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Tallying the Full Cost of the Financial Crisis

To mark the fourth anniversary of the Lehman Brothers bankruptcy, which greeting card would be appropriate? Perhaps a sympathy card? A farewell? If Better Markets, a Washington (D.C.) nonprofit that supports tighter financial regulation, were to design a card, it would probably have a gilded “$12.8 trillion” plastered across the front. That’s the amount Better Markets estimates the 2008 financial crisis cost Americans.

At first blush, the cost of such a colossal crisis seems incalculable. Myriad factors are involved, including such things as the toll of unemployment and lost wages, losses in the stock market and corporate earnings, declining home values, the depletion of retirement savings, and decreased consumer spending.

So Better Markets took a different approach: Instead of trying to calculate the numerous individual costs in different parts of the economy, it looked at the highest level of all economic activity—U.S. gross domestic product. First, Better Markets took estimates from the Congressional Budget Office and the Federal Reserve Bank of St. Louis to calculate actual losses. That’s the difference between the potential GDP the U.S. would have generated without the financial crisis and the actual GDP already created or currently projected to be created. Those “actual” losses total $7.6 trillion from 2008 to 2018.

Then Better Markets tried to take into account the fact that actual GDP would have been even lower if the Treasury Department and the Federal Reserve hadn’t taken extraordinary measures, such as enormous bailouts of such companies as American International Group (AIG), Citigroup (C), and Bank of America (BAC).

To calculate these “avoided” losses, Better Markets updated a 2010 estimate (pdf) by Alan Blinder, an economist at Princeton University, and Mark Zandi, chief economist at Moody’s Analytics (MCO), and determined that fiscal and monetary policies prevented $5.2 trillion in losses from 2008 to 2012, when the Blinder/Zandi exercise ends. So if one adds $7.6 trillion of “actual” losses and $5.2 trillion in “avoided” losses, there’s an estimated grand total of $12.8 trillion in costs for the crisis.

With its tally, Better Markets is hoping to ensure that Americans—especially the politicians and bureaucrats in Washington—will remain attuned to how searing the Lehman collapse and all that followed truly was. As Wall Street complains about the costs of new regulations, Better Markets’ study is a reminder of the losses that come with a crisis. “Only a full accounting of the costs will provide the basis and motivation to take the proper actions to reduce the likelihood that the American people will have to suffer from another financial collapse and economic crisis,” the report says.

In the upcoming issue of the New York Times Magazine, NPR’s Adam Davidson writes about his visit to the current Lehman Brothers offices and said it “appears an awful lot like a normal investment bank … [e]xcept that Lehman’s sole objective is to sell everything it owns so it can repay its lenders and disappear.” He wrote that financial crises end when people forget they ever happened and confidence returns, and that there are signs this is already happening.

Still, at nearly $13 trillion, the 2008 financial bust will be tough for many ever to forget.

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Investor Demands (More! Less!) Show Financial Illiteracy

Investors who participated in a major study on financial literacy published last week spoke clearly: They want more information, more data, more disclosures.

Except when they want less. They want it formatted in tables and, also, not formatted in tables. They demand that the information be posted online, and will only read it in print.

With contradictory findings like these, the report, by the Securities and Exchange Commission, illustrates just how difficult it will be to make Americans smarter about finance: More disclosure doesn’t always mean better disclosure, and if you ask investors what they want, they don’t necessarily agree or even know how to answer.

Consider what happened when the SEC showed study participants mocked-up prospectuses (PDF) for three imaginary mutual funds, which were nicknamed Petunia, Hydrangea Bush, and Gardenia. All three look similar, with charts, graphs, and the like, but with one exception: The paperwork for Petunia and Hydrangea Bush was two pages long, while Gardenia used four pages. The study subjects recoiled at the longer document—rating the Gardenia fund prospectus harder to understand, less visually appealing, less user-friendly, and packed with too much legal jargon.

Hostility to lengthy paperwork is an obstacle for those who are calling on money managers to tell investors more about fee structures, strategies, conflicts of interest, and other important topics. In May, for example, Morningstar (MORN) urged the SEC to require target-date funds (PDF) to show graphs illustrating how their products shift their holdings over time.

“There’s a bit of a diminishing value because the more that is disclosed to us, we may be less likely to pay attention to it,” one member of a Baltimore focus group told SEC researchers. “So somewhere they’ve got to decide the tipping point when people are just going to tune it out because it looks like it’s just too onerous.”

Confusing documents are just one of the reasons American investors consistently flunk financial literacy tests. Last week’s report, which was mandated by the 2010 Dodd-Frank financial overhaul law, painted an especially brutal picture. “Investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud,” SEC staff wrote. Women, African Americans, Hispanics, the elderly, and undereducated groups are worse than the average.

“Studies have found that investors do not understand the most elementary financial concepts, such as compound interest and inflation,” they added, citing Library of Congress research. “Studies have also found that many investors do not understand other key financial concepts, such as diversification or the differences between stocks and bonds.”

“Look, financial things have become more complicated. And we do not explain it very well,” Muriel Siebert, a longtime advocate for financial education, said in an interview. “The funds have gotten more complicated than they were originally. The information is there, but [investors] don’t have the knowledge as to how to take it apart.”

No investor advocates want people to have access to less information, of course. What’s probably called for at this point, rather, is better information, formatted in ways that don’t cause eyes to glaze over. The 40 million-member American Association of Retired Persons (AARP) has called on the SEC to use “information design professionals” to recreate common paperwork so it can be understood by the average investor. The Consumer Federation of America made a similar push to “incorporate lessons from behavioral economics, graphic design, and disclosure design.”

The result, in theory, would be disclosure forms that are clearer, less imposing, and highlight important facts without overwhelming.

Otherwise, the views of some SEC focus group members will continue to be common. “Even though this information may be important,” one said of the current way disclosures are supplied, “it’s more information than I personally want to deal with.”

Summers covers Wall Street and finance for Bloomberg Businessweek.

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The Fuzzy Math in Financial Aid Offers

When Susan Romano first read her son Zach’s financial aid letter from Drexel University, a private college in Philadelphia, her eyes immediately jumped to the line highlighted in yellow: “$13,442 expected payment” for the first year at the $63,000-a-year school. “At first, I thought it was great,” says Romano, an insurance claims representative from Huntingdon, Pa. “The more I read it over and over, the worse it got.” It turned out the college’s “offered financial aid” included $42,000 in loans to be taken out by the family. “A loan to me is not financial aid,” says Romano. “It is money I have to pay.”

While the federal government requires banks and mortgage companies to disclose interest rates and total payments on loans, the financial aid letters sent out by colleges are often unclear about how much families will have to pay. The format for packages varies by school, making it difficult to comparison shop: Loans and grants offered by the federal government are lumped together with the school’s scholarships, and the statements often don’t include information on interest rates.

Jennifer Silverberg for Bloomberg BusinessweekDaniel Jamrozik thought Butler University had made him a great offer—until he figured out his family would need to borrow $28,000 for his freshman year

“You have to be savvy enough to know the fine print exists, and then you have to be eagle-eyed enough to find it hidden in the letters and on websites,” says Debbie Greenberg, a counselor with College Bound St. Louis, a nonprofit that coaches low-income students. Salenia Shaw, a high school senior Greenberg has been advising, was directed to a website for details of her aid package from Bradley University in Peoria, Ill. After subtracting grants from the cost to attend, they realized Shaw and her mother would need to take out $17,000 in loans for the first year.

The U.S. Department of Education, consumer groups, and guidance counselors are pushing for a standard format for award letters. The department is aiming to have a model ready before the start of the next school year, according to spokesman Justin Hamilton. Only Congress, however, has the power to make it mandatory. “Our hope is that institutions will see the wisdom and benefit of moving towards a common form,” Hamilton says.

The National Association of Student Financial Aid Administrators went to Capitol Hill in March to lobby against the standardization. While the group isn’t opposed to requiring schools to use the same terms, members prefer the flexibility to design their own letters, says Megan McClean, director of policy. “We are always in favor of students and families having clear and accurate information,” she says.

The Consumer Financial Protection Bureau introduced a website last month that helps students compare financial-aid options at different schools. “Clear financial aid information with estimates for total debt and monthly payment after graduation would help them make decisions,” said Rohit Chopra, its student-loan ombudsman, in an e-mail. Educational debt has ballooned to $1 trillion, surpassing the amount owed on credit cards in the U.S., according to estimates compiled by the agency.

Joan McDonald, senior vice president for enrollment management at Drexel, said in an e-mail that the college includes federally backed and private loans in financial aid letters so families have a complete view of available resources. David Pardieck, director of financial assistance at Bradley, says the university has not had complaints about the clarity of its letters.

Daniel Jamrozik, 18, the top-ranked student at his high school near St. Louis, needed help from a coach at College Bound to interpret his aid award letters. A letter from the public Missouri University of Science and Technology presented a 10-line breakdown with a boxed amount of $22,536 that corresponds to the total cost for one year of attendance. The package, though, required Jamrozik and his parents, who are Polish immigrants, to take out $12,586 in loans. His father is a contractor and his mother juggles several jobs, including as a nursing-home aide.

A letter from Butler University, a private college in Indianapolis where the total cost of attending for the 2012-13 academic year comes to $47,168, initially appeared to offer Jamrozik more money: The figure highlighted was $28,100. Yet after crunching some numbers, he and his coach determined the family would actually need to take out $28,000 in loans, more than double the amount for the state school. “It’s certainly not our intention for them to be confusing,” says Melissa Smurdon, director of financial aid at Butler. “There is a significant amount of information that needs to be conveyed.” Lynn Stichnote, director of student aid at Missouri S&T, acknowledges the letters can be “intimidating.”

Jamrozik, who has until mid-May to make his choice, says he’s certain about one thing: “You’re just going to be suffering for an eternity to pay off the debt.”

The bottom line: College financial aid officers oppose an effort to introduce a standardized letter for assistance awards.

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U.S. Sees 'Great Difficulties' in Taxing Financial Products

December 07, 2011, 7:41 AM EST By Richard Rubin

(Updates with Camp, Baucus comments starting in seventh paragraph.)

Dec. 6 (Bloomberg) -- U.S. lawmakers seeking to overhaul the Internal Revenue Code are examining how derivatives and other financial products should be treated and how investors can structure transactions for more favorable tax results.

Financial instruments, including exchange-traded notes and options, are susceptible to manipulation, according to a report by the nonpartisan Joint Committee on Taxation. Taxpayers can structure transactions to defer income, accelerate deductible losses and take advantage of lower capital gains rates.

The “ability to combine basic instruments and to create new instruments represents financial innovation that might lower the cost of capital,” the report said. “The flexibility of financial instruments also creates great difficulties in the taxation of financial instruments.”

The report was prepared for a hearing today of the House Ways and Means Committee and Senate Finance Committee. The session is the two panels’ second joint hearing since 1940. The first, on treatment of debt and equity, was held in July.

The hearing is part of a series of discussions on a tax- code overhaul. Ways and Means Chairman Dave Camp, a Michigan Republican, wants to restructure the code to reduce the corporate and individual rates to 25 percent without lowering tax collections.

Changing the Rules

Achieving that goal will require eliminating tax breaks or changing underlying tax rules, such as the way derivatives are taxed. The chairmen of the tax-writing committee didn’t commit to a particular proposal in their opening statements.

Camp said at the hearing today that he hoped to resolve some of the murkiness surrounding financial instruments.

“Today’s marketplace features a wide array of products that can result in different tax or financial accounting treatment of economically similar products, including debt, equity, mixtures of the two and financial derivatives,” he said.

Senate Finance Committee Chairman Max Baucus, a Montana Democrat, said new financial instruments have the potential for mischief.

“They aren’t fair to taxpayers who can’t afford those high-priced lawyers and accountants,” he said.

‘Heading Someplace’

The hearing “means that they are heading someplace,” Bruce Thompson, vice president at Van Scoyoc Associates Inc., a Washington lobbying firm. “Now where they are, I’m not sure.”

Thompson, former senior director of global government relations at Merrill Lynch & Co., said financial institutions that benefit from the current tax system should be wary.

“Ten years ago, they were invulnerable in Washington. They’re not that way now,” he said. “There’s obviously continued anger at the industry. That certainly hasn’t gone away, and it’s from both the left and the right.”

Several features of the U.S. revenue system make it difficult to tax financial products. Those include the ability to defer taxation using some financial instruments and the preferential 15 percent rate for long-term capital gains, said Viva Hammer, a former Treasury Department official who was responsible for tax policy related to financial institutions and products.

“The ability to toggle in and out of capital treatment allows tremendous flexibility in planning your taxes,” she said.

Mark to Market

Hammer said Congress should require mark-to-market taxation of derivatives at ordinary income tax rates.

“Everyone knows what the right answer is, but no one has the courage to impose it,” she said.

Mark-to-market accounting is intended to require companies to assign fair value to financial instruments and to limit the benefits of deferring realization of gains.

David Miller, one of the witnesses set to speak at today’s hearing, in 2008 proposed that large companies and wealthy individuals face a mark-to-market tax regime on publicly traded securities and derivatives. Miller is a partner at Cadwalader, Wickersham & Taft LLP in New York.

Alex Raskolnikov, a professor at Columbia Law School in New York who is scheduled to testify today, supports mark-to-market treatment of derivatives at ordinary income tax rates.

‘Mind-Numbing’ Rules

“The mind-numbing complexity of the current rules, the considerable compliance costs they impose, and the need for Congress to continually monitor and respond to financial innovation will all disappear,” he told a Ways and Means subcommittee in 2008.

The global over-the-counter swaps market is $708 trillion, according to the Basel-based Bank for International Settlements. Derivatives, including swaps, are financial contracts tied to interest rates, currencies or events, such as a company default.

Ken Bentsen, the executive vice president for public policy and advocacy at the Securities Industry and Financial Markets Association, a trade group in Washington, said he welcomed the committee’s discussion.

“These are very good information-gathering opportunities for the members of the committee that will help them as they hopefully ultimately move toward broad-based tax reform,” he said.

Bentsen said he would caution lawmakers about the potential unintended consequences of any changes in the tax treatment of financial products.

“They’re underpinnings of the economy that we have today,” he said.

--With assistance from Silla Brush in Washington. Editors: Jodi Schneider, Robin Meszoly

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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Geithner Sees ‘War of Attrition’ Against Financial Overhaul

May 25, 2011, 12:20 PM EDT By Ian Katz and Cheyenne Hopkins

(Updates with comment on debt ceiling in fifth paragraph.)

May 25 (Bloomberg) -- U.S. Treasury Secretary Timothy F. Geithner said some lawmakers and bankers are waging a “war of attrition” against efforts to strengthen regulation of the financial system.

“You’re seeing some people run a war of attrition against the reform act,” Geithner said at an event today in Washington, without identifying the people. “They’re trying to starve the agencies of funding so they can’t enforce protections for investors.”

Geithner also said opponents of the Obama administration are trying to block presidential appointments to regulatory agencies “as a way to get leverage over the outcome, and they’re trying to slow down so that they can weaken over time the thrust” of the Dodd-Frank financial overhaul law. “We’re not going to let that happen.”

Republican lawmakers are opposing the nomination of Peter Diamond to the Federal Reserve Board. The White House renominated Diamond, a Nobel Prize winner, in January, marking a third try at confirmation after the Senate adjourned in December without approving him. Diamond’s initial candidacy was returned to the White House in August under a procedural objection.

On negotiations to raise the $14.3 trillion federal debt ceiling, Geithner said Congress will ultimately “do the right thing” and raise the limit. Some lawmakers are using the talks for political posturing, he said.

‘All Theater’

“Right now this is all theater,” Geithner said. “I think the vast bulk of Congress understands it completely. I think there are some people pretending not to understand, who think there is leverage for them in threatening default. I don’t understand that negotiating position.” Geithner has taken measures to stay below the debt limit until Aug. 2.

This month, 44 Senate Republicans said they would not confirm a director for the Consumer Financial Protection Bureau without changes to its structure and funding. President Barack Obama appointed Elizabeth Warren, a Harvard University law professor, as an adviser to set up the bureau after then-Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said Republican opposition would prevent her from winning Senate confirmation.

“We want to put up people who can be confirmed,” Geithner said. “We want to put up talented people who can do those jobs. Finding the intersection between those two things has become difficult because people are less willing to come and Congress is proving itself unwilling to confirm Nobel Prize-winning economists.”

‘Dark Forces’

Asked by a moderator at the breakfast held by Politico to identify the “mysterious forces” working against the administration, Geithner said, smiling, “dark forces, I would say.”

On the search for a successor to Dominique Strauss-Kahn to lead the International Monetary Fund, Geithner said both French Finance Minister Christine Lagarde and Mexican central bank Governor Agustin Carstens are “very talented” candidates.

The U.S., the largest IMF shareholder, will play a “significant” role in the choice to replace Strauss-Kahn, a former French finance minister who resigned after his arrest on charges of attempted rape and sexual assault.

Lagarde “is an exceptionally capable person, an excellent mix of financial economic knowledge, talent and the kind of political skill you need to navigate this context,” Geithner said. Carstens “has that as well.”

Lagarde today declared her candidacy, saying she should be judged on the basis of experience rather than nationality. A European has held the IMF managing directorship since its founding at the end of World War II, while an American has always headed the World Bank.

The IMF executive directors representing Brazil, Russia, India, China and South Africa united yesterday to protest publicly the presumption that the fund’s next chief once again be a European.

--With assistance from Sandrine Rastello and James Tyson in Washington. Editors: Chris Wellisz, Carlos Torres

To contact the reporters on this story: Ian Katz in Washington at ikatz2@bloomberg.net; Cheyenne Hopkins in Washington at Chopkins19@bloomberg.net.

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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Obama Says Debt Default May ‘Unravel’ Global Financial System

May 15, 2011, 1:33 PM EDT By Roger Runningen and James Rowley

(Adds Boehner comments starting in fifth paragraph.)

May 15 (Bloomberg) -- President Barack Obama said failure to raise the U.S. debt ceiling by early August might disrupt the global financial system and plunge the nation into another recession.

If investors “around the world thought the full faith and credit of the U.S. was not being backed up, if they thought we might renege on our IOUs, it could unravel the entire financial system,” Obama said on a segment taped for today’s “Face the Nation” program on CBS. “We could have a worse recession than we’ve already had.”

Obama is reaching out to Republican and Democratic lawmakers to win approval of an increase in the debt ceiling. The government projected this month that the $14.3 trillion debt limit will be reached tomorrow. Treasury Secretary Timothy Geithner says that while he can juggle accounts for a time, he will run out of options for avoiding default by early August.

Republicans including House Speaker John Boehner of Ohio and Senate Minority Leader Mitch McConnell of Kentucky are seeking trillions of dollars of spending cuts and no tax increases in exchange for supporting a higher debt limit. Obama on April 13 proposed a long-term deficit-reduction package of about $4 trillion over 12 years. It includes $2 trillion in spending cuts, $1 trillion in tax increases and $1 trillion in reduced interest payments.

‘Totally Irresponsible’

Boehner, who in a May 9 speech demanded spending cuts greater than the amount of any debt-ceiling increase, said today that he understood “what the president was saying about jeopardizing the full faith and credit of the United States.”

“Our obligation is to raise the debt ceiling,” he said on CBS’s “Face the Nation.” “But to raise the debt ceiling without dealing with the underlying problem is totally irresponsible.”

Obama appointed Vice President Joe Biden to lead negotiations with congressional leaders to try to strike a deal on reducing debt and deficits. The small group of negotiators has met three times with Biden. The president held separate talks with Senate Republicans and Democrats May 11 and May 12.

“I’ve said, ‘Get them in a room, hammer out a deal, and make sure that we don’t even get close’” to defaulting on the nation’s debt, Obama said.

Debt reduction must be “balanced” and include tax increases, Obama said.

‘Shared’ Burden

“Are we going to make sure no single group -- not seniors, not poor folks, not any single group -- is carrying the whole burden? Let’s make sure the burden is shared,” Obama said on the CBS program, which was taped May 11 in Washington for broadcast today.

Obama said he would resist cuts in such areas as medical research; infrastructure such as roads, bridges or railroads; or college loans for needy students.

“My hope is that Congress is going to say, ‘This is so serious, we can’t play politics with it,’” Obama said. “Have faith that usually after trying everything else, we end up doing the right thing.”

Obama’s statement “makes me think he is really not serious about tackling the big problems that face our country,” Boehner said. “He’s talking about it, but I am not seeing real action yet.”

Still, Boehner said he was optimistic that the talks led by Biden would yield an agreement on legislation to cut spending and extend the government’s borrowing authority.

‘Opportunity to Act’

“We don’t have to wait to the eleventh hour” like Congress did last month to extend federal spending and avoid a government shutdown, Boehner said. “But I am not going to walk away from this moment” of “opportunity to act” to make serious spending cuts, he said.

“At the end of this process, it’s going to have to come to that,” Boehner said of extending the government’s borrowing authority.

The speaker said that “for quite a while” he has privately discussed with Obama his idea for making drastic spending cuts and changes in entitlements like Medicare and other programs in tandem with raising the debt ceiling.

Boehner said he told Obama, “‘Let’s lock arms and jump out of the boat together.’ I am serious about dealing with this. And I hope he is just as serious.”

One of Boehner’s predecessors as House speaker, Republican presidential candidate Newt Gingrich, said on NBC’s “Meet the Press” that Congress should “avoid default if you possibly can” but that the president shouldn’t get “a blank check.”

McConnell, appearing today on CNN’s “State of the Union,” said he wants extension of the debt limit coupled with broad- reaching fiscal reforms.

“We need to do something significant,” he said. “We need to impress the markets, impress foreign countries that we’re going to get our act together, and astonish the American people that the adults are in charge in Washington and are actually going to deal with this issue.”

--With assistance from Laura Litvan in Washington. Editors: Leslie Hoffecker, Andrea Snyder

-0- May/15/2011 17:11 GMT

To contact the reporters on this story: Roger Runningen in Washington at rrunningen@bloomberg.net; James Rowley in Washington at jarowley@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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