Such government micromanagement of the economy is everywhere. The Post recently reported that Richard Wagoner, the former CEO of General Motors who was removed by the government, remains on GM’s payroll “because senior Treasury officials have yet to decide whether he should get the $20 million severance package that the company had promised him.” His 2009 compensation — $1 — is payable Dec. 31. The $20 million promised to him includes contractual awards, deferred compensation and pension benefits accrued over 32 years with the company. Promise-keeping, including honoring contracts, is the default position of a lawful society. But suddenly, many citizens’ legal claims are merely starting points for negotiations with an overbearing government.

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They’re back. We refer to the global investors once known as the bond vigilantes, who demanded higher Treasury bond yields from the late 1970s through the 1990s whenever inflation fears popped up, and as a result disciplined U.S. policy makers. The vigilantes vanished earlier this decade amid the credit mania, but they appear to be returning with a vengeance now that Congress and the Federal Reserve have flooded the world with dollars to beat the recession.

Treasury yields leapt again yesterday at the long end, with the 10-year note climbing above 3.7%, its highest close since November. Treasury yields had stayed low, and the dollar had remained strong, as long as investors were looking for the safest financial port amid the post-September panic. But as risk aversion subsides, and investors return to corporate bonds and other assets, investors are now calculating the risks of renewed dollar inflation.

They have cause to be worried, given Washington’s astonishing bet on fiscal and monetary reflation. The Obama Administration’s epic spending spree means the Treasury will have to float trillions of dollars in new debt in the next two or three years alone….

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[BARRY] RITHOLTZ: Most of Wall Street is furious at what happened. Most of Wall Street aren’t involved in mortgage securitization or derivatives or any of the other bad assets that have been blowing up. The average guy — you know Wall Street is a meritocracy, eat what you kill, as much as you can earn in profits you get to take as a bonus — and I know a lot of guys, everywhere from Merrill Lynch to Bear Stearns to Lehman, that actually were really profitable. But because this one division was run by rogue pirate traders and reckless derivatives salesmen, they wiped up the entire bonus pool for the entire firm, and then some, all the while engaging in really reckless behavior.

[Kai] Ryssdal: Do you figure we’re stuck now as a bailout nation? We’re going to be subsidizing banks and car companies and insurance companies for some time to come.

RITHOLTZ: You know we’ve already seen the trucking industry make hints they want stuff. And we’ve seen the homebuilders who are key players in this, who just overbuilt everything. They’ve been asking for a bailout. That’s the slippery slope. Once you reward people for their worst behavior, for speculative, irresponsible investing and punish the prudent and the people who are careful with that money. Everybody seems to think it’s a free for all. Hey, you’ve got yours. How do I get mine?

Ryssdal: What’s the alternative to these bailouts? I mean should we have just done nothing?

RITHOLTZ: What you do is what the FDIC does when a bank is found to be insolvent. Look what happened with Washington Mutual….

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The U.S. Treasury auction of long-term bonds on Thursday was “terrible”, in the words of one Wall Street economist, with the rate on the 30 year bond jumping from 4.1 to 4.3 percent. This is just the first sign that the debt-based Obama economic stimulus plan is about to become a major drag on the recovery, just as expected.

The economic news is not all bad. We are seeing signs the rate of contraction is abating quickly, promising a bottom to the recession sometime this summer as many forecasters have expected. But therein lies another piece of the interest rate puzzle, and the trouble ahead.

There are two critical consequences to the economy stabilizing. The first is that the massive liquidity injected into credit markets by the Federal Reserve and central banks around the world transforms from economic medicine to inflationary heroin. Central banks are going to face a difficult task of extracting the excess liquidity before inflation soars and without causing another recession. Doubt about the fight against soaring inflation means higher inflation premiums in interest rates.

The second dangerous consequence is that President Obama is on course to double the national debt in just four years….

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The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation’s biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

The overall reaction to the stress tests, announced Thursday, has been generally positive. But the haggling between the government and the banks shows the sometimes-tense nature of the negotiations that occurred before the final results were made public.

I remain uncomfortable with it all. Read the whole article–KSH.

At one bank in Alabama, the problem is a construction bust. At two in Ohio, the trouble is real estate. And in San Francisco, at Wells Fargo, the worry is credit cards ”” a staggering 26 percent of that bank’s card loans, federal regulators have concluded, might go bad if the economy takes a turn for the worse.

The stress tests released by the Obama administration Thursday painted a broad montage of the troubles in the nation’s banking industry and, for the first time, drew a stark dividing line through the new landscape of American finance.

On one side are institutions like JPMorgan Chase and Goldman Sachs, which regulators deemed stronger than their peers ”” perhaps strong enough to repay billions of bailout dollars and wriggle free of government control.

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The relatively modest size of the hole discovered by regulators carrying out the tests, which were based on an “adverse” economic scenario, led to both applause from investors who believe the worst is over and skepticism among those who think the examination wasn’t rigorous enough.

“The fears of nationalization or of failure have more or less disappeared, and now what we’re getting is details of how banks are going to fill in their capital deficiencies,” said Eric Kuby, chief investment officer at North Star Investment Management in Chicago.

The doubters believe the banks will need much more of a capital cushion than stipulated by the regulators, as the U.S. jobless rate soars and the housing market and economy takes time to pull out of a funk, driving up credit losses.

“I’m a skeptic. I don’t see this as a genuine audit. They have been playing the marketing game strongly lately,” said Robert Andres, president of Andres Capital Management in Philadelphia.

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6 The administration seems to bounce back and forth between emphasizing building a strong capital base and helping BHC[Bank Holding Company]’s get rid of toxic assets. I think the capital cushion is more important.
7 $34 B more for Bank of America is a big number.
8 I continue to be confused about why the administration is so confident they will not need to ask Congress for more TARP money, especially if they intend to use a lot of cash to prevent GM from liquidating.

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Federal regulators told the country’s 19 largest banks that they must raise $75 billion in extra capital by November, a more upbeat verdict on the health of the financial system than the industry had feared just two months ago.

Ten of the 19 bank holding companies deemed “too big to fail” by the Obama administration will be required to raise additional capital, according to the results of the government’s stress tests, released late Thursday afternoon. But the 10 banks will have to raise much less capital than some analysts had expected as recently as a few days ago.

“With the clarity today’s announcement will bring, we hope banks are going to get back to the business of banking,” Treasury Secretary Timothy F. Geithner said during a news briefing on Thursday afternoon.

Mr. Geithner noted that banks had a long way to go to restore the nation’s confidence in the financial industry, and that they could get a start in generating good will by lending more.

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Still, the tea parties are not based on the cold wonkery of budget data. They are based on an “ethical populism.” The protesters are homeowners who didn’t walk away from their mortgages, small business owners who don’t want corporate welfare and bankers who kept their heads during the frenzy and don’t need bailouts. They were the people who were doing the important things right — and who are now watching elected politicians reward those who did the important things wrong.

Voices in the media, academia, and the government will dismiss this ethical populism as a fringe movement — maybe even dangerous extremism. In truth, free markets, limited government, and entrepreneurship are still a majoritarian taste. In March 2009, the Pew Research Center asked people if we are better off “in a free market economy even though there may be severe ups and downs from time to time.” Fully 70% agreed, versus 20% who disagreed.

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Can we afford to fix our financial systems? The answer is yes. We cannot afford not to fix them. The big question is rather how best to do so. But fixing the financial system, while essential, is not enough.

The International Monetary Fund’s latest Global Financial Stability Report provides a cogent and sobering analysis of the state of the financial system. The staff have raised their estimates of the writedowns to close to $4,400bn (€3,368bn, £3,015bn). This is partly because the report includes estimates of writedowns on European and Japanese assets, at $1,193bn and $149bn, respectively, and on emerging markets assets held by banks in mature economies, at $340bn. It is also because writedowns on assets originating in the US have jumped to $2,712bn, from $1,405bn last October and a mere $945bn last April.

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The cavalier use of brute government force has become routine, but the emerging story of how Hank Paulson and Ben Bernanke forced CEO Ken Lewis to blow up Bank of America is still shocking. It’s a case study in the ways that panicky regulators have so often botched the bailout and made the financial crisis worse.

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A conversation about the economy with Bill Ackman, major investor and hedge fund manager of Pershing Square Capital Management LP, Kate Kelly, Andrew Ross Sorkin and Joe Stiglitz, economist and a member of Columbia University faculty.

Watch it all.

President Obama’s top economic advisers have determined that they can shore up the nation’s banking system without having to ask Congress for more money any time soon, according to administration officials.

In a significant shift, White House and Treasury Department officials now say they can stretch what is left of the $700 billion financial bailout fund further than they had expected a few months ago, simply by converting the government’s existing loans to the nation’s 19 biggest banks into common stock.

Converting those loans to common shares would turn the federal aid into available capital for a bank ”” and give the government a large ownership stake in return.

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. Asked about the tea parties, President Barack Obama responded that he was not aware of them. As Marie Antoinette said, “Let them drink Lapsang Souchong.” His Imperial Majesty at Barackingham Palace having declined to acknowledge the tea parties, his courtiers at the Globe and elsewhere fell into line. Talk-show host Michael Graham spoke to one attendee at the 2009 Boston Tea Party who remarked of the press embargo: “If Obama had been the king of England, the Globe wouldn’t have covered the American Revolution.”

The American media, having run their own business into the ground, are certainly qualified to run everybody else’s into the same abyss. Which is why they’ve decided that hundreds of thousands of citizens protesting taxes and out-of-control spending and government vaporization of Americans’ wealth and their children’s future is no story. Nothing to see here. As Nancy Pelosi says, it’s AstroTurf ”“ fake grass-roots, not the real thing.

Besides, what are these whiners so uptight about? CNN’s Susan Roesgen interviewed a guy in the crowd and asked why he was here:

“Because,” said the Tea Partier, “I hear a president say that he believed in what Lincoln stood for. Lincoln’s primary thing was he believed that people had the right to liberty, and had the right ”¦”

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The U.S. Treasury and financial regulators are clashing with each other over how to disclose results from the stress tests of 19 U.S. banks, with some officials concerned at potential damage to weaker institutions.

With a May 4 deadline approaching, there is no set plan for how much information to release, how to categorize the results or who should make the announcements, people familiar with the matter said. While the Office of the Comptroller of the Currency and other regulators want few details about the assessments to be publicized, the Treasury is pushing for broader disclosure.

The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers.

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As a Peruvian educated by British and American teachers, I learned never to embark on a major task without first “doing the math.” No more of that Latino “happy go lucky, trust your gut and say three Hail Marys” approach to life.

Without measurement, my teachers advised, I wouldn’t be able to identify and disentangle the very reality before my eyes. By doing the math, I would see order and coherence, the way things were organized; invisible relationships would come into view, and right behind order would come meaning, followed by confidence. Thanks to my Anglo-Saxon education, I learned the lesson: You cannot manage what you have not previously measured.

So imagine how I have felt watching my role models go to war over weapons of mass destruction that they never actually assessed, or now, watching them wage a losing war against derivatives….

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During World War I, Americans were exhorted to buy Liberty Bonds to help their soldiers on the front.

Now, it seems, they will be asked to come to the aid of their banks ”” with the added inducement of possibly making some money for themselves.

As part of its sweeping plan to purge banks of troublesome assets, the Obama administration is encouraging several large investment companies to create the financial-crisis equivalent of war bonds: bailout funds.

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The pricing of the toxic assets of the banks is in line with the pricing of other risky assets. There is no evidence that prices of credit instruments are now reflecting fire sales or distress selling. The evidence, if anything, suggests that the prices are actually on the high side. This means that the liquidity rationale of the Keynesians has no basis in fact.

The findings are sure to be contested in the literature, as most research is. In the end, they will prove robust. They will hold up.

The debate on bank bailouts is broader than economics. It goes to a question of justice. Should one group, taxpayers, be forced to pay for the mistakes of another group, bankers? It goes to a question of freedom versus socialism and fascism. Should banks operate in a profit and loss system and bear the losses that they incur, or should they not, in which case the financial system becomes more socialist and fascist? Even before addressing these questions, if the Keynesian policy does not do what it is claimed, then in economic terms the Keynesian case falls.
The government and FED claim that the financial system lacks liquidity. They say that there is a market pricing defect or failure. This, they say, is why the bad loans (toxic assets) held by the banks are worth more than the prices that they are fetching in the market. These prices, they claim, are fire sale prices. The remedy, they call for and implement, is for the Treasury and FED to supply the banks with liquidity, i.e., bail them out. Thus, the government and the FED are directing trillions of taxpayer dollars to shore up weak banks by buying their bad loans rather than overseeing a judicial-like process of re-organizing the banks and cleaning out these loans in established bankruptcy-like procedures.

The Austrian position is that the financial system does not lack liquidity. The bad loans were overpriced to begin with, largely because the FED and government engineered a speculative bubble. The bubble burst. The loans were repriced in the market. The loans are now worth what they are bringing in the market. Thus, the government has no liquidity justification for bailing out the banks. The government’s economic rationale has no merit. Many banks are insolvent. On the economic merits, they should be allowed to fail, not bailed out.

This may seem arcane but it really does matter. Read it all–KSH.

Mr. Obama is betting that the totality of economic policies his team and the Federal Reserve have put in place will act, like radiation therapy, to halt the spread and reduce the size of the cancerous tumors eating away at our financial system ”” and stimulate enough new growth and optimism so that Phase II will be small enough to get past Congress and the public.

As Treasury Secretary Timothy Geithner told ABC News, “If we get to that point” ”” where more funds are needed ”” “we’ll go to the Congress and make the strongest case possible and help them understand why this will be cheaper over the long run to move aggressively.”

Have no doubt, Phase II is coming. At best, it will require hundreds of billions of dollars more, at worst more than a trillion, to deal with more bad loans and toxic assets weakening the economy ”” problems that Phase I can’t fully absorb. Because unemployment is still rising ”” ensuring that the initial spate of mortgage defaults, which came from loans to people who could never repay, will be followed by another spate of defaults from those who could repay but now can’t because the deteriorating economy has stripped them of their jobs, their businesses or their credit lines.

Read it all.

Listen to it all from NPR. Note especially what he says about the so-called “Geithner plan” to rescue the banks. At some point it is going to dawn on more people that significant questions need to be asked about this plan and whether it is the right approach, since so many thoughtful industry participants and observers do not think so. But maybe that is just yours truly, since I am worried about the plan–KSH

What happened to the global economy? We seemed to be chugging along, enjoying moderate business cycles and unprecedented global growth. All of a sudden, all hell broke loose.

There are many theories about what happened, but two general narratives seem to be gaining prominence, which we will call the greed narrative and the stupidity narrative. The two overlap, but they lead to different ways of thinking about where we go from here.

Read it all, and note that the first essay mentioned has already been posted on this blog.

Check it out.

Ironically, the moral hazard created by the Geithner plan is similar to the incentivizing of risky mortgage investments by the government’s backing of Fannie Mae and Freddie Mac, which played a major role in causing the financial crisis in the first place, as economists Peter Wallison and Charles Calomiris describe in this paper. Wallison deserves some credit for warning about this danger back in 2005.

Both parties deserve blame for the policy of federal backing for dubious mortgages and investments. Certainly, President Bush didn’t help matters when he, in his own words, “use[d] the mighty muscle of the federal government” to promote the issuing of risky mortgages.

Barack Obama, however, promised to break with the failed policies of the past, and often criticizes those who he claims advocate “the same failed ideas that got us into this mess in the first place.” Ironically, he has now embraced some of the worst of those ideas himself.

Read it all and follow the links as well.

Here is the real plan that now seems odds on to succeed.

The Plan: Dump $500 billion of toxic assets on to unsuspecting taxpayers via a public-private partnership in which 93% of the losses are born by the taxpayer.

—Mish in his latest analysis of the Geithner “plan”

Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.

Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause””Lehman was small relative to Citigroup or Bank of America””is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington. Bank of America obtained its second bailout package (in January) after warning the government that it might not be able to go through with the acquisition of Merrill Lynch, a prospect that Treasury did not want to consider…

To break this cycle, the government must force the banks to acknowledge the scale of their problems….

Read it all.

U.S. Treasury Secretary Timothy Geithner said some financial institutions will need substantial government aid, while warning against any attempt to tax investors who join a federal program to buy tainted assets from banks.

“Some banks are going to need some large amounts of assistance,” Geithner said today on the ABC News program “This Week.” The terms of a $500 billion public-private program to aid banks “cannot change” for investors or they’ll lose confidence in the plan, he said on NBC’s “Meet the Press.”

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After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries’ policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor’s musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to “get their house in order” — without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Read it all.

An interesting array of editorial opinion on the subject.

Update: in yesterday’s Financial Times Jeffrey Sachs did not like the plan:

The idea of “private sector price discovery” is therefore flim-flam. There would be price discovery if the government’s loan had to be repaid whether or not the asset paid off in full. In that case, the investor would bid $360,000. But under the Geithner-Summers plan the loan is precisely designed to be a one-way bet, for the purpose of overpricing the toxic asset in order to bail out the bank’s shareholders at hidden cost to the taxpayers.

The banks could be saved without saving their shareholders ”“ a better deal for taxpayers and without the moral hazard of rescuing shareholders from the banks’ bad bets. Most simply, the government could provide loans to buy the toxic assets on a recourse basis, therefore without the hidden subsidy. Alternatively, the plan could give the taxpayers an equity stake in the banks in return for cleaning their balance sheets. In cases of insolvency, the government could take over the bank, the much dreaded nationalisation, albeit temporary. At the end of the Bush administration, Congress voted for the $700bn (€517bn, £479bn) troubled asset relief programme (Tarp) on the assurance the taxpayer would get fair value for money (for example, by taking equity stakes in the rescued banks). The new plan does not offer that.

The good news from our historical study of eight centuries of international financial crises is that, so far, they have all ended. And we confidently predict this one will end, too. We are just not quite so sure it will be nearly as soon as the chirpy forecasts coming from policymakers around the globe. The U.S. administration, for example, is now predicting that growth will renew in the latter part of this year and continue at a brisk pace of 4 percent for several years thereafter. Is this a fact-based forecast or wishful thinking?

A careful look at the international evidence on severe banking crises suggests a far more cautious assessment. The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11”“12 percent in 2011.

Read it all.