the populist rage? I don't know. People in the past have underestimated the President's political ability and hopefully this is true here, also. Failure is not an option and the public/private partnerships working are key to keep from sliding into a true Depression. The real political risk is not whether these particular bonuses are taxed or not but whether policies that are needed to save our economy are discarded because everybody is so angry. 

Limited Government

Many times when I am in discussions with people on #tcot I hear the constant refrain limited government as principle. The problem with this is historically is there is a principle that is antecedent to this, namely individual liberty. If the principle espoused is at the expense of liberty, it's no principle at all. As we see from James Madison in Federalist #51 limited government or more specifically separated government is a means towards this end. (I would like to note in passing Madison would have been aghast at the concept of the unitary executive.) 

In order to lay a due foundation for that separate and distinct exercise of the different powers of government, which to a certain extent is admitted on all hands to be essential to the preservation of liberty, it is evident that each department should have a will of its own; and consequently should be so constituted that the members of each should have as little agency as possible in the appointment of the members of the others.

This was echoed in Washington's Farewell Address:

It is important, likewise, that the habits of thinking in a free Country should inspire caution in those entrusted with its administration, to confine themselves within their respective Constitutional spheres; avoiding in the exercise of the Powers of one department to encroach upon another. The spirit of encroachment tends to consolidate the powers of all the departments in one, and thus to create whatever the form of government, a real despotism.

It was also assumed at the time that the individual state governments were guarantors of liberty with the only real concern about Congress violating individual liberties. This assumption would later be tested and found wanting.  The state governments it turned out could violate the people's rights with equal felicity as the federal government. What President Lincoln found out was that we needed a strong union to preserve our liberties. This was an even stronger core principle than his fight against slavery. After the Civil War this was elaborated in the incorporation doctrine of the 14th Amendment where the states had to respect the Bill of Rights being forced to do this by a strong central government. 

Francis Bellamy was the author of our pledge of allegiance and a Christian Socialist who described how the middle class could create a planned economy with political, social and economic equality for all. He stated the following as the principles behind it:

It began as an intensive communing with salient points of our national history, from the Declaration of Independence onwards; with the makings of the Constitution...with the meaning of the Civil War; with the aspiration of the people...

The true reason for allegiance to the Flag is the 'republic for which it stands.' ...And what does that vast thing, the Republic mean? It is the concise political word for the Nation - the One Nation which the Civil War was fought to prove. To make that One Nation idea clear, we must specify that it is indivisible, as Webster and Lincoln used to repeat in their great speeches. 

So we have the diffusion of power across multiple institutions as the preserving principle of liberty. It's not the size of the institution but rather making sure that no one institution has a monopoly on power. In the case of the Civil War a strong central government preserved liberty against the tyranny of the individual states. 

As we entered the 20th Century another institution needed to be corralled: business. Teddy Roosevelt was instrumental in providing the balance of power. In his farewell address he noted: regulation not obstruction, wider participation to the fruits of labor, federal control of interstate business, shifting the burden from the poor to the rich, and from employee to employer. 

This continued with Franklin Roosevelt. The concept of countervailing power continued. The TVA was not meant to be socialist but rather a way to force the privately held utilities to behave responsibly. Regulations like Glass-Steagall continued the regulatory tradition started by TR to force privately held banks to be fiscally conservative. The opposition to Roosevelt was rural and Southern. This is a common theme from the Civil War and is the same today. Those who promote limited government do so in order that other institutions they favor are more unshackled.

In 1999, Glass-Steagall was undone allowing banks and investments to merge at the behest of companies like Citibank who are now "too big to fail". These companies along with hedge funds -- whose money came from the Bush tax cuts as hedge funds require a minimum income of $200,000 -- have destroyed the entire World economy. Not only that but a spirit of deregulation helped cause a worldwide credit crisis in the self-regulated derivatives market. This set up a "shadow" banking system with low reserve requirements and no transparency. For example, even though we own 80% of AIG we didn't know the identities of any of the counter-parties paid until this weekend. These counter-parties included foreign banks and were paid 100 cents on the dollar with our money. The New York Times described this today while explaining why we have a huge and seemingly never-ending bailout for AIG and why it posted the largest loss in U.S. corporate history. Behold the glories of deregulation!

When A.I.G. received its first rescue loan of $85 billion from the Fed, in September, it forwarded about $22 billion to the companies holding its shakiest derivatives contracts. Those contracts required large collateral payments if A.I.G.’s credit was downgraded, as it was that month.

Among the beneficiaries of the government rescue were Wall Street firms, like Goldman Sachs, JPMorgan and Merrill Lynch that had argued in the past that derivatives were valuable risk-management tools that skilled investors could use wisely without any intervention from federal regulators. Initiatives to regulate financial derivatives were beaten back during the administrations of Presidents Bill Clinton and George W. Bush. [Note: These toxic over-the-counter derivatives were created through the Commodity Futures Modernization Act. This bill was sponsored by Senator Phil Gramm at the behest of Enron because his wife, Wendy, was on Enron's Board of Directors. The reason why Enron wanted this is this bill also created the toxic energy swaps which in the end destroyed that company.]

Goldman Sachs had said in the past that its exposure to A.I.G.’s financial trouble was “immaterial.” A Goldman Sachs representative was not reachable on Sunday to address whether that characterization still held. When asked about its exposure to A.I.G. in the past, Goldman Sachs has said that it used hedging strategies with other investments to reduce its exposure.

Until last fall’s liquidity squeeze, A.I.G. officials also dismissed those who questioned its derivatives operation, saying losses were out of the question.

Regulation is necessary to protect people from the abuses of a financial industry gone berserk just like just before the Great Depression.  That cannot be done with a limited government. A limited federal government would not be what the Founders intended, a guarantor of liberty. It would be too anemic. We need to make sure that the institutional power is sufficiently distributed so that no one institution is dominant. Thus, those who propose like Grover Nyquist to drown the government in the bathtub are not the friends but rather the enemies of liberty.