I and many other informed, intelligent people believe that the outsized financial sector, with it concomitant political power, is a major source of the downward course of our country – a trajectory that began long before the current catastrophe (at least for those who have been caught in the wheels of the financial implosion).

Here’s excerpts fro the piece on Tech Ticker that caught my attention, together with a link to the video on which it is based and to the full article:

Another Missed Opportunity: Obama Retreats on Wall St. Compensation

Posted Jun 10, 2009 10:18am EDT by Aaron Task in Newsmakers, Banking

News the Obama administration plans to back away from dictating compensation for all of Wall Street is a victory for those who worry about overzealous government meddling and the dangers of wage controls.

But it’s also another missed opportunity by the administration to take advantage of the crisis to materially change behavior on Wall Street, which is becoming something of a hallmark of the Obama administration. Obama’s Chief of Staff Rahm Emanuel has said "you never want a serious crisis to go to waste," but that’s exactly what’s happening when it comes to the issue of reforming Wall Street.

…

This backtrack on compensation reform should not be viewed as a one-off event but as part of a pattern of behavior from the new president.

From day one in office (even during the post-election transition), Obama has talked tough about changing the culture of Wall Street and railed against excessive greed and egregious pay packages. But talk is cheap and his actions tell a different story:

• Most notably when it came to the TARP program, the Obama administration has maintained the policies of its predecessor. Even avid Obama supporters like George Soros and Paul Krugman expressed frustration with this missed opportunity to hit the "restart" button on how the government deals with struggling financial firms.
• Under the guise of preventing "systemic risk", counterparties to Wall Street firms, even those surviving on government bailouts, were made whole via TARP funds. That’s in stark contrast to how the automakers’ creditors were treated. Similarly, the Obama team hid behind the "sanctity of contract law" amid the uproar over AIG bonuses but felt no compunction in redoing contracts between Chrysler, GM and their creditors; in the process, the administration overturned the way secured vs. unsecured creditors have historically been treated in bankruptcies.
• After a lot of proposals about how to reregulate Wall Street, including discussions about creating a new uber-regulator and/or merging some existing regulators, the administration has backed away from the reform agenda, "suggesting the current alphabet-soup of regulators will remain mostly intact," The Wall Street Journal reported. Most notably, the push to regulate derivatives has slowed, which critics say is the result of heavy lobbying by the industry’s largest player, JPMorgan. (As an aside, I’d much rather see the government focus on getting the right regulatory regime and let Wall Street firms do what they want on compensation within those confines.)

With big banks repaying TARP funds and the market in rally mode, the acute stage of the crisis appears over and the zeal to reform Wall Street is fading. But if the regulatory regime remains largely unchanged and bonuses restrictions only apply to a handful of firms still under TARP, what’s really changed after all the sturm and drang?

Anyone out there who believes the industry’s "near-death experience" last fall and nine months in the government penalty box is going to materially change the culture and (more importantly) the actions of those on Wall Street, please raise your hand. I have a bridge I’d like to sell you….

NOT OUT OF THE WOODS YET

Experts Warn that Banking Euphoria Is Premature

By Stefan Schultz

04/23/2009

Good news from six US banks has raised hopes that an end to the financial crisis might be in sight. But German experts think the euphoria is wishful thinking. As they see it, things are going to get worse soon — and banks will be forced to make billions more in write-downs.

The news spreads like wildfire and hope starts to bloom. One after the other, six US banks — including the largest, Bank of America — have submitted performance figures for the first quarter of 2009 that are far better than experts had predicted.

Share traders in New York: Hopes of an upturn may be premature, analysts warn.

Banks like Wells Fargo and JPMorgan Chase have posted profits reaching into the billions. Goldman Sachs has even announced that it plans to pay back the billions in emergency bailout funds it received from the US government. And analysts are also expecting to see positive first-quarter earnings from German banks.

The results have fuelled hope that the financial sector has started its climb out of the economic abyss, and the first batch of optimists are already announcing that the financial crisis, which has already lasted almost two years, will soon come to an end. "We expect that the banks’ reporting season will bring more positive results like the ones JPMorgan has submitted," says Robert Halver, for example, an expert on capital markets at Baader Bank.

But some experts think such conclusions are dangerously misguided. "We’re far from being out of the woods," says Dirk Schiereck, a professor of banking at Darmstadt Technical University. "The banks are still extremely vulnerable." And Hans-Peter Burghof, an expert on finance at Hohenheim University, even goes so far as to speak of an "expansion of the crisis, which might soon even get new banks into serious trouble."

Just a Brief Burst

Analysts are also looking at the rest of the year with extreme skepticism. "To a very significant degree, the bank profits from the first quarter can be attributed to a very special constellation of fortunate factors that are very atypical for banks," says Guido Hoymann, an analyst at Bankhaus Metzler. In fact, in the first three months of the year, major corporations like Siemens and Porsche have taken advantage of rock-bottom prices in the banking sector to refinance expiring bonds.

Hoymann estimates that in the first quarter alone, the volume of debt refinancing amounted to 45 percent of the usual annual volume. As he sees it, this boom has boosted commission income and investment banking profits for many US banks. German banks are likely to have enjoyed a similar interim boost in the first quarter, he adds.

"But it’s not going to last," Hoymann says. "Current forecasts already indicate that the lending business will normalize." And when that happens, the banks will once again lose a major source of profits.

An additional factor is that many US-based financial institutions are taking full advantage of relaxed accounting rules. Such rules make it possible, for example, for companies to postpone write-downs. Goldman Sachs has also benefited from the fact that the government pressured it into transforming itself from an investment bank into a completely normal bank. As such, it has become subject to different accounting rules, which has meant that the company did not have to report results for the month of December.

Bleaker Prospects

The prospects for the coming months are worrying. "It might be that the recession doesn’t get any worse," Burghof says. "But there is no doubt that it will expand — and affect the banks once again."

In fact, the economic situation is anything but secure. Experts argue over whether the economy in 2009 will decline by 4, 5 or 6 percent [in Germany] and whether the turnaround will take place in the summer, fall or winter. But there is one point on which the majority of experts agree. "The economy is unlikely to grow as quickly as it shrank," says Jörg Hinze, an economic analyst at the Hamburg Institute of International Economics (HWWI). "It might stagnate for a long time at a very low level or only gradually start climbing again."

But a slow rebound will not stop the crisis. If the economy improves too slowly, the pressure on companies will mount, and hundreds of thousands of workers in Germany currently on short time might find themselves out of a job in the fall.

And that would present the banks with even more risks. Many banking establishments anticipate an explosion of loan defaults from private and business clients. Bank of America and JPMorgan, for example, have built up reserves reaching into the tens of billions to respond to possible new write-downs.

The New Risks of Market Deregulation

At present, the banks are hardly feeling the recession yet. "Currently, the attitude among politicians is that you should bail out anything that could cause any pain," says Hoymann. But doing so does not correct the structural problems of markets and businesses. As Hoymann puts it, it’s "like avoiding going to the dentist" — in the short term, you save yourself some pain, but in the long term everything gets rotten.

"The government can’t keep following its current line forever," Hoymann adds. As soon as politicians start leaving the market to its own devices again, the restructuring that had been deferred will hit companies and people all the harder. And that would mean new strains on the banks as well.

Burghof fears that lingering weakness in the economy will soon pull even more financial institutions into the crisis. "The longer the recession lasts, the more job losses and serious financial difficulties there will be for small- and mid-sized companies," he says. "A number of savings banks are currently worried that they will have to make some major write-downs soon as well."

He offered a goal for his actions that I applaud:

…I want every American to know that each action we take and each policy we pursue is driven by a larger vision of America’s future – a future where sustained economic growth creates good jobs and rising incomes; a future where prosperity is fueled not by excessive debt, reckless speculation, and fleeing profit, but is instead built by skilled, productive workers; by sound investments that will spread opportunity at home and allow this nation to lead the world in the technologies, innovations, and discoveries that will shape the 21st century.  That is the America I see.  That is the future I know we can have.

He built on a parable in the Sermon on the Mount to lay out a five-point program for building an enduring prosperity:

There is a parable at the end of the Sermon on the Mount that tells the story of two men.  The first built his house on a pile of sand, and it was destroyed as soon as the storm hit.  But the second is known as the wise man, for when “…the rain descended, and the floods came, and the winds blew, and beat upon that house…it fell not:  for it was founded upon a rock.”

We cannot rebuild this economy on the same pile of sand.  We must build our house upon a rock.  We must lay a new foundation for growth and prosperity – a foundation that will move us from an era of borrow and spend to one where we save and invest; where we consume less at home and send more exports abroad. 

It’s a foundation built upon five pillars that will grow our economy and make this new century another American century:  new rules for Wall Street that will reward drive and innovation; new investments in education that will make our workforce more skilled and competitive; new investments in renewable energy and technology that will create new jobs and industries; new investments in health care that will cut costs for families and businesses; and new savings in our federal budget that will bring down the debt for future generations.  That is the new foundation we must build.  That must be our future – and my Administration’s policies are designed to achieve that future.

Again, these are goals that are admirable and upon which most can agree.

Where I continue to part company with the Obama Administration is in its handling of the financial crisis. Obama explained and defended the bailouts of the banking system, but I found the defense disingenuous and unconvincing [my comments interspersed]:

The heart of this financial crisis is that too many banks and other financial institutions simply stopped lending money.  In a climate of fear, banks were unable to replace their losses by raising new capital on their own, and they were unwilling to lend the money they did have because they were afraid that no one would pay it back.  It is for this reason that the last administration used the Troubled Asset Relief Program, or TARP, to provide these banks with temporary financial assistance in order to get them lending again. 

Now, I don’t agree with some of the ways the TARP program was managed, but I do agree with the broader rationale that we must provide banks with the capital and the confidence necessary to start lending again.  That is the purpose of the stress tests that will soon tell us how much additional capital will be needed to support lending at our largest banks.  Ideally, these needs will be met by private investors.  But where this is not possible, and banks require substantial additional resources from the government, we will hold accountable those responsible, force the necessary adjustments, provide the support to clean up their balance sheets, and assure the continuity of a strong, viable institution that can serve our people and our economy.

Of course, there are some who argue that the government should stand back and simply let these banks fail – especially since in many cases it was their bad decisions that helped create the crisis in the first place.  But whether we like it or not, history has repeatedly shown that when nations do not take early and aggressive action to get credit flowing again, they have crises that last years and years instead of months and months – years of low growth, low job creation, and low investment that cost those nations far more than a course of bold, upfront action. 

Those who argue for an alternative to taxpayer-financed bailouts are, for the most part, not opposed to “early and aggressive action to get credit flowing again.” To the contrary, they argue that propping up “zombie” banks is counter to the goal of getting robust bank lending established. Even after the bailouts, the banks with impaired assets are going to be reluctant to lend. In any event, the second sentence is not logically implied by the first, i.e., it is a non sequitur.

And although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.

Again, while it is true that bank capital can support multiple dollars of lending, if there is sufficient demand for the loans, bailouts are not the only way to improve the balance sheets of banks so that they have the capital required to support loans. Obama continues:

On the other hand, there have been some who don’t dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it.  They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear – the reason we have not taken this step has nothing to do with any ideological or political judgment we’ve made about government involvement in banks, and it’s certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.   

Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm.

I believe that Obama is sincere here, but I also believe that he has listened to and sided with advisors who have sold him one side of the argument, a failing in judgment that I attribute to his years at Harvard, where he gained an undeserved belief in the intellectual superiority of the the Eastern Scholarly Establishment, led by Harvard.  Notice that he says, “we believe that preemptive government takeovers …” He does not provide reasons and evidence, only belief to support his policies. Further, he mischaracterizes the situation when he says “preemptive government takeovers.” There would have been nothing “preemptive” in the takeover of Citigroup, Bank of America, and others that were realistically insolvent and only prevented from failure by the infusion of tens of billions of government funds and hundreds of billions of government guarantees.

Obama fails to provide answers to the thoughtful critics of his policies. Rather he mischaracterizes their arguments and rebuts the mischaracterizations. This is neither compelling nor honest. He continues:

So rest assured – we will do whatever is necessary to get credit flowing again, but we will do so in ways that minimize risks to taxpayers and to the broader economy.  To that end, in addition to the program to provide capital to the banks, we have launched a plan that will pair government resources with private investment in order to clear away the old loans and securities – the so-called toxic assets – that are also preventing our banks from lending money.

Obama doesn’t even attempt to answer the critics of his Private Public Investment Partnership (PPIP, or more accurately termed GASP – “Geithner And Summers Plan”), a sweetheart deal for investment banks and hedge funds that acts as a fig leaf for another trillion dollars of taxpayer bailout money.

Although I give Obama A’s and A-pluses on most of his actions and programs to date (including the stimulus package and budget), I give him between a C and D on his bank bailouts. My only hope is that Obama has said many times that he expects to make mistakes, implying that he is open to recognizing and learning from his mistakes. Let’s hope he recognizes this mistake sooner rather than later.

John Dizard: Geithner’s and Citi’s Days Numbered

Now I will admit my headline overstates John Dizard’s current column in the Financial Times a hair, but only a hair. Dizard has a somewhat baroque way of presenting his messages, and the color can take the edge off his communiques. Nevertheless, he has cultivated contacts among central bankers as well as at the major financial firms, so he typically has good intelligence.
The big messages are that Washington simply cannot make all the bank bondholders good, despite its pretenses it can. Citi is going to become a test case sooner than most realize. Dizard also says that the charade that the banks have a liquidity problem not a solvency problem, is wearing thin even on those who have good reason to play along (and as far as I can tell, there is absolutely no Plan B when the world wakes up and realizes what a crock Plan A was).
Dizard’s certainty that Geithner and Citi are goners comes through loud and clear even through his elaborate prose.
From the Financial Times:

“That piece of shit up there, I never liked him. I never trusted him… But that’s history, I’m here, he ain’t.” Tony Montana (Al Pacino), watching a colleague hanged from a helicopter.
Scarface (1981)
It’s nearly time for some Washington careers to get the helicopter-noose treatment, particularly among the crowd of unvetted advisers and the tiny group of confirmed appointees at the Treasury Department. Politicos and policy hustlers have a style that differs slightly from Tony’s, but they’re about as sentimental. Secretary Timothy Geithner, not a bad or dishonest person, just a mediocrity who picked the wrong friends and trusted them for too long, can probably hear the rotor blades in the distance. Sadly, the prospective compensation packages for his next career are more modest than they would have been even a year ago…

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Tarp investigator seeks evidence of book fiddling

By Tom Braithwaite in Washington

Published: April 12 2009 23:32 | Last updated: April 12 2009 23:32

The official policing the $700bn Tarp fund says he is investigating whether banks have “cooked their books” to secure bail-out money.

Neil Barofsky, special inspector-general for the troubled asset relief programme, told the Financial Times he was seeking evidence of wrongdoing on the part of banks receiving help from the fund, which was designed to ease credit conditions and support distressed industries.

“I hope we don’t find a single bank that’s cooked their books to try to get money but I don’t think that’s going to be the case,” said Mr Barofsky, who has been dubbed the “Tarp cop”.

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Thank you professor for rubbing salt into the wound of this taxpayer (yes, Joe Average). This is an instance where ignorance might have been truly preferable to your informed analysis. Do we see the tired masses protesting in the streets? As they say, only in America!

I feel as irked as Mr. Reich by the sweetheart deal that Obama and Geithner are handing out to the hedge funds and big financial institutions. I’m not yet in the street, either, but I have signed on to a nationwide campaign to protest the bailouts and press for reform of the financial system. If you feel as I do, I urge you to sign on now, too.

Why You Should Work for a Hedge Fund

| Apr 6, 2009

Just because I lost a big chunk of my total retirement savings over the last year doesn’t mean I should be upset that 25 hedge-fund managers reaped a total of $11.6 billion during the same interval, according to Institutional Investor’s Alpha Magazine — including $2.5 billion for James Simons of Renaissance Technologies and $2 billion for John Paulson. (To be included on the list, you had to take home more than $75 million.)

I do admit to being irked that some of what these guys earn is taxed at a 15 percent rate because the earnings are treated as capital gains, while I’m just about to be walloped by the Internal Revenue Service come April 15. But what causes me severe heartburn is that these are exactly the sort of investors Tim Geithner is trying to lure in to buy troubled assets from banks, with an extraordinary offer financed by you and me and other taxpayers: If it turns out the troubled assets are worth more than these guys pay for them, they could make a fortune. If if it turns out the assets are worth less, these guys won’t lose a thing because we taxpayers will bail them out. Plus, they get to pick only the highest-rated of the big banks’ bad assets and can review them carefully before buying.

What a deal. Why can’t you and I get in on this bonanza? Because we’re too small. The government will designate only about five big investor funds — run or owned by the richest of the rich — as potential buyers. Hedge funds fit the bill perfectly.

There’s a beautiful symmetry here. The hedge fund managers who raked in billions last year wouldn’t have done nearly as well had taxpayers not bailed out Wall Street to begin with. According to John Taylor, a hedge fund manager who tied for ninth on Alpha’s list, many funds would have gone belly-up had the government not acted. "Thank god for the government, because if they hadn’t intervened, we wouldn’t have had anybody to trade with," he told the Times.

So you and I and other taxpayers have kept these hedge-fund honchos flush enough to be able to reap the bonanza that Geithner now wants to bestow on them for cleaning up the mess they and others on Wall Street made — a bonanza to be financed by you and me and other taxpayers, who are taking on all the risk.

I read this morning that Larry Summers earned nearly $5.2 million in the last two years working one day a week for D.E. Shaw, one of the largest hedge funds of all. I can’t help admire Larry for sacrificing all the money he could be making now had he not chosen to work for the government.

By now, almost everyone must know that in the last week the Federal Reserve and the Obama Administration fired coordinated bombshells at the financial crisis.

First, last Thursday the Federal Reserve announced major increases in asset purchase programs, adding $1.150 trillion to the total. The total included purchase of up to $300 billion of long-term Treasuries. The Fed also expanded the list of the type of assets it would purchase under its Term Asset-Backed Securities Loan Facility (TALF).

Before the financial community and the public had a chance to catch its breath, on Monday, the Treasury unveiled the next blockbuster. Both the FDIC and Treasury would combine with private investors to purchase toxic assets from banks.

In the FDIC program, the government would put up 92.5% of the money and private investors would put up 7.5% — but, here’s the catch, private investors would get 1/2 of potential profits from their 7.5% investment and be liable for no more than their investment. Who is responsible for additional losses? The FDIC, which in theory is underwritten by the banking sector — though if there are big losses, it seems likely that you and me, the taxpayers, will end up paying.

In the Treasury program, the government and private investors would put up equal amounts of initial capital, and then the government would lend the entity twice its initial investment. The entity would then bid for troubled assets from banks. The kicker here is that, once the entity has purchased assets, it will able to borrow against them from the Federal Reserves expanded TALF program; then turn around and buy more troubled assets, and so on. The private investor again may get to leverage its initial sum by 6 times or more, with losses limited to its initial investment. Who is responsible for additional losses? You know who. You and me, the taxpayers.

A key part of the plan is to amend the TALF, which was initially a Federal Reserve initiative aimed at purchasing new loans, with the objective of expanding new lending. The amended plan allows loans against existing securities that were “originally AAA rated.” Of course, many of those AAA mortgage backed securities are, as we are well aware, now junk. You can be sure that these are the ones the new rescue partnerships are going to pledge to the government first.

[Nouriel Roubini's RGE Monitor has provided an excellent summary and brief analysis of the Geithner plan.]

Wall Street Wins!

The response of Wall Street, with a one-day rise on the Monday of the plan’s announcement of 7% in the S&P 500 and 18% in the S&P Financials indices, was ecstatic. The big bond investment firms fell over themselves with praise. This was what the financial community has been looking for, but almost giving up hope of getting: for the government to step in and buy all of the crappy loans on their books. The common estimate is that their are two trillion dollars of such junk held by banks. The government programs, not coincidently, have potential purchasing power of about $2 trillion.

If it works, and the street is currently betting it will, the plans will get the toxic debt out of the zombie banks, making them live once again, to the great benefit of the stockholders and option holders of the banks. Of course, the debt will go into the hands, primarily of the government; so if the plan doesn’t work, the economy doesn’t recover, and all of those bad mortgages, auto loans, and credit-card securities decline further in value, you and I will be left holding the bag.

And, of course, the big investment firms love the plan because they are going to be allowed to participate in buying up the bad debt with only small risk and big profit potential — to say nothing of getting to transfer their lousiest assets to the government. Bill Gross of PIMCO, the worlds largest bond company, has called it a “win-win” plan. It is a win-win plan for the investment community.

You Lose!

The Obama-Geithner plan is a lose-lose plan for you and me. We lose, first, because we as taxpayers are having to pony up almost all of the money to buy up the crappy assets that the financial community sold at very great profit to itself. The shareholders and bondholders of the financial community are getting the BIG bailout at our expense. If the plan fails, we are left holding the bag. Of course, the big financial firms will probably be forced into failure, too, but only after having transferred most of the bad privately-held securities into the hands of the willing government. This is bad public policy on multiple counts, not the least of which is the blatant inequity of it all.

But, what if the plan succeeds, as Geithner has clearly succeeded in convincing Obama that it will? You lose. The government will have succeeded in revitalizing the financial sector with the same players in charge. It will have turned the economy around by once again expanding leverage and debt, raising the burden of debt that for years has been depressing our real economic performance and individual well being. The chance will have been lost for transforming our economy away from pursuit of capital gains and financial aggrandizement toward focusing on meeting the real needs of our population and of the planet.

Obama Fails!

The current crisis, caused by financial excesses, offered the opportunity for us as a country to take away the dominant power of go-go finance and corporate exploiters. Instead of fundamentally rethinking and restructuring the political-economic management of our country, Obama has chosen to side with the entrenched power interests.

There are no outsiders in the inner circle of economic and financial advisors. All apparently come to their task with a mindset that big finance and big business are essential to the future of our country. Geithner was protégé of Larry Summers and Robert Rubin, both instrumental in the deregulation legislation that set the stage for the current crisis.

I am disheartened by this latest episode in the unfolding crisis not so much because of the unfairness of the latest plan but because of what it reveals about Obama’s core beliefs. The pressure that has been building around the financial meltdown has certainly required Obama to search within himself for the right answer.

There was no shortage of voices recommending that the failing banks be allowed to fail, to be restructured with government assistance, and the shareholders and bondholders be required to bear the results of their poor investment judgment. I have published many of these voices here. It seems highly likely that Axelrod, Plouffe, and Emanuel would have seriously challenged Geithner’s plan. Yet, in the end, when Obama had to decide, he supported a plan that is designed to make the financial sector as whole as possible, at huge cost to the government and, ultimately, us taxpayers.

From this episode, I infer that in matters of economics, Obama operates within the mindset of the prevailing economic paradigm of prosperity through continued growth in output, with little concern about what makes up that output.

For me personally, this is very sad. I had hoped, I realize now with little evidence, that Obama would bring a fresh perspective to managing our economy, one that would provide for rebalancing the economy as well as the distribution of income. It is not just who get the money (although this needs to change), but what as a nation we choose to produce and consume. To make changes in the latter, we need to redistribute political and economic power. In Obama’s actions on the financial crisis, there is no evidence that he saw it as an opportunity to accomplish some of this redistribution. This is not encouraging for the future.

James Galbraith has made another effort to get this message across — interestingly in the European media rather than the New York Times, where it properly belongs. The beginning of the Der Spiegel article is below, with a link to the entire article.

US ECONOMIST JAMES GALBRAITH

Financial Crisis Caused by a ‘Culture of Complicity’

While the world talks about new ways to save struggling banks, there are a handful of economists who think some banks shouldn’t be saved at all. American economist James Galbraith told Manager Magazin that it might make more sense to break them up and start over.

Manager Magazin: Professor Galbraith, you suggest that banks that suffer from bad assets should simply be declared insolvent, instead of rescuing them with taxpayers’ money. Why?

What should be done with the world’s ailing banks?

James Galbraith: We need a correct assessment of the degree of losses suffered by a bank which is functionally insolvent. But as long as the old management is in place, there are no incentives to cooperate in the evaluation you need to make. That’s the first problem.

The second problem is: When a bank is insolvent, the incentives for normal banking practice disappear. They become perverse. The incumbent management has good reason to gamble excessively and to make capital losses. This is because it appears that the regulators could soon close down the bank.

Beyond that, if the situation for the bank is truly hopeless or if the management is truly corrupt, then the incentive is to loot the institution, to take as much money out of it — e.g. in the shape of bonuses and dividends — before the true state of the books is discovered.

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Here is a nifty graphic display of relative magnitudes of different sums of money. You see, when talking trillions, we are talking BIG.

What does one TRILLION dollars look like?

All this talk about "stimulus packages" and "bailouts"…

A billion dollars…

A hundred billion dollars…

Eight hundred billion dollars…

One TRILLION dollars…

What does that look like? I mean, these various numbers are tossed around like so many doggie treats, so I thought I’d take Google Sketchup out for a test drive and try to get a sense of what exactly a trillion dollars looks like.

We’ll start with a $100 dollar bill. Currently the largest U.S. denomination in general circulation. Most everyone has seen them, slightly fewer have owned them. Guaranteed to make friends wherever they go.

Click on the $100 bill to see the rest of how many of these we need to get to a trillion dollars. It is amazing and dismaying!

AIG has finally, under pressure, released the uses of a large portion of the taxpayer bailout money provided to it. What was revealed was that many tens of billions of U.S. taxpayers money went, not to companies needing loans to stay in business, but to other banking firms, including many in Europe, that were part and parcel of the the grand casino consortium that speculated wildly and foolishly on esoteric derivatives. It has been well publicized that the leading US investment firms were leveraged 30 to 1 in the boom days (meaning they borrowed $30 for each $1 of equity). What is not so widely known is that leading banks in Europe leveraged up to 70 to 1! No matter we are living under the threat of collapse of a house of cards.

According to the Financial Times, total disbursements made last fall to fulfill AIGs obligations to other banks amounted to about $95 billion, of which $85 billion was provide by U.S. taxpayers. You can break down the disbursements according to the purpose and by who were the recipients.

A big chunk, $52 billion went to deal with the consequences of contracts made by AIG Financial Products , AIGFP. AIGFP was the go-go unit of AIG that wheeled and dealed in the derivative markets, and issued billion of credit default swaps (bond default insurance) without ever providing reserves against losses. The AIGFP disbursements broke down as follows:

AIGFP paid out $22.4bn of collateral related to credit default swaps, $27.1bn to help cancel swaps and another $43.7bn to satisfy the obligations of its securities lending operation. The payments were made between September 16 and the end of last year.

In addition to the direct support detailed above, AIGFP also paid $43.7 billion to counterparties who lent securities of AIG as part of its operations.

The list of beneficiaries reads like a who’s who of those at the center of the financial meltdown:

Goldman Sachs, which has also accepted US government support, received payments worth $12.9bn. Three European banks – France’s Société Générale, Germany’s Deutsche Bank and the UK’s Barclays – were paid the next-largest amounts. SocGen received $11.9bn; Deutsche $11.8bn; and Barclays $7.9bn.

Is it reasonable and appropriate to be bailing out those that created the financial mess that has halved the value of financial assets around the world and thrown millions of people out of work? It was a grand casino, and the players were taking out billions into their pockets while the party lasted. Now the party is over, but taxpayers are still pumping in hundreds of billions to keep the party and the players afloat.

When one delves into the details of the transactions among the parties, one can only become more distressed at the incompetency and unbelievable stupidity, or culpable collusion, that led to the losses now being paid by taxpayers. Read more on this in a related post on AIGs guaranteeing of hedge fund (and Goldman Sachs’) bets on the declining value of U.S. housing bonds.