Over the weekend a fierce and savage cold front descended on New York City making outdoor excursions fit for neither man nor beast. It was the kind of crippling cold that makes you feel like you’ve just stepped out of the shower no matter how many layers of clothing you pile on. So, I decided to hunker down in the apartment.

By 2 a.m. Saturday, temperatures had dropped so low a piece of metal snapped off a window I was trying to close as if it were made of cheap Mexican plastic. I needed that window closed because with the apartment door open, it was creating a kind of wind tunnel effect through the kitchen, making it impossible to boil anything with the precision I required; a classic catch-22. If I closed the door my boiling would take on a proper rigor, but the deliveries from the pub downstairs would wake everyone up. If I left the door open the deliveries would function smoothly but the boiling would become haphazard and problematic, also waking everyone up. The situation demanded a compromise. So I turned the music up.

That’s how my weekend started, with a hard compromise. Two days later I’m sitting here still combing through the Special Inspector General’s report on the Troubled Asset Relief Program and I see the same game plan at work; when confronted with mutually exclusive and impossible-to-achieve objectives, turn the music up. It’s a type of fuzzy, 2 a.m. logic. It’s Washington logic.

Despite clocking in at 244 pages, the report is fairly breezy reading, but when I first came across it early Saturday I almost never made it to the second page. Something about the report’s cover stopped me cold.

But what? The logo was fairly routine for the government; a scale of weights and a skeleton key underneath some kind of perverted Confederacy stars and bars pattern. I asked the deliveryman from the bar his take on it.

“You see anything wrong with this?” I demanded, waving the cover page around.

“Just some of the glasses keep coming back broken, but — ”

“No, no,” I yelled. “This image. You see anything that looks… weird, out of place?”

He took the page, glanced at it and handed it back with a shrug.

“Two dollar bill,” he said flatly. “Means it’s fake.”

Enraged, I chased him out of the apartment, threading the closing elevator door’s needle with a well-thrown shoe; a small price to pay. He was right but for the wrong reason, and now he’d never know why, because sometimes a random show of force is needed to keep the delivery process on track.

Yes, that was it, alright. The American two-dollar bill, not exactly fake, but goofy, suitable only for birthday cards and broken down horse players. Was this supposed to be somebody’s idea of a sick joke? A 244-page report on a massive $700 billion government relief program illustrated by the corner of a $2 bill?

Perhaps there’s something else going on. On his next trip, my deliveryman apologized profusely for insulting the authenticity of the American $2 bill. “I’m Irish, you know, and we’re deeply suspicious of all forms of currency,” he said.

Briefly, in 2006, near the height of the credit bubble, savvy strip club owners across America began stocking up on two-dollar bills. “Strip clubs hand out $2 bills when they give customers their change, and the bills end up in dancers’ garters and bartenders’ tip jars,” USA Today reported at the time. “The entertainers love it because it doubles their tip money,” Angelina Spencer, a former stripper and executive director of the Association of Club Executives, an adult nightclub trade
group, told the newspaper.

But I digress.

See, I did comb through the report, all 244-pages of it, and there are literally dozens of fascinating paragraphs and charts, all explaining in great detail how the program functions and why, exactly, it doesn’t work; it’s a Calculus of Fools. While the word calculus may also mean a kidney stone or some kind of nasty gall bladder concretion, the word fool is straightforward enough. It’s either a lack of judgment or an outright deception. Take your pick.

From the Executive Summary:

“Despite the fact that the explicit goal of the Capital Purchase Program was to increase financing to US businesses and consumers, lending continues to decrease, month after month, and the TARP program designed specifically to address small-business lending — announced in March 2009 — has still not been implemented by Treasury.”

Of course, one of the main dilemmas here is that no matter how comprehensive it is, the TARP program can do little to end the vicious cycle of credit bubble corrections where lenders, having facilitated the bubble by relaxing lending standards too much, are forced as the bubble unwinds to tighten standards, which has the perverse effect of lowering overall credit quality.

What’s happening is that even as the goal of the CPP is to increase lending, the pool of available borrowers is shrinking, and this shrinkage is occurring from several different trigger points, including natural credit aversion and increased lending standards.

But let’s go back to this Capital Purchase Program for a moment, because the purpose of the program and the mechanics of how it’s working are instructive on a couple of different levels.

Click here for Page 2 …

I am a Capitalist Pig, and proud of it. Thus, you would not expect me to support government interference and more strenuous regulation of financial institutions – after all, capitalism (free markets) and tight regulation don’t mix well. Well, at the risk of been kicked out of the Capitalistic Pig Party, I am in support of tighter regulation of too-big-to-fail (TBTF) institutions – the likes of Citigroup, JPMorgan, Bank America, and (God forbid; after all, they are doing “God’s work” – their CEO’s words, not mine) Goldman Sachs.

Lack of tight regulation in the TBTF space leads to the worst economic system of all: asymmetric socialism. The enormous gains are reaped by employees and shareholders, but losses are socialized and paid by taxpayers. That is simply immoral.

Letting companies fail is at the core of capitalism’s DNA, and I still stand by that. However, what we’ve discovered over the last few years is that if we let TBTF banks go bankrupt, their failure may take down other healthy (interlinked) financial institutions
and derail the real (nonfinancial) economy. We saw glimpses of that about to happen when Lehman went bankrupt. If the government hadn’t stepped in to guarantee money-market funds (and almost everything else on earth), the real economy would have stopped in a few days, with massive withdrawals of funds from money markets and a shutdown of the commercial paper market, which in turn would cut off healthy companies like IBM from regular day-to-day activities like financing their inventories and paying their employees.

Our financial system operates on the assumption of continuity: we assume tomorrow will arrive and that we’ll be able to get our money out of the banks if we want to. A failure of large financial institutions is akin to an earthquake of magnitude 9 on the Richter scale taking place in NY, but with aftershocks of 7 magnitude ripping throughout the country; and at the end of the day (or the week) the whole country ends up in ruin.

I could be wrong, and the failure of a large bank might end up being not such a significant event, but we will NEVER find out, as the cost of being wrong is too high. So we end up with the imperfect world we live in – the big banks will not be allowed to
fail.

This imperfect world leads us to two realistic solutions: (a) create incredibly strenuous regulations that will require significantly higher equity-to-debt ratios than for smaller banks and severely restrict the activities of TBTF institutions. Basically, they need to be turned into regulated utilities, like your local gas and water companies. Permit their “God’s work” to be limited to only very transparent traditional banking activities – so they cannot fail. Separate the leveraged hedge fund (the proprietary trading operation) and the bank (the institution that takes deposits and makes loans). In other words, bring back a more sophisticated version of Glass Steagall act.

Or we have option (b): break them up, either by making their lives unbearable through the strenuous regulation described in option (a), or simply by legislating it, as was done with AT&T in the 1980s.

There are upsides and downsides with each solution. I personally believe regulations of complex systems often fails, as Wall Street always figures out how to game the system. Fannie and Freddie had a single regulator, OFHEO, whose sole job was to insure their viability. That didn’t work out well. Of course Fannie and Freddie also had a conflicting goal: they had to report to HUD that they were providing enough financing to low-income households. (Canada, on the other hand, is dominated by just a handful of very large banks that are strenuously regulated and were almost unscathed by the recent financial crisis.)

Breaking them up is what makes the most sense to me. Break them into small enough pieces that their failure becomes a non-event for the economy as a whole. That way failure will not be socialized, but borne by those who were to reap the rewards, rather than your regular Joe and Jane Six-Pack having to fork over a chunk of their paychecks to “bail out” the TBTFs so they can keep their jobs.

Intense regulation of TBTF institutions will slow economic growth, but to its natural, sustainable level. As we have learned, the other type of growth, though fun for a while, has a price tag that only increases with time.

Regulation may even stiffen innovation. I love innovation; I buy anything that has an “i” in front of it – I may even buy Apple’s iPad. But Wall Street and our economy as a whole would have been better off if, over the last decade, Wall Street was less “innovative” and employed fewer mathematicians with PhDs. Their latest & greatest innovations – the financial products that through sophisticated, ingenious, mind-boggling formulas (that often lacked common sense) showed their bosses how to create higher financial leverage on top of already high financial leverage – were
responsible for the bombs that were at the heart of many recent blowups.

Breaking up TBTF will face the criticism that smaller banks will be less efficient and thus borrowing costs will be higher for consumers and corporations. This would be true if TBTF banks did not come with marble conference rooms, million-dollar executive offices, fleets of corporate jets, and $100-million compensation packages. The bottom line, if you compare the financial metrics: smaller banks are not any less efficient than the large ones.

A greater government involvement in the financial sector is not something I thought I’d ever ask for, but it has turned into a necessity in order to preserve, not destroy, capitalism.

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance).To receive Vitaliy’s future articles my email, click here.

This Wednesday, President Obama will broadcast his message from the most visible area of the bully pulpit: the State of the Union address. The AP reports President Obama will unveil a new economic aid package including:

“[A] doubling of the child care tax credit for families earning under $85,000; a $1.6 billion increase in federal funding for child care programs and a program to cap student loan payments at 10 percent of income above “a basic living allowance.” The initiatives will be part of the president’s proposed budget for fiscal year 2011.

His initiatives also include expanding tax credits to match retirement savings and increasing aid for families taking care of elderly relatives. That program would also require many employers to provide the option of a workplace-based retirement savings plan.”

Are these new packages aimed at helping the struggling underemployed, or are they simply political bait to ward off a Republican surge in the upcoming midterm elections? Either way, these new programs represent a new wave of subsidies to continue propping up the economy in the short term.

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JPMorgan’s Jamie Dimon: “Mistakes Were Made” (AKA, Sh*t Happens)

Sometimes certain moments are too epic to easily forget. During last week’s Financial Crisis Inquiry Commission hearings — intended to dissect the causes for the recent financial crisis — Phil Angelides posed this question to Goldman’s chief executive Lloyd Blankfein:

“How do you go to the rating agencies and persuade them to give these subprime mortgage-related securities the highest ratings, at the same time as you have internal information that leads you to believe that in fact those securities may fail?”

I knew it was coming … I just didn’t know when. It didn’t take long … there it was, finally, from JPMorgan Chase chief Jamie Dimon. The old, the tired, the inevitable … “Mistakes were made.”

Cowardly? Yes. Substantive? No.

In fact, this statement, ubiquitous as it may be these days, does not qualify as:

• A statement of accountability;
• An admission of guilt;
• An apology;
• A defensive argument; or,
• A commitment to action.

This poor excuse for an excuse leaves nothing for a “counterparty” to respond to. It’s as if “mistakes” suddenly appeared out of nowhere, like neutrinos — not as a result of any agency or agent, and probably as mystifying as the beginnings of the universe.

The “Mistakes were made” argument is just a step above that other crafty, slice-and-dice excuse: “We’re all to blame.” (Thanks for the promotion, btw, but I really don’t think I had a hand in the financial crisis, other than providing lint-sized bits of capital for speculation.)

Even more maddening, this remark seems to suggest that any mistakes that “were made” were innocent in nature and immune from any under-handed intent. (And we all know how hard it is to prove intent.)

Basically, Dimon’s excuse is roughly equivalent to that other old standby: “Sh*t happens.”

If it were up to me, the “mistakes were made” argument would be outlawed from public discourse. But then again, it’s the perfect hedge.

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Bill Black, associate professor of economics and law at the University of Missouri, wrote recently in a post railing against the Fed’s failed leadership on regulation:

Bernanke recently appointed Dr. Patrick Parkinson as the Fed’s top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS, a.k.a the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.

After citing that Parkinson has no experience in regulation, Black goes on to say:

Dr. Parkinson has a record relevant to supervision that we can evaluate. The most revealing aspects of that record fall into three categories. First, Dr. Parkinson was a leading proponent of the obscene (and successful) effort to prevent Commodity Futures Trading Commission Chair Brooksley Born from taking regulatory action to prevent destructive credit default swaps (CDS). Second, Dr. Parkinson, like Greenspan and Bernanke, subscribed to the naïve view that fraud was impossible in sophisticated financial markets and that credit rating agencies were reliable. Third, Dr. Parkinson endorsed the international “competition in regulatory laxity” that Dr. Bernanke (belatedly) warned has degraded regulation on a global basis.

Is Black right that Parkinson’s record of anti-regulatory failure is evidence that the Fed wants to continue the “regulatory laxity” that caused the current crisis?

When Bernanke said that it was lax regulation, not monetary policy, that caused the mortgage meltdown, wasn’t he really calling for more regulation? In fact, in his recent testimony on the Hill, Bernanke said specifically that:

A new regulatory structure should address this problem. In particular, a stronger financial regulatory structure would include: a consolidated supervisory framework for all financial institutions that may pose significant risk to the financial system; consideration in this framework of the risks that an entity may pose, either through its own actions or through interactions with other firms or markets, to the broader financial system; a systemic risk oversight council to identify, and coordinate responses to, emerging risks to financial stability; and a new special resolution process that would allow the government to wind down in an orderly way a failing systemically important nonbank financial institution (the disorderly failure of which would otherwise threaten the entire financial system), while also imposing losses on the firm’s shareholders and creditors. The imposition of losses would reduce the costs to taxpayers should a failure occur.

But if the Fed had the power to impose higher standards for mortgages markets and did nothing prior to the meltdown, what’s changed? Is this just lip service or more window dressing so as not to upset the wizards of Wall Street? And with the phrase “no more bailouts” still ringing in my ears, doesn’t that bit at the end of the quote suggest that future bailouts are virtually assured? But I digress…

Getting back to Parkinson, why did Bernanke choose Parkinson then?

Maybe this Parkinson quote from July 2008 says it all:

One of the main reasons the credit derivatives market and other OTC markets have grown so rapidly is that market participants have seen substantial benefit to customizing contract terms to meet their individual risk-management needs. They must continue to be allowed to bilaterally negotiate customized contracts where they see benefits to doing so.

So when we hear from Bernanke, Geithner, and Co. that yes, there will be better financial controls, requirements, exchanges, and standardization for derivatives, they are also sure to say there will always be exceptions….

Meet Pat Parkinson… the Fed’s new point man ─ not on regulation, but on exemptions. Exceptionalism rules, and no, I’m guessing there will be no transparency for these “custom” deals. Welcome home, dark markets.

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If you haven’t already started reading Precision Capital Management’s free S&P500 Morning Report, click here to start now.

Since October, 2009, the Federal Reserve has increasingly hyped the inflation meme by publicly touting the more than $1 trillion in excess reserves (held by banks with the Fed) which, as the theory goes, could come flying out into the economy in one hyperinflationary swoop.  If all the world’s a stage, then Bernanke will be winning an Oscar for this performance, because the futures and currency markets are pricing in a Fed rate hike in the second half of 2010 and a robust US economy.

Rather, we have postulated that this tightening theatre is mere preparation for QE 2.0, which has been confirmed today (at least with respect to more Agency MBS purchases by the Fed).  We suspect the Fed will wait until the US Dollar index rallies to at least 81 or 82 before announcing the next round of long term Treasury purchases.  Make no mistake, however, those pesky excess reserve dollars will eventually get itchy to rejoin their friends in the economy (perhaps when they amount to $3 trillion sometime in 2011), and the Fed will need all the tools it can strap around its bloated waist to reign them in.

Through the Emergency Stabilization Act of 2009, passed shortly after the Lehman bankruptcy, Congress accelerated the effective date to October 1, 2008 of an amendment to the Federal Reserve Act that would give the Fed the authority to pay interest on excess reserves.  The pros and cons were best expressed by the manager of the world’s largest hedge fund (the FOMC’s System Open Market Account) in a speech on December 2, 2009 to the Money Marketeers of New York University:

A key part of the framework is the ability to pay interest on excess reserves. This authority alone may allow the FOMC to control short-term interest rates to its satisfaction, even if the banking system is saturated with a large amount of excess reserves. Indeed, the interest rate on excess reserves should act as a magnet for other short-term interest rates, keeping them relatively close together. In the current environment, the federal funds rate has remained modestly below the rate paid on reserves, typically by 10 to 15 basis points. If that spread were to remain steady near those levels even as the interest rate on excess reserves was increased, then policymakers would have sufficient control over short-term interest rates without the use of additional instruments. They could still choose a target level of the federal funds rate and could hit it by adjusting the interest rate on excess reserves.

However, policymakers face some uncertainty about how stable that spread will remain as short-term interest rates increase. The behavior of the spread today might not be that informative in this regard, as the proximity of short-term interest rates to the zero bound prevents the spread from getting much larger. In my view, the most likely outcome is that the spread will not widen substantially as short-term interest rates increase. However, if the spread does become large and variable, then policymakers will need other tools for strengthening their control of short-term interest rates.

With that in mind, monetary policymakers have asked the Federal Reserve staff to develop the ability to offer term deposits to depository institutions and to conduct reverse repos with other firms. These tools are similar in nature, as they both absorb excess reserves by replacing them with a term investment at the Fed. By removing reserves that would have otherwise been available for overnight lending, these tools could pull the federal funds rate and other short-term interest rates up toward the interest rate on excess reserves, providing the Fed with more effective control over the policy rate.

The development of both of these tools has made considerable progress…

We end there because the only sizable test of the triparty reverse repo system was perported to be an unmitigated disaster.  So, on the one hand, paying interest on excess reserves has worked so far, but may cease as short term interest spreads increase (and they undoubtedly will).  This could be solved by locking up reserves for a period of time a la reverse repos, but those do not appear to be doing the trick either (and with the all out assault on the money markets, it’s dubious they ever will).  Selling the Fed’s accumulated Treasury and Agency stash to drain reserves is completely out of the question as it would put a quick end to deficit spending and the housing refi bubble.  Enter the new Term Deposit Facility, but first, a bit of background.

Common knowledge holds that the Fed does not have authority to issue its own debt.  The very thought of the Fed competing with Treasury at auction does not seem kosher.  Yet, little more than a year ago, with a balance sheet that had recently exploded several orders of magnitude, the Fed was seriously contemplating the issue and exploring it publicly.  A WSJ article from December, 2008 had this to say:

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn’t known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn’t explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

…

With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue.

There are also questions about the Fed’s authority.

“I had always worked under the assumption that the Federal Reserve couldn’t issue debt,” said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.

Even current high ranking Fed staff hold this to be true, as San Francisco Federal Reserve Bank President and CEO Janet Yellen stated on May 6, 2009:

The simplest approach—the one that we have used traditionally—would be to shrink our balance sheet by selling the Treasuries, agency debt, and agency MBS we accumulated during the crisis. Many of the special liquidity and credit facilities we have developed will be phased out as financial markets recover. But it is conceivable that, even with the economy rebounding nicely, the credit crunch might not be fully behind us and some financial markets might still need Fed support. In this case, we could increase the interest rate we pay on bank reserves. This would induce banks to remove funds from the federal funds market and lend them to us, thereby increasing the federal funds rate and longer-term interest rates that are more relevant to private borrowers. Importantly, this approach provides us with the flexibility to tighten monetary policy in response to an improving macroeconomic picture without shrinking the size of our balance sheet or our support to financial markets. It is the main method employed by many central banks to influence financial conditions. An alternative approach that could accomplish the same goal, and perhaps do it better, would be something completely new for the Federal Reserve—that’s to issue interest-bearing debt broadly to private investors. Let’s call this debt Fed bills. Congress would have to authorize this, but it too is a tool available to many central banks. The sale of Fed bills would reduce the reserves of the banking system, as in a typical contractionary open-market operation. As with interest on reserves, we could accomplish a tightening of policy while maintaining our support of credit markets. But Fed bills would have an advantage over interest on reserves. The loans to the Fed would come from investors throughout the economy, not just from banks.  [More on this later.] At a time when we need banks to lend to the private sector to fight a credit crunch, this is a decided plus.

Clearly, the Fed cannot issue its own debt.

However, on December 28, 2009, amid the eggnog-sloshed holidays, the Fed solicited comments on a proposed amendment to Regulation D that would combine the features of two of its other excess reserves handling facilities to create a new Term Deposit Facility (TDF).  As we will soon demonstrate, the innocuously sounding facility is nothing more than a de facto debt issuance mechanism that once again pushes the envelope of the Fed’s statutory (not to mention Constitutional) authority.

And, lest we ask you to suspend disbelief any longer, consider the following.  If Treasury decided to become a bit more opportunistic and issued a new series of bills of multiple short term durations that (i) were auctioned competitively, (ii) paid interest, (iii) carried a zero risk weighting, (iv) were not directly transferrable, but (v) did allow for a temporary return of principal for a premium–would we not hesitate to call it a new debt instrument of the US Government?  That is exactly what the Federal Reserve will achieve with the TDF.

So what of the fact that only banks can participate?  First, a developing story here is the filing for bank holding companies by hedge fund affiliates and private equity underwriters, which further blurs the line between banks and nonbanks.  Witness the recent grant of bank holding company status to Alcar, LLC, an affiliate of West Side Advisors.  Though the “conservative leverage of 2-3 times” was enough to bring down at least one hedge fund, one wonders what leverage will be employed with the ability to borrow at 0.12%.

Secondly, it is not difficult to imagine JPM setting up a new Fed Bills bespoke derivatives desk to overcome any transferability hurdles.  One of the interesting features of the Fed bills is that they may be used as collateral at the discount window so that, in a pinch, a bank could regain access to the supposedly locked up funds.  This is functionally no different than a bank pledging a T-Bill at the window; however, as we witnessed last fall, the hoarding and dumping of T-Bills made for some spectacular fluctuations in short term interest rates.

The Fed is only statutorily bound in terms of the interest rate it pays, that it does not “exceed the general level of short-term interest rates.”  In the proposed Regulation D amendment, the Fed writes:

For these purposes, ‘‘short-term interest rates’’ would be defined as the primary credit rate and rates on obligations with maturities of up to one year in which eligible institutions may invest, such as rates on term Federal funds, term repurchase agreements, commercial paper, term Eurodollar deposits, and other [Treasury? No don’t mention Treasury] similar rates.

Conceivably, even an average over several weeks would do.  What premium or discount would Fed Bills command with respect to Treasury Bills?  With hundreds of billions (or trillions) in excess reserves locked up in durations of up to one year, would the Fed not have the ability to directly influence a broader spectrum of the yield curve?  Once Treasury QE 2.0 is announced, would the Fed not be the entire yield curve?  Consider too, it would take but a one sentence revision in a ramrodded Congressional bill circa the next crisis to allow the Fed to pay interest at any rate, thus introducing Fed Notes and Fed Bonds.

No doubt, the Fed has considered this, but there is no precedent for the actions of the world’s largest central bank engaging in these types of activities.  By President Yellen’s own admission, the Fed did not have the authority to issue its own debt in May, 2009, so why does it now?  A simple question posed, but unlikely to get a response, just prior to Mr. Bernanke’s reappointment vote.

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Rewarding Failure: Banks Set to Offer Record Bonuses

This week, Google (GOOG) shockingly announced it will disobey the Chinese government and (after 4 years) refuse to censor searches on the web. Although the company said it will be discussing the matter with Chinese officials, they are prepared to give up google.cn and even close offices in China.

From a monetization standpoint, Google is choosing to forgo monetization of censored search in favor of the democratic ideal of free speech. Those of us fortunate to live in countries with legally protected speech rights can empathize with Google’s decision. As Patrick Henry said, “Give me liberty or give me death.” Apparently, he was speaking on behalf of at least some legal entities as well.

China’s leading search company Bidu (BIDU) shot up over 13% on the news. This may be nice for investors, but just think of how much the stock would have soared if China gave Bidu a legal monopoly over all web search in China? We may even start reading about a new white hot pairs trade: long fascism, short democracy.

Although some people are disappointed with Google’s stand, I applaud the move. Google makes billions of dollars and provides an excellent livelihood and income to many people. If we learned anything from the recent global credit and housing debacles, we may have learned there’s a healthy boundary where we value more important things than the game called business.

In the case of Google, I’m glad to see they’ve drawn that line in front of possibly the most important human right. Since we value the Constitution more than economic transactions (at least in theory) in the US, I think Google’s move is a patriotic one and a great example for others aspiring to add value to societies across the world.

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NAFTA (North American Free Trade Agreement) came into force on January 1, 1994. The agreement has affected the US, Canada, and Mexico by setting out trade rules, reducing or removing tariffs for importation and exportation of many goods and services, and putting in place an infrastructure to handle disputes arising as a result of those rules (including anti-dumping and countervailing rules and the agencies responsible for administering dispute settlement provisions).

Mexico’s Gains and Losses

Mexico’s employment increased, but much of it was in the industries taking advantage of low-wage factories run by US companies, which the promoters of NAFTA promised would disappear.  The agricultural sector was devastated and the share of jobs with no security, no benefits, and no future expanded.

Canada’s Gains and Losses

NAFTA’s effect on the social cohesion of Canada’s society, and the well-being of a large majority of Canadians, has been negative.  Some sectors of the economy, and some income groups have benefitted, but the overall effect has not been good.  While average income growth under free trade has registered its worst performance of any comparable period since World War II, income inequality(after tax and transfers) has grown for the first time since the 1920s.

The most striking feature of this growing inequality has been the massive gains of the richest 1% of income earners at the expense of most of the population.  The growth of precarious employment, the undermining of unions as a countervailing power to transnational capital, the erosion of the Canadian social state, and heightened economic dependence on the US are the hallmarks of the free trade era in
Canada.

National Debts and Trade Balances Under NAFTA

The United States had a small but relatively stable trade deficit with Canada and Mexico(combined) in the 1980s and early 1990s.  After NAFTA took effect in 1994, this country developed large and rapidly growing deficits with these trade partners.

Since NAFTA started, Mexico’s economic policy, based on an open-market economy, resulted in a poor performance of its national economy.  Despite the increase in its trade surplus with the US, its global trade deficit is growing.

During the NAFTA era, Canadian grain and dairy farmers have faced steeply rising debt.  Agricultural prices have plummeted, farm incomes have collapsed, and critical domestic agriculture safety net programs have dismantled.  International free trade and domestic policies have proved to benefit only the largest agricultural businesses, while the majority of farmers and consumers have lost.  The rate of Canadian farm bankruptcies and delinquent loans is five times that before NAFTA.

Conclusion

NAFTA is a social experiment which has accrued 16 years of measurable data. As we enter a new decade, there is no better time for a detailed evaluation of the costs and benefits to all parties to the agreement. Only then can we determine whether the experiment is worth continuing.

Sources

1.) http://www.gfmag.com/archives/25/931-focus-nafta-terms-of-trade.html

2.) http://www.epi.org/publications/entry/bp173/

3.) http://epi.3cdn.net/6def605657a958c3da_85m6ibu0h.pdf

4.) http://www.citizen.org/publications/release.cfm?ID=6788

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In a misplaced and wild effort to collect more revenue, Congress is discussing a transaction tax for market activity. I asked SMB Capital partner Mike Bellafiore how such a tax would affect proprietary trading firms …

Damien Hoffman: Mike, how does the the proposed transaction tax affect traders and trading firms?

Mike: The transaction tax would put a lot of small businesses out of business. There are a lot of very hard working middle-class Americans making a living running small businesses. They trade stocks, options, and other financial instruments. Clearly, increasing the cost of a round trip trade of ten thousand dollars by fifty bucks is not negligible. Margins are often quite thin in this business, so any new taxes would lead to bankruptcies.

Traders hire themselves and spend their days productively making a living for their families. I know one firm which just signed a very long lease while relying on data without this tax. Their partners are personally liable for a very expensive long term lease.

In New York City there’s a lot of office vacancies — particularly on Wall Street. Do we really want more office vacancies and layoffs in New York City and Chicago?

Damien: Is there a disconnect between the proposition of a transaction tax and the real problems which are harming our markets and economy?

Mike: Yes. Overall, this is just a punishment for short-term professional traders who had nothing to do with the securitization of questionable mortgages.

Lets go back to the late ’90s. In the late nineties, former chairman of the SEC Arthur Levitt was a champion for individual investors. At the time, spreads were larger and markets were less liquid. Levitt championed ideas like ECNs which are electronic exchanges that give individual investors more choices. He also encouraged decimalization which narrowed the spreads and made trading fairer.

If we impose a transaction tax, we would only raise trading costs back to the levels common in the ’80s and ’90s. I remember that period of time, and that wasn’t a better period for individual investors. Liquidity will certainly dry up and spreads will widen.  As I said earlier, short-term traders weren’t involved in the securitization of questionable mortgages, but Congress wants us to bear the burden of this tax.

If this were to pass, there would certainly be a flow of capital out of the United States. They tried this in Sweden. They enacted a tax on all stock and bond trading. The tax drove financial business out of Sweden. So, the tax was repealed after a few years. Stock exchanges around the world are robust. The trading will go elsewhere.

Damien: How do you respond to the accusation that traders are nothing more than professional gamblers?

Mike: As somebody who has been an intraday trader for the last twelve years, I can dispel myths by proving every trade I make is based upon study. I trade consistently profitable setups for a short time period. We work very hard at developing our short term trading craft by watching video after the markets close. We keep detailed trading journals everyday. We perform visualization exercises and prepare diligently with our morning meeting before markets open. Short term traders, the ones that do well, are professional, learned, serious, consistently profitable traders. They work as hard as any other professional in another industry.

Damien: Mike, thanks for bringing some more clarity to this important debate.

Mike: My pleasure.

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This is a guest post by Kevin Depew at Minyanville.

Fat Cat Bankers, the Pimps of Wall Street . . . The New American Dream . . . Fear & Apathy on Club Rancho Drive . . . We Got the Money, It’s the Wealth That’s Missing . . . Mackin’ Ain’t Easy

“I did not run for office to be helping out a bunch of fat cat bankers on Wall Street.”
– President Barack Obama, 60 Minutes, December 13, 2009

“I ain’t a playin’ the whore to no man,” the preacher Fritz Linkhorn famously declares on page one of Nelson Algren’s novel, A Walk on the Wild Side, even though the question itself hadn’t been posed by anyone. Last night on 60 Minutes President Barack Obama made a similar declaration, though he limited the pimps in the matter to Wall Street fat cats, even though, like Linkhorn, the question hadn’t been posed by anyone.

Nevermind the fact that the Securities & Investment industry collectively paid the president’s 2008 presidential campaign more than $14 million, nearly twice what was paid to Senator John McCain’s campaign, or that Goldman Sachs (GS) singlehandedly contributed nearly $1 million to his campaign, just a shade less than the amount paid to McCain by Goldman, Merrill Lynch (BAC), Citigroup (C), Morgan Stanley (MS) and JP Morgan (JPM) combined.

The message was clear: President Obama ain’t a playin’ the whore to no banker. Not on 60 Minutes anyway.

If the question wasn’t posed in its precise exactitude last night by 60 Minutes’ Steve Kroft, the fact that the president chose to address it at all, even in subtext, is evidence enough of the weird hyperbolic anger chamber in which we find ourselves simmering these days. Mutant investment bank/ holding companies like Goldman Sachs are now more hated by the general public than one-armed auto mechanics and used car salesmen.

Remember when banking used to be considered a profession? Ho ho, it’s a trick question. Banking has never been a “profession,” not any more than online poker can be considered a sport. It’s an activity. Money changes hands. Eventually, after the other players either lose all their money or tire of playing, a winner is declared. Sometimes the stakes are higher than at others. When they creep up to the point where fear grips even the hearts of the innocent & unaffiliated, then it’s time to mash a few fingers, lower the ante, and cap the maximum bets.

Which is what’s happening right now. After the heat dies down, we’ll find plenty of good reasons to up the ante, peel back the bet limits, and gorge ourselves again on risk.

“It’s been a year since the big financial firms blew a hole in the economy and took down the jobs, wages, pensions, and homes of millions of people. They would have gone down too, devoured by their own greed, were it not for the taxpayer bailout.”
– Bill Moyers, Bill Moyers Journal, December 11, 2009

Whether or not you agree with Bill Moyers is relevant only to country club memberships, cocktail parties, and dinner invitations, especially if you agree with him. In other words, if you disagree, so what? You’re probably a fat cat banker anyway and no one cares what you think, at least not in public, because you never know who may be watching.

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