I arrived in Connecticut to begin a ‘listening tour’ before making the decision to run in the Democratic primary for United States Senate. Tonight I listened carefully to the Democratic candidates as they put forth their agendas for restoring the US economy and both fell far short of the mark. Neither had a credible economic agenda, and what they did propose- tax increases- would only make matters worse.

Making sure that people working for a living are paid enough to be able to buy the goods and services they produce has long been a core economic value of the Democratic party. And what drives the lion’s share of business, both large and small, is the competition to attract the consumer’s dollars by producing the goods and services working people want. Unfortunately, the current situation is clearly one where people working for a living are not taking home enough money to buy what business is desperately trying to sell. Consequently, business has been contracting and laying people off, which makes matters even worse.

The Republican response has traditionally been to give tax cuts and other monetary incentives to business rather than to the people doing the work. That does not result in new hires for the businesses, as business only hire when orders and sales pick up. Instead, it results in higher profits with the hope that those profiting will hire more domestic help and more gardeners, and produce a few jobs that way, which is known as trickle-down economics.

So while, in addition to tax hikes, both Democratic candidates for US Senate proposed tax relief, it was for small businesses- the traditional Republican approach, and indeed, the approach of the Obama administration. Note that last week’s jobs bill featured a $5,000 payroll tax reduction for businesses, and not for employees. In contrast, I have long been proposing a full ‘payroll tax holiday’ where a couple earning a combined $100,000 per year would see their take home pay rise by over $650 per month. That would be enough to fix the economy as people could then make their mortgage payments and car payments, and even do a little shopping. This is the Democratic approach which also gives businesses what they really need- people with enough money to spend to buy their products. It’s people with money to spend that creates the backlog of orders which then quickly results in the millions of new jobs we need to restore our economy to full employment levels and prosperity. The payroll tax holiday also reduces costs for business. In a competitive environment this translates into a combination of both lower prices and better cash flow for business that can be used for the new investment the recession has long delayed.

The reason the Democrats don’t propose this kind of tax cut is because they can’t answer the question of ‘how are you to replace the lost revenues.’ And, in fact the Obama administration has currently put Medicare and social security cuts on the table to ‘pay for’ what they’ve already spent. What both Democratic candidates are displaying is a failure to understand the difference between the function of Federal taxation and State and local government taxation. I grew up on the money desk at Banker’s Trust on Wall St. in the 1970’s, ran my own investment funds and securities dealer for 15 years, currently own a small Florida bank, and visit the Fed (Federal Reserve Bank) regularly to discuss monetary policy and monetary operations. I know how the payment system works, as does the Fed’s operations staff.

What we all know is that when Federal taxes are paid, all the Fed does is change the numbers down in our bank accounts. For example, if you have $5,000 in your bank account, and you pay a Federal tax of $1,000, all the Fed does is change the 5 on your bank statement to a 4, so you then have only $4,000 in your account. With online banking you can watch exactly that happen on your computer screen. The Fed doesn’t ‘get’ anything. It just changes the numbers in your account. And when the Federal government spends, it just changes numbers up in our bank accounts. It doesn’t ‘use up’ anything. In fact, the Federal government (unlike State and local governments and the rest of us who do need money in our accounts to be able to spend) never has nor doesn’t have dollars. Think if it as the score keeper for the dollar. When a touchdown is scored and 6 points go up on the scoreboard, does anyone ask where he stadium got those 6 points? Can the stadium run out of points to post on the score board? Of course not!

So why then does the Federal government tax, when it doesn’t get actual revenue (it just changes numbers down in our accounts) and it does not use up anything when it spends (it just changes numbers up in our accounts)? The fact is, taxes function to regulate the economy by controlling our take home pay. If taxes are too low, the result is excessive spending and the strong upward pressure on prices we call inflation. If we are over taxed, as we are today, and the Federal government is taking too much out of our paychecks, the result is a drop off in sales by businesses, and rising unemployment. Federal taxes are like the thermostat. If the economy is too hot (something I have never seen in my 37 years in the financial markets), they can be raised to cool it down. And when the economy goes ice cold, like it is now, my full payroll tax holiday is in order. The Federal government’s job is to keep the economy just right by keeping taxes low enough so people working for a living can afford to buy the goods and services they are capable of producing.

That’s what fiscal responsibility is all about. But until our politicians understand the difference between State finances and Federal finances, the will continue to fail to make sure our take home pay is high enough to sustain the high levels of output and employment that are the hallmarks of American prosperity.

Let me conclude with a word about China. It was stated in the Democratic debates and not disputed that the US was borrowing $4 billion from China to pay for the war in Afghanistan. However, close examination of monetary operations shows this is not at all as it seems. China has what amounts to a checking account at the Federal Reserve Bank. China gets its dollars by selling goods and services to the US, and those dollars are paid into that checking account at the Fed. And US Treasury securities are nothing more than fancy names for savings accounts at the Fed. So when China buys US Treasury securities, all the Fed does is shift China’s dollars from its checking account at the Fed to a savings account at the Fed. And when those Treasury securities become due and payable, all the Fed does is shift the dollars in the savings accounts (plus interest) back to China’s checking account at the Fed. That’s it. Debt paid. And it happens exactly this way every week as billions of Treasury securities are purchased and mature. And this process has no connection to Federal government spending for the war or anything else. Spending is always nothing more than the Fed changing numbers up in people’s bank accounts, no matter what China might be doing with their Fed accounts. That’s why the ‘national debt,’ which is nothing more than dollars in savings accounts at the Fed, has never created a financial problem, and never will, either for us or for our children. Yet the administration, the media, and the two Democratic candidates for US Senate from Connecticut have the story completely wrong as well, which results in proposals which are bad for Connecticut and bad for America.

America is grossly overtaxed and needs a full payroll tax holiday NOW to stop the bleeding and restore the American dream. The only thing standing in the way of economic prosperity is a lack of understanding of our monetary system.

Sincerely,
Warren Mosler

Another hat in the ring? Financial analyst Warren Mosler considers U.S. Senate run

By Daniela Altimari

Feb. 26 — Mosler, a Manchester native who holds an economics degree from UConn, is currently living in the U.S. Virgin Islands. But he intends to return to Connecticut tomorrow, to start a “listening tour” as he weighs a run for the seat currently held by Chris Dodd, who is retiring.

Mosler says he was planning to run for president in 2012 but has been prodded by people in Connecticut to enter the senate race. If he runs, he’ll do it as a Democrat — joining a field that already includes Attorney General Richard Blumenthal and Mystic businessman Merrick Alpert.

“It looks more than intriguing,” Mosler said. “If it makes sense, I’ll announce…I have a specific agenda for economic development I’m pushing.”

He says he’s motivated by his conscience, adding “I know I can turn the U.S. economy around in 90 days.”

Mosler’s agenda includes three main proposals: a full payroll tax holiday, a $500 per-capita distribution from the federal government to each state and a federal jobs program that would provide an $8-an-hour position to any unemployed person willing to work. (That’s the thumbnail version of his platform. More details can be found on his website.)

Mosler, 60, grew up in Manchester in the 1950s and ’60s and worked in Hartford before leaving for a job on Wall Street. He started his own hedge fund in 1982 and turned most of it over to partners in the late 1990s. He is currently on a government-sponsored project to promote economic development in the U.S. Virgin Islands.

According to his website, Mosler recently spoke to tea party activists in Dallas. That’s not normally a place you’d expect to find a Democratic office-seeker, but he says many of his views are in line with tea party values.

“I look at the tea party and I see a lot of concerned citizens who are unhappy, who believe the government has supported the elites,” he said. “They see their tax money going to AIG and the banks while they’re getting squeezed.”

If he runs, Mosler will pour some of his own money into his campaign but he won’t exclusively self-fund. He said he views campaign contributions as a measure of support. “Broad-based support is important,” he said. “I’m not talking to hear myself talk.”

Markets are getting closer to the idea that:

Interest rates don’t/won’t help
QE doesn’t/won’t help

With the larger point being coming to terms with the possibility the Fed can’t inflate, or do much of anything that actually matters for the real economy, except maybe fund zombie entities to keep them from failing.

So bonds are throwing in the inflation towel and yields are coming down.
The dollar is going up with miles to go before ppp is reached.
Gold is well off the highs and being held up probably by europeans running from the euro to dollars and a bit of gold.

(***Bernanke just again testified that a contango in futures prices is a reasonable forecast of higher prices down the road. So much for the credibility of their inflation forecast)

Meanwhile the eurozone is continuing it’s methodical implosion with no credible response in sight.
And the realization that all eurozone bank deposits are only insured by the national govts has yet to hit the headlines.

The Obama administration believes the US Treasury is ‘out of money’ and we have to borrow from China to spend and leave that for our children to pay back.
So any kind of meaningful US fiscal response seems off the table.

The American economy works best when people working for a living make enough to be able to one way or another buy their own output, and business competes for their dollars. It’s not happening.

We are grossly overtaxed for current circumstances with no meaningful relief in sight.

Lots of reasons to stay on the sidelines.

Forum on “A Fresh Perspective on Critical Development Issues”

Series of audio interviews with Warren.

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This is the text of the address I gave at Dallas.

Will be repeating it in a northern Va meeting next weekend.

Still waiting for the video.

Feel free to distribute.

How tea party democrats can run successfully in the primaries

Honesty in government is a core value of the Tea Party movement and the most basic value in any representative democracy. Accordingly, my first proposal is that all candidates for public office be sworn in: ‘I solemnly swear to tell the truth, the whole truth, and nothing but the truth, so help me God.’ As a consequence, any subsequent lies are perjury, and punishable by law.

I am here to discuss how I believe Tea Party Democrats can win in upcoming Democratic primaries. The answer is to emulate and extend the success of the Tea Party movement by getting back to basics. The Democratic party is the party of Jefferson and Jackson. The founders believed that the public voice should be heard. They believed in limited government. And they never kowtowed to special interests or cowered before purveyors of the conventional wisdom. This means Tea Party Democrats should be running against the Obama administration’s policies which are counter to both traditional Democratic values and Tea Party values.

It is the Washington elite that have moved away from the ideals of Jefferson and Jackson with policies that are, at best, regressive, elitist, and destructive to our quality of life. For example, with unemployment rising, real wage growth falling, and GDP now growing at over 5%, who’s getting all that increase in real goods and services?

Not the millions who voted Democratic who are losing their jobs and their homes, and watching wages fall even as their cost of living goes up. All that real wealth being created is instead rising to the top, due to impossible trickle down policies that would have made even Reagan blush.

The large majority of Americans that elected this administration did not do so to enrich the bankers, insurance executives, drug companies, and union leaders at the expense of the rest of us, in a perversion of true core Democratic values. But it’s clearly happening as even a blind man can see. And all because they don’t understand the monetary system, how and why government spends and taxes, and why we don’t owe China anything more than a bank statement.

I will devote most of the rest of my time talking about the economy. In part, that is because it is my area of expertise, given that I have spent most of my adult life in financial markets. But the most important reason is it is in that arena that the Washington elite have failed us the most. The so-called economic experts have confused themselves and their political masters with contrived explanations for the way the economy works. Their limited vision has limited the range of policy choice. And the result has been a monumental economic disaster and human tragedy.

My first proposal for the economy encompasses both the Tea Party and traditional Democratic values of limited government, fiscal responsibility, and reliance on competitive markets. Working through the logic of this proposal will show both how this straightforward government policy can work, and how convoluted is the elite’s understanding of finance.

I believe that the surest engine for full economic recovery is a full payroll tax holiday. Payroll taxes take away over 15% of everyone’s paycheck, from the very first dollar earned. This is big money- about $1 trillion per year. Half comes from the employee and half from the employer. A payroll tax holiday does not give anyone anything. What it does is stop taking away $1 trillion a year from working people struggling to make their payments and stay in their homes, and businesses struggling to survive. A full payroll tax holiday means a husband and wife earning $50,000 a year each will see their combined take home pay go up by over $650 a month, so they can make their mortgage payments and their car payments and maybe even do a little shopping.

This fixes the banks and fixes the economy, from what I call the bottom up. It fixes the banks without giving them anything more than people who can afford to make their payments. That’s all they need to remain viable.

And what all businesses need most to expand output and employment is people with spending money who can buy their products. Without people to buy goods and services, nothing happens. The payroll tax holiday also means there is also a big reduction in expenses for business. With competitive markets this means lower prices, which also helps consumers, helps keep inflation down, helps businesses compete domestically and in world markets to help optimize our real terms of trade, and helps keep the currency stable as the dollar is ultimately worth what it can buy. So with the payroll tax holiday we get a dramatic increase in economic activity, rising employment in good jobs, and better prices. And we’ll see millions of new jobs, because, again, what business needs most is people with money to buy their products. Then they hire and expand.

What I don’t see is how any self respecting Democrat can allow this tax to stand for a single moment. It is the most regressive, punishing tax we’ve ever had. It starts from the first dollar earned with a cap at $106,800 per year. It’s an utter disgrace to the Democratic party. It should be immediately eliminated. Yet, instead, the Washington Democratic elite are actually discussing increasing it.

Let’s now back up and review how we got to where we are at this moment in time. Headline unemployment is unthinkably high at 10%, and if you count workers who have given up looking for a full time job, it’s over 17%. As you all know, it’s about the financial crisis. The banks got in trouble when their loans went bad. Well, what makes a loan go bad? Only one thing- people who can’t make their payments. If people make their payments, the loans are AAA. If people don’t make their payments the loans are junk and toxic waste. No matter what the security is- a loan, a cmo, cdo, clo, or whatever, it’s all the same. If people are making their loan payments there is no financial crisis. Unfortunately, instead of attacking the problem from the bottom up with a payroll tax holiday, we have an administration that thinks it first needs to fix the financial sector from the top down, before the real economy can improve. This is completely upside down. But the elites believe it, so that’s what they have done to us.

So starting with President Bush, and supported by both Senators McCain and Obama, they funded the financial sector with trillions, while they kept taking away trillions from people working for a living who couldn’t make their payments.

How does that help anyone make their payments, apart from a few bankers? It doesn’t.

What happened for the next year and a half? The banks muddled through, profits and bonuses returned, but unemployment skyrocketed and is still going up, loan delinquencies and defaults and foreclosures skyrocketed and are still going up, and millions of Americans still can’t make their payments and are losing their homes. And a lot of the money the banks are making on federal support is being drained by continuing loan losses. We are getting nowhere as tens of millions of lives are being destroyed by policy makers who simply don’t understand how the monetary system works.

This has been a trickle down policy where nothing has trickled down, because there is no connection between funding the banks, and the incomes of people trying to make their payments. The answer, of course, is instead of giving trillions to the banks, to simply stop taking away trillions from people still working for a living. The government doesn’t even have to give us anything, just stop taking away the trillion dollars a year of payroll taxes with a full payroll tax holiday.

But then there’s the nagging question of ‘how are we going to pay for it? Aren’t we just going to have to borrow more money from China and leave it for our children to pay back? And if it doesn’t work, then where are we, another trillion in debt with nothing to show for it?’
And, in fact the failure to understand that question of ‘how are you going to pay for it’ is exactly what has set the Democratic party, and the nation, on the current path of economic ruin. Therefore, to run successfully against the Democrats who support current policy it is critical you understand what I’m going to say next. This understanding is the basis for achieving our core values of limited government and lower taxes. And what I’m about to tell you is pure, undisputable fact, and not theory or philosophy.

So let me start by examining exactly how government spends at what’s called the operational level. In other words, exactly how does government spend? And this is for the federal government, not the State and local government, who are in much the same position as you and I are. Well, when the federal government spends, it simply changes numbers up in bank accounts. Last May Fed Chairman Bernanke answered Congressman Pelley’s question about where the money comes from that the banks are getting. Bernanke told him the banks have accounts at the Fed and the Fed simply ‘marks them up’- changes the numbers in their bank accounts.

• (PELLEY) Is that tax money that the Fed is spending?
• (BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

The Chairman is exactly right. All government spending is simply a matter of changing numbers upward in our bank accounts. It doesn’t come from anywhere. Just like when you kick a field goal and get 3 points. Where does the stadium get those points? Right, they don’t come from anywhere. It’s just scorekeeping. And that’s exactly how government actually pays for anything.

All it ever does, and ever can do when it spends, is mark up numbers in bank accounts, as the Fed Chairman told us. And with online banking you can actually watch it happen. When a government payment hits your account you can actually watch as the numbers change upward on your computer screen. And notice I’ve never mentioned China or anyone else in this spending process. They are simply not involved. Spending is done by changing numbers higher in our bank accounts. What China does or doesn’t do has nothing to do with this process. Again, this is not some theory or philosophy. It’s simply how it actually works. I’ve been there, I’ve seen it. I grew up on the money desk at Banker’s Trust on Wall St. in the 70’s, and I visit the Fed regularly and discuss monetary operations. I know exactly how it all works.

Now let’s look at how government taxes. And keep in mind what any Congressman will tell you- we have to get money from taxing or borrowing to be able to spend it.
Well, with modern on line banking you can watch what happens when a tax is paid. Suppose you have $5,000 in your bank account and you write a check to the government for $1,000 to pay your taxes. What happens? You can see it on your computer screen. The number 5,000 changes into the number 4,000. The number 5 changes to the number 4. All the government did is change the number in your bank account. They didn’t ‘get’ anything. No gold coins dropped into a box at the Fed. Yes, they account for it, which means they keep track of what they do, but they don’t actually get anything that they give to anyone. The man at the IRS simply changes numbers down in our bank accounts when he collects taxes. And, if you pay your taxes with actual cash, they give you a receipt, and then shred it. How does taking your cash and shredding it pay for anything? It doesn’t. Taxes don’t give the government anything to use to make payments.

So the absolute fact of the matter is, the government never has nor doesn’t have dollars. It taxes by changing numbers down, but doesn’t get anything. It spends by changing numbers up and doesn’t use up anything. Government can’t ‘run out of money’ like our President has repeated many times. There isn’t anything to run out of. It’s just data entry, it’s score keeping. And it has nothing to do with China, which I’ll get to shortly.

So why then does the government tax at all? To control our spending power, which economists call aggregate demand. If the government didn’t tax us at all and let us spend all the money we earn, and government spent all the money it wanted to spend, the result would be a lot of inflation, caused by more spending then there are real goods and services for sale. Too much spending power chasing too few goods and services is a sure way to drive up prices. So the purpose of taxes is to regulate the economy. If the economy is too hot, taxes can be raised to cool it down. If the economy is too cold, as it obviously is today, taxes should be cut to warm it up back to operating temperature.

Taxes are like the thermostat. When it gets too hot or too cold you adjust it. It’s not about collecting revenues, there is no such thing, government never has nor doesn’t have any dollars, it just changes numbers up and down in our bank accounts. It’s all about looking at the economy and deciding whether it’s too hot or too cold, and then making an adjustment.

So, given all this, just what does ‘fiscal responsibility’ mean?
Fiscal responsibility means not overtaxing us to the point we are at today with record unemployment. And Fiscal Responsibility means not spending so much or taxing so little that the economy ‘overheats’ and inflation becomes a problem. That’s what fiscal responsibility means. That’s all it means. The government is responsible for getting the economy right, and the monetary system, including taxation, is a tool for that job.
Taxation is a tool to get the economy right.

So where does China and borrowing come into the picture? To be a successful Tea Party Democrat you will have to understand this and be able to explain it.
So first, how does China get its dollars? It sells things to us and gets paid for them.

And where does China keep its dollars? In a bank account at the Federal Reserve Bank which they call a reserve account. It’s nothing more than a checking account with a fancy name. And why does China buy Treasury securities? To earn a bit more interest.

And what is a Treasury security? It is nothing more than a savings account at the Federal Reserve Bank with a fancy name. And just like any other savings account at any other bank, with a Treasury security you give the Federal Reserve Bank money, and you get it back plus interest. So when China buys a Treasury security, what happens? The Fed moves their funds- the money they earned from selling things to us- from their checking account at the Fed to their savings account at the Fed.

And what happens when those Treasury securities- savings accounts- come due? How do we pay off China? The Fed just moves the funds from China’s savings account at the Fed back to their checking account at the Fed, and makes the number a little higher to include the interest. That’s it. Debt paid. And our children will continue to do this just like our fathers did before us. None of this involves what we call government spending. When government spends to buy something or pay someone else, it just ‘marks up’- as Chairman Bernanke put it- numbers in bank accounts. China’s bank accounts at the Fed are not involved. So why is this administration kowtowing to China on everything from Korea to human rights? And why do we go over there, thinking they are our government’s bankers, worried about getting their money to spend on everything from health care to Afghanistan, when there is no such thing as the US government getting money to spend? Why? There is only one reason. This administration does not understand the monetary system. They reason the Democrats are against a payroll tax holiday is because they think they need those actual revenues to support their spending.

So yes, we are grossly overtaxed and that’s what’s causing the sky high unemployment and the failed economy, as well as the ongoing banking crisis. And fiscal responsibility means setting taxes at the right level to sustain our spending power- not to hot and not too cold, but just right for optimal output and employment and price stability, and a return to prosperity.

And this brings up the next question, which is how to determine the right size of government. First, tax revenues don’t tell us anything about that. Taxing is just changing numbers down. It doesn’t give us anything to spend. Spending is changing numbers up; there is no numerical limit to spending.

So how do we decide how much government we want if the money doesn’t tell us anything? We do it on a very practical level. For example, when it comes to the military we need to ask ourselves, how many soldiers do we need to defend ourselves? How many planes, boats, tanks, and missiles do we need? The more we need, the more people we take who could be in the private sector producing real private sector goods and services, including doctors and nurses, teachers and teaching assistants, scientists and engineers, etc. etc. The military also uses up real resources like oil and steel. That’s the real cost of the military- how many people and resources it takes away from productive private sector activity.

What is the right size for the legal system? That depends on how long you want to wait for a court date, or for a decision. If the process is too slow, we may need more people working there, or we may need better technology. And again, the more people in government, the fewer there are to work in the private sector.

Once we have decided on the ‘right size’ of government, and pay for it by changing numbers up in people’s bank accounts when government spends, we have to decide the right amount to tax to keep the economy not too hot and not too cold, but just right. My educated guess would be, in a normal economy, to start with taxes that are less then spending by about 5% of GDP, if history is any guide. If I’m wrong taxes can either be lowered or raised to get it right. And when government spends more than it taxes- when it changes numbers up more than it changes down- we call that difference the budget deficit.

And when government changes more numbers changed up than down, the economy has exactly that many more dollars in it, which adds exactly that much to the savings of the economy. In fact, in US National Income Accounting, as taught in economics 101, the government deficit equals the total savings of financial assets in the rest of the economy, to the penny. Yes, deficits add to our monetary savings, to the penny. And everyone I’ve talked to in the Congressional Budget Office knows it. And it’s just common sense as well that if government changes numbers up in our bank accounts more than it changes them down, we have exactly that many more dollars.

Let me add one more thing about the size of government. It makes no sense to me to grow the size of the government just because the economy is too cold, if we already have the right sized government. And if we don’t have the right sized government we should immediately get it right, and then adjust taxes if the economy is too hot or too cold.
With this grasp of the fundamentals of taxing, spending, and the size of government, a Tea Party Democrat is well armed to take on the Democratic establishment that’s overtaxing us, driving up unemployment to today’s record levels, destroying our economy and standard of living, and arbitrarily growing government as well.

Conclusions:

Tea Party Democrats have a unique opportunity to be a part of history and overturn the ideas the current administration is employing that are, at best, regressive, elitist, and destructive to our quality of life.

With unemployment rising, real wage growth falling, and GDP now growing at about 4%, who’s getting that increased GDP? Not the millions who voted Democratic who are losing their jobs and their homes, and watching their wages fall. That real wealth being created is instead rising to the top, due to the Obama administration’s impossible trickle down policies. This administration was not elected to enrich the bankers, insurance executives, drug companies, and union leaders at the expense of the rest of us, in a perversion of true core Democratic values. But it’s clearly happening, and all because they don’t understand the monetary system, the don’t understand how and why government spends and taxes, and the don’t understand why we don’t owe China anything more than a bank statement.

The door is wide open for an enlightened, populist Democrat to lead the way to a new era of unsurpassed national prosperity.

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I respectfully do not agree with his prescription to ‘protect our economic future.’

“I welcome the President’s acknowledgement of the economic pain felt widely and deeply and look forward to reviewing his plans to help middle class Americans, who are still hurting economically. We must enable Americans to find and keep good jobs with fair pay. And, to protect our economic future, we need vigorous, sustained fiscal discipline that enables deficit cutting.”

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Tea Party Plan for Democrats — Cut to the Front with Tax Cuts

At Saturday’s Tea Party conference in Dallas I’ll be outlining how Tea Party Democrats can run against Obama administration policies that are counter to both Tea Party and traditional Democratic values. It is the Washington elite that have moved away from the ideals of Jefferson and Jackson with policies that are, at best, regressive, elitist, and destructive to our quality of life. And who’s benefiting? Not the millions who voted Democratic who are losing their jobs and their homes. And with GDP now moving higher while unemployment rises, all that additional wealth is flowing up to the top. This Democratic President and Congress was not elected to enrich the bankers, insurance executives, drug companies, and union leaders at the expense of the rest of us, in a perversion of true core Democratic values. Unfortunately, the so-called economic experts have confused themselves and their political masters with contrived explanations for the way the economy works, and their limited vision has limited the range of policy choice. The result has been a monumental economic and social disaster caused by an obvious shortage of aggregate demand. The spending power needed to make mortgage payments, car payments, and do a bit of shopping- all of which would fix the economy and end the financial crisis- just isn’t there.

The answer is a full payroll tax holiday, where the US Treasury would make all FICA payments for both employees and employers that regressively remove 15% of every pay check from dollar one up to $106,800 of income. The take home pay of a husband and wife with a combined income of $100,000 per year would increase by over $650 a month, and quickly restore output and employment. Rather than funding the banks from the top down with an improbable trickle down theory that would have made Reagan blush, this tax cut restores the incomes necessary to support all economic activity from the bottom up. Instead of funding the financial sector with $trillions, the payroll tax holiday instead simply stops taking $trillions away from people working for a living.

Unfortunately, the Democratic elite has been not only against this kind of tax cut, even though it is a tax so regressive that no self respecting Democrat should tolerate for a single moment, because they think the Federal Government has to actually get revenue to be able to spend. However, that anachronistic gold standard reality has long been replace by our current, non convertible currency regime and floating exchange rate policy. Chairman Bernanke told Congressman Pelley exactly how the Federal Government spends today last May:

(PELLEY) Is that tax money that the Fed is spending?
(BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Our govt has only one way to spend- they ‘mark up’ numbers in bank accounts. The funds don’t ‘come from’ anywhere any more than the 6 points for a touchdown posted on scoreboard at a football game ‘come from’ anywhere. Nor does govt. get anything when it taxes- the IRS just changes numbers down in our bank accounts.

The fact is, the US Government never has nor doesn’t have dollars. It’s the scorekeeper for the dollar. It just changes numbers in bank accounts.

So why tax? To regulate aggregate demand. Taxation is the thermostat. When the economy is too hot, raise taxes to cool it down. When it’s too cold, like it surely is today, a payroll tax holiday will warm it back up to operating temperature.

The Democratic elite have it wrong and their wrongheaded ways are doing serious damage to the US economy and the people struggling under their failed economic agenda. And their latest moves towards what they call ‘fiscal responsibility’ will only cut demand further and make things worse.

Tea Party Democrats can lead the way towards true fiscal responsibility, which means setting taxes at the right level needed to sustain output and employment. And today that means a full payroll tax holiday.

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We’re getting closer to the point discussed a few weeks ago about markets giving up on the Fed.

At the time the 10 year was maybe 3.75-3.80, gold had gone about 1,200, the dollar was near the lows, crude was back over 80, stocks were up, all based on the belief the Fed had the power to ‘reflate’ and was ‘printing money’ through trillions of ‘quantitative easing’ which was, sooner or later, hyper inflationary, along with 0 interest rates and ‘record deficits’ which would drive up interest rates, risk default and a sudden breakdown of the $US, all contributing to the same inflationary collapse.

Now that the bets have been placed, and none of that is happening, it’s all starting to erode. Crude is back below 75 (the Saudis’ actual target/range?), gold is selling off, the dollar is edging higher, the 10 year just traded at 3.57, stocks are selling off, etc.

The next step is for first markets and then policy makers to realize the Fed has no tools to inflate. That 0 rates and qe don’t cut it. Nor are deficits large enough to reflate. Bernanke was asked by Time magazine late last year if he had any tools left. He said yes. When asked what they were, he had no specific answer. Well, if he does have more tools, with 10% unemployment and weak prices and a dual mandate for full employment and price stability, what’s he waiting for?

Should market psychology turn to the notion that the Fed has no tools to inflate, and we have a Congress dead set against larger deficits, it can all get very ugly very quickly in the race to the exit from the inflation plays (including steepeners) currently on the books.

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Out of the frying pan and into the fire…

Proposal Set to Curb Bank Giants

By Damian Paletta and Jonathan Weisman

Jan. 21 (WSJ) — President Barack Obama on Thursday is expected to propose new limits on the size and risk taken by the country’s biggest banks, marking the administration’s latest assault on Wall Street in what could mark a return, at least in spirit, to some of the curbs on finance put in place during the Great Depression, according to congressional sources and administration officials.

The past decade saw widespread consolidation among large financial institutions to create huge banking titans. If Congress approves the proposal, the White House plan could permanently impose government constraints on the size and nature of banking.

Mr. Obama’s proposal is expected to include new scale restrictions on the size of the country’s largest financial institutions. The goal would be to deter banks from becoming so large they put the broader economy at risk and to also prevent banks from becoming so large they distort normal competitive forces. It couldn’t be learned what precise limits the White House will endorse, or whether Mr. Obama will spell out the exact limits on Thursday.

Mr. Obama is also expected to endorse, for the first time publicly, measures pushed by former Federal Reserve Chairman Paul Volcker, which would place restrictions on the proprietary trading done by commercial banks, essentially limiting the way banks bet with their own capital. Administration officials say they want to place “firewalls” between different divisions of financial companies to ensure banks don’t indirectly subsidize “speculative” trading through other subsidiaries that hold federally insured deposits.

The proposal could have the biggest effect on Bank of America Corp., Wells Fargo & Co., and J.P. Morgan Chase & Co., which control a large amount of U.S. deposits, as well as Goldman Sachs, Morgan Stanley and Citigroup Inc., which have a large presence on Wall Street.

If the proposal took effect, big banks could be forced to wall off certain activities in their investing banking units—which trade and underwrite securities and make their own bets on markets—from their traditional businesses, which make loans and take deposits.

The investing banking units have grown dramatically in recent years, were far more profitable than the banking operations and were at the heart of the financial crisis.

The industry has undergone a major consolidation during the financial crisis, leaving the top four banks with an unprecedented market share in businesses such as deposit taking, credit cards and mortgages.

The rules could also keep banks out of the business of running hedge funds, investing in real estate or private equity, all businesses that have become important, profitable parts of these banks. The collapse of two highly leveraged hedge funds began the process that led to the collapse of Bear Stearns.

If investors believe the new rules could take effect, they could sell off the shares of most of the big financial stocks in the belief these companies would be facing years of turmoil and potentially lower profits.

Messrs. Obama and Volcker are scheduled to meet tomorrow in advance of the White House announcement.

The White House’s proposal, one aide said, wouldn’t resurrect the exact limits put in place by the Depression-era Glass Steagall Act, which essentially walled off commercial banks from investment banks and was repealed in 1999. Instead, the White House proposal would seek to return the “spirit of Glass Steagall,” meant to limit large banks from becoming too big and complex that create enormous risk.

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Update

The tea party organizers have invited me to meet with them in Dallas to discuss tea party support of my candidacy for US senate in the democratic primary in Connecticut where Chris Dodd has announced he won’t be running.

Also to be discussed is tea party support for my economic agenda which expresses their core economic values of lower taxes, promotion of competitive market forces for further public purpose, full employment, and limiting and focusing government in support of further public purpose.

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Yes, it all would have been a lot worse with McCain:

>   
>   (email exchange)
>   
>   On Thu, Jan 7, 2010 at 5:06 PM, Tom wrote:
>   
>   And this is the guy that ran second? Wow, what a choice!
>   

My Friend,

I have seen my fair share of battles throughout my years of service to our country. In the Senate, I have waged war against wrong, whether it is today’s massive federal spending, government-run health care or violent extremism that threatens our great nation.

President Obama is leading an extreme, left wing crusade to bankrupt America — leaving the bill with our children and grandchildren. I stand in his way every day in an effort to serve as a voice for the millions of Americans who disagree with the direction he is taking our country. If I get a bruise or two knocking some sense into heads in Washington, so be it. I’ll keep fighting for jobs, economic growth and reduced spending as long as I’m in serving in the U.S. Senate.

My sincere thanks,

John McCain

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More on the Bernanke testimony:

Shortly after the failure of Lehman Brothers, I was in Brazil at an international meeting, and I had a meeting there with bankers, and I asked them how the Brazilian economy was doing. And they said well, it had been doing fine, but within a week after Lehman Brothers collapsed, it was like a frigid wind descended on the economy in Brazil. And there was an enormous impact almost immediately on their economy, on their ability to raise funds and make loans.

In dollars, I’m sure.

And it’s astonishing how quickly that one failure spread throughout the world, and created a very severe recession, not just in the U.S., but around the world.

The Federal Reserve, by making a large loan under very tough terms to AIG,

But allowing those funds to be used to meet margin calls on CDS and probably other related market losses. That’s perhaps the most controversial part. Those payments to creditors perhaps could have been labeled ‘loans from the Fed’ subject to AIG ultimate solvency rather than payments from the Fed.

prevented the failure of that institution, and, therefore, tried to contain the impact of the Lehman Brothers failure on the rest of the global financial system. I’ll come back and talk more about AIG, and those things later, but that was just the first step of many that we took to try to stop the crisis.

Subsequently, again, very concerned with the possibility of a global financial meltdown, we worked with Treasury and the Congress to develop a bill that would provide funding that the Fed, the Treasury and other agencies could use to stabilize the financial system, to prevent collapse of the financial system.

This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.

In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks;

Obviously they didn’t know it was nothing more than regulatory forbearance.

it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.

Again, many of those creditors ‘bailed out’ by the Fed’s liquidity provisions could have had those funds labeled ‘loans from the Fed’ rather than simply receiving payments from the Fed.

The result of this collective global effort over that week was essentially to succeed in stabilizing the global banking system, in that subsequent to that week the fears of utter collapse were largely overcome.

Now, in the following months after that, there were still many, many great difficulties in the financial markets. And the Fed, and other central banks and Treasuries around the world, worked very hard to restore the normal functioning of those markets. For example, following the Lehman failure, there was a run where ordinary investors went as quick as they could to pull their money out of money market mutual funds, which are a common investment vehicle for many Americans. It was very analogous to 100 years ago when a bank was about to fail, and the depositors would go to the bank, they would run and pull their money out as quickly as possible, and then the bank would fail. The money market mutual funds were experiencing exactly the same phenomenon.

The Fed and the Treasury working together provided short-term loans to these funds. The Treasury provided some insurance to depositors, or to investors so they would know they wouldn’t lose their money. We stopped the run on the money market mutual funds, and that was an example of how we helped stabilize the situation.

Not sure why that was critical?

There were many other steps we had to take helping individual institutions, and providing programs for backstop lending to make sure that the key markets in the financial system were functioning again, because for months after Lehman Brothers, the amount of fear and uncertainty in the financial markets was so elevated that these markets were, essentially, not functioning properly, and it took really many months until we had reached the point that these markets had begun to approach a normal state.

Doesn’t mention the dollar swap lines to foreign CB’s???

But bank lending is still weak. The banks had a near-death experience, they are now lending in a difficult economic environment. We are strongly encouraging them to lend. We have taken a lot of steps to help them raise new capital, so they’ll have a basis on which to make new loans. And we are taking a number of steps to try to open up markets through which investors invest directly in various forms of credit, like auto loans and credit card loans. All of these steps are improving the financial situation, but particularly the banking sector, we’re still in the convalescent stage.

They only bought AAA traunches which didn’t address the credit issues. They were more worried about taking losses than restoring auto credit, but wanted to give the appearance they were doing something.

As I said, I was a professor. I never worked for Wall Street. I have no connections on Wall Street. In fact, when I first became chairman, I was criticized in some quarters for not being close enough, or knowing enough about Wall Street. So, why did I take these actions?

I didn’t take these actions, or the Federal Reserve didn’t take these actions because we were trying to help bankers, or trying to help Wall Street. What I understood, and what knowledgeable people all around the world understood, is that the financial system is essential to the functioning of any economy. And that if the financial system had collapsed to the extent to which we believed was very likely in September and October 2008, then no force on earth, no policy, could have prevented the collapse of the entire U.S. economy with long-lasting and extreme consequences for every American.

How about a proportionate fiscal response, like a payroll tax holiday and per capita revenue distributions to the States? Instead, he continues to preach ‘fiscal responsibility.’

It was because we were concerned about jobs and incomes and the economic well-being of every American that we intervened to prevent the collapse of the financial system.

Now, going forward, we have a lot to do to get the economy back to stability, get jobs created. You can talk as much as you like about the things we’re doing there, but we’re also going to have to take some very strong steps to make sure that the crisis doesn’t ever happen again.

There were, certainly, weaknesses in our financial regulatory system. There were weaknesses in the way that financial regulators supervised the banks and other financial institutions. And the financial institutions themselves made lots of mistakes in terms of their ability to measure the risks that they were taking, and to control them properly. And to make sure we don’t ever have a crisis like this again, we need to have extensive reform in the private sector, in the public sector, to eliminate these risks in the future.

You had said that the banks were convalescent still, Mr. Chairman. Can you talk to us a little bit more about what that means?

Well, the banks have been stabilized. They’ve raised a good deal of capital, so they’re in much better shape than they were. They are lending, but they are not lending enough to support a healthy recovery. One important reason for that, is that given their losses, given what they’ve been through, they’re being very conservative in the face of what is still a very weak economy; and, therefore, a sense that many borrowers are quite risky.

As bank supervisors, we have a difficult challenge. We have told the banks very clearly that we want them to make loans to credit-worthy borrowers, where there are borrowers who can repay the loans. It’s in the interest of the banks, it’s in the interest of the economy, and, of course, it’s in the interest of the borrowers for those loans to get made.

But the problem is, of course, that we got into trouble in the first place by banks making loans that couldn’t be repaid, so we don’t want banks to make bad loans. Therefore, we are trying to work with banks to make sure that they are, in fact, able to make as many good loans as possible, that they have enough capital, that they have enough short-term funding, and that the examiners and the regulators who work with the banks are not unduly restricting the loans that they make. We want to work with the banks to make sure that they balance the appropriate prudence and caution against the need to make good loans for the economy, and for their own profits.

Banks and the entire private sector is necessarily procyclical.

Only govt via fiscal policy can be countercyclical.

So, what this means is that economic policy, and financial oversight have to take into account all the international dimensions of that. So, for example, on the monetary policy side, we have worked carefully and closely with other central banks to talk about monetary policy in different parts of the world. In fact, during the heat of the crisis in October 2008, the Federal Reserve and five other major central banks cut interest rates together on the same day, as a sign of how committed we were to cooperating on monetary policy.

Doesn’t seem concerned that interest rate cuts may in fact be deflationary as he knows they remove interest income for the private sectors (Bernanke, Sacks, Reinhart, 2004 Fed paper- see ‘the fiscal channel’)

The system worked.

It did work. It was an important first step. I mean, even after we took those steps, the financial markets were in a great deal of stress, and credit at all levels was very much constrained. But it stabilized the situation, and from there, we were able to take a number of steps to - both we, and our partners in other countries - to get the key markets working again, to get the banks stabilized, and to begin the very difficult process of getting the financial system back on its feet.

Never realizing that all the alphabet soup measures to get liquidity going missed the point that all the Fed had to do was lend fed funds to member banks without limit, as the ECB effectively did by immediately accepting any and all bank collateral, to immediately restore bank liquidity.

So, while it’s difficult to know exactly what the outcome would have been, certainly, just judging on what happened after the failure of a single firm, the collapse of the global financial system would surely have led to a far deeper recession, higher unemployment, much greater fiscal cost to the taxpayer, and to rebuild the financial system, and to get the economy moving again. And almost certainly, [we would have had] many, many years of subnormal - substandard - performance by the U.S. economy, and by other industrial economies, as well. Again, we can’t know precisely, but I think if anything, the financial crisis last fall was as severe, and as dangerous as anything we’ve ever seen, including the 1930s.

The whole point of going off the gold standard in 1934 was to be able to provide liquidity without limit to the banking system, so the fact that he did that, however belatedly, is nothing to brag about. It also allowed for unlimited fiscal responses, which he still seems to not fathom.

There is an irony here that’s literary, that here’s this man who spends his life distinguishing himself studying economic history. And then one day you wake up and realize that you’re at the center of economic history in this really unusual chapter. How do you process that personally? I mean, how does that change how you go from being the academic expert to you are in the arena?

Well, I certainly didn’t anticipate when I came to Washington in 2002, I certainly didn’t anticipate these events, or how things would evolve. No question about it. And when I became chairman in 2006, I thought that - I hoped that my main objectives would be improving the management, communication and monitoring policy.

We were certainly attentive to the risks of financial crisis. Secretary Paulson and I talk frequently to people on Wall Street, and we secured the Federal Reserve. We set up a team of staff drawn from different disciplines to try to identify problems and weaknesses in the financial sector. So, we were certainly aware of the risks of financial crisis, but one as large and as dangerous as this one, I certainly did not anticipate. I wish I had, but I didn’t.

Then when the crisis came, you know, rather unexpectedly, a different part of my training and research became relevant, which was to work on financial crises generally, and also on the Great Depression. And I believe very much that that experience, and that knowledge, was very helpful to me in many dimensions of this effort, ranging from - I think the most important lesson, there are many lessons, but I think the most important lesson was that we were not going to have a healthy stable economy with a completely dysfunctional financial system. We had to take strong measures to prevent that from happening.

And in the 1930s, the Federal Reserve was quite passive, and allowed the banks to fail, and we know the result of that. So, we were determined that that wasn’t going to happen on my watch, on our watch, so we were prepared to take very strong actions to avoid that.

That was under the gold standard. Nothing could be done without losing the nation’s gold supply. It was only after the banks reopened in 1934 with a non convertible currency could there be credible deposit insurance unlimited Fed provision of liquidity. Clearly he doesn’t understand that or a) he’d be stating it b) I don’t want to say…

You’ve been quite forthcoming, I think, in your testimony about saying, there’s a lot of things you didn’t see, there’s some things that we didn’t do. If I gave you a kind of do-over to go back as long as you want to say you know what, if we’d seen this, if we’d looked at the sub-prime mortgage crisis. I mean, how could you have handled it, and the Fed handled it better to have a different outcome?

Well, we have, based on the experience of the crisis, we - the Treasury and others - have made proposals for how the financial regulatory system ought to be reformed and restructured. I’ll say a word about that. If we had been in that forum, I think we would have avoided the crisis. So, there were some important lessons.

One was that our regulatory system was too myopic. It was too focused on individual firms, or individual markets, and there was nobody paying attention to the broad overall financial system. So, the Federal Reserve was not entrusted with looking at the whole financial system. We were - we had very specific assignments. We were supposed to look at specific institutions. Those institutions did not include many of the firms that had severe problems, like Lehman Brothers or Bear Stearns or AIG. Those were outside of our purview, and since they were outside of our purview, we didn’t look at them.

They missed one critical factor- allowing bank loan officers to work on a commission basis. Nor, did the regulators look into actual loan files to check for fraudulent appraisals and income statements promoted by loan officers working on a commission basis. Regulation is necessarily a work in progress. Mistakes will be made, including mistakes of this scale. Critical to our well being is the knowledge of how to keep these errors in the financial sector from damaging the real economy. And that requires appropriate fiscal responses to sustain aggregate demand, preferably in an equitable manner.

But there were many situations where there was really nobody who was looking carefully at what was going on, and nobody who was looking at how the parts of the system fit together. So, a very important recommendation that we have made is that there be a more systemic approach - that is, have some arrangement whereby a regulator, or a group of regulators, has responsibility to look at the system as a whole, and try to identify emerging problems, or gaps in the regulatory apparatus, or weaknesses in individual institutions, as they relate to other institutions, that threaten the integrity of the system as a whole.

Better still, most of the issues came from allowing banking activities that in fact served no further public purpose. That includes any bank participation in secondary markets, loaning against financial assets, using LIBOR as an index, and many others.

We didn’t have that. Therefore, nobody paid enough attention to AIG, nobody paid enough to attention to credit and call swaps, nobody paid enough attention to some of the activities of investment banks. You go on, and on, and on. Again, if we had had a more comprehensive overview approach that would have been helpful.

A second key element is the problem too big to fail, and how to address that. So, I just want to be very, very clear that even though the Federal Reserve was involved in rescuing Bear Stearns and AIG, we did that extremely reluctantly, and with - it was a very distasteful thing for us to do. We did not do it - we were not set up to do it. We were - it was very difficult for us to do, but we did it because there was no appropriate mechanism, there was no set of laws that would allow the government to intervene in a situation like that in a way that would allow the firm to fail, but would not have all the negative consequences for the financial system and the economy.

So, we had a situation where there were firms who were literally too big to fail, or too complex to fail, or too interconnected to fail. When they came to the edge of collapsing, we had only two very, very bad choices: we either bailed them out, put taxpayer money at risk, put the Federal Reserve at risk in terms of our lending, or we could let them collapse and have all the hugely negative consequences for the financial system and for the economy.

So, what we did not have, and what we very much need going forward, is a third option, and that option should be a legal framework which allows the government - and I think that means, in practice, the Treasury and Federal Deposit Insurance Corporation - to intervene when a large complex systemically critical firm is about to fail, and to allow the firm to fail, impose losses on the lenders, the creditors of the firm, the shareholders, fire the management, protect the taxpayer, but be able to do that in a way that protects the system, so that the financial system is protected from the immediate impact of that collapse.

I submit we already have that for the large banks, and the others as well. He just didn’t grasp how to use it. The receivership they did set up did not have to pay off all the creditors, and if there were issues, it would have been a relatively simple matter to petition congress for an ‘emergency’ alteration of current law. They didn’t even try.

We did not have a system like that in place. I think if we had, we could have dealt with Lehman Brothers and AIG in a much more satisfactory way. We would have avoided many of the problems. And, most importantly, we would have not, in some sense, rewarded failure, which is what happened. In the future, it’s important that firms be allowed to fail if they, in fact, take excessive risks, and make bad gambles.

But that mechanism is not in place now.

The mechanism is not in place, and we have asked Congress to address it, and I believe that they will. But until they do, we are really still in a situation where we don’t have good options in dealing with potential collapse of a global financial firm.

It isn’t that hard to do.

Right now people are sort of looking to you, and to Congress, to kind of break the back of unemployment. And you’ve talked about how that is really our biggest challenge right now. Do you feel there is anything else that can be done, or has the Fed shot all its bullets, and has Congress shot all its bullets?

Well, the Federal Reserve has been very aggressive on the unemployment side. So, let me just first say that even though the recession may be technically over., in a sense that the economy is growing, it’s going to feel like a recession for some time, because unemployment remains very high, about 10%. And even people who have jobs, there are many people who are on short hours, that are in voluntary part-time, or maybe people who are not technically unemployed, only because they stopped looking. So, the labor market is in very weak condition, and we’re not going to see a healthy, vibrant economy again until the labor market - the job market - has recovered. So, that is really an extraordinarily important objective for policy going forward. And, certainly, our job won’t be done until the economy is growing again, and jobs are being created.

The Federal Reserve’s attempts to address employment issues, we’ve done several things. Certainly, one of the things is we’re using our monetary policy. In December 2008, while the crisis was still in an intense phase, we cut the short-term interest rate that is the measure of our monetary policy almost to zero. The first time that had ever been the case, the Fed had ever done that, in order to provide the maximum amount of support to the economy, and it remains close to zero today. So, that is a very powerful measure.

Again, he gives no weight to the possibility that the interest income he removed from ’savers’ is weighing on the economy, even though it’s in his own paper from 2004.

Having used that tool to its maximum extent, we have then turned to new and innovative tools, things that have never been done before in the Federal Reserve. I’ll give you two examples. One, we’ve purchased about $1 trillion worth of mortgages that are guaranteed by Fannie Mae and Freddie Mac, and the U.S. Treasury. And in doing those purchases, we have succeeded in reducing the national 30-year fixed-rate mortgage rate from about 6-1/2% to about 4.8%. By lowering mortgage rates that way, we have helped to stabilize the housing sector, to help stabilize the housing crisis, and allow people to refinance, to buy homes. And that, obviously, should get construction started again and house prices stabilizing, and people being able to meet their mortgages. That’s obviously going to be helpful.

The far more effective way would be to directly fund the agencies at the fixed rate the Fed wanted for mortgages and allow that funding to be prepaid without penalty if the mortgages prepaid. But that was never even a consideration.

We’ve also created a program that helps bring credit from Wall Street to support a wide variety of consumer and small-business loans. So, for example, our program allows Wall Street money to come in and support auto loans, credit card loans, student loans, small business loans, commercial real estate loans. By providing that conduit, we are supporting what the banks are doing to get credit flowing into those important sectors.

But only the AAA pieces, as previously discussed.

And I guess a third thing, an additional thing I would mention is that we serve not only as monetary policy makers, but also as bank supervisors. And there we’ve been sparing no effort, as I talked about earlier, to get the banks able and willing to lend again, to create - particularly the small businesses - to create the credit that’s needed to create new jobs and get employment back on track.

I would mention, in particular, our leadership of the stress tests. In the spring, the Federal Reserve led an effort to evaluate the balance sheets of 19 of the largest banking companies in the U.S., and our report on those balance sheets, along with the FDIC, the OCC, to other banking agencies, our reports on those balance sheets is public, greatly increased the confidence in the banking system, which meant that they were able to go out and raise new capital in the stock market, and many of them have paid back the capital to the government.

Still no clue it was only regulatory forbearance.

But by raising new capital, they increased their own capacity to lend. And, as conditions improve, they’ll be able to make new loans as well.

So, by keeping interest rates low, including both short-term rates and long-term rates, like mortgage rates, by supporting a flow of credit to small businesses, consumers and the like, that is our primary effort. Those are the tools that we have. We can always do more, if necessary, but those are the tools that we are applying trying to get job growth going again.

They have more tools but aren’t using them? Unless this is a bluff, what are they waiting for? This is an extraordinary statement.

And we have seen, obviously, the labor market is still very weak, but the last report we saw shows that we’re now coming closer to the point where we’ll stop seeing job losses and start seeing job gains.

We’ve talked about a lot of those extraordinary things you’ve done. But is that it? Like now do we have to - because there’s still really bad numbers, even your forecasts are like what, 10% [unemployment] this year, 9% going forward, I think like 8% in 2012. Do we just have to kind of now sit back and take it?

Well, the Federal Reserve will continue to see what other policy actions we can take. And we’ve really been very aggressive, thus far. And the additional steps aren’t as obvious or clear as the ones that we’ve already taken.

Right, they don’t have any actual ideas.

A lot of the scope now is on the fiscal side of the house. As you know, the government passed a major fiscal program earlier this year, and I think it was just today the President announced a number of individual - a package of programs to try to address unemployment. So, [there are] a lot of new initiatives probably coming from the fiscal side.

While he preaches fiscal responsibility. See below.

Did they ask you for your opinion of those before…

Well, our staffs confer frequently with the Treasury and other parts of the Economic Advisory Groups that advise the President. And we often give our views. Our views are solicited. But, of course, they are responsible for their policy choices.

Have you said before, or are you prepared to say now, that a second stimulus, a round of incentives, is a good idea, on the fiscal side?

So, my domain is monetary policy and financial stability. And we have done, of course, a lot of aggressive things to try to support the economy, try to support job creation. I generally leave the details of fiscal programs to the Administration and Congress. That’s really their area of authority and responsibility, and I don’t think it’s appropriate for me to second guess.

You have said that there’s a long-term deficit program that needs to be dealt with. You said health care costs ought to be cut back, so it’s not like you won’t talk at all about the fiscal situation. Regardless of the details, which I understand that you don’t want to tell them how to do it, do you think that the fiscal side ought to do something?

Well, let me say this, I think that it’s very important that whatever actions that Congress and Administration take on the fiscal side, that they begin soon, or even sooner, to develop a credible medium-term interest strategy for fiscal policy, one that will persuade the markets and the public that over the medium term, the next few years, we will - we, as government, we, as a country - will be able to bring our deficits down to a level that could be sustained over a period of time.

Yes, he’s clearly part of the problem, not part of the answer. He’s failed to realize the ramifications of lifting convertibility in 1934 (and 1971 internationally) and is one of the leading deficit terrorists.

If we can do that, which will increase the confidence of the markets in American fiscal policy, that would give us more scope to take action today, because, again, there would be confidence that we have a way out, a way back towards sustainability.

There is no sustainability issue and he should know that. But he doesn’t even fully understand monetary operations of the Fed itself.

In your testimony the other day, one Senator talked about here’s the money that the federal government takes in, here’s what we spend on entitlements. It’s basically the same. Everything else we have to borrow for. I mean, there are a lot of people saying that it’s not sustainable, as you have said. And they said one of the only solutions is some kind of tax, a sales tax, value-added tax, something other than an income tax. But would you be in favor of any of those alternatives?

So, the way I put this before Congress before is that the one law that I strongly advocate is the law of arithmetic. (Laughter.) That law of arithmetic says that if you are a low-tax person, then you have to - you are responsible for finding ways on saving on expenditure, so that you don’t have enormous imbalances between revenues and spending. And by the same law of arithmetic, if you were somebody who believes that government spending is important, and you are for bigger and more spending, and bigger programs, then it’s incumbent upon you to figure out where the revenues are going to come from to meet that spending. So, again, I think that’s, again, Congress’ main responsibility.

I have spoken about deficit, and I think deficits are important, because they address broad economic and financial stability. We need to talk about that. But in terms of the specifics about how to get to fiscal balance, that’s the elected officials’ responsibility.

He sees spending as revenue constrained where that concept is entirely inapplicable to non convertible currency and floating fx policy.

Do you think Congress is fiscally illiterate? Economically illiterate?

No, of course not. But what they have to deal with is not just a question of understanding. It’s a question of making very, very tough choices, and in a political environment, where people understandably are resistant to cuts in programs or benefits, or increases of taxes. So, there needs to be tough choices made, there needs to be leadership. And I don’t envy Congress those choices, because they’re very difficult ones to make.

Are you saying that time for fiscal and monetary stimulus is over? And, if so, what’s the downside of pushing even harder?

There are not easy solutions. It’s an enormous problem. I think the Federal Reserve - one direction that we can go is to continue to encourage the extension of credit, small businesses, in particular, create a lot of jobs, particularly during economic recoveries. And we have lots and lots of evidence and anecdotes suggesting that small businesses are particularly harmed by the tightness of the bank lending standards and unavailability of credit. So, everything we can do, and that the Administration and Congress can do, to support credit extension to all business, but primarily small business, would be a very powerful.

You don’t think it’s a liquidity problem?

Well, I mean, interest rates are very low, so I think it’s going to be a question, first of all, of getting credit flowing again. And the Federal Reserve has got a role to play there. And then, Congress and the Administration will consider possible programs and fiscal policies.

You’re definitely not okay with long-term profligacy, but are you okay with them doing something in the short-term?

I think if they do that, it’s critically important they clarify the longer-term plan for establishing sustainable fiscal [policy].

Again ducking the question. But it’s clear he is not a supporter of using fiscal adjustments to sustain aggregate demand.

Adair Turner, the chief British [financial services] regulator, said that we’ve learned that much of what the financial services sector did in the past 10 years has no economic or social value. Do you agree? Did the financial services sector just get too big, and should it be smaller?

Okay. Well, a strong financial system is very important. It allocates capital to new businesses and new industries. It allows for people to invest in a wide range of activities, so it’s critically important to have a good financial system. And the evidence for that is that when the financial system breaks down, the system just doesn’t function.

That is not evidence for that. Seems a breakdown of logic???

You see what the impact has had on the economy. With that being said, the financial system is unique to the extent, first, that it is so critical to the economy, and, secondly, to the very, very old tendency to succumb to booms and busts.

Again, this is too confused to not be an insight into his basic sense of logic.

And, therefore, we do need to have an effective comprehensive financial regulatory system that will essentially allow us to tame the beast so that it provides the benefits, the growth and development without creating these kinds of crisis.

And then this says it all regarding his understanding of monetary operations:

Okay. When the Federal Reserve buys mortgages, it pays for them by creating reserves the banks hold in Federal Reserve. So, as we purchase $1 trillion of mortgages, we’ve created roughly $1 trillion of reserves that banks hold at the Federal Reserve. The banks, at this point, are just willing to hold those reserves with the Fed, and not do anything with them.

Banks don’t ‘do anything’ with reserves.

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow.

Banks don’t ‘lend out’ reserves.

And then, ultimately, that would create an inflationary risk.

This is not how it works.

So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

We have a number of means for doing that, which we have explained to the markets, and the public, and everyone is confident we can do that. And we will do that over time, in order to make sure that as we come out of this crisis, we don’t generate inflation at the end.

Reserve management has nothing to do with inflation with a non convertible currency and floating fx. This is ancient gold standard rhetoric.

So, the reserves can be pulled out through various mechanisms or can mobilize. And we don’t have to do that yet, but when the time comes, we have tools to do that.

And are there lurking dangers in those mortgages that you purchased that we don’t even know about now?

Well, the mortgages are guaranteed. The credit, even if they go bad, Fannie and Freddie with the backing of the U.S. Treasury will pay them off, so the Fed is not taking any credit risk by holding these mortgages.

It’s comforting for you, but not for the taxpayers. Right?

Well, on the other hand, what’s happening is that we earn the interest from those mortgages, and then we remit that interest back to the Treasury, so the money finds its way back to the taxpayer.

That’s exactly how the Fed’s portfolio removes interest income from the private sectors.

And, indeed, the Federal Reserve will be paying the Treasury a good bit more money the next few years than it has in the past, because of the interest we’re earning on these mortgages we acquired.

On that note, this week we did learn the TARP is going to pay back nearly all of what it was required to from the taxpayer. Looking back a year later, are surprised by that?

Well, we said at the beginning that the TARP money was an investment. It was going to acquire assets, and that most or all might come back to the taxpayer. Right now, if you look at all these repayments from banks, and the fact that the government is sitting on capital gains, as well as other investments, I think it’s a reasonable probability that the TARP money invested in financial institutions, that the great majority of it will come back to the taxpayer. So, in the end, we will have stabilized the financial system and avoided this global crisis at not a small amount of money, but relative to the alternative, a quite small amount of money.

Were there days where you woke up and you thought, what am I not thinking of that we could be doing?

We had a philosophy right here, which was what we called blue-sky thinking. And what blue-sky thinking was, was we have a problem, I want everybody to give me just three associations. What can you think of? How can we approach this, what can we do? And we’ll worry about getting rid of the silly answers later. So, there’s been a lot of creativity here, and I give credit to terrific staff . I think one of the lessons of the depression, and this is something that Franklin Roosevelt demonstrated, was that when orthodoxy fails, then you need to try new things. And he was very willing to try unorthodox approaches when the orthodox approach had shown that it was not adequate.

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Still haven’t seen any discussion of a per capita revenue distribution to all the States?

$500 per capita would give California maybe $19 billion and be ‘fair’ to all the States.

It would also support aggregate demand (spending power) output and employment, which presumably is a national priority?

Feel free to send this suggestion to your representatives!

Schwarzenegger Seeks Obama’s Help as Budget Gap Defies Solution

By Michael B. Marois and William Selway

Dec. 24 (Bloomberg) — CaliforniaGovernor Arnold Schwarzenegger wants President Barack Obama to help ease large- scale cuts to the most populous U.S. state’s already diminished social programs amid a $21 billion anticipated deficit.

Schwarzenegger, a Republican, plans to ask for relief totaling as much as $8 billion, according to a California official who asked not to be identified because details haven’t been resolved. Instead of seeking one-time stimulus money or a bailout, the state wants the U.S. to reduce mandates and waive rules stipulating minimum expenditures on programs such as indigent health care, the official said.

California has been among the states most affected by the economic recession. It has the lowest credit rating and recorded the nation’s second-highest rate of home foreclosures, trailing only Nevada. Unemployment peaked at 12.5 percent in October amid the loss of 687,700 jobs from the year before, when the jobless figure was 8 percent. Wealth declined as the stock marketlost 40 percent of its value in 2008.

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I was asked by a reporter to state how I’d fix the economy in 500 words and replied:

Fixing the Economy

1. A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%). This will restore ’spending power’ allowing households to make their mortgage payments, which ‘fixes the banks’ from the ‘bottom up.’ It also helps keep prices down as competitive pressures will cause many businesses to lower prices due to the tax savings even as sales increase.

2. A $500 per capita Federal distribution to all the States to sustain employment in essential services, service debt, and reduce the need for State tax hikes. This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP are restored.

3. A Federally funded $8/hr job for anyone willing and able to work that includes healthcare. The economy will improve rapidly with my first two proposals and the private sector far more readily hires people already working vs people idle and unemployed.
In 2001 Argentina, population 34 million, implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years 750,000 were employed by the private sector.

4. Returning banking to public purpose. The following are disruptive and do not serve no public purpose:
a. No secondary market transactions
b. No proprietary trading
c. No lending vs financial assets
d. No business activities beyond approved lending and providing banking accounts and related services.
e. No contracting in LIBOR, only fed funds.
f. No subsidiaries of any kind.
g. No offshore lending.
h. No contracting in credit default insurance.
5. Federal Reserve- The liability side of banking is not the place for market discipline. The Fed should lend in the fed funds
market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as
the FDIC already regulates and supervises all bank assets.
6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than
otherwise.
7. FDIC
a. Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
b. Don’t tax the good banks for losses by bad banks. All that does is raise interest rates.
8. The Treasury should directly fund the housing agencies to eliminate hedging needs and directly target mortgage rates at
desired levels.
9. Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the
government at the lower of the mortgage balance or fair market value of the home.
10. Remove the ’self imposed constraints’ that are disruptive to operations and serve no public purpose.
a. Treasury debt ceiling- Congress already voted for the spending and taxes
b. Allow Treasury ‘overdrafts’ at the Fed. This is left over from the gold standard days and is currently inapplicable.
11. Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only
to cool down an overheating economy, and not to ‘pay for’ anything.

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The stupidity of the rhetoric (from both sides) just keeps getting worse:

President Obama: Federal Government ‘Will Go Bankrupt’ if Health Care Costs Are Not Reined In

President Obama told ABC News’ Charles Gibson in an interview that if Congress does not pass health care legislation that will bring down costs, the federal government “will go bankrupt.”

The president laid out a dire scenario of what will happen if his health care reform effort fails.

Gibson Obama“If we don’t pass it, here’s the guarantee….your premiums will go up, your employers are going to load up more costs on you,” he said. “Potentially they’re going to drop your coverage, because they just can’t afford an increase of 25 percent, 30 percent in terms of the costs of providing health care to employees each and every year. “

The president said that the costs of Medicare and Medicaid are on an “unsustainable” trajectory and if there is no action taken to bring them down, “the federal government will go bankrupt.”

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Yes, this is the essence of the Tea Party movement,

And so far the President has at best refrained from directly addressing these concerns.
At worst he’s been dismissive,
leaving the growing impression that indeed that is his vision,
even as his approval ratings plummet.

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Banking and the entire private sector in a capitalist society is necessarily procyclical. Only the Federal government can be countercyclical, and,
indeed that’s it’s role in supporting aggregate demand in a slowdown. The blame for current conditions falls unambiguously on current policy. Comments below

Obama Plans to Press Banks Monday to Start Lending Again

Dec. 13 (CNBC) —President Barack Obama’s economic advisers are talking tough about the banks ahead of his meeting Monday with heads of financial institutions.

Larry Summers and Christina Romer say Obama will press bankers to ease lending to help Americans get back to work.

As Summers put it, bankers need to recognize that “they’ve got obligations to the country after all that’s been done for them.”
He says no major bank would be intact without the government’s bailout of the financial sector, and now they need to do all they can to get credit flowing again.

Why would we want to demand releveraging of the private sector and not growth through increased incomes via my proposals for a payroll tax holiday, per capita revenue distribution, and an $8/job for anyone willing and able to work to facilitate private sector expansion as demand is restored?

Only one reason- the usual deficit myths.

Summers spoke Sunday on CNN’s “State of the Union” program.
Romer, on NBC’s “Meet the Press,” said Americans are still paying the price for Wall Street excesses.

No, we are still paying the price for poor policy response due to disgraceful flawed mainstream economics mired in deficit myths that has blocked the obvious means of supporting aggregate demand readily available.

On Saturday, Obama singled out financial institutions for causing much of the economic tailspin and criticized their opposition to tighter federal oversight of their industry.

Why does he care if “they” oppose any particular policy?

This shows a profound weakness of leadership where he can’t use his bully pulpit to lobby congress to do the ‘right thing.’

Unfortunately, however, due to the lack of a fundamental understanding of banking and the financial sector in general the administration’s proposals fall far short of the mark even if they did get them passed.

While applauding House passage Friday of overhaul legislation and urging quick Senate action, Obama expressed frustration with banks that were helped by a taxpayer bailout and now are “fighting tooth and nail with their lobbyists” against new government controls.
In his weekly radio and Internet address Saturday, Obama said the economy is only now beginning to recover from the “irresponsibility” of Wall Street institutions that “gambled on risky loans and complex financial products” in pursuit of short-term profits and big bonuses with little regard for long-term consequences.

Its just barely stopped the slide from a too little too late fiscal adjustment that added precious little to the work done by the fiscal ‘automatic stabilizers’ of rising transfer payments and falling incomes due to the slowdown.

Not to forget Fed policy that further removes personal interest income, which should be a good thing as it allows for lower taxes for a given level of federal spending. But of course that’s not recognized and therefore the 0 rate policy is instead a wet blanket on demand.

“It was, as some have put it, risk management without the management,” he said.

Right back to you.

The president also told CBS’ “60 Minutes” that “the people on Wall Street still don’t get it. … They’re still puzzled why it is that people are mad at the banks. Well, let’s see. You guys are drawing down $10, $20 million bonuses after America went through the worst economic year … in decades and you guys caused the problem,” Obama said in an excerpt released in advance of Sunday night’s broadcast of his interview.

Right back to you.

The only question is whether this is innocent fraud or subversion.

(feel free to distribute)

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Looks like a lapse into behavior not becoming a President- name calling, cheap shots, demonizing, and failure to recognize the behavior in question is a consequence of incentives built into the current institutional structure.

More and more voters are beginning to believe this is deliberate.

>   
>   (email exchange)
>   
>   Of course, your reform is vastly superior to anything that is out there.
>   
>   But this criticism of the banks is sheer hypocrisy on the part of Obama.
>   It’s kabuki.
>   
>   It might even be deliberate: see Matt Taibbi’s evisceration of the Obama
>   financial reforms. He’s usually on top of the prevailing zeitgeits.
>   
>   This legislation will be totally ineffective. Interesting today that the
>   bank stocks went UP on passage of the bill.
>   

yes.

Policy just keeps getting worse.

I’ve about lost hope that he can ever get it right, unless accidentally.

The longer term risk is fiscal tightening. So far it’s not actually happening.

A driving force behind tax rate hikes is the misread that the Clinton tax rate hikes ‘worked’ to both spur the economy and drive the budget into surplus.

I suppose a repeat of the massive expansion of consumer debt that reached maybe 7% of gdp by 1999 could
somehow materialize isn’t impossible, but sure seems highly unlikely in the current environment.

Apart from the fact that it’s also not my first choice for supporting output and employment.

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