Maybe Everyone In The Country Can Send A YouTube Testimonial

Ann Minch sent a debtor's revolt video to YouTube a couple weeks ago, refusing to pay off her credit card debt with Bank of America unless the company negotiated a lower rate, which they could easily do since they are receiving interest-free loans from the Federal Reserve. After some Internet notoriety and a handful of conversations, she actually succeeded in getting BofA to lower her interest payment.

The executive "tried to get me to agree to 16.99 percent and I said, 'No, nope, I believe because you guys are getting your money from the Fed at zero percent interest... that 12.99 percent is a more than generous profit margin for you guys.' So he did finally agree to that and he also agreed to send me that in writing."

Unfortunately, it's not practical for everyone facing an exorbitant usury fee from a major bank to shame them into compliance. We need the federal government undertaking a debtor's revolt, not individuals who don't have the same leverage.

However, with respect to Bank of America we may be turning a corner. The SEC is broadening its investigation against the bank, perhaps in response to the company's foot-dragging on compliance with that probe. BofA just missed a Congressional deadline to turn over documents to the House Oversight Committee about the takeover of Merrill Lynch. And as Chris Dodd sought to hammer banks for their automatic overdraft fees to customers, BofA and other banks are moving to change their practices.

Maybe this revolt thing is catching on.

Conservatives Never Met A Criminal They Didn't Like

The Bush Administration sure had a knack for letting criminals get away with it, didn't they? They failed to stop 9/11, never caught bin Laden, and now we're learning about the total incompetence of the SEC in responding to Bernie Madoff's Ponzi scheme.

The U.S. Securities and Exchange Commission repeatedly missed chances to catch Bernard Madoff’s $65 billion fraud over 16 years by assigning inexperienced investigators and accepting “implausible” explanations after catching him in lies, the agency’s internal watchdog said.

At least six warnings from sources including a money manager, a “respected hedge-fund manager” and a firm that studied Madoff’s business failed to spur a “thorough and competent” probe, Inspector General H. David Kotz wrote in a summary of a report released today. Madoff, in an interview with Kotz, said even he “was astonished” when investigators failed to check trading records that would have exposed his scam.

“Despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madoff’s trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme,” Kotz wrote.

This is not only an incredible report, it plays into a larger truth about the conservative conception of regulation as a needless bother rather than a diligent effort to protect the consumer. One incredible moment, referenced above but covered in detail by Zachary Roth, shows that Madoff basically thought he was caught and the scheme had been discovered by federal regulators, only to find himself safe once again.

The agency's biggest screw up, says the summary, was the fact that examiners never verified Madoff's trading through an independent third party.

The details of that failure are more astonishing still. Madoff at one point told examiners that all his trades were cleared through his account at the Depository Trust Company (DTC), a clearing agency -- and he gave the examiners his DTC account number. At that point, Madoff told Kotz in an interview, "I thought it was the end game, over. Monday morning they'll call DTC and this will be over." Amazingly, the SEC never followed up with DTC. Madoff said he was "astonished."

The summary almost makes clear that the SEC's right hand didn't know what the left was doing. It notes with astonishment that at one point, two Madoff examinations were going on at the same time within the agency, without either being aware of the other. It was Madoff himself who informed one team of the other's existence [...]

The final, failed Madoff investigation of 2006 -- triggered by a detailed Markopolos complaint -- was perhaps the most egregious. According to the summary, most of the investigative work was done by a staff attorney "who recently graduated from law school and only joined the SEC nineteen months before she was given the Madoff investigation. She had never previously been the lead staff attorney on any investigation, and had been involved in very few investigations overall. The Madoff assignment was also her first real exposure to broker-dealer issues."

According to the summary, that inexperience helps explain why, when Madoff told the examiners that he got such unprecedentedly good return simply because he had a good "feel" for the market, they took that nonsensical explanation at face value.

Bush's SEC didn't bother to check up on Madoff's dealings, and they took his explanations as good enough for them, because their attitude toward regulation was "don't mess with a good thing." Indeed, the entire stock market during the Bush years was kind of operating under a false reality in its own right. Madoff was a crook, but at least an honest crook. And even he couldn't get caught.

This is not just the story of one agency's embarrassing failure. The failure lied in the theory of government, existing to make profits for cronies and lay off the connected and the powerful. The failure to catch Madoff and the failure of conservatism are essentially the same stories.

A Quiet Push On Regulation

There are two arguments about why the regulators and the government missed the financial crisis. One, that the regulations were gutted by corporate interests in both parties; two, that the regulators had all the oversight abilities they needed but simply looked the other way. Really it's a combination of both. Legislation like the Commodity Futures Modernization Act, and to an extent Gramm-Leach Bliley, did remove some of the regulations over the banks, certainly the SEC under Chris Cox and the Bush Administration actively resisted enforcement of any kind. So while I do believe we need a regulatory overhaul, simply enforcing the law with existing tools would improve our ability to manage the financial industry and the risk to the greater economy.

Therefore I'm excited to see, for example, Sheila Bair at the FDIC taking on Citigroup.

The Federal Deposit Insurance Corp. is pushing for a shake-up of Citigroup Inc.'s top management, imperiling Chief Executive Vikram Pandit, people familiar with the matter said.

The FDIC, under Chairman Sheila Bair, also recently pressed a fellow regulator to lower the government's confidential ranking of Citi's health -- a change that would let regulators control the firm more tightly.

The FDIC's willingness to take an increasingly tough position toward one of the nation's largest and most troubled financial institutions is setting up a bitter clash between regulators -- some of whom disagree with the FDIC's position.

It's completely within the purview of the FDIC to regulate Citi, and just this threat is enough to keep them and other banks more in line. Meanwhile, with respect to new regulations, the Obama Administration is floating an executive rule to appoint a Special Master for Compensation that would enforce laws passed during TARP:

The Obama administration plans to appoint a "Special Master for Compensation" to ensure that companies receiving federal bailout funds are abiding by executive-pay guidelines, according to people familiar with the matter.

The administration is expected to name Kenneth Feinberg, who oversaw the federal government's compensation fund for victims of the Sept. 11, 2001, terrorist attacks, to act as a pay czar for the Treasury Department, these people said.

Mr. Feinberg's appointment could be announced as early as next week, when the administration is expected to release executive-compensation guidelines for firms receiving aid from the $700 billion Troubled Asset Relief Program. Those companies, which include banks, insurers and auto makers, are subject to a host of compensation restrictions imposed by the Bush and Obama administrations and by Congress.

Wall Street has been anxiously awaiting more details on how the rules will be applied. "The law is confusing and a bit ambiguous, and so we're looking for certainty as to how to structure pay incentives," said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a trade association.

There's an excellent debate to be had over future regulations. But I think that we would be served perfectly just by making sure the laws on the books are enforced.

More From Populist Obama

I don't know if it's residual anger over the bondholder revolt or what, but the President does seem to be formulating some legitimate steps to regulate the financial industry. First off, he wants to deal with derivatives:

In its first detailed effort to overhaul financial regulations, the Obama administration on Wednesday sought new authority over the complex financial instruments, known as derivatives, that were a major cause of the financial crisis and have gone largely unregulated for decades.

The administration asked Congress to move quickly on legislation that would allow federal oversight of many kinds of exotic instruments, including credit-default swaps, the insurance contracts that caused the near-collapse of the American International Group.

The Treasury secretary, Timothy F. Geithner, said the measure should require swaps and other types of derivatives to be traded on exchanges or clearinghouses and backed by capital reserves, much like the capital cushions that banks must set aside in case a borrower defaults on a loan. Taken together, the rules would probably make it more expensive for issuers, dealers and buyers alike to participate in the derivatives markets.

As it is now, there are $70 trillion dollars exposed in the derivatives market, more than all the money in the world. Without the need to back up the exchange with capital ratios, these things happen. Traditionally, regulations like this hold for a few years until the Big Money Boyz figure out a way to get around them. But this would essentially stop dead the shadow banking system, a major element of the crisis.

And then we have the Big Kahuna: CEO compensation, and a real effort to limit executive pay:

Obama Administration officials are contemplating a major overhaul of the compensation practices in the financial services industry, moving beyond banks to include more loosely regulated hedge funds and private equity firms.

Federal policymakers have been discussing ways to ensure that pay is more closely linked to performance.

Among the ideas under consideration are incorporating compensation as a “safety and soundness” concern on official bank examinations as well as expanding the existing regulatory powers of the Securities and Exchange Commission and Federal Reserve to obtain more information.

Obviously the issue with regulation is who the regulators are. We had plenty of regulations on the books that could have mitigated the financial crisis, but the regulators looked the other way. I mean, the NY Fed apparently knew about the AIG bonuses when Tim Geithner was at the helm. So while I appreciate the attempt, I have to see some teeth out of the oversight before I believe it will solve the problem.

Go To Jail

Apparently when Bernie Madoff was remanded to a corrections facility pending sentencing the courtroom burst into spontaneous applause. I wouldn't normally feel thrilled about someone being sent to a cell the size of a walk-in closet, but I'll make an exception. Apparently Madoff was running his Ponzi scheme since THE RECESSION OF THE EARLY 1990s. Books could be written about how the SEC missed this for close to 20 years, and I'm sure they will be. For today, I have to be happy that the $7 million dollar penthouse apartment in Manhattan will be empty.

America's Next Top Ponzi Schemer

This Sir Allen Stanford is a piece of work. Self-congratulatory, thinks he's related to Leland Stanford when he's not, knighted by the island of Antigua, and now, under arrest:

The Securities and Exchange Commission yesterday charged R. Allen Stanford, a prominent Texas businessman, and three companies under his control with carrying out a "massive, ongoing fraud" involving the sale of $8 billion in certificates of deposit.

The case is one of the largest alleged financial frauds in U.S. history and comes just two months after the SEC accused New York financier Bernard L. Madoff of orchestrating a Ponzi scheme of up to $50 billion.

Stanford and two colleagues, operating through a web of firms based in Houston and the Caribbean, lied to customers about how their money was being invested and how the firms' investment portfolios had performed in the past, the SEC said in a civil complaint filed in federal court in Dallas.

We knew that Bernie Madoff was but the beginning of this. You find out about fraud in the markets when they go down, not when they go up.

Stanford's a weird guy (just go to TPM Muckraker and keep scrolling. But he also hedged his bets on the fraud by cozying up to politicians of both parties and lavishing them with contributions. I don't know what's sicker - that a criminal thinks he can get away with his crimes through access to power or that it's so likely to work.

Penthouse Arrest

I actually watched a good bit of the replay of yesterday's incredible House hearings with Madoff scandal whistleblower Harry Markopolos and the SEC (yes, it was a rockin' Wednesday night), and they really are amazing. The extent to which government protects the rich and powerful was really on full display. Here are two clips that should be widely distributed.

We now know that Bernie Madoff was running a Ponzi scheme that defrauded investors out of tens of billions of dollars. We know that the SEC had everything it needed to stop the fraud years in advance and did nothing. And yet today, Bernie Madoff is still living in a fabulous New York penthouse instead of a jail cell, with a security detail that he pays for. As Markopolos says in this clip, "He's under penthouse arrest [...] He is leading a life of luxury. He does have serious complaints; he's not allowed to go out for his nosh."



More amazing altogether is the behavior of the SEC officials, who actually tried to assert executive privilege in refusing to discuss their failure in the Madoff case or of any resposible oversight of the financial industry at all.



Go Gary Ackerman. I think we've become so inured to random government officials using "executive privilege" as a get out of jail free card that we don't understand how extraordinary this is. We pay the salaries of these people. Every one of them should be fired.

Meanwhile, Emperor Paulson stole your money in the bailout.

The U.S. Treasury may have significantly overpaid for its investments in financial institutions, a government watchdog said Thursday, as criticism of the $700 billion financial rescue continues to build.

"Treasury paid substantially more for the assets it purchased under the [ Troubled Asset Relief Program] than their then-current market value," Harvard Law School professor Elizabeth Warren told the U.S. Senate Banking Committee.

Warren, who chairs a five-person congressional oversight panel overseeing the Wall Street rescue plan, said a report being released Friday by the group includes an analysis of 10 TARP transactions. Extrapolating that analysis for all of the purchases made by the Treasury in 2008 suggests Treasury paid $254 billion for assets worth approximately $176 billion, a shortfall of $78 billion.

"They did not price for risk, that's what markets do," Warren said, suggesting the Treasury's lack of consistency had made the government funds a better deal for some institutions.

And they're getting ready, under "new leadership" at Treasury in name only, to do it again. More on that in a different post.

It's a wonder that pitchfork and torch sales aren't through the roof.

They Wouldn't Be Able To Find First Base."

There is a rather remarkable hearing playing out right now on Capitol Hill. Harry Markopolos, the whistleblower in the Bernie Madoff scandal, is testifying to a House Committee, and he's basically calling out the SEC for its total incompetence - over a period of several years - in failing to identify the Madoff Ponzi scheme and put a stop to it. Markopolos, who went to the SEC in May 2000, when the Madoff scheme was only about $5 billion, is getting off line after line ripping the SEC a new one. TPM Muckraker has all the details. Some highlights:

• "If you flew the entire SEC staff to Boston, and sat them in Fenway Park, they wouldn't be able to find first base."

• Markopolos discusses Madoff's mob ties: "When you're that big and you're that secrective, you're going to attract a lot of organized crime money, and which we now know came from the Russian mob and the Latin American drug cartel, and when you are zeroing out mobsters, you have a lot to fear. And he could not afford to get caught, because once he was caught. And if he would've known my name and knew he had a team tracking him, I didn't think I was long for this world."

• Markopolos offered to go undercover wearing a disguise to catch Madoff.

• Perhaps the most telling statement: "They (the SEC) were a captive regulator. Mr. Madoff was too big," he just told Congress. "They looked at Madoff and said: 'he's a big firm, we dont attack big firms.'"

That really says it all. The real difference between Madoff's scheme and the rest of Wall Street was that Madoff was more explicitly criminal. But that's it. And the SEC's inability to go after anything substantive on Wall Street turned the place into a deregulated casino.

There is a populist uprising going on in the country right now, as more and more stories like this come out. Which is why Obama's limit on executive pay this morning was significant and important. But the stimulus is being caught in the crossfire, as anything from a position of power is becoming infected with all the talk of theft of taxpayer dollars. The Republicans are being very sanguine, and if they do derail the stimulus or render it ineffective, the next few years will be really terrible and people will just get angrier.

Scumbag Millionaires

You can be forgiven for wondering why Bernard Madoff would try to steal billions in the first place. He was already rich and well-respected, and none of his investors would have complained, presumably, about losses in the midst of the economic collapse of the past few years. But what's coming out in the past 48 hours, about how Madoff had signed checks totaling $173 million ready to pass off to employees at the time of his arrest (I'm assuming to hold it for him), and how he's been mailing jewelry and watches SINCE his arrest, suggests that he's just one of these "greed is good" thieves who always needed more, no matter his position or standing.

The detail was provided in a court filing Thursday as prosecutors argued that Madoff should have his bail revoked and be sent to jail. They said the checks were further evidence that he wants to keep his assets away from burned investors.

In the filing, Assistant U.S. Attorney Marc Litt said Madoff cannot be trusted because he had long engaged in a "scheme that required the defendant to lie routinely to thousands of people and a scheme which has caused extraordinary damage to individuals, families, and institutions all over the world."

The judge will now decide whether Madoff should be sent to jail or remain free on bail in his luxury Upper East Side penthouse.

I would say jail at the very least. And some investors or the US Treasury could use all those assets, too.

As for what to do about the larger problem of financial industry fraud, the SEC is broadening their investigation, and even Republican Congressmen are talking about a "statutory and regulatory structure for the 21st century." I would hope that this doesn't narrow into a solution about how to stop Ponzi schemes. The sickness lies in the lack of regulation throughout the financial services industry. Here's what the President-elect had to say about it, and I think it's largely on point.

Obama: Well, by the time that G-20 meeting takes place, we, I believe, will have presented our approach to financial regulation. I think some international coordination has to be done. But right now, we just have to take care ... (unintelligible) ... and Wall Street has not worked, our regulatory system has not worked the way it's supposed to. So it's going to be a substantial overhaul. We're going to have better enforcement, better oversight, better disclosure, increased transparency. We're going to have to look at this alphabet soup of agencies and figure out how do we get them to work together more effectively. We've got to stop splintering functions in such a way that capital in one form is treated one way and capital in another form is treated another way, because these days in global financial markets, they're all fungible. And there's systemic risks that are possible, whether it's in the form of derivatives or insurance or traditional bank deposits. So we've got to update the whole system to meet the needs of the 21st century. This is an assignment that my team is already beginning to work on and I think that we will have, fairly shortly, a package that we've worked alongside Barney Frank and Chris Dodd, to present to the American people.

This is the perspective we need. The failure of the SEC to recognize the Madoff crime is shameful, especially considering the warning signs were there and investment officers were actually trying to warn them. But the real failure is that the financial industry as an institution was disinclined to blow the whistle.

What’s interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn’t just Harry Markopolos who smelled a rat. As Mr. Markopolos explained in his letter, Goldman Sachs was refusing to do business with Mr. Madoff; many others doubted Mr. Madoff’s profits or assumed he was front-running his customers and steered clear of him. Between the lines, Mr. Markopolos hinted that even some of Mr. Madoff’s investors may have suspected that they were the beneficiaries of a scam. After all, it wasn’t all that hard to see that the profits were too good to be true. Some of Mr. Madoff’s investors may have reasoned that the worst that could happen to them, if the authorities put a stop to the front-running, was that a good thing would come to an end.

The Madoff scandal echoes a deeper absence inside our financial system, which has been undermined not merely by bad behavior but by the lack of checks and balances to discourage it. “Greed” doesn’t cut it as a satisfying explanation for the current financial crisis. Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy. The fixable problem isn’t the greed of the few but the misaligned interests of the many.

(More here.)

You can say much the same about credit default swaps, or mortgage-backed securities, or the credit-rating industry, or any of the instruments and institutions that failed the country. In short there was nothing stopping them from maximizing their own interests and insulating themselves, not the economy, from risk. The problem is bad incentives, and they directly stem from free-market fundamentalism without limits or controls. It's a system where cheerleading is encouraged and dissent is verboten. Where the interests of the shareholders are subservient to the interests of the bondholders and the CEOs. And that MUST change. To quote Gordon Brown, one of the few leaders on the global scene during this crisis:

The prime minister said 2008 would be remembered as the year in which "the old era of unbridled free market dogma was finally ushered out". In his traditional new year message, Brown struck a tone of tempered optimism, saying that Britain can this year build a better tomorrow through strategic investments while dealing with the dangerous challenges of today.

He said: "The failure of previous governments in previous global downturns was to succumb to political expediency and to cut back investment across the board, thereby stunting our ability to grow and strangling hope during the upturn. This will not happen on my watch."

Absolutely. 2008 was the year when free market dogma became so toxic it nearly swallowed up the entire financial system and the fortunes of untold millions. Madoff is not an oddity; he's an EXAMPLE. An example of what can never happen again.

Friedman, In The Study, With The Manifesto Of Laissez-Faire Capitalism

The New York Times had a great article about how the President and his philosophy of the "ownership society" inflated the housing bubble and caused the historic collapse in the market. And I guess this is true to an extent, and the article doesn't presume that encouraging homeownership is solely responsible. But the article only skirts around the edges of why this was dangerous.

From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.

He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.

Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency.

As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.”

The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.

The focus on Fannie and Freddie is kind of ridiculous, as I've gone over on this blog time and again. They were a symptom and not a cause, entering the toxic market well after it had gotten out of control. What the article described, but not boldly enough, is that Bush's crusade for homeownership, a POLITICAL strategy designed to win the hearts of minorities and low-income Americans who could realize their dreams, was achieved through a crusade for deregulation, an IDEOLOGICAL strategy designed to allow financial executives the most leeway possible to conduct their sophisticated Ponzi schemes. Bush and his advisors would never interfere with the inflation of the bubble, because it won them a rhetorical victory, and they laughed off suggestions that the crash would be extremely dangerous. So they allowed lenders to come up with instruments that basically pushed the global economic system to the brink of collapse.

While much of this is the same old story of politics over policy - Bush could go around and say "Owning your own home is the greatest gift of all" and feign obliviousness to the chicanery used to get people into these homes - I don't want to divorce the ideology from the politics. The President was always a laissez-faire capitalist and a free market fundamentalist, using government to encourage homeownership, in this case, but essentially eliminating the rules that would create any barriers to making that a reality. And that was by design.

The president’s first chairman of the Securities and Exchange Commission promised a “kinder, gentler” agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general’s report.

As for Mr. Bush’s banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks.

The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina’s attorney general, said, “They took 50 sheriffs off the beat at a time when lending was becoming the Wild West.”

While it's important that the President tells the whole country that you can own a home no matter how much money you make, it's far more important that he create conditions where lenders can actually give those kinds of mortgages out. The lenders were of course responding to demand for mortgage-backed securities and derivatives and threw away lending standards so they could print up more and more of them. Barry Ritholtz gets this right - the problem was that Bush was an avowed deregulator.

That Bush had as a goal increased home ownership is, quite bluntly, irrelevant. It is a worthy goal, and certainly one that could be achieved without forcing the collapse of the financial system.

Indeed, as the chart at right shows (source: NYT), home ownership has increased every year since 1994. Funny, from that year and for each of the next 10 years, there was no collapse. You have to ask yourself why. No, the 1997 Tax Break, did not, as the NYT implied yesterday, Help Cause Housing Bubble. Home ownership was rising years before that went into effect.

What Bush did differently than prior Presidents was that he genuinely believed that regulations proscribing bad corporate behavior were unnecessary. It was that ruinous belief system, one he shared with other key players, that led to the crisis [...]

Increasing home ownership in America is a legitimate political goal. Waiving down-payments requirements, dropping lending standards, allowing predatory lenders to flourish — that is what is the underlying cause of boom bust and collapse.

You're seeing this similar dynamic now in the revelations that Chris Cox sought to dismantle the SEC while he was the chairman of it, allowing traders free reign and hewing to the anti-regulation mantra of the Bush Administration. This mania was not limited to the housing sector (check out the Consumer Products Safety Commission, for another example). If you want to go all the way back, the culprit is Milton Friedman.

For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley.

Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies.

In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies.

Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown.

On Dec. 16, the U.S. Federal Reserve cut its target lending rate to as low as zero for the first time and said it will buy mortgage- backed securities [...]

Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

“The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001.

University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas.

“The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says.

Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge.

Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality.

The Chicago Boys brought us to this moment of crisis. Their radical theories have ruined the global economic system. I don't know whether having a former University of Chicago professor (whose economic advisors come from that school as well) as the President-elect is a good thing, in that he's been close enough to that heart of darkness to see its flaws, or a bad thing, in that he still holds the vestiges of their theories of deregulation. If Obama is a pragmatist, as he claims to be, he will recognize that Friedmanism must be totally repudiated, buried, locked up and forgotten.

The Bigger Con Is SEC Officials Pretending To Work

Yesterday, Chris Cox, the chairman of the SEC threw his mercy on the court.

The Commission has learned that credible and specific allegations regarding Mr. Madoff's financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action.

Cox is authorizing an Inspector General probe. Someone honorable might resign in disgrace. Apparently, the investigations of Madoff it finally got around to relied on VOLUNTARY information from Madoff himself. Madoff's niece married an SEC official who was involved in oversight of Madoff's brokerage business. The amount of obvious, credible warning signs that the SEC missed in this case are growing. I would simply have looked at the fact that Madoff's own sons' foundations invested elsewhere is a pretty decent sign in its own right. The reason that nobody at the SEC went after Madoff is that he was a "master of the universe."

Fusfeld added that during the 90's he had used Madoff as a witness in a securities case to which Madoff was tangentially connected. "The man had charisma," said Fusfeld."He was one of those people that, when he walked into a room, everyone stopped what they were doing and watched him."

Had the SEC watched him a little closer, however, numerous investors might have been saved some crippling losses.

Unbelievable.

Today, President-elect Obama introduced Mary Schapiro, a longtime regulator, to replace Chris Cox at the SEC. It's impossible for her to do worse, and I hope she wields the Madoff scandal as an impetus to do rigorous and effective oversight over these clowns, and I hope she is provided new regulatory tools to conduct that oversight.

Other regulatory appointments are profiled here.

Not A Bug But A Feature

This Bernard Madoff Ponzi scheme is really kind of incredible, if only because we haven't seen such a con on a high level like this in so many years. In fact, probably not since Charles Ponzi, the original scam artist. Maybe in the future they will be called Madoff schemes. As Anonymous Liberal notes, this is a tragedy for the federal government as well, because there will be billions lost in expected capital gains tax revenue as a result of the crime. All these investor losses will be deductible, as well as rebates of past capital gains that they've paid, and the cost to the Feds could rival the amounts talked about in the auto industry rescue.

Now, I think there's a reason this will wind up to be such a massive loss for those involved, and that's because this is not separate from the current financial crisis, but part and parcel of it. Because in this era of trusting the market, in believing in magical men who make money appear in everyone's numbered back account, the SEC didn't come close to investigating the scheme.

Bloomberg reported yesterday that since Madoff registered the investment arm with the Securities and Exchange Commission in 2006, that agency hadn't got around to looking at the business's books. The SEC usually tries to go through the books of newly registered firms in their first year.

"If the SEC didn't come in and inspect (the Madoff hedge fund), then they have a hell of a lot to answer for," one expert told the Associated Press.

But the problem doesn't appear to have started in 2006.

As early as 1999, an executive in the securities industry had urged the SEC to probe Madoff, on the basis of the remarkably steady returns that his investment business seemed to provide. The executive, Harry Markopolos, argued that Madoff must be generating those returns by "front-running" -- that is, using the brokerage arm of his company to illegally provide information to the investment arm.

The SEC said in a statement that it had conducted two investigations into the brokerage arm -- not the investment arm -- of Madoff's company, in 2005 and 2007. The first, begun in response to allegations of front-running, found three violations of rules requiring brokers to obtain the best possible price for customer orders. That investigation appears to have led to Madoff agreeing to register with the SEC the following year, giving the agency access to far more information than it previously had. But the 2007 probe, conducted after Madoff registered, found no evidence of anything improper.

Investment firms were as off-limits under Clinton as they were under Bush. In fact, as long as everyone made money, regulators weren't much exercised to investigate. This is the same root cause that led us to the crisis. Nobody checked the derivatives, nobody checked the CDOs and the credit default swaps, and nobody checked out Bernie Madoff. In good times, these bullets could be dodged. Not so now.

This is why you can't base an economy on pushing paper and inventing sums of money to trade, dependent almost entirely on greed.

All Cox' Fault?

Looks like the GOP has found a scapegoat for the financial meltdown. John McCain said today that he would fire Chris Cox as the chairman of the SEC. Now, Presidents don't have the power to do that, but clearly that showed a lack of trust in Cox on the part of the Republican nominee, and now CNBC is reporting (no link) that Cox will resign at the end of President Bush's term. In a way, McCain got what he wanted. And expect lots of articles about how lax SEC oversight was the proximate cause of this mess.

But how true is that? McCain tried to lay the blame at Cox' feet for the practice of naked short selling, which is when you can bet on a stock to go down without owning it, sort of like playing the ponies without owning the horse. This isn't exactly the best thing for the market, and Andrew Cuomo is launching an investigation to see if it's fully compliant with current law.

New York on Thursday began a probe into possible illegal short-selling in the stocks of Wall Street companies such as Goldman Sachs Group Inc and Morgan Stanley, Attorney General Andrew Cuomo said.

Cuomo said on a conference call with reporters: "I want the short-sellers to know today that I am watching. If it is proper and legal then there is nothing to worry about." [...]

The New York State prosecutor said his office also would look back into illegal short-selling that may have occurred in stocks of Lehman Brothers Holdings Inc and American International Group Inc, two companies at the heart of the crisis.

In the past week, Lehman has gone bankrupt and the insurance giant was rescued by the U.S. government.

Cuomo has asked the SEC for a freeze on short-selling.

But to suggest that this is why the markets are in turmoil is crazy. It's like blaming the guys betting on the horse for the horse carrying 200 extra pounds and stumbling to the finish line. The banks lent money to people who couldn't pay them back, and then hid the debt in all sorts of tricky new assets and securities that they tried to shovel out the door. That's the main problem, and no change in short-selling would alter that. The other problem is leverage, which may or may not be the SEC's fault.

As we learn this morning via Julie Satow of the NY Sun, special exemptions from the SEC are in large part responsible for the huge build up in financial sector leverage over the past 4 years -- as well as the massive current unwind.

Satow interviews the above quoted former SEC director, and he spits out the blunt truth: The current excess leverage now unwinding was the result of a purposeful SEC exemption given to five firms.

You read that right -- the events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1.

Instead, the 2004 exemption -- given only to 5 firms -- allowed them to lever up 30 and even 40 to 1.

Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.

You can credibly charge Cox with failing to conduct meaningful oversight and indeed encourage over-leveraging, but that's not what McCain said.

He talked about short selling, which is perfectly legal, thanks to the masters of the universe like Phil Gramm, who encouraged and supported the casino-like atmosphere on Wall Street that led to this mess.

If you want to know what happened to blow up the financial markets, it's relatively simple. The banks let anyone buy a house, securitized the mortgages, and over-speculated and over-leveraged themselves, so that investors were buying worthless pieces of paper that they thought were valuable. The fixes are also simple:

Reform One: If it Quacks Like a Bank, Regulate it Like a Bank. Barack Obama said it well in his historic speech on the financial emergency last March 27 in New York. "We need to regulate financial institutions for what they do, not what they are." Increasingly, different kinds of financial firms do the same kinds of things, and they are all capable of infusing toxic products into the nation's financial bloodstream. That's why Treasury Secretary Hank Paulson has had to extend the government's financial safety net to all kinds of large financial firms like A.I.G. that have no technical right to the aid and no regulation to keep them from taking outlandish risks. Going forward, all financial firms that buy and sell products in money markets need the same regulation and examination. That will be the essence of the 2009 version of the Glass-Steagall Act.

Reform Two: Limit Leverage. At the very heart of the financial meltdown was extreme speculation with esoteric financial securities, using astronomical rates of leverage. Commercial banks are limited to something like 10 to one, or less, depending on their conditions. These leverage limits need to be extended to all financial players, as part of the same 2009 banking reform.

Reform Three: Police Conflicts of Interest. The conflicts of interest at the core of bond-raising agencies are only one of the conflicts that have been permitted to pervade financial markets. Bond-rating agencies should probably become public institutions. Other conflicts of interest should be made explicitly illegal. Yes, financial markets keep "innovating." But some innovations are good, and some are abusive subterfuges. And if regulators who actually believe in regulation are empowered to examine all financial institutions, they can issue cease-and-desist orders when they encounter dangerous conflicts.

The SEC could have handled reform 2, but that's about it. There are also reforms that we can do to ensure that people stay in their homes, which would be novel, protecting ordinary people instead of the executives who caused this. AND, we could actually tax hedge fund managers on their income the way we do any other income-generating American, increasing federal revenue and having the people at least somewhat responsible for this mess partially finance the bailouts, as they are no longer creating public wealth.

This remains a scary time. China could decide that holding US dollars doesn't make any sense and divest, which would lead to what Michael Bloomberg has called a next wave crisis.

But you'll see that short-selling, which actually doesn't affect the market as much as claimed, because on the way down you have to buy the stock to cover the sale, isn't on anyone's reform list. The bottom line is that simple regulation that is actually implemented is much cheaper and more efficient than bailing out everyone on Wall Street with phantom money that is just created out of thin air and ends up becoming debt for our children and grandchildren. John McCain is out of touch with what is needed to soothe the markets, but it sounds manly to "strike forth" and fire a guy you decide is responsible. The responsibility lies with Republican love of deregulation, not any one person. You can scapegoat Chris Cox all you want, but it's a smokescreen.

...funny, too, how McCain can stand up to Chris Cox but not George Bush.

In private late Tuesday evening, the McCain campaign circulated a draft statement on the Wall Street crisis that attacked the Bush administration for a slow and "inconsistent" response, and charged that executives at several financial firms had made "misleading and false" statements.

But the criticism never appeared. After being circulated not only among McCain aides but also major campaign donors who have worked in the investment industry, the language was softened.