It seems to the quote-worthy few on major financial websites that the nasty effects of the implosion of the largest credit bubble (and the financial crisis that followed) are no longer rippling through the American economy. The recession, which started in December of 2007, is apparently about to end. They point to any economic figures that top abysmal expectations, and talk of the shocking performance of the stock market (the Standard & Poor’s 500 is up 47 percent from the low of 666 registered on March 9) in order to justify their claims.

But, the latest figures on the economy (fewer job losses and improved car and home sales) and better than expected profit reports conceal the fact that the real problems that could cripple America’s future economic growth are not only being ignored, they are getting worse. The US economy needs to shift away from debt-fueled consumption, toward saving and the investment in productive assets. This is not happening. I read a great newsletter article on Comstock Partners’ website (thank you Naked Capitalism for finding this amazing piece). It explains that overall debt to GDP will continue grow in the wake of the credit bubble’s collapse. The article points out that as consumers are increasing their level of savings, the federal government is dramatically increasing the level of public debt as politicians enact massive stimulus plans and bailout packages.

From Comstock Partners:

…over the past decade (when we believe the secular bear market started) the total debt in the U.S. doubled from $26 trillion in 2000 to just over $52 trillion presently (peaking a few months ago at $54 trillion). This consists of $14 trillion of gross Federal, State and Local Government debt and $38 trillion of private debt. We expect the private debt to continue declining in the future as the deleveraging of America unfolds, while the government debt will very likely explode to the upside as the government tries to slow down the private deleveraging by helping out the entities and individuals in the most trouble with debt (such as over-extended homeowners).

The folks at Comstock Partners also point out that the excesses induced by the credit bubble will dampen business investment and decrease wages in the years ahead.

Here’s a more detailed explanation from the Comstock newsletter:

Other problems we have in the U.S. that will exacerbate the deleveraging are excess capacity, unemployment rates skyrocketing (putting a damper on wages), credit availability contracting, and dramatic declines in net worth. The attached chart (follow link above) of capacity utilization is self evident that excess capacity in the U.S. has just dropped to record lows with the manufacturing capacity dropping to under 65% and total capacity utilization is just a touch better at 68%. It is very hard to imagine corporations adding fixed investment at this time. With unemployment rates close to 10% and rising, it is unlikely that wages will grow anytime soon.

Due to the continuing buildup of public sector debt and the excess capacity created over the past few years, Comstock Partners believe that we are following in the footsteps of Japan – and I couldn’t agree more. The American economy may face its own “lost decade,” marked by stagnant economic growth, falling investment and wages, and a stock market that experiences dramatic swings as it travels on the road to nowhere.

Please note: there is another fantastic piece from the Financial Times (also mentioned on Naked Capitalism) that compares current American economic policy with Japan’s when it tried to revive its economy in the 1990s, after the collapse of equities and property prices.

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I have expressed my skepticism about reading too much into the glimmers of less than lousy news that trickles out concerning employment, housing and corporate profits. My opinions are based on what I dig up during the week on financial sites, such as Bloomberg, Barron’s and the Financial Times. I also read the well-trafficked and credible financial blogs, such as Naked Capitalism, Calculated Risk and Mish’s Global Economic Trend Analysis. I think that it is necessary to find alternative views that are supported by facts and logical reasoning, and seasoned with a grasp of financial history. I believe this is much more useful than stewing mindlessly in the five minute financial web news cycle.

A wider range of information resources helps to counter the punch of conventional wisdom, which, as we all know, got us into this mess. (Because of its dismal track record, conventional wisdom will be referred to as conventional idiocy for the duration of this piece.) Conventional idiocy was the fuel that propelled the housing and credit bubbles, leading to the largest financial crisis since the 1930s. And it is now proclaiming that the beast unleashed by the asset bubbles and consumption orgy is about to die.

I think that the beast that wreaked so much havoc on our financial system and economy is far from dead – it is just resting. This opinion is formed from the economic and financial news that I discover each week, from the sites I mentioned earlier. Below, I list links to articles that should make you hesitate before diving into the stock market to bask in this summer rally. (It’s helpful to remember that many of the writers on mainstream financial websites – the creators of conventional idiocy who were in dire need of anti-depressants just this past March – are proclaiming that the recession is about to end, and that now is the best time to buy stocks.)

Wall Street Analysts Keep Telling Big Earnings Lie: David Pauly (According to this Bloomberg piece, it appears that the analysts are up to their old tricks, highlighting jerry-rigged net income figures, and ignoring the inconvenient issues such as weak revenues and the negative effects of stock option grants to employees.)

PennyMac Poops, Not Pops, on Debut (This Barron’s article, by Randall W. Forsyth, discusses the recent lousy performance of PennyMac, a real estate investment trust (REIT) set up to buy distressed mortgages, run by Stanford L. Kurland, former president and chief operating officer of the giant peddler of subprime mortgages during the housing bubble, Countrywide Financial. Forsyth points out that the artificial support granted by the Federal Reserve for the banks holding toxic assets has retarded the healthy market process that entices vulture investors to step in and buy garbage at the price garbage should sell for. This is why the IPO of PennyMac withered and why the mortgage mess will take even longer to fix.)

Unemployment, Not Bubble Unwind, Starting to Dominate Foreclosure Activity (This piece comes from Naked Capitalism, a smashingly good financial blog run by Yves Smith. It is actually based on a Reuter’s article, but thanks to Naked Capitalism, I, and many other skeptical types are aware that the weak job market is hitting the real estate market just as the pundits are declaring a bottom for home prices.)

Restaurants: 22nd Consecutive Month of Traffic Declines in June (This comes from Calculated Risk; it discusses a recent troubling report from the National Restaurant Association (NRA).

The Investment Slump in Q2 (Also from Calculated Risk. Residential investment declined at a 29.3% annual rate in Q2, the 14th consecutive quarterly decline.)

I am not wishing that now gleeful investors get pummeled in the fall. I do want the financial system’s massive problems fixed, and I would love to see the housing and job markets make a healthy recovery. What concerns me is that the real problems facing the banking sector, the economy and the real estate market (both residential and commercial) are being glossed over. Accounting gimmicks are distorting reported earnings. The Federal Reserve is supporting dying banks and providing generous financing for toxic assets. The federal government’s efforts are focused on saving unhealthy industrial giants and dangerous financial behemoths because they are deemed either too vital, or too big, to fail. The patterns of bad behavior on Wall Street have not changed. The Federal Reserve, by preventing one financial disaster, has laid the foundation for another, larger one in the near future. And the federal government seems more focused on protecting the status quo than on helping to steer the economy in the right direction. The hard work has not even begun, yet a consensus is forming around the mistaken belief that the worst is over, and a recovery is on the way. Beware conventional idiocy.

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The deterioration of the commercial property market poses a serious threat to a large number of regional banks, which do not have as many streams of income or adequate capital to absorb multi-billion dollar loses. Bad commercial real estate loans could cause many regional banks to shut their doors, because they are not deemed “too big too fail.” This could cause another collapse in confidence, setting the stage for another financial crisis. It will also contribute to further consolidation in the American banking industry, leaving consumers with fewer, yet more expensive options. The desperate condition of the commercial property market also shows just how bad things are in America, outside of the government-protected canyons of Wall Street.

Bloomberg.com’s article concerning Bernanke’s Senate testimony included his dire assessment of the commercial property market:

“As the recession’s gotten worse in the last six months or so, we’re seeing increased vacancy, declining rents, falling prices — and so, more pressure on commercial real estate.”

Bloomberg.com also noted that Christopher Dodd, Chairman of the Senate Banking Committee, said that some (I assume he refers to experts in the field) have suggested that the problems facing the commercial real estate market may be much greater than the well known difficulties plaguing the residential property market.

The massive credit bubble that fed an explosion in residential real estate prices also nourished an unsustainable rise in commercial real estate values. The agonizing front page stories of mounting foreclosures plaguing the housing market pushed the disaster that is looming in the commercial market off of the media’s radar screens.

The state of commercial real estate is very bad indeed; all one has to do to see the evidence is walk past an urban commercial district or drive along a suburban highway. The number of vacant storefronts across the nation is rising dramatically. Bloomberg.com provided a succinct, yet sobering summary of the situation this week:

U.S. commercial property prices fell 7.6 percent in May from a month earlier, bringing the total decline to 35 percent since the market’s peak, Moody’s Investors Service said in a report this week. Commercial properties in the U.S. valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double than at the start of the year, Real Capital Analytics Inc. said earlier this month.

Now those unpleasant numbers should provide ample reason for alarm. Bernanke stated in his Congressional testimony that the market for debt instruments backed by commercial mortgages “has completely shut down.” But on Wall Street, the former clowns of high finance are kings again (with a little help from a few trillion dollars in loan guarantees, equity infusions and ultra-low interest rates, of course). A rational soul would think the bad news from the commercial property market should shine a bright light on the truly sad state of the economy. While Wall Street basks in the glow of artificial profits from government-supported banking giants, the rest of the economy is suffering from continuing job losses, and weak demand for goods and services. The struggling economy is hitting the commercial property market hard, causing a rise in defaults among developers, and inflicting pain on the regional banks that supported them during the bubble years.

In order to avoid another potential financial calamity, Brenanke told lawmakers that the Fed’s Term Asset-Backed Securities Loan Facility, awkwardly known as “TALF,” which lends money to those willing to buy consumer and business loans, started accepting debt backed by commercial mortgages in June. He also wants lenders to modify troubled loans.

Bernanke’s recommendations may help ease some of the pain for regional banks that lent money to builders of unnecessary strip malls and office parks by offering these institutions credit in exchange for assets of dubious quality. But it will not make the problem disappear. Eventually, a substantial portion of these loans will have to be written off, or at best, sold at steep discounts. Until there is an open and honest accounting of souring commercial property loans, and the institution of an orderly disposal process, the banking sector and the economy will continue to suffer.

This week investors saw signs of life on the corporate profit front and some stabilization in the housing market, but the economy is still shedding many more jobs than its creating, and banks are still sitting on massive piles of non-performing loans, from credit cards to real estate. The deteriorating employment situation will only cause more defaults in both commercial and residential real estate markets, feeding a vicious cycle that will put further stress on the financial system, requiring more public funds in the form of loan guarantees and credit subsidies. It is way too early for investors to start celebrating. The mountain of bad loans that plague the commercial real estate market is causing the debt markets that deal in these products to seize up, and could easily cause a new panic that will lead to another financial crisis – possibly before the year is out. It may also force many regional lenders to merge with larger commercial banks, or shut to their doors permanently, which will limit consumer options and increase the cost of financial services for everyone.

I’ve provided links to some good articles on real estate and banking below:

Regional Banks’ Profits Are Hurt by Loan Losses

Subprime-Mortgage Loss Forecast Is Raised by Standard & Poor’s

Bailout Overseer Says Banks Misused TARP Funds

Bank of America Credit-Card Bond Ratings May Be Cut by Moody’s

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The view that healthy global capital markets are the key to the resurrection of economic growth has guided American fiscal policy designed to deal with the nasty consequences of the financial crisis. Federal Reserve Chairman Ben Bernanke still pounds the table before Congress to preach that credit must flow at all costs, no matter what misery the remedies may bring to future generations. This attitude is a symptom of the diseased belief that credit is the prime driver of the economy. Historically, the financial industry served the needs of the economy, providing both investment funds and useful capital market innovations that allowed important new industries to prosper, raising productivity and living standards for millions of Americans.

Over the past few years, however, the financial industry served only itself. The largest commercial and investment banks contributed the lion’s share of profits paid out to shareholders invested in American stocks, and provided countless high-paying jobs all over the country. During this time, the financial industry grew way too large in proportion to the overall size of the U.S. economy. There is now a desperate need for it to downsize and restructure.

After a massive financial bailout, loan guarantees and quantitative easing by the Federal Reserve, the financial industry is off to the races again, or so it may seem. Goldman Sachs raked in $3.44 billion last quarter, which is a record amount, surpassing profits earned in the heyday of the recent credit bubble. Goldman was not the only investment bank to earn money last quarter, JPMorgan Chase, Bank of America and Citigroup all reported profits for the period (the last three are involved in both commercial and investment banking). Granted, a large chunk of the profits at Bank of America and Citigroup were due to more favorable portfolio valuations and asset sales, but the message sent to the public seems to be that the financial services industry is back on track again. But it is not. This bloated sector is far from out of the woods. Last month, the economy was hit with a record number of foreclosures, weak retail sales and the loss of another several hundred thousand jobs, yet in the fantasy land inhabited by analysts and over-paid financial media personalities, all is well because the banks are in the black again.

This strain of delusional thinking brings me to CIT. The CIT Group provides credit to small and mid-sized companies, with many customers in the struggling retail sector. The feds ran to its rescue last year, disbursing $2.33 billion in TARP funds to the dysfunctional lender, but the line has now been drawn for CIT. It is in desperate need of funds, but the government’s window has been closed. CIT was deemed too big of a problem, but not too big to fail. Without federal backing, private investors will not lend CIT the funds it needs to survive, and the company will end up like Lehman Brothers, in bankruptcy court. The difference between CIT and it’s Wall Street cousins is that the former lent money to smaller companies, and was not inextricably linked to global capital markets. I guess the feds figured that the failure of struggling retailers is something that the economy can easily digest.

I beg to differ. Although I am not a proponent of bailing out incompetently run firms, I think that the Federal Reserve and the Obama administration’s focus on protecting the flow of credit to the largest financial companies only prolongs the adjustments that need to be made. Banks got too big, they need to downsize. The bailouts and loan guarantees to the largest financial players do not induce them to clean up their acts, it merely rewards bad behavior. And, it will stifle competition and raise the cost of credit for consumers by leaving only a handful of government-backed banks to dominate the industry in the years ahead.

The awful consequences of the worst recession since the Great Depression, such a rising unemployment, an explosion in foreclosures and the failure of countless small businesses is not being addressed forcefully enough. Diverting borrowed trillions to revive reckless financial giants doesn’t help the millions of people outside of finance find a job or stay in their home. It reinforces the idea that the few who are politically connected can earn billions while the rest of us shoulder the losses when their schemes fail, and it sets the stage for the creation of an even bigger and costlier mess that will have to be cleaned up later on.

Here are a few good articles related to Goldman, CIT and the economy in general:

Goldman Sachs Reports Big Profit, Beating Forecasts

Goldman’s Gain, America’s Risk

CIT Shares Plunge After U.S. Denies Aid Request

When to Let a Bank Fail

Geithner to assure Mideast investors

Retail sales remain weak

Report: Record Foreclosure Activity in First Half

Foreclosure Filings Hit Record 1.5 Million; One in Eight Americans Delinquent; Obama’s Mortgage Rescues Create ‘Confusion’

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The financial crisis that erupted last fall, and the financial bailout of Wall Street that followed, provided the perfect pretext to waste hundreds of billions of borrowed dollars, allowing Congress to hand out favors behind closed doors. Every bill that is proposed in the House or Senate, from the economic stimulus package to climate control legislation, is laden with costly giveaways to special interests. This is just business as usual. Crisis always spawns another opportunity for ethically challenged politicians to loot the public coffers for private gain. Enough already!

This, by the way, is an official RANT! As our leaders pile more debt on America’s ledger, they are undermining our nation’s future economic potential, it’s reputation for fiscal responsibility, and its standing as a credible world power. The American model of crony capitalism, based upon socialized risks and personalized returns, is dead. The other nations that embraced this insidious mutation of free market capitalism, like the United Kingdom, Spain and Ireland, are suffering painful economic consequences and a decline in respect and influence – not that Spain and Ireland have much to lose in terms of international clout. (The same unpleasant things are happening to Germany and Japan; although they did not participate directly in the credit bubble and the lunacy that it spawned, they were far from innocent bystanders.)

The world order is shifting as I pound this keyboard, and it is all due to the implosion of a warped American economic ideology, one which, over the course of the past few years, led to a shocking lack of appreciation for risk, the infatuation with consumption, and the reckless accumulation of debt. If you turn an attentive ear toward Washington DC, you can hear the music, and if you close your eyes, you can imagine our elected officials dancing madly, doing the “Debt Bomb Boogie.” This is the nasty number that got us into this mess – when will we turn their music off and force them to honestly address the problems we now face?

I have listed a few good articles that I found this week. Enjoy.

Debt Burden Quickens Power Shift as G-8 Loses Clout

Staggering Budget Gap and a Reluctance to Fill It

Insight: Reservations about the dollar

Big Banks Don’t Want California’s IOUs

Power of Stimulus Slow to Take Hold

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The financial website, Calculated Risk, posted a pair of articles this week about mortgage delinquencies, derived from a recent report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision. Calculated Risk acknowledged some improvement on the mortgage modification front, but summarized the report’s troubling findings with regard to prime mortgages (which make up the bulk of overall home loans), as follows:

“Continued economic pressures, including rising levels of unemployment and a continuing decline in property values, resulted in an increased number of seriously delinquent mortgages and newly initiated foreclosure actions. This report covered over $34 million loans, equivalent to over $6 trillion in mortgage balances. The first quarter data also showed a relatively greater increase in seriously delinquent prime mortgages compared with other risk categories and a higher number of foreclosures in process across all risk categories as a variety of moratoria on foreclosures expired during the first quarter of 2009.”

Calculated Risk also presented the various types of modifications made, in percentage terms, to mortgages as part of the Obama administration’s efforts to save homeowners from defaulting on their loans.

“Of the modifications made in the first quarter of 2009, 70.2 percent included a capitalization of missed payments and fees, 63.2 percent included a reduction in interest rate, and 25.1 included an extended term. By comparison, 12.6 percent of the mortgages received modifications that froze the interest rate, 1.8 percent included a reduction of principal, and 1.1 percent included a deferral of principal.”

The disturbing conclusion from this report is that missed payments and fees are being added to principal amounts, leaving homeowners with greater amounts of negative equity, and increasing the likelihood that more people will walk away from their homes. (Calculated Risk notes that approximately 30 percent of modified loans re-defaulted a quarter after loan adjustments were made, and close to 50 percent did so within a year.) Although some would argue against reducing principal amounts due to the downward pressure it would exert on home prices, I believe that inflating mortgage balances through the capitalization of missed payments and fees will cause more defaults and foreclosures than a reduction in principal. The increase in negative equity could encourage more homeowners to sour on the concept of ownership, and cause a flood of cheap homes to hit a weak real estate market, putting even greater downward pressure on prices. This can easily induce a vicious cycle, pushing still more homeowners to walk away from their mortgage obligations – and it will put further strain on the lending institutions holding these mortgages, forcing them to write down the value of the loans on their books, increasing the need to raise more capital and decreasing the availability of credit to the real estate market.

The Obama administration’s efforts to stabilize the housing market are focused on affordability, a short-term issue, which can be easily accomplished by lowering the interest rate charged or extending the term of the loan. Those modifications are helpful, but a reduction in the amount of principal would do more to help keep owners in their homes. If homeowners think they will never recoup their investment, why bother paying the mortgage? Why not default and live with your in-laws? The affordability strategy put forth by the White House is a short-term fix that is already starting to fail. Lenders made huge mistakes by extending excessive amounts of credit to those least deserving; they also created dubious, and in many cases, criminally complex mortgage products that stressed short-term affordability over the long-term prospects of repayment. Now those lenders need to swallow a reduction in the principal amounts of many of these troubled mortgages that were peddled with reckless abandon over the past few years. Without this unpleasant adjustment, the real estate market and the financial system will be in for even more trouble, reducing the chances of a a sustainable recovery.

Here are the links to the Calculated Risk articles quoted in this piece:
OCC and OTS: Prime Delinquencies Surge in Q1

Modifications and Re-Default

And here is a link to a great article on HUD’s new efforts to address negative equity from Bloomberg.com:
Fannie, Freddie to Refinance Larger Underwater Loans

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Here’s me “in action,” with my new quality control agent, Clementine (don’t let her lack of size fool you – she’s a harsh taskmaster.)

She always thinks she can do better.

Are your paws clean?

One last item: this is a sculpture that is also in my studio, made from wooden skewers.

And this is how a cartoon comes to life:

First, an idea is scribbled onto a scratch pad.

This was done on the NYC subway.

It is then filed in the appropriate soup container:

It doesn't look pretty, but it's quite efficient.

Then it is pulled from the soup container and a new image is sketched in pencil on a piece of Bristol board.

Looks a bit better, doesn't t?

An ink outline is added with technical pens.

Now it's taking shape.

A little extra ink is added for good measure.

Almost ready for an ink bath.

The final step involves applying an ink wash.

Ready for the scanner.

Here are some shots of my studio.

This is my drafting table - quite ordinary:

This is my desk - a tad messy, but fairly efficient.

This is a full shot of my working space.

I hope you enjoyed this series of photos. Please leave a comment or two – and I must state that the kitten pictured is NOT overworked, and actually is paid quite handsomely.

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In the aftermath of the biggest orgy of consumption the world has ever witnessed and the near collapse of global finance last fall, angry fingers of blame quickly rose, stiffened with righteousness, and pointed in directions steered by convenience, as opposed to fact. The accusations still being cast about are often misguided, and the true causes for this financial catastrophe are too widespread and complex to be uncovered, much less understood, so soon after the crisis struck. The truly unfortunate fact is that the perpetrators and beneficiaries are still at the helm of both the economy’s recovery and the financial market’s regulatory reform; it is no surprise that the remedies proposed to repair the damage will amount to little more than window dressing. It is the misguided, and potentially harmful approach to the restructuring of financial regulation that I will discuss today.

Last week, I stated my opposition to granting the Federal Reserve unchecked power to resolve the next financial crisis. But, there is an even bigger problem that is not being addressed by the Obama administration as it seeks regulatory overhaul of the financial system. The creation of a consumer protection agency, a national bank supervisor and a council of financial regulators can be helpful in preventing the next banking crisis. But, as Richard A. Posner, who is a judge on the U.S. Court of Appeals for the Seventh Circuit, pointed out in a NY Times op-ed piece this week, it is the regulators’ culture and their funding sources that needs to change.

Posnner criticizes the bureaucratic and political culture that prevents proactive responses to looming disasters:

“Adding bureaucratic layers will not cure the pathologies of regulation, which are rooted in our regulatory culture — the timidity of civil servants, the contamination of public administration by politics and interest groups, and the power of the “office consensus” to marginalize independent thinkers for not being team players.”

It is painfully evident that selfish interests, paid for by those who are the subject of regulation, will find their way into the halls of Congress, stifling any attempts at true reform emanating from both new and existing agencies. And, once a regulatory agency is established, it will become a bureaucracy, more interested in survival than the actual performance of its mandates.

Another problem, which may be even more damaging, is that there is no plan to change the funding for existing financial regulatory agencies. Right now, these agencies are paid fees by the companies they are charged with overseeing.

Posner describes this problem as well:

“The current system makes the firms customers rather than wards and incites competition among agencies for clients — a competition likely to be won by the agency with the least regulatory zeal.”

And, he offers a potential remedy to this dilemma, which I think is a step in the right direction:

“Another possibility would be to finance regulatory agencies by Congressional appropriation rather than by fees paid by the firms they oversee.”

This funding structure allowed many banks and mortgage lenders to seek the weak oversight of the Office of Thrift Supervision (OTS). This agency, like so many others in the federal government, survived on fees charged to the companies that it regulated. According to an article in this week’s New Yorker, written by Connie Black. failed companies like Countrywide Financial and Washington Mutual were courted by the OTS. Although the OTS is expected to be folded up and tucked into the Office of the Comptroller of the Currency, the same type of “client shopping” could occur again in one of the remaining regulatory agencies.

The financial crisis and resulting recession could have been prevented. Pointing fingers when so many are to blame serves no identifiable purpose. An honest and far-reaching appraisal of what caused the credit and housing bubbles is the only thing that will help determine what to do in order to prevent another financial calamity. Unfortunately, that is not happening. Instead, those responsible for the mess are being paid handsomely, with taxpayer dollars, to clean it up and make sure that it doesn’t happen again. The Obama administration’s attempt to change the nature of financial regulation does much more to entrench the existing corrupt culture than it does to bring true reform to a regulatory system suffering from complete dysfunction.

Here are a few articles that will help will help sort out what’s happening to America’s financial markets after the bursting of the credit bubble:

“Battle Is Brewing Over Watchdogs”, from The New York Times.

“Hedge Funds Step Up Efforts to Avert Tougher Rules”, also from the Times.

“Broad Agreement Reached on Derivative Oversight”, from The Washington Post.

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The Washington Post summed up the Obama administration’s plans on Wednesday:

The Obama administration last night detailed a series of proposals to involve the government more deeply in private markets, from helping to steer borrowers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to curb the kinds of reckless risk-taking that sparked the economic crisis.

I see two major problems with the Obama administration’s proposals to save American finance, and the consumers who still, unfortunately, are addicted to their toxic products.

The first is the expanded role of the largest player in the proposed regulatory structure, the Federal Reserve, which is detailed in the same article from the Washington Post:

The administration’s plan leans heavily on the Fed, expanding its role as the regulator of the nation’s largest banks such as J.P. Morgan Chase and Goldman Sachs to include other giant financial firms, such as the insurance companies American International Group and MetLife. The agency, which has greater independence from the political process than other regulators, would have broad authority to impose special requirements on those companies, such as mandating that they set aside a larger percentage of their assets against possible losses than smaller firms. Such a requirement could limit large companies’ appetite for risk, but also their profit and growth.

The plan calls for a council of regulators to consult with the Fed, including the Treasury secretary and the heads of the other financial regulatory agencies: The Securities and Exchange Commission, Commodity Futures Trading Commission, the Federal Housing Finance Agency and the agencies that regulate banks. A primary task of the council would be to recommend which large, globally interconnected firms are too big to fail and should be subject to more rigorous oversight. But the council will not have the authority to oppose decisions made by the central bank.

I happen to share some of the views of Mike Shedlock of Mish’s Global Economic Trend Analysis about the Federal Reserve’s ability to be proactive by nipping another financial crisis in the bud before it lays waste to global markets and the American economy. Shedlock points out that the Fed did not see the financial crisis coming, and they added fuel to the credit bubble by keeping interest rates freakishly low for way too long – I strongly agree with both criticisms. (But he advocates abolishing the Federal Reserve altogether, which I believe is a ridiculous suggestion because it would increase instability in the financial markets over the long haul.)

The second major problem lies a proposed mandate of the brand new Consumer Financial Protection Agency. Regulating the way loans are marketed and sold is an idea that is very sound, but as the Washington Post points out:

…the agency would have a mandate to increase the availability of financial products in lower-income communities and other underserved areas, in part by enforcing the Community Reinvestment Act (CRA), which requires banks to make loans everywhere that they collect deposits.

I also share the sentiment of MIke Shedlock on the enforcement of the CRA to make banks offer loans wherever they take deposits. Shedlock points out that this was an essential ingredient to the urban subprime loan disaster. This is what helped push Fannie Mae and Freddie Mac to the brink of insolvency. Politicians encouraged the federal mortgage giants to make loans to unqualified buyers so they could buy homes they couldn’t afford. (It’s easier than providing proper eduction and job training that eventually lead to a higher standard of living and increased purchasing power.)

I must elaborate on this last point of criticism of the Obama administration’s plan. I believe that everyone should be allowed equal and fair access to credit. But forcing lending institutions to make bad loans does two dangerous things. Number one, it lets politicians off the hook with regard to providing meaningful improvements to the lives of nation’s poor. During the inflation of the housing bubble, Congress focused on offering easy credit instead of offering opportunities to better education and training – and they will most likely do the same again this time around. The second nasty outcome of such weasel-like policies is that the American taxpayer will have to absorb the losses when people with poor credit can no longer service their loans.

I am very aware of the fact that subprime lending DID NOT CAUSE the financial crisis, which lead to a massive, panic-driven bailout of the banking industry. It was merely a symptom of the disease (which was a mix of greed and ignorance of risk) that created the credit bubble and the consumer spending and real estate booms. But encouraging any form of the bad behavior that provided nutrition to the reckless lending practices of the past few years should be cast on the pile of bad ideas, not implemented under the banner of social justice.

I will sum up my criticisms of the Obama administration’s proposed financial regulatory overhaul. The expansion of the Federal Reserve’s power to deal with troubled financial institutions removes transparency and accountability from the process. The Fed’s mandate to provide full employment will ultimately clash with it’s new responsibilities to keep large financial institutions in line. The Federal Reserve should not be abolished, but it certainly should not be encouraged to continue making trillion dollar deals behind closed doors. And, forcing banks to make lousy loans will only increase risk to the financial system while at the same time ignoring the real issues facing America’s poor communities.

For more on the state of the financial system and the comical “bank stress tests,” read my piece called “Bank Stress Tests are a Complete Farce!”

Here are some worthy articles on this subject:

“Sheila Bair is on Your Side,” from the Nation. (Bair runs the Federal Deposit Insurance Corporation, and is the nemesis of Treasury secretary Timothy Geithner and many Wall Street sycophants.)

“Obama: Government’s role is to unleash creativity in markets,” from Marketwatch.com. (This articles discusses the expanded role of the Federal Reserve in putting out future financial fires.)

“Federal Reserve to gain power under plan,” from The Washington Times. (This piece also offers more details and insight into the Fed’s new role as top financial regulator.)

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I found several useful articles that discuss the major issues that stand in the way of a true and sustainable economic recovery in the United States. The first, from Barron’s Alan Abelson, deals with the sickly state of the housing market. The second article concerns the rising ranks of U.S. citizens who are finding it tougher to land a new job, and the third deals with the U.S. government’s attempt to manipulate the yield curve through quantitative easing (buying U.S. Treasury bonds) in order to reduce mortgage rates and overall lending rates for consumers and businesses – actually there are a few articles that I found on this subject.

After the credit bubble burst, the housing bubble soon followed, for there was no longer free money to support ever-rising prices for poorly built McMansions, unnecessary strip malls and bland office parks. The financial crisis that started brewing in mid-2007, and came to a head last fall (we hope) with the collapse of Lehman Brothers, made the situation even worse. Lenders had to cease with their reckless ways and demand down payments and income verification from prospective home buyers. This, along with a massive inventory overhang, put further pressure on real estate prices. But then the federal government came riding to the rescue of both the banks who made so many foolish loans, and the gullible public, who lapped them up. The feds cobbled together a massive financial bailout of the banks, and helped restructure existing exotic mortgages that were forcing so many over-indebted Americans out of their homes – they also started purchasing mortgages from Fannie Mae and Freddie Mac, and declared a moratorium on foreclosures.

Alan Abelson of Barron’s, who writes one of my favorite weekly financial columns, sites the work of Whitney Tilson and Glenn Tongue of T2 Partners:

T2 posits five waves of (mortgage-related) losses, two of which have crested, while the remaining three have yet to peak. In the first two waves, the losses of which appear largely behind us, the chief causes of distress were rooted in fraud, feckless speculation and payment shock induced by mortgage resets.

The last three waves, the big losses of which have still to come, include prime loans (mostly owned or guaranteed by Fannie and Freddie); jumbo primes, second liens and home-equity lines of credit (most of these are on banks’ books), and loans outside housing, notably the tidy $3.5 trillion of commercial real estate.

Along with a deathly ill housing market, Americans also have to deal with a more treacherous employment landscape. Although there was much cheering form the clueless canyons of Wall Street last Friday as a result of a less than disastrous monthly jobs report (only 350,000 received the boot in May), yesterday’s release of weekly jobless claims showed continuing claims for benefits reached record levels. (There was a good, brief article from Marketwatch.com spelling out the details.)

In order to ease the pain in housing, and induce American consumers and businesses to resume borrowing, the Federal Reserve resorted to quantitative easing to reduce long term interest rates. The Fed started buying U.S. Treasury bonds in March to reduce interest rates on these securities, which are instrumental in setting mortgage interest rates, credit card rates and corporate bond yields. The problem is that this does not appear to be working, because our biggest creditor, China, is shunning long-dated securities in favor of notes maturing in two years or less. Apparently, China does not want to tie up its reserves with a chronic debtor for any longer than it has to. As long rates continue to rise, the Fed will lose billions down the road when it comes time to redeem these securities (rising yields equal lower prices), which will endanger the economy and the Fed’s independence because they’ll have to beg the U.S. Treasury for a bailout.

Reuter’s had a great article last month on this topic. Here’s an excerpt:

Between August 2008 and March 2009, China bought $171.3 billion of bills, debt that carries a maturity of up to a year, compared with just $22.9 billion of longer-term notes and bonds with a maturity of two years or more. It also sold $23.5 billion of long-term agency debt, U.S. data shows.

In an attempt to make things better in the short term, the Federal Reserve and the Obama administration risk making things much worse down the road. Extending a lifeline to reckless businesses and homeowners, guaranteeing all manner of risky assets, encouraging the buildup of even more debt and manipulating interest rates will have dire consequences. These policies will have the accumulative effect of encouraging the same behavior that caused the credit and housing bubbles in the first place, which resulted a nasty financial crisis and a severe recession. Only the next series of bubbles that is currently brewing will be much worse.

For further reading:

The Financial Times on rising yields.

Marketwatch.com on the precarious state of the U.S. dollar.

Latest retail sales figures from Marketwatch.com.

The continuing decline in U.S. household wealth – also from Marketwatch.com.

The New York Times on America’s “Sea of Red Ink”.

I also host a Cartoon Caption Contest on Mondays, and I have brand new original cartoons for you every Wednesday.

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