Yesterday we had brave words and sound logic from Kenneth Feinberg, Treasury’s ’special master for compensation,’ who as quoted in the Wall Street Journal (quotes in blue Times Roman), hopes his new standards “will be voluntarily picked up” throughout corporate America.

You’ll pick it up if you know what’s good for you

He might’ve tried starting with Freddie Mac:

The government-controlled mortgage finance company is giving CFO Ross Kari compensation worth as much as $5.5 million. That includes an almost $2 million cash signing bonus and a generous salary that could top $2.3 million.

It cannot be a coincidence that there are no publicly available pictures of Ross Kari

Would you want your face splashed across the front pages?

There can be no doubt Freddie Mac needs a highly capable CFO, and soon:

The McLean, Va.-based Freddie Mac has been without a permanent CFO for more than a year, when its two top executives stepped down as part of the government takeover in early September 2008. Acting CFO David Kellermann committed suicide in April.

Hideous though the circumstances are, the need to get the best is an argument to pay the necessary price.

Freddie Mac is not just another company.  It’s alive today, and nearly 80% owned by the government, only because almost $51 billion in taxpayer funds were pumped into it over the last year. More bailout money also may be needed in the quarters ahead as losses from its troubled mortgages mount.

An excellent argument to get the best bomb-defusers we can.  Wonder what Mr. Feinberg thinks of it?

You should do it for what I say it’s worth

Perhaps Mr. Feinberg was seeking to give more optics, and less substance?

Some bankers and outside experts said Mr. Feinberg was overstating the extent of the cuts. Many bankers will continue to enjoy seven-figure pay packages, including one who will receive $9.9 million.

Stock isn’t cash, but stock has value, especially in a liquid and public traded company.  Even if the stock is restricted, or the options do not vest for a period of time, they are money and value.

Of the 136 employees whose pay Mr. Feinberg reviewed, 29 are on track to collect total 2009 pay of at least $5 million, according to documents released by Mr. Feinberg.

So are Mr. Feinberg’s rules a big cut, or aren’t they?

And his calculations of 50% cuts in total pay for the top 25 at each firm from a year before depend partly on departures of certain highly paid employees.

Clever, that: It’s 50% less than the overpaid people who are now gone.

While some highly paid executives are exiting, at least one other is entering:

Leave banking and go into burgers?

[Mr. Kari's] cash signing bonus totals $1.95 million and will be paid out in semi-monthly installments over the year.

What makes Mr. Kari worth a signing bonus, the sort of inducement normally associated with star athletes?

You paid a lot for this hat

Market reality, that’s what:

That money is supposed to cover what he forfeited in stock options and grants when he left Fifth Third Bancorp, where he served as CFO since last November.

Mr. Feinberg and the regulators can no more stop the market than they can deny economic gravity.  If the top-quality financial CFOs are worth $1.5 million a year, then anyone who takes a vow of financial chastity has made the decision not to be a top-quality organization.  Particularly when asking someone to leave his home and walk away from previously-agreed deferred compensation.

“You expect me to solve everything?“

Freddie Mac also said it would immediately allow him to sell his home to the company, waiving a 60-day offer period that is required for other executives. It did not, however, specify which of his homes would be covered; Kari has residences in Ohio, Oregon and Washington State, according to the filing.

Hence a trap of aligning incentives via extended deferred compensation. 

A better approach for Kari’s compensation would have been to require him to wait at least three years to receive a bulk of his compensation, instead of allowing him to get as much as 80% of it in cash over one year.

Someone can always come along and buy it out – and, if Freddie Mac and FHFA are an indication, someone will.

No doubt that Kari is an able executive and has a hard task at hand. Before his 10-month stint at Fifth Third, he worked in the executive ranks at the insurance company Safeco and Wells Fargo.

Freddie Mac’s regulator, the FHFA, highlighted his qualifications in a statement it made after the pay package was disclosed. The agency said the approval of Kari’s pay was done after consulting with the Treasury Department.

Treasury, it should be noted, is where Mr. Feinberg works.  

“I have absolutely no idea who that man speaking is.”

When formulating his new draconian policies, he had to have known that Freddie Mac was ready to violate them even before they were announced.

The FHFA declined further comment, and the Treasury Department didn’t return a request for comment.

In its statement, FHFA also said that Kari’s hire came at a “critical time for our nation’s economy and for the company.”

That argument is no help at all.  Companies always face critical times.

Had he stayed at Fifth Third, [Mr. Kari] would not have been able to cash out of his equity compensation until the bank repaid the $3.4 billion in TARP funds it received. But Carol Bowie, head of the Governance Institute at RiskMetrics Group, a financial risk management firm, notes that his cash signing bonus at Freddie Mac effectively allows him to accelerate his receipt of equity he forfeited when he left Fifth Third.

Thus we have it that Mr. Kari was already tied up in regulation, but his new employer wanted him so badly that it paid his ‘exit fee.’ 

Bowie acknowledges that attracting top talent is critically important to a troubled company like Freddie Mac, and supports the idea of executives being paid for their skills.

Which brings us back to my initial question: are the Feinberg caps designed to realign incentives, or to punish the putative transgressors? 

Some small-town bankers are resentful of the coming scrutiny by the Fed, blaming many of the foolish loans and reckless trades that led to the financial crisis on larger institutions. “We’re all having to pay for the sins” of the big banks, said Rusty Cloutier, CEO of MidSouth Bancorp Inc., Lafayette, La.

At the current rate by which we are absolving ourselves and others, eventually we will decide that the entire crisis is the single-handed responsibility of one man, whom we can tar and feather and count ourselves righteous.

With my “securitization”

In the end, the problem is insoluble.  Neither Treasury nor FHFA nor any other regulator can nullify the market’s perception of value.  The best they can do is standardize regulation, insist on transparency, and try to align the incentives.

To make sure firms follow the new rules, Mr. Feinberg imposed reporting requirements on top executives and directors.

Are you trying to sneak money through security?

Regulatory reform is a process, not an event.  Mr. Feinberg’s moves are a blunt instrument.  I hope that, after delivering their thundering shock, they will gradually fade away.

“It’s simple – chop pay”

He said he hopes the standards “will be voluntarily picked up” throughout corporate America.

Fat chance.

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The huge banking institution is giving their new CFO compensation worth as much as $5.5 million. That includes an almost $2 million cash signing bonus and a generous salary that could top $2.3 million.

Catastrophe being a precondition to fundamental financial reform, in the aftermath of the banking crisis and the massive multi-billion-dollar Federal intervention, government is pursuing both the continuing crusade to choose culprits and then excoriate them, and also to put in place a new more expansive post-Paulson regulatory structure  that will reduce systemic risk in the US and global banking systems. 

A spokeswoman justified the pay because it was comparable to what others in the financial services industry make.

“A foolish consistency of the hobgoblin of small minds.”

Both objectives are ostensibly served by Washington’s new announcements of dramatically intrusive rules governing executive pay, as reported in the October 23 Wall Street Journal (quotes in blue Times Roman):

In a one-two punch at the pay culture of banks and Wall Street firms blamed for the financial crisis –

Take that, Gotham City banking malefactors

So now it’s the pay culture?  One single villain?

You mean there’s another?

To be sure, compensation structures shape and reflect corporate culture and played a contributing role in this epic mess, but to demonize a handful of executives is to exculpate everyone else – and we were all greedy, all starving for yield, and all short-sighted.  The entire world got drunk on risk, and we all have the mother of all hangovers.

And we’re not happy about it, are we?

– the U.S. government announced plans to aggressively regulate compensation at thousands of lenders and impose steep pay cuts at seven companies that received billions in federal aid.

Retribution and correction often intermingle.  From the parent who shouts this hurts me more than it’ll hurt you to our schizophrenic attitude toward incarceration – is it supposed to be punishment, or penitence? – human beings who have been hurt want those who hurt them to feel a measure of pain.

While the moves had been anticipated for weeks, Thursday’s separate announcements by the Federal Reserve and Treasury Department represent unprecedented federal intervention in pay decisions traditionally left to boards and shareholders.

In our post-crunch regulatory structure, are we trying:

1. To align incentives?

2. To cut executive pay?

These are not the same thing, and to do the latter in the guise of the former will only lead to tears.

The central bank moved to incorporate reviews of compensation into its routine regulatory process, a step that will affect large and small financial firms across the U.S. as well as American subsidiaries of non-U.S. financial companies.

That’s a good idea; transparency and periodic scorekeeping are helpful. 

The crackdown –

Notice the inflammatory language of vengeance.

– is likely to influence how financial firms pay top executives, traders, loan officers and others whose actions could threaten the soundness of the institutions.

Another implicit confusion.  Government has no business preventing companies from taking risks, but it does have a legitimate business in preventing companies from taking risks that threaten the financial system.  Americans are rightly angry that, in protecting the American economy, the regulators have rescued banks from themselves.

As expected, Treasury official Kenneth Feinberg said cash salaries paid to the highest-earning executives at seven companies getting exceptional federal aid will be capped at $500,000, while the group’s total pay level, annualized, will be 50% lower than a year before.

Mr. Feinberg, I note, has no background whatsoever in finance; he’s a lawyer, a prosecutor, and a mediator.  All these are very odd credentials for his current role.

Judging by his pictures, Mr. Feinberg is fond of shaking his finger

If these are such good ideas, why aren’t the shareholders doing it themselves?  Why rely on Uncle Sugar to do it? 

The rulings cover the highest-paid 25 employees at each of the seven heavily aided companies: Citigroup Inc., Bank of America Corp., American International Group Inc., General Motors Co., GMAC Inc., Chrysler Group LLC and Chrysler Financial.

Are the regulators pandering to the populist mob, or are they doing something that cannot be done except by an external and disinterested agency?

Standards are meaningful only when applied to all.  Individual entities competing with one another – whether companies for market share, or companies for executives, or even individual executives – cannot be expected to renounce potential comparative advantage. 

“I think it will make an important difference” because many banks have been reluctant to change their pay practices unilaterally out of competitive worries, said New York’s banking superintendent, Richard Neiman.

How big a difference?  This big

Mr. Neiman’s got it exactly right. It does no good to take a stand on principle for lower athlete pay if others are profligate.

We bleed Yankee blue … or Steinbrenner green

Indeed, the inevitability effect practically guarantees people will try to steal a march on their competitors, once they know new rulemaking is certain.

Compensation experts said it would be hard for companies to escape the new oversight, though individuals could do so by jumping to hedge funds, private-equity funds and other financial firms beyond the reach of the new curbs.

Exactly.  If compensation is regulated at a defined group of institutions, the most highly compensated will simply jump to new unregulated institutions.

You have to pay me to try this

Many years ago, I was negotiating guarantees from a developer whose integrity I doubted.  (One does this now and then in business.)  To assure that I didn’t have the company’s net worth lost in the shell game, I insisted on having the parent company on the guarantees, not a single-purpose subsidiary.  I thought myself clever – except that shortly thereafter, the developer formed a new parent company, of which the one signing our guarantees then became a subsidiary.  Over the ensuing years, the sponsor ran al the income through the new parent, thus gradually atrophying my guarantor.

Out of that, I learned a lesson – if you want to squelch a behavior, you have to squelch every possible outlet.  In regulatory terms, if you want to cap pay across the board, then you must regulate it everywhere:

Some state regulators said they plan to issue similar requirements for state-regulated banks not covered by the Fed plan.

The rulings will be effective for just November and December; employees won’t have to repay salaries already received.

That’s a sound principle – aside from the impracticality and legal liability associated with attempting to claw back payments legally made under binding contracts.

But the rulings will become the starting point for next year’s salary figures and until the companies repay their government aid.

It sounds like you’re capping 25, but you’re capping everybody.

These moves are the brainchild of Kenneth Feinberg, the Treasury Department’s special master for compensation.

“Stop pointing out that I point my finger a lot.”

Mr. Feinberg is taking seriously his moniker of czar; he is willing to command with laserlike precision:

Don’t come to my attention

Mr. Feinberg said he will have to approve pay for the next chief executive at Bank of America. He already pushed outgoing CEO Kenneth Lewis into giving back $1 million he received so far this year and forgoing the rest of his $1.5 million salary for 2009.

While I have no sympathy whatsoever for Mr. Lewis, that certainly sounds like schoolyard bullying of no conceivable economic or public-policy benefit.  It’s retribution, pure and simple.

And I did so well for B of A, too

Some critics said that Mr. Feinberg was too soft on the banks and that his main accomplishment – forcing firms to use more stock and less cash when paying employees –  didn’t go far enough to rein in compensation.

He’s using a blunt instrument to get their attention.  Being blunt, it won’t necessarily work well.

You dare say this doesn’t work?

While the Fed didn’t propose pay caps, it said it will review compensation policies at “28 large, complex banking organizations,” which it didn’t identify. It will be a “horizontal review” that in effect compares them to one another.

Making this so funny is that scarcely weeks earlier, the government itself violated every single Feinbergian principle when it hired a new CFO for an entity entirely under its control.  As reported Business Week (quotes in red Arial):

When [the new CFO] joins Freddie Mac on Oct. 12, he will receive a base salary of $675,000 and is entitled to an additional $1.66 million in cash for the year. The company said he will be paid in installments, but did not specify the timing of those payments in a Sept. 24 securities filing. The company declined to comment beyond the filing.

He will also receive performance-based pay at the board’s discretion. The target amount for that cash compensation is $1.16 million, but what is actually given to Kari could be higher or lower.

His cash signing bonus totals $1.95 million and will be paid out in semi-monthly installments over the year.

Feinberg says cap cash pay at $500,000, his fellow agency approves paying $1,950,000 as a signing bonus.

The Federal Housing Finance Agency, which oversees Freddie Mac, approved the pay package.

Can we reconcile this seeming contradiction?

“Don’t try to contradict me”

[Continued tomorrow in Part 2.]

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Two years ago, two years after I’d called the market top and just as the subprime mess was beginning to break, in the form of New Century’s bankruptcy and problems alleged at Countrywide, I stuck up for Angelo Mozilo – or more precisely, I questioned the New York Times’s putative expose of Countrywide’s marketing and sales practices, of which the Times breathed a hot aura of indignation. 

Now I feel like a chump.

“Ah’m your worst nightmare”

Not for disemboweling the Times article, which was a potpourri of flung chaff, a bit of wheat, and a few kernels of aggressive salesmanship – none of which, in hindsight, were the root cause of Countrywide’s problems or indeed the nation’s problems.  Rather, I fell into the double-negative trap – concluding that if the Times’ so mighty labor had brought forth only this mouse, there could be no larger creature hiding in the straw.

“Do I look like someone trying to buy influence?”

Then came the steady drip-drip-drip of the Friends of Angelo (FOA) VIP program, the favors here and there to elected officials of every stripe and body and committee. 

Two U.S. senators, two former Cabinet members, and a former ambassador to the United Nations received loans from Countrywide Financial through a little-known program that waived points, lender fees, and company borrowing rules for prominent people.

Senate Banking Committee chair Chris Dodd

What could Senate Banking have done for Countrywide?

Senators Christopher Dodd, Democrat from Connecticut and chairman of the Banking Committee, and Kent Conrad, Democrat from North Dakota, chairman of the Budget Committee and a member of the Finance Committee, refinanced properties through Countrywide’s “V.I.P.” program in 2003 and 2004, according to company documents and emails and a former employee familiar with the loans.

Former Secretary Jackson

What could HUD have done for Countrywide?

Other participants in the V.I.P. program included former Secretary of Housing and Urban Development Alphonso Jackson, former Secretary of Health and Human Services Donna Shalala, and former U.N. ambassador and assistant Secretary of State Richard Holbrooke. Jackson was deputy H.U.D. secretary in the Bush administration when he received the loans in 2003. Shalala, who received two loans in 2002, had by then left the Clinton administration for her current position as president of the University of Miami. She is scheduled to receive a Presidential Medal of Freedom on June 19.

Then came the litany of I-didn’t-knows and I-thought-everybody-was-a-VIP and similarly ingenuous expressions of the Blanche Du Bois defense – the kindness of strangers.

“I have always depended on the kindness of strangers.”

Implausible as I found the response – you’re an extremely powerful person, you are suddenly bestowed with favors, and you assume that everyone is so treated? – I never found a story to post, because what is there to say about alleged venality?

Stick to the true facts, ma’am

Except when it’s structural, and when that structuralism threatens the financial system’s integrity … and that is the point made in a recent Wall Street Journal article on what Sherlock Holmes would call the Case of the Curious Incuriosity:

Panel Split on Need to Probe VIP Loans

A congressional battle is heating up over whether to subpoena records of Countrywide Financial Corp.’s controversial VIP mortgage program.

Transparency is a fundamental of good government.  Particularly here, when we have had a wealth loss of epochal proportions, and we do not understand the causes, much less how to prevent them from recurring.

Rep. Edolphus Towns, the Brooklyn Democrat who is chairman of the House Oversight and Government Reform Committee, reiterated in a Sept. 30 letter to panel members his opposition to Republican calls to subpoena the VIP program’s records.

Can we subpoena the records, Mr. Towns?

I find this curious because I have never yet encountered a Congressional panel that wouldn’t want to investigate alleged wrongdoing:

“When you have eliminated the impossible, whatever remains, however unlikely, must be the truth.”

In the letter, Mr. Towns, who public mortgage documents indicate received two Countrywide VIP loans –

That’s a direct conflict of interest, and grounds for recusal.

– likened the program to “a customer loyalty” initiative, “similar to airline frequent flier programs or supermarket discount cards.”

Hogwash.

You’re running it into the red, Congressman

Unlike a ‘customer loyalty’ initiative, by all accounts:

1.  Loyalty had nothing to do with it, since customers were buying only one loan product.

2.  The program was not generally known, nor generally available.  Indeed, it was anti-advertised!

3.  The CEO was personally approving the discount coupons.

Why was it called “Friends of Angelo” instead of “Friends of Countrywide?”

The letter followed a Sept. 29 letter from the panel’s ranking Republican, Darrell Issa of Southern California, seeking support from committee members for subpoenaing the records from Bank of America Corp., which purchased Countrywide last year.

Mr. Issa’s letter said the VIP program “engaged in a systematic campaign to buy influence” from public officials, and the subpoena is needed to determine the extent of that effort.

That’s the issue, isn’t it?  Was Countrywide trying to buy influence, or secure it with gifts that would create a warm feeling that could be converted into influence?

A serious allegation – that deserves to be taken seriously

Political contributions are legal, and appropriate.  Bribery is illegal.  When a product or service is delivered with a bargain element embedded, is that bargain an oversight, a gift, a political contribution, or a bribe?  It has to be one of those four things.  However, even if it is some underhanded, does the giver know it is?  Does the recipient realize he’s being influenced?

Here’s the rub:

A.  Did the recipients know they were getting a bargain?  We know the givers knew what they were providing.

B.  Even if the recipients were unaware, should they have been compelled to find out?  Skepticism in the face of unexpected generosity would seem a prerequisite for an elected official.

“We were providing a valuable service.”

In his letter, Mr. Towns noted that the Senate Ethics Committee had looked into the VIP program in connection with loans obtained by Democratic Sens. Chris Dodd and Kent Conrad.

Which is irrelevant on two counts, since (x) even if two individual recipients of largesse are as pure as the driven slush, that doesn’t exculpate Countrywide from possibly having a pattern of seeking influence, and (y) Mr. Towns is in the House, not the Senate, and when was the last time the House declined to examine something because the Senate had already done so?

“Pure as the driven slush”

That committee determined the senators, who denied any wrongdoing, hadn’t violated ethics rules.

That’s all right, then

The problem is not the isolated incident, but the pattern of favoring people who could influence the company’s profitability.  Even if these three exemplary individuals are in fact saints incarnate, they are not the totality of the program.

Mr. Towns wrote that his staff’s review of the VIP program didn’t find evidence of special favors to government officials.

Nothing to see here, move along

“So, Mr. Towns, the people who work for you could not find any evidence of special favors to government officials, even though their boss got a specially favored loan?”

That defies logic!

The letter didn’t say what the review entailed.

Don’t you trust me?

His letter also noted that there is a Justice Department criminal investigation of Countrywide.

Another red herring.  A Justice Department investigation of Countrywide is not the same as a Congressional investigation of the VIP program’s applicability to members of Congress.  Further, it’s entirely possible that the VIP program could be legal, yet violate Congressional rules, which are much more strict.  For that matter, since when is ‘not-illegal’ the end of the matter? 

You’re so gullible, you’ll re-elect me

It added that of 28,000 VIP program borrowers, “the vast majority” were private citizens and not government officials.

That too is irrelevant.  Countrywide could well have been trying to influence private citizens – legitimately or illegitimately would not matter – and that by itself would be no necessary subject for Congress.  But if, among the VIP borrowers, we found that every single member of Congress received preferential treatment, and the amounts were substantial, how would the citizens react?

Aux armes, citoyens!

Mr. Towns’s letter didn’t mention the two loans he received from Countrywide in 2003.

Two loans, not just one?  Twice the conflict of interest?

Perhaps two conflicts cancel each other out?

In August, The Wall Street Journal reported that the public mortgage documents from the two loans indicated that both had gone through Countrywide’s VIP unit.  At the time of the Journal story, Mr. Towns’s spokeswoman said his decision not to issue a subpoena had nothing to do with his Countrywide mortgages.  She said that if Mr. Towns received VIP loans, it was without his knowledge, and he didn’t believe he received any favored treatment from Countrywide.

There’s a simple way to find out.

Open the books Countrywide.

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By: David A. Smith

Yesterday we saw infallible proof of ‘green shoots’ in the economy – officials taking credit for something.  Although the credit-taking may be premature – but hey, it is the political vaporware that keeps on refreshing – that we are still alive to apportion credit means we succeeded in something, didn’t we?

Every experiment you walk away from is a good one

As reviewed in the Wall Street Journal, there were three big swings:

Don’t get cheated on those, okay?

Economists, officials and other observers say that among the more unusual measures, the following had the most oomph over the past year.

1. Rescuing ‘Not Quite’ Banks

In the 24 hours after the Lehman bankruptcy, Reserve Primary Fund investors tried to withdraw $24.6 billion, less than half of which was actually paid to them.

Bank deposits have been insured by the FDIC since the 1930s, but $2.5 trillion in money-market funds weren’t.

Yet another example of why we need to cut up the regulatory turf and standardize financial regulation.

That didn’t stop the Treasury and Fed from rushing to the rescue. The Treasury, which didn’t yet have any TARP money, dipped into a kitty created decades ago to support the U.S. dollar, and guaranteed money-market investors that they wouldn’t lose their money.

That was a critical, essential move.

I guarantee you won’t lose your money

Within a week, the Fed had financed $73 billion in commercial paper; within two weeks, it had financed $150 billion. But that didn’t suffice. Companies still were having trouble selling commercial paper and that meant they couldn’t get short-term loans to run their businesses. So a few weeks later, stretching its own rules, the Fed found a way to lend directly to industrial companies. By January 2009, it had lent $350 billion.

Today, the Treasury says the money-market fund deposit insurance arrangement will lapse on schedule at month’s end, and the Fed’s commercial-paper lending is down to $46 billion. One problem on the crisis list is close to being crossed off.

I hadn’t followed these figures. 

That is an unequivocal win.

I like wins

2. Backing the Banks

The financial system only began to stabilize around Oct. 14 when the Treasury chucked its previously announced intention to buy toxic assets from the banks. Instead, Messrs. Bernanke, Paulson and Geithner tapped TARP to force-feed $125 billion of taxpayer money into the biggest banks and pushed the FDIC to guarantee newly issued debt.

I said at the time it was a great move for the country.  It cut through the complexity and valuation challenges inherent in auctioning the complex asset pools, and it delivered capital where it was needed.  It was, in short, the simplest and most direct solution to the visible problem.

Make contact with the problem

The combination of capital and guarantees, in hindsight, was potent. “I believe it worked … because … those transactions were designed to convey a piece of info: The government is guaranteeing the banks,” says Damon Silvers, an AFL-CIO lawyer who sits on the five-person TARP oversight panel created by Congress and has been critical of some of the specifics of the Paulson and Geithner Treasury’s rescues.

This was a sweeping move, one that captured healthy and sick alike:

To the consternation of its critics, the Fed and Treasury’s October 2008 bank rescue didn’t attempt to distinguish between healthy and sick banks. In fact, it soon became clear that neither Citigroup Inc. nor Bank of America Corp. had enough capital to convince the markets they could absorb the losses likely in a deep recession.

Because even healthy banks were strong-armed into taking capital they didn’t need, on terms they subsequently found onerous, whether it was the right move for all the affected banks is more problematic.  Yet in macroeconomic terms, that is secondary:

It didn’t cure the banking system. It bought time. But in October 2008, buying time was what Mr. Bernanke and Mr. Paulson say they figured they had to do.

Yes.

3.         Stress Tests

Can you handle the stress?

Mr. Geithner’s “stress tests” of the 19 largest financial firms got off to an inauspicious start on Feb. 10 when he unveiled them in a widely mocked speech.  [Snip]  But when they were completed in May, they seemed to clear the air and paved the way for banks to raise capital from private investors. “I don’t understand why people were so persuaded by these stress tests,” says [Anil] Kashyap, the Chicago economist who was skeptical of them at the time. “But they proved a decisive moment.”

Kashyap wonders why people were persuaded

The answer comes from the preceding section – forcing capital into every bank provided one piece of information (we stand with you all) but obscured another (which of you can stand by yourselves).  The markets needed that knowledge as well:

The stress tests … made clear which banks were strong, and which weren’t. Then banks were told they needed to raise capital privately or swallow more government capital.

You have to show you can perform under stress

It turned out that eliminating some of the uncertainty — both about the government’s intentions and the condition of the big banks — was more important than the money the Treasury put on the table.

Not only are fuzzy boundaries bad boundaries, fuzzy readings are in some ways worse than no readings at all.

But Mr. Geithner, in remarks last week, also emphasized that unemployment — the most visible of all measures of economic pain — remains high. And he cautioned, “The classic mistake people make is they declare victory too soon, they put on the brakes too early, they withdraw these things and then the system has to go back and build more insurance against the risk of a bad outcome and that could intensify the recession.”

The banking system is stable – but it’s living on life support, and that’s called the sovereign guarantee.

You can trust me.  I’m a doctor.

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Although we are far from recovered, we have the giddy consolation of knowing we’re not dead yet, and that is grounds for celebration, at least to the extent we now have the luxury of debating which of those crazy risks we took and big bets we made were necessary.

We’re here to hear about your big brass bets

Leave it to the Wall Street Journal to review the last year’s wild ride:

It was only a year ago published September 14 – Ed.] that the world economy was enveloped in a financial panic of such dimensions that, if one believes Federal Reserve Chairman Ben Bernanke, it threatened to produce a calamity as bad as the Great Depression.

You have something against calamities?

I believe it did; and said so throughout the sequence.

Today, the economy is far from vigorous.

We’re still shedding jobs.

Unemployment remains high. Huge swaths of the financial system remain on government life-support.

Yes, such as the entire domestic residential housing financial system, among others.

But the global recession appears over –

That’s the economists’ definition: namely that the economy is not actually shrinking.  But from where I sit, employment is falling, and a lot of capable people I know who’d like to work are out of work.  That’s hardly cause for cheer.

What, you can’t take a few hundred thousand layoffs, you wimp?

– and now forecasters are arguing over the pace and sustainability of recovery. Leaders of the world economy are breathing an audible sigh of relief, and talking about the “exit strategy.”

Despite Chairman Bernanke’s brave words a while back – in this selfsame Wall Street Journal – we may talk about exit strategy all we want, but there will be no substantial exit any time soon.

President Barack Obama goes to Wall Street Monday [September 14, 2009 – Ed.], the anniversary of Lehman Brothers’ collapse, to deliver a cautious victory speech.  

With Wall Street executives, as well as government officials, in attendance, the president also will admonish “to avoid a return to the practices on Wall Street that led us to the financial crisis and to recognize their obligation to help produce a wider recovery on behalf of the American people.”

Sounds good, I suppose.

If you don’t like “admonish,” how about “chastise”?

With a modicum of hindsight now available, do governments and central banks deserve credit for preventing catastrophe? The early verdict from most scholars, executives and government insiders is yes.  [What are bloggers, chopped liver? – Ed.]

How about bloggers?  I said yes at each stage:

March 24, 2008, the shotgun marriage of Bear Stearns to JP Morgan Chase: Banking on value.

April 22, 2008, explanation: Banking on value: the explanation.

April 28, 2008, how the Bear Stearns transaction went down: Anatomy of a coup

September 22, 2008, explaining the Paulson Doctrine(s): Part 1, prevent the second great depression

September 29, 2008, explaining TARP: Bailout or bonanza?

October 20, 2008, converting TARP into preferred-stock injections: Paying your rescuer: Part 1, you *will* do it

January 21, 2009: The GSE’s future: Part 1, we need the eggs

March 23, 2009: The AIG Hearings: Part 1, “Now that we’ve killed all the bomb-makers …”

What, you think that counts as evidence?

On the question of which of dozens of extraordinary interventions — rock-bottom interest rates, surging government spending, billions of taxpayer dollars injected into banks, sweeping government guarantees — made the biggest difference, there’s less agreement.

Sometimes the answer is, All of them.

“It was a period of tremendous experimentation,” says Columbia University economist Frederic Mishkin, who left the Fed board in August 2008. “When you’re faced with a crisis of this magnitude, if you take the view that every measure that we take has to be exactly right, you don’t do anything.”

Mishkin: Sometimes you just have to swipe at the air

Experts say the leading candidates for most-successful moves are those that leveraged the credit and credibility of the U.S. government to replace broke and beleaguered private financial institutions and markets.

Oh, you think having the global capital markets seize up and throw the financial system into chaos would have been a bad thing?

Getting thrown isn’t such a good idea

The moves shored up rapidly dissipating confidence in the financial system before panic damaged it irreparably, and kept credit flowing while bankers and government officials debated how to rebuild banks’ depleted capital.

Yes.

Specifically, the Treasury rushed last fall to shield money-market mutual funds from what resembled a 19th-century bank run, and the Fed bypassed banks and markets by giving loans to credit-starved industrial companies.

Nineteenth century?  Try the twenty-first century run on Britain’s Northern Rock.

Twenty-something billion pounds’ later, you’re all satisfied

Never quite clear whether they had all the authority to do all these things, but they did them and everybody decided that the authority was, yea verily, actually there.

Then the government force-fed capital to the banks and, perhaps more importantly, guaranteed nearly all new bank borrowing so banks wouldn’t all shrink simultaneously.

Actually, it’s good for you

Not just our government – the Bank of England, the European Central Bank – they all moved.

More recently, the Treasury’s “stress tests,” to the surprise of their many critics, allowed big banks to take steps crucial toward renewed health.

Stress test doesn’t mean “works in all possible scenarios.”  At least, not to anybody other than an engineer.

Stress?  You call that stress?

One sign of success is the parade of people stepping up to take credit for what seemed, just a few months ago, an unpopular bailout of Wall Street. Mr. Bernanke, in speeches and interviews, recites the litany of Fed innovations. Former Treasury Secretary Henry Paulson is finishing a book that highlights the political risks he took last year to save the economy. Mr. Obama and Treasury Secretary Timothy Geithner emphasize steps taken since January, a case that Treasury will detail in a report to be issued Monday that it calls “The Next Phase.”

Success has a hundred fathers.  I’ve always thought it was the Bernanke-Paulson-Geithner troika, which is why Mr. Geithner, despite his embarrassing and possibly unforgivable tax lapses, was the right man for the Treasury job.

A big question will be debated for decades: Whether Mr. Bernanke and Mr. Paulson could or should have kept Lehman Brothers from bankruptcy a year ago this month.

Yes – that’s the known unknown.

I know I don’t know economics

By a 3-to-1 margin, three dozen economists surveyed by The Wall Street Journal reject the Bernanke-Paulson claim that they were legally impotent as Lehman teetered.

Count me among the super-majority; I am sure the authority could have been found.

Where did I put that statutory authority?

Lehman’s collapse coincided with and contributed to a classic panic, breeding such distrust among banks that they were reluctant to lend even to each other. In the weeks that followed, the Fed and Treasury leapt to keep insurance titan American International Group Inc. from following Lehman into bankruptcy proceedings.

Yes, that’s the case for not letting Lehman collapse – we had to prop up the much bigger AIG.

There are dissenters. Stanford University economist John Taylor says Lehman was “a jolt,” for sure, but he observes that financial markets didn’t panic immediately. Rather, he argues, it was the government’s response — the muddled rollout of Treasury’s $700 billion Troubled Asset Relief Program and frightening Bernanke-Paulson rhetoric — that provoked panic.

Taylor thinks we muddled the gigabucks

In Too many powers: chasing the bus, I observed that having gained authority to remake the GSEs with a wave of their magic wands, Treasury and the Fed found the capital markets expecting them to do so, so the conveying of a power made using that power inescapable. 

“They said [to Congress]: ‘If you don’t do this, and even if you do, it could be the next Great Depression,’” he says. “Those things, I think, were the worst.”

Add to that Mr. Paulson’s rhetoric – equivalent to shouting Depression in a crowded CDS marketplace – and the unthinkable became inevitable.

Do I hear the voices of unlearned critics?

Mr. Bernanke scoffs at that.  A “strong and unprecedented international policy response…averted the imminent collapse of the global finance system,” he said recently. Mr. Paulson has said he sees the situation similarly. Mr. Geithner, meanwhile, seeks credit for what was done last year, while he headed the New York Federal Reserve Bank. He said Thursday that those efforts “succeeded in achieving the vital, but narrow, objective of preventing a catastrophic systemic meltdown.”

Meltdown – it’s a good thing

[Continued tomorrow in Part 2.]

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