by Margareta Pagano and Simon Evans
The Independent - 2008-10-12
Not for nothing did US billionaire Warren Buffett call them the real 'weapons of mass destruction'
The market is worth more than $516 trillion, (£303 trillion), roughly 10 times the value of the entire world's output: it's been called the "ticking time-bomb".
It's a market in which the lead protagonists -- typically aggressive, highly educated, and now wealthy young men -- have flourished in the derivatives boom. But it's a market that is set to come to a crashing halt -- the Great Unwind has begun.
Last week the beginning of the end started for many hedge funds with the combination of diving market values and worried investors pulling out their cash for safer climes.
Some of the world's biggest hedge funds -- SAC Capital, Lone Pine and Tiger Global -- all revealed they were sitting on double-digit losses this year. September's falls wiped out any profits made in the rest of the year. Polygon, once a darling of the London hedge fund circuit, last week said it was capping the basic salaries of its managers to £100,000 each. Not bad for the average punter but some way off the tens of millions plundered by these hotshots during the good times. But few will be shedding any tears.
The complex and opaque derivatives markets in which these hedge funds played has been dubbed the world's biggest black hole because they operate outside of the grasp of governments, tax inspectors and regulators. They operate in a parallel, shadow world to the rest of the banking system. They are private contracts between two companies or institutions which can't be controlled or properly assessed. In themselves derivative contracts are not dangerous, but if one of them should go wrong -- the bad 2 per cent as it's been called -- then it is the domino effect which could be so enormous and scary.
Most markets have something behind them. Central banks require reserves -- something that backs up the transaction. But derivatives don't have anything -- because they are not real money, but paper money. It is also impossible to establish their worth -- the $516 trillion number is actually only a notional one. In the mid-Nineties, Nick Leeson lost Barings £1.3bn trading in derivatives, and the bank went bust. In 1998 hedge fund LTCM's $5bn loss nearly brought down the entire system. In fragile times like this, another LTCM could have catastrophic results.
That is why everyone is now so frightened, even the traders, who are desperately trying to unwind their positions but finding it impossible because trading is so volatile and it's difficult to find counterparties. Nor have the hedge funds been in the slightest bit interested in succumbing to normal rules: of the world's thousands of hedge funds only 24 have volunteered to sign up to a code of conduct.
Few understand how this world operates. The US Federal Reserve chairman, Ben Bernanke, tapped up some of Wall Street's best for a primer on their workings when he took the job a few years ago. Britain's financial regulator, the Financial Services Authority, has long talked about the problems the markets could face on the back of derivative complexity. Unfortunately it did little to curb the products' growth.
In America the naysayers have been rather more vocal for longer. Famously, Warren Buffett, the billionaire who made his money the old-fashioned way, called them "weapons of mass destruction". In the late 1990s when confidence was roaring in the midst of the dotcom boom, a small band of politicians, uncomfortable with the ease with which banks would be allowed to play in these burgeoning markets, were painted as Luddites failing to move with the times.
Little-known Democratic senator Byron Dorgan from North Dakota was one of the most vociferous refuseniks, telling his supposedly more savvy New York peers of the dangers. "If you want to gamble, go to Las Vegas. If you want to trade in derivatives, God bless you," he said. He was ignored.
What is a Derivative?
Warren Buffett, the American investment guru, dubbed them "financial weapons of mass destruction", but for the once-great-and-good of Wall Street they were the currency that enabled banks, hedge funds and other speculators to make billions.
Anything that carries a price can spawn a derivatives market. They are financial contracts sold to pass on risk to others. The credit or bond derivatives market is one such example. It is thought that speculation in this area alone is worth more than $56 trillion (£33 trillion), although that probably underestimates the true figure since lax regulation has seen the market explode over the past two years.
At the core of this market is the credit derivative swap, effectively an insurance policy against the default in the interest payment on a corporate bond. One doesn't even need to own the bond itself. It is like Joe Public buying an insurance policy on someone else's house and pocketing the full value if it burns down.
As markets slid into crisis, and banks and corporations began to default on bond payments, many of these policies have proved worthless.
Emilio Botin, the chairman of Santander, the Spanish bank that has enjoyed phenomenal success during the credit crunch, once said: "I never invest in something I don't understand." A wise man, you may think.
The Capitalist Shakedown
by William Bowles -- October 13, 2008
"It is only in these dire circumstances that the United States, where private property is more sacrosanct probably than anywhere else in the world, is talking about some kind of nationalization of banks, if only limited. In financial circles they are now calling this .regime change,. borrowing the term of course from a different context. But it is clear what it means: the end of neoliberalism, and the rise of aggressive government interventions into the economy. It represents a clear recognition that this is not a liquidity crisis that can be solved by pouring more money into financial markets or by lowering interest rates." -- Interview with John Bellamy Foster, "Can the Financial Crisis Be Reversed?"
On 4 October, I wrote:
So where.s it all headed? The most likely outcome at least in the short term, would seem to be some kind of state capitalism given that the capitalists have proved themselves even more incompetent than was thought possible.
And this scenario is already being played out across the EU and of course in the US to a lesser extent. And in fact, it can be argued that everything that led up to the current situation makes the situation ideal for the creation of a Mussolini-style corporate, security state, a direct partnership between capital and the state. Fascism doesn.t have to wear jackboots, Armani suits will do just as well (especially as we.re paying for them).
I can.t tell you how many times I.ve started this essay on the Capitalist Shakedown that.s going on around us, totally disconnected from us even, due to some pretty nifty media work and, I might add, thirty years of revanchism on the part of our political masters to disconnect us all from the political process.
But millions of us are affected by this crisis but without any kind of input into how it should be solved, and most especially from our trade unions, what.s left of them anyway, who have failed to voice any kind of alternative to this insanity. We have no voice with which to speak, so we are once more being dragged into a crisis not of our making. But a crisis that is endemic to the system and one the rest of us will pay for, unless that is, we take steps to halt it.
Bill Blum put it this way:
"Do we forget how to make things that people need? Do the factories burn down? Are our tools lost? Do the blueprints disappear? Do we run out of people to work in the factories and offices? Are all the services that people need for a happy life so well taken care of that there.s hardly any more need for the services? In other words: What changes take place in the real world to cause the crisis? Nothing, necessarily. The crisis is usually caused by changes in the make-believe world of financial capitalism." -- Anti-Empire Report, 1 October, 2008
For me, these words are a deja-vu straight from my youth, when the very same questions were being asked during some earlier crisis of capital.
I.ve started it so many times not only because it.s been difficult for me to decide on what the focus should be but also, because the leftie analyses has been coming at me from every-which-way, so I.ve been trying to digest it all before committing myself to any particular approach to this frankly, mind-blowing exercise in sheer incompetence on the part of the Lords of the Universe. It.s not like they couldn.t see it coming, in spite of all their protestations to the contrary. The basic laws of physics still operate even in a capitalist universe, namely that you can.t make something out of nothing, so they had to know that sooner or later, the whole crooked enterprise would go pear-shaped. Pear shaped? It.s gone off like a grenade!
One analysis that stands out is F. William Engdahl.s piece in which he suggests that this Shakedown was deliberately engineered by a handful of big banking combines, notably Citibank and JPMorgan Chase, in what.s come down to a power play between US and EU financial capital as to who will own (what.s left of) the planet.
"Knowing that at a certain juncture the pyramid of trillions of dollars of dubious sub-prime and other high risk home mortgage-based securities would come falling down, they apparently determined to spread the so-called .toxic waste. ABS securities as globally as possible, in order to seduce the big global banks of the world, most especially of the EU, into their honey trap." -- F. William Engdahl: Behind the Panic: Financial Warfare and the Future of Global Bank Power
It is classic neo-Darwinism, only the fittest (that is to say, the least broke) will survive. But either way, conspiracy or not, it still comes down to the same thing in the end, chaos.
That said, come on now folks, doesn.t this demonstrate what we on the left have been saying all along, that we gotta get rid of these parasites, they do nothing good for any of us, all they can do is make money and destroy.
Even early on in the game, the rulers were well aware of what is at stake here, that the speculations of the neo-liberal era would at some point unravel, that indeed the Emperor wore no clothes.
"We want entreprenurial capitalism not speculative capitalism" -- president Sarkozy at the EU/G8 summit meeting, 4 October, 2008
But what.s the difference? The former just uses money stolen by the latter. But imagine if you will, that we did have the organizational power to offer an alternative? Now that would really scare Sarkozy and the rest of the gangsters. And as the media pundits never stop reminding us, it.s all hindsight, .cept it isn.t, this crisis has been simmering for years.
Talking of splitting hairs, here.s a gem from the BBC, endlessly repeated over the years as crises came and went and with today.s auto sales figures down the tubes and the FTSE suffering its biggest drop in history, the Beeb told us it was a reflection of,
"A weakening of consumer confidence". Translation: Broke, but more than that, as far as the Beeb is concerned it.s don.t panic the natives.
This is how Channel 4.s email bulletin put it on 11 October,
"And so the grim cycle continues perhaps we should begin tonight.s programme with the verbatim speech by Mr McCawber. Income expenditure happiness and misery etc. Timely perhaps, but a little late. Which is pretty much what they are saying of the efforts coming from Washington thus far, to impose some kind of sanity on the globally crumbling banking industry. So far lots of fine old words. More empty rhetoric from George Bush this afternoon."
Earlier, on the 8th October to be precise, Jon Snow, the author had this to say in his daily letter,
"I.m going to stick my neck out -- I THINK it doesn.t get much bigger than this. But then, I could have said that yesterday.
"This is massive, almost beyond financial description."
But Mr Snow, we don.t need a description, we know what the hell is going on, what we need is a solution and a description that goes somewhat beyond your facile comments and utterly inane interviews with the .experts..
And lo and behold, as I type here comes another even more desperate-sounding notice from Channel 4, this time authored by Alex Thompson,
"As international capitalism continues to eat itself, we can take some comfort from the hope -- surely more than a hope -- that at least the further controls of governments upon banks mean more of the overpaid clowns who got us into this mess will lose their jobs --let alone their bonuses -- at said banks."
Bonuses? Who gives a shit about the bonuses, what we want are the banks! After all, don.t .we. own them now?
What is amazing is the way the mass media plow on regardless of the reality of the situation but I do notice a number of .experts. getting their (largely unread) copies of Das Kapital down from the attic and dusting them off. Seems the old man was right after all, not that I ever doubted him, after all how many times have we been here before, maybe not as extreme as this self-created disaster.
From 1 October, 2008
I mean, how right can you get?
Back in the middle of the 19th century, inbetween trips to the boozer and the British Library, Marx wrote a stunning predictive piece (not something he speculated on very often) about what he thought it took for a truly global revolution to take place.
Chief amongst his offerings, I think, was his observation that before it would be possible for a global, socialist revolution to occur, capitalism would had to have completely taken over all the important countries before the right conditions could exist for said revo to even have a chance of succeeding. In other words, in his day at least, this meant industrializing, but above all incorporating their economies into their deadly embrace. We appear to have almost entered that stage. After all, if all available markets for capital are, to put it mildly, oversubscribed to, where else is there left to go to, exception destruction.
Capitalist theoreticians, such as they are, got it right for once when they named it .creative destruction., the built-in imperative to continually revolutionalize the means of production and be expanding into new markets, even if it means destroying everything else first. And several centuries of experience to draw on that shows quite clearly that Capital is ruthless and remorseless as it seeks to duplicate itself like some kind of virus as it spreads around the globe.
So it seems to be the general concensus that the pirates really have fucked things up this time, for those erstwhile .lords of the universe. aka the ruling elites, so much so that in Europe at least, even the capitalist press is just plain pissed off with the neo-cons, not that they complained when the going was good. Damn, when you need a reliable left alternative, you can never find one! Now Der Spiegel, owned by one of the lords of the universe, Springer Press, had this to say the other day,
"George W. Bush has grown old, erratic and rosy in the eight years of his presidency. Little remains of his combativeness or his enthusiasm for physical fitness. On this sunny Tuesday morning in New York, even his hair seemed messy and unkempt, his blue suit a little baggy around the shoulders, as Bush stepped onto the stage, for the eighth time, at the United Nations General Assembly." -- Der Spiegel, 30 September, 2008
The crazy thing about this crisis, is that the world is awash with filthy lucre, tons of it, surplus capital sloshing about all over the place, all dressed up and no place to go. The entire mess is self-created, never mind the hedge funds and speculators, these are an intrinsic part of the last thirty years of neo-liberal capitalism.
World War III?
And frighteningly, if capital stays true to its form, then we can expect a really big war some time soon. It is, after all, the only way all that surplus capital can be literally burned up. It was a major cause of WWI and II and it will, unless we get rid of the bastards, be the cause of WWIII, or IV or is it V, I.ve lost count of the major wars they.ve initiated under one pretext or another.
The former imperial powers that started the previous wars are no longer major players, so we can rule them out (between them they can.t even .pacify. a motley crew of hill tribesmen). That leaves China and Russia, the only countries with the wherewithal to get down and dirty, but both are, unless actually invaded, unlikely to .play the great game., so we can rule them out.
Now we know the US just loves starting wars and it doesn.t take much in the way of excuses. But they need a comparable .enemy. and Iran just doesn.t seem to cut it right now, but it.s a starting point I suppose. So perhaps lots of .little. ones? Unlikely given what a disastrous, if still just as deadly, military force the US has become. Fat, nay, bloated to extreme, it.s just not what it used to be, not if you need to fight a really big war and only conscription could do that.
Also, and I think even more importantly, the days of whipping up patriotic fervor for a real war seems to be a thing of the past. It.s okay taking on a country like Iraq, bombed back into the Stone Age before occupying it and even then with only a few thousand dead US troops over five years, it.s not a really big war (compare it to 58,159 troops the US lost in Vietnam and then there.s the 3 to 4 million Vietnamese, 1.5 to 2 million Laotians and Cambodians but then they don.t count), the kind that burns up capital in huge quantiities and takes out the competitors.
"Shares in British banks have plummeted. Royal Bank of Scotland shares crashed in value today by a staggering 39 per cent. And shares in Halifax Bank of Scotland dropped 42 per cent."
The bottom line is that they.re going have to do something and do it soon. But the insanity of a global capitalism must surely be apparent to all (except the corporate media of course). On the one hand, we have pundits talking about a global solution with regard to the regulation of the flow of capital across state borders and on the other, we have every nation doing its own thing!
But it stands to reason that if every nation is in competition with every other nation for markets, then hell will freeze over before they consider anything as sane as a global economic order that benefits ordinary people.
The bottom line is that without any kind of political clout to wield we are at the mercy of these gangsters of Mammon.
This essay is archived at: http://www.creative-i.info/?p=1042
Can Congress Bail Out of the Bailout?
And what about the Fed's Even Larger Giveaway?
by Michael Hudson
We are now entering the financial End Time.
Bailout "Plan A" (buy the junk mortgages) has failed, "Plan B" (buy ersatz stocks in the banks to recapitalize them without wiping out current mismanagers) is fizzling, and the debts still can't be paid.
That is the reality Wall Street avoids confronting.
"First they ignore you, then they denounce you, and then they say that they knew what you were saying all the time," said Gandhi.
The same might be said of today's overhang of debts in excess of the economy's ability to pay. First the policy makers pretend that they can be paid, then they denounce the pessimists as spreading panic, and then they say that of course students have been taught for four thousand years now how the "magic of compound interest" keeps on doubling and redoubling debts faster than the economy can squeeze out an economic surplus to pay.
What has ended is the idea that "the magic of compound interest" can make economies rich without having to work and without industry. I hope we have seen the end of derivatives formulae seeking to make money by playing in a zero-sum game. A debt overhang always ends either in foreclosure of the debtor's property, or in a debt annulment to preserve the economy's overall freedom and equity.
This means that the postmodern economy as we know it must end - either in financial polarization and debt peonage to a new oligarchic elite, or in a debt cancellation, a Jubilee Year to rescue society.
But when the government says that it is reviewing "all" the options, this reality is not one of them. Treasury Secretary Henry Paulson's first option was to buy packages of junk mortgages (collateralized debt obligations, CDOs) to save the wealthiest institutional investors from having to take a loss on their bad bets. When this was not enough, he came up with "Plan B," to give money to banks.
But whereas Britain and European countries talked of nationalizing banks or at least taking a controlling interest, Mr. Paulson gave in to his Wall Street cronies and promised that the government's stock purchases would not be real. There would be no dilution of existing shareholders, and the government's investment would be non-voting. To cap the giveaway to his cronies, Mr. Paulson even agreed not to ask executives to give up their golden parachutes, exorbitant annual bonuses or salaries.
Plan A (the $700 billion to buy mortgage-backed junk that the private sector will not buy) failed partly because it let financial institutions avoid putting a fair value on the debt packages they were selling. Instead of telling the truth about their financial position by marking assets to market prices), they can "mark to model," Enron-style.
We have seen the result: A solid week of plunging stock market prices. The public media call this a panic, but there is nothing irrational about it. Who in their right mind would buy securities or buy into a bank without knowing what the securities were worth? Faith in junk mathematical models has ended.
So we still await a public response to the problem of how to write down debts. Whose economic interest will have to give: that of debtors, as increasingly has been the case over the past eight centuries; or that of creditors, which have fought back to create a neoliberal economy controlled by the FIRE sector?
It is not too late to decide which road to take, but Wall Street bankers and creditors have taken the lead in positioning themselves. Seeing which way the political winds were blowing, they moved to empty out the Treasury before the November 3 elections much like medieval citizens fleeing a horde of Mongolian raiders under Genghis Khan. "We're moving. Clean out the cupboards," much as Lehman Brothers emptied out their foreign bank accounts in Britain and elsewhere just before declaring bankruptcy, taking what they could and steering it to their best friends.
The pretense was that a bailout was needed to restore confidence. But the ensuing week showed that the claims were false. It didn't turn the stock market around as promised. The Dow Jones Industrial Average fell 2,200 points from Wednesday, October 1 through the following Friday October 10 - eight straight trading days, not even pausing for the usual zigzags. Friday's plunge was 100 points a minute for the first seven minutes - a 690 point drop to under 8000. Each 100 points was more than a 1 percent drop, which was reflected on the NASDAQ. Nothing could withstand the pressure of so many Americans cashing in their mutual funds overnight and so many foreigners in earlier time zones putting in sell-at-market orders.
Short sellers made one of the largest and quickest fortunes ever, and then covered their positions by buying back the stocks they had pre-sold. This pushed prices up even into positive territory just before 10:30 AM when George Bush began to speak.
Half the financial stocks showed gains - a sign that the Plunge Protection Team had jumped in. But Mr. Bush said nothing helpful and stocks went back into freefall, ending down another 128 points despite the upcoming weekend G7 meeting. There was no talk at all of reducing debt levels - only of giving more money to banks, insurance companies and other money managers, as if "pushing on a string" somehow would lead them to lend yet more to an already debt-ridden economy.
If Congress really wanted to restore confidence, here's what it might have done: First, mark to market, not to model. Investors no longer believe America's Enron-style accounting, debt rating agencies or monoline risk insurers. They don't trust U.S. banks to be honest about their financial positions. They worry about the fraud charges brought by attorneys general in eleven states against predatory lenders such as Countrywide and Wachovia that Citibank, JPMorgan Chase and Bank of America were so eager to buy.
So is it too late for Congress to change its mind and repeal the giveaway? If the $700 billion handout didn't stabilize the unsalvageable for small investors, pension funds and even the financial sector itself, what did it do?
What the Fed has been doing while the media have not been looking
Let's put the giveaway in perspective. While Senators and Congressmen subject to voters' choice were debating $700 billion for the major Wall Street contributors to both parties (admittedly only for starters, Mr. Paulson explained), the Federal Reserve already had given even more, without any public discussion and without the major media noticing.
Since Bear Stearns failed in March, the Federal Reserve has used the small print of its charter to go outside its normal customers (which are supposed to be commercial banks), to give investment banks, brokerage houses and now large corporations almost indiscriminately some $875 billion in "cash for trash" swaps. (The statistics are released each week in the Fed's H41 report.)
Like Aladdin offering new lamps for old, the Fed has exchanged Treasury securities for junk mortgages and other securities that brokerage houses and investment banks did not have time to pawn off onto OPEC, Asian sovereign wealth funds or other investors.
The press lauds Mr. Bernanke as "a student of the Great Depression." If he were, he should know that what led to the 1929 collapse were harsh U.S. Government creditor policies toward its World War I Allied governments. This created a situation where the Federal Reserve had to provide easy credit to hold interest rates artificially low so as to encourage U.S. investors to lend to Britain and Germany, which would use these dollar inflows to pay their Inter-Ally arms and reparations debts.
Mr. Bernanke's predecessor, Alan Greenspan, promoted easy credit simply for ideological reasons, to enrich Wall Street by enabling it to sell more debt.
A student of the Great Depression would understand the conflicts of interest between retail commercial banking and wholesale investment banking and money management that led Congress to pass the Glass-Steagall Act in 1933 - conflicts unleashed once again when Pres. Clinton backed then-Fed Chairman Alan Greenspan and Republican leader (and McCain hero) Senator Phil Gramm in leading the repeal of this act, opening up the floodgates to today's financial double-dealing that has cost the American economy so much.
If Mr. Bernanke does know this history, his behavior is simply that of an opportunistic student of the art of political self-advancement, toadying to Wall Street in campaigning for one last great rip-off before the Bush Administration goes out of business. The Fed has given Wall Street newly minted Treasury bonds, added to the national debt out of thin air. It has done this without feeling any need to rationalize it by drawing absurd public-relations pictures about how the government may "make a profit for taxpayers."
The Fed Chairman is not elected democratically. He traditionally is designated by the Wall Street financial sector that the Fed is supposed to regulate, acting as its lobbyist for creditor interests - the top 10 percent of the population - against that of the indebted "bottom 90 percent." This "independence of the central bank" is trumpeted as a hallmark of democracy. But it is undemocratic, precisely by being isolated from public control.
The Age of Oligarchy
Treasury Secretary Paulson has no such luxury. The Treasury is supposed to represent the national interest, not that of bankers - even though its head these days is drawn from Wall Street and acts as its lobbyist. Mr. Paulson presented his almost totalitarian giveaway gruffly to Congress on a take-it-or-leave it basis, announcing that if Congress did not save Wall Street from taking losses on its mountain of bad loans, the banks were willing to crash the economy out of spite. "Please don't make us wreck the economy," he said in effect. As Margaret Thatcher used to say while selling off the British government's crown jewels in the 1980s, TINA: There is no alternative.
In making this bold threat Mr. Paulson behaved as arrogantly as Lehman's CEO Richard Fuld did when he tried to bluff Korea and other prospective investors into paying the full, fictitiously high book value for his company. (His bluff failed and Lehman went bankrupt, wiping out its shareholders, including the employees and managers who held 30 percent of its stock.) There turned out to be an alternative after all. Responding to the loudest public condemnation in memory, Congress called Mr. Paulson's bluff.
What made his $700 billion Troubled Asset Relief Program (TARP) so much more visible to the media than the Fed's actions is that Congress is involved, and this is an election year. The level of deception and false argument is therefore enormous - along with a few tradeoffs and tax cuts to distract attention. Erstwhile Republican opponent Sen. Jeff Sessions of Alabama came right out and said that "This bill has been packaged with a lot of very popular things to give it even more momentum," so that (as The New York Times explained), "instead of siding with a $700 billion bailout, lawmakers could now say they voted for increased protection for deposits at the neighborhood bank, income tax relief for middle-class taxpayers and aid for schools in rural areas where the federal government owns much of the land."
Left behind while Wall Street's believers in the rapture of free markets were swept up to heaven by "socialism for the rich" have been mortgage debtors, student-loan debtors, the Pension Benefit Guarantee Corporation (PBGC, some $25 billion short), the Federal Deposit Insurance Corporation (FDIC, about $40 billion short), as well as Social Security which, we are warned, may run up a trillion dollar deficit thirty or forty years down the line. Only the wealthiest have been beneficiaries, not voters, homeowners and other debtors.
Still, Congress was panicked into acting on Friday, October 3, because a week earlier, September 26, stocks fell 777 points after Congressmen responded to an unprecedented volume of voter protest against the bailout. "This sucker could go down," Pres. Bush warned as Wall Street's lobbyists blamed the market downturn to the failure of Congress to preserve the "monetary system," and specifically the banks and insurance companies that already had lost their net worth and were plunging deeper into Negative Equity territory.
Democratic leaders Barney Frank and House Speaker Nancy Pelosi said, in effect, "Look what you've done! You irresponsible politicians are grandstanding on principle, and wiping out peoples' stock market savings and threatening their pension funds. If you don't give Wall Street firms enough money to cover their losses so that everyone wins, they'll kill the economy until they get their way." Well, they didn't quite say this, but that was basically their message. It certainly was Wall Street's message: "Wall Street to Economy: Your money or your life."
So Congress gave in. Democrats ran like lemmings to "save the economy." Yet the stock market fell a few hundred points, and kept on plunging all week long, much worse and much faster than had occurred right after Congress had initially defeated the bill.
The "Reality Problem"
What did the "free market" theory underlying the giveaway leave out of account? For starters, "the monetary system" turns out to be a euphemism for the fortunes of financial gamblers using junk mathematics (the Merton-Scholes derivatives formula) based on junk economics (blessed with Nobel Prizes) to buy, speculate and even to insure junk mortgages, junk bonds and junk commercial paper and derivatives based on their relative prices. So what is left out first of all was full knowledge of the value of what is being bought and sold. Mark-to-market models leave the price up to the investment bankers. If trust existed and there really was honor among these thieves, a government bailout would not be necessary, because "the market" could clear.
"Free market" ideology assumes that each party will act in his or her self-interest. If this is so, why should foreign governments accumulate more dollar claims on the U.S. Treasury, which already owes their central banks $4 trillion? When there hardly were enough Treasury securities to go around even as the United States ran unprecedented federal budget deficits, U.S. officials urged these banks and sovereign wealth funds to buy packaged mortgages yielding a higher rate of return. And at least by buying these bonds, foreign governments would not be accused of funding America's war in Iraq that most of their voters opposed. But investors made a fatal mistake in believing U.S. representations of the value of their junk-mortgage packages. This trust has now been lost, all the more so since the bailout's permission to keep on "marking to market."
Congress thought that its $700 billion would distract attention at least until the November 4 election. But to no avail. Markets fell 157 points on Giveaway Friday, and kept on going down another 800 points on Monday, October 6 (to about 9500) before bouncing 500 points off the floor, only to fall even more through Friday. So the giveaway failed in its stated purpose to rescue stock market investors ("peoples' capitalism") or their pension funds. But that was not its real purpose. The time simply had come to clear out and take whatever one could.
Making banks and insurers in the zero-sum derivative game whole, so that winners can collect their bets while losers can sell their bad investments to the Treasury, is supposed to re-inflate the credit pyramid. The idea is to solve the debt problem with yet more debt to prop up housing prices once again to unaffordable levels! This is not a long-term solution, but it would give insiders enough time to arrange a do-over and get out of the game more quickly, to sell out their junk mortgages and junk bonds to the proverbial "greater fool" - in this case, the "greater fool of last resort," the U.S. Treasury, as long as it can be run by Mr. Paulson or, under Mr. Obama, perhaps the former Goldman-Sachs official Robert Rubin.
The banks are to "earn" their way out of their negative equity position by selling more of their product - credit - to increase the economy's debt levels and hence receive more interest payments. The problem is that most families are already "loaned up." They have no more discretionary income to pledge to carry more debt. Without writing down their debts, there will be no fresh lending, and hence no source of credit and purchasing power for new autos, appliances, goods and services in general. Debt deflation is being imposed on the "real" economy. Creditors and speculators alone are to be made whole.
[the operative sentence follows]
If no revenue was available for future Social Security, public health care and repair the nation's depleted infrastructure before this giveaway, think of how bare the cupboard must be now that the government has run up the recent trillions of dollars in new debt rather than writing off a penny of the bad mortgage debts being blamed for causing the debacle.
We can see where this is leading. The wealthiest 1 percent of the population will come into possession of even more returns to wealth than the 57 percent that they are now taking. In contrast to the Statue of Liberty's inscription "give me your poor . yearning to breathe free," the Fed - and now the Treasury, with Congressional blessing - is taking from the public purse and giving to America's wealthiest investors and insiders. This "Robin Hood in Reverse" program is being done without strings, without asking banks to stop paying dividends, exorbitant executive salaries and golden parachutes, and without taking over banks with negative net worth of the kind that many homeowners are experiencing.
Nobody is talking about a debt write-down or moratorium. The subprime mortgage problem could have been solved by writing down just $1 or $2 trillion of the face value and interest rates of predatory loans. Instead, the $10+ trillion in financial-sector damage in recent weeks reflects Wall Street's fraudulent packaging and sale of junk mortgages at unrealistically high prices, using junk mathematics to calculate junk derivatives and sell them to gullible investors who believe that the pretenses these mathematics, credit ratings and projected income have a basis in reality.
The amazing feature of today's crash is how many Wall Street firms actually believed that the game of musical financial chairs could go on before they had to stop dancing and indeed, escape from the room. I remember one day back in the 1970s when I warned Frank Zarb of Lazard Freres about the likelihood of Third World debt defaults, and suggested that the firm should do an ability-to-pay analysis. "We don't have to do any such thing," he replied. "We have the schedule of what they owe right here in this IMF report." It was a thick printout of the scheduled debt service for an African country that soon became insolvent. But Wall Street's mentalité (in the French broad structuralist sense of the word) was that of Herbert Hoover on the eve of the Great Depression: A debt is a debt, and that is that. The response is to blame the victim, as if the irresponsibility lies with debtors rather than creditors.
No reversal of the Bush tax cuts is offered to re-inflate the economy, no move toward more progressive taxation of Wall Street speculators who pay only a 15 percent "capital gains" tax rate instead of the much higher income-tax and FICA withholding rates that wage-earners pay. (Wall Street has its own golden parachute program, so why should it pay for Social Security for the rest of society?) There is to be no reduction in the special tax benefits for real estate, whose tax favoritism led to the crisis by "freeing" more income from the tax collector to be pledged to mortgage bankers as interest.
The Bubble Economy is to be re-inflated by Fannie Mae, Freddie Mac and the FHA lending to help buyers bid up housing and commercial office prices once again to a rate that promises to impose debt peonage on homeowners.
The budget deficit will soar, without any prosecution of tax evasion scams by UBS or KPMG. Instead of a fiscal or regulatory comet driving these dinosaurs to extinction, the climate has turned more conducive to their proliferation. Our Age of Deception is to be locked in even more tightly. The Congressional bailout's suspension of mark-to-market rules to rely on Wall Street's "self-regulation" should win a prize for Oxymoron of 2008 as investors have no clue as to what financial assets are worth. No wonder lending has dried up, especially to banks themselves.
Just as financial victims fail to vote and support their self-interest, predators also turn out to pursue self-defeating "free market" strategies. The financial sector's short-termism is the greatest enemy to its survival. It has translated its wealth into a fatal political control of its legal climate, blocking Congressional efforts to rewrite the oppressive bankruptcy laws that credit-card banks lobbied so hard to pass. These hard bankruptcy terms prevent the courts from renegotiating homeowner debts to keep property occupied, accelerating the real estate price collapse. The result is today's negative equity, posing the question of just who is to bear the cost of bring debts back in line with the economy's ability to pay. Will it be the financial institutions that sponsored asset-price inflation and lobbied for deregulation of lenders? Or, will it be the debtors who thought they were riding the wave to get an inflationary free lunch?
Will voters see the asymmetry in Congress's failure to offer debt relief for homeowners as real estate prices plunge below the mortgages that are owed? Will its members be blamed for not rewriting the nation's bankruptcy laws to free families from debt peonage - and free housing markets from the price declines that result from today's proliferation of foreclosure sales? For that matter, will there be no relief for corporations having to cut back investment in order to service their junk bonds and other debts with which Wall Street's corporate raiders and "shareholder activists" have loaded then down?
Evidently not. Instead of requiring creditors to absorb losses on the excess of debts over what can be paid, the debts are being kept in place, not scaled back to what the economy can pay. The government is to make creditors and computerized derivatives speculators whole - and will act as collecting agent for the overhead of bad debts the economy has run up.
Today we can see the debt-fueled bubble of asset-price inflation that Alan Greenspan trumpeted as real wealth creation for what it really is - credit creation to bid up real estate, stock market and packaged-debt prices. Tangible capital formation has been left out of account, as if postindustrial economies no longer need it.