Hurricane Katrina Hits the Banking System

It was not  Hurricane Katrina that killed thousands of people in New Orleans. It was the breaching  of the levies. And the incompetence of FEMA administrators who were supposed to mount a rescue. The sheer indifference of the ruling class, symbolized by that flyover by Bush. Even as images of thousands of people taking refuge in the SuperDome filled our TV screens, Bush administration officials were deriding it all as a figment of our imagination. Sounds familiar?

Now a similar catastrophe is under way with the US banking system. The Hurricane is the downturn in the business cycle.  Dare I call it  the recession? The levies are the system of checks and balances put in place after the crash of 1929.  Federal guarantees of deposits under $100K. Freedie Mac and Fannie Mae to help with  mortgage liquidity.

The levies have been breached. Banks are failing. Bears Stearns. Indymac. Freddie Mac and Fannie Mae themselves need to be bailed out. The whole system is drowning in bad debt.  And the week before each Bank failed, its Government Regulator assured us that everything is fine. No need to panic. It is all in our mind. It is a mental depression, folks. Don't be whiners, says Dr. Phil Gramm. Like those people in New Orleans.

Not since 1929 has the American banking system been in such dire straits. The  investment bank Bear Stearns failed in June and had to be bailed out by the taxpayers. Up until the last minute, the SEC assured us that everything was fine

Bear Stearns was given a boost this week when Securities and Exchange Commission Chairman Christopher Cox said his regulatory agency is comfortable with the 'capital cushions' at the nation's five largest investment banks.

Just last week IndyMac of Pasadena failed. Just the latest  of  a rapidly growing list published by the FDIC . Even more  upsetting is the impending collapse  of venerable New Deal Era institutions Fannie Mae and Freddie Mac. All of these were brought down by the deregulation of the banking industry.

The Government guarantees-both statutory and implicit- took  much of the pain of failure  away from the owners  and managers of Banks. This is why  the New Deal insisted on the Govenrment  tightly regulating  what they could do. Banks who  write mortgages could not play in the stock market. Inverstment banks could not take Federally insured deposits. Right wing politicians, helped by some academic economists, mounted a systematic attack on Government regulations for the last three decades. It started during the Reagan administration but got   virulent during Bush years.  "Hell of a Job Brownie" types were  put in charge of Government agencies overseeing banks. What we are seeing is the beginning of  the resulting  catastrophe. The Hurricane Katrina of  the financial world.

The Savings and Loan debacle of the eighties and nineties was a foretaste of what was to come. Savings and Loans are  those neighborhood banks made famous in the Frank Capra movie It's a Wonderful Life. Except that by the nineties it was not Jimmy Stewart running them. It was people like Charles Keating, the real life Mr. Potter.  Greedy. Crooked. The Government regulators had been cutback due to an earlier phase of de-regulations. Imagine that the Government deregulated Airlines. And then also closed down the FAA and cancelled all inspections of aircraft. That is what was allowed to happen with the Savings and Loans.

Things like that don't happen without the crooks having strong allies in Congress. The infamous Keating Five are five Senators who went to the  Federal Home Loan Bank Board   and threatened the agency with cutbacks unless it  looked the other way on Keating.  In return for a million dollars in contributions. The resulting scandal ended the career of four of those Senators. Guess who the fifth is: Sen. John McCain. Mr. Straight Talk himself. Oh, but he said he was  sorry for it in a book he wrote. That should make it alright,  then.

You would think the lesson was learned. It was not. Phil Gramm, while he was in the Senate, led another round of deregulations. The Glass-Steagall act of 1933, which prevented Banks protected by Federal Guarantees from playing the stock market, was repealed in 1999 by the Gramm-Leach-Biley act. That not only meant that Banks could now invest in the stock market. It meant that they had to compete against investment banks, who made so much more money from risky investments. So they had to take risks themselves. The cost  of their failure would be passed on to the tax payers.  Add to it reductions in the budgets of Federal agencies that enforce the rules. And a recession--excuse me, Dr. Phil,  a mental impression of a recession. And you have the Category Five Financial Hurricane that is hitting the Banking system now.

Why would Congressmen agree to such stupid policies? Sure,  a couple of them are corrupt. But that alone does not explain it. I do not believe Sen. McCain is corrupt. (Not because he is a war hero: Randy Cunningham was a crook.) It is not because they get contributions from lobbyists either. It is because they are led astray by experts. Perfectly reasonable people can lose their common sense when advised by technical experts..

Of course,  many rock solid scientific principles go against common sense. The rotation of the Earth. Or Newton's Laws. Economists have convinced some gullible people  that there's is a hard science on par with physics or evolutionary biology.  Phil Gramm has a Ph. D. in Economics and was Chairman of the Economics Dept at Texas A&M, a good school. As the man proved recently, this does not mean he has any common sense at all. But he can bamboozle Rep. Leach (who chaired the banking committee in the House) to go along.  He can solicit testimony of economists from Chicago to sing the praises of the Free Enterprise. Congress took a few good ideas for needed reform and added corporate loopholes  to create  bonanza for crooks and imbeciles. Free Enterprise is supposed to be Free in the sense of Free Speech. Not in the sense of Free Beer.

It would be as though, in an effort to improve the confusing off-side rule in soccer you abolished all rules. And fired the referee. And gave a bonus to the player who would break the opposing goalies knee. And then guarantee that both teams will win a handsome  purse   paid for by the fans. No matter who wins.

One of the most respected Economists in the country, Greg Mankiw (Prof.  at Harvard) wrote a sort of wishlist of academic economists in yesterday's NYTimes. Hello? Not one word about the financial crisis. I guess the news has  not yet wafted up the Ivory tower. The front page of the  Sunday Business Section is usually about big time Business Deals and the occasional CEO being send off to jail. This week, both leading stories are about the banking crisis. Maybe Prof. Mankiw noticed? Or did he go directly to page 4 to admire his own article? May be he reads it online.

Economics is not without merit or unanimity as a discipline. Mankiw lists all the points on which academic Economists agree, regardless of Party affiliation.

Free Trade. ( Free Beer for  some people. For others, Freedom from having employment.)

Leave Oil companies Alone. (Haven't they done enough?)

Tax the use of Energy.(i.e., tax gasoline).

Raise the Retirement age. (Especially for tenured Professors.)

Invite more skilled immigrants. (Especially economists).

Legalize Marijuana. ( That one surprised me. Then again, it might  explain  the rest.)

And most importantly, Repeal  Farm Subsidies. Economists are unanimously against subsidies.  Because subsidies   promote sloth and  inefficiency. With one exception. They want subsidies for Economics Research.

Raise Funds for Economic Research

If Senator McCain or Senator Obama wants to endear himself to economists, there is no easier way than by promising an extra few million dollars ..

Get in line. Who wouldn't love an extra few million dollars?