One of the problems with unfettered faith in free market capitalism is that one has no idea where the free market is going.  The reason is simple.  Free markets don’t know where they are going either.

Ever since 1981 when President Reagan damned government by telling the nation “Government is the problem,” the nation has simply careened into the future without any real sense of direction.  The reason is simple.  National direction is a function of government.

So now it’s 28 years later and along comes President Barack Obama, and along comes direction with him.  Finally.

One thing’s obvious, a lot of direction is needed right now.  Let’s just go through a basic list.   Among the “directions” President Obama promises are:  Some form of universal health care because the current system will bankrupt the nation and 48 million Americans have no health care; Tax reform because since Reagan made his pronouncement, an increasing amount of wealth has drifted to the top 1% of Americans, while the rest go nowhere; Reducing America’s dependence on oil because America is not only funding it’s own military, it’s funding terrorists by buying most of its oil from petrodictators who fund terrorism; And finally to bring transparency to government activity, in part by halting the practice of putting real expenditures off budget and thus hiding deficits.

And this doesn’t include Obama’s strong response to the global financial meltdown he inherited, including a $787 billion stimulus package and what is likely to be several more billions helping underwater home mortgage owners.  In total Obama is showing  an excellent combination of thought and action.

In the intermediate to long term there are two overwhelming issues.  Issues about national survival: health care reform and energy transformation.

On health care, America’s system ranks 37th in the world, and among developed countries is among the worst systems no matter what metrics you use to compare systems.  As the baby boomers move further into old age, the stresses on this system will bankrupt the nation.   Obama is recommending a 10 year, $630 billion committment to revamping health care.  Making the complete transformation will cost more than this, but the alternative is bankruptcy.

The reasons for energy transformation away from petroleum products to “Green” energy were summarized best by Thomas Friedman in his best selling book “Hot, Flat, and Crowded.”  On page 81 he writes: “Our own oil dependence is behind more bad trends domestically and around the world than any other single factor I can think of.  Our addiction to oil makes global warming warmer, petrodictators stronger, clean air dirtier, poor people poorer, democratic countries weaker, and radical terrorists richer. Have I left anything out?”

If you have a greater interest in Obama’s budget, go to the White House site here.  From that site you can also navigate to the entire budget proposal.  If you want to get an education on energy and broad global issues surrounding energy, the environment, population and other trends, two books are mandatory reading: Friedman’s book mentioned above, and Lester Brown’s “Plan B 3.0.”

Today on CNBC the talking heads were lamenting the supposed “class warfare” of President Obama on those who make $250,000 or more annually.  The top rate would go from 35% to 39.5% in 2011.  Unlike recent Presidents Obama is determind to put spending on the budget, instead of hiding it off budget, and equally determined to be honest about how he’s going to pay the bills.

As for the “class warfare” charge it would be nice to let the lesser folks win a battle or two because they obviously lost the war long ago.  They lost it particularly big the last eight years under Bush as the top 1 percent sucked up almost 6% more of incomes vs the rest of us.

Donnie Deutsch, a successful Manhatten based advertising agency owner, was the only one defending Obama at all.  And Deutsch is one of those 1 percenters.

He pointed out that hedge fund managers who can manage billions of dollars, get 2% per year of assets under management “Whether they make any money or not.  They have no risk…  And they get 20% of the profits if there are any.”  And Deutsch should know.  He’s got investments with hedge funds.

So here’s a prayer:

“Dear Lord,

After we’ve spent trillions bailing out bankers.

Can we have enough left over

to win the class warfare battle

And have health insurance?

Amen”

You have to hand it to our central banker, Federal Reserve Chairman Ben Bernanke.  Bernanke’s no punches pulled appearance before the Senate Banking Committee today carried a lot of water for Treasury Secretary Tim Geithner.

Unlike Geithner so far, Bernanke revealed many important details of what Treasury intends to do.  For starters, Bernanke said it was his intention to keep all 19 banks open and functioning.   Even when pressed, the Fed Chairman did not back off on that statement.

Bernanke said the nation’s top 19 banks are well capitalized and he bristled at one Senator’s characterization some are ”zombies.”  Which isn’t saying that the banks don’t need help apparently, because then Bernanke explained in some detail how this government is going to bail out these heretofore well capitalized banks.

Using public money the government intends to buy more convertible preferred stock in banks that it deems may need some help.   As any bank needs more capital, the government will convert preferred shares to common.   The government will complement this effort with a program of buying, and thus removing, troublesome assets–a key problem with almost all bailout plans because no one can agree what taxpayers should pay for these securities.

At some point, said Bernanke, the taxpayer should get paid back as private capital comes in replacing taxpayer common, or preferred, stock.

Regarding the preferred shares, Bernanke is borrowing from a program by Great Depression era President Franklin D. Roosevelt.

“We have not been in this exact situation before, but in the 1930s, when numerous banks were insolvent, thousands were closed, and others, about 50 per cent of the banking system, received injections of government money (preferred equity, purchased by the Reconstruction Finance Corporation) with significant and for the banks unpopular conditions attached.

That programme was largely viewed as successful, as many of the banks were able to buy out the government position within about five years. A key reason for its success was that thousands of banks were closed first, and the worst remaining banks did not receive RFC assistance and also had to close. In other words, the US government was able to make tough decisions, and tough decisions are what capitalism is all about. A big difference between this crisis and the 1930s: then many of the ‘money centre’ banks were able to make it. Now, a number should not.”  This from FT.com here.

And that’s a problem Bernanke addressed directly.  He pointed out there’s no existing playbook for taking over a large holding company bank with many moving parts and offices around the world.  Such a takeover, said the chairman, would additionally destroy that bank’s “franchise value,”–essentially it’s ability to offer the same level of services as before.

As to the issue of poor regulation, Bernanke said there needs to be a “new regime” where Federal Reserve audits of large, complex financial firms will include subsidiaries instead of being limited solely to the holding company level.  Currently many parts of the large firms, such as brokerage or insurance operations, aren’t supervised by the Federal Reserve.  American International Group (AIG), for example is regulated by the New York Insurance Commissioner.  AIG has received more taxpayer subsidies than any company and is now effectively nationalized with taxpayer’s owning 80% of the common stock.

The stock market indices are now at levels not seen since 1996/97 as investors stand aside waiting for the Government to act decisively in cleaning up insolvent banks.

This is a basic problem of too much leverage and an unwillingness of Government regulators to force a realization of loss.  Instead, the Government appears determined to protect existing bank investors somehow.

Given the continued deterioration of the economy, failing to act simply increases the losses.  It appears fairly clear at this point that Secretary Tim Geithner cannot muster the nerve to pull the plug and thus begin the healing process. 

That this attitude still prevails at Treasury is troubling, especially given that AIG has announced that it will declare a $60 billion loss, the largest in corporate history.  And it’s AIG that is drowning under insurance it wrote on derivative securities many of which are owned by Wall Street banks.  Incredibly, the taxpayer has pumped billions into AIG to the tune of just under 80% ownership, while AIG still can’t afford to back up its insurance to Wall Street banks, who are long the securities AIG was supposed to backstop.

Meanwhile, today Treasury is expected to announce that it will exercise an option it has to convert to common stock some or all of $45 billion in convertible preferred stock it owns in Citi.  That boosts Citi balance sheet while taxpayers will give up the 5% interest payments the preferred stock carried.  After the action is accomplished, taxpayers could own as much as 40% of Citi common stock.  Considering that Citi’s book value is about $12 billion today, and that taxpayers paid $45 billion for the preferred, taxpayers overpaid by 3x, at least by today’s prices.  Why doesn’t the taxpayer own 100% of the stock?  They’ve certainly paid enough to own Citi outright.

Despite the overpayment, investors were skeptical and didn’t bid up Citi stock to any significant degree.  The market is saying, in unmistakeable terms, that Citi is bankrupt.  Too bad Treasury is tone deaf.

Citi should be made a National Bank.  The illiquid assets should be sequestered and put in deep freeze until the market recovers and the securities can be sold at rational prices.  This would allow current Citi bondholders some relief eventually.  But the taxpayers should not be forced to pre-pay for these securities..a move that would just be another wealth transfer from taxpayers to bank investors.

As a National Bank, with a clean balance sheet, Citi can do what private banks can’t do in this economy: Lend.  At least with this bank, taxpayer will be paying taxpayer.

Treasury Secretary Tim Geithner this week is supposed to provide more details on his plan to solve the insolvent bank problem.  He’s in what we call Bartlett’s choice territory.  This is the delimma expressed by University of Colorado physics professor Albert Bartlett regarding the world’s use of resources to produce energy.

Bartlett said you had two choices:  Behave as though the supplies are infinite or behave as though they are finite.  If you approach this choice as though both options are wrong, the question becomes which wrong option is worse.  In this case the least wrong choice is to behave as though supplies are finite.  That way if you’re wrong and supplies are infinite, you’ve just wasted some money and effort.  If you behave as though supplies are infinite but they turn out to be finite, you’ve thrown yourself back to the stone age where everyone lived “off the grid.”

In a way Geithner’s got a Bartlett’s choice to make.  The options he has are: Repair bank balance sheets by using taxpayer funds to backstop, or insure bank assets–or burn through bank shareholders and creditors before committing taxpayer funds to repair bank balance sheets.  Either one could fail.  But which one is the worst if it fails?

From our perspective, this is a rhetorical question.  Using taxpayer funds before exhausting current investor funds is the worst option.  If Geithner offers a plan this way and it doesn’t work, he will have unnecessarily authored a massive wealth transfer from the middle and working class to the wealthy.   And in addition he will have authored huge additional public debt that will cripple America’s ability to manage its future.

Better to use investor funds first.  If these funds are insufficient liquidate the bank.  If investor funds are enough to repair a balance sheet, but are too little to keep the bank effective because there’s not enough capital, then use taxpayer funds. But Nationalise the bank.  That way capital injections will be taxpayer paying taxpayer, not taxpayer paying creditor. 

And a National bank can do something private banks are unwilling to do in a deep recession:  Lend.

That’s the simple overview, with no details.  But there is more than enough detail in blogdom.  Read this from The Market Ticker:  “AIG still hasn’t been forced to disgorge and close their CDS book, despite over $100 billion in direct support.  Why not BEN (Federal Reserve Chairman Ben Bernanke)?  Is it because AIG’s liability under those contracts might be several hundred billion more, and if you net them and then close the book you’d have to make good on it or default them, and the guys on the other side are your banking buddies?

That’s right – the truth is almost certainly that firms like JP Morgan, Goldman and Morgan Stanley (along with Bank America and others) are, to no small extent, the people who are long those contracts from AIG.  If they’re netted and then the book is closed the fact that these contracts are worth zero would be revealed and that could cause every one of these firms to detonate at once.

But the fact of the matter is that these contracts are worthless, unless “someone” is going to pony up their face at AIG!  And since AIG doesn’t have the money, and it all links back to The Fed, what it comes down to is the taxpayer doling out another half-trillion to these banks – and even then, it might not be enough.”

Or this from another section of the same website: “I write today out of concern for a conclusion that must inevitably be drawn after reading the minutes of the most recent meeting of the Federal Open Market Committee (FOMC) of the Federal Reserve Board (Fed) on October 8, 2007. The pertinent quote from the FOMC minutes reads as follows:

“Given existing commitments to customers and the increased resistance of investors to purchasing some securitized products, banks might need to take a large volume of assets onto their balance sheets over coming weeks, including leveraged loans, asset-backed commercial paper, and some types of mortgages. Banks’ concerns about the implications of rapid growth in their balance sheets for their capital ratios and for their liquidity, as well as the recent deterioration in various term funding markets, might well lead banks to tighten the availability of credit to households and firms. Tighter credit conditions were likely to weigh particularly on residential investment and to a lesser extent on other components of aggregate demand in coming quarters.” (emphasis added)

In light of even a cursory understanding of the Fed’s oversight responsibilities vis-à-vis banks, this statement should make one’s jaw drop. The Fed is, in effect, conceding that: a) they are fully aware that banks have managed to divert considerable liabilities off of their balance sheets; b) the size of these diversions is large enough to threaten the banks’ ability to meet their capital reserve requirements; and c) the Fed is prepared to bend the rules in order to assist the banks in ongoing commission of this fraud.”

Even those not in favor of nationalisation seem to assume major activity soon from Treasury.  This from Baseline Scenario.   “Will there be a clear, upfront commitment to reprivatization, with a promise that large banks will be broken up in the process?  Changing the industrial structure of banking is essential for altering the political economy of the sector.”

And this from Interfluidity:  “We are all tired of the lies, Mr. Geithner. By all means, let nationalization be a last resort, and do all you can to offer liquidity to private parties willing to take both the upside and downside of speculating in questionable paper. But if you keep nationalizing the downside and privatizing the upside, it will not be very long at all before the public concludes that stress tests and market prices are just a sleight-of-hand for Davos man while he picks our pockets, again. Act fairly, and you may end up nationalizing the worst few of the larger banks. Keep up the games, and we will insist that you nationalize them all. It is getting hard to believe that there is a banker in the land who has not already robbed us. Eventually we will tire of drawing fine distinctions.”

And in a revealing article from London’s Financial Times comes this:  “At the heart of the internal battle inside the Treasury Department is what to do with the estimated $2 trillion of toxic and mostly mortgage-related debt that is threatening to topple the entire banking sector – the bedrock of US capitalism.

When Mr Geithner announced his plan to stabilise the financial sector last week it was received badly because it was so short on detail. The heart of the strategy – his prescription to remove the bad debt off the banks’ books – was to entice private investors to buy up the toxic assets. He gave no firm proposals, however, about how the loans would be valued and how the private sector would be co-opted.

It has now emerged that Mr Geithner was deliberately vague at his press conference because he had a change of mind and suddenly began to pursue a different course.

He decided that his original plan to use government funds to buy up the toxic assets was too expensive and exposed taxpayers to too much risk, and that using the private sector was the best option.”

This seems to get back to our initial reaction to Geithner’s roll out two weeks ago.  At that time we interpreted this plan to be, in effect, an RSVP to private investors.  If they didn’t take the RSVP, then the message seemed to be pretty clear:  “Well, a guy’s gotta do what a guy’s gotta do.”

Cowboy Up Mr. Geithner.  Time to kick some serious rear-end.

While the bank issues have most recently taken over the public stage, it’s a good time to review the impact of Bush’s Socialism for the Rich and the huge budget deficits and debt he rolled up onto the general population as a result.

Republicans are constantly asserting they are the party of responsibility.  The public now knows they are anything but.  The truth is they are the Socialist Party of the Rich.

Look at the record.  First, let’s consider that Bush rolled up more than $5 trillion in debt and handed it to Obama, along with the global economic crisis.  A responsible President who, rightly or wrongly, decided to wage wars in Afghanistan and then Iraq, would have raised taxes in order to pay for these military operations.  Bush not only didn’t do that, he decreased taxes and thus insured that a huge asset bubble in housing would emerge and then burst.

The most bankrupt aspect of America is the Republican party’s bankrupting adherence to a tax policy that has been shown conclusively not to work in any real sense.  Any wealth created by avoiding the responsibility of paying for government turns out to be illusory.  Smoke and mirrors leaving an unsuspecting public holding the bill. 

And the damage from this irresponsibility has to be listed to understand its severity.  Not only did Bush hand over to  Obama an unecessary $5 trillion in debt but his tax policy amounted to Socialism for the Rich.  The wealthiest Americans sucked up almost 6% more of the income produced during his 8 years in office.  It wasn’t “trickle down” economics, it was “flow up” economics.  As a result, the income disparity grew larger between the lower and middle income classes and the wealthy.  

Not coincidentally, this income disparity eerily mirrors what happened during the 1920s as private wealth increased dramatically more than increases for labor during that decade as well.  That growing disparity, many economists believe, was a main cause for the 1929 stock market crash and subsequent Great Depression of the 1930s.

In the 1920s an increasing concentration of wealth at the top was not recycled into productive investment, but instead drifted into stocks.   Fast forward to today and it can be strongly argued that the same thing has happened, as an increasing concentration of wealth drifted into stock and mortgage backed securities and mortgage derivatives.  In both eras the money was not invested in productive activity.  In both eras the money just pumped up non-productive investments and built the inevitable bubble and an economic crash.

But there’s more.  The flip side of Socialism for the Rich meant Bush didn’t address longterm infrastructure needs, nor the need for an efficient health system.  How could he?  He wasn’t even paying for what he did do.  So he not only handed over $5 trillion in unecessary debt, he handed over a multitude of problems he neglected to address.

And that was before he handed over to Obama the world’s worst recession since the Great Depression.

Not surprisingly, the public at large sensed something had gone terribly wrong and elected a Democrat to the Presidency and also followed that up by electing large Democrat majorities in both houses of Congress.  For the Democrats, the admonishment of “Be careful what you wish for,” rings very true.  Now the Democrats, crippled by irresponsible debt, have to use debt to stimulate an economy flat on its back, while simultaneously starting the necessary structural improvement for the next economy.

If you want to see the scope of work that needs to be done, visit the White House website here.

What Obama first needs to do, other than what he’s already done, is to rollback Bush’s Socialism for the Rich program by restoring tax rates to pre-Bush levels.  With the leverage Obama needs to use now to  mitigate a global recession, restoring some sanity to the tax system is only responsible. 

If socialism is going to exist, it should exist for labor, not the rich.  Under Bush, socialism existed to build a moat around the wealthy.  That’s a perversion of socialism.  Socialism is simply a philosophy that a country has certain social obligations to its citizens.  Universal Health Care is a good example of one of those social obligations.  A caring nation doesn’t tolerate the routine cruelty of 40 million citizens not having health care, for example.

Another legitimate social goal of government is to enable and fund the nation’s various infrastructures.  This goal helps private wealth invest in productive activities.  And this productive investment employs labor, which avoids the income disparity gaps that helped create the Great Depression as well as the current problems. 

It can all be done, of course.  It will take time and Obama will have to present realistic expectations.  He will have to be positive, but also display a determination that overcomes short term doubt.   He has the problems identified accurately, something Bush never got around to doing.  So that’s a big plus.  You have to know where your going to get there.

The sooner he explains and unwinds Bush’s Socialism for the Rich, the closer he’ll be to success in all his endeavors.