Letter on Too-Big-To-Fail Banks

While federal government retiree and Social Security payments will be frozen this year, Wall Street is granting huge bonuses to its workers, who drove the US to the brink of a second great depression. Secondly, there has been little progress on improving financial regulation to prevent what happened a year ago from happening again. In particular the federal government still puts the full faith and credit of the United States behind half a dozen banks that are “too big to fail,” as Fannie Mae, Freddie Mac, and AIG were, while the rest of the US is left to its fend for itself. That policy encourages the big banks to take too many risks, and it gives them an unfair competitive advantage over smaller, local banks.

Government retirement benefits are frozen this year primarily because Wall Street almost bankrupted the country, which meant that there was no economic growth. Wall Street was responsible for throwing millions of people out of work. I believe they are pleased with that. The financial elites -- the one percent who make 95% of America’s income, the CEOs who make 400 times the salary of average workers, or whatever huge statistic you accept -- want a new paradigm where most labor is done overseas by workers in China or Bangladesh who are paid a pittance compared to American workers. In the future 10% or 15% percent unemployment may be the new normal, if Congress does not act.

“Too big to fail” is the primary problem that financial regulation must address. I am a big fan of Elizabeth Warren, the chair of the Congressional bailout oversight program. In one of her recent interviews, she warned that local banks likely face a crisis as commercial mortgages come due and need to be rolled over. There may be huge defaults, and she said that unlike the half dozen banks that are too big to fail, the FDIC would probably shut down the local banks. This creates unfair competition, because the FDIC only insures deposits up to $250,000, chicken feed for the financial elite. Meanwhile the too-big-to-fail banks (Chase, CitiBank, Bank of America, Wells Fargo, etc.) will never need to depend on the FDIC, because the federal government will never let them fail. They will be bailed out by billions of taxpayer dollars, as they were last year, rather than by the insurance fees paid by member banks of the FDIC. It means that the elite billionaires will bank primarily with the big banks, where they don’t have to worry about FDIC limits for the millions they have on deposit. They would be more reluctant to put those millions in a smaller bank that depends on the FDIC, rather than on the full resources of the US Treasury and the Federal Reserve currently pledged to the big six.

It’s important to regulate derivatives, as Congress has proposed, but I believe that it is more important to deal with “too big to fail.” If some banks had not been too big to fail, they would have failed because of their flawed derivatives dealing. It looks like some banks, Goldman Sachs for example, were smart in their derivatives trading. Even there, however, when the US bailed out AIG, about $12 billion of the AIG bailout went to Goldman to pay off their derivative bets. Goldman should have had to absorb that $12 billion bad bet with AIG. There should be a “moral hazard” to bad management, but the government has eliminated the moral hazard penalty for the big banks by making them failure proof.

A particularly terrible thing was the elimination of the Glass-Steagall Act provision preventing bank holding companies from owning other types of financial institutions, a revision done under the Clinton administration. This is part of the too-big-to-fail problem.

The bottom line for me is that the American government is abandoning the middle class, of which I am (or used to be) a member. It’s not unusual. The problem for many failing, developing countries is that they have no middle class. I saw this first-hand in Latin America and Asia. One reason China is making such huge strides in overtaking the US financially is that it is creating a vibrant middle class. Throughout history, societies have deteriorated as corrupt elites have gained more and more power; the Roman Empire is just one big example.

Israel Needs To Man-Up

Israel is pressing back against the UN Goldstone report finding Israel probably guilty of war crimes in its attack on Gaza. According to the AP, the report is having a number of perhaps unanticipated effects, including undermining Fatah leader Abbas, delaying Israel's participation in US peace plans, and putting Israel on the hotseat in the UN. Israel is outraged, but Goldstone, a Jew, has said that he calls them like he sees them and only wants the best for Israel.

The bottom line is that Israel needs to face the fact that morally it is falling short. It needs to man-up and behave in a manner acceptable to the world community of nations.

One of the main criticisms is Israel's use of white phosphorous artillery against people, including civilians. White phosphorous should not be fired on the ground; it should be used in air bursts as a marking round to see where artillery going. If it hits you, it burns until the phosphorous is consumed, because you can't put it out. But it makes a visible puff of white smoke during the day and a fireworks-light bright flash at night. It used to be fun to watch other artillery batteries shoot in delta tangos (defensive targets) for our fire base at night, so that they would know where high explosive rounds would land if they had to be called for during the night. They weren't intended to be used against enemy personnel in a fire fight.

I Still Like Elizabeth Warren

Elizabeth Warren was on Bloomberg TV this morning, and I was again struck by her ability to discuss the banking crisis in plain, straightforward terms that don't appear to be spin. It's very unusual in today's media world. Unfortunately, I thought her interlocutors asked very softball questions (not the link above); I suspect that's because they don't want to offend their patrons on Wall Street, who are often villains in Warren's explanations.

The most interesting thing she had to say in this interview was that the small, local banks are in trouble because they hold so many commercial mortgage loans. The terms of these loans are changing on a longer time frame than the sub-prime mortgages that have already begun to turn bad. The smaller banks may get into trouble as these commercial mortgages come due. She said that they would probably not be bailed out like the big banks, but would just be allowed to fail.

Calvin Trillin Is Right

Calvin Trillin's op-ed in the NY Times is probably right, although it pretends to be humorous. To some extent, the problem is all those smart people on Wall Street. It reminds me of the old Jonathan Winters routine in which he plays a senator; when they ask him about reports that he is inept, he replies that it's all those "ept" people that we have to worry about. When both the bankers and the regulators were somewhat inept, we didn't have to worry too much, but when the bankers became so much smarter than the regulators, we ran into huge problems. Or as Trillin says, when the traders became so much smarter than their bosses, so that the bosses at the big banks did not understand what their subordinates were doing, except that they were all getting insanely rich.

It's the same joke they told about law school: the A students because professors, the B students became judges, and the C students became rich. It's as if the A students have left the classroom for the courtroom, where they are winning huge judgments for undeserving plaintiffs.

Scale Back Afghanistan

After thinking about Afghanistan some more, I believe it's time to start leaving, or at least to scale back. My first consideration, as a Vietnam draftee, is what would happen if we started drafting people to fight in Afghanistan. We would have a rebellion just like we had during Vietnam. Very few people would go. Right after 9/11/2001 there was a patriotic impulse, personified by Pat Tillman, to go fight al-Qaeda there, but that impulse has gone cold. Our main mission there was to find and punish al-Qaeda, especially Osama bin Laden, and we have so far failed at that for over eight years. Now there's concern that the Taliban will return to power and give sanctuary to al-Qaeda again. First, the Taliban is not exactly our enemy, although they are awful people, oppressing women, destroying Buddhas, etc. Al-Qaeda is our enemy, but what do they get from the Taliban? Probably unfettered access to a few square miles of land to use as training bases to plan attacks on the West. Can't we interdict these bases without bringing Jeffersonian democracy to Afghanistan, reportedly an impossible job? I think we can. We can reach some kind of agreement with the Afghans to shoot missiles at any such bases or send in airborne commandos or some such arrangement. Karzai will be happy to have us our of his day to day affairs and let him get back to the corruption that's making him rich. The goal of protecting America does not require us to turn Afghanistan into a Western democracy.

There is the matter of Bush/Cheney sacrificing hundreds of lives of American troops for nothing. That's awful, but there is no sense in sacrificing more lives in a wasted effort. The thing to do is for America to do all it can for the families of the fallen and the wounded.

I am skeptical that America will care for the Iraq and Afghanistan veterans. They are too isolated from the rest of American society. They come from a relatively small cohort in terms of income and political views. They are basically mercenaries, although they come from within American society, except for the significant number who are immigrants who are not citizens. If my return from Vietnam is any indication (and I think in some ways the return of these veterans will be worse) they can't expect much from American society. Few people are going to help them find jobs, for example, except a few who think they can get some good publicity from hiring a few veterans. Vietnam veterans returned to active hatred or at least opposition from those who refused to go; today's veterans return just to indifference, and many have an even more difficult job adjusting because they have served so many tours in such difficult conditions. With the draft, in general, people just went once. "Lifers" kept going back, but they planned to make the military their career. There are more lifers today, but there are a lot who are disillusioned, but find it very difficult to leave, but they don't fit into the society they left behind.

Afghanistan Quandry

As Obama is seized with the issue of what to do in Afghanistan, there is more and more discussion of Pakistan, which is good.

I don't think you can blame Obama for the position he has taken to date on Afghanistan. He correctly determined that the Bush administration had failed terribly in Afghanistan by starting a war and then walking away from it to fight a new war in Iraq. It was unconscionable to walk away from a war while leaving thousands of US troops fighting there. Bush and Cheney flushed the lives of soldiers who died in Afghanistan down the toilet, starting with Pat Tillman. Obama said that we were going to stop killing these troops for nothing. But in doing so, he stepped into quicksand, because there was no coherent strategy for Afghanistan, just as there was none in Iraq until Gen. Petraeus came up with one for Bush and Cheney. But so far, Petraeus, who oversees Afghanistan from the US, has failed to come up with an Afghan strategy, apparently leaving that task to the general on site, Gen. McChrystal, whose proposal has become a political football. It's ironic that McChrystal replaced a general there who was fired because of insubordination, although publicly he appeared to be as quiet as a mouse, much quieter than McChrystal. Either this was a botched change of command, or there's something going on that's not getting reported, some kind of kabuki drama to get us to a place that's not currently apparent.

In McChrystal's defense, I think he is opposed to continuing to see the lives of the troops he commands being flushed down the toilet. Therefore, he might be amenable to a strategy that draws down the troops in harm's way, if that can be done. On the other hand, if Richard Engel of NBC was right on "Morning Joe" recently, saying that unlike Iraqis the Afghans in general hate the US and just want us out, then there may be no small-footprint strategy that protects US troops. There's some poll that people cite that only six percent of Afghans like the Taliban, but what if an even smaller percentage like the US?

The other big unknown in this equation is Pakistan, with its nuclear weapons. Both the Taliban and al-Qaeda appear to have migrated from Afghanistan to Pakistan. For a while, it looked like the Taliban were successfully challenging the government of Pakistan. Now Washington Post columnist David Ignatius is omnipresent saying the Pakistan is doing much better against the Taliban and that things are not as bad as they were. But to what extent are the Taliban and al-Qaeda in league with elements of the Pakistani government and leadership elite? Can we be sure they didn't just agree to cool it to get the US off Pakistan's back and resume its aid. Once the US is out of Afghanistan, it will much more difficult for it to interfere in Pakistan's affairs. If you have doubts about the ability of the current Pakistani government to control its nuclear weapons for the foreseeable future, then that's an argument not to leave Afghanistan.

It's a little less provable, but it's arguable that Bush/Cheney led to this impasse in Pakistan by unquestionably supporting former President Musharraf in the absence of any popular democratic support for him. Thus when he left, there were no institutions in place to replace him, especially after the assassination of Mrs. Bhutto.

In any case, Obama is faced with a very difficult decision about a war that he inherited. For him the easiest thing for him to do politically would be to wind it down and walk away from it, declaring it a Bush/Cheney quagmire that he has decided to crawl out of. But is that the best thing for the US? Does that continue the Bush/Cheney decision to flush the lives of fallen American soldiers in Afghanistan down the toilet, i.e., does it devalue eight years of valiant service by American soldiers? Does it undermine American security by allowing Afghanistan to again become a sanctuary for anti-American terrorists? Will it make it easier for terrorists to gain access to Pakistan's nuclear weapons?

I don't envy Obama.