Corruption as an Element in the Financial Crisis

The only surprising thing about this essay is that it appears in Forbes.

After the demise of Glass-Steagall the gloves came off and corruption became an unusually prominent factor in our financial system. There should be little doubt that the taint reached the highest levels in the US over the past ten years or more, and is still a serious problem.


Forbes
Corruption And The Global Financial Crisis
Daniel Kaufmann
01.27.09, 02:58 PM EST

The financial debacle has many causes and implications, but it would be wrong to underestimate systemic corruption.

It would be very convenient to start this article by stating that corruption is a challenge mainly for public officials in developing countries and that it is unrelated to the current global crisis.

I also wish I could claim that corruption has declined worldwide as a result of the global anti-corruption and awareness-raising campaign, the many effective anti-corruption commissions, and the recognition that poverty and culture are the reasons why corruption prevails.

But none of it is true. For starters, corruption is not unique to developing countries, nor has it declined on average. Some developing countries, such as Chile and Botswana, exhibit lower levels of corruption than some fully industrialized nations. And countries like Colombia and Liberia have made gains in recent years, while others, such as Zimbabwe, have deteriorated. Bribery remains rife in many countries, totaling about $1 trillion globally every year.

In truth, anti corruption commissions, revised laws and awareness-raising campaigns have had limited success. Focus on petty or administrative bribery has been misplaced at the expense of high-level political corruption.

One neglected dimension of political corruption is "state capture," or just "capture." In this scenario, powerful companies (or individuals) bend the regulatory, policy and legal institutions of the nation for their private benefit. This is typically done through high-level bribery, lobbying or influence peddling.

The cost to society of bribing a bureaucrat to obtain a permit to operate a small firm pales in comparison with, say, a telecommunications conglomerate that corrupts a politician to shape the rules of the game granting it monopolistic rights, or an investment bank influencing the regulatory and oversight regime governing them.

As a country becomes industrialized, its governance and corruption challenges do not disappear. They simply morph and become more sophisticated: Transfer of a briefcase stashed with cash is less frequent.

Instead, subtler forms of capture and "legal corruption" exist: an expectation of a future job for a regulator in a lobbying firm, or a campaign contribution with strings attached. In many countries this may be legal, even if unethical. In industrialized nations undue influence is often legally exercised by powerful private interests, which in turn influence the nation's regulations, policies and laws.

This has dire consequences: Witness the various forms of corruption underlying the current global financial crisis that started in the U.S.

There are multiple causes of the financial crisis. But we can not ignore the element of "capture" in the systemic failures of oversight, regulation and disclosure in the financial sector. Concrete examples abound...

(The examples given are Fannie Freddie, AIG, the mortgage lenders, and the Investment Banks)

The new U.S. administration has stated its intention to address the challenges of transparency and accountability in its stimulus plan. The devil will be in the details. Merely creating an oversight institution will not do; system-wide reforms in incentives are required. Deep-seated transparency reforms need to be a cornerstone in the government's plan, and should apply to U.S. public agencies as well as domestic and international financial institutions. Regulations supporting effective disclosure, as well as improved audit, accounting and risk-rating standards, should be preferred to restrictive regulatory controls that block innovation and growth.

Humbly learning from other nations will also go a long way. The situation in the U.S. warrants studying other countries--for instance, Sweden and Chile, which successfully addressed their financial crises long ago. Chile also offers guidance on how to structure less corrupt and effective concessions in infrastructure, where the U.S. is a novice.

In order to restore confidence, citizens, entrepreneurs and bankers need to have renewed trust in the financial system. That way they can be persuaded that it is no longer a giant Ponzi scheme. Transparency is the key.

The Banks Are Making an Offer They Think that the People Cannot Refuse

Better we tie off the bleeding wound now, nationalize the banks, and start again with an honest financial system, than pay one more cent of blackmail tribute to this den of thieves.

They would use our own money to buy us.


Bloomberg
Stiglitz Criticizes Bad Bank Plan as Swapping ‘Cash for Trash’
By Simon Kennedy

Feb. 1 (Bloomberg) -- Nobel laureate Joseph Stiglitz said any decision by President Barack Obama to establish a so-called bad bank to rid financial companies of toxic assets risks swelling the national debt.

Obama’s administration is moving closer to buying the illiquid assets currently clogging bank’s balance sheets and preventing them from boosting lending, people familiar with the matter said this week.

That amounts to swapping taxpayers’ “cash for trash,” Stiglitz said yesterday in a panel discussion at the World Economic Forum in Davos, Switzerland. “You shouldn’t chase good money after bad. We’re talking about a national debt that’s very hard to manage.”

Stiglitz, a professor at Columbia University in New York and a former adviser to President Bill Clinton, says the plan would leave taxpayers paying for years of excess lending by banks. It would also deprive the government of money that would have been better spent shoring up Social Security, he said.

Whether a bad bank would accelerate an end to the financial crisis split delegates attending the Davos talks. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said such an operation would help if “executed well.” Billionaire investor George Soros said in an interview that “it’s not the measure that would turn the situation around and enable banks to lend.”

Obama Plan

Obama said yesterday he’s readying a plan to unlock credit markets and lower mortgage rates. Under the initiative, the government would buy some tainted securities and insure the banks against losses on the rest.

“Soon my Treasury secretary, Timothy Geithner, will announce a new strategy for reviving our financial system that gets credit flowing to businesses and families,” Obama said in his weekly radio address.

Stiglitz drew criticism from panel participant Angel Gurria, head of the Organization for Economic Cooperation and Development, who says a bad bank is necessary for lending to resume.

“I agree about the moral, ethical fallout, but you’ve got to face the music and someone has to take the loss,” said Gurria, Mexico’s former finance minister. “It’s the only way to jumpstart the economy.” (Blackmail. Injustice. Infamy - Jesse)

Bank losses worldwide from toxic U.S.-originated assets may double to $2.2 trillion, the International Monetary Fund said in a report released Jan. 28.

John Monks, general secretary of the European Trade Union Confederation, told the same audience that governments are getting “close to straining the patience of the public and voters” by repeatedly extending lifelines to banks.

Philippines President Gloria Arroyo urged Obama to make a quick decision on his plan.

“We want Americans to do something,” she said at the session, which was called “Rebooting the Global Economy.” “We can discuss what to do but the worst thing is to do nothing.”

US Financial Rescue Plan Delayed to Second Week in February

Did Turbo Tim misplace "The Plan?"

Check Hank's locker. Zimbabwe Ben has a copy.

Or are they just giving the frat boys some extra time to 'arrange their affairs?'


Economic Times
US financial rescue plan delayed a week: Report
1 Feb 2009, 0639 hrs IST

WASHINGTON: The announcement of President Barack Obama's financial rescue plan will be pushed back a week to the second week of February, media reported on Saturday, citing administration sources.

"Administration aides are saying that they want to get the details right, that there are a lot of moving pieces, and so it's going to take an extra week," a news channel said. Administration officials are weighing elements to include in the plan, including whether to restrict executive compensation, how to get credit markets flowing and how to deal with the foreclosure crisis, channel said.

Efforts to get the first installment of the $700 billion bailout initiative were rushed, resulting in difficulties, and the Obama administration believes that "getting these details right might make sense," channel said.

President Barack Obama said earlier in the day the plan would be announced soon and would help lower mortgage costs for homeowners and spur the flow of credit to businesses and households.

Notes from Underground

This is a composite of chatter and 'gossip' and anecdotes picked up from multiple sources, some that could be considered reasonably informed, formally regarded as hearsay.

Treat it as rumour as none of it can be guaranteed authentic. More of it is coming from Europe than the US. There can be no verification in such opaque conditions without investigative staff and the power of subpoena.

Verify it for yourself; it is not a bad starting point to use as a skeleton upon which to hang events as we go forward. Sometimes you hear enough of the same thing from different sources, things that make sense and ring true, and the dots connected, even if in a rough way.

There was more of a struggle in deciding to allow the speculative portion of this out than you might imagine. The 'history' part seems consistent and valid, but probably a selective caricature. It could all be the overreaction of frightened people who merely do not see the next step yet. But since we started acting on it this week, not in terms of investments, but in bringing capital back to safer harbors, it did not seem right to ignore it.

The whole outlook could change next week, and for the better. Anything is possible, if one does not know what is true and what is not, even if it does not seem probable. And we never trade on rumours, only the charts which tell us things known only to the markets.

It seems as if the government is downplaying the seriousness of the situation a bit while they work to find a way forward. That is natural and expected. What might seem today like a radical solution may be adopted eventually but the people are not ready to hear it yet, and it is not clear that this will be required, so why do it?

No one wants to make the first moves ahead of an unfolding crisis, especially with the Republicans playing hardball politics and the blame game. The pressure is on from the moneyed interests, but there is a growing concern about the public mood.

In the meantime, people's favorite ideas for solutions are getting play because no one can agree on a comprehensive plan. Obama brought in an impressive array of experienced people who know where the levers are. The problem is that they are philosophically at odds with one another, and sometimes poles apart from the president and his inner circle. There are the natural start up problems, but there is a more serious lack of cohesion of vision that is going to be resolved. Obama seems capable of doing this.

There is an air of quiet desperation as the situation grows progressively worse, and there is intense debate on when and how to break it to the public. They are not even sure what exactly to break because the situation is so fluid. No one wishes to be the messenger and possibly be blamed for inciting a loss of confidence.

Wall Street and the banking system has been every bit as irresponsible and out of control as we thought in our worst moments, perhaps more. A group of twenty somethings with little or no adult supervision developed ideas for 'financial products' with the same care and planning that their counterparts perform extreme stunts on Youtube.

They did it because they could. They tested the system for boundaries and didn't find any.

You want leverage? Imagine a 20 billion dollar portfolio of mortgage backed securities with a capital base of $10k, literally 2 million-fold leverage. Imagine the shock of the inventor as he watches as his successors expand similar portfolios up to $900 billion.

After running out of gullible Japanese bankers these young cowboys began trolling for other pools of gullible buyers: hedge funds, pension funds, and University endowments sufficed. They even found some local suckers. Anything to make a sale and keep the money machine turning.

How did we go so far off the tracks?

The guys initially putting these packages together had some sense that they were crazy, that they made no sense, but nobody said stop, and they didn't care. It was a good time to make money and then move along.

Government regulators being paid $100k couldn't tell connected guys making $20 million what to do. They also had their marching orders from above. Don't get in the way of financial progress on Wall Street. The US has to be competitive. The senior managers loved the money flows.

A sea of cubicles were staffed with engineers, chemists, physicists, and mathematicians from the best colleges in the country with no knowledge of the history of financial markets, fat tails, and past human follies. But they knew how to turn the crank on financial engineering.

The average career age in the business is about 7 years. A twenty year veteran is a very old man. The creators of these innovative financial products understood the toxicity at some level. As they retired, however, the next generation of twenty somethings came in and had zero sense of risk. They were simply told which button to push and which lever to pull to make money. Nobody was really driving the bus.

The Street looked from one market to the next to find and angle and make money. Enron was only the tip of the iceberg. And when they found a market that was vulnerable they swarmed on it like a pack of wolves.

The money overwhelmed the system. The money pushed all regulations aside. It bought deregulation, politicians, and anything else necessary to keep the money machine growing. Nobody dared yell stop because so damned much money was being made.

Greenspan became a believer--he lost consciousness of what he was there to do. The reason he turned a blind eye and allowed the damage to accumulate remains unanswered.

So where are we now, and where are we heading?

Our financial system is infected by flesh eating bacteria. Every day looks more dire than the previous day. The solutions being proposed look feeble, and the Fed looks both powerless and confused.

TARP is throwing money down a rathole. That is why there is such a mood of abandon on the Street. They know this is just an exercise.

One of the so-called model banks is on a don't ask/don't tell policy; the Fed simply cannot handle another mega-catastrophe while they wrestle with the fully-insolvent among the top five. (Note: think derivatives). The word on the Street is to keep everything bad off the radar to buy time.

There are rumours swirling that there will be a bank holiday in the UK, and they will be particularly hard pressed because of the high percentage of their GDP that financial services represent. The pound is heading to parity with the dollar. The good news is that it will probably not be as bad as Iceland.

The problem with Germany, and by inference continental Europe, is that their regulators refuse to acknowledge their errors and deal with the problems. They are the polar opposite of the Fed which acts first and plans later. The problem is that the Germans cannot seem to get beyond the planning stage because they cannot believe that their regulations and safeguards failed so badly. It has shaken their confidence. Additionally, the failed German bond auction was deemed catastrophic in its implications and has them fearful of policy error.

There is no way out of this mess without serious pain. Despite a deflationary bias today, most insiders see inflation and spiking interest rates as the risk going forward, probably early 2010 or sooner depending on how fast things start moving.