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Tuesday, April 21, 2015

Lack of Integrity and the Revolving Door

Lack of Integrity and the Revolving Door

E. Jeffrey Ludwig

Last week, the NY Times ran a lead story in its "Business Day" section reporting that Ben S. Bernanke, the former Federal Reserve chairman, had signed on to advise the Citadel Investment Group, a hedge fund founded by Ken C. Griffin. Mr. Bernanke believes there is no conflict of interest because he "won't be doing any lobbying" and because he will not be working for "any firm regulated by the Federal Reserve." He has joined an impressive list of government economic leaders who took jobs with major investment or banking interests upon leaving their roles as major government players in the U.S. economy. Alan Greenspan became a consultant for a number of private financial entities such as Deutsche Bank, Pacific Investment Management, and the hedge fund Paulson & Co. Last year, Tim Geithner, former Secretary of the Treasury joined the equity (stocks and bonds) firm of Warburg Pincus.

These outstanding individuals are not only brilliant, but according to their own statements remain paragons of integrity. They tell us that their decisions, at the Fed or heading the Treasury Department, were not influenced by their aspirations in life after they would leave their governmental positions, nor are they now using either insider information or influence via connections they still have with the Fed.

Their claims to being ethical based on legal technicalities of what constitutes "conflict of interest" defy the common-sense experience of just about everyone on the planet Earth.

For example, we know that the Fed has been pursuing an almost zero percent interest rate policy for lending money to banks. The low discount rate means that banks can and will only charge low interest rates for loans. It also means that banks are paying amazingly low rates on CDs. This has had the effect of penalizing savers in our economy. Interest rates have not been this low since the 1950s. 

However, the rate of inflation has been rising faster than the interest people can earn on their savings. A home in the U.S. in the 1950s cost approximately 2.2 times the average income, whereas today it costs 3.7 times the average income. College tuition in the 1950s cost .18 times the average income, but today is .79 times the average income. An automobile in the 1950s cost .45 times the average income, whereas today it is .61. That's almost an increase of 50% relative to income to buy a car, and 68% to buy a home.

During the years 1949-1965, the average inflation rate was under 2% for 14 of those 17 years. For the years 1986-2014 the average inflation rate was over 2% for 13 of those 18 years. Those years include three Republican presidents and two Democratic presidents. Our leaders are equal opportunity inflictors of economic pain on the hardworking middle-class of America. 

Since interest rates are low, banks are making their money not by lending money, but by investing money they borrow in stocks and/or bonds. Banks can do this because the Glass-Steagall Act (1932), one of the truly wise moves under the New Deal, was repealed by Congress by the Gramm–Leach–Bliley Act of 1999, and signed into law by Bill Clinton in 1999. Glass-Steagall set up a firm partition between a bank's commercial banking activities and their investment activities. That barrier no longer exists. So commercial banks can invest their depositors' moneys and their own borrowed funds in investment instruments.

Thus money borrowed by banks from the Fed (at a low rate of interest) are likely to be invested in stocks and/or bonds, or invested in mutual funds, or loaned to hedge funds which then can be used to invest in more high risk investments than banks or mutual funds would normally make since hedge funds are unregulated.

Many hedge funds also use an investment technique called leverage, which is essentially investing with borrowed money -- a strategy that could significantly increase return potential, but also creates greater risk of loss. In fact, the name "hedge fund" is derived from the fact that hedge funds often seek to increase gains, and offset losses, by hedging their investments using a variety of sophisticated methods, including leverage. 

So we can now understand the oft-repeated slogan from 2007-2008 that the government cares more about Wall Street than about Main Street. Not only are businesses on Main Street not bailed out when poor decisions cause them to fail, but the savers -- those prudent individuals who are socking money away for retirement, for their kids' college education, or to buy a first home or a new car -- are ignored. Long run consumer goals are being sacrificed for the sake of the investment community. 

This writer would not go so far as to declare this a conspiracy by the leaders of the financial community and the leaders of our governmental monetary and fiscal policies. However, the fluid movement between the two spheres suggests that there is an unhealthy convergence of interests. Without extraordinarily principled management of the public coffers such as that shown by Secretary of the Treasury Andrew Mellon in the 1920s, we cannot escape the conclusion that there is 'collusion-lite' between government and financial services in the managing of our economy. It would seem to be in the public interest to keep inflation down, whereas the financial managers have no stake in that goal. 

Instead the Fed has been printing money at the rate of $85 billion a month (with occasional downward adjustments) as an expression of its Quantitative Easement policy. This goes beyond propping up an ailing financial services industry. It is inflationary, just as the vast increase of our national debt is inflationary. This side of the equation was long ignored because the financial services industry has everything to gain and little downside risk with these policies. The leaders of our country's economic policy know what their policies engender, and that it enables them to move seamlessly from the quasi-governmental institution of the Fed or the Department of the Treasury to the entirely private world of high finance. It is entrenched cronyism.

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