Dear President Obama,
I say this as a supporter and as someone who wishes you success as we face extreme challenges on many fronts. I work among conservative Republicans and actually had to sneak out of the office to watch your inauguration. It was a touching and historic moment I will never forget.
You are on the verge of losing whatever political capital you had coming into office due to your refusal to acknowledge that the people you are relying on for economic policy are the very people who are responsible for getting us into this situation. Greenspan, Bernanke, Paulson, and now Geithner (and Summers) all continue to fail to see the causes of the crisis. As a consquence, current proposed regulatory reform is bound to fail yet again.
At this point, the rapid loss of confidence in both Geithner and Bernanke are weakening your ability to push your agenda in other critical matters. You must do something to remove them both or you will imperil your potential to accomplish lasting and necessary change.
He enunciates six unacceptable weaknesses in your proposal:
1) No major changes for the ratings agencies!
2) Turn Derivatives into Ordinary Financial Products
3) If they are too big to fail, make them smaller.”
4) The Federal Reserve, Despite its Role in Causing the Crisis, Gets MORE Authority
5) Require leverage to be dialed back to its pre-2004 levels.
6) Restore Glass Steagall
All of which suggests that the status-quo-preserving, sacred-cow-loving, upward-failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall-Street Rahm Emmanuel have yet to assert authority over the finance sector.
All these should be considered uncompromising requirements of any regulatory reform. Anything less than these six items will have no positive effect and will likely lead to another crisis before the end of your first term.
You are running out of time.
There are many exemplary American’s doing everything they can to expose the reality of our current financial crisis. Here, I would like to highlight William K. Black.
You must watch William Black’s recent appearance on Bill Moyers Journal:
Moyer: Why are they firing the president of GM and not firing the head of the all these banks that are involved?
Black: There are two reasons: 1.) they are much closer to the bankers. These are people from the banking industry and they have a lot more sympathy. In fact, they’re outright hostile to auto workers as you can see. They want to bash all of their contracts, but when they get to banking they say, “Oh! Contracts! Sacred!” But the other element of your question is, we don’t want to change the bankers because, if we do, if we put honest people in who didn’t cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up, and the cover up is…
Moyer: Cover up? That’s a serious charge. Who’s covering up?
Black: Geithner is covering up, just like Paulson did before him. Geithner is publicly saying that it is going to take two trillion, a trillion is a thousand billion, two trillion taxpayer dollars to deal with this problem. But they’re allowing all the banks to report that they are not only solvent, but fully capitalized. Both statements can’t be true. It can’t be that they need two trillion because they have massive losses and that they’re fine. These are all people who have failed. Paulson failed. Geithner failed. They were all promoted because they failed. Not because they may have succeeded.
Moyer: What do you mean?
Black: Well, Geithner was one of our nation’s top regulators during the entire subprime scandal that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig-in-the-poke stuff happened under him. So in his phrase about legacy assets, well he was a failed legacy regulator.
Moyer: To hear you say this is unusual because you supported Barrack Obama during the campaign last year, but you’re seeming disillusioned now.
Black: Well, certainly, in the financial sphere I am. I think first the policies are substantively bad, second I think they completely lack integrity, third they violate the rule of law. This is being done, just like Secretary Paulson did it, in violation of the law. We adopted a law after the savings and loan crisis called the “Prompt Corrective Action Law” and it requires them to close these institutions and they are refusing to obey the law.
Moyer: In other words, they could have closed these banks without nationalizing them?
Black: Well, you do a receivership. Nobody… Ronald Reagan did receiverships and nobody called it nationalization.
Moyer: And that’s the law?
Black: That’s the law.
Moyer: So Paulson could have done this? Geither could do this?
Black: Not could. Was mandated.
Moyer: By the law?
Black: By the law.
Moyer: This law you’re talking about?
Moyer: What’s the reason they give for not doing it?
Black: They ignore it. And nobody calls them on it.
Moyer: Well, well, where’s congress? Where’s the press?
Moyer: Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration with the banks are engaged in a cover up to keep us from knowing what went wrong?
Moyer: You are?
Black: Absolutely. Because they are scared to death. Alright. They are scared to death of a collapse. They are afraid that if they admit the truth that many of the large banks are insolvent, they think that Americans are a bunch of cowards and that we’ll run screaming to the exits and we won’t rely on deposit insurance. And by the way, you can rely on deposit insurance. And it’s foolishness. Alright. Now, it may be worse than that. You may impute more cynical motives, but I think they are sincerely just panicked about we just can’t let big banks fail. That’s wrong.
Moyer: So how did they get away with it?
Black: I don’t know whether we’ve lost our capability of outrage or whether the cover up has been so successful that people just don’t have the facts to react to it.
Black: Now, going forward. Get rid of the people that have caused the problems. That’s a pretty straightforward thing as well. Why would we keep CEOs and CFOs and other senior officers that have caused the problems? That’s facially nuts. That’s our current system. So stop that. The current system. We’re hiding the losses instead of trying to find out the real losses. Stop that because you need good information to make good decisions. Alright. Follow what works instead of what’s failed. Start appointing people who have records of success instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today. As late as it is. Even though they’ve had a terrible start to the administration, they could change and they could change within weeks. And by the way, the folks who are the better regulators, they’ve paid their taxes so you can get them through the vetting process quicker.
The entire interview is fantastic and potentially historic. Please go have a look.
If I could add anything to what Black had to say, I would strongly encourage everyone, including Black, to look beyond mortgages. As dire as Black makes the situation appear, this situation we find ourselves in is much worse than even that because the problems are not confined to mortgages. Every single form of debt imaginable experienced the same lax underwriting standards that were seen in mortgages, e.g. credit cards, auto loans, student loans, residential mortgages, commercial mortgages, corporate bonds and even government bonds experienced the same wreckless behavior. All forms of debt were bundled into pools and resold to pension funds, mutual funds, hedge funds, and university endowments after receiving the AAA stamp from the ratings agencies. The problem is beyond the scope of the adminstration to handles with any policy other than massive simultaneous, even globally coordinated, receivership of all major banks.
Dear Mr President,
It is almost unfair to criticize you given the extraordinary circumstances surrounding this country when you took the oath of office. Time was a precious commodity and you were forced to make urgent decisions. To be clear, I cannot think of anyone else I would rather have at the helm now than you. Choosing generals was job number one and, for the most part, you did a fantastic job.
However, we clearly find ourselves in a severe financial crisis that, due to improper handling and an initial failure to recognize the scope of the problem, has mutated into a full blown economic crisis. Continued failure to right the ship is increasing the chances of a total global economic and social breakdown. In 2007, Bernanke and Paulson’s assurances that the subprime mortgage crisis would be contained only served to illustrate their complete lack of understanding of the circumstances. The crisis was no more about subprime mortgages than an influenza outbreak is about runny noses.
People smarter than me will tell you that a large contributor to economic growth over the last 10 years (some would say 20) was fueled by increasing levels of debt. Debt came to pervade every aspect of developed economies from consumers, to corporations and financial institutions, all the way up to local and federal governments. This debt came in the form of credit cards, auto loans, school loans, residential mortgages, commercial real estate loans, corporate bonds, municipal bonds as well as Treasury bills, notes, and bonds.
Scholars will debate the true causes for decades, but let me offer this as a plausible explanation. Pension funds, endowments, and trusts have financial obligations that are met by targeting a given level of return on investments made over a period of time. When the Federal Reserve, in conjunction with global counterparts, brought interests rates below 4% in 2001, these pension funds, endowments, and trusts found it increasingly difficult to meet their obligations. This forced them to move away from traditional safe investments such as Treasury bonds and into other investments that appeared safe, yet paid higher rates of return. In fact, many investors were restricted to securities that were christened the coveted AAA rating from ratings agencies such as Moodys, S&P, and Fitch.
The investment instrument that many of these funds turned to was something called a collateralized debt obligation (CDO). There are many fantastic explanations of CDOs around the web, e.g. see This American Life for mortgage CDOs. Think of a CDO as a bunch of debt sources (some listed above) whose interest payments are pooled together into a cashflow waterfall. The advantage of having a pool is that it is less susceptible to borrowers not making payments. For example, if you gave one person a loan and you depended on them making their interest payments so that you could pay your own bills, you’d be in trouble if they stopped paying. But if you were receiving interest payments from 1,000 loans, the impact of single borrower stopping payments is less severe.
A CDO goes one step further. A CDO takes this waterfall and redistributes the cashflows in a way very much reminiscent of the champagne tower. As long as some borrowers continue to make interest payments, the top champagne glass is likely to always be full. Ratings agencies then published models that attempted to assess the risk that the top glass may run dry in order to facilitate the design of these pools. The goal was to achieve a AAA rating on that top champagne glass so that the banks could sell them (the cashflows, not the loans) to pension funds, endowments, and trusts that were starving for safe investments that paid more than traditional safe investments rendered unattractive by the Federal Reserve and the Treasury Department.
This was a boon for the ratings agencies because they charge fees to rate securities. If a bank owned a bunch of loans and wanted to get them off their balance sheets to free up capital, they’d structure them into a CDO, plug a few parameters into the ratings model, and essentially pay the ratings agency to christen the top champagne glass AAA. In some cases, the loans in the pool were so risky that even the top champagne glass was not sound enough to warrant a AAA rating. In such cases, the insurance companies were happy to step in, and for a fee, would guarantee that the top glass always remained full.
Now, Mr President, I understand that you are already familiar with CDOs. Nevertheless, I hope this short description was helpful because it sets the stage for what I need to say next. Statements by Bernanke, Paulson, and now Geithner have focused on the mortgage market because that was the first symptom to appear. If the problems were confined to mortgages, Geithner’s plan might have a chance to succeed. Unfortunately, the scope of the problem is more accurately described as a global epidemic infecting all forms of debt. Banks have been pooling together every form of debt imaginable and constructing CDOs from the interest payments. There are CDOs of auto loans. There are CDOs of school loans. There are CDOs of residential mortgages. There are CDOs of commercial real estate loans. There are CDOs of corporates bonds. There are CDOs of municipal bonds. There are even CDOs of other CDOs.
I’m sorry Mr President, but you do not have enough money to back stop all of these legacy assets. Drastic measures are needed and they are needed now. As incomprehensible as it may sound, I believe that you should consider using your Executive power to declare a national emergency. Seize the investment banks and give a blanket guarantee on existing bank deposits to avoid bank runs, while setting rates on new deposits close to zero to avoid draining foreign capital from other struggling countries. Halt the issuance of new CDOs. Impose a temporary 90% tax on all income in excess of $1,000,000.00 to temporarily reduce the need to raise funds from foreign central banks who are dealing with their own problems. Transfer all outstanding credit derivatives to an exchange and enforce punitive taxation on over-the-counter (OTC) derivatives transactions to encourage the swift migration to transparent exchanges, while offering substantive tax incentives for financial institutions who can demonstrate they have completely migrated and no longer participate in the opaque OTC derivatives market.
Your advisors will surely tell you that the OTC market should not be demonized and serves an important role in the market place. I say they are wrong and you should be looking for ideas outside of the establishment. I would be glad to argue my case for any of these proposals on a point by point basis. I would not suggest such radical measures if anyone other than you were in office. Your knowledge and personal conviction in the sanctity of the United States Constitution places you in a unique position to be able to make it work without destroying the foundations of this country.
Many people in the United States are not happy. Some are outraged. Some are confused. Personally, I am outraged by what is going on at the Federal Reserve, The Treasury Department, and on Wall Street and am determined to educate anyone who will listen to me. I hope that includes you. However, the general outrage has not reached critical mass yet. It is not too late to correct course. I am writing these letters because I am still audacious enough to have Hope in your ability to steer this country back to prosperity for all Americans, not just Wall Street cronies living in their echo chambers.
Despite progress you may be making on other fronts, you will ultimately be judged by how well you manage the economic crisis. You’ve chosen your generals and have placed your trust in them. It is time you consider that perhaps you have made a mistake. Geithner and Bernanke are not up to the problems that face them. It is not too late to change course. Listen to Krugman. Listen to Volcker. Listen to Roubini. They are capable and willing to help, but so far you have turned a def ear to them.
The last time public outrage began to overflow was in the 1960’s and 1970’s during the Vietnam War. At that time, many people found their voice in music. I want to leave you by pointing to an example of what makes this country great. Jonathan Mann is an amazingly talented writer and musician who, like me and millions others, have the audacity to continue to have Hope. But, as I said in an earlier letter, the only thing more audacious than the audacity of Hope would be the audacity of squandering that Hope. In this song, Jonathan powerfully communicates the internal struggle many of us feel as we hang on to our remaining strands of Hope: